The Baptist Foundation of Arizona recently proclaimed a banner financial year despite the fact that investigators from three different state agencies are scrutinizing the foundation's multimillion-dollar real estate and stock transactions with insiders, New Times has learned.
The Organized Crime and Fraud Section of the Arizona Attorney General's Office, with the assistance of the Securities Division of the Arizona Corporation Commission, is conducting a criminal investigation of certain BFA staffers and others involved in some of the complicated insider transactions, sources close to the investigation say. The insiders with whom the foundation has done business include one current and two former BFA board members.
New Times has confirmed that grand jury subpoenas have been issued in connection with the attorney general's investigation.
Investigators are working with former BFA staff accountants and a former staff attorney who quit the foundation in 1996 after warning top managers that their business dealings were unethical and possibly criminal.
"I am convinced that you honestly fail to appreciate the moral, economic and legal gravity of your actions," former BFA attorney L. Kyle Tresch wrote to his BFA superiors in a draft of his letter of resignation. The letter, which was obtained by New Times, goes on to say that BFA had for a decade engaged in transactions that amounted to "actionable fraud."
Former accountant Richard Polley wrote to BFA bosses that their business practices seemed intended "to deceive our investors regardless of the outcome to them. The Scriptures are quite clear that such an outcome is sin."
The Reverend W. Berry Norwood, chairman of the BFA board, dismisses the criticism, saying the former staffers "never had the information necessary to evaluate the transactions" and did not understand them.
The attorney general and Corporation Commission are not the only state agencies scrutinizing BFA. The Arizona Board of Accountancy is investigating Arthur Andersen LLP, a Big Five accounting firm with offices in Phoenix, to determine if the firm followed acceptable accounting standards and principles when preparing BFA's audited financial statements.
No one has been charged with any crime in connection with any of the current state investigations, which were initiated following the publication of a New Times series detailing the findings of a six-month public records investigation of BFA.
The series revealed that BFA, a nonprofit corporation chartered in 1948 to help Southern Baptist causes, in 50 years had returned only $1.3 million of its own money to the Southern Baptist community, yet lent nearly $140 million to companies associated with current BFA director Dwain Hoover and former directors Jalma Hunsinger and Harold Friend. Much of the cash BFA funneled to insiders had come from church treasuries and the faithful, who have lent BFA more than $317 million.
Although BFA says it has always repaid every penny to investors, public records raise serious questions about the true value of the real estate assets collateralizing some of those loans. BFA does not guarantee repayment of the loans (which are not federally insured), but relies instead on its position of trust in the Southern Baptist community to retain a steady stream of investors. BFA acts like a bank, borrowing money from investors and lending some of that money out for real estate projects. BFA's most recent audited statement reports that it has interest payments going out much faster than coming in: In 1997, interest-bearing liabilities totaled $382 million, while interest-bearing assets totaled $209 million.
Transactions between insiders and BFA are conducted through a web of at least 60 interlocking corporations, and many transactions were conducted without the knowledge of BFA's full board of directors. Such a complicated corporate structure and insider transactions are unusual for a religious foundation, officials of similar foundations say.
Five former BFA employees--four certified public accountants and one attorney--are assisting state investigators. All five resigned from BFA in 1996.
Their resignation letters and other internal documents obtained by New Times reveal that as early as 1996, BFA management was repeatedly warned by its own employees that, in their opinions, BFA management might be criminally liable for some of the complicated transactions.
A key question the state investigations may answer is whether illegal "self-dealing" occurred, whether transactions benefited insiders at BFA's expense. Self-dealing violates the Internal Revenue Code, fiduciary-duty laws, and fraud statutes. Penalties may range from revocation of tax-exempt status to criminal prosecution of officers and board members.
Attorney General's Investigation
Neither the Arizona Corporation Commission nor the Arizona Attorney General's Office will comment on the ongoing criminal investigation, which was confirmed to New Times through several knowledgeable sources, including BFA President Bill Crotts.
"As usual, we can't confirm or deny criminal investigations," says Karie Dozer, spokeswoman for the attorney general.
Dozer also declines to answer specific questions about the expected length of the probe, possible crimes that may have been committed or names of any individuals targeted in the investigation.
In general, explains Dozer, the Organized Crime and Fraud Section prosecutes fraud schemes and white-collar crimes. The Securities Division of the Arizona Corporation Commission has assistant attorneys general assigned to it, she adds, and investigates such crimes as the sale of unregistered securities and ponzi schemes.
In an October 30 letter to New Times, BFA President Bill Crotts confirmed the attorney general's investigation.
"The Baptist Foundation of Arizona welcomes investigation by the State," he wrote. "We have pledged our full cooperation to the State and, indeed, have already provided thousands of pages of documents. We welcome every opportunity to share with the state our 50-year history of growing an endowment that helps house, clothe, educate and feed children, the elderly and the needy."
In November, Crotts sent two communiques to investors and others in the state's Southern Baptist community confirming the attorney general's investigation. In both communiques, Crotts blamed the attorney general's criminal probe, which he identified as an "inquiry," on a "poorly written and poorly reported" series in New Times.
Crotts called the newspaper "quite anti-Christian."
"We have carefully examined the New Times articles about BFA," Crotts wrote. "They are vague and full of innuendoes. They clearly indicate that the reporter has an agenda to make the Baptist Foundation, certain benefactors and directors, our General Counsel Tom Grabinski and me look bad.
"We expected that state governmental authorities would, sooner or later, examine the articles. That day has come. The Office of the Arizona State Attorney General [State] has begun an inquiry that is based on the information reported in the New Times articles.
"You should be aware that when we learned the State was asking questions about us, we asked our attorneys to initiate contact with them. We told the State we would be happy to supply all of the information they wish and are now doing so.
"We welcome this inquiry because we want to set the record straight. The New Times has tried to damage our reputation and impede the Foundation's mission. This inquiry will finally bring this matter to a favorable end."
Officials of the Arizona Southern Baptist Convention, which nominates BFA's directors, did not respond to a fax and letter from New Times seeking comment on the investigation.
The Former Employees
In 1996, five employees of BFA--four certified public accountants and an attorney--began to question their superiors about the safety of millions of dollars of investors' money that BFA was plowing into real estate transactions, some of which did not seem ethical to the young professionals, all devoted Southern Baptists.
The attorney and two of the former accountants committed their concerns to paper, writing letters to their bosses complaining that the full BFA board and Arthur Andersen auditors did not know that BFA was hiding nonperforming loans worth millions of dollars by "selling" them to companies associated with insiders. The insider companies often wrote IOUs to BFA for the nonperforming loans. The loans were then hidden in the web of insider companies, and the insider IOUs, which were recorded as assets, had the effect of making BFA's books look artificially good, two of the employees wrote.
One letter alleges that BFA funneled $2.2 million in Individual Retirement Account funds to a worthless insider company, which turned around and used the money to make a down payment to BFA so it could purchase the nonperforming loans from BFA.
The concept is called in accounting parlance "good bank-bad bank." According to documents written by some of the former employees, BFA played the good bank with an impressive balance sheet to show off to investors, while the insider companies played the bad bank by hiding BFA's nonperforming loans.
The accountants urged BFA to tell its auditor, Arthur Andersen, and the full BFA board that the bad banks were actually insider companies.
One insider company that worried the employees was former BFA director Jalma Hunsinger's ALO and its subsidiaries. In 1996, ALO reported that it was $116 million in the red. That same year, ALO and its subsidiaries owed BFA $58.2 million. The CPAs wondered how cash-poor ALO could ever pay BFA back. (According to BFA's most recent financial statement, ALO's debt to BFA has since increased to $70.2 million.)
(When asked by New Times if Don Deardoff, a CPA who serves as BFA's controller, had a duty to advise BFA to ask Arthur Andersen to audit ALO, BFA board chairman W. Berry Norwood answers in his December 3 letter: "No.")
The employees also worried about the safety of millions of dollars in Individual Retirement Accounts to which BFA had access. Some of the IRA money was--still is--entrusted to Arizona Southern Baptist New Church Ventures (Ventures), which is managed by BFA. Ventures is a nonprofit company chartered in 1983 to help start new Southern Baptist churches. In a communique to the Arizona Southern Baptist community, Crotts noted that "as an IRA custodian, BFA allows investors to self-direct their investments to start up new churches." He said that Ventures in its history has lent more than $22 million to 46 churches in Arizona. That's about $1.5 million per year. What Crotts did not say in the communique is that Ventures also has lent millions to insiders for real estate transactions.
In response to a New Times letter seeking comment from Crotts, Grabinski and Don Deardoff, BFA's controller, the Reverend W. Berry Norwood, chairman of the BFA board, acknowledges in his December 3 letter that the Ventures board "invests its funds as it determines appropriate, including collateralized loans to ALO and other entities."
Crotts has said there is nothing wrong with such investments, because they are collateralized with real estate.
However, the staff CPAs and lawyer begged to differ. Dissatisfied with their superiors' assurances that nothing was amiss at BFA, they all resigned in 1996.
One of the first to quit was L. Kyle Tresch, an attorney licensed in Oklahoma and Arizona. Tresch had worked for BFA for only 17 months before he resigned in April 1996.
In a draft of his resignation letter addressed to Grabinski, Crotts and Deardoff, Tresch alleged "actionable fraud" had been going on for at least 10 years, and the three executives had put themselves in "a position of civil and criminal liability."
Tresch's primary concern was ALO, and the millions of dollars of BFA debt hidden in that particular "bad bank."
He wrote that he had voiced his concern with BFA executives--including Grabinski and Crotts--"about the large debt owed to BFA by ALO, and my concerns that the relationship between these entities had not been fully disclosed to either the Foundation Board of Directors or the Foundation's outside auditors."
According to Tresch, ALO's assets were "speculative," and interest ALO owed to BFA was "out of control."
Tresch acknowledged that just a few days before he wrote his letter, Crotts had told four BFA board members about the ALO problem, but Tresch indicated he did not trust that Crotts' disclosure was complete.
"Given the magnitude of the current problems, disclosure to any Board member that is not full disclosure could be more harmful than helpful," Tresch wrote.
"To the extent that you consider your position regarding BFA and ALO moral and justified, I am convinced that you honestly fail to appreciate the moral, economic and legal gravity of your actions," he wrote.
Tresch also chastised his bosses for "raiding IRA dollars" entrusted to Ventures to "facilitate the debt" of ALO.
"Legally, the current situation is fraught with liability," Tresch wrote. "Beginning with the first transfer of bad assets [from BFA] nearly ten years ago to a so called 'bad bank' which would not be audited but which you controlled through an outside party, there was actionable fraud. Each transfer of assets made to such off-balance sheet companies over the last ten years that was similarly made to improve BFA's balance sheet was likewise fraudulent. Not only have you placed yourselves in a position of civil and criminal liability for your actions, but you have likewise placed the auditors, directors and even innocent officers in positions of civil liability. After consulting with counsel, I have been advised that in fact I have a duty to ensure that the Board of Directors is informed about ALO and its relationship to BFA."
In closing, Tresch expressed his fear that the actions of BFA's executives would cast Southern Baptists and Christians in a bad light. He wrote: "My heart aches for my family, our churches, the reputation of Christians and Southern Baptists, the employees of BFA, the outside parties who have given credence to BFA without fully understanding the problem, and the many individuals who have invested millions of their hard-earned dollars with BFA."
After receiving the Tresch letter and hearing complaints from the accountants, Crotts did disclose the ALO debt to the full board in secret executive session. One board member tells New Times the "full board wasn't too upset" upon learning of the previously undisclosed loans to ALO. However, former board members say that once the scale of the ALO loans was disclosed, BFA directors ordered Crotts to work with a committee to approve subsequent investments.
Today, Tresch lives in Oklahoma. He declined an interview, explaining he cannot speak publicly about his tenure at BFA because he is "cooperating fully with the authorities in the ongoing investigations."
Richard Polley, BFA's trust accounting manager, was a friend of Tresch's. Just three weeks after Tresch resigned, Polley wrote a "for the file" memo blasting BFA for selling $7.3 million worth of nonperforming loans to a shell company called East Valley Investment Group (EVIG), a company Polley noted had no assets. EVIG was solely owned by former BFA director E.A. Kuhn and was managed by BFA.
Kuhn had so little knowledge of the workings of EVIG that he said in a deposition this summer that he didn't even know where his own company did its banking. He testified that he left complete management of EVIG up to BFA.
In his May 1996 memo, Polley wrote that the EVIG deal was "deceptive," and noted that BFA had funneled $2.2 million of IRA funds through a web of corporations to EVIG. The reason: The IRA dollars were used to make a "down payment" to BFA for the $7.3 million nonperforming loans EVIG bought, he alleged.
Polley also wrote that the $2.2 million in IRA funds had been shunted to EVIG without approval of the Ventures board of directors.
"Even if there are currently no church loans for which to use the money . . . I think most IRA investors [in Ventures] would be shocked to learn that their dollars were put to this use," Polley wrote.
"It appears the main motivation behind this transaction was to remove these notes from our books before the auditors required a writedown," the memo says. Polley added that ". . . BFA's investors stand to lose dollars unless the deficit problem is solved."
New Times asked BFA to comment on the Polley memo, and on June 30, Grabinski responded, "The East Valley Investment Group transaction described in the memo you provided has worked out as expected by all parties. The concerns in the May 9, 1996, Memorandum were unfounded."
Then, in a July 2 memo to the BFA board, Crotts and Grabinski made no mention of Polley's serious allegations--that IRA money was being misused and that BFA's nonperforming loans were being hidden in a shell company belonging to a former board member.
Instead, their memo to the BFA board confirmed the EVIG transaction had occurred in 1996. They wrote that "the original $5.1 million promissory note, from EVIG to a BFA entity (Foundation Administrative Services, Inc.), has been paid down to approximately $3.6 million, and the note is current. At the time of the transaction, staff felt the sale was a strong economic move, and their analysis has proven correct."
In August 1996, three months after writing the memo, Richard Polley resigned from BFA.
Polley noted in a letter to Crotts that he had met several times with Crotts and "always held out hope that you would begin to understand the enormity and severity" of the "good bank-bad bank" problem. The bad banks, according to Polley, were ALO and Ventures and their many subsidiaries. BFA was the good bank, "presenting good financial statements." This would amount to "assembling false and misleading financial statements," Polley wrote.
"As I stated in my earlier conversations with you, I believe that at its core this situation is a sin issue. I do not believe that our Lord and Savior, Jesus Christ, would have us conduct His business in a manner that withholds important information from our investors--information that might possibly change their decisions regarding investing with BFA. To have done so, and to continue to do so, is to deceive our investors regardless of the outcome to them. The Scriptures are quite clear that such an outcome is sin," wrote Polley.
Polley would not comment to New Times. He is reportedly cooperating with the state investigators.
In November 1996, three months after Polley resigned, Michael Maxson, also a CPA, quit BFA. In a letter to Crotts, Maxson wrote that he had met with BFA executives on several occasions and expressed his concern over the Ventures and ALO transactions.
Maxson wrote that he was so concerned about what was going on at BFA that he sought legal advice, "both civil and criminal."
"Although I have had no direct involvement in the transactions in question or the associated accounting for these transactions, I am being encouraged by all counsel to disclose this information to the appropriate authorities," Maxson wrote Crotts.
"To date, I have been reluctant to take this step because of the religious nature of this organization and the possible adverse consequences to new, as well as current investors. However, it appears that a systematic effort has been made to continue hiding this questionable activity as the dollars invested in BFA continue to grow. I believe that I have certain responsibilities professionally, ethically and morally to bring these unprofessional and criminal actions to light. I feel it would be in your best interests to come forward and, therefore, I must respectfully request that you contact the appropriate legal authorities, i.e. United States Attorney or Arizona Attorney General as soon as possible."
Maxson would not comment for this story, and is reportedly cooperating with state investigators.
Two other CPAs--Karen Paetz and Steve Brock--also resigned from BFA in 1996. Sources say they, too, are cooperating with state investigators. Paetz could not be reached for comment; Brock lives in Oregon and would not comment for this story, citing the investigation.
In a December 3 letter responding to New Times' questions about the complaints voiced by former staffers, the Reverend W. Berry Norwood, BFA's board chairman, said that the full BFA board had seen the letters and memo written by Tresch, Polley and Maxson.
"The individuals upon whom you apparently rely never had the information necessary to evaluate the transactions, transactions in which they had limited involvement," Norwood wrote. "Perhaps it was lack of information or failure to understand the transactions that led some individuals to believe that there were 'ethical reasons' to resign that never existed."
Board of Accountancy Investigation
The state board that regulates CPAs is currently investigating Arthur Andersen LLP in connection with its preparation of BFA's audited financial statements, New Times has confirmed.
Because the state board operates in secrecy during the investigative process, Ruth Lee, executive director of the State Board of Accountancy, could not confirm or deny the probe.
"By statute, I'm not allowed to acknowledge whether an investigation is taking place," Lee says.
She will not disclose the names of the accountant or accountants being investigated, the reasons prompting the probe, or the expected length of the inquiry.
Arthur Andersen is an 85-year-old accounting firm that has expanded into a global business advisory company with 61,000 employees and $6.1 billion in revenues for the fiscal year ending August 31.
In Phoenix, Arthur Andersen has audited BFA for at least 14 years.
A spokesperson at Arthur Andersen's Phoenix office would not answer questions about the state investigation but referred New Times to the firm's world headquarters in Chicago.
Jim Spangler, Arthur Andersen's chief spokesman in Chicago, also would not comment.
"My understanding is that the type of inquiry you're asking about is a confidential process until a final report is issued by the state board," Spangler said last week. "In honoring the spirit of that confidentiality process, we are prevented from either confirming or denying that there is such an inquiry."
The Arizona board, like all other state boards, tries to protect the public by ensuring that Arizona CPAs follow the standards and principles set forth by the American Institute of Certified Public Accountants (AICPA). The standards are complicated, but the bottom line is that all CPAs are professionally obligated to take extra steps to ensure that audited financial statements are not misleading or fraudulent.
The AICPA is so concerned about preventing white-collar crime that it recently issued a detailed primer of guidelines called "Consideration of Fraud in a Financial Statement," which is effective for all audits after December 15, 1997. The guidelines list risk factors for possible fraud that a CPA must take into account when conducting an audit. The risk factors don't necessarily mean that fraud is occurring, according to the AICPA, but they do indicate that the auditor must take extra steps to ensure that no fraud exists--steps such as ensuring that insider companies borrowing millions are fiscally sound, and that the collateral used for the loans to the audited company is legitimate.
Some of the risk factors for fraud listed by the AICPA include:
* An overly complex organizational structure with many legal entities.
* Difficulty in determining who, exactly, is in control of entities doing business with the audited company.
* Complex related party (insider) transactions with companies not audited or audited by a different firm.
* Adequate control over senior management by the board of directors and the internal auditing staff.
The standards are designed to help the auditor protect investors from bogus audited financial statements.
"If investors are duped [by audited financial statements]," says Tom Ray, of the AICPA's Audit and Attest Standards Committee in New York, "then auditors can be found culpable and have to pay the piper."
At the state level, paying the piper can range from revocation of a CPA's license to such mild disciplinary measures as ordering continuing education, says Lee, the executive director of the state board.
Arthur Andersen has tangled with the Accountancy Board before. In 1995, without admitting guilt, the firm paid $562,000 to the Accountancy Board to settle allegations that in 1985 it misrepresented the financial status of Charles Keating's failed companies, American Continental Corporation and Lincoln Savings and Loan. Elderly investors had lost their life savings by purchasing American Continental junk bonds they thought were safe.
In 1994, Arthur Andersen paid $1.3 million to the California Board of Accountancy to settle three cases, including the Lincoln Savings and Loan case.
In the courtroom, an accounting firm might be held liable for damages to investors if they made investments based on a misleading audited financial statement. Case in point: In 1992, Arthur Andersen, without admitting wrongdoing, agreed to pay elderly victims of Charles Keating's failed American Continental Corporation $22 million in an out-of-court settlement. The victims had claimed, among other things, that the financial statements were misleading.
Spangler, Arthur Andersen's spokesman, will not comment on the out-of-court settlement, citing a confidentiality agreement. But Spangler confirms both settlements with the state boards. He notes that Arthur Andersen cooperated fully with both investigations. After the state probes were concluded, says Spangler, Arthur Andersen was "not found to have committed false or misleading financial reporting" in either case. He says the two boards did not sanction the firm, and did not place any restrictions on the firm's activities.
BFA would not comment on the Accountancy Board's current investigation of Arthur Andersen.
A Banner Year
In November, BFA President William P. Crotts addressed the annual convention of Arizona's Southern Baptists. He said this past year has been BFA's "very best year."
In two written communiques sent in November to BFA clients and the Southern Baptist community, Crotts painted a picture of a generous religious foundation dedicated to its ministry of helping Southern Baptist causes. For instance, he wrote that $2.7 million worth of BFA's "expert staff time, talent and services" were donated in 1997 to Southern Baptist agencies, "entities" and churches. He claimed BFA recently forgave loans to the Southern Baptist community totaling about $100,000. He said eight seniors came to know Christ in BFA's retirement centers.
The financial picture looked good, according to Crotts. He wrote that from October 1, 1966, to September 30, 1998 (32 years), trust funds managed by BFA had given a total of more than $17 million to various charities. (He failed to note BFA itself had contributed only $1.3 million of its own funds to charity in its 50-year history, or that its most recent audited financial statement indicates that BFA spent $34.6 million in 1997 alone on salaries for its approximately 160 employees and for "general and administrative" expenses.)
Crotts noted that BFA by mid-November held investments totaling $448 million. He noted that BFA had $34 million in cash.
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But a June 1998 "Offering Circular" issued by BFA paints a more modest picture and underscores the foundation's need to borrow more money, which troubled some of BFA's accountants as early as 1996.
In the circular, which states that BFA's net worth is $12.4 million, BFA offers to borrow $50 million through "Easy Access Investment Agreements"--term loans of $50 or more with principal redeemed at any time. The collateral is not specified. The circular says it plans to "sell" the nonguaranteed notes predominantly to "members and constituents of Southern Baptist churches, their family members and friends as well as the churches themselves."
"Our investment results this year have been outstanding," Crotts wrote.
"These are wonderful days of blessing, but they have not come without attacks from Satan, our spiritual enemy," Crotts wrote. "I trust you will join me in seeing this as an assault on our common faith and begin to pray earnestly with me about it. Not only is this an assault on the values we as Christians hold dear, but I am also personally insulted because it totally mischaracterizes my 16 years of committed hard work at the Baptist Foundation of Arizona and BFA's 50 years of service to Arizona Southern Baptists."
Contact Terry Greene Sterling at 229-8437, or online at email@example.com