The Pitfalls of Shrouded Finances

By Bill Frogameni
National Catholic Reporter
March 21, 2008

Santiago "Charlie" Feliciano spent two decades working as an in-house lawyer for the Cleveland diocese. When he finally left in 2000, he had been the general counsel, Bishop Anthony Pilla's main legal adviser, for 16 years.

Feliciano held one of the top posts in the diocese's Financial and Legal Office. Yet, talk to Feliciano and he'll tell you how large swaths of diocesan finance remained a mystery to him.

He paints a picture of himself as a man who was inside, but really on the outside. Someone who should have known the details of questionable schemes then being cultivated -- schemes that later mushroomed into the ugliest diocesan-level money scandal to hit American Catholicism in decades.

But Feliciano says he didn't know.

"They never let me anywhere near a checkbook," he said.

The Cleveland case may present an extreme example of a lack of financial accountability, but it hardly stands alone. Cases of embezzlement and improper handling of parishioner and diocesan money are so widespread that the U.S. bishops were prompted recently to emphasize the need for controls. But there is little the bishops as a group can do to enforce their own recommendations, since each bishop is autonomous and without oversight when it comes to running his individual diocese. A number of lay groups have attempted to highlight the issue of financial accountability within the church. One group of professionals has put forward recommended standards for accountability.

In Cleveland, Feliciano was cut out of policy meetings, where he might have expressed legal opinions about the imprudence of self-dealing or other questionable executive compensation practices. "They should have regularly run things by me, but they chose not to," he said.

The Cleveland scandal, now approaching its last act in federal court, involves Pilla and other top diocesan officials, one of whom, Anton Zgoznik, was convicted last year in federal court and another, former chief financial officer Joseph Smith, who faces his own trial later this year.

It was only after Feliciano left the diocese that another insider mailed a stack of financial documents to Cleveland media -- the proverbial smoking gun. It was then, said Feliciano, that he started to get a clear picture of the embezzlement that had been happening more or less under his nose.

If it seems a bit peculiar for a top church insider to be that out of the loop concerning church finances, what can the average parishioner expect to know about the finances of an institution where virtually all control is in the hands of local bishops and the diocese is largely exempt from publicly disclosing its financial operations to the Internal Revenue Service?

Special protections

In the United States, churches, church auxiliaries and many other religious-affiliated institutions enjoy special financial protections. As nonprofit establishments, they are exempt from paying taxes, although they are still obligated to abide by tax laws regarding accurate accounting, executive compensation, insider deals and so forth. Unlike most secular nonprofits, churches and many religious affiliates are not required to file IRS Form 990, a comparatively simple disclosure that gives a basic picture of an institution's finances and, perhaps most important, is available for public scrutiny.

Within the Catholic church, individual dioceses often have tens of millions of dollars in assets under management. Given the scope of church operations, mandatory public disclosure via IRS Form 990 could make the difference between good stewardship and the kind of fiasco that has rocked the Cleveland diocese.

There is a growing awareness in clerical, lay and academic circles that church financial policies need to be improved, but no mechanism exists to force something to be done about it. In January 2007, an advisory committee to the U.S. Conference of Catholic Bishops called for greater internal financial controls at the parish level. The committee recommended the bishops implement several "best practices," including greater documentation and "prosecution for all cases of fraud in the diocese." For several years, the bishops' conference has also had in place detailed recommendations for financial management at the diocesan level. The recommendations, however, remain only that: Canon law and civil law don't obligate any bishop to answer to his brother bishops in other dioceses.

Making the church publicly account for finances is a goal of numerous reform advocates, including Professor Charles Zech of Villanova University's Center for the Study of Church Management. In 2006, Zech published a study that identified embezzlement in 85 percent of U.S. dioceses for the five years prior to the study. Zech's study compiled data from the chief financial officers of 78 dioceses who responded to a survey that 174 diocesan CFOs were asked to complete. If the percentage of dioceses reporting embezzlement seems startling, "you can only wonder about those [96] dioceses that didn't respond to our survey," Zech told NCR in 2006.

Zech thinks the church needs an overhaul to achieve reliable fiscal stewardship. He recommends better internal controls but barring that, he thinks a good start would be to make it mandatory for all incorporated Catholic entities to face the external scrutiny that comes from reporting to the IRS. "There's no reason why we don't [file 990 Forms]. ... These forms aren't that onerous," said Zech.

The ease or difficulty of filing 990 Forms notwithstanding, most nonprofits are required to do so. The most notable exception is for standalone nonprofits (for example, those unaffiliated with other nonprofits) that have gross yearly receipts of $25,000 or less.

Churches are universally exempt from filing. While the IRS is understandably at pains to offer a concise definition of "church," everyone seems to agree on the generic "house of worship" model. In this sense, a church is a brick and mortar institution where people congregate to practice religion. Beyond that, things get tricky.

'Loosey-goosey' laws

The IRS, in its literature, distinguishes between "churches" and other "religious organizations," such as nondenominational ministries and interdenominational or ecumenical organizations.

In general, the IRS is reluctant to talk in layman's terms or even discuss hypothetical examples of religion in action. That may largely be because the IRS faces great political pressure when it comes to religion, says a U.S. Senate tax aide who asked to remain anonymous. The agency's reluctance may be compounded because "the tax-exempt laws generally are very loosey-goosey," according to the aide.

So how is the government, or even a Catholic bishop, supposed to define reasonable compensation for key executives of a church? Difficult as that question is to answer, it's even more difficult, given the lack of mandatory public oversight regarding religion, to identify financial wrongdoing in the first place.

"It's hard for the public to understand ministries' expenses because they're not required to file public disclosure of their activities, while other nonprofits have to file a Form 990 that offers some information about their activities," said Iowa Republican Sen. Charles Grassley, the ranking member of the Senate Finance Committee, who is conducting an investigation of six (non-Catholic) televangelist ministries. Grassley isn't yet making the leap to advocating mandatory 990 filing for all nonprofits. "But, in general, more transparency helps the public understand how tax exemption is used," he said.

Since the widespread exposure of the clerical sex abuse crisis in 2002, Catholic reform groups such as Voice of the Faithful have advocated sweeping changes in church governance and transparency. In response, some dioceses have begun to make financial statements publicly available. The reports are sometimes compiled by outside accounting firms hired by the dioceses, but the reports -- when dioceses provide them -- are under no obligation to reveal the diocese's finances with the kind of detail required by IRS Form 990. Unlike the 990, the self-reports of dioceses are typically meaningless, said Tom Gallagher, a Catholic and former Wall Street securities lawyer.

Gaping holes

"Any seasoned pro can look at the audited financials most dioceses put out and find gaping holes," said Gallagher, who favors mandatory 990 filing. To illustrate his point, Gallagher dissects the 2005 and 2006 financial statements of the Los Angeles archdiocese, which are available on the archdiocese's Web site. Digging through the footnotes, Gallagher questions the consistency and transparency of the audit on several points. One notable omission is a breakdown of salary and benefits for key employees -- including Cardinal Roger Mahony.

Were 990 filing mandatory, every American diocese would have to list its top employees and their compensation. Gallagher thinks that would constitute a positive step toward discouraging bishops and others who control the coffers from excessively compensating themselves. The same dynamic would work in parishes incorporated separately from their parent diocese or other Catholic entities, such as schools below the college level and religious orders, which are currently exempt from filing.

In addition to providing a detailed image of a nonprofit organization's financial status, the 990 requires disclosure of the compensation of each officer, director, trustee and key employee.

Likewise, the 990 requires disclosure of the compensation of the top five highest paid contractors employed by the nonprofit. This requirement could be helpful in identifying artificially inflated contracts and scuttling kickback schemes, said Gallagher. One can only speculate what effect this latter provision might have had on the $17.5 million in contract work that Cleveland's Joe Smith, the former diocesan financial officer, steered to his friend, the now-convicted Anton Zgoznik.

The 990 is "the one document that gives you a snapshot of the health and wellness of an organization" said Gallagher. To Gallagher's mind, there's much to gain and little to lose if tax disclosure becomes mandatory for all nonprofits.

But unless lawmakers muster the political will to make that happen, Cleveland Catholics are unlikely to get a complete picture of how their church fell into a financial quagmire. And Charlie Feliciano, the Cleveland diocese's former top lawyer, will still be scratching his head, wondering exactly what happens after the basket goes around on Sunday.


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