How Firm a Foundation?

editorialgators note: this piece has been republished with the authors consent with the following notes; first that it was written in 2000 so it is not completely current but still right on target; secondly some of the information here was originally footnoted with website links, the original can be found online at www.sfsu.edu/~rdaniels/howfirm

© 2000 Robert H. Daniels, Professor of Accounting, San Francisco State University

Introduction: The "New" University Foundation

The San Francisco State Foundation has been a mystery to most observers on its own campus – a somewhat distant and costly private bank which oversees academic grant paperwork and acts as caretaker for our modest endowment. However, much of the mystery was dispelled on May 10, 2000, when the Foundation put its last four years of income tax returns on line: right here. (All tax-exempt charities must make such returns public on request.) This unveiling, however, has only replaced mystery with bewilderment. The numbers don't seem to make much sense, and some of them don't even add up correctly. The dollar amounts on the Foundation's tax returns seem to wriggle and squirm like live shrimp in a pot near the stove.

This essay -- an Internet work in progress -- will explore what may be happening below the surface, and why this campus charity is now peddling Pepsi-Cola and developing the "Centennial Village" real estate project. Accounting has been called the "language of business", and just as my colleagues who study natural languages have learned the art of "deconstruction", of extracting deep meanings, I will try to unmask the motives, ambitions and deceptions that are beneath the numbers printed on the page.

Two brief background notes, to set the stage:

(1) Foundations that are operated exclusively for public benefit, with religious, scientific, charitable, educational or civic aims, receive two powerful tax breaks. The donations they receive are tax deductions for the donors, and the foundations themselves pay no tax on their earnings. (They are sometimes referred to by the misleading phrase: "nonprofit organizations." An organization with no profits does not have to worry about taxes.) Profitable foundations are granted this valuable tax exemption on condition that they serve the public good, rather than benefiting insiders or stockholders. The Internal Revenue Service is the gatekeeper in deciding which organizations qualify, but its workforce shortages and failing computers mean that continued qualification has the elements of an honor system. The California State University System "has not undergone any recent IRS or state income tax audits", according to its most recent annual report.(1)

(2) Education bureaucrats, especially those in the civil service environment of California's state universities, like to think of themselves as business executives. It magnifies their self-importance, for "educrats" are not respected in the ivory tower where knowledge is valued above power or money. The educrats are, as a result, tempted to engage in business ventures that are beyond the zone of state control, in search of a self-funding power base. Sometimes the goal is personal gain, but more often it seems to be a desire to feel important – power and status, rather than money.

This is where the Foundation comes in. It is technically a semi-independent "auxiliary" organization for the benefit of the university itself, with its budget and policy controlled by the President. However, it does not see itself as a State agency, so it is free from tedious rules about competitive bidding on contracts, or having to comply with the State's Freedom of Information Act. The Foundation is sufficiently connected with the State, however, to claim yet another valuable tax privilege that States possess. Investors who lend to the Foundation pay no tax on interest they receive, so the organization can borrow at very favorable rates. The Foundation thus has a happy spot in the penumbra of the State University system. It is in this world, but not of it, minimally accountable and triply tax free.(n2)

So what exactly does our Foundation do? Traditionally, it collected and invested the donations generated by University fundraising, and it administered funds and the paperwork aspects of government and institutional grants for faculty research. The funds collected were paid out for "program" costs and its own internal "management" expenses. For example in the academic year ending June, 1995, it had total revenue of about $12 million, spent $11.5 million, and added the balance to the endowment -- reasonable sums for an urban State University with 1,000 faculty and 20,000 students.

The Foundation's tax returns, however, indicate that things began to change around 1995. The Foundation discovered the stock market: in 1994 it was almost 100% invested in stodgy, safe bonds, but five years later 59% of its $22 million nest egg was in stocks. The Foundation discovered real estate development: it undertook in early 1999 to construct, by August 2000, the Centennial Village dorm/garage/store/student affairs office building under a complex leasing arrangement with the University and Catellus Residential Group, Inc. The Foundation discovered the joys of tax-exempt borrowing: it had debts of $262,000 back in June of 1995, and debts of $59,660,000 just four years later. The Foundation discovered merchandising: it now licenses campus coffee shops and vending machines, helped bring Enterprise Rent-a-Car onto the campus, and is hiring intellectual property lawyers to protect the rights to its crown jewel, the Gator Trademark.

The analysis of the "New" San Francisco State Foundation will have three parts. First, since everyone likes to peek at the doings of the rich and powerful, we'll look at the list of "big" (over $5,000) donors that was so helpfully included in the 1998 forms posted to the Web. Next we'll see how real estate operations have come to dominate the financial picture, culminating in the Centennial Village construction mess and the Fall, 2000 student housing crisis. Centennial Village is best understood as an attempt to finance a new student services building on the sly and off the State books, and fits nicely into the privatization agenda of the mandarin bureaucrats at the CSU's headquarters in Long Beach. The final part is a more technical look at the accounting mysteries – the almost deliberate murk -- that make the Foundation's tax returns an exercise in cryptology.

All material has been gathered from the Internet, and is of public record. I welcome additional information: those who have more intimate knowledge of the details or can dispel my errors are welcome to e-mail me. I wish to state clearly that I am not accusing anyone of financial improprieties or malfeasance. My concern is with the unacknowledged risks of treating educational charities as profitmaking businesses. It is a matter of accountability, and the natural tendency of those in high positions is to demand it from others while avoiding it for themselves.

I) Lifestyles of the Rich and Generous (under construction)

The Foundation's list of donors who gave over $5,000 during the 1998-99 school year is available here. For extra credit, count the number of corporate donors (Catellus, Pepsi, etc.) who also have business deals with the Foundation.

II) Centennial Village: the Charitable Face of Property Speculation

In "The Prisoner", a cult television series of the 1960's, a secret agent resigns -- and wakes up in a strange town where his will to keep his individual identity and secrets will be constantly challenged. He wonders:

"Where am I?"

"You are in the Village."

"What do you want?"

"Information."

"Who are you?"

"I am the new Number Two."

"Who is Number One?"

"You are Number Six."

No doubt the 700 or so students who had anticipated living in SF State's own Village this Fall were equally baffled at being suddenly forced to scramble for space in a skin-tight housing market, or at being carted back and forth between their school and one of the picturesque abandoned military bases the University located as replacement housing. They would be even more mystified to learn of the intricate financial arrangements designed to get our Number Sixes to pay for a new university office building (n2) while keeping the financing off the books of the University itself. Here, roughly, is how the scheme was supposed to work:

1) After nine years of negotiations, the Federal government agreed to put up $9 million (actually $7 million with $2 million state matching) to help SF State replace Verducci Hall, a highrise dorm built on spongy ground that was damaged in the 1989 earthquake and stood condemmed and vacant all during the 1990's.

2) SF State agreed to a long term, if somewhat incestuous, land lease with the SF State Foundation, and obtained the necessary blessing from the bureaucrats and trustees in CSU's Long Beach headquarters. The lease let the Foundation use for 32 years a plot of University land that had been a parking lot and a base for plant maintainance operations.

3)The Foundation sold $48.5 million in bonds to finance construction (and to pay $3 million in fees to lawyers, brokers and insurers per the presentation to the CSU Trustees ) Essentially it was a long term mortgage, at low interest rates because the lenders would be getting tax-free interest. The loan money plus the federal money went to build the Centennial Village apartments -- and the garage underneath -- and 12000 sq. ft. of retail store space -- and a new student services office building on the leased land. The Foundation acted as its own property developer, and chose Catellus Corporation as the contractor (Catellus is also developing the giant Mission Bay "biotech city" south of Market Street, and has the distinction of being a major corporate contributor in state and city election campaigns.)

4) The University gets to use the office building for only the cost of maintaining it, and will own all the buildings when the lease is up in 32 years. When the Village is finished, the Foundation will turn over day-to-day property management to EHA Associates, a non-profit organization experienced in running low-income housing. The money to pay the cost of operating the Villiage and to pay the interest and principal on the long term bonds, will come from the rent students pay to live there, from the garage parking receipts, and from renting the retail space to merchants.

5)The level of rent the students pay will have to cover the debt service on the construction bonds for the whole complex -- in effect, the students will be paying both for their apartments and for the University's office building.

So clever. What can go wrong?(n1) Well, the bondholders want their money come hell or high water, so SF State and its Foundation arranged a side deal with Catellus. The contractor, it is said, made a $1 million advance, promised to pay for every day that completion was delayed, and to guarantee certain minimum rent levels. Additionally, Catellus made a $250,000 grant to the Foundation -- one of the largest "gifts" that show up in the tax disclosures. And what did this shrewd, well-connected land developer ask and get in return? Merely the power to raise rents during the two years its guarantee would last, and a payment of $2,885,000 from the Foundation, spread over 10 years, plus 4% interest.

Is it really a "gift" if you get $250 from someone but have to pay them $350 per year for ten years? Multiply by 1,000, and that's what it says on the Foundation's tax returns. The Trustee's agenda says "The obligation by the Foundation, in the form of a promissory note, is in consideration of the development services, the completion guarantee, the developer advance, and "other undertakings" provided by CRG."

So what's the problem now? The Village is months behind schedule, and it's a safe bet that costs are over budget. Interest on the bonds -- which must be paid whether or not the Village is finished -- is running at the rate of approximately $8,000 per day. (Although technically the Foundation could walk away from the debt, the idea of creditors foreclosing the mortgage on student housing on University land -- and the resulting newspaper headlines and lawsuits -- should scare even the most hardened bureaucrat.) The powers that be at the University -- who also are, or control, the Board and management of the Foundation -- are saying nothing, leaving rumor free to run wild. (The University already has a lawsuit going against the contractor of the 400-room student apartment complex it built in 1990, which has been closed indefinitely since May, 2000, due to toxic mold and which could now be the world's largest highrise mushroom farm.) The Catellus "guarantees" may well turn out to have had some wiggle room for delay due to strikes, or due to the instructions from or bungles by the Foundation, which kept for itself the job of property development manager. We have some clue as to the real estate savvy of the University's representatives: they enthusiasticly announced on the Internet about a year ago that:

"Construction will last for a period of 14 months using a very fast, innovative "design-build" technique which makes use of the idea of actually designing interior spaces as the buildings go up."

Read that again. People have been building large projects for 4000 years -- since the Pyramids, at least -- and now SF State has discovered the "innovative" idea of going ahead with construction on the outside while still trying to figure out what's going to go where on the inside. When the story was told to an experienced construction contractor, he just laughed and laughed.

The predictable lesson: universities and charities aren't good real estate developers -- the skill set is just too different. When a public university turns real estate development over to a shadowy, tax exempt alter ego, which operates off-budget and outside the normal rules of accountability for public institutions, sooner or later something will go wrong.

III) The Mystery of the Forms

The Foundation seems to have realized that no one was looking at its tax returns. This meant:

- It could plug in a $4.3 million bookkeeping adjustment for 1995, though the Cal State Internal Auditors found that $2.7 million was counted in the wrong year and "incorrectly states the result of fund-raising activities."

- It could post on the Web the names and social security numbers of 200 student scholarship recipients.

- It could show a $1.77 million "adjusting entry" with the meaningless name of "GT" to offset 60% of its management overhead in 1996, with similar "negative expense" GT adjustments (-$890,000 and –$1,051,000) in the next two years.

With no one watching, it's easy to call $190,000 or $450,000 of income "miscellaneous", and it saves the inconvenience of an explanation..

In 1997, the Foundation reported $310,000 of income coming from "plant assets funded", although the fine print shows an identical offsetting amount of "other expenses not included on Form 990 – reclassification of plant assets". Like a new circus trick, it seems to have worked so well that it was enhanced the next year: $3,950,000 of "plant assets funded" income (and an equal amount of non-included reclassification expense).

The ploy was also performed in reverse in 1998: a $390,000 total loss on "disposal of various fixed assets" generated a symmetrical "negative loss" which offset part of the non-included reclassification expense. Got that? (It's as meaningful as a lawyer calling child support a "writ of habeus babieus".) There's probably something perfectly legitimate going on under the blanket here, but these words do not indicate what it may be. No doubt it's connected to Centennial Village – why else would "general equipment rental expense" increase from $40,000 in 1997 to $3,800,000 in 1998?. It almost makes one feel sorry for the IRS – but if the Foundation gave the IRS a break, it would also have to explain why the "permanently restricted" part of the endowment fell from $12.2 million in 1997 to only $1.66 million in 1998.

And there would be further explanation, too, why the bond sale proceeds that are financing the Centennial Village construction – at $45 million, now more than half of the Foundation's total assets and twice the size of the endowment – are tucked away in the "other assets" footnote under the unhelpful heading of "asset whose use is limited"? Perhaps when the Foundation gets around to releasing its Income Tax return for the school year from July, 1999 to June, 2000, we will learn what really happened, and who to hold accountable for two ruined student dorms and the staggering debt load that clouds our endowment. Somehow, however, I doubt it. (n3)

* * * * *

Sometimes a University can appear to be very much like the "real world" -- and sometimes we might wonder whether we are all, indeed, "in the Village."

Notes: in progress (n) In the Prisoner's village (n3) A projected sequel to this essay, in the form of a classic tragedy, has been given the working title of "Edifice Wrecks." Be seeing you!