Nonprofit Law Prof Blog

Government $ + Nonprofit Lax Internal Controls = Theft Waiting to Happen

This hypothesis is based only on anecdotes, but it appears that there are an increasing number of reported high-dollar thefts from charities that involve a mix of government funding - and so potentially lots of money - and lax internal controls that unfortunately are all too common at nonprofits. In this space we have reported on perhaps the largest such instance, which is the Feeding Our Future scandal in Minnesota that allegedly added up to at least $250 million. But there have been a number of other, alleged multi-million dollar scandals that involve similar fact patterns, including:

• The FBI is investigating an Orange County, California nonprofit that the County is suing based on claims that it misused more than $13 million in COVID-19 relief funds. The daughter of a County Supervisor works for the nonprofit, Viet America Society, and has also been named in the lawsuit. Additional coverage: L.A. Times (subscription required); N.Y. Times (subscription required); Orange County Register.

• The U.S. Attorney's Office in the Eastern District of Missouri announced late last month the indictment of a St. Louis nonprofit executive who allegedly fraudulently obtained "more than $2 million in funds intended to feed low-income Missouri children, both before and during the coronavirus pandemic." Coverage: St. Louis Post-Dispatch (subscription required).

• The CFO of the Detroit Riverfront Conservancy pled guilty late last month to stealing nearly $15 million from the nonprofit. As an earlier Detroit Free Press article detailed, the theft raised serious questions about the nonprofit's internal controls, including not only with respect to its privately provided funds but also the at least $15 million in direct government grants received over the past decade and the $3 million per year provided by the city of Detroit for operating costs.

• In August the U.S. Attorney for the Southern District of New York announced the conviction of the "shadow executive director" of a nonprofit for stealing millions of dollars from the federal Head Start Program. Apparently the defendant lied to the U.S. Department of Health and Human Services when forms he submitted claimed the nonprofit had an independent board of directors and controls in place to guard against fraud, waste, and abuse.

And I could keep going, especially if I included smaller dollar amount cases that state and local authorities are investigating or prosecuting. As Professor Nicolas Duquette (USC) commented for the Detroit Free Press article about the Detroit Riverfront Conservancy, reliance on nonprofits to handle public business can present a “fundamental problem” for accountability. These examples raise the concern that a perhaps not sufficiently appreciated downside of governments farming out the provision of public services to nonprofit organizations is that this farming out often comes with substantial funds but not sufficient internal control requirements.

Lloyd Mayer

Donors: You Can't Live With Them, You Can't Live Without Them

Two recent lawsuits involving multi-million donations and donor demands for their return highlight the difficulty charities face when large donors become upset with how their donations allegedly have, or have not, been spent.

As reported by the Boston Globe, one lawsuit has been brought by an alum of the College of Holy Cross, who pledged $25 million for a performing arts center (named after the donor and pictured here) but now wants $18 million back plus another $3 million he donated for new athletic facilities. He accuses the College of refusing to account for the use of the donated funds. In response, the College has asserted that the donor reneged on the remaining $7 million he pledged for the center in a 2014 written agreement. A federal magistrate judge is now considering whether to compel mediation and arbitration, which the college asserts are required under the agreement.  The case is Prior, Jr. v. Trustees of the College of the Holy Cross.  (Full disclosure: My former colleague, Vincent Rougeau, is the current President of Holly Cross College..) Additional coverage: Inside Higher Ed.

As reported by the Gothamist and previously blogged about in this space (with a link to the complaint), the other lawsuit has been brought by the Stella and Charles Guttman Foundation against City University of New York (CUNY) relating to a $25 million donation made more than 10 years ago. The Foundation alleges that CUNY failed to fulfill a commitment to build a new campus for CUNY's New Community College in Midtown, now named the Stella and Charles Guttman Community College. The Foundation is asking for $15 million that was committed to an endowment to benefit the new campus, plus interest, for a total of $21 million.

Lloyd Mayer

 

 

More Johnson Amendment Excitement: National Religious Broadcasters v. Werfel

It’s exciting times for those of us (like me!) who follow Johnson Amendment developments. The SAFE SPACE litigation is temporarily dismissed in Tax Court, but I have been assured that it’s only so the parties can develop the administrative record with the IRS, and it will be back in court as soon as that happens. Meanwhile, as was pointed out by my co-blogger Darryll Jones last week, the National Religious Broadcasters and others (“NRB”) filed a complaint in Eastern District of Texas, arguing that even though no adverse action had been taken against any of them, the existence of the Johnson Amendment unconstitutionally chills their speech and religious expression. The lawsuit will almost certainly be dismissed, but the complaint is interesting, nonetheless.

First, like SAFE SPACE, NRB tries to make a First Amendment argument by ignoring the “alternate means” doctrine introduced by the Supreme Court in 1983 in Taxation With Representation v. Regan and applied to the Johnson Amendment by the DC Circuit in Branch Ministries v. Rossotti. The Complaint doesn’t even mention these leading cases. It’s hard for me to imagine that this approach will get very far, but the Easter District of Texas may see things differently from me. Stranger things have happened.

But NRB goes farther than that by making two distinct arguments about unequal treatment by the IRS, claiming that the IRS is singling out conservative churches for discriminatory application of the Johnson Amendment. If that were true, it would radically transform the legal arguments because, as NRB points out, it would turn the speech claim into a “viewpoint discrimination” case, the religious liberty claim would involve discrimination between particular religious doctrines, and there might be a viable equal protection claim. If the IRS were discriminating against conservative churches, I think we would all agree that they should be stopped.

So, it’s worth looking at NRB’s arguments about discrimination. First, they argue that the existence of a Revenue Ruling from 1972 that holds that the editorial board of student newspapers are allowed to endorse candidates means that “it is a denial of equal protection to interpret § 501(c)(3) to allow college newspapers to endorse candidates while prohibiting nonprofits like Plaintiffs from doing the same.” The 1972 Ruling is admirably concise, but it manages to squeeze into its two short pages the basis of its reasoning, which establishes why the opinions of college newspaper student editors are materially different from the kinds of organizational communications that NRB and its co-plaintiffs seek to make. It says that the editorial opinions “are acts and expressions of opinion by students … of the educational institution …. [not] the acts of the university[.]”.

Second, NRB argues that the IRS permits campaign activity in churches if that activity favors Democratic candidates while it prohibits campaign activity in churches if it favors conservative candidates. Again, the complaint lists several examples of campaign activity in churches that favors Democratic candidates, which “goes unhindered by the IRS.” The complaint also lists examples of 501(c)(3) news organizations (not student newspapers) that endorse candidates, while the IRS “allows this to proceed unhindered.” But when the complaint turns its attention to IRS action against conservative churches, it has much less to say. It states generically that “Plaintiffs are aware of instances of recent investigations and adverse actions against conservative religious organizations,” (¶ 94), but apparently those instances are so secret that they cannot be named in the complaint. It mentions an adverse action against an organization called “Christians Engaged” (¶ 93), but that action was reversed by the IRS. Most intriguingly, it describes IRS action against the Cornerstone Chapel of Leesburg Virginia, which resulted in “a tax penalty for violating the Johnson Amendment” that the Cornerstone Chapel paid. (¶ 92). That’s it. I couldn’t find anything on the internet about this tax penalty paid by Cornerstone Chapel, but I’m really not that good at googling, so maybe that’s on me. It’s a shame that Cornerstone Chapel didn’t think to call Michael Farris, the lead attorney for the NRB complaint, because Cornerstone Chapel would be an ideal plaintiff in this action. I think they’re practically in his backyard. If the IRS assessed an unconstitutionally discriminatory penalty against them, I would like to see their rights vindicated in court.  

Maybe I’m devoting too much space to a single complaint that appears destined to be dismissed in short order. But in a way it does a much better job of identifying the underlying problem with the Johnson Amendment than SAFE SPACE does: fear of discriminatory application. Anyone (not just Republicans) looking for seemingly egregious examples of political adversaries violating the Johnson Amendment can find them, and they will generally also find that such violations “go unhindered by the IRS.” In that atmosphere, mere rumors of enforcement against one’s political friends may be enough to warrant a suspicion of discrimination. Discriminatory application of the Johnson Amendment would indeed be a violation of the Constitution, of numerous laws, and of the core values of our nation. The fact that there appears to be no evidence beyond rumors should be enough to dismiss a lawsuit, but that doesn’t necessarily solve the problem.

There was a time when the IRS had a “political action compliance initiative,” which sought to enforce the Johnson Amendment in as transparent a way as possible while still respecting taxpayer privacy. Some mechanism like that could be used to enable the IRS to increase its enforcement of the Johnson Amendment in a way that counteracts fears of discriminatory application rather than letting them fester. It may be that we are past the point when government can use transparency mechanisms to build trust in the rule of law, and that these mechanisms are destined to fail. But I hope not.

--Benjamin Leff

Supreme Court Rules NRA's 1st Amendment Lawsuit Against Former NY Official Can Proceed

In National Rifle Association v. Vullo, the Supreme Court of the United States earlier this month unanimously held that the NRA had alleged sufficient facts to state a First Amendment claim against the former superintendent of the New York Department of Financial Services, reinstating the NRA's lawsuit against that official. As summarized by the Court, the NRA's complaint alleged that the state official had pressured entities regulated by her agency to "help her stifle the NRA’s pro-gun advocacy by threatening enforcement actions against those entities that refused to disassociate from the NRA and other gun-promotion advocacy groups," One interesting aspect of the litigation was that the ACLU represented the NRA before the Supreme Court. Coverage: SCOTUSblog.

Lloyd Mayer

11th Circuit Rules That IRS Conservation Easement Listing Notice Is Invalid

The U.S. Court of Appeals for the Eleventh Circuit affirmed a federal district court decision that IRS Notice 2017-10 is invalid because the IRS failed to comply with the Administrative Procedure Act's public notice and comment requirements. The Notice identified certain syndicated conservation easement transactions as tax avoidance "listed transactions" and so subject to disclosure and other requirements. The case is Green Rock LLC v. IRS (No. 23-11041, June 4, 2024). The 11th Circuit joins the 6th Circuit (Mann Construction, Inc. v. United States, 27 F.4th 1138 (2022)) and the Tax Court (Green Valley Investors, LLC v. Comm'r, 159 T.C. No. 5 (2022)) in reaching this conclusion.

Reacting to the earlier decisions, in Announcement 2022-38 Treasury and the IRS stated they had published proposed regulations to address the asserted APA deficiencies in the previous Notice. While the announcement said Treasury and the IRS intended to finalize the proposed regulations in 2023, to date they have not yet done so.

Lloyd Mayer 

 

Reports from AMT/EITC Continued - All.The.Politics.

Or should I say, electioneering....

It's a unique and polarizing election year and we have a very active Supreme Court on a variety of First Amendment topics,  so it's no suprise that we had two important presentations on the Johnson Amendment's prohibition on the politicial campaign intervention. 

Ben Leff presented a project that he is working on with Sam Brunson are working on some public interest litigation in this space.   As many of you may know, and as blogged about most recently here just a couple of days ago,  SAFE SPACE v. Commissioner s a test case in the works challenging the Johnson Amendment, a project that Ilya Shapiro had a hand in.   SAFE SPACE takes an all-or-nothing approach to the problems, clearly stating that the organization intends to do both electioneering and lobbying directly.

Ben and Sam intend to do something similar, in that they are filing with the intent of developing a test case.  Ben discussed their project on the blog previously - see here.  With the latest report that SAFE SPACE has been dismissed and returned to the administrative stage to develop additional facts,  Ben and Sam's project may be able to catch up procedurally.   Their project is very different from SAFE SPACE, however, as it will continued to utilized an affiliate organizations in their structure:

This Article describes the actions that Sam and I plan to take to create our own nonprofit organizations to endorse candidates in November 2024 using our
“alternate means” strategy that is explicitly distinguished from the marginal cost paradigm advanced by SAFE SPACE.  While it is likely that noting will happen to our application prior to the 2024 election, we believe that engaging in Constitutional self-help using an alternate means strategy is urgent given the existence of SAFE SPACE and its case pending in Tax Court.

The paper walked its way throught the Constitutional analysis of Branch Ministries and Taxation Without Representation, and why their alternative structure works to address the First Amendment speech issues while also protecing the charitable sector from being overrun.  Look for more updates on all of this - I'm sure Nonprofit Law Prof Blog will have the scoop, since both Ben and Sam are contributors here.

Phil Hackney, yet another of our bloggers and one who has been very active on this issue, presented his paper "The Political in Taxation."   Phil says that the motiviation for the article was "the House Ways and Means recent suggestion that spending on voter registration and get out the vote efforts ought to be prohibited."  It takes a wider view of how the tax code view political (again, in the electioneering sense) expenditures.   The article is a wonderful take on the artifical and overlapping distinctions among electionerring, lobbying, issue advocacy, and straight up personal consumptions that we deal with regularly in the Code.    As nonprofit types, we are used to these silos, but the are really artificial to the rest of the world.   Phil's project is really important as we try to think through an issue that threatens the legitimacy of our sector.

Speaking of Phil... he takes over blogging this week so be sure to ask him about it!

Thoughtfully, eww

 

 

 

Legislative Inquiry into Nonprofit Litigation Decisions

Sunday night, Senators Warren and Whitehouse sent a letter to the U.S. Chamber of Commerce, demanding the Chamber answer questions about its litigation challenging a CFPB rule capping late fees at $8.

The Chamber is a nonprofit membership organization claiming to "represent[] the unified interests of U.S. business before Congress, government agencies, and the courts," but the Senators' question whether the Chamber "is not adequately representing its membership." The Senators doubt that the lawsuit is, in fact, representative of "the broad range of Main Street businesses, or their customers," suggesting that, "[i]nstead, the 'Chamber is again doing the dirty work of its big bank members,' such as JPMorgan, Citi, and Bank of America." Thus, the Senators ask the Chamber: "Did the Chamber conduct a vote or otherwise receive input from its members before deciding to file this lawsuit? a. If so, how did it do so? b. What did the opinions received by the Chamber indicate about members' opposition or support for the rule?"

Of course, concepts of representation for a nonprofit organization--even a membership-based organization--are rarely straightforward, as members rarely weigh in directly on specific policy positions, and members come and go for reasons that often have little to do with a single piece of litigation. (Counterexamples do exist: thousands of AARP members quit the organization after its support for the Affordable Care Act, and thousands of ACLU members left the organization due to objections to representation of Nazis in a free speech case although in both instances the nonprofit stood by its principles/stubbornly defied accountability to its members). "Who do we represent?" is a tough question that nonprofit leaders should constantly be asking themselves; it's much less clear that Congress has (or should have) much to say on the question.

The Senators' letter makes two further criticisms of the Chamber's litigation. First, it argues that the claims are frivolous. Second, it calls the Chamber out for being caught forum-shopping: adding a local chamber of commerce with dubious standing to file in a court believed to be advantageous to the challenge. (The district court granted a motion to transfer the case to the District of Columbia, only to have the Fifth Circuit issue a mandamus preventing transfer for the time being). Forum-shopping in cases challenging federal agency decisions is not novel, but it has come under consistent and increasing criticism--from across the political spectrum--with special attention being paid to forum-shopping in Texas federal courts specifically.

My two cents: Publicly criticizing a nonprofit for its litigation choices (especially when it is caught engaging in rather transparent forum-shopping) is one thing, but demanding details of the nonprofit's internal decisionmaking related to that litigation is quite another.

-Joseph Mead

Ugh! Tax Court Invalidates Conservation Easement Regulation

Yesterday, the Tax Court released an opinion about the validity of a quite technical regulation about what constitutes a valid conservation easement. It held that the regulation is not valid, following 11^th Circuit precedent, reversing its prior position, and stating that it will follow the 11^th Circuit precedent in the future. Forbes has a good explanation of the case, to which I have nothing much to add.

The “Ugh!” in my headline is on purpose, primarily because this trend in administrative law (invalidating long-standing regulations because of deeply retrospective and somewhat strained application of the Administrative Procedure Act) has the potential to do a lot of harm to the possibility of regulating the nonprofit sector far beyond conservation easements, as pointed out, e.g., in a forthcoming article by Ellen P. Aprill. But the secondary reason for the “Ugh!” is that the IRS has been doing a quite remarkable job of shutting down dramatically abusive uses of conservation easements. It would be a serious bummer if this weird technical battle over a particular regulatory requirement prevents the Service from continuing to devote resources to protecting the integrity of the nonprofit sector against abuse.

--Benjamin Leff

Fourth Circuit Holds that 501(c)(3) Status is Not “Federal Financial Assistance” for the Purposes of Title IX

Back in January, I blogged about a lawsuit against Hillsdale College seeking to hold the college accountable under Title IX (the federal law that prohibits sex discrimination in higher education) for sexual violence against its students. Hillsdale argued that Title IX didn’t apply to it because it doesn’t receive any “federal financial assistance.” The plaintiffs argued that it does apply because the school is tax-exempt and receives tax-deductible contributions under sections 501(c)(3) and 170(c) of the Tax Code. In that post, I referenced a case decided in the District of Maryland that held that tax exemption does constitute “federal financial assistance” for the purposes of Title IX, supporting the plaintiffs;’ argument in the Hillsdale case.

Well, the Fourth Circuit Court of Appeals just decided the issue on interlocutory appeal from the District of Maryland case and reversed the District Court. It held that tax exemption is not “federal financial assistance” for the purposes of Title IX, and so schools are not subject to Title IX just because they are tax exempt and receive tax-deductible contributions. In doing so, the court acknowledged that tax exemption is a subsidy to its recipients, but that just because it is a kind of subsidy does not mean that it is “in all respects identical” to a cash subsidy. In the case of Title IX, it then determined that Congress did not intend to subject schools to the law based only on their tax status, and the government has been acting under that understanding for a long time.

--Benjamin Leff

More on SAFE SPACE v. Commissioner

Yesterday, I blogged about SAFE SPACE’s declaratory judgment suit, in which they are seeking recognition of tax-exempt status despite the fact that they plan to endorse candidates on their website. I mentioned that I had been planning (with Sam Brunson) to create a 501(c)(3) organization that would endorse a candidate on an affiliate 501(c)(4) organization’s website. And I said that the difference between our approach and theirs “may seem like a difference without a distinction” but that it is “probably quite significant.” So, why is it significant?

First, important to both approaches are two ideas: (1) the Constitution protects charities’ right to endorse candidates, while also (2) the government has a legitimate interest in preventing charities from using their government-provided subsidies to pay for such endorsements. As I mentioned yesterday, the tension between these two ideas – and the solution to vindicating them both – comes from the Supreme Court’s Taxation With Representation case and the DC Circuit’s Branch Ministries case, both of which affirmed both ideas. The solution described in those cases is the one Sam and I planned to adopt in our “test case” organization: have the 501(c)(3) charity use a 501(c)(4) affiliate to pay the costs of publicizing the endorsement. This structure has sometimes been called the “Alternate Channel Doctrine,” because the use of a 501(c)(4) affiliate was described in Taxation With Representation as an “alternate means” for the charity to communicate its views. If all the expenses are paid for by the 501(c)(4) affiliate, then the case is strongest that the charity is not using its subsidized funds to intervene in a campaign. It permits the government to fulfil its legitimate purpose of “nonsubvention.”

SAFE SPACE has chosen not to use this “alternate means” to communicate its endorsements, but instead to publicize them on the charity’s own website. It concedes that the website will “be developed and hosted for a low, flat fee” and that there will be no “additional expense for developing and hosting additional pages or materials on its website.” (emphasis added). It then claims that, “[t]he cost to SAFE SPACE of endorsing candidates and publishing its endorsements will be zero.” Well, which is it? A “low, flat fee” or “zero”? These two apparently inconsistent statements can be made consistent by adopting a specific theory of what it means for the cost of an endorsement to be zero. In my 2009 article, I called that theory a “marginal cost” paradigm, explaining that proponents of that paradigm argue that speech or action has no cost if it can be accomplished without making any additional expenditures beyond those already being made for other purposes. If the organization is already developing and hosting a website for its educational purposes, and no additional cost is required to post an endorsement, then the cost of endorsing candidates is zero.

As I mentioned yesterday, SAFE SPACE argued that it couldn’t use the affiliate-organization structure because that would impose “insurmountable” administrative burdens on the fledgling charity. SAFE SPACE therefore is taking the position that (1) the affiliate organization structure is unnecessary because a government subsidy has only been used when there is a marginal cost to the organization, and (2) forcing an organization to create an affiliate is such a substantial administrative obstacle that it constitutes an undue burden on the charity’s speech rights.

If SAFE SPACE could persuade the Tax Court to adopt its marginal cost theory of campaign expenditures, that could be very important for 501(c)(3) organizations going forward. Over a decade ago, at the request of Senator Charles Grassley, the Commission on Accountability and Policy for Religious Organizations (CAPRO) proposed legislative reform to permit 501(c)(3) organizations to engage in low-cost electoral speech, like the endorsement SAFE SPACE proposes. Republicans in Congress have repeatedly proposed the Free Speech Fairness Act, modeled on CAPRO’s recommendations, but it has never been adopted. But scholars like Ellen Aprill have pointed out that in an “age of cheap speech,” permitting all low or no-cost political speech under a marginal cost paradigm would open the floodgates to extensive use of charitable funds (and therefore government subsidy) in electoral speech. Under this theory, as long as the organization was promoting its charitable message, it could include its electoral message so long as that message had no marginal cost. In addition to the website that SAFE SPACE plans to operate, charities could use newsletters, email blasts, paid social media posts, television advertisements, and paid door-to-door educators to promote their views. Scholars like Sam Brunson, Roger Colinvaux, Edward Zelinsky, Nina Crimm, and Laurence Winer have all attempted to address the same problem. There’s no easy answer, but I think the use of an affiliated 501(c)(4) organization does a better job of balancing speech rights with our collective interest in nonsubvention, and that the administrative burden that imposes on a small charity like SAFE SPACE is therefore warranted.

I think that’s what’s at stake in this tiny organization’s declaratory judgment case.

-Benjamin Leff

Finally, a Johnson Amendment Case in Tax Court!

Well, my fellow bogger reported it on Friday, but I’ve got to say I’m pretty excited that this has finally happened: A 501(c)(3) organization has gotten into court to argue that the Johnson Amendment is unconstitutional. Why am I so excited?

Back in 2016, I wrote a blog post called “If Churches Really Want to Vindicate Their Right to Endorse a Candidate, It’s Easy to Get Their Case into Court,” in which I proposed forming a new 501(c)(3) organization and checking the “wrong” box on Form 1023 that asks whether the organization will “support or oppose candidates in political campaigns in any way?” That wrong box should get the IRS to deny the application, and when it does, or if it does nothing for 270 days, the organization can seek declaratory judgment in the tax court that it qualifies for tax-exempt status under section 501(c)(3). After years of writing that the IRS’s interpretation of the Johnson Amendment is unconstitutional (see here and here), I was planning with Sam Brunson (see here) to create our own organization to test the theory in this election cycle.

But, it turns out that more than 270 days ago, Ilya Shapiro (with Alex Reid’s help) beat us to it, filing a Form 1023 for an organization called SAFE SPACE that plans to endorse candidates on its website. The IRS never acted on their application, and so Presto, they’re in court! (I have been told over the years that some organizations have tried this tactic, but had their exemption applications approved, so the IRS’s inaction in this case is notable.) SAFE SPACE’s constitutional argument is obviously not very fleshed out in the Petition, but the key to it appears to be their claim that, “[t]he unconstitutionality of section 501(c)(3)’s political speech and lobbying restrictions is even more apparent with respect to SAFE SPACE because the low- to no-cost of SAFE SPACE’s political speech and lobbying activities means the government, simply by recognizing SAFE SPACE’s tax exemption, could never be viewed as subsidizing those activities.” This focus on the government subsidy embedded in the deduction for charitable contributions is directly related to the Supreme Court’s leading case on the constitutionality of lobbying restrictions for charities, Taxation with Representation of Washington v. Regan, and the DC Circuit’s leading case on the constitutionality of the Johnson Amendment, Branch Ministries v. Rossotti, both of which relied on the existence of a government subsidy as an essential component of their holdings.

Sam and I were planning a similar approach, but with a slightly more conservative approach to avoiding any cost in our charity’s endorsement. We were going to use an affiliated 501(c)(4) organization to assume all the costs of operating a website that was going to post the 501(c)(3) organization’s endorsement. SAFE SPACE claims that its endorsement costs are “zero” even though it admits that it will pay a flat fee for its website (which will have lots of other content). It then argues that the solution we planned to use, creating an affiliated 501(c)(4) organization, would impose significant administrative burdens,” and that “these administrative burdens are insurmountable.” This may seem like a difference without a distinction, but it is probably quite significant for reasons that are beyond the scope of this post. Whatever the next step in this case, we may be witnessing some interesting times for the Johnson Amendment in the runup to the 2024 presidential election.

-Benjamin Leff

Feeding Our Future Continuing Fallout: A Guilty Plea, More Indictments, and New Counterclaims

The U.S. Attorney's Office for the District of Minnesota announced last month that the executive director of House of Refuge Twin Cities pleaded guilty to one count of wire fraud in the $250 million fraud scheme centering on the nonprofit Feeding Our Future. The charge related to her redirection of millions of dollars in federal funds to pay personal expenses and family members. According to the press release, she is the seventeenth defendant to plead guilty to charges arising from this fraud scheme. Coverage: CBS News; Sahan Journal; Star Tribune.

And she is unlikely to be the last, as this week the same U.S. Attorney office announced federal criminal charges against 10 additional defendants arising from the same fraud (on top of approximately 60 already charged). Those defendants included six members from the same family who allegedly used a variety of legal entities to receive and launder the stolen federal funds, as well as four others who allegedly falsely claimed to have provided meals to children. Coverage: MPR News.

Not all the action is on the government's side, however. According to an MPR News article, the founder of Feeding Our Future and alleged leader of the fraud conspiracy is pushing back. She is asserting that Minnesota Department of Education officials who oversaw the hunger relief funds intentionally mislabeled document and used burner phones to improperly thwart a 2020 lawsuit brought by the nonprofit challenging the Department's treatment of Feeding Our Future. Her attorney stated that she plans to raise these allegations as part of her defense against federal wire fraud and bribery charges.

Lloyd Mayer

 

NCAA Update: NLRB Employee Ruling and NIL Rules & Disputes

The Associated Press reports a National Labor Relations Board (NLRB) Regional Director has ruled that Dartmouth basketball players are employees, which would allow them to create a labor union. The decision is particularly significant because the players, in common with other Ivy League athletes, do not receive athletic scholarships  As the story notes, this holding is consistent with the NLRB General Counsel's 2021 memo concluding that certain college athletes should be considered employees. The decision is subject to review by the NLRB. Additional coverage: Inside Higher Ed; N.Y. Times; Slate; Washington Post.

Separately, in the rapidly developing name, image,  and likeness (NIL) area the Division I Council of the NCAA approved new rules relating to disclosure and transparency. The press release highlights "four elements of student-athlete protections": voluntary registration for NIL service providers; required disclosure by student-athletes to their schools of more than nominal NIL agreements; development of a template contract and recommended contract terms; and development of an education plan for student-athletes and other stakeholders. The Council also introduced new proposals for consideration relating to school involvement and recruiting in NIL activities, including ones that would remove certain restrictions on school support for such activities.

At the same time, disputes between the NCAA and schools relating to NIL arrangements are heating up. Last month the NCAA announced an agreement relating to a violation of NCAA rules by a Florida State assistant football coach, including various recruiting-related restrictions. Coverage: ESPN; Washington Post. And earlier this month USA Today reported a federal judge refused to issue a temporary restraining order relating to the NCAA's NIL rules in an antitrust lawsuit brought by Tennessee and Virginia. A preliminary injunction hearing in that case is set for next week.  Additional coverage: Law360 (subscription required). 

Lloyd Mayer

 

 

 

Ministry Watch: "Bankruptcy Case Forces Churches to Repay Hundreds of Thousands of Dollars in Donations"

I previously blogged about a U.S. Bankruptcy Court decision that required a church to repay over $500,000 in donations. It turns out that a test case, as MinistryWatch reports that because of that result dozens of churches (including some that have settled) are required to repay donations they received. The donors were apparently shareholders in the now-bankrupt Health Diagnostic Laboratory of Richmond, Virginia.  And this is in addition to other, non-church charities from which the bankruptcy trustee is also seeking to recover donations. Critical to the court's holding was that the Bankruptcy Code section at issue does not allow the court to take into account potential hardship to a subsequent transferee, even if that subsequent transferee is unaware of the fraudulent nature of an earlier transfer.

Lloyd Mayer

Trifecta Follow-up to Title IX, NIL Collectives, and NRA Trial

This fine Friday, I have follow-up mini posts about all three of the things I blogged about this week: Title IX, NIL collectives, and the NRA trail. So, in reverse chronological order, here they are:

Yesterday, I wrote about the suit against Hillsdale college asserting that it was subject to Title IX regulation on account of its tax-exempt status. My colleague Darryll Jones alerted me to a press release from Senator Marco Rubio on Wednesday announcing proposed legislation to clarify that tax exemption is not “Federal financial assistance” for the purpose of Title IX. Obviously, if the legislation passes, that clarifies the law. But our legislative branch is not designed to easily pass legislation, and (it sure seems like) that the problem is worse these days, so I think it’s likely courts will probably have to make up their own mind what the original statute means.

On Wednesday, I wrote about NIL collectives, and got a very good series of questions from a commenter that I think are worth answering. A reader commented, “How do they determine the amount of the payments to avoid them being classified as excess benefit payments?  Do equal payments have to be paid to all players on the team?  How do you determine if one player's NIL is more valuable than another? I heard that Univ. of Texas is paying $50,000 to new football linemen; can they pay this to certain players and not to others?”

The answer to the first question is easy: “excess benefit” payments (if this is meant in its technical sense to refer to “excess benefit transaction” penalties in the Tax Code) occur between an organization and “disqualified persons” (people who have some level of control over the organization). Players are unlikely to be disqualified persons, so payments between NIL collectives and players will probably never be “excess benefit” payments. That’s why the question for NIL collectives is whether there too much private benefit, not whether there is any “inurement.” Honestly, if I were to try to identify the five most important things to understand about nonprofit law (for the students who take my introductory class, for example) this line between inurement and private benefit is definitely on the list, and so I can’t help point it out, even at the risk of fetishizing the phrase “excess benefit.”

But charities still have an obligation not to make excessively large payments to private persons who are not “disqualified persons,” notwithstanding the fact that “excess benefit” is technically the wrong word for such payments. As a state law matter, this obligation is found somewhere in the duty of care or the duty of obedience, the concept of “waste,” or in statutes that try to clarify this obligation. Some people (including the IRS) think that this duty is also reflected in the Federal-law concept of “excess private benefit.” Jurist Richard Posner famously proposed that idea (in dicta) in his opinion in the United Cancer Council case. This is also plausibly what the IRS means when it says that private benefit can be excessive either quantitatively or qualitatively. As I mentioned on Wednesday, Hail! Impact (the charitable NIL collective that has received IRS approval of tax-exempt status) solves the quantitative problem by only using 30% of its fund expenditures to pay NIL fees to athletes and uses the other 70% for truly charitable expenditures. But that 30/70 solution doesn’t solve the “qualitative” problem.

So, how should a charitable NIL collective make sure that it is not providing an excessive private benefit to athletes qualitatively through the wrong structure of its individual payments? The answer is: hard to know. The theory should be that it’s pretty safe if it pays them “fair market value” for the rights. That’s what American University (my employer, a charity) does when it decides how much to pay me. It tries to figure out what the market would bear, and then (if my economic theory serves me in this case) pays me the lowest it can get away with to keep me from jumping ship and to motivate me to do whatever it is that it wants me to do. So, as to the question of whether the NIL collective must (or can) pay the same amount to all players or must (or can) pay each player based on the value of their individual NIL, the default answer should be that it makes more sense to pay them based on an evaluation of their individual NIL value. But, of course, if the collective thinks that it can get away with paying all players the same amount, and if it thinks that’s good for the team or school, I can’t think of an argument for why that would violate the “private benefit” doctrine (or the directors’ state-law duty of care or obedience). But because the “qualitative” aspect of the private benefit doctrine is so under-developed as a legal matter, I’m not sure there is a clear answer to how it would apply in this case. Now that the IRS Chief Counsel’s office is focused on NIL collectives (as evidenced by the pretty quick and excellent Memorandum), I could imagine them using this opportunity to provide some guidance on their interpretation of the question. But, just like with Congress clarifying the scope of Title IX, I wouldn’t hold my breath. They’ve got a lot of other legitimate priorities, to say the least.

On Tuesday, I wrote about the expert testimony given by Jeffrey Tenenbaum in the NRA case. It was pointed out to me that there is some tension in what I wrote (that I wasn’t really aware of) about the purpose of Mr. Tenenbaum’s testimony: whether it was to establish “customary” practices among nonprofits or “best” practices. As I pointed out in the first paragraph, the court permitted his testimony about “what is regular and customary in the nonprofit sector.” But then in that same paragraph, I said he testified that “best practices” counsel against boards of more than 30 members because large boards make it “impossible [for individual board members] to fulfill their duties.” That’s a confusing quote because “best practices” is a quote of my source, NRA Watch, which said that “Tenenbaum said that best practices typically dictated an ideal non-profit board size of between 12 and 20 people.” But it did not quote him as using the term “best practices.” Instead it quoted him as saying that if a board has more than 30 people, it “becomes impossible [for individual board members] to fulfill your duties.” Anyway, in case it was confusing at all, I changed my own sentence in my final paragraph to clarify that I think it is valuable for juries to be educated about customary practices in the nonprofit sector, and that I’m glad Mr. Tenenbaum did that in this case. Although, obviously, it is still true that the jury will have to apply the legal standard, not whether NRA practices are “customary” or not.

Benjamin Leff

Hillsdale College, Title IX, and the Charitable Contribution “Subsidy”

A recent Wall Street Journal opinion piece notified readers to a pending case against Hillsdale College by students who allege they were raped by classmates. The legal issue is whether Title IX -- the federal law that prevents sex discrimination in education -- applies to tax-exempt schools that do not receive federal funds. That’s the question that interest me. But I’m having trouble focusing on that issue because the WSJ piece is so weirdly inflammatory in its rhetoric that it is distracting. As tax professor Ted Seto pointed out in an email to the Taxprof Listserve, the claim (in the headline and first sentence of the piece) that the lawsuit is an “assault” on the college is absurdly hyperbolic.  Given that the plaintiffs are college students who allege they were raped by classmates at Hillsdale, the fact that the WSJ calls their lawsuit an “assault” on the college, despite the fact that they are trying to hold the school accountable for allegedly failing to meet minimum standards to protect them from harm, is to say the least distracting.  But, as they say, the WSJ Opinion Page will be the WSJ Opinion Page.

As for the substance of the legal issue, it’s actually quite important for nonprofit law generally, as well as being critical to the application of Title IX. Title IX is the federal law that governs sex discrimination in education. Congress wrote the law to apply to any “education program or activity receiving Federal financial assistance.” It does not apply to those that don’t. It is settled law that the “assistance” doesn’t have to go directly to the school, but that it is enough for the students who attend the school to receive them. What arguably is not settled is whether the fact that the school is exempt under section 501(c)(3) is sufficient by itself to constitute “Federal financial assistance.” On the one hand, there is a 2001 case out of the Northern District of Illinois called Johnny’s Icehouse, Inc., in which the court rejected the argument that the Amateur Hockey Association was subject to Title IX because of its tax exemption. It reasoned that Federal regulations define “Federal financial assistance” with a list of five enumerated types of assistance, none of which are the tax exemption provided in Section 501(c)(3) (to say nothing of the even juicier charitable tax deduction provided in Section 170). 34 C.F.R. 106.2(g). Since the regulations don’t define tax exemption to constitute Federal financial assistance for the purposes of law, the court held that it doesn’t.

On the other hand, there is a 2022 case out of the District of Maryland (currently on appeal to the Fourth Circuit) that holds the opposite. In that case, the court rejected a summary judgment motion by the defendant, who argued that Title IX didn’t apply to them because they receive no Federal financial assistance. The plaintiffs argued that tax exemption under section 501(c)(3) was sufficient financial assistance to subject the defendant school to Title IX, and the court agreed. It relied primarily on (very brief!) discussions of those two towering cases of the nonprofit law curriculum from 1983: Regan v. Taxation with Representation, 461 U.S. 540 (1983) and Bob Jones University v. United States, 461 U.S. 574 (1983). The court’s reasoning went something like this: (i) Taxation With Representation holds that tax exemption is a “subsidy;” (ii) in so holding, the Court said, “[a] tax exemption has much the same effect as a cash grant to the organization …;” (iii) Q.E.D., the fact that the Title IX regulations don’t specify that tax exemption is a form of financial assistance is not important because, “The Supreme Court has [recognized that tax exemption is] the equivalent of a cash subsidy.”

The problem with this reasoning is that it potentially opens up a can of worms in other areas of nonprofit law. At the heart of the theoretical foundation of all nonprofit law is the observation that tax exemption and the deduction for charitable contributions both acts as a subsidy and is different from other kinds of subsidies. It’s a subsidy that can be applied in a way that tries really hard to preserve the autonomy of the recipient from government control. That’s why it is a form of subsidy well designed for religious organizations, to take just one teensy example. Our Constitution prevents the government from establishing religion, which makes certain kinds of subsidies for religious organizations problematic. Because it is so broad and inclusive, the charitable tax exemption and contribution deduction serve the purpose of governmental support for religious organizations better in many instances than other types of more direct “financial assistance.” That’s true not just for religious organizations but in more instances than I could possibly list here.

With respect to actual question at hand – does Title IX apply to institutions that forego federal funds for themselves or their students – it seems to me that before deciding that based on the broad language of the Supreme Court about the equivalency of tax exemption and cash grants, I would want to know what Congress and/or the Department of Education think about the matter. By my reading, Congress’s choice of the phrase “Federal financial assistance” does not unambiguously include the concept of tax exemption. Therefore, the agency’s interpretation in regulations may be due some degree of deference (I know I know, everything I think I know about administrative law is either already wrong or will be by this time next year). In that case, I think a close reading of 34 C.F.R. 106.2(g) is warranted in this case. The operative question I think is whether Congress intended to apply Title IX to all schools that are tax-exempt? Or whether they intended Title IX to only apply to schools that accept some other kind of Federal financial assistance?

So, what is there to say about the pending lawsuit against Hillsdale College? First, the court will have to decide (without Sixth Circuit precedent) whether tax exemption alone constitutes “Federal financial assistance” sufficient to trigger the application of Title IX. In doing so, it has the reasoning of two sister district courts to aid its own analysis, one that applied a relatively narrow textual analysis of the Title IX regulations, one that reasoned in a broader way from principles announced in a 40 year old (but still great!) Supreme Court case. Obviously, I prefer the narrower analysis, although that doesn’t mean I necessarily know what that narrow analysis will produce in the suit against Hillsdale College. But also, while it is probably hyperbole to say (as Hillsdale’s president reportedly said) that a ruling for the plaintiffs on this issue would “sweep into the government’s net hundreds of thousands of American institutions that have sought to stay out of it,” it is also probably not completely untrue. Too many double negatives? Let me try again: I think that a ruling that relies on reasoning that tax exemption is the same as a cash subsidy in all cases is bad for nonprofit law. 

Benjamin Leff

Founder of Christian Health Care Sharing Ministry Pleads Guilty to $8 Million Wire Fraud Conspiracy

Following up on an earlier post that reported federal authorities had shut down section 501(c)(3) Medical Cost Sharing Inc., the U.S. Department of Justice has announced that the founder of this charity has pleaded guilty to conspiracy to commit wire fraud and making false statements on a tax return. According to the press release:

[Craig Anthony] Reynolds admitted that he and his co-conspirators used false and fraudulent promises to market Medical Cost Sharing as a “Health Care Sharing Ministry” to defraud hundreds of “ministry members.” Reynolds and his co-conspirators collected more than $8 million in member “contributions,” yet paid only 3.1 percent in health care claims so that they could personally profit and take most of the members’ contributions for themselves

Of course health cost sharing ministries do not automatically qualify for section 501(c)(3) status, for the reasons discussed in the recent IRS ruling discussed by fellow blogger Darryll Jones earlier this week. But this case highlights that even when they do appear to qualify, problems can still arise from their actual operations.

Coverage: KMBC; Medium.

Lloyd

UCLA Sues Mattel for Allegedly Failing to Make Good on $49 Million Pledge

According to the L.A. Times (subscription required), UCLA and related entities have filed a lawsuit against Mattel for failing to make good on a 2017 pledge to donate $49 million to the UCLA children's hospital over 12 years. Mattel had previously given $25 million to support the children's hospital, in exchange for naming rights. While UCLA Health initially agreed to allow the company to suspend payments because of asserted financial issues, the company's profits in recent years and this year's Barbie movie success led to the lawsuit when payments did not resume. In defense, Mattel is asserting that the donation related to a new hospital tower that UCLA Health is no longer committed to building.

UPDATE: Thanks to fellow blogger Darryll Jones, I now have a link to the complaint in this case.

Additional coverage: CBS News; KTLA.

Lloyd Mayer

Church Ordered to Repay Over $500,000 to Bankruptcy Estate

As readers of this blog know, donations can bring with them a host of issues. These can include will disputes, naming rights conflicts, and of course donors seeking to perhaps unduly interfere with a charity's operations. The latter is illustrated by recent clashes between donors and universities relating to the Israel and Gaza; see, for example, the Philadelphia Inquirer story headlined  "Penn’s donor backlash raises questions about how much influence philanthropists should have" (subscription required).

A recent federal bankruptcy court case highlights another issue, and one that can result in the charity having to repay a major donation. In Arrowsmith v. First United Methodist Church Centre, Alabama (In re: Health Diagnostic Laboratory, Inc.), the Liquidating Trustee alleged to have traced between $550,000 and $850,000 as fraudulently transferred from the debtors to intermediaries and then from there to the defendant church (pictured here). After trial, the court ruled that the initial transfers were recoverable by the bankruptcy estate and that of those initial transfers $569,435 made its way to the church using accepted tracing methods.

Once that was proven, the main defense the church raised was an exception to recovery for a "transferee that takes for value, . . . in good faith, and without knowledge of the voidability of the transfer avoided." It was uncontested that the church had acted in good faith and without such knowledge, leaving the only open issue whether the church had provided anything of value in return for the funds it received. The church had issued the standard donation receipt stating it had not provided any goods or services in return for the donations, but the church argued that the donor had received intangible emotional benefits from contributing and, alternatively, that church members had provided (volunteer) services to  utilize the funds to further the churches charitable activities. The court found neither assertion demonstrated return value.

The church also argued that because it had spent the funds on its charitable activities, there were "changed circumstances" that should excuse the donations from recovery. However, the court noted that Congress has decided that the changed circumstances defense is not available when there has been a fraudulent convenience. The court also concluded the church could not invoke equity to allow this defense, since Congress had enumerated the available defenses.

Lloyd Mayer

 

Proposed Class Action for Solicitation Fraud Filed Against LDS Church

We previously reported about the August 2023 Ninth Circuit decision reinstating John Huntsman's claim against the Church of Jesus Christ of Latter Day Saints (more on that decision here) and the March 2023 survival in the face of a motion to to dismiss of a civil RICO claim against the LDS Church by another disgruntled donor. Now a different set of unhappy donors have filed a proposed class action against the LDS Church.

The thrust of their complaint is that the Church told them that their donations would be used immediately for charitable purposes, including "humanitarian relief," but instead some or all of their donations became part of a now multi-billion dollar endowment. The specific claims filed in the U.S. District Court in Salt Lake City include breach of fiduciary duty, fraud, and unjust enrichment. The docket is available on Pacer, but I have not been able to find a copy of the actual complaint that is not behind a paywall. 

Coverage: AP; Law360 (subscription required); NY Post.