California’s Attorney General filed suit against the L.B. Research Foundation (“L.B.”) and its board members this past September, disclosing alleged areas of “gross mismanagement” and requesting involuntary dissolution of the organization.
The apparent deficiencies noted, as described below, could easily occur in charities that are not aware of pertinent legal requirements.
Failure to Maintain Adequate Books & Records
L.B. was unable to produce many of the many of the documents requested by the Attorney General, including adopted bylaws, grant applications, grant agreements, final grant reports, or meeting minutes for the first 7 years – all things required of private foundations under various US and California code sections.[1] Board members have a fiduciary duty of care to keep proper books.
Violation of Board Officer Rules
In California, a nonprofit public benefit corporation must have a chairman, a secretary, and a chief financial officer. The chairman cannot concurrently serve in either of the other two offices. In this case, Mr. Buckberg (the founder) was single-handedly selecting the officers – who purportedly did not even know of their appointments until the annual meeting. Board members were sometimes uninformed of the names of fellow board members. Grants were being fully distributed before the “officers” were aware of them.
The board was not operating as a board as it did not have control; all decision making was in the hands of Mr. Buckberg. This scenario may have an all too common resemblance to many nonprofit boards.
Self-Dealing
The prohibition of private inurement and self-dealing, though central to the definition of a nonprofit organization, are too often glossed over by nonprofit leadership. This apparently was true of the board of L.B. – which to all appearances was unaware that the charity could not award grants for the private benefit of board members.
Substantial contributors to a private foundation or those in management over it are considered “disqualified persons,” meaning that they are prohibited from using, receiving, or benefiting from the organization’s assets or income.[2]
Yet according to the Attorney General, L.B. reportedly made the following grants:
- Over $60,000 to UCLA Foundation to support Mr. Buckberg’s research and laboratory
- Over $120,000 to produce an educational DVD, all rights being owned by Mr. Buckberg and his cousin, and which also supported a patent owned by Mr. Buckberg and another board member
- Over $15,000 to a for-profit company owned by Mr. Buckberg and his cousin for the production of the Helical Heart Model, which was also patented by these individuals
- Over $140,000 for research which would be overseen by Mr. Buckberg
- Over $50,000 for expenses related to conferences to promote a medical device patented by Mr. Buckberg and another board member
- Over $40,000 for statistical analysis related to the same medical device
- Over $8,000 to a board member for research and a conference
- Funneling $25,000 to a board member’s friend as quid pro quo for the member’s donation
- Over $1,000,000 to UCLA to create an endowed faculty chair that Mr. Buckberg applied for, which he did not get, and then spent over $400,000 in legal fees suing UCLA for the position
Members of a nonprofit board have a fiduciary duty of loyalty, which prohibits the kind of self-dealing that was seemingly pervasive among this board, and primarily by its founder.
Expenditure Responsibility
When a private foundation makes a grant to a non-tax-exempt entity, it is required to exercise expenditure responsibility, whereby it must 1) make pre-grant inquiries, 2) enter into grant agreements, 3) obtain full and complete reports and final reports from the grantees, 4) base grants to individuals on procedures preapproved by the IRS, 5) award grants on an objective, nondiscriminatory basis from a pool large enough to constitute a charitable class, and 6) keep all records related to grants made to individuals.
L.B. adhered to virtually none of these requirements when doling out grants, which consequently should have been considered taxable expenditures.
Settlement
A settlement agreement was reached by all on December 4, requiring the organization and several of its officers to pay hefty sums, including all the Attorney General’s legal fees. The organization is required to undergo board member training and hire consultants to rework its policies and develop proper granting procedures. The board must also increase the number of independent members. Mr. Buckberg was stripped of financial control, including the checkbook. He even has to turn over his keys to L.B.’s post office box.
Although L.B. was not forced to dissolve as the Attorney General originally sought, this resolution has left the organization unrecognizable in terms of its management, and probably its reputation.
Organizations should not be lulled into apathy because past corner-cutting has yet to be exposed. L.B. Research Foundation “got away with it” for ten years before paying a big price.
Lastly, the ignorance of L.B.’s board not only didn’t serve as a defense – it was in fact counted against them.
This case and settlement can be located at the following links, respectively:
http://ag.ca.gov/cms_attachments/press/pdfs/n1799_lbresearch.pdf
http://ag.ca.gov/cms_attachments/press/pdfs/n1840_document.pdf
[1] 26 U.S.C. § 4945; California Corporations Code §§ 6620, 6321, and 6322.
[2] 26 U.S.C. § 4946(a) and (b).
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