Tax issues raised by Madoff-related charity investment scandals.(PERSPECTIVES)

"In the 1960s, and for many years thereafter, I believed that regulation of charities was the proper province of state government, even suggesting federal subsidies to support state programs that met minimum federal standards and reliance on state attorneys general to do the regulating.

I would not advocate such measures now for two reasons. The first is a practical one: in 1964 there were ten states actively regulating charities and now, forty years later, there is only one more. The second is more basic: namely, the important change in the nature of federal regulation that has made it more suitable to police charities. Exempt organizations are no longer the stepchildren of the Service; the entire structure of the exempt organizations division has been radically altered so that it is no longer a branch avoided by Service personnel. Rather, TE/GE is staffed by specialists at the national level and for the most part in the regions who view their role as assuring that exempt charitable organizations continue to make the contributions to our society that are the rationale for the special status they are afforded in the tax system."--Marion R. Fremont-Smith, Governing Nonprofit Organizations, 2004.

Mr. Chairman, Senator Grassley, I am grateful for, and honored by, your invitation yet again to appear before your committee, this time on "Tax Issues related to Ponzi Schemes." As the head of the New York State Attorney General's Charities Bureau from 1999 to 2004, I shall testify about those issues as they relate to donors, charities, and their regulators for which the Madoff scandal has had, and will continue to have, profound bad consequences.

The damage has already forced several charities to close: the JEHT [Justice, Equality, Human dignity, and Tolerance] Foundation, the Robert I. Lappin Charitable Foundation, and the Chais Family Foundation.

I will also try to address some of the issues that relate to whether or not the more than 150 private foundations that invested with Madoff will be forced to pay onerous taxes as a result of the fraud.

In order to prevent future Madoff charity investment scandals, the committee should consider what further regulation should be required:

1) Of those charities, and of their donating individuals, trustees and officers, and investment advisors that invested materially, let alone entirely, with Madoff.

2) Of the many different public accounting firms that audited those charities and the funds through which some of them invested materially with Madoff, that apparently never discovered, as the Madoff bankruptcy trustee, Irving Picard, says, that Madoff bought no--repeat no--securities during the past 13 years. Did none of them ever test the "controls over related party transactions" or do the periodically required physical "walk throughs"? I would have thought that after nearly 50 years we would have learned something--from, for but one example, the $24 million Billie Sol Estes salad oil scandal in 1962, let alone Enron--namely that one has periodically actually to measure the oil in the tanks. [On April 15, 2009, the PCAOB released for comment a concept release that would update the standard on audit confirmations.]

3) Of lawyers, some of whom represented both the charities and their substantial contributors, both of which invested materially with Madoff--if they perceived no conflict of interest or ever exercised even ordinary due diligence.

4) Of the Public Company Accounting Oversight Board: Why did it exempt from registration auditors of nonpublic broker-dealers, which exemption it only revoked on February 19, 2009?

5) Of the Securities and Exchange Commission: Why?

A good place to start to address the Senate's concerns is the committee's Staff Discussion Draft of June 2004. Many of these proposed reforms have been enacted, but many have not. I will not here talk about all the unfinished business of charity reform, but I will discuss the staff proposals that I think most relevant to the Madoff scandal.

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