I. Executive Summary

“We will continue to work tirelessly with our partners from SIPC, the FBI, and the IRS, to track down any and all proceeds of Madoff’s Ponzi scheme and return them to their rightful owners. . .The investigation of prodigious fraud, like that of Madoff, remains one of the FBI’s top priorities. From robbers to fraudsters, the FBI will continue to bring to justice crooks who steal.” 

-Preet Bhara, U.S. Attorney

 “Nonetheless, there are some investigations underway. The California attorney general’s office has received sufficient complaints to have begun its own investigation. . . . . [C]ontacts have been made with the FBI and the Los Angeles district attorney. . . . Meanwhile, these projects will have to track down known donors, explain the details of what amounts to a fiscal sponsorship Ponzi scheme, and hope that the donors will be willing to ante up more money to make up what was lost.”

-Nonprofit Quarterly

The two above quotes may sound like depictions of the same problem, but the first statement was made by U.S. Attorney Preet Bharara concerning the money laundering, embezzlement, and fraud of white collar criminal Bernie Madoff.  The second, however, came from a Nonprofit Quarterly article about the nonprofit International Humanities Center that defrauded over 200 projects it sponsored and ran off with nearly $1 million.

While the IRS’s recent attention has been focused on scrutinizing tax-exempt applications, it has approved the tax-exempt status of charities that have engaged in money laundering and fraud. This system of abuse involves CEOs and corporate fraud, but its culprit cannot be found on Wall Street or in the boardrooms of large, publicly-traded corporations.  This fraud occurs in small, tax-exempt nonprofits, often run by one or two individuals who have discovered an opening in the tax code that allows them to dupe unsuspecting start-up charities and fly under the radar of an over-complicated tax code.

What follows in this report, based on Cause of Action’s fifteen-month investigation, is an account of a dangerous pattern of abuse that has destroyed jobs and ruined charities whose aim was the public good.  This abuse, combined with fabricated tax documents and bank statements and the mismanagement of federal grant money, paints a picture of corruption protected under the auspices of a process called fiscal sponsorship that is unmanaged, unchecked, and undefined by the Internal Revenue Service (IRS).

Whether through Congress or IRS rulemaking, the abuse of fiscal sponsorship warrants correction to protect taxpayers and charities. By clearly defining the parameters and standards of fiscal sponsorship, the IRS can alleviate its backlog of failed oversight of tax-exempt groups and prevent future non-profit Ponzi schemes.

Fiscal sponsorship was intended for good, but is being used for harm

When individuals seek to establish a new charity, they often apply for 501(c)(3) tax-exempt status in order to receive tax-exempt donations.  However, many projects only intend to exist temporarily and therefore have no incentive to seek formal tax-exempt status.  Other projects may require donations while their tax-exempt applications are being processed.  Fiscal sponsorship solves these problems by allowing existing tax-exempt organizations to accept grants and donations on behalf of the charity, or “project.”  As reflected by the current IRS scandal, the process for attaining tax-exempt status can be lengthy and arduous. For groups that either cannot afford the time or money to attain their own status before wanting to conduct their charitable activities, or have no desire to become an independent organization, fiscal sponsorship allows them to come under the umbrella of an existing non-profit organization.

But despite the benefits of fiscal sponsorship, we see in the cases of International Humanities Center (IHC), Christian Community, Inc. (CCI), and Help Is Here, Inc. (HIH) that these organizations were able to use the practice of fiscal sponsorship to abuse their tax exempt status, and in some cases even commit fraud.

IHC served as a fiscal sponsor for over 200 projects, funneling almost $1 million in project funding toward its own mismanaged debts before closing its doors.

Though IHC’s overall structure was not necessarily illegal, the organization may not have abided by the law governing sponsored projects’ individual transactions, and while the IRS was conducting an audit at the time of its collapse in 2011, former IHC employees reported to Cause of Action that the agency had focused on smaller issues and missed the fundamental problem which plagued IHC: uncontrolled and unaccountable spending.

IHC came under federal investigation for the potential mismanagement of federal grant money.

Through a Department of Energy program under the American Recovery and Reinvestment Act of 2009, Cause of Action found that IHC potentially improperly accepted federal grant funds intended for one of its sponsored projects, ultimately resulting in a DOE investigation. A criminal and civil case was pending against IHC as of April 2012 and DOE was considering debarring high-level IHC officials.

CCI fabricated tax documents, audits, and bank statements, costing its projects over $400,000 in lost funding.

CCI’s director, Steven Clapp, ran the fiscal sponsor organization for twenty years with little repercussion for his fraudulent activities.  For instance, Clapp told projects that he withheld Social Security taxes but never actually submitted the withholdings.  He also failed to file accurate 990 forms with the IRS.  When a former employee of one of CCI’s projects attempted to verify forms, payments, and legal filings by CCI, she discovered “nothing but fake colored pieces of paper.”  Prior to joining CCI, Clapp himself spent over four years in prison for bank fraud in Illinois for forging financial statements in order to obtain loans to support his business. Despite a history of financial fraud, the IRS was only alerted to potential problems at CCI when the organization failed to file its tax forms.

HIH preyed upon projects, improperly seizing funds, refusing to disburse funding to projects, and attempting to wrest control over projects which attempted to leave.

Under the leadership of Maggie Lane-Baker, HIH mismanaged funds intended for its projects which, without oversight by the IRS, were forced to take HIH to court.  HIH not only attempted to seize donations, but also claimed control over the charitable projects themselves.  When one project attempted to end its agreement with HIH, the request was denied.  While Lane-Baker eventually acknowledged that she confiscated $50,000 in funding, she claimed HIH was justified in keeping the funds.  This organization not only mismanaged money, but caused its sponsored projects to expend the time and resources required to initiate litigation, all of which could have been avoided with IRS oversight and a better understanding of how to properly structure a fiscal sponsorship arrangement.

Remedy

Cause of Action’s findings demonstrate a substantial lack of guidance regarding fiscal sponsorship that has subjected hundreds of charities to abuse and allowed substantial sums of donations—including federal government grants—to be mismanaged by unaccountable sponsors.

Furthermore, the IRS’s failure to properly oversee tax-exempt groups puts all projects who find themselves under a non-compliant fiscal sponsor at risk of losing funding and shutting down. Either Congress or the IRS must define fiscal sponsorship and remove ambiguities that have allowed groups such as IHC, CCI, and HIH to exploit and defraud American taxpayers through fiscal sponsorship.