A $15.8 million judgment against the former foundation president; a $5.8 million judgment against the corporate secretary; more than $500,000 in personal settlements with directors: So ended the 2004 trial of a lawsuit brought by the Texas attorney general against directors and officers of the Carl B. & Florence E. King Foundation. The case is on appeal and an appellate opinion, one of the first of its kind, is expected this summer. Should wealth advisors and foundation managers care?

Regulatory attention to charity executive compensation and conflicts of interest is on the rise. For more than three years, the nonprofit sector has endured national criticism that eventually may rival the turmoil that gave us the 1969 Tax Reform Act. We nonprofits must get our houses in order now — and advisors should lead the way.

The King scandal could have been prevented at many points in the foundation's 40-year existence. These teachable moments were lost opportunities for the family's trusted advisors, mostly lawyers in this case, to educate their clients about the realities and liabilities of creating and operating a private foundation.

Recent news reports show that foundations and their advisors still have a lot to learn. The year 2005 closed with the Council on Foundations, a membership organization of grant-making foundations, placing the multibillion-dollar Getty Trust on probation because of issues related to the president's compensation and perks, such as a trust-provided $72,000 Porsche Cayenne SUV. Also, two state attorneys general sued a small foundation that purchased a $1.5 million luxury home overlooking a Las Vegas golf course, apparently for the use of the foundation's president, a lawyer.1

King-like cases are not going away — and neither are their lessons.

Lesson 1: Fairy-tale endings are for the Brothers Grimm.

Among many other reasons for their philanthropy, donors often hope that a family foundation will help keep the family together, a selling point offered by lawyers.

Carl B. King hoped for family togetherness when establishing the King Foundation in 1966. Instead, the foundation ultimately became a source of friction and embarrassment under the leadership of Carl L. Yeckel, King's grandson. Yeckel's estranged sister, Dorothy “Toady” Yeckel, ultimately started the investigation that led to his downfall.

A goal to keep a family together through philanthropy must be tempered with a clear-eyed realism about the family's particular dynamics. Are there domineering parents? Feuding stepfamilies? Sibling resentment or enmity? Spendthrift children?

Philanthropy, despite the wonders it can accomplish, cannot heal deep family rifts. A family already likely to spin apart will not be held together by a joint philanthropic enterprise, and advisors should make an effort to disabuse clients of any false hopes to the contrary.

Lesson 2: Justice Holmes was right.

Supreme Court Justice Oliver Wendell Holmes, Jr., once famously observed that, on occasion, a lawyer's most valuable role is to tell the client that he's a fool. Accountants and investment advisors could assume this role as well. But professionals of all stripes are often more comfortable as obedient executors of clients' decisions, rather than candid advisors.

Estate-planning attorneys routinely learn not only the full extent of a family's wealth, but also the family's secrets of substance abuse, mental illness, infidelities or declining business fortunes. Indeed, a competent estate-planning professional should have all this information, both the hard and the soft, in order to structure an estate plan properly.

But why, armed with this same information, should the advisor limit its application to the technical parts of the plan? If a client wants to start a foundation staffed by family members who are known to despise each other, for example, the advisor should discuss with the client how the family dynamics are likely to frustrate the client's charitable objectives — to say nothing of generating legal liabilities if the foundation runs aground — and find an alternative. To warring relatives, a family foundation is more likely to become a new field of battle than a place where justice and peace will meet and kiss each other.

Lesson 3: Failure starts at the top.

Like parallel scandals in the corporate world, nonprofit scandals almost invariably result from a governance failure. The King case was no exception.

Serving on the board of a nonprofit entity, be it a private foundation or a public charity, carries genuine legal responsibilities. Texas law requires nonprofit directors to discharge their duties in good faith, with ordinary care and in a manner reasonably believed to be the corporation's best interest.2 Although the rules differ from state to state, it is clear that neither deliberate ignorance nor abdication of responsibility will do.

Texas law mandates that the board of directors manage the nonprofit's affairs.3 Yet the evidence in the King case showed a board that simply didn't make much of an effort. Board meetings apparently consisted mostly of kibitzing about investment performance. Directors never reviewed the foundation's tax returns or annual budgets. They allowed Yeckel to set salaries without interference or inquiry. Yeckel disclosed salaries to the board of directors only once, in a 1994 memo. A sole director questioned the salaries and then let the matter drop.

The board's inattention was especially troubling because of the directors' backgrounds. In addition to Yeckel, the directors included an investment consultant whose principal market was charitable endowments, an experienced oil producer and family friend, the foundation's former bookkeeper and a board-certified estate-planning lawyer whose mentor had been the lawyer for the family and foundation for decades.

Over time, the directors jeopardized their independent oversight role through other business relationships. The investment consultant provided paid consulting services to the foundation. The bookkeeper had a private pension from the foundation. The lawyer served as counsel to nearly everyone in sight: the foundation, Yeckel personally, and Yeckel as executor of both his grandmother's and aunt's estates. Thomas W. Vett, the corporate secretary, also claimed that the lawyer represented him.

Given these relationships, it is little wonder the former directors were shocked — shocked — to learn of misconduct by Yeckel and Vett. Settlements with the directors yielded more than $500,000. At the time, the foundation had no directors' and officers' liability insurance, another oversight by the overpaid president, so the directors paid the settlements personally. One director filed for bankruptcy. Another gave up half his pension. At last report, the lawyer-director was still fighting with his malpractice carrier to recover what he paid in settlement.

Although doing business with a director is sometimes legal, I suggest that no business is the best business of all. Human relationships being what they are, it's highly unlikely that a board with internal business ties will maintain its freedom of action to pursue the foundation's best interests. There's nothing quite like a client with perpetual existence to maintain a book of business, but directors should think long and hard about becoming vendors.

Lesson 4: Responsibility is real.

Yeckel claimed that his outsized salary was appropriate because his family promised him a salary commensurate with the private sector. Even if that hotly disputed assertion were true, it is irrelevant because of the state and federal laws governing charities. Yeckel's claim, however, illustrates how family foundation managers can blur the lines between family and foundation, in utter ignorance or disregard of the law.

Professional advisors must shoulder some of the blame for this ignorance. Donor surveys and news reports suggest that the administrative responsibilities of running a private foundation come as an unwelcome surprise to many new philanthropists.4 In the absence of early professional advice on the subject, it is perhaps natural for newly minted foundation managers to assume that they can run a private foundation as they do their personal affairs or the successful business that made the foundation possible.

Wealth advisors also should moderate their frequent advice that private foundations offer donors the “ultimate” control over their charitable giving. While foundations do offer control, stressing this point can encourage a belief, as misguided as it is passionately held, that the foundation's assets remain “my money” to be disposed of as the donor sees fit.

A foundation's board or staff should include people who understand budgeting, nonprofit accounting, tax, investments and grant making. This not to say that operating a private foundation should be the lone province of professional managers or that family members should not serve on the board — far from it. But private foundation boards should consider whether the foundation has the resident skills necessary to keep on the straight and narrow, and if not, how to get them.5 The days when a foundation post could be the sinecure for a long-time family employee, or the full employment program for less-than-marketable progeny, should be long past.

Lesson 5: Corporate records matter.

One area of nonprofit governance that often gets short shrift is corporate record keeping. A nonprofit corporation is generally required by law to maintain corporate records, including minutes of board meetings and board committees that carry the authority of the board.6

Yeckel claimed he was entitled to lavish retirement benefits because of a 1983 employment contract signed by his aunt, then the foundation's vice president. Vett made a similar claim based on a 1995 agreement signed by Yeckel. The foundation's corporate records showed no authorization, approval or ratification of either agreement, and an entire years' worth of minutes were missing. All of the 1983 directors who supposedly ratified the Yeckel agreement were deceased, and the 1995 directors denied approving the Vett agreement. With no corroborating testimony or records, Yeckel and Vett were unable to convince the jury that the board ever approved the employment agreements. The judge ruled both contracts to be void from the beginning — and rightly so on multiple grounds.

In practice, board minutes should clearly show any board decision approving contracts, hiring investment managers, awarding or declining grants, approving budgets, or adopting policies. A lawyer serving on the board has a special obligation to ensure that corporate formalities are observed.

Lesson 6: Trust but verify.

Foundation directors generally may rely on the financial and other reports prepared by officers or employees of the foundation.7 But directors would do well, in the words of former President Ronald Reagan, to “trust but verify.”

Verification can come about in a number of ways. For example, the board should consider what internal controls or administrative policies are necessary to give the directors confidence in the integrity of financial reports, assurance that controls and policies are followed and protection against abuses. Obtaining a regular independent audit and management letter is a superb way to gain assurance of both the quality of the foundation's internal controls and the reliability of the financial statements presented by staff.8 The King Foundation was never audited until a new board took control in 2003, a step that would have uncovered the substantial credit card abuse years earlier.

A board's financial oversight also should include a review of executive compensation and a thorough understanding of the method for setting it. Private foundations can pay reasonable compensation for services provided.9 The Council on Foundations recommends that private foundations follow a compensation-setting process that includes approval by a disinterested board, reliance on comparable data, and concurrent documentation of the basis for the board's decision.10

Regulatory interest in compensation and governance is growing across the nonprofit sector. Senate Finance Committee Chairman Charles Grassley sent a four-page letter to the American Red Cross in December 2005 inquiring about a range of issues, from how the compensation of the former president had been set, to how many board members attended meetings.11 The Exempt Organizations section of the Internal Revenue Service announced last fall that it will continue its 2005 investigations of executive compensation at charities through 2006.12 The IRS recently revised Form 990, the informational tax return filed by public charities, to include specific questions about conflict of interest policies and compensation. Similar revisions to Form 990-PF, the private foundation tax form, can't be far behind.

Lesson 7: Enforcement works.

In the past two years, there has been much discussion about the need for new nonprofit laws, and I would agree that some changes are necessary. But the reformers shouting the loudest about nonprofit abuses curiously avoid the one real change that will help address problems in the sector: increased enforcement.

The Charitable Trusts Section of the Texas Attorney General's office has just a handful of lawyers and investigators, yet is responsible for overseeing an estimated 63,000 Texas-based charities. The IRS is similarly understaffed. The IRS conducts only about 100 nonprofit audits a year, while the number of IRS-recognized charities, both public and private, stands at more than one million.

Until both state legislatures and Congress are willing to allocate greater resources for enforcement and stand behind the regulators, impassioned demands for new laws and regulations — supposed cures for what ails the sector — amount to nothing more than barkers' calls for patent medicines.

Lesson 8: Remember the roots of philanthropy.

Philanthropy is as old as humanity itself. It is only during the course of the last century that charity has developed the legal and tax structure and societal role that it possesses today; and nowhere more than in the United States.

The size and scope of the charitable sector in this country, although wondrous, also can obscure the tiny seed of human connection found at its roots. Donors' motives for philanthropic giving can be a complex mixture of altruism, vanity and tax advantage. But I am convinced that even the vainest or most tax-motivated donor still has that seed of connection buried somewhere.

The cynicism that gives rise to charitable abuses ignores the power of what the late Alan Pifer, former president of the Carnegie Corporation, called “the extraordinary social invention for which those of us in the foundation field today are the current guardians.”13 Foundation grants have helped create incredible things: the polio vaccine, the American public library system and the 911 emergency system, to name just a few. Who knows what future advances will come from today's philanthropies?

At its center, any charity — large or small, public or private, family or independent — is one person trying to make life better for someone else. Surely making things better deserves our best.

Endnotes

  1. Press Release, Council on Foundations, “Council Places Getty Trust on Probation” (Dec. 20, 2005). The Indiana and Nevada attorneys general sued the Olin B. and Desta Schwab Foundation, formerly based in Indiana, claiming the board improperly moved the foundation to Nevada to escape regulatory attention. “State Sues Schwab Foundation,” Fort Wayne Journal Gazette, Dec. 29, 2005; “Schwab Assets Frozen,” Fort Wayne Journal Gazette, Jan. 7, 2006.
  2. Texas Business Organizations Code Section 22.221.
  3. Ibid, Section 22.201.
  4. Stephanie Strom, “New Philanthropists Find Drudgery,” N.Y. Times, Jan. 12, 2003; What California Donors Want: In their Own Voices, National Center for Family Philanthropy, 2004.
  5. Extensive resources are available to foundation boards and managers through professional associations such as the Council on Foundations, the Association for Small Foundations, regional associations of grant makers like the Conference of Southwest Foundations, and sometimes citywide grant makers groups.
  6. Revised Model Nonprofit Corporation Act Section 16.01.
  7. Ibid, Section 8.30(b).
  8. The American Institute of Certified Public Accountants offers a number of useful tools on its website to help nonprofit organizations ensure financial accountability. See “The AICPA Audit Committee Toolkit: Not-for-Profit Organizations,” www.aicpa.org/audcommctr/toolkitsnpo/homepage.htm.
  9. Internal Revenue Code Section 4941 (d)(2)(E). Similar provisions exist at the state level, such as Texas Business Organizations Code Section 22.054 (a corporation may pay “compensation in a reasonable amount to the members, directors, or officers of the corporation for services provided”).
  10. Recommended Best Practices in Determining Reasonable Executive Compensation, Council on Foundations, December 2002.
  11. Press Release, Senator Charles Grassley, “Grassley Questions Red Cross Board on Its Practices, Effectiveness” (Dec. 29, 2005).
  12. Internal Revenue Service, FY 2006 Exempt Organizations (EO) Implementing Guidelines, October 2005.
  13. Alan Pifer, “Speaking Out-Reflections on Thirty Years of Foundation Work,” Foundation News & Commentary, July/August 1997.

HOW BAD WAS IT?

Don't let this happen to a foundation or family you advise

Carl L. Yeckel, the founder's grandson, became president of the Carl B. & Florence E. King Foundation in 1993. His salary was $227,000 that year; the foundation's assets were $31.5 million.

Yeckel's annual salary reached $975,000 in 2002 on net assets of $26 million. That year, the average salary of chief executive officers at the nation's 10 largest private foundations (with assets between $3.5 billion and $24 billion) was $442,000.

The salary of the staff accountant and corporate secretary, Thomas W. Vett, was $122,000 in 1993, and $450,000 in 2002.

Yeckel and Vett claimed they were entitled to retirement benefits of 75 percent of their last years' salaries for life, with survivorship benefits for their wives.

Between 1997 and 2002, Yeckel and Vett charged $750,000 in personal expenses to foundation credit cards for family vacations overseas, collectible fountain pens, antique toy soldiers, veterinary bills and other personal items. There were more than 5,000 separate charges for such items.

A trial court in Austin, Texas, on Aug. 20, 2004, ordered Yeckel to pay $5.3 million in actual damages and prejudgment interest and $10.5 million in punitive damages. At the same time, that court ordered Vett to pay $2.3 million in actual damages and interest, with $3.5 million in punitive damages. The foundation itself was originally a defendant in the case, but realigned as a plaintiff after all the previous directors resigned and a new board was appointed.

In addition to the monetary judgments, the court voided Yeckel's and Vett's pension claims. Removal of that $10 million liability, along with lower administrative expenses and better investment management, has increased the foundation's current assets to more than $50 million.

The current president's annual salary is $100,000. There is no longer a paid corporate secretary.

Yeckel appealed the state court judgment in November 2004 and filed for bankruptcy reorganization under Chapter 11 in August 2005. The bankruptcy court allowed the state appeal to continue and converted Yeckel's bankruptcy to a liquidation under Chapter 7. The state appeal is pending in the Texas Third Court of Appeals in Austin. Yeckel filed another lawsuit in the federal district court in Dallas in January, again arguing his entitlement to a pension. Meanwhile, the foundation continues its efforts to collect its judgment within the bankruptcy proceeding. In addition to the foundation's judgment, Yeckel is facing an IRS demand for $13.2 million in self-dealing penalties alone.
Michelle D. Monse

Collectors' Spotlight

American Masters: “Mother and Two Children” was painted in 1906 by Impressionist artist Mary Cassatt, famous for her paintings depicting mothers and their young children. The painting sold for $4.3 million at Christie's “Important American Paintings, Drawings & Sculpture Sale” in New York on Dec. 1, 2005.