Strategic Source Online

September 2004

Alert: Private Foundation Compensation Remains a Hot Issue in Washington

Compensation to officers and directors of private foundations continues to be one of the hot issues before regulators and legislators. On June 11, 2004, a Texas court held that the compensation and expense reimbursement paid to its president and another key officer were excessive. The suit was brought by the Texas Attorney General against Carl Yeckel and Thomas Vett, former officers of the Dallas-based Carl B. and Florence E. King Foundation. The jury held that Yeckel and Vett should repay over $7.5 million to the Foundation, and an additional $14 million in punitive damages.

This isn’t the only case on this issue. The Boston Globe reported that the Massachusetts Attorney General was investigating the Cabot Trust, a private foundation. The Globe had run a story earlier in the year that the trustee, Paul C. Cabot Jr., was taking more than $1 million in annual pay from his family foundation, whose assets had dwindled to less than $5 million by last year.

The IRS, in part in response to these stories and others at public charities, announced on August 10 that it would be conducting examinations of up to 200 organizations, and will be questioning nearly 1,800 more, on the issue of compensation and benefits. The commissioner of the tax exempt and government entities division of the IRS stated that the IRS would add 70 auditors to its current staff of about 230 agents.

Internal Revenue Service (IRS): Charitable Giving Problems

Charity Governance Blog:  What, Me Worry?

Philanthropy Update: Charitable Giving in the U.S. Reached a New High in 2003

In its annual report, Giving USA 2004 reported that giving grew to $241 billion, which represents 2.2% of gross domestic product. This is just under its highest level of 2.3% in 2000. Most of the contributions came from living individuals (about 75%), and from deceased individuals through bequests (about 9%). Together, this represents 85% of all donations. Foundations contributed $26.3 billion, representing nearly 11% of the total. Corporations gave about 5.6% of the total.

Foundation giving in 2003 was down from 2002. This is most likely due to the decline in foundation assets in experienced in 2002. Most foundations base their grants on the prior year’s average asset values. The Association of Small Foundations reported in its 2003 Foundation Operations and Management Survey that its members lost an average of nearly 5% of their asset value in 2002.

Because the investment experience in 2003 was better than in the previous couple of years, it is expected that grants made in 2004 will be ahead of 2003.

American Association of Fundraising Council (AAFRC): Giving USA 2004

Planning Reminder: Directors’ and Officers’ Liability Insurance (“D&O”)

The increased focus by regulatory agencies (IRS and the Attorneys General of several states) as well as by the courts (as in the King case cited above) is a good reminder that all officers and directors of foundations, whether public or private, should be protected by Directors’ and Officers’ Liability Insurance (“D&O”), as well as standard liability insurance for typical business risks (property, casualty, workers compensation, fidelity, general liability). Most states permit indemnification of the officers and directors, which will protect, to some extent, the liability exposure of these individuals. However, state law may limit the extent to which the foundation assets may cover the legal costs, as well as damage claims. For these reasons, it is important to consider appropriate risk management.

D&O coverage is relatively inexpensive, but the variety of risks and limits of coverage can vary extensively. It is highly advisable that the board confer with a professional insurance broker or consultant who is experienced in working with nonprofit organizations. Coverage cannot protect against tax violations (including taxes and penalties), but can include such things as employment discrimination, embezzlement, and breach of fiduciary duty. Since all directors and officers have a duty of care to their organization, a breach by one member may subject all members to legal and economic risk. So, a word to the wise – consult with a professional, compare costs and benefits on the best carriers, require due diligence on the final selection, and review regularly.

For many years, the IRS argued that at least some portion of the premium paid by the foundation was compensation for self-dealing purpose and thus subject to the Intermediate Sanction rules under Internal Revenue Code section 4958. This is no longer a problem, and it is clear that premiums paid by the foundation are a permitted as a “working condition fringe benefit” and deductible as a business expense.

Risk Management Resource Center (RMRC): D&O FAQ

Nonprofit Risk Management Center (NRMC): nonprofitrisk.org

New Publication: The Influence of Affluence, Aspen Interest, Summer 2004

Lee Hausner, Ph.D.:  The Influence of Affluence

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