t c no united_states tax_court united cancer council inc petitioner v commissioner of internal revenue respondent docket no 2008-91x filed date petitioner was organized in in a ruling letter dated date respondent ruled that petitioner was exempt from federal_income_tax and was an eligible charitable donee sec_501 sec_501 sec_170 i r c on date petitioner entered into a 5-year fundraising contract the contract with a professional fundraiser w h during through w h helped petitioner conduct a nationwide direct mail fundraising campaign petitioner received a total of about dollar_figure¼ million in net fundraising revenue under the contract w h received more than dollar_figure million in fees from petitioner and in addition derived substantial income from exploiting the co- ownership rights in petitioner’s mailing list which rights had been granted to w h under the contract on date respondent revoked the favorable ruling letter retroactively to date petitioner initiated the instant action under sec_7428 i r c for a declaratory_judgment that it qualifies as an exempt_organization and as an eligible charitable donee held w h was an insider for purposes of the inurement provisions of sec_501 sec_170 i r c and held further there was an inurement of net_earnings to w h petitioner fails to qualify as an exempt_organization or as an eligible charitable donee held further respondent’s retroactive revocation of the favorable ruling letter back to date was not an abuse_of_discretion leonard j henzke jr james w curtis jr mackenzie canter iii theodore r weckel jr and joseph greif for petitioner dianne i crosby deidre a james sandra m jefferson and chalmers w poston jr for respondent table of contents page introduction and statement of issues findings_of_fact background and summary direct mail fundraising after the trial was held and opening briefs were filed but before the parties filed their answering briefs theodore r weckel jr was given permission to withdraw from the instant case briefs amici curiae were filed by thomas a troyer albert g lauber jr and catherine e livingston as attorneys for american heart association american lung association american cancer society and independent sector hereinafter sometimes collectively referred to as american sector and by roger warin as attorney for non-profit mailers federation hereinafter sometimes referred to as mailers w h aicr the contract related agreements a the contract date b the escrow agreement c petitioner's draw arrangement d agreement to continue at percent the percentage of net housefile mailing income the fundraising contract required to be retained in the escrow account to reimburse w h e date addendum to the contract direct mail fundraising campaign a in general b w h’s advances of the initial capital to conduct the direct mail fundraising campaign c vendors who furnished goods or services d rentals of mailing lists e sweepstakes mailings f adverse publicity g petitioner's escrow account-related problems draws and petitioner's dispute with w h over the calculation of cumulative net mailing campaign revenue w h’s purchase and invoice control procedures h petitioner's attempt to obtain a copy of its housefile petitioner's and w h’s respective accounting treatments of the direct mail campaign's revenue and expenses petitioner's allocation of expenses between fundraising and public education opinion i status under sec_501 and c a w h as insider b did any of petitioner’s net_earnings inure to w h ii retroactivity of respondent's revocation of the prior favorable ruling letter issued to petitioner chabot judge petitioner initiated this action pursuant to section for a declaratory_judgment that for all periods beginning on or after date it qualifies as an organization described in sec_501 which is exempt from tax under sec_501 and that it qualifies as an organization described in sec_170 the action was initiated after respondent revoked a favorable ruling letter which had been issued to petitioner the revocation is retroactive to date petitioner has exhausted its administrative remedies and satisfied the other statutory predicates sec_7428 rule c the issues for decision are as follows whether petitioner is operated exclusively for charitable educational scientific or other exempt purposes under sec_501 and sec_170 whether any part of petitioner’s net_earnings inured to the benefit of private shareholders or unless indicated otherwise all section references are to sections of the internal_revenue_code of or the internal_revenue_code_of_1986 as in effect for the period of time referred to unless indicated otherwise all rule references are to the tax_court rules_of_practice and procedure in 100_tc_162 we denied petitioner’s motion for summary_judgment holding that the due process clause of the fifth_amendment to the constitution does not require respondent to initiate judicial review before revoking the ruling letter issued to petitioner individuals within the meaning of sec_501 and sec_170 if the answer to issue is no or the answer to issue is yes then whether the retroactive revocation of the favorable ruling letter was an abuse_of_discretion the parties have also raised ancillary issues including the following whether petitioner’s direct mail fundraising arrangement with watson and hughey company hereinafter sometimes referred to as w h constitutes a joint_venture whether a portion of the direct mail campaign expenses petitioner incurred are properly allocable to public education and whether the mailings made under petitioner’s nonprofit mail permits violate united_states postal service regulations as cooperative mailings due to the nature of the fundraising arrangement between petitioner and w h and to w h’s co-ownership rights in petitioner’s mailing list findings_of_fact some of the facts have been stipulated the stipulations and the stipulated exhibits are incorporated herein by this reference on date petitioner filed for bankruptcy under chapter of the bankruptcy code in the u s bankruptcy court for the southern district of indiana indianapolis division on date the bankruptcy court granted petitioner’s motion to lift the automatic_stay and permit petitions to be filed in the tax_court for purposes of initiating the instant declaratory_judgment action and a related deficiency proceeding when the petition was filed in the instant case petitioner was a not-for-profit corporation in bankruptcy in indiana gregory fehribach the trustee in bankruptcy maintained an office in indianapolis indiana background and summary petitioner was organized in as a delaware not-for- profit corporation petitioner is a membership_organization its members consist of local cancer agencies throughout the country by letter dated date respondent ruled that petitioner was exempt from federal_income_tax under sec_501 and that donors may deduct contributions to petitioner under sec_170 sec_2055 sec_2106 and sec_2522 petitioner’s founding members had previously been local chapters of the american cancer society hereinafter sometimes referred to as the acs these founding members separated from the acs because they wanted to participate in united way fundraising campaigns which acs prohibited at that time and they wanted to concentrate on cancer prevention and alleviation of pain and suffering of cancer victims rather than research to develop a cure for cancer the related deficiency proceeding docket no involves deficiencies determined for and the parties have agreed to hold that case in abeyance until after the resolution of the instant case from until petitioner acted as a support organization for its affiliate member agencies it published a quarterly newsletter offered access to cancer educational materials and held an annual meeting of its membership each fall petitioner was an umbrella organization coordinating its affiliate member agencies which met the direct needs of cancer patients through the providing of medical_supplies cancer research and public education about cancer prevention detection and treatment petitioner was supported primarily by the membership dues paid_by its affiliate member agencies petitioner also received contributions in small amounts as a result of direct solicitations of individuals who were members of petitioner’s board_of directors or of the boards of directors of petitioner’s affiliate member agencies until petitioner’s annual budget never exceeded dollar_figure in some affiliate member agencies indicated they intended to withdraw from petitioner this precipitated a budget crisis for petitioner its board_of directors realized that petitioner might have to be dissolved unless other sources of funding could be secured for petitioner the board directed petitioner’s executive director to conduct a search for a professional fundraiser that could assist petitioner in conducting fundraising to meet its increased need for funds without the necessity of petitioner’s contributing initial capital for the fundraising effort as a result during and petitioner and w h discussed their possible entry into a fundraising contract as of date petitioner estimated it would have an operating deficit for of dollar_figure without additional fundraising income in addition to providing the initial capital to conduct petitioner’s direct mail fundraising campaign w h offered to furnish funds with which petitioner could continue to operate on date petitioner and w h entered into a full service direct response fundraising agreement hereinafter sometimes referred to as the contract for a term ending date as of the date the contract was entered into petitioner was on the verge of insolvency petitioner did not have money to start a direct mail or other fundraising program on its own the contract was amended by an addendum on april unless the context indicates otherwise references to the contract are to be taken as including both the contract entered into in and the amendment the contract expired in date and was not renewed in conjunction with the formation of the contract w h agreed to advance money to petitioner in order to cover the initial costs of the mailings w h also agreed to give to petitioner an immediate advance or draw against petitioner’s projected future earnings from the contract from until its bankruptcy in petitioner maintained its principal office in either carmel or indianapolis indiana as part of the direct mail fundraising campaign petitioner conducted from through pursuant to the contract a washington d c office mailing address was maintained for petitioner contributors were directed to send their donations to the washington d c office mailing address during through about million fundraising letters were mailed under the contract of the million letters about million were prospect letters and million were housefile letters the terms prospect letter and housefile letter are discussed more fully infra the contract provided that w h was to receive as compensation among other things mailing fees of dollar_figure per prospect letter mailed and dollar_figure per housefile letter mailed however the contract was a no-risk contract for petitioner in that petitioner was liable to pay fundraising expenses only to the extent proceeds were raised if insufficient proceeds were raised to cover the fundraising expenses then w h was liable to pay the excess fundraising expenses during the term of the contract w h advanced funds to conduct petitioner’s direct mail fundraising campaign and generally was paid its fees only after other fundraising expenses had been paid under the contract petitioner was further guaranteed that for the first years of the contract petitioner would receive at least percent of the cumulative net_income produced from its housefile mailings after the first years petitioner would receive at least percent in date petitioner agreed to keep the guarantee pincite percent in exchange for w h’s reducing its creative package fee on housefile mailings and capping its mailing fee on any housefile mailing of more than big_number petitioner generally maintained its books under an accrual_method of accounting for through petitioner received the amounts of total annual contributions set forth in table table year total contributions dollar_figure big_number big_number big_number big_number big_number total big_number an analysis of petitioner’s financial statements prepared by petitioner’s counsel and assumed to be true by petitioner’s expert witness richard s steinberg indicates that dollar_figure of the contributions were produced under the contract for through petitioner incurred at least the amounts of total annual expenses in fundraising and in its mailing campaign set forth in table table year total expenses dollar_figure big_number big_number big_number big_number big_number total big_number the amounts in table include mailing campaign expenses from petitioner’s donor development fund that petitioner concluded were allocable to its public education activities as distinguished from its fundraising activities the amounts in table do not include other management and general_expenses that petitioner incurred as a result of carrying out its fundraising activities and mailing campaign petitioner received a total of about dollar_figure¼ million in net fundraising revenue under the contract in through petitioner paid to w h the amounts for fundraising shown in table table amounts paid dollar_figure big_number big_number big_number big_number big_number year total big_number the amounts in table do not include list rental fees and commissions paid to washington lists a division of w h or income derived by w h from exploiting its rights in petitioner’s housefile for through petitioner paid to washington lists the amounts for mailing list rentals shown in table year table amounts paid dollar_figure big_number big_number big_number big_number total big_number after the end of the term of the contract petitioner entered into a fundraising contract with another fundraising consultant under this second contract petitioner was liable for all fundraising expenses however when petitioner was not able to pay certain debts to vendors the new fundraiser paid those debts the fundraising efforts conducted under the new contract were not successful and petitioner suffered a substantial financial loss on the mailings done and was unable to pay all of the fundraising expenses on date respondent issued to petitioner a final notice of revocation of the favorable ruling letter retroactive to date the notice of revocation states in pertinent part as follows we have completed our review of your activities and examination of your forms for the years ending date and date by a determination_letter dated date we recognized your exemption from federal_income_tax under sec_501 as a result of the examination of your activities and financial records for the years noted above we had unresolved questions concerning your mailings and your exempt status on date we requested technical_advice from our national_office in order to resolve these questions in response to the request for technical_advice our national_office ruled that your exemption from income_tax should be revoked effective date this letter constitutes formal notification of revocation of your exemption from federal_income_tax effective date there are some slight differences between the notice of revocation letter identified by both sides in the pleadings and the one that the parties have stipulated in the administrative record these differences appear to be irrelevant to any matter in dispute in these findings we have used the letter that is in the administrative record contributions to you are no longer deductible as provided in sec_170 on date respondent also issued a notice_of_deficiency to petitioner determining income_tax deficiencies for and on date after the bankruptcy court lifted the automatic_stay petitioner filed its petition initiating the instant declaratory_judgment action pursuant to sec_7428 on date petitioner also filed its petition initiating a proceeding for review of the notice_of_deficiency issued to it for and united cancer council inc v commissioner docket no the parties have agreed that the deficiency proceeding should be held in abeyance pending the resolution of the instant declaratory_judgment action direct mail fundraising w h operated with the understanding that direct mail solicitation allows an organization’s marketing and solicitation efforts to directly focus on and target specific individuals in w h’s view in comparison to direct mail solicitation solicitations conducted through the print media or radio will generally reach a nonspecific and less targeted audience w h’s advice to petitioner and actions under the contract were based in part on these understandings in a direct mail fundraising campaign a prospect letter is a letter mailed to an individual who has not previously contributed or otherwise responded to the mailing organization a housefile letter is a letter mailed to an individual who has contributed to the organization or has responded favorably to a communication typically as the result of a prospect letter an organization’s housefile mailing is a mailing sent strictly to that organization’s housefile an organization’s housefile containing the names addresses and other pertinent information with respect to that organization’s previous contributors can be a valuable asset in that organization’s present and future fundraising efforts typically in a direct mail fundraising campaign practically all of an organization’s net mailing revenue will be generated from its housefile mailings as a result a usual primary goal of a direct mail fundraising campaign is to develop a productive housefile of contributors for use in the organization’s fundraising efforts in contrast to housefile mailings an organization will usually lose money or at best break even in conducting prospect mailings however an organization typically first develops and establishes a productive housefile through conducting prospect mailings moreover over the course of time a housefile will suffer from attrition not all previous contributors will continue to contribute to the organization as a result even after an organization has built up a productive housefile the organization will periodically conduct prospect mailings to refresh and add new names to its housefile an organization’s housefile can also be of considerable value to other organizations in their fundraising or solicitation efforts accordingly an organization may be able to profit economically from its housefile by using its housefile to produce rental income or by exchanging its housefile for another organization’s housefile thereby reducing its fundraising expenses before the late 1970's there were few mailing lists on the market and most that were available were exchanged list for list rather than rented for a fee by the late 1970's and early 1980's a rental market for mailing lists had developed the rental market has expanded since the mid-1980's because there are more lists being made available for rent and more list rental brokers however some organization that have mailing lists did not rent or exchange their lists it is common practice to use monitoring or dummy names sometimes called seed names in a housefile to guard against unauthorized use of the housefile and to monitor the patterns of mail drops across the united_states both petitioner and w h maintained their own separate monitoring names with regard to the mailing lists developed under the contract the parties have not presented us with illustrations of how this dummy name monitoring works in practice or how much effort or funds are expended in such monitoring programs generally or were expended under the contract by industry custom if a rented name responds favorably to the mailing made by the lessee of the mailing list ie by sending a contribution making a purchase or entering a sweepstakes contest then the lessee is entitled to add that name to its own housefile the lessee thereafter may use the name as its own and will not have to pay a further rental fee w h had wiland associates described infra as a services vendor provide management information reports to petitioner among these reports was one that evaluated individual contributors on mailing lists based on an analysis of the following three factors recency ie how recently the last donation by that contributor was made frequency ie how frequently that contributor has made donations to the organization and size of the gift all other things being equal a contributor who made a donation within the past months is considered more valuable than a contributor who last made a donation years ago similarly all other things being equal a contributor who made donations is considered more valuable than a contributor who made just one donation lastly all other things being equal a contributor who made a dollar_figure gift is considered more valuable than a contributor who made a dollar_figure gift in the 1960's and the 1970's the use of computers revolutionized the operation of the direct mail fundraising industry using the electronic data processing capability of computers mailing lists could be analyzed compiled and utilized much more efficiently than previously was possible before the use of computers mailing lists were maintained on by-5 cards or on metal plates richard viguerie hereinafter sometimes referred to as viguerie was an early pioneer in the contemporary direct mail fundraising industry by the late 1970's viguerie and his company richard viguerie and associates hereinafter sometimes referred to as the viguerie company had received considerable press and publicity as a result of their ability to successfully conduct direct mail fundraising campaigns for conservative political candidates and causes the viguerie company reportedly had a master mailing list comprising the names and addresses of millions of contributors the viguerie company also conducted nonpolitical direct mail fundraising campaigns for charitable organizations exempt under sec_501 as of the early 1980's viguerie and the viguerie company which maintained offices in the washington d c area had several competitors who offered similar fundraising services some of these competitors were former employees of the viguerie company by the 1980's many states enacted charitable solicitation statutes generally such statutes require most charitable organizations to register with a state governmental regulatory agency before soliciting contributions from members of the general_public within that state some state charitable solicitation statutes further prohibited or restricted charitable organizations from soliciting contributions unless a prescribed minimum percentage of the proceeds raised would be expended in the charitable organization’s charitable program thereby limiting the percentage of the proceeds to be used by the charitable_organization to pay fundraising expenses the council of better business bureaus hereinafter sometimes referred to as the cbbb and the national charities information bureau hereinafter sometimes referred to as the ncib established certain guidelines for organizations that solicit charitable_contributions from the public the objectives of the cbbb as to these matters are to encourage self- regulation of charities and assist potential donors by helping them to make better-informed gift-giving decisions the objective of the ncib is to promote informed giving by providing to the public information that will help potential donors to evaluate charities the cbbb is exempt under sec_501 as a business league its activities in the charitable area are conducted by a division called the philanthropic advisory ultimately the united_states supreme court held unconstitutional on first amendment grounds several state charitable solicitation statutes that limited the amount or percentage of the proceeds raised that could be expended by charitable organizations to pay fundraising expenses see 487_us_781 467_us_947 schaumburg v citizens for better environ 444_us_620 see also united cancer council inc v commissioner t c pincite service the cbbb and the philanthropic advisory service were formed in as the successors to the national better business bureau and its solicitations control division respectively the ncib is exempt under sec_501 as a charity it was founded in cbbb and ncib also prepared and issued reports on whether particular charitable organizations met cbbb’s and ncib’s respective fundraising and operational guidelines typically a report on a particular charitable_organization was prepared as a result of cbbb’s or ncib’s receipt of inquiries with respect to that charitable_organization among its guidelines cbbb generally recommends that a charitable organization’s fundraising costs not exceed percent of related contributions and total fundraising and administrative expenses not exceed percent of its total income however cbbb recognizes that a charitable_organization that does not meet these percentage limitations may provide evidence demonstrating that its use of funds is reasonable in particular the cbbb pamphlet on standards states as follows the higher fundraising and administrative costs of a newly created organization donor restrictions on the use of funds exceptional bequests a stigma associated with a cause and environmental or political events beyond an organization’s control are among the factors which may result in costs that are reasonable although they do not meet these percentage limitations the overwhelming majority of the charities that the cbbb reviews meet all of the cbbb’s guidelines similarly among its guidelines ncib generally recommends that not more than percent of the contributions grants and bequests a charitable_organization receives should be spent on fundraising ncib suggests that where more than percent was spent on fundraising then the prospective contributor should further analyze the charitable organization’s operations and ask the charitable_organization for an explanation regarding the percentage of proceeds spent in fundraising in particular ncib’s contributor’s checklist pamphlet states as follows some fund-raising practices are always expensive-- acquisition of new donors through direct mail or telemarketing for example--and yet they may be the only methods available to an organization if it hopes to reach the general_public some charities which rely heavily on bequests will have fundraising costs that vary considerably from year to year new organizations organizations with causes that are little known or controversial organizations with a contributor base made up of many smaller contributions rather than a few large grants--are all likely to have relatively high fund-raising costs and yet they may be quite well managed w h aicr w h began business in late as a two-person partnership owned percent each by jerry carroll watson hereinafter sometimes referred to as watson and byron chatworth hughey hereinafter sometimes referred to as hughey as of the time of the trial in the instant case watson and hughey have been w h’s only two partners before forming w h hughey was employed at the viguerie company from to from through the time of the trial in the instant case w h maintained its offices in the washington d c area in alexandria virginia in date w h changed its name to direct response consulting services herein we continue to refer to it as w h w h is engaged in the direct mail and fundraising services business and has had up to about to employees its clients primarily have been nonprofit_organizations over the years w h began to specialize in offering direct mail fundraising services to nonprofit health organizations in w h had one or two clients in addition to petitioner which were nonprofit health organizations over the years more and more of w h’s clients were in health-related areas in w h received percent of its income from three major clients and petitioner accounted for percent of w h’s gross_income for that year in w h had a total of clients american institute for cancer research hereinafter sometimes referred to as aicr which has been recognized by respondent as tax-exempt under sec_501 since its incorporation in date was one of w h’s first nonprofit health clients watson and hughey are the two sole founding members of aicr aicr’s articles of incorporation provide that only its founding members have the right to vote the articles also provide that no changes may be made with respect to the founding members who were designated at aicr’s initial board meeting and that no other founding members may be added unless all the founding members are dead aicr and w h entered into successive fundraising contracts that covered the period from aicr’s inception through date when w h did its first mailings for aicr watson and hughey consulted an attorney the attorney advised them that they and aicr would have to be careful that sec_501’s prohibition against inurement was not violated in light of watson’s and hughey’s status as founding members of aicr as a result w h reduced its fees drastically w h relinquished all ownership in aicr’s mailing lists and other changes were made table summarizes certain features of w h’s fundraising contracts with aicr petitioner does not object to respondent’s proposed finding of fact to this effect we note that the first of the contracts that respondent listed in support of this finding was executed on date this contract states that it is effective the 1st day of date but aicr had been incorporated in date similarly the last of the contracts that respondent listed states that the term of this agreement is two years beginning date thus the last contract appears to have expired year before the date specified in the agreed-to proposed finding we have treated the agreed-to proposed finding as in effect an additional stipulation between the parties table mailing fees effective prospect--cents housefile--cents date of no-risk term of per letter per letter contract provision contract letter per year letters per mailing retainer1 list ownership ye sec_1 yr cents cents dollar_figure mo capital list-- forever ye sec_1 yr cents cents big_number mo joint--w h aicr no cents thereafter big_number mo sole property of aicr cent sec_1st big_number cent sec_1 yr no yr cent sec_1st mil cent sec_1st big_number cent next mil cent next big_number cents next mil free after big_number free after mil big_number mo sole property of aicr no yr cent sec_1st mil cent sec_1st big_number cents next mil cent next big_number dollar_figure cents next mil free after big_number free after mil no sole property of aicr no yr cent sec_1st mil cent next mil dollar_figure cents next mil cent sec_1st big_number add’l letters--price cent next big_number to be arranged free after big_number no sole property of aicr no yrs cent sec_1st mil cent sec_1st big_number cent next mil cent next big_number no sole property dollar_figure cents next mil of aicr add’l letters--price to be arranged payment to be applied to aicr’s debt to w h not a separate package fee contract signed date retroactive to date later as a result of advice by another attorney changes were made regarding watson’s and hughey’s control_over aicr under aicr’s original articles of incorporation directors are elected by and may be removed without cause by aicr’s founding members watson and hughey under amendments filed date any founding member is forbidden to elect or remove directors during any period in which such founding member has a commercial relationship with the corporation aicr and for a period of three years thereafter for these purposes the term founding member’ shall be deemed to include any partnership in which a founding member has a material interest these amendments also provide as follows during any period that all founding members are prohibited or are abstaining from exercising their rights with respect to the election and removal of directors directors shall be elected and removed by the affirmative vote of a majority of the entire board_of directors the contract related agreements a the contract date the contract provides that during its 5-year term ending date w h would be petitioner’s exclusive fundraising consultant and adviser in petitioner’s conduct of its direct mail fundraising solicitations petitioner agrees not to retain or use the services of any other person or company to provide counsel and advice to petitioner in conducting its direct mail solicitations w h agrees to furnish its services and to advise counsel and make recommendations concerning all aspects of preparing petitioner’s direct mail fundraising and membership solicitations and to be responsible for implementing all of the work required either directly or through affiliates or other suppliers subject_to the approval of client petitioner w h further agrees to maintain petitioner’s housefile and to perform all follow-up correspondence the contract further provides that all mailing campaign materials prepared and recommended by w h including the proposed numbers of letters to be mailed would be subject_to petitioner’s approval and no such material shall be mailed or made available to the public without such approval the contract additionally provides that a bank or caging company described below would be hired to act as cashier and escrow agent for the funds generated under the contract the bank or caging company would process receipts and disburse payments under an agreement to be entered into by it petitioner and w h the contract requires w h to promptly furnish to petitioner copies of invoices received from suppliers of goods and services used in fulfilling w h’s obligations under the contract the contract also requires w h to make reasonable efforts where market conditions and time permit to obtain competitive bids or rates for work subcontracted to suppliers w h affiliates would be allowed to perform such subcontract work subject_to this competitive bid and rate requirement no markup was to be added by w h on the supplier or subcontractor invoices billed to petitioner the contract provides that w h would be paid as compensation_for its services mailing fees of dollar_figure per prospect letter mailed and dollar_figure per housefile letter mailed as well as certain creative fees for each housefile mailing package mailed on a housefile package mailed to under big_number previous contributors w h would be entitled to a dollar_figure creative fee on a housefile package mailed to big_number or more previous contributors w h’s creative fee would be dollar_figure petitioner would pay a retainer of dollar_figure per month to w h as a draw against these fees during the term of the contract all materials packages and ideas developed by w h on behalf of petitioner would remain the sole property of w h and all such material could be used by petitioner only with w h’s written consent with respect to petitioner’s mailing list the contract provides that w h and petitioner would have respective co- ownership rights as follows section list ownership it is expressly understood covenanted and agreed upon that any and all names and addresses and amounts contributed if any of persons firms associations or corporations which are obtained developed compiled or otherwise acquired for client by or through the direct or indirect efforts of w h in connection with any services rendered by w h to client pursuant to the terms hereof shall at all times be and constitute the property solely and exclusively of w h and client these names and addresses and the amounts of contributions if any can be used at any time by client in any manner for any purpose for its own account client shall use these names and addresses developed by w h for no purpose other than in direct connection with client’s own projects client shall not at any time during the life of this agreement or any time thereafter rent exchange lease sell or give away these names and addresses developed as the result of the efforts of w h to any other parties for any purpose whatsoever however w h shall be free to use the names and addresses referred to in section in any way it so desires and for any purpose it may so determine the contract also states that it is expressly understood and agreed upon that section the list ownership rights provision shall survive the termination of the contract the contract also requires that during the contract’s term any computer work that petitioner wants to have done with respect to the names developed as a result of the contract must be done at w h or at a company designated by w h the contract provides as follows with respect to its no- risk nature section payments to w h and suppliers w h assumes full obligation and responsibility for the payment of all vendor suppliers and w h invoices arising out of the fulfillment of w h’s obligations hereunder said invoices to be subsequently reimbursed by client only under the terms and conditions set forth in this section client shall reimburse w h only to the extent that w h has raised such funds w h shall have no right or claim upon any other funds or accounts of client w h shall be reimbursed for money owed to it only out of funds obtained as a result of w h’s efforts however if client raises additional funds through their own efforts from names that w h has generated these funds shall be considered in the same category as funds raised by w h people who are members of ucc or prior donors to ucc are excluded from the provisions of this section in other words w h is liable for all expenses connected with this contract to the extent that w h has not raised funds to cover those costs this section applies throughout this agreement client shall make monthly payments to w h to the full extent that w h has raised funds to pay the costs incurred by w h in carrying out its obligations under this agreement for the first two years of this agreement up to of net_income from house file mailings may be applied to the cost of prospect mailings after two years and for the remainder of this agreement up to of net_income from house file mailings may be applied to the cost of prospect mailings client will only utilize house file net_income for its projects under the terms and conditions set forth in this section for purposes hereof net_income received pursuant to this agreement by client shall hereby be defined as all contributions received less all expenses_incurred pursuant to the terms hereof including supplier invoices postage w h charges and all other items described in this agreement the contract provides that it is automatically renewable for five years if either party does not in writing specify the canceling of this agreement at least three months prior to the expiration of this agreement apparently this provision was intended to give each party to the contract a veto over the contract’s automatic renewal however the contract does not include a provision permitting termination for cause b the escrow agreement on date petitioner w h and washington intelligence bureau hereinafter sometimes referred to as wib entered into an escrow agreement hereinafter sometime referred to as the escrow agreement whereby wib would provide escrow services in connection with the contract the escrow agreement which w h provided to petitioner and wib is essentially the same agreement that w h uses in all of the escrow arrangements that w h has with wib during the term of the contract wib was at all times the escrow agent and did most of the caging wib began to deal with w h in or wib has been the escrow agent for most of w h’s clients wib’s first w h-related client was aicr in about percent of wib’s business pertained to w h’s clients by this had grown to percent thereafter the percentage dropped to about percent wib has always been unrelated to w h in ownership the escrow agreement provides in pertinent part as follows whereas the client petitioner agrees to pay all costs for direct mail fund raising services as well as cost for others providing services and supplies for the direct mail fund raising program it is therefore agreed escrow fund the agency w h and the client hereby agree that returns from the direct mail fund raising programs shall be received by the escrowee wib and the sum so received shall be known as the escrow fund payment of creditors the escrow fund shall be held by the escrowee separate and apart from the other funds of the escrowee the agency shall present the escrowee with invoices of creditors including invoices of the escrowee which the escrowee shall pay from said escrow fund all invoices paid from said escrow fund shall be caging involves receiving opening and processing the return mail generated by a direct mail campaign a caging company generally performs such functions as depositing the return mail receipts with a bank providing to the client an account of these receipts verifying and correcting name and address information with respect to contributors recording pertinent information with respect to contributors and relaying such contributor information to a computer company selected by the client approved by the agency and submitted to the escrowee promptly for payment mail charges the escrowee may transfer all sums necessary to pay charges by the united_states postal service for the client’s business reply mail without approval of the agency or client escrowee’s compensation the compensation of the escrowee shall be established by the agency the client and escrowee the escrowee shall render billings for escrowee services to the client in care of the agency and shall be paid on a priority basis if approved invoice is not received from the agency by the escrowee within days from the date of invoice the escrowee shall be authorized to pay such billing without the approval of the agency accounting the escrowee shall provide the client and agency an accounting as to each payment or disbursement made from the escrow fund those disbursements shall only be upon the written approval of the agency the escrowee shall be provided compensation_for these services disputes in the event of any dispute with respect to disposition of all or part of the escrow fund the escrowee shall not be obligated to disburse the disputed portion thereof nor shall the escrowee be required affirmatively to commence any_action against the client or agency or defend any_action that a creditor might bring in his sic sole discretion the escrowee may in the event of a dispute as to the disposition of all or part of the escrow fund commence an action in the nature of interpleader and seek to deposit the disputed portion in a court of competent jurisdiction the business reply mail postage referred to represented postage on the return mailing envelopes provided to the persons solicited in the direct mail fundraising campaign for purposes of making contributions to petitioner or otherwise responding unlike the outgoing fundraising letters and materials which were mailed under petitioner’s nonprofit mail permits at the lower nonprofit mailing rate postage at the regular united_states postal service rate was required on the return letters mailed by recipients of the fundraising letters pursuant to the escrow agreement wib opened a bank account hereinafter sometimes referred to as the escrow account in which to maintain the escrow fund only authorized employees of wib could withdraw funds from the escrow account the money deposited into the escrow account came primarily from the following sources the money w h advanced to pay for petitioner’s fundraising expenses and operational expenses and the contributions made by the general_public in response to the fundraising letters mailed under the contract all of the revenues from petitioner’s direct mail campaign not merely the profits from the mailings went into the escrow account c petitioner’s draw arrangement as indicated above during its discussions with petitioner about entering a possible fundraising contract w h offered to provide funds with which petitioner could continue to operate w h furnished such funds to petitioner after the contract was executed a date letter agreement between petitioner and w h provides in pertinent part as follows in order to meet your cash_flow needs for administration and program you petitioner plan to transfer funds from the escrow account that were generated from prospect letter mailings to date dollar_figure was transferred on november dollar_figure was transferred on december and you plan to transfer another dollar_figure on date this letter acknowledges the fact that these transfers are made in such a manner from prospect letter mailing revenues will be replenished from ucc’s income from housefile letter mailings within six months of making such a transfer contrary to what is suggested in the above letter agreement as of date no net mailing revenues had yet been produced from either the prospect letter mailings or housefile letter mailings conducted only losses or relatively small amounts of net mailing revenues were produced by the housefile letter mailings up until june or date it was not until about date that the cumulative net revenue produced from housefile letter mailings began to somewhat approach the cumulative amount of funds w h provided to meet petitioner’s operating_expenses initially some of the funds used to meet petitioner’s operating_expenses were advanced by w h to the escrow account also w h deferred receiving payment of its fees later as the net revenue produced from mailings began to increase w h authorized and permitted petitioner to draw increasingly larger monthly amounts of funds from the escrow account to finance petitioner’s larger annual operating budgets up until about the execution on april of an addendum to the contract petitioner was fully liable to repay the draws it had taken to the extent the draws exceeded the percent of cumulative housefile income guaranteed to petitioner under the contract the draws petitioner received were to be repaid within months regardless of the direct mailing campaign’s profitability the events leading up to and culminating in the execution of the date addendum to the contract are discussed more fully infra once the mailings had become sufficiently more profitable in deciding the amount of petitioner’s monthly draws w h considered petitioner’s budget plans and the future net mailing revenues expected to be produced w h based its decisions in large part on its calculation of the current monthly net housefile mailing revenue being produced and the percent of the cumulative housefile income that petitioner in all events was guaranteed under the contract monthly draws from the escrow account were taken by petitioner over the period from date through date as shown in table 6_month table monthly draws dollar_figure -- big_number big_number -- big_number big_number big_number big_number big_number big_number -- big_number big_number big_number big_number big_number big_number cont table cumulative draws dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number month monthly draws cumulative draws big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number so shown in the stipulated exhibit evidently there is a dollar_figure error in either the date monthly draw amount or the cumulative draws this discrepancy does not affect our analysis or conclusions d agreement to continue pincite percent the percentage of net housefile mailing income the fundraising contract required to be retained in the escrow account to reimburse w h as indicated above the contract originally provided that after years the percentage of net housefile mailing income that petitioner was required to retain in the escrow account be lowered from percent to percent in march and date watson proposed to petitioner that this percentage remain pincite percent rather than be lowered because of higher prospect mailing expenses resulting from an increase in postal rates in exchange for petitioner’s agreement to this w h would reduce its creative fee on housefile package mailings from dollar_figure to dollar_figure and cap its mailing fee at dollar_figure for any housefile mailing done in excess of big_number letters on date petitioner’s board_of directors accepted watson’s proposal e date addendum to the contract the certified public accounting firm that examined petitioner’s annual financial statements issued a qualified opinion dated date as to petitioner’s financial statement the certified public accounting firm elaborated on its concerns in a management letter dated date to the executive committee of petitioner’s board_of directors this management letter states in pertinent part as follows general fund continued existence of the agency petitioner our gravest concern is the viability of the organization it is our understanding that the budget totals dollar_figure including grant commitments of dollar_figure you expect to fund this ambitious budget with the excess of revenues over expenses from the direct-mail campaign what will the council petitioner do if the excess of revenues over expenses does not materialize at the level expected the general fund must borrow heavily from the donor development fund escrow account to finance the budget and if required to repay such borrowings it is doubtful the general fund would have the ability to make the repayments over a to 8-month period beginning in or about date petitioner discussed with w h its concerns regarding petitioner’s full recourse_liability to repay the excess draws taken and petitioner’s inability to receive unqualified opinions from the certified public accounting firm with respect to petitioner’s future annual financial statements on date watson sent a letter to petitioner’s executive director stating w h’s position with respect to petitioner’s repayment of the excess draw liability stating in pertinent part as follows this letter is to confirm our discussion relating to program draws from the ucc escrow account as we understand it ucc’s concerns surround the procedure by which this percent of net_income from housefile mailings is transferred to your regular operating account rather than receiving the exact amount as determined by the formula ucc with w hs knowledge is taking a fixed amount each month when the final net_income figure becomes known some months later uccs draw from the escrow account can be greater than it should be your question is will ucc be required to pay the escrow account back for this excess draw according to the terms of the agreement i suppose that technically you would have to do this however since w h does have knowledge that these transfers are taking place we currently have no objection to this in light of our hope that we can overcome the deficits w h would not request ucc to repay any overdraws unless we objected to a specific draw at the time it was taken or in the event that ucc would unreasonably interfere with w h’s efforts to continue the mailing campaign to recover the deficits the worst thing that could happen is that should the deficits continue to grow or can not be reduced and if ucc substantially overdraws it sec_50 program allocation it could become necessary to reduce the draws to bring them back into balance should we determine this situation to be developing i would like for us to sit down well in advance of such time and create plans so that a reduction would not adversely impact ucc’s operation after reviewing watson’s date letter petitioner’s executive committee and executive director concluded that the letter was not satisfactory for petitioner’s purposes and did not relieve petitioner from having full recourse_liability with respect to excess draws petitioner’s executive committee asked petitioner’s executive director to contact watson to ask that he rewrite it ie the date letter in time for our auditors review watson sent a new letter to petitioner’s executive director on date the date letter is substantially the same as the date letter except as follows the november letter omits the date paragraph that states according to the terms of the agreement i suppose that technically you would have to do this ie repay the excess draw and the november letter replaces the phrase the draws by the phrase future draws after reduce in the october letter clause it could become necessary to reduce the draws to bring them back into balance on date petitioners executive director sent a letter to watson about the treatment of general and administrative costs under the contract in the course of this letter he pointed out that the auditors were in the office to begin preliminary work on the financial statements petitioner and w h executed an addendum to the contract on april the addendum provides that beginning with petitioner would not have to repay draws taken in excess of it sec_50 percent of its housefile income to the extent sufficient net fundraising revenue was not raised the addendum states that such excess draws would be treated in the same manner as prospect mailing debts for purposes of the contract the addendum further provides that petitioner’s monthly draws would be agreed to in writing by w h and petitioner and requires w h to give days’ prior written notice to petitioner in order to effectuate any reduction in the monthly draws petitioner’s then-chairman believed that w h agreed to the date addendum--especially the nonrefundability of the draws--because w h hoped that it would improve relations with petitioner’s board_of directors and increase the likelihood that the contract would be renewed as a result of the addendum provision regarding monthly draws petitioner received an unqualified opinion for that is the certified public accounting firm’s report no longer included qualifications or reservations about petitioner’s practices or potential liabilities direct mail fundraising campaign a in general from date through date w h conducted a nationwide direct mail fundraising campaign for petitioner mailings were eventually sent throughout all states however petitioner directed w h not to make mailings to areas serviced by certain of petitioner’s member agencies as those member agencies received annual funding from the united way campaign and a condition of their receipt of such funding was that they not be involved in competing fundraising efforts w h created and developed direct mail fundraising packages with petitioner’s assistance and input before each direct mail package was mailed petitioner received from w h all materials to be included in the package as well as the names of all mailing lists to which w h proposed to send the package and the estimated numbers of names from each mailing list to be used in the mailing petitioner through its staff and a committee of its board reviewed and revised the package and the mailing list and gave instructions as to the mailing list numbers the copy the dates of mailing and the total number of letters to be sent petitioner received from w h a monthly status report of the cumulative costs and revenues of each direct mail package mailing and a proposed schedule of future mailings petitioner was also advised with regard to test mailings typically of big_number letters that w h had done of proposed mailing packages if a test mailing was successful then w h generally recommended that more mailings of that package be rolled out in greater quantities w h issued purchase orders on behalf of petitioner with respect to all of the goods services and other expenditures required for the various mailings this was done on an on-going basis and involved such items as computer work mailing house expenses mailing list rentals and printing when petitioner approved the making of a mailing w h and petitioner considered petitioner to have authorized w h to order and arrange for all of the related goods services and other expenditures required to effectuate the mailing petitioner accrued the amounts shown in table as its expenses for postage and shipping printing and publishing fundraising fees and mailing list rentals compare the accruals shown on the fundraising fees column in table with the payments shown supra table when adjusted for the w h reimbursements pursuant to the contract the net accrual amounts are fairly close to the actual payment amounts except for where the difference is about dollar_figure continued petitioner allocated about percent of each of these categories of expenditures--other than fundraising fees--to program services rather than donor development and fundraising continued table postage printing professional reimbursable net professional mailing and and fundraising or not fundraising list year shipping publications fees reimbursable1 fees rentals dollar_figure dollar_figure dollar_figure -- dollar_figure dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number totals big_number big_number big_number big_number big_number big_number expenses reimbursable or no longer reimbursable by w h under the contract the amounts are taken from petitioner’s forms the parties have not explained why these amounts net to dollar_figure rather than -0- b w h’s advances of the initial capital to conduct the direct mail fundraising campaign as indicated above the contract was a no-risk contract with respect to petitioner’s payment of fundraising expenses for the first years or so under the contract w h advanced money to the escrow account to pay for postage postage was an upfront expense while other expenses generally were billed after the fact when petitioner had already received the revenue generated by the mailing for a while w h continued to advance money to pay for postage even when there were substantial amounts in the escrow account w h did this because its people believed that there was not enough money in the escrow account to pay both the postage and the other vendors and because of the draws that w h paid to petitioner w h’s last advance of funds to petitioner for postage occurred on date thereafter petitioner earned sufficient profits from its mailings to cover its postage expense the contract does not specify how much capital w h would provide to fund petitioner’s direct mail fundraising campaign w h’s decisions to advance additional capital were based in substantial part on its evaluation of the results from the mailings that had already been done and on its conclusions about the mailing campaign’s profits prospects where w h and its clients entered into no-risk fundraising contracts similar to the contract w h’s practice was to stop advancing funds to finance a client’s direct mail fundraising campaign if the initial mailings were unsuccessful and w h concluded that reasonable prospects for conducting a profitable mailing campaign did not exist if w h decided to stop advancing funds w h then advised that client its mailings would be curtailed unless that client paid the expenses of the further mailings that the client wanted to do on the other hand if w h concluded that strong prospects for conducting a profitable mailing campaign existed w h then might substantially increase its advancements of funds in order to finance larger mailings for that client in this manner w h effectively limited the risk that it had apparently assumed in any no-risk fundraising contracts similar to the contract c vendors who furnished goods or services in the course of petitioner’s direct mail fundraising campaign goods and services were obtained from a number of vendors as indicated above wib was the escrow agent and provided most of the caging services with respect to the return mail received in response to petitioner’s mailings wiland associates hereinafter sometimes referred to as wiland was retained by w h and performed the computer services required in connection with the contract several other vendors at various times furnished goods or services in connection with petitioner’s direct mail campaign w h did not own or have any interest in the vendors who furnished printing mailing telemarketing or data processing services under the contract nor did w h own or have any interest in wib or wiland the art department company a corporation owned by watson and hughey prepared mock-ups and layouts and performed other art work-related services for w h’s clients and for other customers petitioner was billed at the rate of dollar_figure per hour for the art department company services washington lists a division of w h performed list brokerage services for petitionerdollar_figure a list broker represents an organization that wants to rent a mailing list from another organization one of washington lists’ functions as a list broker was to arrange for petitioner to use as lessee certain mailing lists washington lists arranged these mailing list rental transactions for petitioner through standard industry channels for such transactions d rentals of mailing lists as indicated above wiland was retained by w h to perform the computer services required in connection with the contract including maintenance of a computer list of petitioner’s housefile wiland also maintained computer lists which w h owned in washington lists changed its name to capitol list hereinafter use of the term washington lists includes where applicable reference to capitol list or co-owned with its other clients wiland as instructed by w h automatically merged and added to w h’s masterfile on a monthly basis all new names and donor information that had been added to petitioner’s housefile w h’s masterfile included the names and donor information that was owned by w h or was jointly owned by w h and its clients w h had joint_ownership rights in most of the client housefile mailing lists developed under the fundraising contracts it entered into with its nonprofit clients w h did not have such an arrangement with respect to aicr in conducting petitioner’s prospect mailings prospect mailing packages were mailed to the following categories of names and addresses hereinafter for convenience referred to as names names that w h as lessor rented to petitioner from the w h masterfile names that washington lists arranged for petitioner to rent as lessee from outside list owners unrelated to w h names that w h as lessor rented to petitioner through washington lists which names w h obtained from outside list owners in exchange for petitioner names and names that w h as lessor through washington lists rented to petitioner which names w h obtained from outside list owners in exchange for non-petitioner names on w h’s masterfile the contract forbids petitioner to exchange or to rent as lessor its housefile list names when petitioner as lessee used names from w h’s masterfile w h charged petitioner w h’s advertised rental rate for the names published in the current standard rate and data publication hereinafter sometimes referred to as srd srd is a direct mail industry advertising publication that sets forth the characteristics of a number of mailing lists available for rental the rental rates and the name and telephone number of the particular list owner or list owner’s agent to contact when petitioner as lessee used names that w h obtained from outside list owners either through exchanges of petitioner’s housefile list names or exchanges of non-petitioner names on the w h masterfile w h charged petitioner the outside list owner’s currently advertised srd- published rental rate for the names furnished to petitioner or if no current srd-published rental rate existed for the names furnished to petitioner w h’s currently advertised srd-published rental rate for the names w h gave up in the exchange transaction generally by engaging in an exchange transaction a list owner is able to obtain additional names at a significantly cheaper cost than it would otherwise incur to use the names as a lessee in a rental transaction for instance in a typical exchange transaction the two list owners involved might agree that each would furnish to the other big_number of their respective housefile list names that meet certain prescribed specifications the two owners would not pay one another any cash fee the only costs an owner would incur include computer-related production_costs for a computer tape or mailing labels containing the big_number names that owner furnishes postage to ship the tape or labels and a list broker’s fee or list manager’s fee12 for arranging the exchange transaction when w h exchanged for petitioner names it owned jointly with petitioner the cost to w h of acquiring the third party’s names included charges for computer processing postage and a list broker’s or list manager’s fee w h did not pay a rental fee to the owner of the third-party names in these situations because w h was providing names to the third party that normally rented for dollar_figure per thousand names table shows the amounts petitioner as lessee paid to washington lists by way of mailing list rental fees for renting mailing lists which w h owned or mailing lists to which w h claimed mailing list rights the payments petitioner made to w h include payments for names that w h acquired by exchanging petitioner’s names for names owned by unrelated third parties table payments for w h masterfile names payments for names w h obtained by exchanging petitioner names -0- dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number big_number year in the direct mail industry a list manager functions as a sales agent who represents a list owner in marketing the list owner’s mailing list to others the list manager promotes the mailing list and arranges for rentals and or exchanges of the mailing list to other parties -0- totals big_number big_number when w h obtained names for petitioner to use as lessee including non-petitioner names from w h’s masterfile and third- party names for which w h exchanged petitioner names w h charged or passed on any direct out-of-pocket costs of obtaining those names to petitioner these out-of-pocket costs included computer-processing charges and mailing charges w h’s masterfile had numerous subparts or discrete list selects that could be selected via computer processing for example list selects of all donors to sweepstakes contest appeals all donors to health causes all donors to cancer- related health causes or all donors to a particular w h client could be obtained through computer selection during through w h exchanged segments of petitioner’s housefile list between and times these exchange transactions involved as few as big_number petitioner names or as many as big_number petitioner names for each of these exchanges w h charged petitioner the published srd rental fee of the names received in the exchange if no published srd rate existed then w h charged petitioner the published srd rental fee of petitioner’s names that were given up in the exchange ucc’s payments to w h on account of these charges constituted income to w h w h also rented as lessor the names on its masterfile to third parties including other w h clients and w h-controlled entities petitioner’s names could be separately selected from the w h masterfile and were occasionally rented by w h to third parties as a discrete separate list of petitioner names petitioner’s names were also contained in lists rented by w h to third parties mixed together with non-petitioner names on the record in the instant case it is virtually impossible to determine how often any particular petitioner name was rented as part of a mixed list from through the time of the trial in the instant case w h as lessor rented discrete segments of petitioner’s housefile names about to times these rental transactions may have involved as few as big_number petitioner names or as many as big_number petitioner namesdollar_figure from through the time of the trial in the instant case w h as lessor rented segments of the w h masterfile more than big_number times any such rental may have involved no petitioner names one petitioner name or a substantial number of petitioner names on at least one occasion as many as big_number petitioner names were contained on a rented for example a list rental order dated date submitted on behalf of the norris hospital at the university of southern california to w h reflects that an big_number name representative cross section of certain petitioner names was being ordered the order indicates that the segment of petitioner names selected consisted of donors who had made a donation of dollar_figure or more to petitioner within the past months note that the contract had expired more than months earlier segment of the w h masterfile w h as lessor rented petitioner names at rates that were common in the list rental market a typical rate was dollar_figure per thousand names the contract did not require w h to and w h did not notify petitioner before renting parts of the w h masterfile including petitioner’s names to third parties pursuant to the contract w h retained all rights to approve a mailing sample of what would be mailed by the third parties renting parts of w h’s masterfile w h also retained all rights to control the mailing dates when these third parties using parts of w h’s masterfile would make their mailings to the rented list names during the term of the contract some of petitioner’s directors and staff became aware that w h was exchanging petitioner housefile names for other names and then charging petitioner full regular rental rates for_the_use_of the other names some of petitioner’s directors and staff also became aware that other w h clients including certain nonprofit cancer organizations were mailing fundraising packages similar to petitioner’s they were further aware that w h possibly could be renting or otherwise providing petitioner housefile names to the w h clients that were mailing fundraising packages which were similar to petitioner’s in fact w h did so use petitioner’s housefiles and did mail similar sweepstakes packages for petitioner’s competitors petitioner did not try to have w h stop such activities as petitioner concluded that w h was acting within its rights under the contract under the contract it would have been improper for w h to impose a markup on charges made by suppliers thus if w h secured a desired mailing list for petitioner as lessee and the lessor charged dollar_figure per thousand then it would have been improper for w h to pass a cost of dollar_figure per thousand on to petitioner w h and petitioner operated in accordance with the contract however when w h paid for the desired mailing list by exchanging one of petitioner’s mailing lists for it so that the lessor imposed no monetary rental fee then as petitioner’s staff understood the contract it was appropriate for w h to pass on to petitioner a rental fee in the amount that the lessor would have charged for the desired mailing list if the lessor had not instead received petitioner’s mailing list in exchange in exchange situations then w h received as its own revenue the as if rental that the lessor had not in fact charged as well as w h’s regular fees under the contract the bar against petitioner’s exchanging its own names extended past the term of the contract because petitioner could not exchange its own names petitioner had to pay the greater costs associated with renting names from others e sweepstakes mailings the first sweepstakes contest mailing that w h conducted was done under the contract w h then used sweepstakes contest mailings extensively with most of its other clients before they formed w h both watson and hughey had experience with the use of sweepstakes contests on behalf of either their employers or their clients as part of its initial program of prospect mailings for petitioner w h tested various packages a check package performed best and became petitioner’s control package--a package that is mailed until a later package can net more money in date a sweepstakes sweeps package was tested and also performed well as watson put it in an date memorandum to several of petitioner’s directors and its executive director at this point ucc had two control packages the check package which could be mailed to the traditional donor market and a sweepstakes offer which could be mailed to markets that respond to sweepstakes a date major prospect mailing was planned using the check package however although the package had been approved by petitioner petitioner’s board_of directors then urged that the check package be replaced by a different package that different package then lost dollar_figure the record reflects that petitioner’s directors directed the check package not be used because they believed certain representations contained in the package were inaccurate recipients of the package were informed that if they made a contribution petitioner then essentially would receive a matching donation from another party in actuality at the time the solicitation was made petitioner had not yet secured a continued in date an annual fund package was successfully tested as a result petitioner again had two control packages an annual fund package was first mailed out in substantial volume almost big_number letters in date apart from the foregoing for petitioner every substantial volume prospect mailing and almost every test prospect mailing in was a sweeps package five of these sweeps prospect mailings each lost more than dollar_figure one lost dollar_figure however from mid-1986 to mid-1987 sweeps packages produced continued commitment from another party to make matching_contributions in his letter dated date to petitioner’s executive director watson complained that the projected dollar_figure loss on the date poll package mailing excluding at least another dollar_figure due w h in fees done at petitioner’ directors’ urging was the largest single loss w h ever experienced he stated that it was essential that what happened not occur again and formally requested that once petitioner approved a mailing package that petitioner be committed to the package’s use unless it was obvious and conclusive that the package’s continued use would result in irrevocable harm to petitioner his letter concluded in pertinent part as follows i’m sure you are disappointed in what has happened in regard to this poll package mailing but i assure you no one is as concerned as i am i hope it has been a lesson for us all i had the hope and still have the dream that ucc could be made financially strong within a relatively short time and i pray this setback doesn’t postpone that day too long into the future copies of this letter to the executive director were also sent by watson to three of petitioner’s directors the greatest percentages of responses to prospect mailings also contrary to the usual experience with prospect mailings some sweeps packages produced substantial profits although the sweeps packages were often profitable for petitioner they had their drawbacks sweeps packages generally worked on individuals who were primarily interested in playing the contest as opposed to being interested in supporting petitioner in his memorandum dated date to petitioner’s executive director watson in generally commenting on petitioner’s direct mail campaign made the following observations about the sweeps package donors who contributed to petitioner ucc basically has two donor files--one being sweepstakes donors and the other being regular or straight donors the sweepstakes file makes up of all donor names and the straight file has the balance of although sweeps names have a higher conversion rate into second and third donations the life span of these donors is less than straight donors we are continuing to try to expand the straight file which is a true donor base and is the one that can be tapped for future major gifts in summary it appears that the ucc direct mail fundraising program is healthy and shows signs of continued improvement as the straight donor file expands it should lend stability to the monthly income for ucc the sweepstakes housefile mailings should continue to provide the buffer needed to provide the minimum revenues to help ucc make its monthly budgetary commitments in addition to the problem that watson noted some of the sweepstakes contest mailings generated adverse publicity for petitioner because some individuals who received the mailings believed the solicitations were misleading the adverse publicity petitioner experienced in conducting its direct mail campaign is discussed more fully infra although w h attempted to convert some of petitioner’s sweepstakes donors into straight donors by sending them non- sweepstakes mailing packages the conversion efforts were not successful w h concluded that the only way to obtain further contributions from sweepstakes donors was to continue to send them sweepstakes contest mailing packages during through date sweepstakes contests mailings were used heavily in petitioner’s direct mail fundraising campaign beginning in late or early petitioner sharply reduced the numbers of sweepstakes contest prospect letters it mailed because petitioner realized the sweepstakes contest prospect mailings were not helping petitioner to develop a strong housefile in his letter dated date to the w h executive who handled petitioner’s account on a daily basis petitioner’s executive director responded as follows to the w h executive’s prior argument that petitioner should not reduce the level of its prospect mailings so greatly below the level of the prospect mailings because the prospect mailings the w h executive claimed had added million new names to petitioner’s housefile your reference to the million names added in housefile is interesting why were we continuing to mail to only thousand with housefile packages given this million new names my opinion is that we both knew those names wouldn’t produce due to their acquisition from sweeps and if they did work their lifespan was a matter of weeks not months we wish to see greater cultivation of housefile names with new packages and straight packages if we only get big_number names or less but they have been generated via quality straight packages we will be better off than adding another million sweeps players in date petitioner stopped conducting prospect mailings during through a total of prospect mailings were done in petitioner’s direct mail fundraising campaign of the prospect mailings involved the use of sweepstakes contest mailing packages the total number of prospect letters mailed in petitioner’s mailing campaign was big_number of which big_number involved the use of sweepstakes contestsdollar_figure so stipulated the parties stipulated as an exhibit w h’s date status report to petitioner in that exhibit the listing of the prospect mailings occupies three pages the stipulated number of letters is the total of the prospect mailings listed on the first two pages of this portion of the exhibit the total for the prospect mailings listed on all three pages is big_number only of the prospect mailings are identified in the status report with the word sweeps these involve big_number letters we cannot clearly identify which of the other prospect mailings are among the stipulated sweeps prospect mailings based on the descriptive terms used in the status report our best estimate is that the status report shows that the stipulated sweeps prospect mailings involved about million letters similarly the parties have stipulated that the status report show sec_75 housefile mailings of which were sweeps letters and a total of big_number housefile mailings letters of continued as of date near the end of the term of the contract petitioner’s housefile contained a total of big_number donor names of which big_number were active names and big_number were inactive names dollar_figure as of date petitioner’s housefile contained big_number active donor names which had been produced from the sources indicated in table table source number of names sweepstakes mailings big_number continued which big_number were sweeps letters the stipulated status report show sec_75 housefile mailings but a total of only big_number letters the sweeps housefile mailings that we were able to identify involved big_number letters it may be that the status report misidentified mailings totaling about big_number names although the discrepancy between the stipulation and the stipulated exhibit is substantial more than percent of the total it does not affect our ultimate conclusions the parties stipulated to these numbers of active names and inactive names an invoice dated date to petitioner from wiland the computer company that maintained petitioner’s housefile reflects that wiland had prepared a computer tape of petitioner’s housefile that contained big_number active names and big_number inactive names according to dan wells an employee of wiland who testified at trial active names were the names that petitioner had mailed most recently interestingly watson during his testimony estimated that petitioner’s housefile as of the date date petitioner’s contract with w h ended contained approximately big_number to big_number active names and another million inactive names watson however defined active names to be names which at that point would produce a profit if mailed to and inactive names to be names which at that point would not produce a profit if mailed to he elaborated that the actual categorization of a particular name as active or inactive results from applying a complex statistical aging formula non-sweepstakes mailings miscellaneous big_number big_number total big_number f adverse publicity as a result of its direct mail fundraising campaign and its association with w h petitioner received adverse publicity this adverse publicity began in or about date and persisted through the term of the contract in late some of petitioner’s directors and staff began receiving complaints and inquiries about the direct mail fundraising campaign petitioner was conducting adverse newspaper articles concerning petitioner had been published the negative press came from all parts of the country to which petitioner was mailing fund-raising letters the areas of concern raised in the complaints or inquiries included w h’s control of another cancer charity aicr the mailing packages petitioner employed the adverse impact of mailings done in certain areas covered by petitioner’s member agencies and whether petitioner was spending a sufficient portion of its receipts for charitable purposes as distinguished from spending for fundraising and administration at petitioner’s board_of directors meeting on date the board members viewed and discussed a videotape of an unfavorable dayton ohio television news story about petitioner’s direct-mail fundraising the news story focussed on petitioner’s asserted high-pressure fundraising tactics and sweepstakes contests petitioner’s directors were divided concerning the course of action petitioner should pursue as a result of the above adverse publicity petitioner experienced some directors wanted petitioner to discontinue its direct mail fundraising campaign entirely however a majority of the directors decided that petitioner’s direct mail fundraising campaign should be continued and that the adverse publicity was a problem which could be managed financial considerations were a controlling factor in the majority’s decision to continue the direct mail campaign the fundraising arrangement with w h accounted for substantially_all of petitioner’s operating funds additionally at this time petitioner was fully liable on a recourse basis to w h for the excess draws petitioner had obtained from the escrow account although petitioner had tried at various times to develop other sources of funds these efforts were not successful and petitioner remained heavily financially dependent on its direct mail fundraising campaign revenues throughout the term of the contract in early ncib issued a report on petitioner that among other things concluded petitioner’s fundraising expenses for equaled about percent of the related contributions petitioner receiveddollar_figure the ncib report resulted in further adverse publicity for petitioner in or about date petitioner began using a sweepstakes prospect mailing package known as the instant cash package the instant cash package mailings were highly profitable for petitioner--especially unusual for prospect mailings however petitioner’s use of this sweeps package resulted in adverse publicity for petitioner after receiving complaints from contributors who received the instant cash package petitioner stopped using the package by about date at petitioner’s board_of directors meeting on date its executive director proposed that petitioner establish a cancer patient assistance fund which it would fund with dollar_figure per month in discussing the proposed patient assistance fund as is discussed infra table and the text following ncib did not accept petitioner’s allocation of a portion of its direct mail campaign expenses to public education recipients of the package were informed that they were winners in a contest with a prize of dollar_figure if they would enter the contest as applicable state laws generally prescribed that the recipients of such sweepstakes contest solicitations be allowed to enter the contest without making a contribution they were also asked but not required to make a contribution to petitioner although the solicitation letter also indicated that the actual amount won by a recipient would be decided in a later drawing the individuals who complained to petitioner believed the package was deceptive in actuality the dollar_figure prize money awarded in the contest would be split evenly among all the contestants who entered the contest and these contestants typically received about dollar_figure in some instances petitioner refunded the contributions it received from the complainants petitioner’s executive director stated that the direct mail campaign is a form of public relations some viewing it as a negative form but with a cancer patient assistance fund in place it could be turned around to a positive form in the future in date petitioner retained a consultant to assist petitioner in soliciting donations and grants from corporations and foundations the consultant reported to petitioner on the date meeting that took place between the consultant and an executive with the lilly endowment a large foundation in indianapolis the consultant advised that the lilly endowment’s executive’s unfavorable reaction to petitioner during the meeting indicated that petitioner’s continuance of its fundraising contract with w h would jeopardize petitioner’s efforts to obtain funding from corporations and foundations the consultant advised that it is doubtful that lilly will ever fund ucc perhaps a case could be built three or four years after the termination of the direct mail consultant contract the consultant’s report was given to petitioner’s administrative fundraising committee and mentioned by this committee in its date report to petitioner’s executive committee several of petitioner’s affiliate member agencies withdrew from petitioner as a result of the adverse publicity petitioner experienced in addition investigative inquiries with respect to petitioner’s direct-mail fundraising activities were begun by various state attorneys general including the attorneys general for alabama illinois maryland massachusetts new york and pennsylvania later lawsuits were begun by some of the state attorneys general including the attorneys general for new york and pennsylvania g petitioner’s escrow account-related problem sec_1 draws and petitioner’s dispute with w h over the calculation of cumulative net mailing campaign revenue pursuant to its draw arrangement with w h petitioner received monthly draws from the escrow account maintained by wib see supra table preceding text in late these draws were dollar_figure per month w h exercised final authority with respect to approving and directing wib to release the funds petitioner sought even though the escrow account was in petitioner’s name and wib considered that the funds in the escrow account belonged to petitioner wib paid money out of the escrow account only in response to check requests submitted by w h this was so whether the payments were to vendors in connection with petitioner’s fundraising activities in which events wib also required the vendors’ invoices to w h or directly to petitioner petitioner could not have obtained immediate possession of the funds that wib held in the escrow account by unilaterally revoking the escrow agreement between petitioner wib and w h if a dispute between petitioner and w h had arisen with respect to the disposition of the funds held in the escrow account then wib would have frozen the account at petitioner’s executive committee meeting on date the committee members directed petitioner’s staff to ask w h to increase petitioner’s monthly draw from dollar_figure to dollar_figure beginning date during the meeting petitioner’s executive director expressed his reservations about petitioner’s increasing the amount of its monthly draws unless w h provided written assurance that petitioner would not have to repay the excess draws it received however the executive committee member who proposed that petitioner should seek to increase its monthly draw responded that he wanted to have those funds in ucc’s control and accounts despite the possible future need to repay w h this member’s proposal was further supported by another of the committee members at petitioner’s executive committee meeting held on date a w h executive who attended a part of the meeting advised the committee members that w h was of the opinion that petitioner should not increase its monthly draw beyond the then-current dollar_figure because of a decrease in petitioner’s housefile mailing income w h suggested that petitioner wait until date before increasing its monthly draw to dollar_figure petitioner’s monthly draw was increased to dollar_figure beginning in date and was again increased to dollar_figure beginning in date in his letter dated date to watson petitioner’s executive director advised watson that there was a substantial discrepancy between w h’s calculation of petitioner’s escrow account balance and what petitioner calculated its escrow account balance to be the executive director asked that w h authorize transfer from the escrow account of the entire remaining dollar_figure of petitioner’s draws for in his letter dated date to watson petitioner’s executive director acknowledged petitioner’s receipt of its mid-november semimonthly draw of dollar_figure from the escrow account and stated that he assumed petitioner would be receiving its draws for as originally scheduled rather than in the lump sum he had asked for in his date letter he further asked that w h immediately transfer to petitioner half of the proposed dollar_figure it would draw from the escrow account for the period january through date in his letter dated date to watson petitioner’s executive director advised that petitioner’s executive committee had decided petitioner should stop receiving monthly draws of dollar_figure from the escrow account and instead receive percent of the housefile mailing income based on petitioner’s calculation of the net housefile mailing income petitioner’s executive director stated that these transfers are to be made within working days of petitioner’s calculations in her letter dated date to watson petitioner’s chief financial officer enclosed a copy of petitioner’s tentative calculation reflecting as of date a dollar_figure positive balance of cumulative net_income from the direct mail campaign as petitioner had not received all invoices of mailing expenses in connection with the date mailings petitioner’s chief financial officer asked that petitioner be paid dollar_figure which would leave another dollar_figure to cover any additional mailing expenses her letter stated that if w h had any questions regarding any of this petitioner should be contacted otherwise petitioner would expect to receive its requested check for dollar_figure no later than date in her letter dated date to a w h executive petitioner’s chief financial officer noted that there was a substantial discrepancy between petitioner’s and w h’s respective computations of cumulative housefile net_income as of date petitioner’s chief financial officer stressed that petitioner’s figures were audited petitioner computed that as of date its cumulative housefile income was dollar_figure its cumulative transfers from the escrow account amounted to dollar_figure and there was a resulting deficit of dollar_figure in contrast w h computed that the cumulative transfers were only dollar_figure but there was a deficit of dollar_figure w h prepared a status report dated date in which it took the position that as of date the cumulative transfers had grown to dollar_figure and the deficit had risen to dollar_figure in order to wind up the fundraising arrangement between petitioner and w h the escrow account was kept open until at least date as petitioner’s last housefile mailing under the contract was sent out in early may of petitioner expected that w h would render a final accounting to it on date however no final accounting was ever made or agreed to by petitioner and w h petitioner’s position is that all debts incurred for prospect mailings had been paid for by the revenues produced from the mailing campaign and that petitioner did not owe any money to w h w h’s purchase and invoice control procedures similar to the authority it exercised with respect to the funds petitioner sought from the escrow account up until about w h generally exercised final authority with respect to approving and directing wib to release funds to pay the direct mail campaign’s expenses as indicated above in discussing the escrow agreement the sole exceptions to w h’s authority concerned wib’s transfer of escrow account funds to pay business reply postage and invoices for wib’s own services beginning about w h generally obtained petitioner’s approval with respect to the payment of certain vendor invoices before issuing payment instructions to wib during through w h generally furnished wib with copies of all vendor invoices along with check requests and payment instructions wib relied on w h to tell wib that petitioner had approved the check requests when wib paid an invoice it promptly sent to petitioner a copy of the invoice the check request and payment information any time that petitioner called wib to ask questions about an invoice wib referred petitioner to w h because wib did not review the correctness or appropriateness of the invoices to petitioner petitioner never asked wib not to pay a vendor invoice however on at least one occasion w h authorized a payment without petitioner’s approval w h finally agreed that it would pay that bill in a memorandum dated date watson addressed and discussed a number of matters raised during an date meeting between himself two of petitioner’s directors and petitioner’s executive director among the matters dealt with in the memorandum are w h’s procedures with respect to its issuance of purchase orders processing of invoices and issuance of check requests to wib to pay invoices w h’s asserted practice was to send to petitioner copies of purchase orders for all goods or work contracted by w h after completion of the work or delivery of the goods and w h’s receipt of an invoice from the vendor the w h account executive reviewed the invoice for accuracy and returned it to w h’s accounting department a check request was then prepared and sent to wib and a copy of that check request was also sent to petitioner in his memorandum watson stated that should ucc wish to raise a question concerning any bill all they need to do is pick up the telephone and call the escrow agent wib and request that payment be held up until ucc is satisfied in his date memorandum watson also responded to petitioner’s concern that w h as required by the contract make reasonable efforts to solicit competitive bids from vendors where time and market conditions permitted watson explained that w h’s executives in soliciting bids prepared specifications for the various goods and services needed on a standardized 7-part purchase order form the executives then contacted prospective vendors advised them of the specifications for the goods and services sought and requested bids the bids submitted typically were given to the executives over the telephone rather than in writing however the w h executives who received these bids recorded the bid the name of the company making it and the date the bid was submitted on the last page of the purchase order watson maintained that requiring w h to obtain written bids as petitioner wanted would be too cumbersome a procedure and might deter prospective bidders from submitting bids if petitioner wanted to audit a bid watson suggested then petitioner could contact various vendors and ask them for their internal documentation on the bids they had submitted to w h among the concerns raised by petitioner’s certified public accounting firm in its later management letter dated date to petitioner’s board_of directors and executive committee are the following w h responsibility for documentation it is our understanding that certain procedures in the areas of purchasing and cash disbursements are executed by w h personnel we performed a limited test of such procedures and have the following observations a we could not locate a check request for each cash disbursement it was our understanding that at the very minimum each check issued is to have a corresponding check request identified with it the check request is the only document which indicates w h approval of the cash disbursement b during our testing there were several instances where we could not locate the invoice s associated with specific checks we recommend that council personnel perform a timely limited review of all cash disbursements to insure that the proper supporting documentation exists one area that needs special attention is postage although invoices are not issued for postage disbursements receipts are given to w h upon payment we strongly recommend that the council request that the original postage receipt be sent to the council and if w h requires the receipts for their files they could retain a copy of the receipt although our testing did not indicate that any of the checks written for postage were used for items other than postage the receipts would provide verification of these substantial expenditures see supra table which shows that postage and shipping was petitioner’s largest category of expenses for and c w h appears to be decidedly lacking in its adherence to the stated procedures regarding obtaining competitive bids on behalf of the council a number of the goods and services are paid for on a contractual basis so that the main items subject_to purchase using competitive bids are printing and mailhouse costs of the items we examined on a test basis which should have been subject_to competitive bids we could find documentation that bids had been obtained only approximately of the time it is possible that bids were obtained over the phone but not documented in some instances the documentation we reviewed stated that a bid could not be obtained due to time constraints we do not understand how this could occur as the mailing schedule is determined months in advance another possibility which exists is that competitive bids are not obtained but documentation is provided that states bids were obtained to pacify council personnel requesting adherence to the stated procedures regarding obtaining bids true compliance testing of the procedures can only be achieved through independent verification with the vendors involved lack of timely information the final major item we would like to discuss concerns the lack of adequate timely financial information summarizing the activities of the direct mail campaign it is our understanding that management decisions are often based on financial information obtained from reports generated by w h and the modified cash-basis monthly financial statements prepared by the council’s accountant this could be a dangerous course we have made two attempts to reconcile financial information in the w h reports to the council’s financial records and have been unable to do so we were then informed by watson that these reports were not complete contain several estimates and would probably not agree with the council’s books therefore we strongly recommend that the board not rely quite so heavily on the reports generated by w h the best course of action would be for council personnel to prepare the monthly financial statements in the same manner as they have been prepared at date however given current circumstances it would be impossible to do this on a timely basis one problem is that w h can take up to four months to record an invoice in accounts_payable particularly w h’s own invoices with that kind of time lag the council cannot determine the true accounts_payable at month-end until four months later petitioner’s concern about w h’s use of reasonable efforts to obtain competitive bids from vendors continued throughout the term of the contract during and petitioner further discussed with w h petitioner’s desire to exercise more control_over the payment of its direct mail campaign expenses however petitioner’s efforts to obtain full control_over disbursements from the escrow account ultimately were unsuccessful in his letter dated date to watson petitioner’s executive director confirmed that he and petitioner’s chief financial officer would be attending a meeting at w h’s offices on date as part of the agenda for their meeting the executive director enclosed for watson a list of petitioner’s staff concerns among the listed staff concerns was one which stated that the executive committee moved to bring all accounting functions in-house effective january approval of all invoices and check requests shall come from the ucc headquarters as well as the actual writing and reconciliation procedures in his letter dated date to watson petitioner’s executive director stated his understanding that at the date meeting with watson it was agreed that when ucc demonstrates the capability of assuming escrow authority and the escrow account debt level is significantly reduced then ucc will become the escrow agent in her letter dated date to petitioner’s chief financial officer preparatory to a meeting scheduled for date a w h executive stated as follows concerning petitioner’s previously expressed desire to take over management of disbursements from the escrow account beginning in early concerning moving the escrow account payable management to the petitioner’s carmel office early in you are probably referring to the discussion we had concerning this matter during the last visit by you and petitioner’s executive director to our offices in alexandria at that time we mentioned that only one of w h’s clients handles this function in that way that organization maintains a surplus cash balance in their accounts in excess of dollar_figure million and a positive fund balance of over dollar_figure it is our policy that once a client is able to develop a positive fund balance or the outstanding deficit can otherwise be reduced to a reasonable level we would be supportive of such a move as we have been in the past frankly with nearly dollar_figure in outstanding postage loans to ucc on the books as of last week it makes us somewhat nervous to hear mention of this again for the reasons outlined in your letter certainly those areas that were brought up can easily be overcome if on the other hand there has been any serious discussion within your organization which is outside the scope of what we have already stated i would appreciate your advising me so that we can review this with watson and the w h executive who handled petitioner’s account on a daily basis in her letter dated date to watson petitioner’s chief financial officer discussed her understanding from her meeting and discussions with watson and two w h executives on date of some actions w h would take to address petitioner’s concerns with respect to the conduct of its direct mail campaign and the accounting for and disbursement of funds to pay the mailing campaign expenses among these actions to be taken by w h the letter states that watson will write an addendum to the escrow agreement which would allow the council to approve invoices paid_by the escrow agent wib the council would be able to provide written requests for payment of invoices without the approval of w h with respect to petitioner’s desire to control the funds held in the escrow account the chief financial officer’s letter states as follows again the council desires to obtain control of accounts_payable through a separate bank account which would be funded by the current escrow account our reason is the lack of control we currently have over escrow account funds while i appreciate the w h executive who handled petitioner’s account on a daily basis’ wish to shield us from the aggrevations sic associated with accounts_payable i feel the council is quite capable of shouldering the responsibility if the other changes requested previously in this letter occur within the next few months we will be willing to delay the transfer for a period of time ultimately the council wants to control all of its accounts in her letter dated date to a w h executive petitioner’s chief financial officer objected that the date listing of accounts_payable submitted by w h that were to be paid contained invoices previously disapproved by petitioner petitioner’s chief financial officer complained that it appeared to her that w h intended to circumvent the invoice approval procedure that had been established her letter further stated as follows this scenario only emphasizes the lack of control the council petitioner exerts over its own funds w h previously has expressed that the council is incapable of managing the escrow account yet the recent activity has been unacceptable to us and goes against standard accounting principles just as w h insists on administering the council’s accounts_payable so will we insist that standard accounting policy be followed which includes maintaining vendor correspondence and reviewing invoice costs the proposed addendum to the escrow agreement discussed in petitioner’s financial officer’s above letter dated date to watson was never executed by petitioner w h and wib in his letter dated date to petitioner’s executive director watson offered to revise the escrow agreement to provide that petitioner would have the right to approve the payment of all invoices if petitioner agreed to an early renewal of the contract and entered the proposed new fundraising contract he enclosed petitioner eventually abandoned its efforts to obtain full control_over disbursements from the escrow account in his letter dated date to petitioner’s certified public accounting firm petitioner’s executive director stated as follows the council petitioner chose not to bring all of the record keeping for accounts_payable and cash disbursements in-house w h insisted that it would no longer be responsible for the prospecting debt if such action were taken mr watson explained that he did not want his firm to be responsible for the debt in the event that the council spent all of the proceeds of the campaign on programs and did not pay the fund raising expenses although we all agree that it would be considerably easier and more efficient for the council to exercise direct control of the record keeping the decision was made not to jeopardize the council’s financial health by incurring a large prospecting debt we hope these explanations help you understand the council’s position and actions during the past year h petitioner’s attempt to obtain a copy of its housefile in date petitioner asked wiland the computer services company that maintained petitioner’s housefile to provide to petitioner a complete computer tape of its housefile as of date petitioner stated that it would pay for the file petitioner’s stated reason was that at the urging of our legal counsel it wanted to have a copy of the housefile to maintain a ‘file copy’ in the event some disaster strikes wiland watson responded that wiland has a file copy in the vault of a bank in fredericksburg va and the safety procedures are standard in the industry watson also pointed to the contract provision that ‘any computer work client desires to have done with any names developed as a result of this contract with w h must be done at w h or at a company designated by w h during the term of the agreement’ in date watson told petitioner that petitioner would receive a copy of its housefile after the contract ended in date petitioner’s general counsel james w curtis hereinafter sometimes referred to as curtis tried to get for petitioner a copy of its housefile curtis was not successful in persuading w h to provide to petitioner a copy of its housefile on date curtis formally notified watson that petitioner was invoking the arbitration provisions of the contract and was going to begin an arbitration action in order to obtain the copy of its housefile after an unsatisfactory response from w h’s counsel on date curtis authorized another attorney to prepare an arbitration petition for filing on petitioner’s behalf on date curtis spoke with watson by telephone concluded that watson appeared to be cooperative and instructed the other attorney to put the arbitration matter on hold on date curtis followed up the february telephone call asked for the housefile tape and certain other material needed to understand and use the housefile tape and assured that petitioner would respect w h’s right to designate the company that would do any computer work with the housefile during the term of the contract on date w h responded that it would direct wiland to provide to petitioner a sample tape containing donor information on big_number names from petitioner’s housefile together with the other material that curtis had asked for that was needed to understand and use the housefile sample tape w h also agreed that as soon as the entire housefile is needed by whoever ends up working on it we can request that it be sent to them by wiland on date w h advised wiland that petitioner would transfer its housefile to another computer company after the contract ended in date w h instructed wiland to prepare a sample tape containing donor information on big_number contributors from petitioner’s housefile and to provide certain other information about the housefile that would be useful to any other company in deciding whether to become petitioner’s computer house petitioner’s and w h’s respective accounting treatments of the direct mail campaign’s revenue and expenses on its financial statement and form_990 for petitioner failed to treat the direct mail campaign’s expenses that exceeded the direct mail campaign’s gross revenue as being its expenses in his letter dated date to petitioner’s executive director watson advised that petitioner’s accounting treatment of the direct mail campaign’s expenses was incorrect watson’s date letter stated in pertinent part as follows the proper way to account for all your funds and expenses is to account for all of the income generated from ucc mailings as ucc income and all of the expenses related to all of the mailings must be recorded as ucc expenses if w h through its direct mail assistance raises dollar_figure for ucc and spends dollar_figure doing it then the financial statements must reflect a gross_income of dollar_figure and dollar_figure in expenses if your accountants are overly concerned about the contract i would recommend that they list the contract as a contractual obligation in the footnotes to the financial statement and they may want to even indicate that w h is potentially liable for any losses_incurred in the fundraising efforts but most importantly and i have said this over and over again w h is not the keeper of ucc funds w h does not dole out net_proceeds of fundraising campaigns to ucc on its through financial statements and forms petitioner treated all of the direct mail campaign’s revenue and expenses as its revenue and expenses on its partnership returns w h included in cost_of_goods_sold the postage advances it made and included in income the subsequent reimbursements it received for these advances petitioner’s allocation of expenses between fundraising and public education on its financial statements for through petitioner concluded that substantially_all of its direct mail campaign expenses were joint expenses allocable to public education and fundraising its through financial statements reflected that petitioner received total annual contributions and incurred joint expenses that it allocated to public education and fundraising as shown in table table contributions dollar_figure dollar_figure dollar_figure dollar_figure joint expenses-- education big_number big_number big_number big_number fundraising big_number big_number big_number big_number petitioner’s certified public accounting firm advised it of certain factors to be considered in allocating its direct mail campaign expenses between public education and fundraising the accounting standards division of the american institute of certified public accountants issued two statements of position hereinafter sometimes referred to as sop sop and sop concerning the appropriateness of allocating fundraising appeal expenses to a charitable organization’s exempt_purpose function sop amended the earlier-issued sop sop states in pertinent part as follows continued primarily by providing additional matters to be considered and had an effective date which made it applicable to petitioner’s financial statementdollar_figure as petitioner’s chief financial officer interpreted sop if the considerations set forth in that sop were applied-- to or we would have to show all expenses of the donor development fund as fund raising this means that continued all joint costs of informational materials or activities that include a fund-raising appeal should be reported as fund-raising expense if it cannot be demonstrated that a program or management and general function has been conducted in conjunction with the appeal for funds however if it can be demonstrated that a bona_fide program or management and general function has been conducted in conjunction with the appeal for funds joint costs should be allocated between fund-raising and the appropriate program or management and general function demonstrating that a bona_fide program or management and general function has been conducted in conjunction with an appeal for funds requires verifiable indications of the reasons for conducting the activity such indications include the content of the non-fund-raising portion of the activity the audience targeted the action if any requested of the recipients and other corroborating evidence such as written instructions to parties outside the organization who produce the activity or documentation in minutes of the organization’s board_of the organization’s reasons for the activity sop and sop address only whether allocation of a charitable organization’s fundraising appeal expenses is appropriate sop states that this statement of position does not address the issue of how to allocate joint costs a number of cost accounting techniques are available for that purpose of our total expenses general fund and donor development fund would be allocated to supporting services obviously we cannot afford such a devastating report at the end of and must correct any deficiencies in the direct mail program immediately during through petitioner was well aware of the guidelines cbbb and ncib established for members of the general_public to use in evaluating charitable organizations that solicited contributions petitioner planned and endeavored to meet eventually all of the cbbb and ncib guidelines as petitioner believed that doing so would enable it to gain more support from corporations foundations and the general_public although petitioner during through was never able to meet all of the cbbb and ncib guidelines petitioner concluded that it was in its interest to allocate as much of the direct mail campaign’s expenses to public education as possible all of the mailing packages petitioner utilized during through contained some educational material a list of the nine warning signals of cancer was included with almost all the housefile and prospect letters petitioner mailed as its mailing campaign progressed petitioner tried to increase the educational content of its mailings petitioner’s financial statements published as part of petitioner’s annual report for contain the following explanation of petitioner’s allocations of its and mailing campaign joint expenses between public education and fundraising note 4--allocation of joint costs of mailings expenses related to both prospect mailings and housefile mailings are allocated to public education and fundraising based on the relative content and intent of all mailings the content of each and every mailing is evaluated to determine what percentage of the mailing satisfies the goal of educating the public and what percentage of the mailing deals with fundraising public education includes any information about cancer its treatment and cures as well as discussion of the council’s petitioner’s programs in research and cancer patient services fundraising includes direct requests for money as well as emotional appeals intended to solicit funds the relative content of individual prospect mailings and housefile mailings are summarized and a composite percentage is determined which is then applied to total costs since the goals of the direct mail campaign are to educate the public and to raise funds none of the costs directly associated with the mailings are allocated to management and general_expenses petitioner’s financial statement published as part of petitioner’s annual report for contain the following explanation of petitioner’s allocations of its and mailing campaign joint expenses between public education and fundraising note 5--allocation of joint costs of mailings in the council petitioner incurred joint costs of dollar_figure for informational materials and activities that included fundraising appeals these joint costs are expenses related to both prospect mailings and housefile mailings and have been allocated as follows dollar_figure to public education and dollar_figure to fundraising in allocating the joint costs between public education and fundraising the counsel evaluates the content or message of the mailing and the intended audience if the content is information about cancer its treatments cures and prevention and requests for the reader to take some action other than sending a contribution then the public education function has been fulfilled an audience selected because of its interest in cancer and other health related issues also indicates the reason for the mailing is public education conversely if the message is a direct appeal for funds and sent to individuals based on their ability to contribute money then the fundraising function has been fulfilled all circumstances surrounding a mailing with regard to content and audience are examined together to arrive at the joint allocation of costs for each mailing between public education and fundraising in the council incurred joint costs of dollar_figure for informational materials and activities that included fundraising appeals of those costs dollar_figure was allocated to public education and dollar_figure was allocated to fundraising expenses related to both prospect mailings and housefile mailings were allocated to public education and fundraising based on the relative content and intent of each mailing without regard to intended audience ncib did not accept petitioner’s allocations of its and mailing campaign expenses to public education in preparing its reports on various charitable organizations ncib generally accepted the financial information contained in a charitable organization’s financial statements except for the charitable organization’s allocation of its fundraising appeal expenses to exempt_purpose activity while aware of sop and sop ncib examined the reasonableness of the allocations made by the charitable_organization for example as indicated above in a report it issued on petitioner ncib concluded that petitioner’s fundraising expenses for equaled about percent of the related contributions petitioner received with respect to petitioner’s mailing campaign joint expenses petitioner’s certified public accounting firm experienced considerable difficulty in applying sop and was unable to conclude what portion of the direct mail campaign expenses qualified as joint expenses the accounting firm essentially let petitioner itself decide how to categorize and allocate the expenses the compensation that w h received under the contract by way of direct payment by petitioner and by way of the value of w h’s use of the names generated by petitioner’s fundraising efforts exceeded reasonable_compensation respondent’s revocation of petitioner’s favorable letter_ruling retroactively to the start of the contract was not an abuse_of_discretion opinion i status under sec_501 and sec_170 sec_501 provides that an organization described in subsection c shall be exempt from taxation under this subtitle dollar_figure in order to be described in sec_501 an exceptions from this broad rule because of sec_502 relating to feeder_organization relating to prohibited_transactions by certain categories of transactions b relating to unrelated_business_income and various other provisions of the code do not appear to be issues in the instant case sec_501 provides in pertinent part as follows continued organization must meet all of the following criteria it must be both a organized and b operated exclusively23 for certain specified exempt purposes including charitable educational and scientific purposes no part of its net_earnings may inure to the benefit of any private shareholder or continued sec_501 exemption from tax on corporations certain trusts etc c list of exempt_organizations --the following organizations are referred to in subsection a corporations organized and operated exclusively for charitable scientific or educational_purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual no substantial part of the activities of which is carrying on propaganda or otherwise attempting to influence legislation and which does not participate in or intervene in including the publishing or distribution of statements any political campaign on behalf of or in opposition to any candidate for public_office the text includes an amendment made by sec a of the omnibus budget reconciliation act of obra publaw_100_203 101_stat_1330 this amendment applies to activities after date the date of the enactment of the act this amendment relates only to political campaigns and so does not affect the instant case exclusively in this context means that there is no nonexempt purpose that is substantial in nature 326_us_279 950_f2d_365 7th cir affg tcmemo_1990_484 324_f2d_633 8th cir affg on this issue 39_tc_93 ndollar_figure individual no substantial part of its activities may consist of lobbying efforts no part of its activities may constitute intervention or participation in any political campaign on behalf of or in opposition to any candidate for public_office sec_501 and its purpose must not be contrary to a fundamental public policy 461_us_574 see generally 92_tc_1053 these requirements are stated in the conjunctive petitioner’s failure to satisfy any of these requirements would be fatal to its qualification under sec_501 american campaign academy v commissioner t c pincite 39_tc_93 affd on this issue 324_f2d_633 8th cir donations to sec_501 organizations generally are deductible for income_tax purposes under sec_170 sec_170 sec_170 416_us_725 sec_170 c defines the term charitable sec_170 provides in pertinent part as follows sec_170 charitable etc contributions and gifts c charitable_contribution defined --for purposes of this section the term charitable_contribution means a contribution or gift to or for the use of-- continued contribution to mean a contribution or gift to or for_the_use_of certain types of organizations enumerated thereunder with a few minor differences the organizations and requirements listed in sec_170 are virtually identical to those described in sec_501 in view of the nearly identical statutory language the courts have applied many of the same standards in interpreting sec_170 and sec_501 see bob jones university v united_states u s pincite for continued a corporation -- a created or organized in the united_states or in any possession thereof or under the law of the united_states any state the district of columbia or any possession_of_the_united_states b organized and operated exclusively for charitable scientific or educational_purposes c no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual and d which is not disqualified for tax exemption under sec_501 by reason of attempting to influence legislation and which does not participate in or intervene in including the publishing or distributing of statements any political campaign on behalf of or in opposition to any candidate for public_office the text includes an amendment made by sec a of obra publaw_100_203 101_stat_1330 this amendment applies to activities after date the date of the enactment of the act this amendment relates only to political campaigns and so does not affect the instant case convenience we shall refer to sec_501 but our analysis and conclusions in the context of the instant case will apply equally to sec_170 in the instant case respondent contends only that petitioner was not operated exclusively for exempt purposes because its activities served private commercial purposes petitioner operated in large part for the private benefit of w h and petitioner’s net_earnings inured to the benefit of private shareholders or individuals respondent does not contend that petitioner is an action_organization sec_1 c - c income_tax regs has not raised any contention that petitioner has failed to satisfy any of the other requirements discussed above for exemption under sec_501 and does not dispute petitioner’s organization exclusively for exempt purposes respondent further acknowledges that respondent bears the burden_of_proof in establishing inurement because respondent’s notice of revocation did not indicate that inurement was a ground for the revocation rule c b 73_tc_650 we note that while the inurement prohibition and the private benefit analysis under the operational_test of the treasury regulations may substantially overlap the two are distinct requirements which must independently be satisfied american campaign academy v commissioner t c pincite9 however it is not clear that the first two of respondent’s contentions-- activities serving private commercial purposes and operation for the private benefit of w h--are meaningfully different requirements at least in the context of the instant case we consider first the issue of inurement in order for an organization to qualify for exemption under sec_501 no part of the organization’s net_earnings may inure to the benefit of any private_shareholder_or_individual sec_501 sec_1_501_c_3_-1 income_tax regs a private_shareholder_or_individual is broadly defined as any person having a personal and private interest in the activities of the organization sec_1_501_a_-1 income_tax regs such private shareholders or individuals are sometimes referred to for convenience as insiders see american campaign academy v commissioner t c pincite 71_tc_158 we consider first whether w h was an insider with respect to petitioner and then whether there was an inurement of petitioner’s net_earnings to w hdollar_figure a w h as insider petitioner does not make the argument that w h cannot be an insider under the statutory language because w h is not a shareholder in petitioner and is not an individual accordingly we do not consider that question see 46_tc_214 n in any event sec_501 deals with whether there is an inurement to the benefit of any individual if there were an inurement to w h then it may well be that any such inurement would be to the benefit of w h’s owners--the individuals watson and hughey petitioner maintains that the inurement doctrine applies only to insiders who receive an impermissible benefit from the organization not to third parties with whom the exempt_organization contracts for services emphasis in original petitioner was independent of w h and the two entities had no common directors officers or employees and petitioner--and not w h--had control in that a petitioner directed its charitable program b petitioner renegotiated the contract with w h in mid-stream gaining an important financial advantage c petitioner diligently exercised its right of review over all proposed mail copy mailing lists vendor’s invoices and volume and frequency of mailings and d petitioner exercised ultimate ‘control’ by terminating its relationship with w h respondent contends that an ‘insider’s’ control consists of a meaningful opportunity to influence any portion of the organization’s activities that could readily be manipulated to the benefit of the insider respondent asserts that in the instant case the record clearly shows that w h controlled most of petitioner’s income and assets including controlling most uses of and all rental income from petitioner’s donor and non-donor names even after the five-year term of the contract petitioner rejoins that its board_of directors retained ultimate control and to the extent that any control_over any assets or activities was delegated to w h petitioner’s board_of directors exercised due diligence in supervising w h’s actions mailers contends that if a charity and an outsider negotiate a contract at arm’s length then the contract does not make that person an insider for inurement purposes with respect to that contract the contract between petitioner and w h was negotiated at arm’s length and was market rate mailers asserts and so w h was not an insider and there was no inurement to w h american-sector contends that the case law often labors to craft metaphysical distinctions between these requirements --the ban on private_inurement the ban on private benefit and the general requirement that a charity be organized and operated exclusively for an exempt_purpose we agree with respondent’s conclusion the term private_shareholder_or_individual appears at present in sec_170 three places c eight places c d c a vi a four places and b this term has been unchanged since the revenue act of pub l 68th cong 1st sess ch 43_stat_253 the revenue act of pub l 67th cong 1st sess ch 42_stat_227 used the term private stockholder or individual as did the prior revenue acts back to the tariff act of pub l 63d cong 1st sess ch 38_stat_114 the term private stockholder or individual also appears in sec_38 of the tariff act of commonly called the corporation excise_tax act of pub l 61st cong 1st sess ch 36_stat_11 neither the parties nor the amici have directed our attention to and we have not found any statutory explanation of any of these terms our examination of the legislative_history of the revenue act of has not turned up any explanation of the shift from stockholder to shareholder we note that the administration’s proposed bill leading to the revenue act of retained the word stockholder while the bill as reported by the house ways_and_means_committee used the word shareholder we note also that the term private stockholder or individual appears in paragraph of sec_2055 and its code predecessor sec_812 while the term private_shareholder_or_individual appears in paragraph of the same sec_2055 we have not found any explanation of the intended difference between stockholder and shareholder nor any reason why stockholder was replaced by shareholder in the revenue act of see 102_tc_338 affd 65_f3d_90 8th cir sec_1_501_a_-1 income_tax regs provides as follows c private_shareholder_or_individual defined the words private_shareholder_or_individual in sec_501 refer to persons having a personal and private interest in the activities of the organization see sec_1_501_c_3_-1 income_tax regs this definition is unchanged from regs art except that the older regulations use individuals and corporation instead of persons and organization respectively art of regs is essentially similar to regs art in general the case law appears to have drawn a line between those who have significant control_over the organization’s activities and those who are unrelated third parties 75_tc_127 we proceed to consider whether and if so then to what extent w h controlled petitioner’s activities on the one hand neither w h nor watson nor hughey was a director or officer of petitioner nor did any of them have a formal voice in the selection of any director or officer of petitioner on the other hand in exchange for a funds to keep petitioner operational and get it past its financial crisis and b fundraising services w h received compensation effectively exclusive control_over petitioner’s fundraising activities including supposedly separate computer activities and substantial control_over petitioner’s finances the amounts that w h would advance for petitioner’s operational costs and as capital for petitioner’s fundraising costs were not specifically contracted for but were essentially discretionary with w h moreover up until the execution of the date addendum to the contract petitioner was fully liable on a recourse basis to repay w h for the excess draws petitioner received this repayment liability caused petitioner’s certified public accounting firm to express serious concern about petitioner’s continued existence and economic viability in the accounting firm’s management letter dated date to petitioner’s board_of directors and executive committee although petitioner had a longstanding existence before its involvement with w h the position w h occupied in relation to petitioner during and was in many ways analogous to that of a founder and major contributor to a new organization petitioner which was on the brink of insolvency was being heavily financed and kept in existence by w h pursuant to the fundraising arrangement that petitioner and w h entered petitioner became dissatisfied with its lack of control_over the escrow account funds in and petitioner made a number of concerted efforts to obtain more control_over the escrow account however its efforts were unsuccessful as a result of w h’s refusal to give up control_over the account w h continued to retain control_over the escrow account long after it and petitioner knew the direct mail fundraising campaign was financially successful w h’s control_over petitioner’s fundraising campaign is further manifested by petitioner’s unsuccessful efforts to obtain a copy of its own housefile in date about months before the contract ended w h refused to provide to petitioner a copy of its housefile until the contract was over it instructed wiland the computer company w h selected to maintain petitioner’s housefile not to comply with petitioner’s date request despite the extensive efforts of its attorney petitioner was unable to obtain its complete housefile until after the contract ended from a practical standpoint w h exercised substantial control_over petitioner’s finances and direct mail fundraising campaigns during the period from through in light of w h’s extensive control_over petitioner and petitioner’s near- insolvent financial condition when the fundraising arrangement was entered into in date we conclude that w h was an insider with respect to petitioner petitioner and mailers contend that one cannot become an insider merely by entering into an arm’s-length negotiated contract we are not aware of any such one-free-bite principle in this part of the law whether the control thus transferred or shared makes the transferee an insider depends on the circumstances the arrangement authorized by the contract in the instant case was not a one-shot deal but a 5-year relationship involving many transactions during its term the arm’s-length negotiations may have a significant bearing on the fairness of the contract but they do not inoculate w h against insider status mailers makes a further argument along this line by pointing out that-- even the definition of self-dealing provides that the term does not include ‘a transaction between a private_foundation and a disqualified_person where the disqualified_person status arises only as a result of such transaction ’ sec_53_4941_d_-1 however the cited regulation explains this rule in the very next sentence as follows for example the bargain sale of property to a private_foundation is not a direct act of self-dealing if the seller becomes a disqualified_person only by reason of his becoming a substantial_contributor as a result of the bargain element of the sale thus the cited regulation which does not apply to public_charities anyway focuses on the one-shot deal and does not appear to immunize a substantial course of dealing merely because the substantial course of dealing is pursuant to one contract and its amendments and extensions we conclude that the cited regulation fashioned in an environment of disqualified persons and prohibited_transactions is distinguishable from what we face in the instant case viz insiders and inurement we hold for respondent that w h was an insider with regard to petitioner b did any of petitioner’s net_earnings inure to w h petitioner points out that respondent has the burden_of_proof and contends that respondent has failed to carry this burden respondent acknowledges having the burden_of_proof but contends that this burden has been carried because it was shown that w h received excessive and unreasonable_compensation and other private benefit from petitioner mailers argues that private_inurement does not result from a third-party contract for fair_market_value and contends that the contract was at market rate especially in light of all the facts and circumstances when the contract was executed we agree with respondent’s conclusion an organization’s payment of reasonable_compensation to an insider for services performed for the organization would not constitute inurement of net_earnings but payment of excessive_compensation would 666_f2d_1096 7th cir 74_tc_507 affd without published opinion 647_f2d_163 2d cir whether the compensation in question is reasonable neither side suggests that we should examine the statutory term net_earnings and so we do not see 75_tc_127 n alive fellowship of harmonious living v commissioner tcmemo_1984_87 n see also discussion in b hopkins the law of tax-exempt organizations sec 6th ed is a question of fact 412_f2d_1197 factors similar to those considered in determining reasonable_compensation under sec_162 are examined founding church of scientology v united_states supra 72_tc_681 in determining whether there has been an inurement of net_earnings we are to consider all forms of compensation and not merely direct payments from the organization to the insider founding church of scientology v united_states supra unitary mission church v commissioner t c pincite a cap or limit on the contingent_compensation that may be earned under a particular incentive formula can be considered a factor supporting the reasonableness of that contingent_compensation arrangement see people of god community v commissioner t c pincite at trial petitioner and respondent offered the testimony of several expert witnesses on the issue of whether w h received more than reasonable_compensation as trier of fact we are not bound by the opinion of any expert witness and will accept or reject expert testimony in whole or in part in the exercise of sound judgment 304_us_282 538_f2d_927 2d cir and cases there cited affg t c memo petitioner offered the testimony of three expert witnesses james feldman hereinafter sometimes referred to as feldman a professional direct mail marketing and fundraising consultant j curtis herge hereinafter sometimes referred to as herge an attorney practicing in the washington d c area who has advised nonprofit_organizations and professional fundraisers about fundraising contracts and represented such clients in the negotiation of their fundraising contracts and richard s steinberg hereinafter sometimes referred to as steinberg an economist who has specialized in the economics of nonprofit_organizations respondent offered the testimony of four expert witnesses nora carrol hereinafter sometimes referred to as carrol a professional fundraising and marketing consultant john kehoe hereinafter sometimes referred to as kehoe a professional fundraiser who at the time of the trial specialized in mailing list brokerage services william c mcginly hereinafter sometimes referred to as mcginly president of the association for healthcare philanthropy a professional organization of health_care_facility and hospital executives concerned with fundraising marketing and public relations for nonprofit health care facilities and hospitals and robert s tigner hereinafter sometimes referred to as tigner general counsel for the association of direct response fundraising counsel hereinafter sometimes referred to as adrfco a professional organization of professional fundraising companies that provide direct response consulting services to nonprofit_organizations herge attached to his expert report copies of fundraising agreements for various nonprofit_organizations filed with virginia’s office of registrations division of consumer affairs herge asked the virginia office of registrations to provide him with copies of all fundraising agreements filed with it by up to to professional fundraisers during a specified time period from the agreements thus provided herge selected agreements which he believed were representative and typical of the agreements similar to petitioner’s found in the market place these fundraising agreements were entered into during the period from through they involve various professional fundraisers and client organizations nineteen of the client organizations involved in these agreements have been recognized by respondent as being exempt from federal_income_tax either under sec_501 sec_501 or sec_501 four of the agreements essentially provide that the nonprofit organization client is fully liable on a recourse basis for the fundraising expenses the remaining agreements are essentially no-risk contracts for the nonprofit organization however a few of the essentially no-risk agreements require the nonprofit organization client to either contribute a specified amount of the initial capital to conduct the mailing campaign or bear financial responsibility for certain specified types of expenses without going into an analysis of each of these expert witness’ testimony we draw the following overall conclusions from their testimony contingent-fee charitable fundraising arrangements occur with modest frequency although some in the fundraising field regard such arrangements as being improper others treat such arrangements as an ordinary part of the fundraising landscape it is expected that a fundraising arrangement with a contingent- fee element would present opportunities for greater total compensation_for the fundraiser than a similar fundraising arrangement that does not have a contingent-fee element no-risk charitable fundraising arrangements occur with less frequency they may take various forms most of which may more appropriately be labeled as limited risk rather than no- risk it is expected that a fundraising arrangement with a no- risk or limited-risk element would involve greater total compensation_for the fundraiser than a similar fundraising arrangement that does not have a no-risk or limited-risk element as petitioner’s experts feldman and herge point out co- ownership of mailing lists is typical in no-risk charitable fundraising arrangements and is regarded as a method of enhancing compensation to the fundraiser without requiring the charitable_organization client to actually write checks although such co- ownership is understood to be an element of compensation it has the side effect of making it more difficult to determine what is the total compensation to the fundraiser note that petitioner’s form_990 did not report this as an element of compensation paid and respondent does not suggest that petitioner should have tried to find out how much w h earned as a result of this feature of the fundraising agreement in the instant case the co-ownership had features that significantly restricted petitioner’s use of its own mailing listdollar_figure under section of the contract all of these restrictions even survive the term of the contract in addition w h and petitioner interpreted the contract to permit w h to exchange petitioner’s mailing list for another organization’s mailing list and then require petitioner to reimburse w h for the expense that w h did not in fact incur because of the exchange of mailing lists a side effect of this feature is that in such a situation a payment by petitioner to w h which appeared to be a simple reimbursement of w h’s out-of- pocket expenses would in fact have been additional compensation by petitioner to w h see sec of the contract set forth supra the contract expressly forbids petitioner to rent exchange lease sell or give away the names and addresses that w h develops to any other parties for any purpose whatsoever on the other hand the contract expressly permits w h to use these names and addresses in any way it so desires and for any purpose it may so determine petitioner’s mailing fees under the contract--dollar_figure per prospect letter and dollar_figure per housefile letter--were within but about the high end of the range of charges in what herge described as a representative group of fundraising contracts petitioner was charged package fees for housefile mailings under the contract in herge’s group of contracts package fees were ordinarily found only in conjunction with lower mailing fees in only one instance in this group the viguerie co ’s contract with the solidarity endowment was there both a package fee and a high mailing fee as tigner points out it is difficult to evaluate the reasonableness of a particular mailing fee unless one understands the volume of mailings that are anticipated in general the greater the volume of mailings anticipated the smaller the mailing fees this relationship was clearly recognized in five of the fundraising contracts in herge’s group of contracts involving four different fundraisers which provided graduated mailing fees depending on the volume of mailings actually sent thus when the parties to a fundraising contract do not have a basis for confidently estimating the volume of mailings to be sent a graduated mailing fee schedule is a device that may be used to protect both sides in date petitioner and w h agreed to a cap on housefile mailing fees in exchange for a reduction from to percent in the cumulative net_income from housefile mailings that petitioner was guaranteed to receive the dollar_figure cap applied to any single housefile mailing of more than big_number in almost all of herge’s group of contracts the exempt_organization could terminate the fundraising contract with some form of advance notice the longest notice so required i sec_120 days and the shortest i sec_30 days often these contracts provide that an exempt_organization that terminates its fundraising contract becomes liable for mail campaign losses in contrast the contract does not make any provision for petitioner to terminate it by giving notice or for cause on the contrary the contract provides that during its entire 5-year term w h would be petitioner’s exclusive fundraiser and specifically forbids petitioner to retain or use the services of any other person or company to provide counsel or advice to petitioner in conducting its direct mail solicitations thus w h had an effective way to limit its risk if the contract did not prove to be productive--w h could reduce or eliminate the monthly draws that it allows petitioner to take and it could end the advances used to fund future mailings for petitioner once petitioner had grown accustomed to this lifeline petitioner could not remain viable without continued infusions w h could figuratively pull petitioner’s plug and thereby effectively rid itself of future losses or insufficiently profitable obligations petitioner on the other hand had no exit presumably petitioner could have refused to authorize more mailings but petitioner could not use another fundraiser no matter how unhappy it was with how the contract was working out this suggests that the uncertainties normally attendant on a no- risk contingent_fee arrangement warranted less of a premium to w h under the circumstances of the contract than might be appropriate in the usual run of no-risk contingent_fee cases the dollar amounts in some of the tables set forth supra in our findings_of_fact in many instances do not properly match the dollar amounts in other tables this results from the inconsistent and usually unreconciled exhibits that the parties introduced in the extensive record in the instant case nevertheless the following conclusions may fairly be drawn from the information we have w h’s services under the contract netted petitioner about dollar_figure¼ million for its own uses unrelated to the contract table sec_1 and this net is less than percent of what donors contributed to petitioner in the fundraising campaign table sec_1 and petitioner directly paid more than dollar_figure million to w h as fundraising fees table sec_3 and in addition petitioner paid almost dollar_figure million to washington lists a division of w h for list rental fees and commissions table sec_4 and more than percent of petitioner’s payments to washington lists were for rentals of lists that w h or washington lists had obtained at little or no cost by exchanging petitioner names table although the record does not show how much w h or washington lists profited from being able to use petitioner names for mailing list exchanges on behalf of w h’s other clients it does show that about percent of petitioner’s payments to washington lists were for rentals of lists that w h or washington lists had obtained at little or no cost by exchanging w h masterfile names table at trial watson testified that the mailing fee rates that w h charged to petitioner under the contract were equal to the highest rates that he understood professional fundraisers in the washington d c area charged their nonprofit organization clients in no-risk fundraising contracts in his letter dated date to petitioner’s executive director watson proposed that petitioner and w h agree to an early renewal of the contract and enter into a new proposed contract that would replace and supersede the contract under the proposed contract watson enclosed w h’s mailing fees would be reduced from dollar_figure to dollar_figure per prospect letter and from dollar_figure to dollar_figure per housefile letter when w h entered into contracts with aicr on a no-risk basis aicr’s mailing fees were percent less than what petitioner had to pay and aicr did not also have to pay package fees supra table the second aicr contract and the aicr contract both of which were entered into before the contract showed w h’s understanding of the uses of graduated mailing fees the market as exemplified by herge’s sample of fundraising contracts provided two significant checks on excessive_compensation in no-risk situations--early termination rights for the exempt_organization almost all the contracts and graduated mailing fee five contracts until the date agreement the contract did not provide either of these checks on the effect of high mailing fees thereby reducing the market justification for charging what watson acknowledged to be equal to the highest rates in the washington d c area although our inquiry in the instant case is to some extent similar to that in sec_162 cases this inquiry is easier in one important respect--if we determine that there is excess compensation in a sec_162 case then we must set a dollar amount on that excess while in the instant case we merely have to determine whether there is excess compensation and need not then set a dollar amount airlie foundation inc v united_states aftr 2d ustc par d c cir 893_f2d_529 2d cir affg tcmemo_1988_380 see 823_f2d_1310 9th cir affg 83_tc_381 founding church of scientology v united_states f 2d pincite unitary mission church v commissioner t c pincite but see 973_f2d_1479 n majority opinion tang j concurring in part and dissenting in part 9th cir the instant case does not involve an insider’s embezzlement or any other kind of theft or use of assets unbeknownst to the other insiders what we conclude to be excessive_compensation resulted from what petitioner and w h apparently believed the contract permitted or required the fact that the contract was bargained for is a significant factor pointing toward reasonableness sec_1_162-7 income_tax regs however even under the standards of sec_162 the bargaining factor does not by itself conclusively protect an arrangement from a determination that the compensation was unreasonable we are required to consider all the circumstances sec_1 b income_tax regs our examination of the other contracts provided by herge of the multiplicity of compensation sources that w h had under the contract of the open-ended nature of w h’s charges under the contract even though graduated fees were already being used in the industry--and specifically by w h in connection with aicr-- convinces us that the initial risk that w h bore did not justify so high a level of compensation we are not holding that an arm's-length arrangement that produces a poor result for an organization necessarily would cause the organization to lose its tax-exempt status we conclude and we have found that the compensation that w h received under the contract by way of direct payment by petitioner and by way of the value of w h’s use of names generated by the fundraising efforts that petitioner already paid for exceeded reasonable_compensation as a result we conclude that as of the date date on which the contract started the contract was not a reasonable contingent_compensation arrangement that w h’s compensation under the contract exceeded reasonable_compensation and that thus there was an inurement to an insider in violation of the restrictions in sec_501 and sec_170 it is suggested that the dollar_figure¼ million that petitioner cleared during the course of the contract may justify such high compensation however the dollar_figure¼ million is so small in comparison to the amounts of contributions of w h compensation of postage and shipping costs of printing and publications costs and of mailing list rental costs as to be almost an incidental product of the fundraising campaign and w h was supposed to provide a substantial asset to petitioner--a housefile that petitioner could exploit in future fundraising see supra findings under direct mail fundraising --but w h’s services were a practical failure in this regard thus the magnitude of w h’s compensation is not justified by adequacy of results we hold for respondent on this issue ii retroactivity of respondent’s revocation of the prior favorable ruling letter issued to petitioner petitioner contends that it was improper for respondent to revoke the prior favorable ruling letter retroactively to date the date on which petitioner entered into the contract petitioner contends that the retroactivity of the revocation violates its fifth_amendment due process rights and constitutes an abuse of respondent’s discretion under sec_7805 petitioner’s constitutional arguments were considered and dealt with in 100_tc_162 and in the hearing that preceded that opinion petitioner asks the court to reconsider our previously detailed arguments and we also note our preservation of the issues in the event of an appeal we believe that our earlier rulings in this matter were correct and that there is no need to restate them we proceed to consider the abuse-of-discretion issue under sec_7805dollar_figure sec_7805 provides as follows sec_7805 rules and regulations b retroactivity of regulations or rulings --the secretary may prescribe the extent if any to which any ruling or regulation relating to the internal revenue laws shall be applied without retroactive effect this provision was extensively revised by sec_1101 of the taxpayer bill of right sec_2 publaw_104_168 110_stat_1452 effective for regulations which relate to statutory continued the supreme court has held that respondent has broad discretion under sec_7805 and its predecessor in deciding to revoke a ruling retroactively and that such a determination is reviewable by the courts only for abuse of that discretion 353_us_180 see 381_us_68 see generally 85_tc_743 affd 799_f2d_903 4th cir more recently in a different but analogous setting we described review of exercise of discretion as follows whether the commissioner has abused his discretion is a question of fact 92_tc_641 82_tc_989 in reviewing the commissioner’s actions however we do not substitute our judgment for the commissioner’s nor do we permit taxpayers to carry their burden_of_proof by a mere preponderance_of_the_evidence buzzetta construction corp v commissioner continued provisions enacted after date and so does not affect the instant case we note that present sec_7805 provides as follows sec_7805 rules and regulations b retroactivity of regulations -- application to rulings --the secretary may prescribe the extent if any to which any ruling including any judicial decision or any administrative determination other than by regulation relating to the internal revenue laws shall be applied without retroactive effect t c pincite 91_tc_1079 70_tc_1001 taxpayers are required to clearly show that the commissioner’s action was arbitrary capricious or without sound basis in fact 743_f2d_781 11th cir mailman v commissioner t c pincite 34_tc_1070 capital federal savings loan v commissioner 96_tc_204 the contract caused the inurement violation it is not arbitrary capricious or without sound basis in fact for respondent to determine that the revocation of the favorable ruling letter should relate back to the start of the contract neither the parties nor the amici refer to sec_601_201 statement of procedural rules nor to revproc_90_27 1990_1_cb_514 both of which provide in pertinent part that the revocation of an exemption ruling may be retroactive if the organization operated in a manner materially different from that originally represented the start of the contract marked a substantial change in petitioner’s operations this change was material with respect to inurement petitioner has not suggested that there was any event after the start of the contract which marked a change in w h’s actions or w h’s rights under the contract such that there was an inurement after that event or change but not before that event or change if the revocation which occurred after the contract expired had been made prospective only then the revocation would have been a meaningless act we conclude that the retroactivity of the revocation to the start of the contract is not an abuse_of_discretion when tested by the usual standards petitioner does not maintain that these standards have been modified as a result of sec_601_201 statement of procedural rules or revproc_90_ and the retroactivity would not be an abuse_of_discretion even if the usual standards were so modified see capital federal savings loan v commissioner t c pincite we hold that respondent’s determination that the revocation be retroactive to the start of the contract was not an abuse_of_discretion in light of our holdings for respondent we do not consider whether petitioner should be denied tax-exempt status for other reasons whether anyone’s actions violated postal regulations and if so what effect that should have on petitioner’s exempt status whether petitioner and w h engaged in a joint_venture whether a portion of petitioner’s expenses is properly allocable to public education or whether any particular feature of the contract constituted a per se violation of any of the requirements of sec_501 and sec_170 finally sec_4958 imposing an excise_tax on excess_benefit transactions applies only to transactions occurring on or after date and so does not apply to the instant case decision will be entered for respondent