PUBLISHED ARTICLES

January 1996

THE FOUNDATION FOR NEW ERA PHILANTHROPY DEBACLE:
NEW ERA PHILANDERING

Wendell R. Bird

TABLE OF CONTENTS

  1. THE HISTORY OF NEW ERA
    1. DESCRIPTION OF NEW ERA'S GRANT PROGRAM.
      1. Matching Donor Grants.
      2. Matching Charity Funds.
    2. LOSSES BY NEW ERA VICTIMS.
      1. Total Losses.
      2. Victims.
    3. PROCEDURAL HISTORY OF BANKRUPTCY PROCEEDINGS.
      1. Filing.
      2. Trustees.
      3. Creditors.
  2. THE FUNDS AVAILABLE FOR CHARITIES
    1. TRUSTEE FUNDS.
    2. POSITIVE DONEES.
    3. THIRD PARTIES.
    4. ALLOCATIONS.
  3. LEGAL PRINCIPLES FOR ALLOCATING AMONG CHARITIES
    1. PREFERENCE PAYMENTS DURING THE PRECEDING 90 DAYS.
      1. Definition of Voidable Preferences.
      2. Exception for New Value Payments.
      3. Exception for Earmarked Payments.
    2. FRAUDULENT CONVEYANCES DURING THE PRECEDING YEAR.
      1. Fraudulent Conveyance Definitions.
      2. Exception for Reasonably Equivalent Value.
      3. Exception for Value and Good Faith.
    3. STATE FRAUDULENT CONVEYANCE LAWS.
  4. LEGAL PRINCIPLES FOR CLAIMS AGAINST THIRD PARTIES
    1. JACK BENNETT.
    2. PRUDENTIAL SECURITIES.
    3. NEW ERA ACCOUNTANTS AND ATTORNEYS.
    Copyright 1990 W.R.Bird. All Rights Reserved.


    I. THE HISTORY OF NEW ERA

    The largest scandal involving charities, except that of PTL and Jim Bakker, emerged in 1995 with the Foundation for New Era Philanthropy. New Era filed for bankruptcy protection, and it became evident that its "anonymous benefactors" did not exist to provide matching grant funds. Instead, matching funds came from later receipts from individual donors or charities, and New Era amounted to a grant Ponzi scheme.

    1.     DESCRIPTION OF NEW ERA'S GRANT PROGRAM.

    The Foundation for New Era Philanthropy derived its name from offering a new approach to fundraising, with a heavy emphasis on matching grants from "anonymous benefactors."

    A. Matching Donor Grants.
    The three-party transactions involved a donor to a charity depositing the funds with New Era for six months (or a stated time period) in order for a larger amount (typically double) to be delivered to the charity. This was said to be possible through "anonymous benefactors."

    B. Matching Charity Funds.
    The two-party transactions involved a charity depositing its own newly-raised funds with New Era for six months (or a stated time period) in order for a larger amount (typically double) to be delivered back to the charity. The New Era annual report is attached as Appendix A.

    New Era reported that its 1993 contributions received were $41,259,917, and contributions paid and other program services were $36,319,839. Form 990 at 1.

    Its contributions received in prior years were $8,641,170 in 1992, $2,616,847 in 1991, $1,402,946 in 1990, and $306,201 in 1989. Id. Sch.A at 2.

    The trustee has characterized the New Era scheme as "a fraudulent scheme, whereby the Debtor misdirected subsequent principal funds placed into the Fund to pay principal and matching funds to prior depositors or contributors' designated third party charities. Schemes of this nature are commonly referred to as 'Ponzi' schemes. . . . [T]he Debtor operated the Fund as a 'Ponzi' scheme."

    2.     LOSSES BY NEW ERA VICTIMS.

    A. Total Losses.
    New Era's voluntary petition listed assets at $80,000,000 and liabilities at $551,000,000 minus Prudential Securities accounts of $45,000,000. Voluntary Petition at 3, In re Foundation for New Era Philanthropy, No. 95-13729BIF (Bankr. E.D. Pa. May 15, 1995). The interim trustee's schedules and statement of affairs listed $97,991,671 in cash losses (exclusive of promised doubling of donations). This amounted to cash in of $225,940,164, and cash out of $153,392,891.

    B. Victims.
    The interim trustee's schedules listed 255 donors and charities who placed cash in New Era. These included financiers such as Laurent Rockefeller, a Goldman Sachs partner, and William Simon, and institutions such as the University of Pennsylvania, American Red Cross, and Nature Conservancy. Schedule of Net Cash Loss, In re Foundation for New Era Philanthropy, No. 95-13729BIF (Bankr. E.D. Pa. June 16, 1995).

    3.     PROCEDURAL HISTORY OF BANKRUPTCY PROCEEDINGS.

    A. Filing.
    New Era filed voluntarily for bankruptcy on May 15, 1995, hoping to keep Chapter 11 status. The judge converted the bankruptcy to Chapter 7, and ordered the appointment of a trustee, on May 19. New Era filed, with the petition, an emergency motion to seal the required list of creditors. The Philadelphia Inquirer, the New York Times, and other publications and creditors opposed the motion. The judge denied the motion, on May 18. Prudential Securities held approximately $44 million of New Era's funds. It filed a motion to excuse turnover of the funds to New Era or its trustee, and to freeze the funds, on May 15. Thus, Prudential knew in advance of the bankruptcy filing. The court granted that motion, on May 16 and May 18. The court then ordered Prudential to turn over the funds to the trustee, along with a list, on May 24.

    B. Trustees.
    An interim trustee, John Carroll, was appointed on May 19, 1995. He unified creditors against him when he notified them that he would oppose all their proofs of claim and notices of claim, evidently seeking to disqualify all or most creditors from voting on a permanent trustee. A successor trustee, Arlin M. Adams (a former Third Circuit judge), was then elected by the creditors, on June 26, 1995. The court confirmed his appointment on July 6. He selected legal counsel, Buchanan Ingersoll of Philadelphia, and accountants.

    C. Creditors.
    The first meeting of the creditors occurred on June 26, 1995. That set the last day to file proofs of claim 90 days later, at September 25, 1995. Two primary unofficial committees of creditors have been formed: the Philadelphia Informal Creditors Committee (primarily secular organizations) and the United Response (primarily religious organizations, sponsored by the Evangelical Council for Financial Accountability).



    II. THE FUNDS AVAILABLE FOR CHARITIES


    There are three primary sources for recovery by negative donees: trustee funds, positive donees, and third parties.

    1. TRUSTEE FUNDS.

    The trustee received approximately $30,000,000 from Prudential's accounts for New Era or its charitable participants. The trustee is pursuing adversary proceedings against Jack Bennett, Prudential, and others.

    2. POSITIVE DONEES.

    The positive donees received funds beyond what they or other donors deposited. The trustee is entering settlement agreements with positive donees, under which they repay the excess or positive amount and are released. E.g., Motion of Arlin M. Adams, Trustee, for Approval of Settlement Agreement and Release between Trustee and Turning Point for Women at 5, In re Foundation for New Era Philanthropy, No. 95-13729BIF (Bankr. E.D.Pa. filed Nov. 22, 1995). The trustee can be expected to file claims against those positive donees that do not voluntarily settle.

    3. THIRD PARTIES.

    The most likely third parties against whom trustee claims and private claims will be, or are being, litigated are Prudential Securities, New Era's accountants, and New Era's attorneys. These are discussed in IV below.

    4. ALLOCATIONS.

    The most likely allocation of New Era funds is as follows:
    a. Administrative claims, such as the trustee, his legal counsel, and his accountants.
    b. Trade creditors.
    c. Negative donees, who placed funds with New Era for themselves or for other charities, and whose funds were not delivered before bankruptcy.

    It is expected that there will be a significant shortfall in repaying the negative donees, and that there will be nothing to pay donees promises beyond their actual funds lost.


    III. LEGAL PRINCIPLES FOR ALLOCATING AMONG CHARITIES



    New Era's bankruptcy case is under Chapter 7 of the U.S. Bankruptcy Code, which provides for liquidation of the debtor. Under bankruptcy law, any total net amounts received from New Era in excess of funds previously contributed to New Era within the 12 month period prior to the bankruptcy will likely constitute a "fraudulent conveyance" which must be paid back to the bankruptcy estate. One exception covers "new value," or subsequent payments by the organization back to New Era, which can offset prior payments received from New Era during the preference period. Another exception exists for payments earmarked for the recipient organization. Funds received from New Era prior to making any payments to New Era may also constitute fraudulent conveyances which must be paid back to the bankruptcy estate.

    In addition, any amount received from New Era within 90 days before the May 15 bankruptcy filing will almost certainly constitute a "preference payment" which must be paid back to New Era. However, any preference payments received from New Era within that 90 day period should be offset by subsequent payments by the organization to New Era, but likely will not be offset by payments to New Era before the preference payment was received. The earmarking exception might not apply.

    In addition to bankruptcy law, even if payments occurred more than one year before the bankruptcy, the fraudulent conveyance law of the applicable state may require that funds received from New Era be paid back to New Era.

    For a Chapter 7 bankruptcy liquidation, the Bankruptcy Code provides that certain payments by New Era prior to its bankruptcy be paid back to New Era for distribution to New Era's creditors. Under the bankruptcy Code, the two primary tools for requiring third party creditors to return funds received from New Era are provisions regarding "preferences" and "fraudulent conveyances."

    Several cases have addressed the bankruptcy of a Ponzi scheme, which generally involves the use of funds from new investors to pay returns promised to earlier investors. These cases include In re M&L Business Machine Company, Inc., 160 B.R. 851 (1993); In re International Loan Network, 160 B.R. 1 (1993); In re Mark Benskin & Co., Inc., 161 B.R. 644 (1993); In re United Energy Corp., 944 F.2d 589 (9th Cir. 1991); and In re Independent Clearing House Co., 77 B.R. 843 (1987). These court cases addressed the application of preference and fraudulent conveyance doctrines to payments received and paid out by organizations that turned out to be Ponzi schemes.

    1.     PREFERENCE PAYMENTS DURING THE PRECEDING 90 DAYS.

    A. Definitions of Voidable Preferences.

    The Bankruptcy Code provides that certain payments made to creditors within 90 days prior to New Era's May 15 bankruptcy filing (in other words, on or after February 16) must be paid back to the debtor's "bankruptcy estate" for distribution to all the creditors.

    Section 547 of the Bankruptcy Code provides that a payment is a voidable preference if the transfer was:

    1. to or for the benefit of a creditor,
    2. for or on account of an antecedent debt owed by the debtor before the transfer was made,
    3. made while the debtor was insolvent,
    4. made within 90 days before the filing of the petition (or within one year if the creditor as an "insider"), and
    5. the transfer enables the creditor to receive a greater percentage of its claim than the creditor would have received had the transfer not taken place and the debtor's assets had been liquidated in a Chapter 7 case.

    Payments by New Era to organizations within 90 days of the bankruptcy filing will almost certainly be classified as voidable preferences. The organizations that contributed funds to New Era are listed in the bankruptcy petition as "creditors" and will be considered unsecured creditors of New Era bankruptcy estate (see M&L Business Machine). Payments to New Era created a "debt" under the Bankruptcy Code's broad definition of debt. The bankruptcy trustee will be able to show that New Era was insolvent, and will be able to specify which payments were made within 90 days of the bankruptcy. The question of whether the preference exceeds the expected recovery on liquidation will depend on the facts of each organization's situation.

    The preference period is one year (instead of 90 days) if the creditor was an insider or affiliate of the debtor.

    B. Exception for New Value Payments.

    However, Section 547(c)(4) of the Bankruptcy Code provides if a creditor provides "new value" to the debtor after receiving a preference payment, then only the net preference amount must be returned to the bankruptcy estate. This is often called the "subsequent advance" defense. It is important to note that this netting process only applies to payments to the debtor made after the voidable preference payment was made to the creditor within 90 days of bankruptcy (see M&L Business Machine).

    For example, if New Era paid an organization $10,000 fifty days before the bankruptcy and ten days later the organization contributed $6,000 back to New Era, then the net preference would be $4,000. However, a $50,000 contribution by an organization to New Era seventy days before the bankruptcy would not offset the $10,000 preference because it was made before receiving the preference payment.

    C. Exception for Earmarked Payments.

    A payment may not be considered a preference payment if it the payment consisted of "earmarked" funds. Under the "earmarking doctrine", where property of a third party is given to the debtor, but is earmarked for payment to a specific creditor of the debtor, the bankruptcy trustee cannot void the transfer as a preference, as long as the property does not become property of the debtor.

    The earmarking doctrine could be especially helpful where a third party donor gave funds to New Era which were designated to be distributed to a particular organization.

    The key factual determination is whether the funds became the property of the debtor (New Era) or whether the funds were sufficiently segregated so as to constitute earmarked funds. If the third party donor funds were not segregated and were deposited directly into New Era's account and were commingled with other New Era funds, then the funds were not sufficiently earmarked and the earmarking doctrine likely will not apply. However, if the donor funds were deposited in a separate account and clearly designated for the exclusive use of the recipient organization, such payments may be sufficiently earmarked so as to prevent their disbursement from being construed as a voidable preference.

    The trustee is taking the position, in order to avoid the earmarking or deposit rule, that "in order for the contributors to deduct the contributions from their income they had to agree that the contribution was a gift to the Debtor and to give up all rights, title and interest in and to the principal contributed into the Fund." E.g., Motion of Arlin M. Adams, Trustee, for Approval of Settlement Agreement and Release between Trustee and Turning Point for Women at 3, In re Foundation for New Era Philanthropy, No. 95-13729BIF (Bankr. E.D.Pa. filed Nov. 22, 1995). However, that argument would only apply to individual donors, and not charity donors or charities depositing their own funds for matching.

    2.     FRAUDULENT CONVEYANCES DURING THE PRECEDING YEAR.

    A. Fraudulent Conveyance Definitions.

    Any payments by New Era to an organization within 12 months prior to the bankruptcy in excess of amounts previously contributed by the organization will likely be voidable preferences which must be returned to the New Era bankruptcy estate. The trustee is likely to use the fraudulent conveyance provisions of the Bankruptcy Code to require the repayment of certain funds distributed by New Era within a year prior to the May 15, 1995 bankruptcy filing.

    There are two definitions of fraudulent conveyance; the first is set out in Section 548(a)(1) and the second in Section 548(a)(2).

    First Definition: Section 548(a)(1) of the Bankruptcy Code provides that the debtor has fraudulently conveyed property if: (i) there is a transfer of an interest of the debtor in property to a third party, (ii) the transfers take place within one year of the filing of the bankruptcy petition, and (iii) the transfers were made by the debtor with actual intent to hinder, delay or defraud creditors.

    The question of whether the funds were transferred within one year depends on the facts of the particular organization's situation. Courts addressing the issue have consistently held that Ponzi schemes inherently involve intent to hinder, delay or defraud. Alternative Definition: Section 548(a)(2) of the Bankruptcy Code provides a second definition of constructive "fraudulent conveyance" consisting of the following elements:

    1. a transfer of an interest of the debtor in property,
    2. the transfer must have been made within one year of the date the bankruptcy petition was filed,
    3. the debtor must not have received reasonably equivalent value in exchange for the property transferred, and
    4. the debtor must have been insolvent, or have been made insolvent, by the transfer.

    Regardless of which definition is used, an organization may be able to defeat the fraudulent conveyance argument and keep funds it has received from New Era, to the extent that the amount of funds received was less than the dollar amount of funds contributed to New Era. These defenses are the "reasonably equivalent value" defense and the "for value and in good faith" defense.

    B. Exception for Reasonably Equivalent Value. The second definition of fraudulent conveyance under Section 548(a)(2) does not apply if the debtor (New Era) received reasonably equivalent value in exchange for the property transferred.

    The In re Independent Clearing House Co. court held that the debtor received a "reasonably equivalent value" in exchange for all transfers to the creditors that did not exceed the amount the creditor had previously paid to the debtor. However, to the extent a creditor received more than it gave the debtor, the excess represented a fraudulent conveyance. This argument is based on the theory that anyone who unknowingly invests in a Ponzi scheme has a legal and equitable right to receive his investment back, and any amount paid out by the Ponzi scheme first goes to pay back this investment. Because the pay out by the scheme reduces the legitimate amount owed to the investor, the debtor has received "reasonably equivalent value" for the payment.

    However, the "reasonably equivalent value" exception will likely only apply to the extent that the debtor receives property or satisfaction of an already existing debt. This becomes important in the New Era situation because some organizations received funds from New Era before paying any money to New Era. These transfers are likely to be considered fraudulent conveyances by New Era's trustee because the recipient organization had not yet made any initial payment that was being recouped.

    The New Era situation differs from other Ponzi schemes in that third party donors were involved, with the result that some organizations received New Era funds prior to making any payment to New Era. In the typical scheme, an investor pays funds in before receiving any return. However, in the In re International Loan Network case, there is an analogous situation where some persons apparently invested money on behalf of others. The court found that it was the individual on whose behalf a person invested money who has the claim against the bankruptcy estate. The right to participate belonged to the name of the person listed. In the New Era situation, this may allow organizations that received third party donor money and matching grants to be treated as the creditor with respect to the third party donations, which may help avoid the problem of receiving funds prior to contributing any funds.

    C. Exception for Value and Good Faith. An exception provided by Section 548(c) may insulate the creditors from the trustee's power to avoid fraudulent conveyances, regardless of which definition of fraudulent conveyance is used. Section 548(c) exempts transactions where the creditor "takes for value and in good faith."

    The In re Independent Clearing House Co. court held that contributors to a Ponzi scheme gave "value" to the extent of their contribution to the scheme. The court concluded that only the amounts received in excess of amounts previously contributed constituted fraudulent conveyances. Once again, the cases do not address situations where the recipient received funds prior to investing any funds in the scheme. The question of whether contributions to the Ponzi scheme were made in "good faith" is a factual one. Courts have found an absence of good faith where the contributor to the Ponzi scheme knew it was a Ponzi scheme. In the M&L Business Machine case, the court found an absence of good faith where the participant in the Ponzi scheme did no due diligence, accepted post-dated checks and was promised very large profits. For the most part, those who contribute money to New Era appear to have a strong argument that they acted in good faith.

    D. Possible Exception for Earmarked Payments. It is possible that the exception discussed above for earmarked payments will apply during the prior year, as it does during the prior 90 days, to bankruptcy.

    3.     STATE FRAUDULENT CONVEYANCE LAWS.

    Section 544(b) allows the bankruptcy trustee to avoid "any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim." The "applicable law" is that state law that applies, usually that state's Fraudulent Conveyance Act. Most states have Fraudulent Conveyance statutes that function essentially like the fraudulent conveyance provisions under the Bankruptcy Code as discussed earlier in this memorandum. The key difference is that state fraudulent conveyance statutes often reach back for a longer period of time than the one year provided by the Bankruptcy Code.


    IV. LEGAL PRINCIPLES FOR CLAIMS AGAINST THIRD PARTIES



    1. JACK BENNETT.

    Bennett was the president of New Era. Although its Form 990 for 1993 listed his compensation as $0, in fact his consulting company received substantial payments from New Era.

    Bennett made the false claim that New Era had anonymous benefactors that would match donors' and charities' funds, and apparently designed the New Era structure.

    2. PRUDENTIAL SECURITIES.

    Prudential was the depository for a substantial part of New Era's funds. New Era told donors and charities that their funds would be in "quasi-escrow" accounts at Prudential, and Prudential personnel confirmed that when various donors and charities called. In fact, there were no escrow accounts, or anything like them, at Prudential.

    A typical New Era memorandum to charities informed them that

    The Foundation for New Era Philanthropy has established a quasi-escrow account in the amount of $...... at Prudential Securities for the benefit of [charity] with a maturity on [date]. . . . The investment vehicle used: U.S. Treasury Bill. The code given to the agent to designate your account: [a code].
    See Appendix B.
    Charities can be expected to argue that funds delivered to "quasi-escrow accounts" at Prudential Securities were never New Era's, and were always earmarked to the charity as its property, held in a "quasi-escrow" account at Prudential. There is no way to predict the success of this argument.

    3. NEW ERA ACCOUNTANTS AND ATTORNEYS.

    New Era's accountants were John P. McCarthy & Co. That firm audited New Era for 1993, with an unqualified auditor's report, and performed accounting services in 1994. The firm had not conducted the 1994 audit when New Era filed for bankruptcy.

    New Era's attorneys were Dechert Price & Rhoades.



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