Bad Governance, Big Losses: What Went Wrong at the Schwan Foundation

In 1992, Marvin M. Schwan created a charitable supporting organization under Section 501(c)(3) of the Internal Revenue Code. The foundation was established for the support and benefit of seven named beneficiaries—all organizations associated with the Lutheran Church. The foundation was funded with nearly $1 billion.

The trust instrument creating the foundation specified that it was to be managed by at least two and not more than five trustees. It is the responsibility of the trustees to manage the foundation’s investments and determine the amount of distributions to each beneficiary.

The trust instrument also provided for the creation of a Trustee Succession Committee (TSC) comprising three to 10 members with the exclusive power to appoint new foundation trustees and TSC members. The TSC had to meet at least annually to review the trustees’ administration of the foundation.

Since inception, the TSC has been composed of seven members. Marvin’s two sons were two of the TSC members along with three foundation trustees and two other people who were not affiliated with the foundation in any manner. Therefore, four members of the TSC were independent of the foundation and three TSC members were foundation trustees whose work the TSC was charged with reviewing.

The first point to make about this case is that it was inappropriate to have foundation trustees as part of the committee charged with the oversight of those same trustees. It should have been obvious to everyone that the foundation trustees were not likely to find fault with their own actions. Although the majority of the TSC members were independent of the foundation, any actions against the foundation trustees needed the unanimous agreement of these four non-foundation members. That is a significantly high bar to reach.

Between 1993 and 2013, the foundation made some dubious investment decisions, the result of which was an investment loss of approximately $600 million. The nearly $1 billion foundation was reduced to approximately $340 million as of November 2013.

The two Schwan brothers (Marvin’s sons) requested information from the foundation trustees regarding these large investment losses. However, their desire for information was not shared by the two other independent TSC members and certainly not by the three foundation TSC members. Thus, only two of the seven TSC members voted to request the underlying financial records of the $600 million investment loss.

The two Schwan brothers sought to obtain a court order for the additional financial information. The circuit court in South Dakota indicated that the brothers lacked legal standing and determined that they were not a “trust committee” and dismissed their petition. On April 7, 2016, they appealed to the South Dakota Supreme Court. I believe they will lose again.

The key governance point demonstrated in this case is that decisions made by a governing body are the decisions of the body and the opinions or dissenting votes of any member or members of that body are irrelevant to the group’s decision. When a board or other governing body votes to take action or does not vote and does not take action, that decision becomes the final decision of that governing body. Any dissenting opinions held by individual committee members are irrelevant. Furthermore, the dissenters have no recourse to compel the majority to adopt their position on the issue.

The only recourse of a minority opinion holder is to reinforce the seriousness of his or her opinion by threatening resignation from the committee. Of course, when this tactic fails to sway the opinions of a sufficient number of others, resignation is appropriate. Continuing to raise the issue for a vote at subsequent meetings is also inappropriate unless the dissenter knows that he or she now has sufficient votes to overturn the prior decision of the body.

In such a situation, the proper procedure would be to make a motion to re-open the discussion of the previously decided issue. When that motion is seconded and passes, the issue would be discussed to the extent necessary and a motion made for certain action (presumably the opposite action than that previously taken by the body) and that motion will be seconded and passed.

The Schwan brothers had only two of seven votes on the TSC. The circuit court ruled that the Schwan brothers themselves do not constitute a “trust committee.” The “trust committee” is the seven-member TSC and that body did not request additional financial information regarding the $600 million investment losses.

The court also indicated that as individuals, the Schwan brothers did not have legal standing. The trust instrument indicated the foundation was to be administered by trustees and the trustees’ actions were to be overseen by the TSC. So while the TSC would have legal standing in a court of law, individual members of that committee do not. Their authority resides in their one vote on the committee. The fact that they were the sons of the foundation’s founder is also irrelevant.

In general, I have found that board members of public charities do not realize the importance and limitations of their votes on organizational issues. While your vote is very important, a vote in the minority means that you, as a board member, are now supporting the majority decision. If you can’t live with that, there is little you can do to distance yourself from the action or inaction that was the majority vote other than to distance yourself from the organization entirely. 

See more articles by Frank A. Monti.