A recent case in California is illustrative of the worst nightmare for any nonprofit or charitable organization. On September 9, 2009, the California State Attorney General's Office filed a civil lawsuit to permanently stop UCLA Professor Gerald D. Buckberg, M.D., and five officers of the nonprofit L.B. Research Foundation from allegedly "diverting donations" from the charity to their own personal business ventures and medical research activities.
Under California law, "no part of a charitable organization's income or assets may inure to the benefit of any director, officer, member or private person." However, the State's lawsuit alleges that since 1997, L.B. Research Foundation's officers have used its funds to finance their own medical research, the research activities of companies in which they had a financial interest and the development of medical devices that they sold.
The State's lawsuit was filed in Los Angeles Superior Court. This lawsuit by the State only sets forth allegations, and L.B. Research Foundation and its officers are entitled to a full defense of these allegations. Simply because these allegations are set forth in a lawsuit, they cannot be presumed to be true. The lawsuit sets forth the following allegations against the charity and its officers:
- Failed to maintain adequate books and records in violation of Corporations Code section 6320;
- Breached their fiduciary duties in violation of Corporations Code sections 5233, 5260 and U.S. Code section 4945;
- Failed to maintain an independently elected board of directors in violation of Corporations Code sections 5210 and 5213;
- Filed and distributed false and incomplete reports in violation of Corporations Code sections 6215 and 6812; and
- Engaged in unfair competition in violation of Business and Professions Code section 17200. This allegation is designed to allow the State to recover attorney's fees and obtain injunctive relief.
The State is seeking to recover over $500,000 in misappropriated funds, permanently dissolve the charity, assess civil penalties of over $100,000 and prohibit the defendants from running a charity until they provide accounting statements to his office.
The alleged facts as set forth in the lawsuit are that Dr. Buckberg founded L.B. Research Foundation in 1997. The purpose, as stated in the articles of incorporation, was to assist people suffering from physical and mental disabilities. The Foundation was funded primarily by Dr. Buckberg, although it also received some donations from several other individuals and businesses.
The Attorney General's office launched an investigation in 2007. The investigation allegedly revealed that the foundation has been under the primary control of Dr. Buckberg and L.B. Research has been used primarily to fund Dr. Buckberg's research and development projects and the research of his colleagues and friends. The allegations include the following:
■ The lawsuit alleges that from 1997 through 2004, Dr. Buckberg used $120,000 in donations to produce an educational DVD for use by medical professionals. The rights to the DVD belong to The Helical Heart Company, a for-profit corporation which Dr. Buckberg owns.
■ The lawsuit also alleges that in 2000, $1 million of the charity's funds were donated to UCLA to establish an endowed faculty chair. Dr. Buckberg then purportedly applied for an appointment to the chair and, when that application was rejected, L.B. Research Foundation sued UCLA. Approximately $300,000 of the Foundation's assets have been allegedly used to pay legal fees related to that lawsuit.
■ The lawsuit further alleges that in 2003, Dr. Buckberg used $15,000 of the charity's funds to pay General Theming Contractors, LLC - which he owns -- to build plastic heart models, which he subsequently sold.
■ The lawsuit also alleges that from 2002 to 2006, Dr. Buckberg used over $50,000 of the charity's funds to pay the travel and hotel expenses of physicians whose research benefited a medical device licensed and patented by a for-profit corporation owned and controlled by Dr. Buckberg. The investigation further revealed that not all board members knew they were officers of L.B. Research or that they were even part of L.B. Research's board of directors.
■ Dr. Buckberg allegedly had sole custody of the charity's financial records and checkbook. The State also claims that very few of the board's grant-making decisions were documented and board members failed to understand that the charity's assets could not be used for their personal benefit.
Attorney Commentary: This lawsuit involves Gerald D. Buckberg, M.D., a world-recognized pioneer in the development of life-saving heart surgery techniques, which shows that even well-credentialed persons can be the subject of investigations by the State. The investigation went on for at least two years before the lawsuit was filed. It is during this time in which the nonprofit charity has an opportunity to present the facts and seek to prevent such a lawsuit.
Nonprofits should understand that it is not simply the IRS who regulates them. The California Attorney General's Office regulates charities and the professional fundraisers who solicit on their behalf. The purpose of this oversight is to protect charitable assets for their intended use and ensure that the charitable donations contributed by Californians are not misapplied and squandered through fraud or other means.
Nonprofits should understand that the Attorney General operates a regulatory program and encourages the reporting of "charity fraud. " This reporting can be legitimate or it can be frivolous complaints made anonymously by disgruntled ex-employees or persons who do not have all the facts.
The State Attorney General's Office has a 60-page publication entitled "Guide For Charities" which outlines that office's oversight over nonprofits and summarizes many of the laws applicable to nonprofits. It can be found at:
Nonprofits need to ensure compliance with the state law as set forth in the California Corporations Code regarding fiduciary duties, maintaining adequate records, maintaining an independently elected board of directors and other related laws. Compliance and obtaining proper legal advice regarding potential conflicts of interest can prevent or limit any issues arising later. A lawsuit such as the one filed here can often cripple a nonprofit and harm its fundraising even if the case is later dismissed or won in the nonprofit's favor.
Mr. Moravec has a specialty in representing nonprofits and in nonprofit law. Mr. Moravec was a consultant and chapter editor for California Continuing Education of the Bar, Advising California Nonprofit Corporations, 2nd Edition 1998. In addition, he was the 1998-1999 chair of the Exempt Organizations Committee of the Los Angeles County Bar Association.