Arts & Entertainment, Law, and Nonprofits

‘Earmarked funds’ is a loaded term

As Grand Rapids Art Museum faces trial for alleged misuse of donations, law professor and certified fundraiser weigh in

October 13, 2017
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When a philanthropist or foundation donates to a charitable organization, the laws for how it should be used can be tricky to interpret.

According to Nelson Miller, associate dean and professor of nonprofit law at Western Michigan University Thomas M. Cooley Law School, it’s not uncommon for challenges like a recent local case to occur because of gray areas.

On Sept. 22, Grand Rapids-based Howard Law Group filed a whistleblower protection lawsuit on behalf of D. Neil Bremer, former chief operating officer of Grand Rapids Art Museum (GRAM). Bremer alleges GRAM terminated his employment after he reported alleged misuse of “earmarked funds” to pay for operating expenses.

Dana Friis-Hansen, CEO of GRAM, declined to comment on the lawsuit but noted that “there is a lot of confusion surrounding this topic,” and “we fully reject the accusations cited in the complaint and have strong documentation to refute the complaint. The allegations have no merit whatsoever, and GRAM’s actions have at all times been entirely lawful and appropriate.”

The museum opened its LEED Gold-certified building in 2007 at 101 Monroe Center St. NW downtown, and public and private donations to the endowment and building fund leading up to the facility’s opening came from an array of foundations and individuals via a $75-million campaign announced in 2003.

The Wege Foundation was the lead donor, with a gift of $20 million pledged in 2002. The Downtown Development Authority donated the parcel on which the museum was built, worth $2.5 million. In 2003, the Richard & Helen DeVos Foundation donated $5 million, the Daniel & Pamella DeVos Foundation another $1 million, the Frey Foundation $1 million, Meijer Inc. $1 million and the DQF Foundation $1 million.

The Business Journal reached out to all of the above foundations to request information about whether their donations had been allocated for specific purposes, and if so, for what. All sources either declined to comment or did not respond as of press time.

Miller said he teaches a class called “Tax-Exempt Organizations” at WMU-Cooley, which is how GRAM would be classified due to its 501(c)3 nonprofit status.

In the class, he talks about “donor-advised funds,” which are different from the less clear-cut idea of “donor-restricted funds,” the term the lawsuit uses in connection to GRAM’s alleged mishandling of contributions.

According to the Internal Revenue Service, donor-advised funds are created when an entity or individual gives money to an organization that will go into a “separately identified fund or account that is maintained and operated by” the recipient organization.

Once the donation is handed over, the recipient organization has legal control over it. But “the donor, or the donor’s representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account.”

Miller said this separation is in place to prevent donors from gaming the system, i.e., putting money toward causes for which they control the outcome but still receive tax deductions.

“The donor may certainly state their wishes: ‘We intend the funds to go to this program or family in need.’ But if the donor were to control that donation, it wouldn’t be to the organization and it wouldn’t be tax-deductible,” he said. “If you say, ‘I’m going to give you $100,000, but you’re going to put it in a bank account,’ you haven’t given it away. Why should you give it to them and still expect a tax deduction?”

On the other hand, Miller said if an organization is specifically soliciting donations during a fundraising campaign, and donors agree to give funds for a specific purpose, the organization needs to honor that — and such a scenario would tie into the idea of donor-restricted funds.

“When soliciting a donation, a charitable organization must not misrepresent the use of the funds,” he said.

“If the organization said, ‘We are going to feed hungry children, and this is what it’s for,’ and the individual donated, and the organization spent it on (something else), that would be fraud. If the organization induced fraud, there are strong anti-fraud laws to address that.”

Miller noted accidental mishandling of funds does not usually happen in large, reputable organizations, but fraud allegations aren’t uncommon.

“Reputable organizations can often be challenged when they do not allocate the donations to programs but instead allocate them to operating expenses,” he said.

Catherine Rogg, president of the West Michigan chapter of the Association of Fundraising Professionals (AFPWM), said her volunteer role at AFPWM guides the work she does as development director of Wayland-based nonprofit Paws with a Cause, which helps match people with disabilities and service animals.

AFP spells out a strict professional code of ethics for the solicitation and stewardship of philanthropic funds. Member fundraising professionals must “ensure that contributions are used in accordance with donors’ intentions; ensure proper stewardship of all revenue sources, including timely reports on the use and management of such funds; and obtain explicit consent by donors before altering the conditions of financial transactions.”

“We believe ethical behavior fosters better philanthropy,” Rogg said. 

She said all 501(c)3 organizations are required to track their expenses and file an IRS Form 990 each tax season, which spells out what funds were received and how they were used.

“You need to track certain gifts with certain dollar amounts, and you receipt every gift you receive indicating where the gift will go,” she said. “Sometimes, (a gift) is submitted with no restriction at all. And other times, people make gifts, and they are highly restricted. 

“If someone were to send a $25 check in response to an appeal, unless the appeal was very specific to what they are going to use it for, the organization would put it into their main operating fund. But specific gifts go to specific purposes within the organization.”

Miller said Form 990s contain detailed information about all grants and donations, and inferences can be made about the organization’s priorities based on the percentages spent on programs versus administrative costs, fundraising or debt payments. He said his personal rule of thumb is that at least 75 percent of contributions should be spent on programs.

According to financial statements available on GuideStar from 2013, the most recent year publicly available, GRAM spent about 43 percent of its donations on programs and 54 percent on administrative costs.

“The forms are designed to catch all the red flags, like how much are you paying the top five employees,” Miller said. “If it’s excessive, that’s a red flag.”

On the other hand, not all nonprofit budgets are structured the same, he said, nor do they need to be. In one national lawsuit of which Miller is aware, donors sued a cancer organization after they discovered 95 percent of all contributions were being channeled back into fundraising. 

“(The court) ruled that there is still some charitable value to advertising the need for cancer cures,” Miller said. “They held it was not fraud to raise money and spend 95 percent of it on raising more money. I’m sure the donors were very disappointed. But the organization was still providing a public benefit about the need to fund public donations.”

Rogg said it goes back to the AFP code of ethics, which requires member organizations to clearly spell out their mission to prospective donors so they understand how the funds will be used.

“I just really believe fundraising professionals should have a lot of integrity and follow ethical standards as they pursue their profession,” she said. 

“You’re stewarding the gifts of other people and telling them you’re going to do something with their funds, and it’s a really important role that’s vital to the organization and the reputation of the organization.”

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