director has two primary duties: a duty of care
and a duty of loyalty.
33 The duty of care generally
looks at the manner in which directors make decisions on behalf of the organization and requires
that a director participate in decisions, be reasonably informed, act in good faith, and act with the
care of an ordinarily prudent person in similar
34 A director is permitted to rely on
others, such as employees of the organization or
experts like lawyers, accountants, appraisers, and
35 Generally, courts will take
into account the director’s responsibilities with regard to the particular corporation, the information
available to the director at the time a decision is
made, and the director’s special expertise, if any.
The courts generally do not second-guess business
decisions, as long as the directors made reasonable
efforts to make informed decisions.
37 The duty of
loyalty requires a director to act in the best interests of the charitable organization and to put the
interests of the charitable organization before his
or her personal interests.
There is sometimes reference to a third duty
imposed on directors: the duty of obedience. Under
this duty, directors are required to comply with
all laws applicable to the organization, act in accordance with the organization’s articles of incorporation and bylaws or other relevant governing
documents, and act in furtherance of the charitable
organization’s exempt purpose or mission.
Key aspects of any claim under state law will
be the extent to which pre-investment due diligence
was undertaken, as well as whether the investments, once made, were monitored regularly. If
decisions to invest were made with little or no due
diligence, particularly if the organizations were
told not to ask questions, there may be a greater
likelihood of a breach of duty. On the other hand,
an organization that received information, even
though false, may have exercised appropriate due
diligence and should not be held accountable for
another’s fraud. Again, to protect against state
claims of breach of fiduciary duty, charities—
whether public charities or private foundations—
that invested with Madoff should document the
due diligence performed in connection with making and monitoring the investments. These foundations should also take all appropriate and practical
or feasible steps to recover the funds invested with
Madoff. For those organizations that invested all
of their funds with Madoff, of particular concern
under state law will be the failure to diversify.
Other concerns may be the lack of formal, writ-
ten agreements with Madoff and the failure to
question statements he provided. States will also
have to carefully consider whether to pursue these
claims, taking into account the likelihood of recovery, state protections afforded to volunteer directors and officers, and other considerations.
While the immediate damage caused by Madoff’s
fraud is obvious, Madoff’s long-term legacy to the
charitable community may actually be beneficial to
the nonprofit sector. Madoff’s legacy to charities is
likely to involve greater regulation of investment
activities, particularly at the federal level.
On the one hand, there are calls for changes
to the laws to penalize those who permit charities to make imprudent investment decisions. In
a recent letter to Senators Baucus and Grassley,
dated March 25, 2009, and submitted in response
to specific questions they raised, William Josephson, former head of the New York State Attorney
General’s Charities Bureau, recommends changes
to the jeopardy investment rules as they apply to
private foundations and application of the excise
tax on jeopardy investments to public charities.
Josephson states in his letter,
The legislative change that I think should
occur first ... is serious reconsideration of the
entire substance of Internal Revenue Code
Section 4944, which relates to so-called jeopardy investments. It should also be made
applicable to all public charities, as
well as to private foundations, and
enforceable by states’ charity officers by amendment of Code Section
508(e). It should become a comprehensive prudent investor and investment oversight provision, not displacing state laws ... but with sharp and
strong excise teeth.
Josephson also recommends increasing the
tax on foundation managers and making it
applicable even if no tax is imposed
on the organization.
In fact, he
no tax be
imposed on the