Thursday, March 19, 2009
IRS Commissioner Indicates Private Foundation Excise Taxes Under Consideration for Nonprofit Boards That Approved Madoff Investments
Last December, we opined that boards of private foundations should probably be getting advice regarding the private foundation excise taxes in the wake of the Bernie Madoff ponzi scheme rip-off. We noted the "dirty little secret" amongst private foundation boards -- that for the most part private foundation boards don't know the meaning of due diligence. Two days ago, Douglas Schulman, Commissioner of Internal Revenue, told the Senate Finance Committee that the Service is looking into the applicability of at least one of those excise taxes. Commissioner Schulman's prepared statement before the hearing is available here. During the question and answer session, though, according to the Chronicle of Philanthropy, Commissioner Schulman opined on the applicability of IRC 4944:
The Internal Revenue Service has not decided if it will take steps to tax board members of private foundations who placed all or some of their organizations’ assets with Bernard L. Madoff, the investor who ran a $65-billion pyramid scheme, according to Douglas Shulman, the Commissioner of Internal Revenue. “But I will tell you it is a tool that is available to us that we certainly will consider,” Mr. Shulman today told a Senate Finance Committee hearing looking into the Madoff scandal.
Another witness, William Josephson, former head of the New York State Charities Bureau, told the finance committee that Congress needs to pass tough new laws regarding the fiduciary duties not only of private foundation boards but public charities as well. His very comprehensive and useful written statement regarding nonprofits and the Madoff fiasco is available here. In the meantime, here is what Mr. Josephson had to say about the standards for imposing the tax on jeopardizing investments and enforcing fiduciary duties of board members:
A few more words need to be said about jeopardy investments. First, no one knows what Code section 4944 truly means, and the all-too succinct regulations thereunder, which have not been revised since they were promulgated in 1972, are not helpful. Second, contrary to the Panel’s analysis infra, and despite vast public education efforts, apparently the prudent investor state laws rules are ineffective to insure diversification, due diligence and reduction of risk by charities. How could charities have made such material Madoff investments, up to 100 percent of their portfolios in some cases, over long periods of time, without doing any meaningful oversight? Third, from my own experience the state laws are too difficult to enforce. Calculation of investment losses for state law damages purposes is not simple nor easy, even if one could prove, by a preponderance of the evidence, imprudence. Such proof is particularly difficult because of state law business judgment rules and other defenses based on the state law exculpating provisions of the Uniform Management of Institutional Funds Act, now, alas, to be further extended by the misleadingly named Uniform Prudent Management of Institutional Funds Act (emphasis added). The excise tax percentages in section 4944, recently doubled at this Committee’s initiative by the Pension Protection Act of 2006, are objective and have teeth. But like the Code section 4958 maximum discussed above, the maximum foundation manager limitations of $10,000 and $20,000, in light of the Madoff scandal, now seem far, far too low. If the substantive standard of section 4944 were rewritten, as it should be, to provide a comprehensive prudent investor standard for all exempt organizations, and liability were extended to all disqualified persons, not just to the charity’s managers, future Madoffs scandals should be deterred.
I disagree that "no one knows what Code section 4944 truly means;" it may be hard to articulate in the overly specific terms that lawyers too often desire (as a substitute for careful analysis and intellectual moxy in my opinion), but we know bad management when we see it. IRC 4944 simply means "don't make investments with publicly subsidized money without doing basic homework, period." You can lose money all you want if at least you can say you checked out the investment first. Simple! It is the job of lawyers and judges to determine meaning from generally expressed standards, such as are obviously contained in IRC 4944. We should not always call for the Service to do our jobs by writing regulations that answer every conceivable question. So here, I think, is another call for more verbiage either in the code and regs, to which practitioners will then complain that there is too much detail and complexity in the code. Mr. Josephson complains, for example, that the 4944 regs are too succinct but in the same breath complains that state laws (presumably expressed in greater detail) are too difficult to enforce. IRC 4944, in my opinion articulates a useful standard and it is up to the judiciary, at the behest of the Service and tax professionals hired to figure things out, to provide precedential, case by case guidance that will eventually obviate the need for so much verbiage in the regulations. This is a pet peeve of mine, that the judiciary has abdicated its role to fill in the blanks in tax statutes and regulations that are standard based, thus leading to the enactment of a whole bunch of detailed rules that, ironically, facilitate the very evil we try to avoid.