The Philanthropic Family

Bernard Madoff  and his $50 billion ponzi scheme have so far taken down a number of charities and private foundations, the almost $1 billion Picower Foundation among them.

It was immediately evident to me that foundation board members would find themselves held accountable for these problems with the investment of their endowment funds.  As soon as I saw those articles, I sent this update to my Twitter network:

Major warning to all foundation board members: your fiduciary duty extends beyond spending to the investments: http://is.gd/bMjT 9:32 AM Dec 15th from twhirl

Last week, a wealth management firm wrote me a letter to let me know that none of its clients were affected by the newly discovered scandal. This “manager of managers” said that when they checked in with their chosen managers, a few had done preliminary due diligence on Madoff’s fund but quickly opted not to invest based on the murky findings.

Real-world Consequences Starting to Appear

Now we’re seeing the first hints that my warning will be backed up with some serious consequences.  Thanks to the Chronicle of Philanthropy for this article on how the Connecticut Attorney General Richard Blumenthal is going to look into whether the trustees of the charities who were taken in acted appropriately as “prudent investors” protecting the foundation’s endowment funds.  Mr. Blumenthal said “The standard is that the director or fiduciary at any nonprofit has to exercise due diligence and the care and caution of any ordinary prudent investor.”

The Picowers may have been thrilled with the growth of their endowment in the seemingly capable hands of Mr. Madoff, but if it turns out that they didn’t do appropriate due diligence and trusted the foundation’s many hundreds of millions of dollars to “a friend” based on word of mouth–millions for which they already received a huge tax deduction when they donated to the foundation–the government could easily penalize them (maybe even imposing  personal finacial penalties) for being careless with charitable-use funds entrusted to their care.

Balancing the Equation

There are two sides to the financial equation for any organization: money in and money out.  For private  foundations, the income comes from donations or from investments–interest, dividends and realized capital gains.  But most boards pay far more attention to the money going out: grants and administrative expenses. 

So here’s my single prediction for 2009: Charity boards and trustees, especially those at private foundations who rely on the endowment to produce income for grantmaking, are going to suddenly take the income side of their fiduciary duty very seriously.  To play this trend out, I think smart foundations will take at least some of the following steps:

• More grantmakers will decline to have their investment advisor sit on the board, or to say the same thing in reverse they’ll decline to pay a board member to provide investment advice. 
• More foundations will hire firms to review their choice of financial advisors and their adherence to the investment policy.
• More foundations will revisit their investment and conflict of interest policies and make sure they are in compliance with their own policies.
• Foundations may also trend more conservatively in their investment decisions so  as not to appear to be prioritizing short-term gain over the conservation of principle.

If you’re on the board of a private foundation or a public charity with some investable assets, I highly recommend that you use your next board meeting to make sure you aren’t going to be taken down by the next Bernie Madoff.  For example, you should be familiar with the Prudent Investor Rule. 

For many nonprofit boards, financial committee reports may be limited to reporting on the investment returns and as long as the returns seem reasonable for the market conditions, there aren’t a lot of questions about where those returns come from.  If you and your board need guidance, you may consider whether to hire an independent firm to review your investment policy, make sure your policy is being followed, and to provide some educational sessions so that your board is well-informed and comfortable with the investment management. 

In 99% of cases, you’ll be comfortable with what you find and everything will be fine.  But it’s the process that matters–and your documentation of that process.  Jack Siegel, a Chicago lawyer who advises charities, was quoted in the Chronicle article as saying “It’s all about process. The question is, did they do what normally would be done in selecting investment managers?”

So in the end, your litmus test should be whether you, as a board member, would feel confident answering the questions of an IRS agent or your state’s Attorney General about how your investment process works.  If you’re not, get professional help.