DATELINE: April 14, 2009, Chicago
On January 1, 2009, Janet Frankston Lorin of Bloomberg reported that Ira M. Millstein, the corporate governance guru from Weil, Gotshal, advised Yeshiva University with respect to conflicts of interest and investing with members of the university’s board of trustees. Millstein Letter Helped Keep Yeshiva Money on Path to Madoff. Bloombergclaimed to have seen a letter from Millstein in which he said that Yeshiva had “followed procedures adequate to prevent either the appearance or the reality of a conflict of interest.” According to Bloomberg, this cleared the way for the fateful investment in J. Ezra Merkin’s fund that invested its funds with Bernie Madoff. Merkin served on Yeshiva’s investment committee. In his letter, Millstein reportedly said, “There is no reason why the board or its committees should institute a blanket rule prohibiting members (or major donors) from doing business with Yeshiva.” We previously pointed out that there are plenty of reasons for a blanket prohibition.
Another Wall Street corporate law firm, Sullivan & Cromwell, have now given their own verdict on Millstein’s advice. As is typical, Sullivan & Cromwell was retained following the revelation that Yeshiva University lost somewhere around $110 million in the Madoff scandal—cash-out-of-pocket was somewhere around $14 million. There charge was to develop governance policies that met the gold standard. Sometime around the end of March, the Yeshiva board of trustees adopted a new conflicts-of-interest policy which was developed with the assistance of Sullivan & Cromwell. Noach Lerman, Board of Trustees Adopts New Rules to Limit Conflict of Interests, Yeshiva Commentator (April 1, 2009). The policy...
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sharply limits conflicts of interest. As a general rule, it allows conflicts, but only in rare situations. Before the conflict can be approved, it must be reviewed by a special conflicts waiver committee. That committee will not include any person who had a previous business relationship with Yeshiva—presumably to prevent back-scratching approvals. The committee can only approve transactions that provide Yeshiva with “overwhelming benefit.” There also are “enhanced conflict disclosure requirements.” The university will develop and maintain a database of all conflicts transactions. The policy is university-wide.
There is a second component to the policy. There is an absolute prohibition against investing endowment with board members or retaining them as investment managers. No waivers. So while Ira Millstein may have thought there was no reason for a blanket prohibition, Sullivan & Cromwell and the university apparently found at least one in the wake of the Madoff scandal. Was it the bad press, upset donors and alum, potential action by the New York State Attorney General, or something else?
The pattern exhibited in this battle of the law firms is all too typical. Real men can manage conflicts of interest so they need not be bothered with the niceties that good governance wimps advocate. And then we have the Three-Mile Island meltdown. All of a sudden the wimps don’t look so wimpy and the macho men find religion. Everybody would be far better off if boards would skip the meltdown stage and just adopt tough conflicts-of-interest policies from the outset.
Certainly J. Ezra Merkin would be better-off. We have previously written about the conflict he allegedly managed to engineer. Recall that both Madoff and Merkin sat on Yeshiva board of trustees. Assuming that Madoff’s little Ponzi scheme was actually a good investment—a rather fanciful assumption—Yeshiva had two options for investing with Madoff. If could have invested directly with Madoff or it could have placed its money with Merkin, paid him his fees, and then had Merkin hand the money over to Madoff. Had Madoff and Merkin been discharging their duty of loyalty, the appropriate option would have been to let Yeshiva invest directly with Madoff, thereby saving Yeshiva Merkin’s fees. According to a complaint filed against Merkin by New York State Attorney General Andrew M. Cuomo on April 6, 2009, Merkin and Madoff opted for indirect investment of Yeshiva funds through Merkin—although the complaint takes a page of out of the Patrick Fitzgerald’s book, the U.S. attorney who is pursuing Illinois ex-Governor Blago. Cuomo’s complaint refers to Yeshiva (or at least what appears to be Yeshiva) as Non-Profit Organization A. Paragraph 119 of the complaint states:
Madoff and Merkin were friends, and both were on the Board of Trustees of Non-Profit Organization A, which had a large investment in Ascot. Investors in Merkin’s Ascot funds paid Merkin an annual management fee, but those who invested with Madoff directly did not. Merkin breached his fiduciary duty to Non-Profit Organization A by accepting its investment in Ascot, and the management fees that came with it, when Merkin and Madoff could easily have arranged for a direct investment with Madoff.
The complaint refers to other alleged breaches of fiduciary duties to other charities by Merkin. Cuomo asks for an accounting of all fees and compensation received by Merkin from the alleged transactions, restitution and damages, and payment of attorneys’ fees and costs. He also asks for an injunction prohibiting Merkin from serving as a board member, trustee, director, or officer of any nonprofit corporation. The injunction also would prohibit Merkin from acting as an investment manager or advisor to any nonprofit organization. Finally, Cuomo asks the court to enjoin Merkin from any employment, consultation, or unpaid service as an investment manager or advisor, and enjoining Merkin from serving as a general partner, managing partner, officer, or director of any investment fund, or otherwise managing the investments of others.
We suspect this lawsuit will take some to resolve itself. If this matter were like most involving allegations of wrongdoing by board members, the attorney general and Merkin would reach a settlement, but this case in unusual. Merkin has been sued by others so he may be reluctant to take any action that suggests he acted inappropriately. We therefore are willing to bet that this matter will be resolved through a trial.
Attorney General Cuomo’s action against Merkin puts all other directors of New York nonprofits on notice. Directors are taking a big risk if they enter into transactions with nonprofits that result in loss to the nonprofit, particularly if there is evidence that the nonprofit had better alternatives.
We suspect boards, investment committees, and attorneys advising both will be taking a good look at Yeshiva’s new conflicts-of-interest policy and the lawsuit against Merkin. Over the next year or so, we expect to see board’s redefining the duties and role of investment committees, examining investment policies, and severely restricting conflicts of interest in the context of investments.
We can't say for sure because of redaction, but these draft minutes may be from a Yeshiva University investment committee meeting. They make for interesting reading.
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