Some details in the appeals filed by 3 charities

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As mentioned previously, appeals have been filed by the three charities receiving cease & desist orders from the California A.G.

This discussion will highlight some comments in the appeals. Will have a few observation from an auditor perspective along the way. Might want to get a fresh cup of coffee before you dig in. This will be a long post.

Previous posts:

 

Catholic Medical Mission Board appeal

At seven pages, this appeal is a bit shorter than the others. The page count includes the proof of service and a cover sheet which is the page the AG provided to request an appeal.

In the appeal, CMMB denies all the factual allegations and conclusions of law (para 4). Specific assertions are listed for emphasis:

  • The AG is not properly interpreting GAAP.
  • Geographic restrictions on medicine do not make the US a prohibited market for valuation purposes.
  • Representations to California citizens are neither unfair nor deceptive.

In the appeal, CMMB requests:

  • A hearing on the AG’s findings, after discovery.
  • A preliminary hearing to request a separate hearing on whether the accounting complies with GAAP. Note the specific wording, which I will quote:

2.For a prehearing conference, at which time CMMB will request, inter alia, that the hearing officer bifurcate the hearing such that the first issue to be resolved is whether CMMB’s accounting complies with GAAP;

  • The Cease and Desist order be vacated.
  • Reimbursement of costs.

Appeal was served on April 11 by sending it via overnight delivery. Served from Santa Monica.

 

Food for the Poor appeal

This appeal is seven pages, including one page for proof of service.

In the appeal, FFP denies essentially all the factual allegations and conclusions of law asserted by the AG, excepting only such matters as FFP exists, serves the poor, provides donated medicine, solicits contributions from residents of California, and had its financial statements audited by a CPA firm.

As for valuation, the appeal asserts (which I will quote since this is the heart of the matter):

10.FFP valued its pharmaceutical gifts in kind (“GIK”) in accordance with GAAP. Specifically, FFP’s use of the U.S. as the principal market for purposes of valuing its pharmaceutical GIK, is in accordance with GAAP. To the extent that FFP was subject to any restriction by a pharmaceutical donor, which FFP denies, such restriction was an “entity” restriction and thus, was not relevant to the fair value measurement of the GIK. Further, FFP denies that it accepts pharmaceutical GIK that is close to expiration; FFP adheres to strict controls on what can be shipped and when, in order to prevent the shipping of pharmaceuticals that cannot be used in any recipient country before the stated expiration date.

The appeal asserts the U.S. is the principal market for valuation.

If I read and translate the legalese correctly, FFP denies there are any donor restrictions, but if they exist they are not an “entity” restriction and therefore the restrictions (which are non-existent, by the way) do not affect the valuation.

In terms of the functional allocation, the appeal states (which I will again quote so you can see the nuance for yourself):

11.FFP allocated its expenses associated with its joint activities in accordance with GAAP. FFP allocated expenses from its joint activities to both fundraising and program only in connection with two of its programs: (1) its “speakers bureau,” where ministry speakers appear at churches to lead the congregation in prayer and to raise public awareness about poverty in the developing world and to give American Christians the opportunity to respond directly to the needs of the poor; and (2) its donor relations department, which emphasizes prayer and customer service to its donors. In the speaker’s program, the audience criterion is met because FFP does not select the audience members, nor does FFP have any knowledge of the identities of the members of the congregations who will be present. In the donor relations activities, the audience criterion is met because FFP does not select the members based on their likelihood of giving, but rather, to accomplish FFP’s mission by praying together. FFP does not allocate any expenses in connection with any of its other fundraising activities.

I will come back to this paragraph later in more detail. Even more detail than what follows.

In the meantime, after reading FFP’s one paragraph defense CPAs will realize there are open issues on the audience and purpose criteria for both the speakers bureau and donor relations department.

Consider the focus: is the audience a congregation that invites FFP to make a presentation (by a fundraising staffer) or the individuals in the congregation? Ponder for yourself whether that is a distinction without difference.

For additional reflection, ponder whether FFP sends speakers out to congregations that aren’t expected to provide enough new donations to make the trip worthwhile, whether FFP conducts that fundraising activity in locations or in manners other than those expected to raise funds, whether education on a charity’s mission is a call to action, and whether the donor relations department takes prayer requests from non-donors.

Based solely on paragraph 11, it sure seems to me there could even be some discussion on whether the content criterion has been met.

So, after reading the appeal it seems to me the purpose, audience, and content criteria are open for discussion with the speakers bureau and it seems to me the purpose, audience, and content criteria are open for discussion with the department that interacts with…donors. For all the non-CPAs in the audience who for some reason haven’t fallen asleep yet, be advised all three individual criterion must be met.

I have personally seen two presentations from FFP at my church. I listened to each full length sermon with my auditor ears turned on. I read and re-read each fundraising brochure from an accounting perspective.  I was surprised to read in the C&DO that any costs of the speakers bureau were allocated to program.  Asserting those presentations meet the joint cost allocation criteria is somewhat problematic, in my opinion.

For the CPAs following along at home, what do you think of the comments in paragraph 11? Wouldn’t it be interesting to read the workpapers to see the pertinent audit evidence?

In the appeal, FFP requests:

  • A hearing on all the matters raised by the AG.
  • A preliminary hearing to request a separate hearing on whether the accounting complies with GAAP. Note the specific wording:

2.For a prehearing conference, at which time FFP will request, inter alia, that the hearing officer bifurcate the hearing such that the first issue to be resolved is whether FFP’s accounting complies with GAAP;

  • Dismissal of the Cease and Desist order.
  • Restore full registration with the AG.
  • Revoke penalties.
  • Reimbursement of costs.

According to the appeal, it was served on April 10 by an email to the AG with a printed copy sent via overnight delivery.

I reached out to Food For The Poor seeking comment on the functional allocation issues mentioned in the appeal, asking several specific questions focused on the joint cost allocation criteria.

In a very prompt reply, a representative of the charity indicated the financial statements were prepared in accordance with requirements of generally accepted accounting principles and audited by an independent CPA, with the audit performed in accordance with generally accepted auditing standards.

 

MAP International appeal

This is a slightly longer appeal at 10 pages, including two pages for proof of service.

Appeal says the original C&DO was dated March 7, 2018, with the first amended C&DO dated March 12, 2018, less than a week later.

I have long since learned that legal filings often contain some huffing and puffing. I realize this is sometimes needed to meet legal thresholds and sometimes it seems to be posturing. For example the AG’s C&DO for MAP contains phrases such as “materially false” (note 1), “false misrepresentation” (para 13), “misrepresentations were unfair and deceptive” (para 19), and “false and misleading” (para 25).

Some comments in the appeal are along that same line. Paragraph 2 challenges the AG’s consideration of facts and conclusions regarding application of law. The appeal calls out

… the Attorney General’s remarkable and demonstrably false contention that MAP’s audited financial statements for the years of 2012-2015 do not comply with generally accepted accounting principles (“GAAP”) …

The appeal claims the AG claims MAP should have developed a market price for each medicine in each country where a medicine might be distributed. Read para 2 for yourself:

According to the Attorney General, MAP ought to value the GIK of medicines using hypothetical market prices for each of the medicines in each of the 100 or so countries other than the U.S. where the Attorney General contends the medicines ultimately might be used.

Maybe I missed it, but I don’t recall seeing that comment. The comments in paragraph 2 aren’t really important to the appeal, but they do make for good reading.

Paragraph 7 quotes a federal court ruling defining GAAP as having many sources. As a wild guess, that may be an effort to get a variety of resources into the discussion. As an intellectual exercise for discussion by CPAs, how well do you think that quotation stands up in light of the codification of the accounting standards?

Paragraph 10a makes several defenses and concedes several points. While the C&DO asserts that “at least the majority” of donated meds are restricted from being distributed in the U.S., the appeal asserts that the volume is “less than half.” The exact comment is:

During the period at issue (2012-2015), less than half of the medicines donated to MAP were subject to donor preferences or contractual restrictions that the medicines should not be distributed in the U.S.

I’m not sure what the ramifications are on the case at hand if the weight, or the pill count, or the dollar amount of donated medicine with restrictions is over or under 50% of the total amount.

Of more interest is the comment that there are not only donor preferences but contractual requirements that some medicine may not be distributed in the U.S. This is new info to me and I’m not sure what the implications are from that additional source of restriction from a donor.

Paragraph 10b also says that the restrictions are “waived routinely.” That concept and its implications will need to be developed.  One of the unintended directions that could go is to reinforce the accounting idea that distribution is restricted except when explicitly waived.

CPAs, ponder how releasing some restrictions sometimes could have a bearing on valuation of all other medicines most of the time.

Paragraph 11 gets to the heart of the objections to the C&DO. As a rhetorical flourish it asserts the

… Attorney General’s contentions concerning the proper application of GAAP are likewise inaccurate, incomplete, and contrary to GAAP.

It seems to me that defining the principal market will be one of two key issues in the AG’s case. Paragraph 11b provides a very concise explanation of the issue when it says:

But when (the Attorney General) claims that the U.S. is not the principal market for those donated medicines that have been designed for the U.S. market and approved by the Food and Drug Administration (“FDA”), simply because they may be destined for eventual distribution outside of the U.S., the Attorney General ignores or misapplies the generally accepted accounting principles (including, for example, the applicable FASB standards) that demonstrate that in almost all instances, the U.S. is the principal market for the GIK of medicines at issue here.

It then takes a subtle jab, correctly pointing out GAAP contains no reference to

…the Attorney General’s novel concept of “the prohibited market.”

Paragraph 11c points out the definition of “access” will be critical to defining the principal market.

Paragraph 11d addresses what seems to be the second of two critical issues, that of entity restrictions. Quoting it in full, 11d says:

11.d.The Attorney General misapplies GAAP where a donor expresses a preference to MAP or contractual restriction in the donor’s agreement with MAP that the donor’s GIK of medicines should be distributed outside of the United States. Contrary to the Attorney General’s position, these sorts of “entity restrictions” represent limitations on MAP as an “entity,” but do not change the intrinsic character of the medicines themselves. Thus, an entity restriction does not impact the value of the donated medicines.

The entity restriction concept will require more discussion. If you have already started your own research, try reading the Nonprofit Audit and Accounting Guide with fresh eyes, as if you didn’t already know what we accountants think it means.

The appeal requests:

  • A hearing on the AG’s alleged facts and conclusion of law.
  • A pretrial hearing to request a separate hearing on the accounting issues. I will quote the comment:

1.b)For a prehearing conference, at which time MAP may request an expedited hearing and may make additional pre-hearing motions to ensure a full, fair and complete hearing and record including, inter alia, that the hearing be bifurcated such that the first issue to be resolved is whether MAP’s accounting complied with GAAP;

  • Vacating the C&DO, revoke penalties, reinstate charitable registration.
  • Reimbursement of costs.

According to the appeal, it was delivered on April 11 by personal service and transmittal by email.

 

Overlap of wording in request

Now go back and reread each charity’s request for a separate hearing. Starting after the inter alia, they read:

…that the hearing officer bifurcate the hearing such that the first issue to be resolved is whether CMMB’s accounting complies with GAAP

…that the hearing officer bifurcate the hearing such that the first issue to be resolved is whether FFP’s accounting complies with GAAP

…that the hearing be bifurcated such that the first issue to be resolved is whether MAP’s accounting complied with GAAP

Oh, inter alia means ‘among other things.’

I’m an accountant, not an attorney. I don’t know how these type of filings work. It does jump out at me that all three charities make the same request with slight differences in the first phrase and near identical wording in the second phrase.

For the attorneys out there, is that phrasing a standard request? Is that just the way everyone would naturally phrase a request? Is that pulled from a boilerplate sample pleading?

Or is it indicating the legal teams for the charities are working together? If so, can anyone enlighten the rest of us what the implications would be from doing so? I can’t even guess what that means.

Another question comes to mind. For the attorneys out there bold enough to speculate, what is the strategy of asking for a separate hearing on the propriety of accounting before addressing the other issues? Does that isolate the core issue, which if it isn’t sustained would collapse the entire C&DO? Or does that give the charities two chances to argue the issue, once in each hearing? Is there some other concept in play? I ask because I don’t know the strategy is this type of case.

 

Dates appeals became visible

Only article I’ve seen discussing the C&DOs since they were filed was Charities Get Cease And Desist From California AG by Mark Hrywna writing at The Nonprofit Times. Food for the Poor issued an additional statement, but I don’t know the date it was released. Can anyone point me to other coverage?

I performed an internet search for articles on the appeals and found no publicity as of April 15. As of that date, there were links to the appeals, with a count of how many days earlier the item appeared. Making the huge assumption that the day count is full days and is accurate, that would infer the appeals were posted at the AG site on the following dates:

  • 4/09/18 – FFP
  • 4/10/18 – MAP
  • 4/11/18 – CMMB

 

Professional representation

For those who recognize different firms, and for future reference, here is the visible professional representation for each charity:

CMMB

  • Attorney – Murphy Rosen LLP, Santa Monica, CA and Gallagher & Matthews, Esqs., Rockville Center, NY office
  • Auditor – Marks Paneth, New York office

FFP

  • Attorney – Perlman and Perlman, New York office
  • Auditor – Mayer Hoffman McCann, Boca Raton office

MAP

  • Attorney – Freeman Mathis & Gary LLP, Hermosa Beach office
  • Auditor – Capin Crouse LLP, Lawrenceville, Georgia office

 

Full disclosure

It is time again for disclosures.  I worked for the Capin Crouse LLP firm for about 12 years before starting my firm, which provides attestation services to the nonprofit community. That means I have been a teeny tiny competitor to Capin Crouse since 2002.

MAP was a client of Capin at the time I was working for the firm, if I recall correctly. I am quite sure I did not do any work on the engagement while I was there, but am not absolutely certain of it. During my time at the firm, it was quite rare for any audit staff to work on any engagement from another office.

I have no idea who has worked on the MAP audit for the last decade or more, but would guess I know several of the senior staff on the engagement.

 

What do you think?

Professional comments welcome. All comments are moderated. Keep in mind the only basis for determining what constitutes professional on this blog is my preference at the moment. Strong opinions are welcome but get too enthusiastic in your expression and your comment won’t appear.

I would also welcome guest posts, should anyone be so interested.

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