DATELINE: September 30, 2009, Chicago
Train wrecks always make for great photographs, but train wrecks only serve a purpose if we learn from them. If the allegations made by the New Jersey Attorney General against those running the Stevens Institute of Technology turn out to be true, Stevens will become one of the great train wrecks in nonprofit history. Already the story offers...
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The early portions of AG Milgram’s complaint may explain how Stevens jumped the tracks, assuming the allegations are true. CEO Raveche was hired by Stevens in 1988 to serve as its president. According to the complaint, the bylaws were then amended to expand Raveche’s powers. Following the amendment, he not only served as president, but became CEO and a voting member of the board of directors. He also, according to the complaint, served as an ex officio member of the executive, audit and investment committees. The complaint asserts that “Raveche also exercised control over committees that he was not a member of, including the committees that determined employee compensation.”
By stating those alleged facts upfront, AG Milgram is showing her hand. She and her investigators view Raveche as an imperial leader. AG Milgram is taking the same approach that those who examined the American University and Smithsonian compensation scandals took. She is painting a picture of an out-of-control CEO.
Throughout the complaint, AG Milgram supports her view of Raveche by examining the role played by the board of trustees. We see that in Paragraphs 119 through 126. When it came to the receipt of financial information, one board member apparently told AG Milgram or a member of her staff, “The Board of Trustees is a Mushroom patch and always has been from my experience.” That trustee could “almost guarantee…that the Trustees did not know about the actual performance of SIT.” Another trustee reported that the board was never provided with final budgets or a report reconciling proposed and actual budgets. A third trustee stated that during his years of service (1996 to 2005) there “was never a report on the state of any of the endowments.” A fourth trustee who was interviewed apparently told AG Milgram or a staff member that the board was not provided with key financial information documents. This trustee indicated that when questions were asked, “[t]he President, Chairman of the Board obfuscated the results so you could not tell what happened.”
The discussion of Raveche’s compensation also suggests a strong executive and passive board (Paragraphs 323 through 359) AG Milgram alleges that the compensation committee was an ad hoc committee that was not created in accordance with Stevens’ bylaws or New Jersey law. Until 2003, the board did not nominate or vote for members of the compensation committee, according to the complaint. The complaint refers to a retroactive salary adjustment, email authorization of a loan to Raveche for $500,000 secured by a home in Vermont (the board apparently was not advised of prior to the loan closing), and after-the-fact notifications of the board regarding Raveche’s salary. One trustee wrote an email to a professor which described the process by which Raveche’s compensation was determined, which stated:
The key figure in all this is Larry Babbio who…is the one who organizes the compensation committee and OKs these salaries and perks. The Board never saw the details any of the deals during my time. If you asked you got some but not all of the details. It is a complicated web and needs to be audited in detail.
Another trustee allegedly reported that from 1999 to 2005, the board never voted on, approved, or was shown comparability analysis relating to Raveche’s compensation. AG Milgram then does something that we are seeing more frequently. She alleges that Stevens failed to make adequate disclosures regarding Raveche’s compensation in its Form 990. AGs are using the Form 990 misstatements and omissions in their enforcement actions.
According to AG Milgram, those running Stevens played fast and loose when it comes to outside advisors. If the allegations are true, boards should not take comfort in the fact that the institution has hired big-name and expensive lawyers, accountants, and consultants.
Both PricewaterhouseCoopers and Grant Thornton are named as key actors in the introduction to the complaint (Paragraphs 18 through 19), but there are no allegations of wrongdoing on their part. Every auditor should read Paragraphs 138 through 179 of the complaint. PwC, in what apparently was a 2005 management letter, wrote:
The existing finance and research administration infrastructures, and related policies and procedures, have proven inadequate to the demands posed by this unprecedented growth.
According to the complaint, Stevens had to pay approximately $1.5 million to PwC before PwC could finish the PwC 2004 Report and its FY2004 audit. The PwC report indicated that on an “overall basis…[the] internal controls at Stevens Institute are below acceptable levels throughout the organization.” The report concluded that the staff did “not possess the requisite sets to process, account for and manage financial information." According to the complaint, the board was not provided with the complete 2004 PwC Report, nor was its advised of the key conclusions. On January 7, 2005, PwC informed the audit committee:
PWC annually assesses the relationship with all their clients and performs a risk asseesment…Stevens has been identified as a high risk client. [PWC] put Stevens on notice that there was a possibility PWC would not continue its relationship with Stevens.
The complaint indicates that “PWC fired Stevens as a client due to the risks it posed to PWC."
Paragraph 158 may be the most important paragraph in the entire complaint. It quotes an unnamed person as stating that the board was told that PwC was:
unable to continue as external auditor to Stevens due to costs inefficiency of not having dedicated work force for non-profit organizations.
We bet our friends at PwC who work with nonprofit clients are surprised by that fact.
This is less likely to happen today because of changes in the auditing standards that now require that auditors communicate with the board. Those pronouncements permit communication with the audit committee, but assume the audit committee is independent. Paragraph 158 aptly demonstrates why the board, not management, should retain and control the relationship with the auditor and why Raveche should not have been an ex officio member of the audit committee. The engagement letter should require that the auditor provide at least several independent members of the board with all communications from the auditor. It should also require that every member of the board be informed if the auditor withdraws from the engagement and the reason for the withdrawal.
Grant Thornton also reported finding material weaknesses and significant deficiencies in internal controls, according to the complaint. The complaint also refers to significant restatements of the 2006 and 2007 financial statements. We are unable to judge the merits of these allegations from the complaint.
Senator Grassley will be particularly interested in Paragrpahs 372 through 447 of the complaint. These paragraphs focus on the use of outside compensation consultants. Paragraph 373 alleges that certain insiders attempted to influence the executive-compensation comparability study conducted by Towers Perrin. According to the Paragraph 374, one email from Stevens CFO:
urged Towers Perrin to include Carnegie Mellon, MIT. California Technical Institute, and others in Stevens’ peer-group, presumably to increase the permissible levels of compensation that could be paid to senior Stevens employees.
Towers Perrin responded:
Size-based criteria, and particularly revenue operating budget, typically best predict compensation levels and are therefore most important to consider when evaluating organizations for a peer group….That explains why Carnegie Mellon, MIT and CalTech are not appropriate schools to include in the peer group.
Towers Perrin reported that:
[C]ash compenation levels (base salary and bonus) for virtually all the executives fall above the 90th percentile. [B]onuses provided to executives at Stevens are not typical market practices among academic institutions…In addition, the level of bonus opportunity is above competitive practices where bonus practice where bonus programs are in place.
On the issue of the forgiveness of the debt owed by Raveche, Towers Perrin wrote, “The forgiveness of mortgage loans falls considerably above market practice.”
Paragraph 384 alleges that none of this information was shared with the full board. At some point, Stevens replaced Towers Perrin with Hewitt Associates. Paragrapgh 392 alleges that Hewitt’s preliminary report concluded that Raveche’s total compensation was far above market value. Hewitt doesn’t fair as well in the complaint as Towers Perrin. There are allegations suggesting that Hewitt was more amenable to making peer group adjustments than Towers Perrin. While we are sure that all consultants know this, there is an obvious lesson here for auditors, lawyers, and compensation consultants: Don’t be thrilled when you replace a competitor unless you know the true reason for the change of horses. And if you are replacing a competitor, make sure you the real reason for the departure.
The complaint alleges that the board was not provided with the full Hewitt reports. The complaint alleges Hewitt’s conclusions were not fairly presented to the board during a teleconference. If true, this serves as evidence of why face-to-face board meetings with handouts are to be preferred to teleconferences.
As for Senator Grassley: You are in such a hurry to eliminate the rebuttable presumption because it is an impediment to the IRS. If the allegations in the complaint are true, the IRS should have no trouble overcoming the presumption in this case. Do we, however, want IRS agents second guessing honest business judgments? We think not given the costs of those battles.
And so we come to the question of the day: Why didn’t AG Milgram name the full board in the complaint? A spokesperson for the board described the board as being composed of “sophisticated men and women” James Queally, Stevens Tech Makes Pre-emptive Move as AG is Set to Slam Hoboken College, NewJersey.com (Sept 17, 2009). If the allegations are true, there was a concerted effort to keep the board in the dark, but we do not believe that excuses the board. Until boards, particularly those comprised of sophisticated individuals, understand that they perform an important oversight function and must be prepared to push back and demand information, we will continue to see stories like this one. And that is why we believe AGs should get tough with boards that abdicate their duties.
We are reluctant to second-guess AG Milgram at this point in the process. It may be that she is holding the Sword of Damocles over the board’s head, hoping that they will vote to replace or sue key members of management. She also may be pulling her punches in an effort to gain their cooperation, which may already be bearing fruit, as several statements from board members in the complaint demonstrate. Time will tell, but at this point, if the allegations prove to be true, we are unwilling to give the board a pass. Sophisticated people should know how to ask questions, make demands, and discharge their responsibilities as board members.
We'd also like to know who is representing the board and management in this matter. At this point, we would hope that the board has retained separate legal counsel.
Stay tuned for Part III, in which we examine the student body’s reaction to events.
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