Last Wednesday’s Philadelphia Inquirer had a fascinating story regarding Malvern Preparatory School, recipient of funds from Joseph S. Forte, a now convicted felon and a former trustee of the school. Harold Brubaker, A Workout in Court Over Ponzi-Scheme Gift (July 7, 2010). Forte had pledged $1 million for the construction of an athletic facility for the school. According to the Inquirer, Forte only paid half the pledge.
Forte is serving his time because he ran...
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an investment Ponzi scheme that represented a $35 million fraud. The receiver is busy looking for funds to return to the victims. According to the Inquirer, the biggest potential sources are $2 million in contributions that Forte made to charities and $8 million in false profits distributed to investors. Given the facts, the receiver is looking to apply a clawback to the funds received by Malvern from Forte by filing suit against Malvem. The school has responded with a counterclaim. Compounding Malvern's problem: It borrowed $3.3 million to complete the project that was inspired by Forte's donation.
At this time, we aren’t clear whether the Madoff bankruptcy trustee has exercised clawback rights against charities that profited from the much publicized Madoff Ponzi scheme. Our sense is that the Madoff bankruptcy trustee is addressing clawbacks on a case by case basis, but that the bankruptcy trustee believes that charities are not immune from a clawback simply because their status as charities. In January of this year, the Madoff trustee entered into a settlement with Norman F. Levy’s estate and family. Amir Efrati, Settlement Boosts Madoff Recovery of Funds, Wall Street Journal (January 27, 2010). Apparently Levy and family received $305 million in withdrawals from Madoff within the six-year period immediately preceding the discovery of the Madoff scheme. Of that amount, $85 million was attributable to contributions to a family foundation, which had been disbursed to other charities. Under the agreement, Levy's estate and members of his family will pay $220 million to the trustee, but the trustee has agreed to forgo collecting $85 million that had been given away by the family foundation.
On the other hand, Bloomberg News reported last September that the Madoff trustee was pursuing a clawback against the charity run by Jeffry Picower, with the trustee contending that Picower either knew or should have known about the Ponzi scheme. Erik Larson and Linda Sandler, Madoff Liquidator May ’Claw Back’ Charities’ Profits (Update 1) (September 1, 2009).
The case currently involving Malvern Preparatory, which is now percolating in the Eastern District Court for Pennsylvania, could produce some clarity on how clawback procedures apply to charities, which is why we were first drawn to the Inquirer story. Unfortunately, the documents we have reviewed to date in the Malvern Preparatory proceeding don’t shed much light on the governing law.
There, however, are two other important lessons to be drawn from this incident. The Inquirer reports that the school initially had no plans to build a new strength-and-conditioning facility when Forte was pushing for better training and conditioning programs. And for good reason: The Malvern Preparatory sank $7.2 million into a new athletic facility in 1999.
The school eventually "gave in" when Forte upped the ante by offering more money for a performing arts campaign. Forte was apparently satisfied at that time with a renovation of an existing weight room, but the school concluded that building a new facility made more sense. It then borrowed $3.3 to supplement Forte’s pledge.
The two lessons are independent of the clawback aspects of the case: First, the shovel should not go into the ground until the institution has the pledged cash in hand or an adequately secured pledge. Second, not every offer of a gift is one that should be accepted. Forte’s money appears to have caused Malvern to change the direction its mission was taking. The change might have more justifiable had Forte been willing to pay the full amount for a new strengthening and conditioning facility, but the facts, as reported by the Inquirer, indicate that the bulk of the money for the new facility came from the school’s borrowings, which means that to repay the loan, the school will need divert funds that otherwise would have financed the programs it intended to pursue before Forte came along with his ideas, all other things being equal.
We can't necessarily fault Malvern for falling victim to a Ponzi scheme, particularly if Malvern undertook due diligence with respect to Forte. However, and this may come as a surprise to many, we can fault Malvern for being easily swayed by a donor's money. That would be true even if there had been no Ponzi scheme and the pledge had been fulfilled.
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