Charities Still Have Much to Learn From Madoff

June 29, 2012 marked the third anniversary of the sentencing of Bernard Madoff, mastermind of the largest ever Ponzi scheme in U.S. history. Hundreds of investors lost more than $13 billion to Madoff, including many foundations, some of which had to shut down as a result of their investments.

A few years ago in Learning from Madoff: Lessons for Foundation Boards, our examination of data from the New York Times’ Nicholas Kristoff and Daniel Smith found that only 15 percent of the analyzed foundations had boards comprising five or more members. Among those boards with five or more directors, the trustee names showed great homogeneity. We also noted that many of the foundation boards did not exercise their due diligence in deciding whether or not to invest with Madoff and many of them fell prey to relationships of trust with the investor.

So what has changed in the intervening three years since Madoff was sentenced? Apparently, not much. In a recent article in Forbes, Ken Berger, president and CEO of Charity Navigator, states, “The lessons of Madoff have not been learned. The overwhelming majority of boards do not take their responsibilities seriously and many operate like social clubs. Investments are not managed as thoughtfully as they should be—very conservatively and with great care. If the board is asleep at the switch with respect to investments, trust me, they are not minding the store in other areas. Especially in the current economic environment with less government support for charitable causes, squandering precious charitable dollars is unforgivable and is, unfortunately, leading to donor fatigue.”

Surprisingly, the Forbes article notes that reviewing the civil and criminal backgrounds of board members and senior staff could yield unforeseen results. “Charitable fraudsters tend to be recidivists that, apparently due to a lack of scrutiny characteristic of these organizations, escape detection. These scammers don’t seem to be afraid to continue to focus upon the same type of victims, i.e., charities, and find new ways to personally profit.”

This is absolutely shocking and unacceptable – how can grantmakers or grantees allow such malfeasance at the highest levels of decision-making to occur? Moreover, there are issues of conflict of interest that arise when, for example, board members are current employees of financial firms. Accountability and transparency are meaningless buzzwords in our sector that are repeated ad nauseam. Yet, do foundations or grantees investigate whether the individuals who govern them have a history of substantial fiscal malfeasance or losses?

We lost important funders such as the JEHT Foundation to Madoff. It is high time for our sector to engage in serious self-reflection about the issues of governance and transparency. Here are two concrete steps that foundations can take to improve board oversight:

• Increase board size to a minimum of five individuals with diverse perspectives and background. A study by Scott E. Page shows correlation between diversity and improved decision-making and problem solving in larger groups. Additionally, recent research suggests that dissent actually leads to be better decision-making than does brainstorming. This indicates that boards should comprise members who bring differences of opinion to the table and not just unanimous or shared perspectives. The Council on Foundations reported a median of 11 trustees at the time among its members and the Association of Small Foundations noted a median of five at the time when we released our research on Madoff.
• Maintain policies and practices that promote ethical behavior. These include conflict of interest policies and whistleblower policies, subscribing to codes of ethical conduct and good governance, and disclosing demographic information on a foundation’s trustees and staff.

If we as a sector fail to take action on these issues, we will be leaving ourselves open to falling prey to the likes of Madoff and have only ourselves to blame.

Niki Jagpal is research and policy director at the National Committee for Responsive Philanthropy (NCRP). She frequently blogs on the role of philanthropy in society. This blog originally appeared on NCRP’s blog, Keeping a Close Eye.