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MEMORANDUM

 

TO: Sonia Sanchez

FROM: Applicant

DATE: July 30, 2013

RE: In re SIA

I. INTRODUCTION

 

In this memorandum the following issues regarding Sensory Integration Alliance Inc.’s (SIA) potential liability for the following acts will be examined: (1) Canceled or unscheduled seminars; (2) Payments for Klene Up Kroo janitorial services; (3) Unfiled Form 990s; (4) Expense account reimbursements to Vernon Ellis; and (5) Cruise taken by board members.

For each of the above-listed acts the following will be considered: (A) Potential remedies; (B) Applicable statutes and sections that prescribe a remedy; and (C) Whether the available facts would support an effort by the Attorney General to impose a remedy.

In addition, this memorandum will discuss whether the Attorney General could successfully seek a receivership or dissolution of the corporation for each of the above-noted acts.

 

II. DISCUSSION

 

A. Whether SIA Will Incur Liability for Canceled or Unscheduled Seminars

Columbia Corporations Code (CCC) Section 5250 establishes that the Attorney General may institute the proceeding necessary against a charitable corporation to correct noncompliance or departure from the trusts it has assumed. At issue is whether the Attorney General may proceed against SIA as a charitable trust on behalf of paying customers that did not receive a refund or commensurate compensation for canceled or even unscheduled seminars.

CCC Section 5233(a) provides that a self-dealing transaction to which the corporation is a party and in which one of its directors has a material financial interest may serve as the basis for a proceeding against the corporation. Further, CCC Section 5233(e) establishes that the interested director shall pay damages including the payment of any profits made from such transaction(s) in addition to any exemplary damages for a fraudulent or malicious violation of this section.

Given the testimony of SIA Executive Director Karen Barber that her predecessor Vernon Ellis may have been self-dealing in having only partially refunded a total of $18,000 to paying customers over a three-year period — while depositing a substantial but precisely unknown amount of customers’ refunds to his own private account — it is clear that there is the basis for at least general and exemplary damages as a result of this probable breach of his fiduciary duty. As such, a compelling argument may be made that CCC Section 5233(a) has been violated as a result of Vernon Ellis’s material financial interest and that SIA as a charitable corporation is a party through the self-interested conduct of its former executive director.

CCC Section 6511(c) does establish that a receiver may properly wind up the affairs of a corporation — or order dissolution — subject to the supervision of the court. In addition, Sidley Memorial and Children’s Trust have established that the court analyzing whether a corporation has abandoned its charitable purpose will balance the equities in determining whether the objectionable practices have been corrected, whether other directors were involved in fraudulent practices or profited personally by lapses in proper fiscal supervision, and whether the overall operation of the corporation has been efficiently managed.

An analysis of the SIA Quarterly Board Meeting Minutes from September 15, 2011, to January 15, 2013, would seem to support the proposition that aside from Executive Director Ellis — and perhaps Director Zackler — there was no knowledge of the potential wrongdoing by the other directors. Further, Executive Director Barber’s voluntary act in addressing this issue — in bringing it to the attention of the Attorney General’s Office — offers additional mitigating evidence that SIA should neither be dissolved nor ordered to be placed under a receiver. Also, according to Director Barber’s testimony, the overall operation of SIA appears to have been effectively managed through a steady stream of revenue, renewed foundation grants, and half a million dollars in reserves. Again, potential liability for canceled — even unscheduled — seminars will likely be limited to the damages remedy discussed, above. Receivership or dissolution seems unlikely because, equitably, SIA has met the balancing criteria articulated in Sidley Memorial and Children’s Trust.

 

B. Whether SIA Will Incur Liability for Payments Made to the Klene Up Kroo

The combination of CCC sections noted above are also pertinent in assessing SIA’s potential liability, given the evident self-dealing by Executive Director Vernon Ellis and Director Alan Zackler, the chair of the board’s budget and finance committee, described below.

Executive Director Barber’s testimony that Directors Ellis and Zackler each personally benefitted from SIA payments allegedly made for janitorial services provided to SIA by the Klene Up Kroo — with over $22,000 initially drawn on SIA’s account and then $8,000 funneled to each of them through Arden Bank — appears to be an intentionally fraudulent act of self-dealing that will also result in at least general and exemplary damages as a violation of CCC Section 5233(a).

Further, the actions by Directors Ellis and Zackler do not appear to be exempted by CCC Section 5233(a)(3), given heir likely actual knowledge of their self-dealing conduct.

Again, however, given the same factors noted as to the canceled seminars, it is unlikely that the actions of Directors Ellis and Zackler will result in dissolution or receivership. Even together, a balancing of the equities established in Sidley Memorial and Children’s Trust appears to favor SIA — although a stronger case may be made through an analysis of the minutes of the SIA board’s quarterly meetings from September 2011 through January 2013, which indicate that there may well have been lapses in proper fiscal supervision.

 

C. Whether SIA Will Incur Liability for Failing to File Form 990s

Section 125(a) of the Columbia Government Code (CGC) establishes that a corporation shall file form 990 not later than four months and 15 days following the close of the first calendar or fiscal year in which property is initially received. CGC Section 126(a) provides that any person who violates any provision of this Act with the intent to deceive or defraud any charity is liable for a civil penalty not exceeding $10,000. Subsection (d) also establishes that reasonable notice of the violation from the Attorney General is necessary and that 30 days must be given to correct the violation.

From Executive Director Barber’s testimony — along with the documentation she discovered and the IRS memo received by SIA — it is clear that at least for the years 2010 and 2011 that SIA did not submit Form 990 to the Attorney General and Internal Revenue Service. It is also clear Director Alan Zackler may have filled out — but not submitted — the necessary Form 990 documentation for these years given the original-looking documents discovered by Barber. Further, the SIA Board was evidently misled by Director Ellis when he informed the Board that the necessary 990 forms had been submitted.

The self-dealing described above by Directors Ellis and Zackler from 2010 through 2012, involving their evident deception in funneling either customer refunds or alleged payments to their respective personal accounts, is highly suspicious, and it is probable that the failure to report the 990 forms during this period was intentional. Again, however, analyzing the Minutes of the Board’s Quarterly Meetings during this period, the SIA Board members appeared to have no knowledge of the deception. In fact, Director Zackler even assured Director Jeff Garcia that the required IRS and State Franchise Tax Board documents had been filed at the January 15, 2013, meeting.

As a result, dissolution and receivership does not appear to be an appropriate remedy given the equitable balancing test applied in Sidley Memorial, as originally stated in Children’s Trust. Further, the omission to file the 990 forms does not appear to rise to the standard articulated in Orange County Charitable Services (OCCS) which resulted in injunctive relief and imposition of a charitable trust.

In OCCS, inaccurate reports over an approximate four-year period resulting in multimillion dollar discrepancies when compared to OCCS fundraising activities caused that court to order a host of equitable remedies. Purposeful conduct by the OCCS Board members entrusted with the management of the corporation was essentially viewed as a breach of their fiduciary duty. In contrast, SIA’s Board was substantially unaware of the financial discrepancies resulting from Director Ellis’ and Zackler’s conduct so that the remedies imposed in OCCS seem unlikely. Also, SIA is still within the 30-day reporting period to correct any violation.

 

D. Whether Expense Account Reimbursements to Vernon Ellis Will Result in SIA Liability

The expense account reimbursements made to Director Ellis as reported by Director Barber occurred in 2011. Here, there appear to be legitimate expense reimbursements of $4,000 to Ellis — but also unsupportable reimbursements to him totaling $8,500. This suggests more self-dealing by Director Ellis. The SIA Board Minutes for 2011 and April 2012, however, support the proposition that the Board was unaware of this potential wrongdoing. In fact, Director Zackler confirmed at the Board meetings the legitimacy of the corporate expenditures — even noting that an increase in expenses was attributable to an increase in SIA public seminar programs.

While the possibility for individual liability for breach of fiduciary duties by Directors Zackler and Ellis is high in view of the applicable CCC sections regarding self-dealing, the likelihood of SIA corporate liability through a violation of CCC Section 5233(a) appears low, given the Board’s lack of knowledge.

It is also unlikely the Attorney General would seek receivership or dissolution of SIA in view of the lack of knowledge by the Board of Director Ellis’s and Zackler’s actions. However, the Board’s failure to investigate the expense issue beyond the brief Quarterly Meetings does not support a defense of good business judgment and, applying the balancing standard earlier noted in Sidley Memorial and Children’s Trust, a probable lapse in the SIA’s Board’s proper fiscal supervision.

 

E. Whether SIA Will Incur Liability for the Cruise Taken by Board Members

A review of the SIA Board Minutes from 2011 to 2013 only briefly refers to consideration of travel expenditures incurred by SIA staff and Board members. There is no reference to the 10-day cruise taken by Board members Ellis, Zackler and Melanie Wanderly. Only the testimony of Director Barber — as substantiated by the $70,000 check she discovered written to Wanderly Travel Service — serves as documentation of the cruise expenditure.

The $70,000 expenditure — compared to the cumulative amounts attributable to Director Ellis’s and Zackler’s self-dealing conduct described above — is more substantial. While some of it may be marginally justified as a legitimate business expense given the “long-range planning” achieved at the cruise’s breakfast meetings, another instance of self-dealing seems apparent given payment of this expenditure to Director Wanderly’s personal travel business. Applying Sidley Memorial and Children’s Trust, this appears to be evidence that Director Wanderly had a substantial and material financial interest attributable to the expenditure. Further, it also indicates a lapse by the SIA Board in providing proper fiscal supervision. As such, on balance, this expenditure could be construed as an act justifying receivership or dissolution and a violation of CCC Section 5233(a).

CCC Sections 6511(a)-(c) also provide for restitutionary relief in the event the self-dealing is construed as a breach of fiduciary duty in reasonably managing the financial affairs of SIA. In this event, at least a portion of the $70,000 may be restored.

Finally, CCC Section 6511(a) and subsections (1)-(3) may be applicable in construing the payment of this expenditure as a serious offense and even fraudulent abuse of SIA’s corporate privileges. As a result, CCC Section 6511(c) would mandate at least partial restitutionary and/or injunctive relief for the $70,000 expenditure — in addition to dissolution or the appointment of a receiver to wind up the affairs of SIA.

 

III. CONCLUSION

 

SIA’s potential liability for CCC or CGC statutory violations, and in view of applicable case law, seems to be mostly limited to remedies such as damages, restitution, or injunctive relief. Receivership or dissolution, however, are also possibilities in view of SIA’s failure to file the required 990 forms and the failure of the SIA Board of Directors to properly supervise and account for the cruise expenditure.

 

This answer was provided by Cal Bar Tutorial Review. Cal Bar is a customized and personalized total review course – and has been serving California bar candidates since 1979. Cal Bar may be reached through 800-783-6168. Cal Bar’s website address is: www.cbtronline.com.