Koch Brothers, Cato Institute, and Stock-based Non-Profits

New Orleans   I think the colloquial expression would be that there’s a “falling out among thieves” over at the Cato Institute between the co-founders, Edward Crane, and the two gazillionaires from Kansas, the Koch brothers, Charles and David.  The Koch’s after having bankrolled the allegedly independent Cato outfit to the tune of $30 million over the years have cut their contributions down to zero, so Crane and the existing president of Cato as the holdouts are whining to the New York Times and anyone who cares that they are being frozen out of the fundraising market because, get this, of their association with the Koch’s.  The whole mess hinges on the non-profit structure of Cato, which obviously is unfamiliar to the Times reporter, many, many lawyers, and the average bear out there trying to get a grip on the story.

In short summary, it couldn’t happen to a nicer bunch of guys, but as much as I might try, I have to admit, I have something in common with the Koch Brothers now and regardless of what some junior associate in a white shoe firm in DC might be saying, they are almost undoubtedly correct about their legal position and are holding the marbles in most every way imaginable.

I realize all this may seem like a brave new world to many, and in fact it was humorous to see how Wikipedia changed the definition of non-profits yesterday to reflect this “new” information about non-profits as if it were a peculiarity of some exotic foreign land, meaning Kansas.  It is not.

Stock-based non-profits are a very common legal structure for non-profit formations in many states.  I think our old ACORN general counsel once told me they existed in some 20 states, which may not be true now.  Categorically, they still exist in states like Missouri (which we used often), Michigan, Nevada, Maryland, and, as I say many other places than Kansas.  We used such non-profit structures frequently in organizing the property and media holding non-profit corporations associated with ACORN.  For it made sense because rather than creating a membership-based non-profit where there would never be a broad based individual membership, it made more sense to give out single shares of stock to all of the organizations that would have tenancy in a property so that they could manage the property much like a cooperative would.  Same for applications for various local non-commercial radio licenses, where the participating organizations with local operations would combine to appoint the boards for such applications at formation until replaced by a different structure or permanently.

None of these structural considerations have anything to do with the tax-exempt status of a non-profit which despite the inability of seemingly everyone out there, few seem to understand.  Tax-exemption is a matter of applying to the Internal Revenue Service for special consideration as a public charity or for providing a social and public good.  Non-profits simply mean that there is no ownership stake that can be converted into money and inure to the personal benefit of a director, staff member, or other entity.  In other words no profits can be distributed.  That’s the heart of it, and the rest is blarney.

Now in ACORN’s case the stock was distributed at formation to other non-profit organizations who would then appoint through their own process members of the board to represent them.  In the case of the Cato Institute it appears that the four founders each issued themselves one share of stock personally, and then bound each other at the hip to appoint board members by some formula that was not clear in the article, but seems to have left the Koch Brothers able to name 7 of the 16 members of the board.  I’m just guessing but I suspect each of the four founders might have had the right to appoint 4 members, but the two brothers, being brothers, were not allowed to appoint the majority.

All of which leaves a mess now because one of the founders has passed on his reward and the others are split with the two brothers on one side and the lone outsider hanging out by themselves.  This dispute seems to have been simmering for some years in a stalemate now broken by the Koch’s going to court in Kansas to resolve the matter, which seems appropriate, and indicates that Cato was formed originally in Kansas, making that a proper jurisdiction.

The Times story contained the following paragraphs at the back end:

But the brothers still wield significant influence over Cato’s governance because of its unusual structure, which created four “shareholder” seats, each with shares of capital stock bought for a dollar each. The Kochs have used their shareholder positions to name seven employees and associates to the 16-member board.

The shareholder arrangement has raised questions among some nonprofit tax experts, who said a sale of the shares was legally problematic and possibly in conflict with Internal Revenue Service regulations. But Wes Edwards, a lawyer representing Koch Companies Public Sector, defended the structure as legally permissible under Kansas law.

Hopefully, the first paragraph is now clearer since this is certainly not an unusual structure and the shares were probably issued for $1 rather than having been bought for $1, but no matter that’s all on the up and up.  The rest is all blarney and posturing.  None of this would have anything whatsoever to do with IRS tax exempt regulations unless somehow there was a distribution of profit to someone or something, and in this case it’s all about power – who controls Cato – and not about profit.

The billionaire brothers Koch are simply saying that they are tired of playing patty cake with their former BFF and read to align their interests.  Transferring the last founder’s share to some other individual or entity would not be “legally problematic” unless there was some kind of preposterous auction to the highest bidder or something, and that’s not happenin’ captain.

Simple truth:  the Koch’s lawyer is 100% correct here not only in Kansas but in a couple of handfuls of other places where they could have created Cato, and if Cato is counting on conning folks in fundraising or finding a political haven for a false claim about non-profit structures, as much as I enjoy this mess, they are “out of luck, Chuck,” and better be looking for new jobs somewhere else on the Beltway.  Koch’s win this one going away.

Now a harder question might be:  what are these so-called libertarians doing sorting their business out with the government’s rules, regulations, and courts?

 

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