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California AG Accuses Another Aid Charity of Misleading Donors with Inflated Gifts-in-Kind Reporting

   Jun 24, 2019

The office of the California Attorney General (OAG) “is committed to protecting generous donors from the harm caused by misleading accounting gimmicks,” states a May 30th, 2019 press release announcing the OAG’s lawsuit against Aid for Starving Children (ASC). ASC’s purported mission is to provide food, water, education and medical supplies to starving and needy children worldwide, according to its website. One of the “misleading accounting gimmicks” at issue in the lawsuit is the valuation and reporting of non-cash donations or “gifts-in-kind” (GIK), a subject that has long been a concern of CharityWatch.

The complaint against ASC alleges that the charity “improperly reported inflated revenue on its financial reports by valuing donated pharmaceutical drugs using U.S. drug prices when it never had possession or control over the drugs” that it shipped overseas, per the OAG’s press release. In conducting its GIK program, the complaint asserts that ASC was “simply acting as an agent, intermediary, or ‘pass-through’ between the upstream donors and end recipients” of the GIK donations. Intermediaries are not permitted to report the value of such GIK as contributions or program expenses in their financial statements, yet ASC did just that. Moreover, the OAG alleges that the bulk of the pharmaceutical GIK donations ASC included in its reporting were for the treatment of conditions not commonly associated with starving children, such as high cholesterol, dementia, and menopause.

ASC’s reported GIK transactions have made up a substantial portion of its total revenue. Of the approximately $105.2 million in ASC’s reported total revenue in fiscal years 20122018 (from 5/1/20114/30/2018), nearly $97.4 million, or over 92%, consisted of GIK, according to the complaint. The complaint further asserts that ASC had approximately $6.2 million in “overhead, salaries, consulting contracts, and fundraising expenses,” leaving ASC with less than $1.3 million in cash available to spend on its charitable programs to assist starving children. “Despite this fact,” the complaint states, “[ASC’s] mail solicitations, website, and information it provided to the state and federal employee-based fundraising campaigns mislead [sic] potential donors into thinking a much higher percentage of their potential donations would go to feeding starving children and families.”

As an example of ASC’s allegedly misleading solicitations, the complaint notes that some of ASC’s fundraising mailers included pie charts depicting almost all of its donations received being spent on programs, with accompanying text such as: “96.3% of all donations were allocated to life-saving programs!*” (for fiscal year 2015). The asterisk at the end of the statement appears to be noting the small text below the chart on the mailer that states, among other things, that the overhead percentage is based on “total income from all sources, including gifts-in-kind.” The relatively large portion of ASC’s income that is comprised of its valuation of GIK, however, is not included in the disclaimer text on the copies of ASC’s direct mail solicitations that are exhibits to the complaint. Furthermore, the “About ASC” page on ASC’s website has a link to its most recent annual report, and the first page of the “20172018 Annual Report” highlights a pie chart with the statement: “93.6% of all donations were allocated to life-saving programs!” The pie chart figures are noted with an asterisk disclaimer that states: “Figures include non-cash contributions.” The complaint includes a description of the pie chart from ASC’s “current” annual report at the time (its 20162017 Annual Report) that shows and states: “93.7% of all donations were allocated to life-saving programs!” Regarding this annual report pie chart, the complaint notes: “Unlike its mailers, this chart does not include any disclaimers, and it does not explain that only a tiny percentage of cash donations were and are used to provide food to starving children.”

When the portion of ASC’s GIK contributions are excluded from the calculation of its program spending percentage, the difference compared to the over 90% figures illustrated on ASC’s direct mail solicitations and annual reports is substantial. For example, the 96.3% program percentage used in ASC’s mailers based on fiscal 2015 would be 55.3% on a cash basis, and the 93.7% program percentage used in ASC’s fiscal 2017 annual report would be 32.5% on a cash basis, according to ASC’s fiscal 2015 and 2017 tax filings. 

In CharityWatch’s opinion, a disclaimer about non-cash contributions being included in the high program percentage figures touted by ASC is meaningless without also disclosing the dollar valuation of the GIK or the cash-only equivalent percentages. Absent that information, pie charts depicting program percentages that include the value of GIK transactions have the potential to mislead donors, as being alleged by the OAG. As the complaint asserts:

When a charity unfairly includes GIK valuations as revenue and program expense in its solicitation materials, it makes the charity appear larger and more efficient than it really is, and thus more attractive to potential donors. Reporting inflated values for program expenses also deceptively diminishes the percentage of the charity’s reported fundraising and administrative costs.

Furthermore, if GIK donations represent a relatively large portion of a charity’s revenue and expenses, as with ASC, the magnitude of the misinformation can be significant, like shown in the bar chart illustration, above.

As exemplified by CharityWatch’s current “D” rating for Aid for Starving Children, our rating methodology is designed to help donors understand how efficiently their cash donations are being raised and spent by charities. We do this in part by adjusting out the value of GIK received and distributed when calculating a charity’s program spending and fundraising efficiency ratios. This eliminates the inconsistencies and deception that can exist in the reporting of GIK transactions and allows donors to better compare charities on an apples to apples basis. Therefore, rather than potentially being misled by what would otherwise look to be a charity that spends over 90% of its budget on aid programs, CharityWatch informs donors that ASC’s program percentage is only 44% on a cash basis (and after adjusting for joint solicitation/educational activities, or “joint costs”), based on ASC’s audited consolidated financial statements for the fiscal year ended April 30, 2018.

ASC is not the only charity under fire from the State of California. In recent years, the OAG has accused several charities of improper financial reporting related to GIK. For example, in July 2018 CharityWatch reported on the OAG’s Cease and Desist Order filed against Food For The Poor (FFTP). MAP International (MAP), Catholic Medical Mission Board (CMMB), and Giving Children Hope (GCH) are among the other charities against which the OAG has taken action. In February 2019, the California State Assembly further demonstrated the state’s commitment to the issue by introducing legislation (Assembly Bill 1181) aimed at promoting transparency in the reporting and fair valuation of GIK. “The legislation would require charities operating in California to consider donor restrictions in valuing their non-cash donations,” according to the OAG’s May 2019 press release announcing the ASC lawsuit. An example of such “donor restrictions,” per the press release, is if a pharmaceutical company restricts drugs from use inside the U.S., then charities should not value those restricted donated drugs using U.S. prices. The respective OAG actions against ASC, FFTP, MAP, CMMB and GCH include allegations related to misusing U.S. prices to value donated pharmaceuticals distributed overseas. “Assembly Bill 1181 is a necessary and promising first step to ensure transparency in the reporting and valuation of non-cash donations to protect donors, and to promote a level playing field among charities operating in California,” the attorney general asserted in the OAG press release.

As a longtime critic of the GIK valuation and reporting practices used by charities, CharityWatch is encouraged by California’s effort to enact legislation to promote transparency in the reporting and fair valuation of GIK. Although Assembly Bill 1181 reportedly has faced some pushback during the legislative hearing process, it overwhelmingly passed the California State Assembly on May 13th, 2019 (by a vote of 69 to 1) and has advanced to the Senate. If the bill does become law in California, additional states may follow, and the accounting standards concerning the valuation of GIK may ultimately change. Whether or not these events transpire, donors can continue to count on CharityWatch to provide ratings that follow the cash received and spent by charities, thereby removing the potential effects of any inflated GIK valuations and “accounting gimmicks” charities like ASC may try to use in their favor.

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