​Stakeholders in the Madoff Scandal and Their Need to Act Promptly and Proactively -Victims of a Ponzi Scheme Operated as a Charitable Gift Annuity Program by a Purported Charity – Installment 13

July 28, 2009Articles White Collar Defense & Compliance Blog

This is the thirteenth in a series of installments on this blog that is discussing issues that face the manifold stakeholders who have been materially affected by the long and worldwide Ponzi scheme scandal of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. This installment is a little different in that it does not relate directly to the Madoff morass but rather addresses a recent court decision on a Ponzi/Madoff scheme operated as a charitable gift annuity (“CGA”) program by a purported charity. The victims and stakeholders in this case were not bona fide charities that were duped but rather well-meaning donors who were misled into purchasing bogus CGAs. It is being included to underscore the endless varieties of investment vehicles that are in reality Ponzi/Madoff schemes.

A CGA is a contract under which a charity, in return for a transfer of cash, marketable securities or other assets by a donor, contracts to pay a fixed amount of money to one or two individuals, usually 60 years of age or older, for their lifetime(s). A person who receives payments is called an “annuitant”. The payments are fixed and unchanged for the term of the contract. The CGA payments are not “income”, because a portion of the payments are considered to be a partial tax-free return of the donor's gift, which are spread over the life expectancy of the annuitant(s).

The contributed property (the gift), given irrevocably, becomes a part of the charity's assets, and the payments are a general obligation of the charity. The CGA is backed by the charity's entire assets, not just by the property contributed. In these uncertain and risky economic times, a number of charities, including some that have invested with Madoff, have declared bankruptcy, which would cause severe economic loss to annuitants.

A CGA should be deemed by the donor to be primarily a gift to the charity, not an investment. The total return on a CGA is significantly less than that which could be earned through an annuity issued by a commercial insurance company. The gift annuity rates recommended by the American Council on Gift Annuities(“ACGA”), which are widely used by bona fide charities, have been computed to produce an average gift to the organization at the expiration of the annuity agreement of approximately 50% of the amount originally donated under the contract.

On June 24, 2009, the United States Court of Appeals for the Ninth Circuit decided the case of Warfield v. Alaniz, wherein the Court held that “CGAs” sold in this case (“Sham CGAs”) were investment contracts illegally sold under federal securities laws. Outside contractors such as financial planners and insurance agents had sold Sham CGAs aggregating $55 million on a commission basis for an organization that was a putative charity but in reality was using funds raised from the Sham CGAs solely to pay contractual returns to earlier annuitants and make payments to the promoters and contractors. Selling materials used by the sellers trumpeted high rates of returns, tax benefits, and superiority to commercial annuities, not a charitable intent for the Sham CGAs.

This type of Ponzi/Madoff scheme unfortunately seeks to prey on senior citizens who have a charitable motivation while seeking to maintain a secure return for their lifetimes. Those who would purchase CGAs should visit the Web site of the ACGA at the link above for explanations on CGAs and how to be aware of risk and dangers in purchasing CGAs.

In addition, points raised in earlier installments of this blog series should be followed by those interested in purchasing a CGA, including the following:

1. Go to websites for Guidestar or Charity Navigatorto obtain the most recent Forms 990 filed by the charity with the Internal Revenue Service and read about the charity’s mission, analyze its financial statements, see how much it pays for administrative and fundraising expenses and learn about its governance structure.

2. Contact the charitable registration agency or attorney general of the state in which you live to ascertain whether the charity that is selling the CGA is in good standing in the state.

3. If your state is one that requires registration and annual filings for CGA programs, contact the state office that oversees this process.

4. Buy a CGA directly from the charity that you wish to benefit through an officer, employee, trustee or director of the charity (each a “Charity Representative”). Never purchase a CGA through a third party, whether or not on commission.

5. To the extent possible, meet in person with the Charity Representative - find out how long the CGA program of the charity has been in existence and the number of annuitants that exist.

6. Ask the Charity Representative for the current disclosure statement for the CGA program under the Federal Philanthropy Protection Act of 1995. If the Charity Representative does not have such a statement or does not know what you are talking about, you may be well advised to consider another charity.

7. Take into account your total assets, income and obligations to carefully limit the amount of money you commit to a CGA, as you should for all charitable contributions and investments.

8. Seek advice from a lawyer, accountant, financial planner or other adviser that you trust to advise you on the purchase of the CGA.

9. If the CGA program returns sound too good to be true, they should be suspect.

10. If after doing all of the above, you do not understand how a legitimate CGA works or you have pause on making what should primarily be a charitable donation, your purchase of a CGA may be inadvisable.

[To be continued in Installment 14]