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07th May 2013

Asleep at the Wheel: the Accountability of Charity Trustees and Regulators

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Trustees and the Charity Commission are responsible for governing their particular charities and the sector as a whole, respectively. Yet two high profile cases demonstrate this control is not always effective. If the public’s trust in charities is to be maintained, there must be a better show of strength in governance and regulation.

Their Cup Runneth over

The Cup Trust was created to exploit gift aid tax relief by the use of circular financial transactions, generating substantial gift aid claims for the charity and its investors. The Charity Commission’s investigation of this charity demonstrates the Commission’s limitations as a regulator as well as its ineffective relationship with HMRC in combating tax avoidance schemes.

It seems The Cup Trust scheme worked thus: investors paid a small fee to join, government bonds (gilts) were bought by the Trust with £97m of loan funding, these were transferred to the investors for a nominal sum, they then sold the gilts at market value and ‘donated’ the proceeds to the Trust. The Trust then used the donations to pay off the bank loans, and investors claimed gift aid relief on the difference between the basic and higher rate of tax related to their ‘donation’. The only loss they suffered was the modest initial joining fee. Despite donations of around £176m over two years, only £55,000 was applied for charitable purposes.

The Commission investigated; but the matter only became widely known when The Times reported it. Following its investigation between 2010 and 2012, the Commission found that although the charity had an unusual structure and operation, and had donated such a small proportion of its income to charity, it could not be removed from the register of charities. The Trust, it concluded, was legally established as a charity and its sole trustee had complied with its obligations under charity law. The Commission noted that trustees are entitled to decide how much of their resources they spend.

This is remarkable. The Cup Trust is legally constituted as a trust, so should only have been registered as a charity if, amongst other things, the majority of its trustees reside in England and Wales: the sole trustee in this case is a corporate body registered in the British Virgin Islands. Trustees should balance carefully the proportion of resources spent in generating income for the charity, and gross failure when detected is likely to lead to intervention by the Commission or a formal inquiry (one wonders what was described on the registration application as to proposed activities): this trust applied 0.3% of its income for charitable purposes. Trustees have duties which include avoiding risk, preserving reputation, acting prudently, fulfilling the objects and delivering public benefit: the sole trustee for this trust seems to have fallen pitifully short on these.

Finally, it is arguable the trust should not have been allowed to register at all: as well as being registered abroad, the sole trustee was established by tax avoidance firm NT Advisors (NT denoting ‘no tax’) who previously ran a high profile lobbying campaign against the government’s attempts to close tax loopholes retrospectively. I have had registration battles with far less exciting applications. The Commission has a triage system for applications in order to focus resource on those requiring special consideration and to streamline the process for straightforward cases. Perhaps this system was under construction at the time.

The House of Commons Public Accounts Committee on 7 March highlighted these failings, questioned if the Charity Commission was fit for purpose, and expressed discontent at the Commission’s failure to collaborate with HMRC. Just prior to the Commission’s investigation, HMRC had issued ‘Spotlight 9: Gift Aid with no real gift’ and described circular arrangements very similar to The Cup Trust’s, saying in these cases no gift aid relief would be granted. Claims of around £46m are pending in relation to The Cup Trust and we must reserve final judgment for now on the role of HMRC in all this, save to say its slow response is itself damaging and unhelpful. William Shawcross, the Commission’s chair, has said The Cup Trust tax avoidance scandal has been a disaster for the sector and has hurt public trust in charities.

The trustee of The Cup Trust seems to have escaped relatively unscathed, with the Commission concluding it had not breached any of its duties. This is particularly difficult to accept as now, more than ever, there is a need for the charity sector to sustain and improve the public's trust and confidence in the work of charities generally. Schemes such as The Cup Trust seriously hinder this as there seems to have been no effective trip-switch operating on the regulator’s part.

Ignorance by Degrees

Slightly longer ago, but still a very raw memory for those affected, is the LSE debacle and the Woolf Report it generated. This also featured a failure by trustees and regulators.

The London School of Economics and Political Science, like most English universities, is an exempt charity and therefore not subject to the direct supervision of the Charity Commission. It is regulated for charity as well as educational and funding purposes by the Higher Education Funding Council for England. Even though not under the Commission’s glare however, LSE is still a charity, an old and well respected institution (whose very name lends an irony to what took place), and an educational business operating in a global market. One would have thought strong and prudent governance would be called for.

The LSE came under scrutiny in 2011 for allowing its links with Libya and the Gaddafi family to grow unnoticed and unchecked, during the period when Colonel Gaddafi's son, Saif Gaddafi studied at the university.

In particular, there was a donation of £1.5million solicited and accepted from the Gaddafi International Charity and Development Foundation, of which Saif was the chairman and which was funded from "private sector sources". This particular debacle led ultimately to the commissioning of a formal inquiry under Lord Woolf to look into the university's links with Libya. The inquiry found a clear relationship had been established, which given the political climate at the time should have been subject to rigorous risk assessment. A particular concern was that the source of the donation was never properly established: it may well have emanated from the bribes of foreign companies operating in Libya. The Council, the governing body of LSE, together with its senior management to whom much of the business of the university was delegated, was found to be significantly inadequate in risk assessment, governance, communication and effective delegation.

The inquiry report stressed the need for a structure to be put in place whereby donations are properly scrutinised. Although the LSE’s development office had carried out some limited due diligence into the sources of the funds regarding GICDF, that information was never presented to the Council of the LSE before it made its decision. Lord Woolf stated if the matter had been properly presented to the Council the donation would almost certainly not have been accepted.

Of course, the LSE’s links with Libya posed serious reputational risks, which equally went unchecked. Reputation is as important to a charity as its finances and strict legal compliance. Lord Woolf recommended the LSE should put in place a code dealing with ethics and reputational risk, and set up an appropriate committee structure to deal with issues relating to that code.

The LSE’s Council failed, but so did its regulator. The Charity Commission was not the principal regulator so was not directly involved. Very little has been said about the role of LSE’s principal regulator HEFCE in the matter, other than in the Charity Commission’s “Charities back on track 2011-12” publication which states it is satisfied the risk of a similar incident occurring has been significantly reduced due to satisfactory controls being implemented. I am not confident of this. This may, we hope be so for LSE, but this case shows us alternative principal regulators for exempt charities do not by any means ensure good governance, also that HEFCE in this case had no system for checks of the damaging governance failings in one of the universities it regulates. However, I think the most worrying evidence arising from the LSE case is that governance best practice and common sense of the most fundamental kind was not recognised and engaged by such a significant charity.

The Safety Valve I suppose mistakes will always happen, but disasters such as these two cannot be allowed to happen. Further, the trustees or regulator presiding over such a failing should face sanctions or the public will have no faith in the considerable reputation and status which charities still enjoy. The Commission rarely exercises its powers to recover loss from trustees or remove them: those powers should be reconsidered The Commission’s relationship with HMRC is an important one yet it should be stronger: can they not collaborate more? Perhaps if they had done so over The Cup Trust its true aims would have been understood.

Lord Hodgson’s review of the law and regulation of charities, published in July 2012, recommended the Commission should focus on proactive regulation and compliance, and its core functions should be consolidated as registering charities, dealing with misconduct, and providing generic advice. There was also a recommendation of joint registration for new charities between the Commission and HMRC.

The Public Administration Select Committee launched an inquiry into the regulation of the charity sector in July 2012 and its report is due soon. One submission made to PASC, from The Association for Charities, suggests the Commission should give evidence annually as to how it has exercised its regulatory powers, claiming it is currently insufficiently accountable. The government's full response to Lord Hodgson's review will follow PASC’s report. It will be interesting to see what lessons have been learnt from high profile failings. Let us hope we can avoid the undermining of the well established but ultimately fragile status of charities.

For further information, contact Chris Knight, our Head of Charities on 01604 233233 or click here to email Chris.