Hawaii's rules lax on oversight of charities
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By Rob Perez
Advertiser Staff Writer
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Hawai'i is one of only 11 states that do not require charities to register, a gap that allows thousands of local nonprofits to raise millions of dollars from the public with virtually no regular oversight from regulators.
The lack of a registration requirement, considered the foundation of an effective monitoring system by many national experts, means charities can collect donations from residents without anyone from the state making even cursory checks to see how that money generally is spent.
"Charities aren't getting much oversight in Hawai'i," said Peter Swords, who has taught nonprofit law at Columbia University in New York for about 30 years. "With nobody looking at you, it means people can abuse the charity system. It's as simple as that."
Although the vast majority of Hawai'i's 5,000 public charities follow the rules and have financial safeguards in place, some organizations invariably stray from their tax-exempt missions — usually without drawing any scrutiny from the state.
Without a registration system that provides for annual reviews, regulators typically intervene only if someone complains or the questionable conduct is flagged some other way.
Take the case of Alphabetland Preschool & Kindergarten, a family-run, Waipahu-based charity that has an average monthly enrollment of 300 students and annual revenue of roughly $2 million, according to its tax returns.
For three consecutive years, starting in 2002, the Waipahu nonprofit paid one of its top executives more than $250,000 annually, far more than what officials earn at education institutions much larger in size. At KCAA Preschools of Hawai'i, a nonprofit that had double the enrollment and revenue as Alphabetland during that same period, its top executive earned less than $75,000 a year.
Over roughly that same period, Alphabetland also loaned more than $100,000 to another officer of the charity — the husband of the top-paid one — while he earned a salary of up to $120,000. Hawai'i law prohibits nonprofits from loaning money to their officers and directors. The husband served in both roles.
The wife's pay, which raised questions of excessive compensation, and the husband's loan were duly noted on Alphabetland's federal tax returns from 2001 to 2004.
But because Hawai'i has no registration system, which usually includes the filing of a charity's tax return, the Alphabetland transactions went unnoticed by state regulators — until one of them read a national story about questionable loans to nonprofit officials. The story had a brief Hawai'i reference, eventually leading the state attorney general's office to the Waipahu charity.
Authorities found more red flags once they started digging.
They learned, for instance, that the tax-exempt organization had paid its husband-and-wife management team, Gary and Amy Arizala, about $1 million from 2000 to 2003 (Gary Arizala died in 2004) and that the nonprofit was leasing two luxury cars, a Jaguar and Volvo, for $1,200 a month.
They also could see from the tax returns that the Arizalas were listed as Alphabetland's only board members during the period the husband was borrowing money and the wife's annual salary peaked at $264,000. The couple's daughter was added as a third board member in 2004, the returns show.
Such an arrangement runs afoul of standards that watchdog groups such as the Better Business Bureau recommend for governance of charities, including having a board that is independent, free of self-dealing and has at least five members.
Alphabetland declined comment except to say it was in discussions with the AG's office, has not admitted any liability and cautioned against jumping to conclusions about the issues raised by the state.
"We are confident that the matter should be resolved in the not-too-distant future to everyone's mutual satisfaction," the charity said in a June statement.
The AG's office declined comment because the case is still pending.
CRIMES AND MISDEEDS
The issue of charitable oversight has taken on greater significance in Hawai'i because of some relatively recent high-profile cases of misconduct or alleged misconduct. Among the cases:
Those cases and other publicized ones delivered some damaging public-relations blows to Hawai'i's industry, raising questions about whether the state and charities themselves have sufficient safeguards in place to protect against abuse.
The federal government grants tax-exempt status to charities, but it does so few audits — far less than 1 percent of all nonprofits nationally — that oversight has fallen largely to the states. The Internal Revenue Service did not have statistics on audits of Hawai'i nonprofits.
The quality of charity monitoring varies considerably from state to state, with some jurisdictions devoting entire divisions to it. Pennsylvania, for instance, has about 30 people, including attorneys and support staff, in its charitable trusts and organizations section. Oregon has nearly 20.
In Hawai'i, the AG's office, which is responsible for charity oversight, doesn't have even one full-time deputy assigned exclusively to that task.
That dearth of resources was reflected in a December 2004 survey by the National Association of State Charity Officials. Of the 30 states that responded, every one had more budgeted positions — from clerks to attorneys — dedicated to charity oversight and enforcement than Hawai'i, which at the time had none. Today, it has one.
"Oversight (around the country) generally is pretty lax," said Burnis Morris, a Marshall University journalism professor who specializes in nonprofit issues. "But at least some oversight is better than none."
Proponents say registration systems provide states with valuable information on what groups are out there collecting money, what they're collecting it for, how they're spending it in a broad sense and other aspects of a charity's operations. The information can help enforcement officials spot red flags, such as questionable transactions or compensation deals, and answer questions from the public.
Having regulators review annual filings also can serve as deterrents to abuse and is designed to give donors confidence that someone independent of the organization is watching to protect their interests.
National experts say Hawai'i's lax system, one of the weakest in the nation, is worrisome.
"I can't think of another state that has less of a commitment to regulating charities and protecting the interests of donors," said Trent Stamp, president of Charity Navigator, a watchdog group based in New Jersey.
"It really sounds like a wild west atmosphere," said Daniel Borochoff, president of the American Institute of Philanthropy in Chicago.
IN-HOUSE WATCHDOGS
Industry officials, however, say Hawai'i nonprofits generally have done a good job of protecting donor interests, spending money efficiently and keeping misconduct at bay.
"I'm not aware of any wholesale abuses," said John Flanagan, chief executive of the Hawai'i Alliance of Nonprofit Organizations. "I think Hawai'i nonprofits have a pretty good track record."
The board of directors of each organization provides some outside oversight, many charities hire outside accountants to review their books, and nonprofits that receive funding from government agencies and private foundations have to file reports accounting for how those dollars are spent, according to charity executives.
"The nonprofit sector here is subject to much greater scrutiny than any (government) agency," said Nanci Kreidman, executive director of the Domestic Violence Clearinghouse.
Adding to that dynamic, the tight-knit nature of the industry in an island community means word quickly spreads when a charity strays from its mission, so nonprofits go to great lengths to protect their integrity and the trust of donors, the executives say.
"Reputation is what they live by," said Kelvin Taketa, president of the Hawai'i Community Foundation.
Taketa and other executives agree that the AG's office doesn't get nearly enough funding to provide oversight under the existing system, let alone under any expanded one. They particularly laud Hugh Jones, the deputy AG who provides the bulk of that oversight, including maintaining the office's Web site on charity fundraisers. Jones, however, also has other, non-charity-related duties. The main responsibility of the tax division he heads is to provide representation to the state Department of Taxation.
"Hugh does a terrific job," Taketa said of Jones' nonprofit duties. "But frankly we need four Hughs, not just one."
Guarding against abuse is critical to the industry because charities rely on public support, and donors will be reluctant to give if they don't trust that their money will be used wisely.
The stakes are considerable.
Hawai'i residents give hundreds of millions of dollars annually to philanthropic causes. In 2001, the most recent year for which statistics were available, local residents donated about $430 million in goods and money to Hawai'i and national charities, according to a 2002 study commissioned by the Hawai'i Community Foundation.
The funds that go to local nonprofits help support a sizeable chunk of the state economy. Hawai'i's 5,000 charities control more than $12 billion in assets. Another 500 private foundations, formed by companies or wealthy families to help fund charitable services, control $1.2 billion in assets.
All told, these nonprofit organizations generate more than $2 billion in revenue, employ more than 41,000 people and pay wages topping $1 billion.
Given such weighty numbers, even if a tiny fraction of charities stray from their missions and divert assets for non-charitable purposes, the impact can be significant, according to regulators.
NO REGISTRATION SYSTEM
That was among the arguments the AG's office made several years ago when it attempted to get a registration system resurrected in Hawai'i. Registrations were required here until legislators repealed the law in the mid-'90s. But lawmakers were unwilling to support a new statute that the AG's office proposed in 2001 and 2002.
While Hawai'i has a strong law regulating paid solicitors for charities and another statute allowing the state to remove directors for fraud or gross abuse, Jones said a registration system would provide valuable information that would help the public separate the good charities — the vast majority — from the bad and enable the AG's office to better monitor the industry.
One of the big drawbacks of not having an effective system is that consumers have no single place to turn to for comprehensive, timely information about charities seeking donations. Would-be donors, for example, can't check to see if an organization that they're unfamiliar with and that is asking for donations is a legitimate charity registered with the state. They also can't see if the organization has provided the state with information on its finances.
Some watchdog groups, such as the Better Business Bureau (www.give.org) or Charity Navigator (www.charity navigator.org), provide online evaluations of certain charities, but the offerings tend to be limited or the participation of charities is voluntary.
A charity's federal tax returns, called 990s, also are available online (www.guidestar.org), but regulators and others often lament that the returns can be untimely, inaccurate or incomplete. Nonprofits with income of $25,000 or less and most faith-based groups are not required to file 990s.
TAX DEDUCTIONS AT RISK
Without a registration system, local donors who contributed more than $74,000 in 2006 and early 2007 to the Music Foundation of Hawai'i likely wouldn't have known that the charity was involuntarily dissolved by the state Department of Commerce and Consumer Affairs in 2004 and not re-incorporated until January 2007.
That meant the donors' contributions during that period were not tax-deductible, according to the AG's office.
Under a typical registration system, a significant change in status — such as an involuntary dissolution — would have to be reported to the state AG's office, and that information likely would have been added to what was publicly available about the charity.
The Hawai'i AG's office came across the music foundation case only because the charity's paid fundraiser, Hawai'i Promotions, was required to register with the state under the charitable solicitations law. All paid solicitors fall under that law.
Hawai'i Promotions' license was suspended in May for 90 days, partly for providing misleading information to foundation donors, according to the AG's office. The company didn't contest the suspension and paid a $3,000 fine.
In providing receipts to the donors, Hawai'i Promotions included its federal tax identification number and a "Keep this portion for your records" statement, implying that donations were tax-deductible, Jones said in a May letter to the fundraiser.
But even though the foundation had formally incorporated again, its previous tax-exempt status didn't apply to the new organization, meaning donations in 2006 and 2007 were not tax-deductible, Jones said in the letter.
Johnny Kai, the foundation's executive director, denied that the charity or the fundraiser was attempting to mislead anyone.
The foundation was involuntarily dissolved because of a technicality that Kai wasn't even aware of until the AG's office sent him a notice, according to Kai.
He also said the IRS recently told him the foundation's tax-exempt status still was good — the IRS Web site indicates as much — but the agency recommended that the charity reapply anyway because of the state's contention. Kai has done that.
"It was all innocent," he said. "We weren't trying to fool anybody."
The need to oversee charities is not just limited to the smaller, less obscure ones, analysts say.
High-profile, more mainstream organizations also can slip up, sometimes unknowingly.
That apparently was the case when the Honolulu Academy of Arts, as part of a compensation package to its newly hired president and director in 2003, loaned Stephen Little money to help him with a home purchase.
When the charity's board learned the following year about the AG's position on such lending practices, it immediately addressed the issue: the board and Little decided that he would step down as an officer of the academy but maintain his position as chief administrator.
"This was done to comply with the law and to prevent either a conflict (of) interest or the perception of a conflict of interest," Little said in an e-mail.
He repaid the loan in full in 2005.
Although the academy mentioned the loan on its tax returns the past several years, the AG's office wasn't aware of it until last week — when The Advertiser called to inquire about it.
Reach Rob Perez at rperez@honoluluadvertiser.com.
