Dateline, February 16, 2007, Chicago
Stephanie Strom broke a blockbuster in to today’s New York Times. See Stephanie Strom, Donors Sweetened Directors’ Pay at MoMA, New York Times, February 16, 2007. Some are already calling it their favorite Strom story. Others are demanding that it be included in good governance presentations. The story involves the Museum of Modern Art (MoMA) and Glenn D. Lowry.
We’ve all confronted the problem that Lowry faced some twelve years ago when he was asked to leave Toronto to become MoMA’s executive director. New York is an expensive place to live. How does one make do...
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on the paltry salary paid to the executive director of one of the wealthiest museums in the world? In 2005, Lowry earned a mere $1.28 million, including bonus and benefits.
According to Strom, one looks to two of the museum’s wealthiest directors for some off-the-books funding. Enter David Rockefeller and Agnes Gund, who solved the problem by creating a new charity—the New York Fine Arts Support Trust (Trust). How to fund the charity? Rockefeller apparently convinced his brother, Laurence, to part with a spare Bonnard, probably gathering dust in the back of a closet. A small group of others also contributed to the Trust.
The Trust’s 2003 Form 990-PF reports that the Trust's activities are limited to “cultural and fine arts organizations in the New York City Metropolitan area,” but its schedule of grants for 2003 show Lowry as the only recipient. In 2002, there were two grants, one to Lowry ($178,787) and one to another MoMA official. There were no grants to MoMA officials or other individuals in 2004 or thereafter, according to a supplemental schedule posted by MoMA on Guidestar and filed with the New York Attorney General. The schedule shows that the Trust paid Lowry $397,967 in 1999, $50,640 in 2000, and $129,990 in 2001. Strom reports that the Trust paid Lowry a total of $5.35 million between 1995 and 2003.
The New York Attorney General opened an investigation last year, but has put the matter to rest now that the Trust has made requested filings. There are some very interesting tax issues here, but before discussing those, let's first focus on corporate governance. It is very troubling that two directors are funding side payments to an executive director, particularly if this was not widely known by other board members. We don't know how much the full board knew. Let's be honest, however, the executive director has a lot influence in shaping any board's view of the institution and why the board should approve certain actions, but not others. If a couple of board members are making side payments to the executive director without the knowledge of other board members, the executive director has an incentive to emphasize his benefactors' agenda when interacting with the full board. In other words, the executive director risks becoming a toady. As a consequence, the full board may no longer be getting the benefit of the executive director's best or impartial judgment. We don't know whether that was in fact the case here. But side payments of the sort in question certainly pose that risk. There is probably a risk of toadyism even if the full board does not know about payments. It is only natural that someone in Lowry's position will want to please his benefactors.
Now, let's consider the tax issues. The question is whether the IRS will begin an examination. As a practical matter, it may not be worth the IRS’s time. If the bulk of the payments were made in the 90s, the statute of limitations may preclude the IRS from raising questions about those specific years. That does not prevent the IRS from raising the bigger question: Whether the trust was operated for exempt purposes or for private benefit. There is some evidence that the Trust may have been less than forthcoming in revealing its true nature when the Trust sought recognition of its tax-exempt status. That could lead the IRS to rethink its exempt status.
When we first read Strom’s story, we assumed the Trust had escaped private foundation status by claiming that it was a Section 509(a)(3) supporting organization, but its tax returns indicate that is is a private foundation. So the IRS might want to examine any grants (made in open tax years) to determine whether there has been a taxable expenditure in violation of Section 4945 of the Internal Revenue Code. This section requires that grants to individuals be awarded on an objective and nondiscriminatory basis pursuant to a procedure approved by the IRS in advance. Did the Trust fully disclose how it intended to select grantees? If so, did it follow the stated procedures?
The more interesting question involves the intermediate sanctions under Section 4958. Of course, the intermediate sanctions do not apply to private foundations, but that does not necessarily eliminate the sanctions from this analysis. They clearly apply to the MoMA. We suspect that MoMA’s tax lawyers are busy reading Regulation Section 53.4958-4(a)(2), which provides that in determining whether a charity (MoMA) has paid any excess benefits, payment through a controlled entity or an intermediary will be taken into account. As is always the case with these long-arm provisions, it is necessary to read the definitions defining what constitutes an affiliated, controlled, and related entity. In this case, Regulation Section 53.4958-4(a)(2)(ii)(B)(iii) appears to describe the most relevant relationship, but it isn't drafted broadly enough, at least on first impression.
For purposes of this paragraph, control by an applicable tax-exempt organization [MoMA] means: In the case of a nonstock organization [Support Trust] (i.e. an entity in which no person holds a proprietary interest), that at least 50 percent of the directors or trustees of the organization [Support Trust] are either representatives (including trustees, directors, agents, or employees) of, or indirectly controlled by, an applicable tax-exempt organization [MoMA].
Rockefeller and Gund are reported to be MoMA directors. But here is the rub: They are not directors of the Trust. The sole trustee is the Rockefeller Trust Company. Presumably Rockefeller has an involvement with the Rockefeller Trust Company, but as the sole director of the Trust, the Rockefeller Trust appears to eliminate the direct link between Rockefeller and Gund, on the one hand, and the Trust on the other. We haven't worked through all the possibilities, but this would appear to check any attempt by the IRS to invoke Regulation Section 53.4958-4(a)(2).
This does not end the matter, however. The IRS has a couple of powerful weapons in its arsenal. As we have already noted, the IRS can take the position that the Trust was not making grants, but was in fact, operated for private benefit, meaning that it was never a tax-exempt entity. Alternatively, the IRS could make a substance over form argument, taking the position that the grants by the Trust were in substance made to MoMA, followed by a constructive payment by MoMA to Lowry. That brings the analysis back to the intermediate sanctions. There is some support for that view. As noted earlier, the 2004 Form 990-PF shows no grants to Lowry or any individuals, but it does show a small grant to MoMA. The 2005 and 2006 returns are not yet available. It will be interesting to see whether there were additional grants to MoMA. We suspect if there are any, they will be minimal because the Trust's assets are just above $20,000. The IRS may want to ascertain whether other New York institutions were made aware of the Trust and its criteria for making grants. If not, then that would further bolster the argument that payments to Lowry should first be attributed to the MoMA.
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