New Jersey Attorney General Anne Milgram recently sued the trustees of the Stevens Institute of Technology (Stevens Institute) and several of its officers, accusing the nonprofit, in what appears to be a reprise of the Allegheny Health, Education, and Research Foundation (AHERF) story, of misusing donor money and excessively compensating its president. The AHERF lawsuits alleged that funds from restricted AHERF accounts were used for improper purposes, including covering AHERF's operating losses instead of their original charitable purposes.

The attorney general is seeking the removal of the Stevens Institute board president and chairman and the appointment of a monitor to oversee the organization’s finances. The attorney general has alleged that the board and officers breached their fiduciary duties by adopting a growth plan to "aggressively expand and modify, among other things, [the nonprofit’s] research activities, curricula, student body, faculty, program and infrastructure." The breaches, according to the attorney general, included:

  • Misappropriating restricted funds to fund Stevens Institute’s operating budget and for other purposes in violation of the donors’ restrictions;
  • Collateralizing endowment assets without board approval and in violation of donor imposed restrictions;
  • Excessively borrowing from Stevens Institute’s endowment and imprudently appropriating gifts;
  • Engaging in "grossly-negligent, imprudent and ultra vires transactions that often violated donors or the board’s spending restrictions"; -6- Health Law Update–October 1, 2009 The administration’s expenditure of endowment fund investment gains above the board’s approved spending rate, without board approval, after the board declared the funds quasi-endowment funds that could not be spent without board approval;
  • The administration’s spending of endowment funds at rates (7.3 percent to 9.94 percent) in excess of that approved by the board (5.2 percent to 5.4 percent). The attorney general contended the spending rate must "preserve the endowment’s value for future beneficiaries, while satisfying current obligations";
  • Misrepresenting facts to the board regarding Stevens Institute’s spending and borrowing practices and financial management;
  • Individual trustees, board committees and administrators failing to provide key financial information and inform the board of committee actions, including executive committee actions, and administration’s actions. One former trustee told the attorney general that the "Board of Trustees is a Mushroom patch and always has been;"
  • Employing grossly negligent internal controls and accounting practices;
  • Failure of the board to perform its oversight functions;
  • Failing to properly monitor and diversify endowment funds, resulting in excessive amounts of illiquid alternative investments in violation of the board’s investment asset allocation plan;
  • Excessively compensating the president and failing to obtain executive compensation comparability analyses;
  • Providing ultra vires loans to the president; and
  • Administration’s excessive borrowing under the organization’s lines of credit, which the attorney general characterized as long-term debt, without board approval.

Stevens Institute claimed that the attorney general was wildly overreaching her authority. Seeking to pre-empt any damage to it’s reputation, Stevens Institute filed its own lawsuit against the attorney general, accusing her of overstepping her authority by threatening legal action against Stevens Institute if it did not dramatically change its board and administration practices. Stevens Institute unsuccessfully sought to keep the proceeding under seal.

This case is part of a trend that bears watching by nonprofit directors and officers, especially in light of the New York Attorney General’s April 6, 2009, action against Ezra Merkin in connection with his self-dealing and breach of fiduciary duties on the Yeshiva University Board in connection with Bernard Madoff investments.

Officers and directors should keep the following guideposts in mind when investing nonprofit organization funds:

  • Each investment and its risks should be well understood and, where necessary, internal or external experts should be consulted;
  • All material information reasonably available and relevant to making a decision to act or not act with respect to an investment should be reviewed;
  • The investment decision-making process should be well structured and implemented pursuant to a documented well-thought-out investment plan and strategy;
  • Investment decisions should be made with reasonable care, skill and caution in a timely manner;
  • Responsibility for investment decisions should be assigned clearly to specific individuals;
  • Each investment must be consistent with (1) the organization’s ability to sustain a loss; (2) the organization’s temporal funding needs; (3) donor instructions and the organization’s governing documents; and (4) what a reasonable person would do, when considered in the context of the organization’s overall diversified portfolio of investments;
  • Sufficient resources must be provided for the administration of the organization’s investment program, provided that investment costs must be reasonable in relation to the organization’s investments and the financial skills available within the organization;
  • Investments should be monitored routinely for suitability, diversification and performance;
  • Delegations of investment authority also should be monitored routinely for appropriateness;
  • Robust conflict of interest polices and procedures should be in place to address personal, financial and professional conflicts of interest; and
  • Organizations should consider establishing an investment committee composed of individuals with strong backgrounds in accounting, financial analysis, asset and liability management and/or investment strategy.