The wrecking of a blue-chip New York nonprofit

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FEGS. (PIX 11)
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ALBANY—When Federation and Employment Guidance Services announced a month ago that it planned to close amid a $20 million revenue shortfall, the nonprofit world was shocked.

But the ruinous series of decisions that wrecked FEGS—a health and human services nonprofit that has long been one of New York’s largest, most well-regarded social services organizations—was years in the making.

A Capital review of the nonprofit’s financial disclosure forms and yearly tax returns reveal an agency engaged in risky long-term behavior and slowly drowning in debt, seeking capital financing from an ever-widening array of sources to expand its operations and interests even as those operations failed to produce profit.

As that behavior was intensifying, city and state governments continued to provide FEGS’ grants and finance its debt, lending the organization money while it approached collapse.

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Now, FEGS is considering declaring bankruptcy, according to sources familiar with discussions among the nonprofit’s leadership and other social services agencies. And state and city agencies that contract with the nonprofit are feverishly working out plans to transfer the charity's caseload to other organizations.

FEGS revealed an unexpected $19 million operating shortfall in an all-staff email that was sent Dec. 12, and first reported by The Jewish Daily Forward, which also reported that the charity's C.E.O. Gail Magaliff and executive vice president had been replaced.

The potential implications of the nonprofit’s collapse aren’t just financial and logistical—FEGS is responsible for running hundreds of city and state social-service programs—but also political, raising questions about how a host of well-connected directors, regulatory entities and elected officials failed to see the disaster coming.

“Our view is that there were sufficient signs for the board, funders and lenders to question the financial direction and health of the agency,” said Doug Sauer, head of the New York Council of Nonprofits. “It had to be brewing. There are usually straws that break the camel’s back but it's usually a long road.”

The work of unraveling what happened and who is to blame—to say nothing of what happens next—is only just beginning.

The Manhattan district attorney’s office and the state attorney general’s office are reportedly investigating the circumstances of FEGS’ collapse. At the same time, two nonprofit umbrella agencies—the Human Services Council and UJA (one of FEGS’ funders)—have launched their own independent inquiries into the charity’s downfall.

But it is already possible, using information in the organization’s financial disclosure documents, to see the outlines of a disastrous pattern in which FEGS made unwise investments, then used loans and grants to cover faltering components of the business.

The nonprofit effectively borrowed to cover up its losses until the debt became insurmountable.

According to the tax forms reviewed by Capital, FEGS poured money into its for-profit subsidiaries, launched an ultimately unsuccessful managed long-term care providing offshoot, invested money in offshore funds in the Cayman Islands, Greenland and Iceland, engaged in unusual auditing practices, increased executive salaries even as debts mounted, and may now owe the state tens of millions of dollars because of Medicaid overcharges.

FEGS IS PART OF AN INSULAR UNIVERSE OF OVERLAPPING Jewish nonprofits, and it is tied to the UJA Federation, the umbrella group that raises and distributes money to a number of its related charities.

In the past couple of years, nonprofits within that universe have been at the center of a number of scandals: The C.E.O. of the Met Council on Jewish Poverty was convicted in a wide-ranging decades-long fraud scheme last year, and the C.E.O. of the New York Legal Assistance Group resigned amid stories of a federal investigation into the charity’s finances. NYLAG, Met Council and UJA Federation all shared board members. And NYLAG, FEGS and Met Council all have connections to the accounting firm Loeb & Troper, which has been FEGS’ accounting firm for years.

FEGS now operates nearly 200 different programs. It constructs housing for the developmentally disabled, pays aides to care for those clients, and operates as a vocational center, finding employment for them in specialized work programs. The agency also operates programs to help transition formerly incarcerated individuals back into society, setting individuals up with mental health providers and case managers to help them acquire housing, jobs and schooling.

It runs affordable housing buildings for the deaf, blind and poor, and uses its ample staff to help enroll clients in city and state funded social services, from Medicaid and Medicare to food stamps.

FEGS began as a small vocational center for Jews in 1934, helping poor immigrants in the New York area. Over time, its mission expanded to the range of social services it provides today, with particularly sharp growth in the mid-90s, after a wave of Jewish immigration from the former Soviet Union.

By then, FEGS had also developed a reputation as one of New York City’s most trustworthy nonprofits, routinely winning the city and state’s largest contracts for disability services and welfare-to-work programs. It was one of seven charities used each year by the New York Times to find profile subjects for the paper’s annual holiday-time solicitation, “The Neediest Cases.”

In 1998, in a boom economy for welfare-to-work programs like the ones FEGS ran, the agency signed a 15-year lease at 315 Hudson Street, on Manhattan’s West side, taking six floors and 400,000 square feet on the site of the former Jujube candy production factory.

The lease was worth a reported $60 million.

It was also in the mid-1990s that the nonprofit opened the first of several for-profit subsidiaries, a plan the company later described as a strategy to save on outsourcing costs. Many nonprofits create for-profit subsidiaries to help produce revenue in an era of unreliable government funding. But FEGS’ for-profit strategy, over time, became a burden and a source of instability.

A 2006 PROFILE IN HEALTHCARE EXECUTIVE MAGAZINE of FEGS’ then-C.E.O. Alfred Miller said the organization had evolved in a Darwinian fashion to survive over its decades of existence, growing from “a small employment and guidance service to a comprehensive health and human services system with a $230 million budget, 15 subsidiary and affiliated corporations, and more than 300 facilities, residences, and off-site locations.”

At the time of the interview, Miller cited General Motors as the charity’s primary business model, praising the automotive giant's ability to integrate “previously independent brands” and “create economies of scale and create a shared infrastructure.”

(This was three years before General Motors filed for the largest industrial Chapter 11 bankruptcy in American history, a victim of its unwieldy economies of scale and massive, unsupportable shared infrastructure.)

FEGS, like G.M., had “created, or became affiliated with 15 different corporations covering everything from technology and human resources to disaster management and home care,” the magazine wrote.

Miller was gone by 2007, when C.E.O. Gail Magaliff took over. The company’s efforts to diversify got more aggressive, and unusual.

Since 2009, the earliest year for which the charity’s tax returns are available, the nonprofit has been investing millions of dollars in offshore accounts in Greenland, the Cayman Islands and Bermuda, a practice nonprofit experts said was atypical.

(A FEGS spokeswoman did not respond to a question from Capital asking when the nonprofit first began investing in the off-shore accounts, and declined to comment substantively on any aspect of this article.)

By 2014, FEGS owned 66 different properties, and leased 414 sites around New York as part of its organization, disclosure documents show. It had a $250 million annual budget, thousands of employees, and claimed to serve an estimated 100,000 clients a year. It had created four for-profit subsidiaries, and eight related not-for-profit subsidiaries, five of which were related to FEGS through common board members.

It is unclear whether FEGS’ for-profit firms ever made any money. And disclosure documents show the reverse—that the charity has for years been propping up the for-profit subsidiaries with a steady stream of funding.

Last week, the Forward reported that the charity began transferring millions of dollars to the for-profit subsidiaries by 2011. Returns reviewed by Capital show FEGS moving $8.6 million from the nonprofit side to one for-profit information technology company, AllSector, in 2011. In 2012, the charity transferred even more: $9.1 million.

Both that company and another for-profit subsidiary to which FEGS had made substantial payments, called HR Dynamics, had more than a half-dozen creditors as of July 2014, according to a review of financing statements filed with New York’s state department. AllSector signed financing agreements with at least five different creditors, dating back to 2009, using the company’s equipment as collateral. HR Dynamics opened two separate lines of credit from Chase Manhattan Bank and JP Morgan Chase beginning in, 1999, records show.

These subsidiaries investments might have raised alarms if they’d been subject to wider review. But because of the way the payments were accounted for, they were hard to notice.

As the Forward reported, transfers of funds between FEGS and these for-profit subsidiaries were not traceable in the organization’s 990 tax forms or the audit prepared by FEGS’ long-time accounting firm Loeb & Troper. The firm performed a consolidated audit—that is, a review that did not separately audit each of the company’s subsidiaries.

"If the auditor is doing its job then it in fact prepares an audited statement or relies on an audited statement that’s prepared for each separate entity and then it compiles them," said Bill Josephson, an expert in tax-exempt organizations and former assistant attorney general-in-charge of the New York Charities Bureau.

Josephson said the charity’s tax returns would have made it virtually impossible for the board members to know which assets belonged to the nonprofit and for profit subsidiaries, clouding the picture of AllSector’s financial health.

"The 990 has a question on it that says 'has the audit committee and the board read the financial statements' … but since they’re consolidated there would be no way for even a careful reader to know that there was a problem with AllSector technology," Josephson said.

EVEN AS IT POURED MONEY INTO ITS ILL-FATED for-profit subsidiaries, FEGS itself continued to expand, building up its shelter and housing services for developmentally disabled, elderly and impoverished clients. The charity’s $250 million annual budget was propped up largely by grants and roughly $200 million in annual revenue from state and federal Medicaid dollars.

But its debt obligations were piling up.

To build up its housing portfolio, FEGS routinely had gone to a variety of city and state funding sources over the past decade, seeking millions of dollars’ worth of advances on construction and capital costs for their new facilities, taking out low-interest loans that it didn’t have the means to pay back.

From the federal Department of Housing and Urban Development, the charity received $800,000 in advances for housing developments and S.R.O.s. From the state’s Office of Mental Health, more than $3.4 million for facilities in East New York and the Bronx. And for more than a decade, FEGS, like many other nonprofit institutions around the state, had been financing new projects with money from bond proceeds through the Dormitory Authority of the State of New York, a state public authority.

It’s through the dormitory authority, or DASNY, that state leaders could have exercised some discretion over FEGS’ ultimately unsustainable levels of borrowing, spending and new investment.

DASNY is controlled by an 11-member board, a majority of which are by statute the responsibility of the governor. (There are five direct appointees of the governor on the board—though one spot is currently left vacant and waiting to be filled by Governor Andrew Cuomo—with three more seats filled by the administration’s health and education commissioners and the state budget director.) The remaining three slots are controlled, respectively, by the state comptroller and the leaders of the Assembly and State Senate.

In addition, many of the bond issues that the DASNY board votes on must be approved by the state Public Authorities Control Board, which is made up of five members, including the state budget director, State Senator John DeFrancisco and, until very recently, former Assembly speaker Sheldon Silver.

In total, FEGS has received $23.25 million in building loans from DASNY, from three different bond offerings, the most recent of which was issued in 2012. The debt is secured by the properties that FEGS used the money to build—residences and facilities to house the nonprofit’s disabled, elderly or impoverished clients.

FEGS is still repaying the state for those bond proceeds. Financial records from mid-2014 show the nonprofit still owes $11.9 million to DASNY to pay back the principal on its debt.

The charity also received money from other public authorities in recent years, including the Industrial Development Agencies of the City of New York and Suffolk County.

FEGS owed a total of $14.9 million to all of the public authorities as of June 30, 2014, according to disclosure documents filed with DASNY last summer and marked “Draft.”

By last summer, FEGS had so much debt that it failed to meet the state’s requirements for debt coverage, meaning that its income was not enough to pay down its the principal and interest on the debt it owed. In its June 2014 disclosure forms, the charity indicated it would seek a waiver from the state to get around the debt-service requirements.

“As of June 30, 2014, FEGS was not in compliance with the debt service coverage ratio on three DASNY bond issues covering eight properties operated under the auspices of OPWDD,” the application says. 

DASNY spokesman John Chirlin declined to comment on whether the state had granted FEGS the waiver, saying the authority is subject to Securities Law constraints because of its outstanding bonds, and could only provide such information through “appropriate secondary market filings.”

Nonprofit experts said auditors from Loeb & Troper, the accounting firm that prepared FEGS’ tax returns and financial statements for years and also serve a multitude of other New York nonprofits, never distinguished between current and non-current assets in the charity’s filings, which may have obscured just how little liquid cash the charity actually had to pay off its debts.

Regardless, DASNY only acknowledged the existence of FEGS’ problems in a disclosure document published on February 25, 2015, weeks after news broke of FEGS’ impending closure. It was the first time in dozens of legally required state disclosure filings that the extent of FEGS’ financial difficulties was made apparent.

“DASNY has been advised that FEGS is experiencing serious financial difficulties, intends to discontinue some or all of its operations in the near future and has been in contact with the New York State Office for People with Developmental Disabilities (‘OPWDD’) with regard to identifying potential replacement operators for a number of the programs and facilities which FEGS currently operates,” the disclosure document said.

Josephson, the former state charities bureau regulator who described the challenges FEGS posed to would-be auditors, nevertheless questioned DASNY’s lack of awareness about the charity’s finances.

"It is certainly relevant to ask DASNY whether they had any early warning with respect to the AllSector problem or were they relying on Loeb & Troper,” he said. “And how could they rely on Loeb & Troper if Loeb & Troper didn’t separately disclose the AllSector investment, which it doesn’t look like it did.”

Asked when DASNY first became aware of FEGS’ financial problems, DASNY spokesman John Chirlin said, “DASNY filed disclosure documents in connection with bonds that DASNY issued on behalf of FEGS. FEGS’ bond debt service payments are current as of the date of such disclosure documents. Please note that because DASNY has outstanding bonds, we are subject to Securities Law constraints and need to provide information through appropriate secondary market filings.”

The charity has also looked beyond government for credit advances.

In March of 2012, FEGS took out a $3 million, five-year equipment loan for a VOIP telephone system from JP Morgan Chase.

Disclosure documents show the charity also owes more than $14 million in mortgage payments over the next five years, an amount that may be larger than the value of the mortgaged properties, which are "on the books" for $9.8 million. And the charity is paying rents for buildings it cannot afford. By 2014, roughly 10 percent of its annual revenue, more than $25 million dollars a year, was tied up in long-term operating leases that are extremely difficult or costly to break.

Some observers questioned whether the charity’s size had made it difficult for its leadership to know its own sprawl.

The charity itself has a 26-member board of directors, and four officers. Its 2013 tax returns show 17 key employees and medical directors, each of whom earns low- to mid-six-figure salaries to manage the nonprofit.

“Somehow the issue to me is board governance,” said Naomi Levine, director of N.Y.U.’s Center for Philanthropy and Fundraising. “Boards are critical and they are not being trained properly. If the boards assumed those responsibilities you might avoid the tragedy that happened at FEGS.”

The scale of the financial damage isn’t yet known, but the picture is likely to look worse, not better, as numerous investigations progress.

Disclosure documents revealed that one of FEGS’ related subsidiaries is the subject of a state Office of Medicaid Inspector General audit that examined roughly $80 million worth of Medicaid payments to the charity made between 2006 and 2009. The audit is estimated to have found the charity overcharged Medicaid by between $13 million and $20 million, a finding that would mean between one quarter and one-fifth of all the charity’s billings covered by the audit were in error. That audit has not yet been released.

FEGS, according to its financial reports, had very little cash on hand, which gave it little ability to maneuver if it encountered unexpected setbacks. The Medicaid audit appears to be one.

And it coincided with another: In late 2014, New York City decided against renewing two longtime contracts for city employment and training programs. The costs to FEGS of losing those contracts was $11 million. With little cash on hand, there was no way to buffer the losses.

In addition, two social services agencies are now conducting separate investigations into what happened, as rumors of an impending bankruptcy swirl.

The Human Services Council, a nonprofit industry body, began its investigation this week, setting up a council of roughly 20 members—academics, local nonprofit heads and consultants who advise nonprofits on financial and organizational matters. The committee met for the first time on Tuesday, and plans to issue a report analyzing what led to FEGS’ failure and what lessons it holds for the industry moving forward.

If FEGS does declare bankruptcy, the former social services agency’s union employees say they worry they’ll be too far back in the line of creditors to be paid what they’re owed.

The Social Service Employees Union Local 215, which represents around 1400 of FEGS’ 2200 employees, says FEGS currently owes employees around $5 million in vacation pay, severance pay and benefits.

“If they declare bankruptcy that means the union will have to get in line with other creditors to get those benefits,” said union spokesperson G.L. Tyler.

Groups associated under the UJA Federation of charities have already picked up a slice of the charity's 172 different programs, but according to Jewish Week, more than 100 different programs are still without a future operator.