Nonprofits that use private management firms to pay executives can shield compensation from the public

The Illinois Department of Human Services has notified nonprofits that they must now disclose salaries and benefits of executives paid through private companies

By Matthew Walberg, Chicago Tribune reporter

August 2, 2012As the head of an Illinois nonprofit that provides care and job training to the disabled and elderly, James Starnes was required to report publicly that his compensation more than doubled over four years, eclipsing $428,000 in pay and benefits.

But because his salary now comes from a private company he formed to run the day-to-day operations of the Galesburg charity, he didn’t have to disclose publicly what he earned last year, Starnes said.

“That’s private information,” he said.

The use of for-profit companies to manage nonprofits has grown increasingly common in Illinois, a practice that has permitted organizations relying heavily on state money to shield pay levels from public scrutiny, critics say.

“Current IRS rules allow charities to hide what they pay their executives,” said Daniel Borochoff, president of Chicago-based CharityWatch, which evaluates and rates nonprofit organizations. “There’s a loophole that some of them are using to avoid transparency.”

But the loophole may be closing. The Illinois Department of Human Services — one of the state’s largest funding agencies — notified nonprofits in late June that they are now required to disclose the salaries and benefits of executives paid through private companies.

The new requirement took effect in the fiscal year that started in July, which means it’s unlikely the information will be made public for at least another year.

The state agency said nonprofits that received $250,000 or more must release pay data for all employees, including those working for private companies. Next fiscal year it will lower the threshold to $25,000.

“This issue is of serious concern to the department, and we are taking steps to address it,” DHS spokeswoman Kayce Ataiyero said.

Officials still don’t know how widespread the practice is but have begun work to set up databases that will allow them to track such cases, Ataiyero said.

The Tribune revealed in June that executives at 18 major nonprofit organizations that rely on state funding for more than three-quarters of their revenue saw average annual pay increases of 4.3 percent in 2009 and 2010 and that many were making more than $150,000 annually. The average raise was double the rate employees in the private sector experienced during that same period.

Many of the executives were paid far more than the top officials at state agencies that fund the tax-exempt groups.

The pay data for those executives was listed in their organizations’ annual federal tax filings, which are available to the public, unlike the nonprofits that use private management companies.

Illinois relies heavily on charities to provide health and social services to those in need, disbursing more than $9.8 billion to nearly 6,000 nonprofit organizations in fiscal 2011.

Over the past decade, the use of a private company to manage a nonprofit organization has grown more common, said Sheldon Holzman, former chairman of the Illinois CPA Society.

There are advantages to the approach, among them allowing for more progressive employee benefit plans and centralizing control of management and operations, he said.

In the case of the Galesburg organization, Bridgeway Inc., the arrangement allows more than a dozen related charities to pay a flat fee to the private company, which then provides the pay, benefits and other expenses incurred by Starnes and about 10 other executives who run the charities, Starnes said.

If extra management costs are incurred, they are borne by the company, he said.

Starnes said he doesn’t see the need for the Department of Human Services’ new payroll requirements, pointing out that Bridgeway and the related charities — which together employ 900 to 1,200 people — already open their books to virtually every agency that funds them as well as to independent accrediting organizations.

“If anything, we’re over-regulated, and our costs go up astronomically because of the amount of regulation that’s going on,” he said.

Bridgeway relies on state funding for about 70 percent of its budget, and its related charities have received millions more from the state, records show.

Over the last several years, management expenses have been gradually shifted from the nonprofit to the company Starnes formed in 2008. By the 2011 fiscal year, that company was paid nearly $2 million to handle the day-to-day management of Bridgeway Inc. and its smaller affiliated nonprofits, records show.

A spike in his pay from 2005 to 2009, Starnes said, was due to IRS requirements that he take any deferred compensation accrued over his 30 years of service before retiring. He is now retired from the nonprofit but is still president as part of the contract between the company and the charity.

“Do I make pretty good money? Yes, I do,” Starnes said. “Do I have a lot on my table? I have a huge amount on my table. I have 10,000 people that I care for every year in all of our entities. And so, you know, if you want to compare my job with the person that has a shelter that serves 23 families a year in a small town, I don’t think they’re comparable.”

Just a few miles from Bridgeway’s headquarters are the Galesburg offices of Frances House Inc., where CEO Tim Bledsoe and Chief Financial Officer Ron Wilson are both paid by companies the charity either hired or created to run major aspects of its operation.

Frances House and its affiliates provide residential care and health services to the elderly and disabled and rely heavily on state funding. The group received about $37 million from the state in 2010, of which about one-third went to Frances House, totaling about 86 percent of the charity’s revenue for that year, records show.

The group of charities formed a company to provide “consulting services to its members and others” and paid it nearly $1.5 million, according to a copy of the organization’s 2010 financial statement.

The statement notes that a second company, RFMS Inc., handles administrative and accounting duties for Frances House and its related organizations. Payments to the company from the group of charities totaled nearly $2.6 million in 2010, according to the statement.

Tax filings that year noted that Wilson — who is also the chief financial officer of RFMS — was paid $121,000 by RFMS. No compensation figure was given for Bledsoe, who could not be reached for comment.

Wilson declined to respond to questions about why the organization chose to employ private management companies.

Similarly, Bridgeway’s 2011 tax filings provided no compensation figures for Starnes.

Charities are supposed to list compensation of top executives in a section that was added to the federal tax form in 2008, even if payments come from a related charity or for-profit company, according to a former head of the IRS Exempt Organization division, which oversees nonprofit groups.

“That was the intent of the change to the 990 (tax form), to capture that information and make it part of the public record,” said attorney Marcus Owens, now a partner at the Washington law firm Caplin & Drysdale, where he represents nonprofits.

But Holzman, the former chairman of the CPA group, said it isn’t unusual for organizations to reach different conclusions about what kinds of compensation they must disclose.

“There’s some room for interpretation,” he said. “Some of the issues are not as black and white as the IRS might think. They keep refining it, but they’re not quite finished yet.”

Owens said he believes some organizations use private management to make it more difficult for the agencies that fund them to find out what executives are being paid.

State Rep. Greg Harris, D-Chicago, is chairman of the House’s Human Services Committee, which exercises oversight over the Department of Human Services and other state agencies. Harris said he had concerns about the lack of public reporting.

“When there is a lack of transparency and there are large amounts of money going from a nonprofit to a related for-profit company, it raises a red flag for me as a funder,” he said.

Nonprofits that use for-profit companies to pay their executives should be required to make their pay levels public if they want to continue to receive state funding, Harris said.

He has asked DHS to review the grants and contracts awarded to Bridgeway and Frances House.

“If there are organizations that take their not-for-profit funds and transfer them to for-profit entities for legitimate purposes, they shouldn’t have any problem disclosing that,” he said.

mwalberg@tribune.com

 

Copyright © 2012, Chicago Tribune