Who Made Off With Our Tzedakkah? Time to blame the victims
Who Made Off With Our Tzedakkah?
Time to blame the victims.

-- Daniel E. Loeb

Several prominent Jewish institutions figure among the many victims of Bernie Madoff's fifty billion dollar Ponzi scheme. They invested our tzedakkah (charitable giving) in Bernard L. Madoff Investment Securities LLC, hoping to share in the hedge funds unbelievable success, leveraging their assets in pursuit of their charitable mission. Unfortunately, the returns reported by Bernie Madoff's funds were fictive as he used the deposits from one investor to fund the withdrawals of another. This 48-year charade unraveled in late 2008, as the stock market began to plunge, investors tried to withdraw $7 billion from the firm. In the weeks prior to his arrest, Madoff struggled to keep the scheme afloat but was unable to raise sufficient capital from new investors to pay off the old investors.

Madoff claimed to be using sophisticated techniques to guarantee consistent profits of about 10% year after year. Yeshiva University believed Madoff's spurious claims that its $14,500,000 in deposits had appreciated to an astounding $110,000,000.

Two of Madoff's investors, William Foxton and Rene-Thierry Magon de la Villehuchet, committed suicide after learning that their entire life's savings had been swindled away.

Now, Bernie Madoff is under house arrest while awaiting his indictment for security fraud. Having betrayed the trust of his investors and his community, he deserves what is coming to him. The extent of this scandal is still to be determined as the FBI continues to investigate his wife Ruth, sons Mark and Andrew, co-worker Frank DiPascali, and accountant David G. Friehling.

Not to underestimate the incredible breach of trust perpetrated by Madoff and his co-conspirators, one wonders if the victims were completely blameless.

Lack of Due Diligence

As stewards of our tzedakah (charitable donations), Jewish institutions have a legal and moral obligation to apply due diligence and properly vet any proposed investment. Basic oversight was sadly lacking. As the old adage says, "If something seems too good to be true, it probably is too good to be true."

Although foundations are exempt from federal income taxes, they are subject to an excise tax, for failing to vet Madoff's proposed investments properly, to heed red flags, or to diversify prudently. Penalties range from 10 percent of the amount invested during a tax year, to 25 percent if they fail to try to recover the funds. These penalties are estimated to total a billion dollars.

The responsibility of a financial custodian to properly diversify his investments is well known to the Jewish community. Even the Talmud (T. Bava Metzia 42a) required funds being overseen to be diversified: one-third in land, one-third in business and one -third in cash.

Nobel Prize winner and Holocaust survivor Elie Wiesel founded the Foundation for the Humanity to combat indifference, intolerance and injustice through international dialogues and youth-focused programs that promote acceptance, understanding and equality. Sadly, Elie Wiesel's Foundation ignored these fundamental teachings of diversification and invested virtually all of their assets ($15,200,000) in Madoff's investment scheme. At the Foundation's grant rate of $1,507,254 per year, these funds would have otherwise allowed the foundation to continue for over a decade!

Conflict of Interest

Prior to his arrest, Madoff was well respected for his philanthropy while at the same time defrauding the very charities he contributed to such as the Gift of Life Bone Foundation. At Yeshiva University, he served as chairman of the Sy Syms School of Business and treasurer of the board of trustees. He only resigned after Yeshiva University's losses of $14,500,000 came to light.

In retrospect, Madoff was clearly not motivated by his generosity. He probably enjoyed the respect earned in the community by his largess, but more crucially his charitable work gave him the credibility and the financial connections to guarantee a net flow of cash into his hedge fund for almost five decades.

Not all charities Madoff was involved with suffered in this way. The UJA Foundation of New York averted disaster by declining to invest their endowment with Madoff citing the conflict of interest since Madoff was on their executive council.

Stockpiling Funds

Prof. Mitchell Zuckoff, author of Ponzi's Scheme: The True Story of a Financial Legend , says that "the 5% payout rule," a federal law allowing foundations to pay out as little as 5% of their funds each year if they wish, allowed Madoff's Ponzi scheme to go undetected for a long period since he managed money mainly for charities. Zuckoff notes, "For every $1 billion in foundation investment, Madoff was effectively on the hook for about $50 million in withdrawals a year. If he was not making real investments, at that rate the principal would last 20 years. By targeting charities, Madoff could avoid the threat of sudden or unexpected withdrawals."

However, why should charities amass such stockpiles of wealth that they only need 5% per year in pursuit of their charitable mission. When a charity's success in fundraising so drastically outstrips its need of the funds in the coming year, one wonders if donors should look elsewhere for charities which are in more critical need of funding. In other words, if one contributes $36 to a charity which uses only 5% of its assets each year, this donation will have no impact on its grants and program services until 2029! In comparison, a charity using "just-in-time fund-raising" will be grateful to be able to make immediate use of your contribution.

Consider for example the American Jewish Congress which "defends Jewish interests at home and abroad through public policy advocacy using diplomacy, legislation and the courts." It reported about 24 million dollars in assets, but only spends about 3 million dollars per year. At that rate, it could have continued its work through 2017 without further fundraising or investment income. Instead they invested their money with Bernie Madoff, losing 87% of the endowment!

These kinds of endowments are typical of many very successful charitable organizations, some of whom like the Jewish Community Foundation of Los Angeles lost money to Madoff's hoaxes, and their own naiveté and greed. However, other smaller charitable organizations do good work on the ground, and live from day-to-day in financial uncertainty. Being perennially short of cash, the smaller organizations are forced to rely as much as possible on volunteer support, and exercise their creativity to get things done. They constantly have to define themselves and justify themselves to potential donors in order to continue to survive.

In contrast, there is a temptation for larger charities to rest on the laurels and become bureaucratic and stagnate.

A typical investor may divide his assets into two parts: His nest egg which he needs to pay ongoing expenses and to ensure necessary expenses, and "Mad Money" defined as anything in excess of that. The investor should be especially prudent with his nest egg, but might be tempted to try any tempting investment opportunity with his "mad money". In a similar way, a charitable institution with too much money on its hands may be lulled into a sense of confidence and not exercise due diligence.

Getting Our Economy Moving Again

The Federal government has recently taking decisive action to stimulate the economy by passing the American Recovery and Reinvestment Act of 2009. However, the government can not turn around the economy by itself. Charitable organizations should not stockpile unseemly endowments. Despite decreased charitable giving during this recession, the need for program services is greater than ever: the hungry need to be fed, the uninsured require medical care, the unemployed need retraining, and the hopeless need leadership. Medical research needs to be continued. Renewable sources of energy need to be explored. Like the government stimulus package, charitable spending can also stimulate the economy by getting Americans working again, giving them purpose and putting cash in their pockets to help them provide for their families.

Food banks, synagogues, schools and other charitable organizations should step to the plate and take their program services to the next level. They ought do so of their own accord, but Harold Katzmir suggests we take this a step further:

As part of the stimulus plan, the administration should shift the IRS rule that minimum payout [from a charitable foundation] must exceed 10% for the next 3 to 5 years [compared to 5% currently]. The money in foundations is money that our society has set aside without taxation to improve our common good...Our society and the nonprofit sector need the influx of that cash now. Government is going to up taxes on everyone to pay for the stimulus eventually.Today without raising taxes, or impacting our deficits, the new administration could stimulate massive amount of activity by forcing the hands of these foundations.Many progressive and good foundations are already spending down. They are stepping up to help in this economic crisis well above the minimum IRS allocation. However, for those that wish to sit out (and sit on assets) at such a time when our society and the nonprofit sector need them so much seems unacceptable. A small change in a regulatory rule effecting so few and benefiting so many seems in order.

I have received solicitations from Madoff's victims pointing out their losses and asking for me to increase my support. In no case, have I received even a tacit admission that they failed in any way to exercise proper oversight.

It is not enough for us to point fingers at Bernie Madoff and his cohorts. We must also look at our own failures and see how our charitable institutions can make the best possible use of the generosity of our community.

Group Madoff Deposits Total Assets % of Exposure to Madoff Annual Grants/Program Services 2007 Cash Pipeline (years) Management & General Expenses Fundraising % Overhead
Jewish Community Foundation of Los Angeles $18,000,000 $458,232,577 3.93% $69,495,597 6.59 $2,178,350 $2,595,039 $2,595,039
Yeshiva University $14,500,000 $2,187,792,963 0.66% $560,078,060 3.91 $22,693,411 $15,436,260 6.37%
Elie Wiesel Foundation for Humanity $15,200,000 $9,797,817 155.14% $1,507,254 6.50 $148,627 $399,707 26.68%
New York Law School $300,000 $251,178,703 0.12% $35,753,326 7.03 $29,325,973 $1,204,113 46.06%
Hadassah (2006 data) $90,000,000 $132,644,619 67.85% $38,653,223 3.43 $7,979,258 $782,538 18.48%
Yad Sarah $1,500,000 $51,588,000 2.91% $14,796,000 3.49 $1,067,000 $709,000 10.72%
American Jewish Congress $21,000,000 $24,000,000 87.50% $3,139,375 7.64 $486,165 $1,586,289 39.76%
Bard College $3,000,000 $332,659,313 0.90% $130,662,136 2.55 $22,656,037 $1,897,464 15.82%

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