The Madoff Opportunity
Madoff. What more is there to say. Pretty soon, we’ll be saying “so-and-so pulled the most amazing ‘madoff.’” Poor Mr. Ponzi may end up being left by the wayside, eclipsed by the shear scale, the unreal duration, and the depth of betrayal exhibited by the now jailed Bernie. But, as we all rue his very birth, I think it worth asking a question about just how and why so many charities and their assets went down the drain.
These charities that invested much or, in the case of several, all their assets with the now notorious Mr. Madoff have exposed just how poorly they oversaw the investment process. Two questions emerge. How could regulators have failed to expose the fraud long before it was made public? Second, are the standards for charities in this regard adequate for the quasi-public nature of charitable funds? The first I will leave to the myriads of people addressing it (though I will be avidly consuming every article I can find on the subject). The second question, though, fascinates me. My conclusion? The answer is a simple “no.”
Let me explain. Most funds “owned” by charities are the result of gifts to charities by donors, both living and dead. These assets were significantly aided by our system that rewards donors with tax deductions for the gifts. The theory is simply that our society benefits from private charity: schools, volunteer fire departments, museums, symphonies, environmental organizations, faith organizations, and all the rest. This rich tradition evolved from the earliest days of the Pilgrims and has been honored and honed into a tax regime that allows charities, including foundations often controlled by the donor’s family, to manage their own assets with no more scrutiny than an annually filed tax return that shows the results. Independent audits, while frequent with larger charities, are not required. No audit would have uncovered the Madoff fraud, by the way, since he would have falsified “confirms” just has he did the investment statements themselves.
What he would not have survived, and didn’t, was the scrutiny of knowledgeable professionals. The press has reported on a number of instances where charities or individuals sought the advice of experts, where those experts simply didn’t find Madoff credible, and where potential clients passed on the opportunity or limited their exposure. These firms analyze and advise on the hiring of asset managers; firms like Mercer Consulting, Cambridge Associates, Deloitte Consulting, and many more. Such reviews should be made mandatory for charities with any substantial sums invested. In other words, charities should have higher bar.
I’m not optimistic such a reform might be adopted. The field of philanthropy has been reluctant to curtail the discretion of its members, even in the face of the abuses of some. One of the most alarming developments in the field is not new, but touches on this issue. The Fidelity Gift Fund was formed in 1991 and successfully received exempt status from the IRS. What was so shocking to me was that the Fund limited its investments to a set of choices from within the Fidelity group of mutual funds. Its board, while nominally independent, has never even considered investments elsewhere – something that normal charities should consider periodically, as a matter of prudence. The advent of Fidelity, quickly followed by Vanguard and Schwab and many banks, has in many ways hamstrung the field. No longer can we see ourselves as separate from the financial industry; instead, we have become part of it. No longer do we celebrate our role as fiduciaries in the same way; instead, good directors or trustees may be those “who can get you in with Bernie…..you know, he doesn’t let everyone in….”
I certainly don’t want to malign the entire field, and I know many very serious trustees who take their fiduciary role very seriously. I know many of them would support a shift requiring audits, independent investment committees, obligatory reporting of financial malfeasance, and a separation of the “commercial” funds from their captor investment companies.
We are all coming out of the fog of 30 years of venerating the private good over public purpose. As a field devoted to public purpose, let’s use the opportunity to ask some hard questions. If we don’t, we will risk the shaky public trust that we have.