2014 Lane Reports

Beware the Perils of Blurred Lines Between For-profits and Nonprofits

The Lane Report, April 2014
Tuesday, April 1, 2014
by Elizabeth A. Prendergast

As the Wall Street Journal reported this week,¹ investor demand for socially responsible business practices is stronger than ever. (For more information about socially responsible investing, please visit www.AdvocacyInvesting.com.) This notable evolution is motivating more profitable enterprises to establish a nonprofit arm through which they conduct related charitable activities. Indeed, such arrangements can be advantageous to the for-profit company, the charitable organization, and the community and marketplace as a whole. However, when the parallel operations converge, blurred lines between nonprofit and for profit operations can create significant problems for both entities.

Take the educational publishing giant Pearson Inc., for example. Pearson, Inc. (“Pearson”) sells instructional content, assessment materials, and other products and services for profit to states and school districts throughout the United States and across the world. When the New York Attorney General’s Charities Bureau examined Pearson’s efforts to develop a suite of educational products through its nonprofit arm, Pearson Charitable Foundation (the “Foundation”), a corporate culture was revealed in which the lines between business and charity were often obscured, resulting in the Foundation paying a $7.7 million settlement to the attorney general in December 2013.

Around 2010, Pearson began investing in the development of courses, associated instructional materials and software offerings based on the Common Core State Standards, the new set of K-12 academic standards that have been fully adopted by 45 states, the District of Columbia and four U.S. territories. The lucrative opportunity was projected to generate tens of millions of dollars for Pearson.

The effort was financed through the Foundation in order to win an endorsement from the Bill and Melinda Gates Foundation. Pearson executives believed that branding their courses by association with the prominent foundation would enhance Pearson’s reputation with policymakers, the education community and potential customers, thereby building credibility for its commercial products. The plan was for the Foundation to retain rights that would enable it to make four of the courses openly available to the public free of charge and to license the commercial rights to Pearson. But once the attorney general began its investigation, Pearson and the Foundation “undertook a legal and business reconsideration” of the arrangement (according the settlement agreement), resulting in the Foundation’s sale of the partially developed courses to Pearson for $15.1 million.

The investigation also revealed that the Foundation had helped woo clients to Pearson’s business side by paying their way to international education conferences that were attended by Pearson executives. The school officials who were invited to attend the conference were from jurisdictions where Pearson actively did business or sought to do business. Moreover, executives from other companies were not invited to attend, giving Pearson’s corporate side a clear advantage. Several attendees said the fact that the trips were financed by the Foundation rather than Pearson’s corporate divisions demonstrated that the purpose was educational, rather than commercial. Nonetheless, expensive hotels and meetings with top executives from the commercial side of Pearson were reportedly staples of the experience.

The attorney general found the Foundation in violation of the New York Not-for-Profit Corporation Law and the New York charitable trust laws which, like the federal tax code and laws of every other state, prohibit the misuse of charitable assets to benefit an affiliated for-profit enterprise.

The close relationship between the Foundation and Pearson contributed to the attorney general’s findings. For example, Pearson’s employees also serve as the Foundation's staff; the Foundation's board was comprised entirely of Pearson executives until 2012; select Foundation programs have been conducted with the advice and participation of senior Pearson executives; the Foundation continues to rely heavily upon Pearson for administrative support; and Pearson remains the Foundation's primary funder.

Despite agreeing to a settlement of $7.7 million, Pearson and the Foundation maintain that they did nothing wrong. “We have always acted with the best intentions and complied with the law,” they said, in a joint statement. “However, we recognize there were times when the governance of the foundation and its relationship with Pearson could have been clearer and more transparent.”

As part of the settlement, the Foundation agreed to alter its governance structure by appointing three independent board members to review any financial transactions that might benefit Pearson and has also adopted “stronger operational systems.” Also, Pearson’s commercial products may no longer be featured or sold at any events funded by the Foundation, and Pearson’s corporate employees may no longer attend foundation-funded events.

A relationship between a for-profit corporation and its nonprofit affiliate can be advantageous to both organizations. However, as Pearson and its sister foundation learned, even when all parties have only the best intentions, such an arrangement can easily blur the lines between business and charity if the relationship and dealings are not structured to adhere to applicable non-profit and charitable trust laws as well as the rigid tax rules and regulations governing §501(c) organizations. Beyond proper structuring, sound governance practices are also of critical importance.

The Law Offices of Marc J. Lane, P.C., is intimately familiar with the many rules and regulations governing nonprofit organizations, for-profit entities and hybrid social enterprises. We would be delighted to help you explore how your profitable enterprise can benefit from a relationship with a nonprofit organization without running afoul of state law and federal tax regulations. Please feel free to call Marc Lane at 312-372-1040 (or 800-372-1040), or e-mail him at mlane@marcjlane.com.

¹ Chasan, Emily (2014, March 31). More Companies Bow to Investors With a Social Cause. The Wall Street Journal.

Elizabeth A. Prendergast is an Associate Attorney with The Law Offices of Marc J. Lane, a Professional Corporation. Ms. Prendergast is a graduate of Loyola University Chicago School of Law (J.D.), Loyola University Chicago Quinlan School of Business (M.B.A.) and Creighton University (B.S.B.A.).

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