California AG settlement with charity for valuation of GIK

What is the proper valuation of a pallet of medicine purchased on the international market? Image of pharmaceutical warehouse courtesy of Adobe Stock.

Back on January 29, 2019, the California Attorney General announced a settlement with a charity for financial reporting which was misleading because of the valuation of donated pharmaceuticals.

Although the settlement is four months old and thus counts as ‘old news’, it is worth discussing as an indication of the level of concern the AG has for valuing GIK.

The AG’s press release: Attorney General Becerra Announces $410,000 Settlement with Giving Children Hope, After the Charity Engaged in a Misleading Reporting Scheme.

The settlement consists of $400,000 from the charity and $10,000 from four named individuals.

A page on the charity’s website comments on the settlement: Giving Children Hope’s Settlement Resolution.

The charity says its insurance company agreed to pay the $400,000. The charity asserts the penalty was “not paid from donated dollars of program funds.” That would be a technically true statement because the insurance company would have cut the check and not the charity.

The charity also said there were “no fines or penalties levied against” the charity. On one hand I suppose that is correct because an agreement to pay four hundred thousand dollars is not the same as a fine or penalty. I don’t think that’s quite correct for two reasons. First, the AG doesn’t collect voluntary contributions; the payment was made as settlement of civil charges. Second, insurance companies don’t write checks out of the generosity of their heart; they settle the liability of their insureds.

I think most people looking at the situation would agree the charity was hit with a $400,000 penalty.

Individual penalties

The press release says four individuals will also pay $10,000 in total. It is not clear from the press release whether this is a joint and several liability or each person will be billed individually for $2,500.

One of the individuals mentioned is a board member with no other visibility or responsibilities that I can see after a quick search. I cannot guess why he was cited but the other 14 directors (including chair, treasurer, and secretary) were not.

One of the individuals is currently the CEO of Giving Children Hope.

A third individual is listed on the founding documents of GCH as the CEO at the time it was formed. This person is also listed as president as he signed the 990 of the charity that is cited as one of the “subsidiaries” of GCH.

CPAs, here is a variation of the ‘front page of the Wall Street Journal’ test

An old line I offer as a gauge of whether an action is ethical or not is the WSJ test. It goes like this.

  • How would you like to read about this thing/ action/ decision/ memo/ text on the front page of the Wall Street Journal?

Here is a new test for CPAs:

  • How would you like to read your name and your client’s name in a press release from the California AG?

The fourth person who will be chipping in for that $10,000 penalty is the CPA who issued a clean audit report and signed the 990 for Giving Children Hope. She also signed the audit report and 990 for one of the charities cited as a “subsidiary” by the AG.

I choose not to mention the names of any of the individuals sanctioned by the AG. Any readers who are seriously interested can find out on their own.

Another thought for CPAs to ponder:  How would you like to explain to your insurance carrier and your state Board of Accountancy that the AG reached a negotiated settlement with you that involved you sending the AG a check?

Oh, one more tidbit about the CPA. In the charity’s statement on their website they indicated they fired their CPA at some point during the investigation.

Timing

In the charity’s statement, they say the AG started its inquiries in June 2017.

I’ll make a wild guess that is when a number of investigations began which have now resulted in this settlement, the lawsuit last week, and the three cease-and-desist orders for which the AG lost on appeal but which quickly resulted in AB 1181. Oh, don’t forget the charity that agreed to dissolve at the same time as the three C&D orders were issued.

Makes me wonder if there are other inquiries far enough along to have charges or settlement appear in the near future. Are there more enforcement actions in the pipeline? If so, how many?

Other parts of the settlement

The AG said the charity agreed not to file any additional false reports.

In addition, the AG also said “(a)s part of the agreement, GCH will … terminate its pharmaceutical Gift-in-Kind program.”

In contrast, the charity said that it “voluntarily terminated” the medical GIK program back when the AG started the investigation.

Those two comments are somewhat in conflict. I will make a guess the charity decided to voluntarily terminate the program sometime in 2018 when they realized the alternative was litigation and decided to agree to AG terms. That’s just a guess.

What did the charity do?

The AG’s press release gave this description of why the Giving Children Hope financial statements were misleading:

“GCH created two subsidiaries, Giving Hope International and International Clinic Aid, which purchased pharmaceuticals from a wholesaler in the Netherlands for less than $225,000. The two subsidiaries then donated the same pharmaceuticals to GCH. GCH reported the total value for these pharmaceuticals as being over $34.9 million using U.S. prices of drugs rather than the actual purchase price paid by its affiliated charity. GCH should not have reported $34.9 million in revenue and donations when the pharmaceuticals cost less than $225,000. Also since GCH failed to submit any documentation showing that the pharmaceuticals were, in fact, distributed in furtherance of Giving Children Hope’s charitable purpose, the actual value for those pharmaceuticals should have been zero.

The charity formed two other charities, which the AG refers to as “subsidiaries.”  I looked at the financial statements available at the AG’s website. I could not track with the interrelationships between the organizations based on what is on file. My wild guess based upon the few documents visible is the relationships between the charities would not have required consolidation under GAAP accounting rules.

That still leaves some major related party issues on the table, which aren’t visible in the documents I read.

Update: There are also the issues of significant influence and control by other means which should be pondered. (For non-CPAs, the ramification is whether substantial disclosures should have been present in the audited financial statements, to include relationships and condensed financial information.)

The only overlap that I can see, based on a cursory review, is the same CPA who issued clean audit opinion and prepared the 990 for one of the “subsidiaries” is the same CPA who audited the financials and signed the 990 for Giving Children Hope. The initial CEO of Giving Children Hope is currently the president of this “subsidiary.”

For the other ‘subsidiary’, documents on file with the AG for this entity were prepared by a different CPA. It appears that several years worth of 990s and RRF-1s were prepared in 2019 as part of preparing a filing for dissolution.

I cannot see from the available documents how the ‘parent’ got the money into the ‘subs’ or where the GIK went from the ‘subs’ to the ‘parent.’ Obviously there is a lot more going on than is visible in the posted documents. I am wondering if I am missing something that is actually visible but I don’t recognize it; I have one specific idea which I won’t pursue.

If you for some reason are still wondering why the regulatory community is so worked up about GIK, consider the data cited by the AG. Some large volume of meds which can be readily purchased on the international market for about $225K can be valued at $34.9M using U.S. prices. That is an expansion factor of 155 times purchase price. That isn’t as high as charities were seeing with Mebendazole several years ago, but still a big multiplier.

About that “…failed to submit any documentation showing that the pharmaceuticals were, in fact, distributed in furtherance of Giving Children Hope’s charitable purpose…” comment, two thoughts.

First, the alternative argument from the AG is that since there was no documentation the meds furthered the charitable purpose of the organization, they should have been valued at zero. That is an issue by itself and has ripple effects because…

Second, hold that thought until we discuss the suit filed by the AG last week. One issue in the case is recording revenue for donated medicines used to treat illnesses of grown adults by a charity whose purpose is feeding children.

Visible financial data

Financial statements and 990s for GCH can be found on their website here.

The 990 for the year ended 6/30/16 shows the following. I have condensed and summarized the information.

Detail of revenue:

 GIK   33,115,959
 other contributions       780,812
 program revenue       423,349
 other income         99,456
 total revenue   34,419,576
 cash income     1,303,617

 

Summary of expenses:

 GIK   30,033,282
 salary        625,180
 benefits         91,024
 other cash exp.        682,956
 depreciation        101,839
 total expenses   31,534,281

 

Summary of functional allocation of expenses:

 program  Mgmt/gen  fundraising
 salary & benefits        420,613        132,665        162,926
 other cash expenses        431,201        174,960         76,795
 cash expenses        851,814        307,625        239,721
 depreciation        101,839
 non-GIK expenses        953,653        307,625        239,721
 GIK   30,033,282
 total expenses   30,986,935        307,625        239,721

 

Reason I summarized the info that way is so it is easy to calculate the functional percentages in total and for cash expenses only. This allows you to see the impact of the GIK on ratios. I calculated each functional category as percent of total expenses as:

 program  Mgmt/gen  fundraising
 cash expenses 60.9% 22.0% 17.1%
 non-GIK exp. 63.5% 20.5% 16.0%
 total expense 98.2% 1.0% 0.8%

 

If you still can’t quite sort out why the California AG is so focused on GIK, look at those ratios again. Check out how far the ratios swing with the $30M of GIK.

Now, imagine you are a charity that doesn’t have a lot of GIK and have to raise funds in the market place when a charity out there has a 1.8% ‘overhead’ ratio.

Schedule M shows the following components of GIK:

 Clothing and household    1,664,473
 Food inventory    1,158,821
 Drugs & medical supplies   31,957,138
 total GIK   34,780,432

 

To understand the impact of the donated meds on the financials, consider that 96% of revenue in 2016 was from GIK and 92% of GIK was drugs and medical supplies. That suggests that somewhere around 88% of revenue is from donated medicine.

One last item

Oh, if you are a CPA and have persevered to the end of this post, you will want to look at the organization’s audited financial statements.  Check out the third to the last line on the statement of activity (between change in net assets and opening net assets) and the last paragraph on page 11. Compare the numbers. Ponder the description.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: