It All Adds Up: State Attorneys General, Nonprofit Oversight, and Drastic Action
To what extent can a state attorney general control a nonprofit organization? The answer may be surprising – quite extensively! Under many states’ charitable trust and fundraising laws, a state AG may remove a nonprofit leader, deny fundraising opportunities, and even seek a court receivership or corporate dissolution. Such draconian measures are extremely rare, and rightfully so given that most nonprofit directors and officers capably handle the extensive leadership responsibilities and complicated aspects of nonprofit governance.
A recent court case though, involving the Otto Bremer Trust, amply demonstrates that a state AG can powerfully flex its regulatory muscle – if a court agrees that drastic measures are warranted. Here’s what happened, and what responsible nonprofit leaders can learn from the adverse consequences in that case.
Minnesota Court Ruling – Nonprofit Leader Removal
On January 17, 2023, the Minnesota Court of Appeals affirmed an April 2022 order issued by a lower Minnesota court, which granted the Minnesota Attorney General’s petition to remove one of the trustees of the Otto Bremer Trust (the “Trust”).
The Trust long functioned as a Section 501(c)(3) nonprofit, with trustees serving as its directors. Well known banker and philanthropist Otto Bremer formed the Trust in 1944, thereby subjecting the Trust to Minnesota charitable trust laws.
Consistent with Section 501(c)(3) nonprofit parameters, the Trust’s stated purpose is to carry out several charitable purposes relating to serving the poor and aiding those with diseases. Bremer initially funded the Trust with $2 million in stock in one of his privately held holding companies, Bremer Financial Corporation (“BFC”). Over time, the Trust’s assets grew to over $2 billion in value.
As typical with nonprofits, the Trust has had various trustees during its lengthy existence. Governing leaders of the Trust are entrusted with stewardship of the Trust’s charitable assets, each held to fiduciary duties of care, loyalty, and obedience to the corporate mission by law.
Commonly, nonprofit leaders serve as volunteers – with no compensation. But here, and somewhat unusually, the trustees were compensated pursuant to the Trust instrument (functioning substantially like nonprofit bylaws, since the Trust was not incorporated) in various ways including fees. Presumably in recognition of such considerations, the Minnesota AG and state court under the Minnesota Supervision of Charitable Trusts and Trustees Act consistently reviewed and approved the trustees’ fees.
AG’s Petition to Remove Trustees
But in 2020 (and after a new AG was elected), the AG’s office filed a petition alleging trustee self-dealing and related improper compensation. More specifically, the AG asserted that the Trustees had engaged in wrongdoing to the Trust’s detriment, as follows:
1. The Trustees’ compensation constituted self-dealing and a breach of loyalty;
2. the Trustees had violated the Trust’s conflict of interest policy by engaging in abbreviated grantmaking processes for certain organizations with which the Trustees had prior relationships;
3. Trustee Brian Lipschultz misused Trust resources for personal purposes and engaged in hostile relations in the sale of the BFC stock;
4. the Trustees’ decision to invest in private equity funds knowingly violated the prudent investor rule; and
5. the Trustees’ sale of BFC stock was improper under the Trust instrument.
Court Rulings – Trustee Lipschultz’s Removal
In response, the lower court declined to hold all Trustees responsible. Instead, the court focused on a sole governing leader, Trustee Lipschultz, and concluded that he had used Trust funds for his personal benefits, engaged in misconduct in connection with the sale of BFC stock, and engaged in wrongful self-dealing regarding the Trust’s grantmaking – cumulatively amounting to such significant breaches of fiduciary duty as to warrant removal from his Trustee position.
The appellate court affirmed the lower court’s ruling, holding that Trustee Lipschultz’ “series of breaches” “collectively constitute[d] ‘a serious breach of trust’” that justified the lower court’s determination to remove him. In other words, while the individual actions the court identified may not themselves have necessitated removal, the court found no other viable recourse when viewed together.
The court’s decision to remove Lipschultz, as affirmed on appeal, may be interpreted as an example of excessive interference with a charitable entity. Alternatively, the outcome could be seen as an example of effective government oversight of charities. Either way, the case clearly shows that a state attorney general holds a potentially powerful and broad role with respect to charitable organizations. Such power includes not only oversight generally but also power to investigate, enforce remedial measures, and even seek relief from the judicial system to substantially change the leadership and operation of a nonprofit corporation.
Notably, a handful of states (e.g., Texas, Nebraska) do not have charitable fundraising laws, and each state should be evaluated with respect to its own charitable trust laws. But the charitable legal principles that the Minnesota courts are common to all charitable organizations and their leaders, under IRS requirements as well as applied to Section 501(c)(3) organizations. Consequently, the Otto Bremer decision serves as an important reminder for nonprofit leaders to comply with applicable fiduciary responsibilities, related legal requirements, and optimal best practices in their governance and use of charitable assets – as further addressed in the next section.
Follow Your Own Policies
A primary reason why the Minnesota AG sought to remove the Trust’s trustees was the allegation that they failed to follow the Trust’s conflict of interest policy related to grantmaking, by inserting their own personal self-interest into the process.
As a basic proposition, every nonprofit organization should have a conflict of interest policy that governs situations in which a decisionmaker has a personal or other conflicting interest, such as related to financial matters or confidential information. The IRS Form 990 asks for such policy information, and state nonprofit laws often include their own requirements for such situations.
There’s more! Every nonprofit needs to follow its conflict of interest policy – and scrupulously so. Appropriate measures include completion of annual conflict of interest disclosure statements, supplements thereto as warranted by newly emerging information, appropriate review of such information, and recusal of a conflicted leader regarding any board deliberation and vote on conflicted decisions. In addition, and just as importantly, the independent board members should then evaluate the decision at hand in terms of the following question: What is in the best interest of the organization, both financially and otherwise (e.g., expected quality of a proposed contractor’s work, other opportunities to sell real estate, whether the organization can afford a proposed purchase, other information that may need to be gathered)? Consequently, is this transaction permissible, or does it amount to an impermissible conflict of interest?
Note too that government regulators and courts may interpret a nonprofit’s violation of its conflict of interest policy, as well as other policies and even its governing bylaws, as per se breaches of the directors’ applicable fiduciary duties. In short, every nonprofit leader should follow the organization’s established rules (or change them, in compliance with applicable law), apply best practices, and optimally promote the nonprofit’s charitable purpose.
Be Very Careful with Nonprofit Leadership Compensation
The Trustees’ compensation was another key element of the AG’s adverse claims in Otto Bremer. Pursuant to the Trust instrument’s terms, the Trustees could be paid for management of the Trust estate and for related investment advisory services. They could also be reimbursed for any sums they spent to protect and manage the Trust. Unusual yes, but generally reasonable – provided that all such payments were accompanied by sufficient controls to avoid impermissible conflicts of interest.
Notably, the Trustees could not be compensated more than a combined amount of 4% of the Trust’s income. Over time, the Trustees’ income was approved and reviewed multiple times by the court and the AG. But for whatever reasons unbeknownst to the general public, the new AG called the Trustees’ compensation into question in 2020, challenging it as unreasonable and in violation of the Trustees’ duty of loyalty.
Ultimately, the ruling court did not find that the Trustees’ compensation was unreasonable or a breach of duty because it was within the limits set by the Trust instrument. But it presented a surface conflict of interest issue, which opened the proverbial door for the AG’s scrutiny and objection on self-dealing and fiduciary breaches grounds.
How could the Trust have better avoided this issue? First, they could have all served as volunteers, thereby eliminating the issue entirely. Second, they could have compensated only some of the Trustees, thereby allowing the uncompensated Trustees to serve as the independent board members to deliberate and vote on their fellow Trustees’ compensation. Third, they could have outsourced all compensation matters such as to an independent compensation committee, with accompanying professional guidance of reasonable compensation. Each such option would help refute any actual or apparent result that a Trustee was putting his or her own financial self-interest in front of the Trust’s charitable interests, thereby reflecting sound stewardship.
Don’t Use Nonprofit or Trust Assets and Resources for Personal Use
This point is rather obvious, yet it cannot be emphasized enough. In Otto Bremer, the removed Trustee spent a total of $1,875 of Trust money for his own personal use and did not reimburse the Trust for those funds. Not exactly highway robbery. The court thus acknowledged that this amount was de minimus and took the Trustee’s word that he acted in good faith. However, the court further took a hard line, finding no exception to the rules against self-dealing. The clear lesson for nonprofit leaders? Do not use a nonprofits’ funds toward any personal use, no matter how small or how innocent. Correspondingly, keep personal expenses separate, and any identified mistakes should be followed up promptly with reimbursement. Any ambiguities should be clarified too, such as through detailed substantiation of expenses incurred for the nonprofit’s benefit.
Mind Your P’s and Q’s
One of the more unusual findings in Otto Bremer was that Lipschultz’s “inappropriate behavior” culminated to “vindictive acts of administration,” as he communicated with others. The duty of loyalty prohibits a trustee from placing their own interests as an individual above those of the beneficiaries. The court found that Lipschultz committed a breach by “putting his own frustration, aggression, and personal interest in revenge ahead of the important interests of the Trust,” and further that “Lipschultz displayed a crude, vulgar[,] and otherwise offensive brashness that has no place in the charitable world.”
Lipschultz’s vulgar and brash language thus contributed to his removal as a Trustee. Such behavior is not typically viewed as disqualifying for nonprofit leadership or otherwise amounting to a breach of fiduciary duty. But this decision confirms that at least when connected with other questionable behavior, bad words and a bad attitude can get a nonprofit leader in trouble and perhaps even removed from the helm of a nonprofit organization. So, watch one’s own language and manners.
Practice Good Governance, No Matter What
Did politics affect the Minnesota AG’s involvement here? Would it have been appropriate to remove all Trustees? It does seem odd that the AG’s office got involved, and aggressively so, after decades of affirmation and consent – especially with respect to the Trustee’s compensation – and some underlying politics may or may not have been at play.
But aside from such background considerations, the main lesson here is clear. Nonprofit leaders owe fiduciary responsibilities to govern their organization well, in legal compliance and otherwise consistent with best practices. As noted above, no excuse exists for failing to have (and follow) a conflict of interest policy. Nonprofit leaders should never use charitable assets for their own purposes and they should comport themselves professionally and honorably. Whether the organization is mindful of a state AG, the IRS, its donors, grant-makers, other stakeholders, or its reputation overall, all governing nonprofit leaders should demonstrate integrity consistently through their actions.
By: Wagenmaker and Oberly Law Firm Note too that a state AG typically only requires that fundraising registrations and reports be properly filed, on pain of monetary penalties only, in the states with such applicable laws. For additional information about fundraising and state AG compliance generally, please see W&O’s article on fundraising across state lines. For an earlier example of a state AG exercising significant power against a nonprofit charity, please see W&O’s article addressing the New York AG’s efforts against the National Rifle Association.
 For additional guidance regarding these fiduciary duties, as well as higher-level charitable trust principles, see W &O firm’s Maxwell Manor article and the articles addressing the fiduciary duties: Duty of Care, Duty of Loyalty, and Duty of Obedience.
 For additional information about conflict of interest policies and examples of conflicts, see this conflict of interest article.
 For further guidance on the advisability of paying nonprofit leaders, please see this related article.