SSU foundation's private land loans

<p>When Ruben Armiñana arrived as president at Sonoma State University in 1992, the SSU Academic Foundation was a tiny organization that helped professors apply for federal grants.</p><p>A year later, Armiñana ordered the foundation be transformed into a fund-raising machine, ending its role managing academic grants and turning it into a vehicle that would ultimately be used to pursue his vision of building a $110 million music center on campus.</p><p>The foundation, which is run by Armiñana and the university’s top executives, began building a network of wealthy donors while investing contributions in an ever riskier strategy.</p><p>In 1994, the foundation began issuing private loans to local landowners as an alternative to government securities — a practice that would escalate by decade’s end.</p><p>The foundation’s investment practices came to light after Santa Rosa developer and financier Clem Carinalli, the key recipient of foundation loans, said he could no longer repay a $1.25 million loan from the foundation. Carinalli served on the foundation board and resigned in 1995 — two days before he received his first foundation loan for $500,000.</p><p>Carinalli and his mortgage company would arrange more than half of the 19 private loans to local landowners that followed — including one as large as $4.5 million. By 2003, the foundation had placed half of its $40 million investment portfolio in private loans — a policy it continued despite warnings from its auditors and its own board members.</p><p>Last week Carinalli returned to the foundation a 10-acre field outside Windsor used to secure the loan he cannot repay. The group’s attorney said it now is worth less than the amount of the loan.</p><p>Some donors, SSU faculty and foundation experts now question the foundation’s governance, asking whether the loans were advantageous deals made at favorable terms that resulted in the foundation being excessively vulnerable to a downturn in property values.</p><p>“They were operating as a bank,” said county Supervisor Shirlee Zane, a Sonoma State University graduate and donor to the foundation.“It was very careless. The foundation board should be held accountable for this, absolutely.”</p><p>Armiñana, as chairman of the foundation, was at the center of the loan decisions that now are being scrutinized. He declined requests to discuss the Carinalli loans made daily over the past three weeks. </p><p>Two other members of the foundation’s management team, both university executives, defended the private loans to Carinalli and others. They said the practice was approved by lawyers, was in the best interest of the foundation and provided more than a decade of stable investment revenue.</p><p>“These loans were all proper and in the best interest of the foundation,” said Larry Furukawa-Schlereth, who acts in the dual role of chief operating officer for the foundation and chief financial officer for the university. “We have not had a single loss until now.”</p><p>The foundation disclosed financial documents and minutes of board meetings going back 19 years, but refused to provide a complete list of its private loans.</p><p>Sonoma State’s academic foundation, as well as foundations across the 19-campus state university system, operate outside the spotlight cast by the state’s public record laws. That has raised legislative concerns, resulting in a bill approved by the state Senate and now before the Assembly that would bring the foundations under the state public meeting laws.</p><p>Officials at the headquarters of the California State University system in Long Beach would not comment on the foundation’s lending practices or whether they adhered to CSU guidelines.</p><h3>How the private loans began</h3> <p>Founded in 1974, the Sonoma State University Academic Foundation was a small nonprofit that helped professors administer grant money while also managing a small endowment fund.</p><p>That began to change in 1993 when Armiñana, newly arrived as SSU president, joined the foundation board.</p><p>The work of managing grants was given to university staff, leaving the foundation to focus solely on raising and investing money from donors. The goal was to create a well-financed organization that could fund scholarships and support the university’s academic mission.</p><p>“Dr. Armiñana really wanted to emphasize more fund-raising,” Furukawa-Schlereth said.</p><p>The foundation, which managed just $3 million in assets in the early 1990s, would swell to $72 million in assets last year.</p><p>To achieve that growth, the university embarked upon a plan to engage potential donors by creating an advisory board of about 20 wealthy Sonoma County residents, said Jim Meyer, the foundation’s former president who retired in 2002.</p><p>Two of these potential donors recommended the university consider private loans that would pay higher interest rates than lower-risk investments such as government bonds.</p><p>Jim Mattos, then owner of Sonoma Mortgage & Investment in Santa Rosa, presented the investment concept to the foundation’s finance committee as a new way to leverage donations into even bigger sums, Meyer said.</p><p>Mattos proposed investing $270,000 spread among a few different mortgages, according to minutes from the meeting. Meyer and other finance committee members liked the idea. Mattos agreed to bring them loan offers, indicating that 90 percent of the loans he would recommend would be residential properties located in Sonoma County.</p><p>Foundation officials would soon expand on that original vision and begin making large, real-estate backed loans. The opportunity brought a dramatic change in the foundation’s relationship with Carinalli.</p><h3>Carinalli asked to step down</h3> <p>On May 15, 1995, Carinalli resigned from the position he had held on the foundation’s board of directors for more than five years.</p><p>“I personally had to ask Clem to step down from the board,” Meyer recalled.</p><p>On May 17, two days later, Carinalli received a $500,000 loan from the foundation.</p><p>The issue centered on a $500,000 loan proposal that had been submitted by Sonoma Mortgage & Investments and approved by the foundation. The borrower was Clem Carinalli.</p><p>Although Carinalli had not voted on the loan and attorneys had approved the transaction, a university official raised a concern that the loan was a conflict of interest. The foundation concluded it could not distribute the money if Carinalli was on the board, Meyer said. If he wanted the money, Carinalli would have to leave.</p><p>Carinalli sent his resignation letter directly to Armiñana, saying, “Due to some new time constraints, it is with great regret that I must now take my leave from the board.”</p><p>A year after resigning, Carinalli purchased Sonoma Mortgage & Investments from Mattos, using it to arrange at least 16 additional foundation loans for himself and others, according to county land records. The foundation used Sonoma Mortgage in all but three loans it issued, according to land records.</p><p>Carinalli declined requests for comment on his dealings with the foundation.</p><p>From the outside perspective of an expert on the structure and governance of foundations, that relationship was problematic.</p><p>“It would certainly appear that standard practices were not followed here,” said Blaine Aikin, president of Fiduciary360, a Pennsylvania company that provides training on how to manage foundations.</p><p>He questioned the prudence of agreeing to loan a board member money, and then channeling millions of dollars through the former board member’s company.</p><p>“They are in a pretty tough spot to justify what was done,” Aikin said. “There are a whole lot of issues here.”</p><p>However, foundation attorney Jeremy Olsan said the Carinalli loans were appropriate. “Based on the facts as I understand them, the loans to Mr. Carinalli were proper, ‘arms’ length’ transactions,” he said.</p><p>Further, the loans to Carinalli did not pose a conflict of interest because he did not vote on any of them, including the 1995 loan arranged while he was a board member, Olsan said.</p><p>Under procedures established by the foundation, board members never actually voted on any of the more than $20 million in loans issued between 1994 and 2003. The approvals were given by two foundation executives — the president and the chief operating officer.</p><p>Meyer, who was president until 2002, and Steve Wilson, who held the COO position until his departure in 2003, approved almost all of the more than $20 million in loans during that period.</p><h3>Loans funded with donations</h3> <p>The loans were funded with donations intended for a wide range of purposes, including scholarships. As donations poured in for Armiñana’s dream of building the $110 million Green Music Center on campus, Meyer and Wilson channelled some of the money into private loans.</p><p>A $4.5 million loan Carinalli received in February 2001 was funded with money donated for the Green Center. He repaid the loan in 2004, and the money likely has been spent on construction for the music center, Meyer said.</p><p>The foundation used $6 million in donor money to help pay for remodeling Salazar Hall on campus, which houses the administration offices. The foundation made the loan to the university after bids came in high and additional construction money was needed. The loan originally was to be repaid in 2007, but the university extended that date to 2025 and lowered the interest rate from 8 percent to 7 percent.</p><p>Initially, the private loans took the place of lower-risk investments in government bonds, which at the time were paying 7 percent to 8 percent, Meyer said. Private loans had interest rates of 10 to 11 percent, he said.</p><p>Beginning in 1997, after Carinalli had purchased Sonoma Mortgage & Investment from Mattos, the number of private loans issued by the foundation increased rapidly and interest rates became more favorable for at least some borrowers.</p><p>The foundation made an additional eight loans during the next four years, including a $3.75 million loan in 2001 secured with lands in Napa County and a $1.5 million loan in 2003 to John Balletto, a grape grower, farmer and longtime Carinalli associate.</p><h3>Concentration of investments</h3> <p>By 2003, Sonoma State’s foundation had invested slightly more than half of its $40 million investment portfolio in private loans, according to its annual filings with the Internal Revenue Service.</p><p>That concentration was significantly larger than investments at university foundations of similar size across the country, according to a 2001 study that is widely used to compare foundation investments.</p><p>It found that universities with less than $100 million in assets on average invested about 3 percent of their funds into alternative investments such a private loans, according to the the National Association of College and University Business Officers. That compares to the 50 percent the SSU foundation had invested in private loans.</p><p>In contrast to the SSU foundation, university organizations of a similar size invested about 90 percent of funds into stocks and bonds, according to the study.</p><p>Most of the private loans issued by the foundation were secured with local real estate and were susceptible to a downturn in the real estate market. A borrower would have incentive to stop paying back a loan if the property value dropped below the loan value.</p><p>For years, the rising real estate market supported these investments and generated stable returns for the foundation. None of the loans went bad — until this spring.</p><p>In May, Carinalli notified the foundation he would stop making payments on one of two outstanding loans. The $1.25 million interest-only loan was secured with an undeveloped parcel of land north of Windsor.</p><p>Carinalli had refinanced the foundation’s loan in 2004 at an interest rate of 7 percent.</p><p>“Seven percent was an exceptionally good rate for vacant land,” said John Graziano, president of Santa Rosa Mortgage, who discussed general lending practices but was not familiar with the specifics of the Carinalli loans. “Back in 2004, we were doing it at 12 percent.”</p><p>Some foundation management experts said they consider it best to invest no more than 5 percent of an investment portfolio with one company or individual.</p><p>That guideline is used by one of the county’s largest foundations, Community Foundation Sonoma County, which administers community grants and manages $77.4 million in investments, said Paul DeMarco, chief financial officer.</p><p>In 2001, about 20 percent of the Sonoma State foundation’s investments were loans to Carinalli.</p><p>Between 2001 and until the most recent review in 2007, the auditors hired to provide an independent analysis of the foundation’s financial statements warned that the large number of private loans to a few individuals constituted a risk.</p><p>“The board is aware of this concentration as they review the audited financial statements every year,” Furukawa-Schlereth said. “There is nothing unusual about the disclosure.”</p><h3>Opposing private loans</h3> <p>The issue of private loans created disagreement among board members in 2005.</p><p>The foundation’s finance committee recommended ending the private loans. The committee had concluded it might need greater expertise to appropriately review the loans, according to the foundation’s board minutes. It concluded the foundation could invest in other types of investments and maintain a comparable return.</p><p>But board members balked at the idea, and Armiñana told the finance committee to reconsider its decision, according to board minutes.</p><p>The finance committee reversed its position. At the next board meeting, Furukawa-Schlereth said the foundation would continue making private loans but “strengthen their due diligence and credit analysis,” according to minutes of the meeting.</p><p>While the policy remained in place, the last time the foundation funded a private loan was in 2004, when it refinanced an existing loan to Carinalli, according to the university.</p><h3>Possession of vacant lot</h3> <p>Along a quiet frontage road north of Windsor, a pasture scattered with unkempt trees is the most tangible evidence of the fallout from the foundation’s loans.</p><p>The foundation announced last week that it is taking back the 10.5-acre plot, all that remains of $1.25 million in donations to the foundation.</p><p>Carinalli has repaid the second outstanding loan, totalling $232,500.</p><p>The extent of the losses are not yet known. The land is now worth less than $1.25 million, according to an internal memo from foundation attorney Olsan to the board.</p><p>In the long run, the foundation hopes to recoup its money and is evaluating its options for the land.</p><p>“We ultimately expect the asset to perform again,” Furukawa-Schlereth said.</p><p>The chances the foundation will have to repossess more land is unlikely, as it appears to only have two outstanding real estate loans left as investments. Most were paid off in the past six years, and none have been issued since 2003, according to the foundation’s financial filings and county records.</p><h3>Less money for scholarships?</h3> <p>The impact of the unpaid loan on the foundation’s finances is unclear.</p><p>Six donors who invested in the foundation’s charitable remainder trusts, which entitles them to regular interest payments until their deaths, might see those cash payments decrease, said Patricia McNeil, vice president for development at SSU and president of the foundation.</p><p>She would not identify the donors.</p><p>Any losses to the principal balances of those charitable trusts would likely result in less money going to fund scholarships and academic programs when those donors die.</p><p>Any losses from the Carinalli loan to the endowment fund would not impact scholarship recipients until the next academic year, McNeil said. Scholarship disbursements for the incoming class were decided last year. This summer’s decision about disbursements has been postponed, she said.</p><p>The $31 million endowment fund has suffered large losses of about 20 percent from the tumultuous downturn on Wall Street, which is expected to result in fewer scholarships next year, McNeil said.</p><p>Donations are already down 66 percent compared to last year due to the recession, McNeil told board members in March, before the disclosure of Carinalli’s loan.</p><p>If the public loses faith in the foundation’s ability to manage and invest their donations, it could hurt further fund-raising efforts, Aikin said.</p><p>He thinks the university will lose money going forward from potential donors who have lost trust in the foundation. “They really should have factored that into their decisions,” he said.</p><p>Supervisor Zane said she will not give any more money to the foundation until it re-establishes itself as trustworthy.</p><p>Zane said she received a scholarship from the foundation when she was a student. She later created an annual $500 scholarship, and invested an extra $250 annually with the foundation’s endowment in hopes of creating a large enough pool of money that it would one day generate enough investment return to fully fund the scholarship indefinitely.</p><p>“Now I’m not going to give any money to the foundation. I’m going to give it all to the student,” she said. “The foundation has lost my trust.”</p><p>McNeil said she is confident that the public and alumni will continue to support the university, and that she has not heard from anyone expressing sentiments such as Zane’s.</p><p>“I have not heard that from others,” she said. “I think our donors will recognize that the foundation followed appropriate policies and made wise investment choices.”</p><p>News researchers Michele Van Hoeck and Teresa Meikle contributed to this story. <em>You can reach Staff Writer Nathan Halverson at 521-5494 or nathan.halverson@pressdemocrat.com.</em></p>