Michael and his younger brother George grew up poor Jewish kids in Hungary in the mid-1950s. Unlike so many, Michael managed to avoid a grim fate in the Holocaust — only to have his country swept up in a bitter revolt against the cruel occupation government of the Soviet Union.

The revolt failed, and like tens of thousands of their countrymen, the two brothers left their homeland and its bloodshed and managed to make their way to New York and a new future.

Nearly 60 years later, their lives are something even Horatio Alger would not have thought possible. Their quiet careers at the periphery of Wall Street investing and forays into the real estate and insurance industries (all while they averted publicity) have made both men billionaires, according to Forbes magazine.

Like so many rich people, the Karfunkels opened nonprofit foundations to share

their good fortune. Through the donation of large blocks of shares of AmTrust Financial Services — an insurance concern they built in the 1990s — their foundations have amassed considerable size as the share price has climbed: By the end of 2013 Michael Karfunkel’s Hod Foundation had assets of $286 million; his brother George’s Chesed Foundation of America had assets of $293 million.

(Their foundations give almost exclusively to yeshivas and synagogues connected to Haredi Judaism, many of which are affiliated with the Belz Hasidic sect.)

And this is where the story would normally end: Two miraculously successful brothers in their later years — Michael is now 71 and George is 65 — have the rare privilege of seeing their fortunes put to good use.

Except that, taking a hard look at how these foundations operate leaves a lot more questions than answers.

For three months the Southern Investigative Reporting Foundation analyzed the foundations’ publicly available documents, primarily though CitizenAudit.org, an online repository of nonprofit foundation annual reports. What the Southern Investigative Reporting Foundation found was that all good intentions aside (Hod means “prayerful submission” in Hebrew and Chesed translates into “loving kindness”), regulatory filings indicate that the foundations, while generously supportive of the Belz Hasidic community, have become key instruments in furthering the Karfunkels’ business interests.

Unfortunately for the two brothers, based on the Southern Investigative Reporting Foundation’s analysis, it appears that their management of the foundations may expose them to regulatory scrutiny and possibly force them to sell a large amount of their foundation’s AmTrust shares, creating a material concern for company shareholders.

What follows below is how lax regulation and imprudent management turned the capstone of the American dream into what may be the first act of an American nightmare.

————————

The Karfunkel brothers’ nonprofit foundations reflect their unusual tolerance for risk.

George and Michael Karfunkel’s first attempt at making their way on Wall Street is illustrative. The brothers were employees at a mutual fund boiler room called Economic Planning Corp.; their bid to diversify the firm by having it engage in the capital markets ended with them at the center of a wide-ranging pump and dump scam that collapsed in 1971. Never disclosed in their AmTrust filings, the Securities and Exchange Commission injunction and suspensions they received hardly set them back.

In response to a question about the lack of disclosure surrounding their SEC sanctions, the Karfunkels’ spokesman, Kekst and Co.’s Robert Siegfried, said the brothers have nothing to disclose, having sought and obtained a dissolution of the SEC injunction in January 2000. (The Karfunkels’ spokesman declined to provide the Southern Investigative Reporting Foundation the motions arguing for dismissal, stating that they are a matter of public record. A search of PACER the online legal database, however, did not yield any results.)

Their next venture, American Stock Transfer & Trust, a share registry that tracked changes in holders of record in the stock and options of publicly traded corporations, was a spectacular success and was sold to an Australian company for $1 billion in May 2008.

While managing American Stock Transfer, the brothers began cobbling together seemingly disparate insurance units in 1998, calling the collection AmTrust Financial Services. The company listed shares in 2006 with Barry Zyskind, Michael Karfunkel’s son-in-law, installed as chief executive.

Unlike other medium-sized commercial insurers like W.R. Berkeley who focus on standard retail and commercial policy business, AmTrust is a publicly traded portfolio of insurance risks, like Italian medical malpractice, manufacturer warranties and California workers’ compensation.

From enough distance, there’s wisdom aplenty in seeking out niche markets as less competition in insurance can offer high returns, but those profits come with ample risk.

There is an established pattern of insurance companies that grow quickly misjudging the breadth of risk in their portfolio and facing cruel reckonings when claims begin to mount and reserves prove inadequate.

AmTrust, however, has had no reckoning despite a mounting chorus of critics who have voiced their concerns over the quality of its disclosures and accounting. The company’s response to the skeptics was bolstered by the company’s strong recent earnings report.

The Hod and Chesed foundations employ risk in a fashion rarely seen in other private foundations. This is an interesting orientation for a foundation given that the IRS, the federal regulator for private foundations, has a blunt view of the role of risk in managing foundation’s operations and assets — namely, to avoid it.

But in case a foundation executive didn’t get the message, the IRS released guidelines designed to prevent “a lack of reasonable business care and prudence” in the foundation’s management.

Called “Jeopardizing Investments,” the IRS document promises additional scrutiny of a foundation if it starts to do things like use options, employ leverage or started making swing-for-the-fences trades, where the risk/reward ration was clearly skewed towards risk.

The Hod and Chesed filings reveal that the IRS memorandum didn’t make much of an impression on the Karfunkels because much of what the IRS warned about is how their foundations have regularly done business.

For instance, they used their foundations to make aggressive, directional market bets on controversial stocks. To that end, consider Michael Karfunkel’s waltz with Fannie Mae put options in mid-2008.

According to Hod Foundation filings from June 2008 to 2009, Michael Karfunkel began selling put options on Fannie Mae stock, a strategy that limited his profit to the option premium (or price) on the put options he sold.

But in mid-2008, Fannie Mae, the Grand Central Terminal of mortgage risk, was the proverbial house on fire, a once high-flying company en route to a collapse into conservatorship.

The high-stakes wager on Fannie Mae’s survival cost the foundation a total of $10.5 million. The rationale for the trade aside, it is a fine example of the skewed risk/reward ratio the IRS warned about — Hod’s profits were capped at $2.6 million.

Chesed also paid dearly for George Karfunkel’s adventures with Citigroup options trading in 2008, when he sold nearly 500 put option contracts, making him effectively long the stock as the bank began to totter toward its mid-September bailout. Like his brothers bet on Fannie Mae, he was effectively betting that an institution laden with dubious mortgage-related securities would emerge essentially unscathed from the then raging crisis.

It was a spectacularly bad bet, with the trade costing Chesed more than $820,000 and potential profits capped at about $105,000. Similar bets on AIG (a loss of nearly $500,000) and Lehman Brothers (a loss of almost $250,000) also proved costly.

Another remarkable aspect of these trades is their timing, with the Lehman Brothers and AIG option positions being opened on Friday, Sept.12, with both once iconic companies promptly collapsing that weekend. The historical price action for both Lehman and AIG in the weeks leading up to that Friday is testament to the depth of investor panic. Shorting the puts of these companies wasn’t so much speculation as an attempt to catch a falling knife.

Contrary to the Karfunkel’s assertions below, losses from their option trading adventures — in combination with the collapse in the equity markets — had a disastrous effect on the fair market value of the foundations’ portfolios, with declines of 64 percent for Hod and 43 percent for Chesed.

Through their spokesman, the Karfunkels responded that the use of options — common among veteran market participants such as themselves — did not lead to a material decline in the size of the foundation portfolios, especially given the intensity of the 2008-2009 market collapse. A chart of both foundations that they provided the Southern Investigative Reporting Foundation portrayed their book value growth as favorable to a peer group of similarly sized family foundations. View the full Karfunkel reply.

The more one digs into how Hod and Chesed conduct their affairs, the idea of the foundations as complex economic vehicles begins to emerge.

Both foundations use money borrowed from a bank or broker — through what is known in finance as a margin account — to (presumably) amplify investment returns. The 2011 Chesed filing lists a $9.8 million margin account; Hod’s 2013 margin account filing shows just under $1.35 million of margin owed.

Moreover, both foundations regularly extend loans, like Hod’s unnamed $2.5 million receivable from 2013. This is a potential red flag: According to regulations, foundations are allowed to receive zero interest loans, but they are prohibited from making loans or extending credit, especially to what the IRS refers to as “disqualified persons“(meaning the founder, a spouse and immediate family members, as well as substantial donors to the fund).

These issues come to the fore when the relationships between Hod and Chesed and a complex entity called the Michael Karfunkel 2005 Grantor Annuity Trust are explored. Known in financial planning circles as GRATs, these structures are a popular way for the ultra-wealthy to pass down part of their estate tax-free.

GRATs allow a grantor like Michael Karfunkel to transfer assets into a trust for a specified period; in return the trust pays the grantor an annuity over a set period of time. At the end of the term, what assets remain can be distributed tax-free among beneficiaries. Distilled to its essence, a GRAT is a bet that the assets in the trust will increase in value. (A Bloomberg News article argues that for the grantor, the bet often pays off spectacularly.)

Filings disclose that Hod was owed money by the Michael Karfunkel 2005 Grantor Annuity Trust $375,055 in 2010 and 2011, and Chesed started disclosing a receivable in 2010 with a $199,219 loan. After 2011, Hod’s filings no longer mention a receivable to the GRAT but Chesed does.

With the beneficiaries of the trust disclosed as Michael Karfunkel’s wife Leah and their children, including his daughter Esther (the wife of AmTrust CEO Barry Zyskind), the concept of the GRAT owing money is troubling, given the self-dealing prohibitions described above.

More than just being at the center of a series of eyebrow-raising transactions, however, the Michael Karfunkel 2005 GRAT is also the owner of ACP Re Holdings Ltd., a Bermuda-based reinsurer that is attempting to purchase troubled insurer Tower Group International Ltd.

One of the fundamental questions the Southern Investigative Reporting Foundation had about Michael Karfunkel’s GRAT was about a July 22, 2013, SEC filing disclosing that he had “gifted” 320,000 (worth over $10 million at the then share price) AmTrust shares to the GRAT. Two things are noteworthy about the filing: The first is that it was made four months late, with the transaction occurring on March 25. The second is that making a contribution of additional shares to a GRAT is flat-out forbidden.

In reply to Southern Investigative Reporting Foundation’s questions, the Karfunkels said that no loans were extended to or from the GRAT, but rather the receivable balance was due to the transfer agent getting behind on book entries which led to the GRAT receiving dividends otherwise owed to Hod, a problem soon discovered and corrected.

The issue of the additional contribution to the GRAT was, according to the spokesman, part of the transfer agent lag time issue referenced above. (View their full response.)

The Karfunkels’ response is, quite frankly, odd. Start with the fact that IRS and SEC filings have no record of, or reference to, any stock transfer whatsoever between Hod and the GRAT. (An elaboration on these points from the Karfunkels’ spokesman is linked at the bottom.)

Reconciling the balance of their reply with the documentary record didn’t get any easier.

For example, the GRAT, by definition, is prohibited from distributing assets — like their purported 2008 gift of AmTrust shares to Hod — to anyone (including beneficiaries) until the annuity with Michael Karfunkel, the grantor, is executed. Whatever the attributes or drawbacks to the GRAT as a financial instrument, it is designed as a simple contract: There is an annuitant (Karfunkel), the beneficiaries (his family) and the rest is math. Based on interviews with Wall Street operations department veterans, it appears unusual that a transfer agent would be unable to discern who the grantor was.

Nor would a “donation” from a GRAT — imagining that it was even legally feasible — be a rational exercise: If a donor wanted to make a donation to a charity, why would they take assets from the tax-advantaged GRAT structure and defeat the purpose of passing on tax-free gains to beneficiaries?

For an independent view, SIRF called Richard B. Covey, the 85-year-old Carter Ledyard & Milburn LLP partner who developed the GRAT in 1990 and without using their name, described the Karfunkel GRAT transactions, as laid out in the SEC and IRS filings transactions.

Contacted at his Spring Lake, New Jersey, home in early August, Covey was blunt in his response to the scenario posed by the Southern Investigative Reporting Foundation.

“That’s an absurd question. No one rational would seek to add assets after the annuity is struck, it would violate the agreement under most every understanding of [a GRAT],” said Covey. “They would be better off just [opening] a second GRAT.”

When asked to elaborate on this, Covey said the construct of a GRAT is cut and dry: Its fundamental component is the annuity, which, at bottom, is a contract that takes an asset and pays out a specified amount at some agreed upon date in the future.

Adding assets after the contract is struck changes the contract’s entire equation, Covey said. Nor, for the record, did he understand why a GRAT could make a donation.

Covey, when asked if there was some long-buried exception to these GRAT rules, said that without resorting to broad brush condemnations, he still wouldn’t want to be a lawyer pressing the argument in front of a [hypothetical] judge but perhaps, “there is a one in one thousand scenario where they could [convince a judge an exception was warranted].”

————————

The Karfunkel brothers’ foundations grew to their current size after an earlier family charitable vehicle, the Karfunkel Family Foundation, distributed most of its assets to Hod and Chesed between 2000 and 2003 — almost $45 million, or 87 percent of its then $51 million was given to the foundations — and their asset base continued to grow sharply afterwards from large grants of AmTrust and other stocks.

That’s all standard enough. What’s really interesting is buried toward the back of the filings where the donations are disclosed, where some arithmetic reveals that the large blocks of stock donated were valued at prices sharply higher than the market price on the day of the grant.

There’s only one beneficiary from inflating an asset value and it’s the donor, who gets a receipt allowing them to claim an out sized — and inappropriate — deduction. For its part, a foundation is saddled with an overpriced asset that locks in a loss if they sell in the near term and which exaggerates their asset base.

The donation of overvalued shares was not a one-time event for the Karfunkel brothers, but was done at least six times between 2005 and 2012.

The Southern Investigative Reporting Foundation estimated that of the nearly $110 million in shares Chesed received from George Karfunkel, almost $31 million of this came from valuations above the then market prices.

For his part, Michael Karfunkel’s donation on Dec. 31, 2009, of Fannie Mae, Maiden Holdings and AmTrust stock that he valued at $60,974,615 to Hod appear to have been $8.65 million overvalued.

To prevent something like this from happening, the IRS introduced an accounting concept, fair market value, to be used when recording gifts of publicly listed securities. Whether its Berkshire Hathaway or a mercurial biotech startup, all stock gifts are put on the books at the average of the high and low trades on the day the donation is made.

So how could rich, sophisticated donors like the Karfunkels stumble over this methodology?

The Southern Investigative Reporting Foundation asked Ronnie McLure, a Dallas accountant and university professor whose practice has frequently provided accounting services to private foundations, if there is room for interpretation in the statutes.

“There isn’t really a way around using fair market value for public securities,” McLure said. “The federal regulations make that one easy and with liquid stocks the accountant can’t avoid it.”

Regardless, the Karfunkels seem to prefer a more freewheeling approach.

Consider the Nov. 1, 2005, donation of 187,500 shares of MRU Holdings to Chesed. Valued at $806,250 in the annual filing, this implies a price of $4.30 a share. The closing price on that date, however, was $1.03, making Chesed’s valuation — and George Karfunkel’s deduction — over $613,000 greater than if he had donated it at market price.

Other instances emerged.

On July 1, 2009, George Karfunkel gave Chesed 1 million shares of Plano, Texas-based energy concern Cubic Energy and 6.15 million shares of AmTrust, worth, the filing asserted, $78.33 million. Chesed’s claimed value was well above the market value of the securities. According to Yahoo! Finance, the average of the high and low prices for Cubic and AmTrust on July 1, 2009, were, respectively, $1.07 and $11.55 versus Chesed’s implied values of $4.50 and $12 per share.

(The Southern Investigative Reporting Foundation used Yahoo! Finance for historical prices and relied on the unadjusted stock price to reflect the price of the security on that date so that subsequent dividends and stock splits would not distort comparisons.)

Using the average of the high and low stock prices on Jul. 1, 2009, the gift should have been worth $72.1 million.

On July 1, 2010, Chesed received 380,853 shares of Citigroup from Karfunkel that it claimed were worth $17.98 million, or $47.21 per share.

Citigroup’s average share price on the date the donation was recorded was $3.74, making the value of the entire block of stock just over $1.42 million, a difference of $16.55 million.

And it gets weirder.

Recall that Chesed’s tax year is from July 1 to June 30 (the 2010 Form 990 has a filing date of June 30, 2011), so when Citigroup announced a 1-10 reverse split on May 9, 2011, the share prices were readjusted upwards by a factor of 10. What Chesed did is claim a value for the July 1, 2010, donation that was not in effect until more than 10 months later.

Incredibly, even after the reverse split, Chesed’s implied value of $47.21 (or $4.72) was still above the $3.74 average July 1, 2010 price.

In 2012, George Karfunkel made another two grants to Chesed: 200,000 shares of Organovo on Nov. 13 and 1.8 million shares of BioTime on July 1. Valued at $12.67 million, or $9.35 and $6 a share, respectively, the claimed values were again higher than Organovo’s then-average market prices of $2.34 and BioTime’s $4.38. (The market was closed July 1, 2012, so the Southern Investigative Reporting Foundation used prices from June 29, 2012.)

The fair value of the gift comes in just under $3.72 million — $8.95 million less than what Chesed stated.

Company Symbol Shares Granted Value of Grant Implied Px. FMV Difference MRU Holdings 187,500 $806,250 $4.30 $1.03 $613,125 Cubic Energy CBNR 1,000,000 $4,500,000 $4.50 $1.07 $3,435,000 AmTrust AFSI 6,150,000 $73,835,500 $12.01 $11.55 $2,803,000 Citigroup C 380,853 $17,980,070 $47.21 $3.74 $16,557,584 BioTime BTX 200,000 $1,870,000 $9.35 $4.48 $975,000 Organovo ONVO 1,800,000 $10,800,000 $6.00 $2.34 $6,588,000 $109,791,820 $30,971,709

How did a pair of billionaires end up donating more than $170 million dollars of stock at prices that were not fully reflective of the then market conditions? The answer isn’t clear but the Karfunkels, as the sole signatories and directors of their foundations, sure can’t claim ignorance.

In response to Southern Investigative Reporting Foundation questions, the Karfunkels replied that the issue was a time lag between the date of the donation and the foundation’s receipt of the shares. See their full response. With regard to the grant of Citigroup shares discussed above, the issue was apparently more complex:

“The lag time between date of the grant by George Karfunkel and date of receipt of the shares by Chesed spanned approximately 2 years,” according to Siegfried, the spokesman from Kekst & Co. “The reason for the long lag time was that the certificates for Citicorp shares donated by George Karfunkel bore a legend and could not be transferred physically at the time he made the donation.”

Like the reply to the Southern Investigative Reporting Foundation’s GRAT questions above, the Karfunkels’ answer frames an unusual scenario that is difficult to square with current market practices.

The concept of the physical delivery or transfer of shares between a buyer and seller — or a donor and foundation — is something that over the past 25 years has become increasingly rare in the U.S. capital markets. To be fair, there are hobbyists who collect stock certificates, and, rarer still, investors who insist on having their shares in physical form to prevent them from being lent out to short sellers, but beyond that, share transfers in the U.S. capital markets are entirely digital.

It bears recalling that the Karfunkel brothers founded and ran a successful, technologically advanced stock transfer operation and would, as a matter of daily business, understand fully what is necessary to transfer stock to another entity. As such, the central role repeated transfer agency mistakes play in their explanation for both the GRAT above and the valuation question is notable.

The concept of a legend posing a significant hurdle for the transfer of the shares is also difficult to wrap one’s arms around.

A legend is a restriction on the sale or transfer of stock, usually because the shares were purchased during a private placement of shares (a sale of stock to higher-net worth investors or institutions) that requires an agreed-upon holding period, or, alternately, legends are often attached to shares issued as payment in a transaction. To remove a legend requires two things that George Karfunkel had ample access to: a legal opinion stating that the conditions of the restriction had been fulfilled and a transfer agent to process the removal.

Poking around SEC filings, however, brought the explanation. In August 2000, Michael and George Karfunkel sold a unit of American Stock Transfer & Trust then called AST StockPlan Inc. to Citigroup for an undisclosed sum. An SEC filing (a registration statement called an S-3) notes that as of Dec. 20, 2001, each brother held 380,853 shares of the bank. A previous registration referenced a filing the Karfunkel brothers made on Sept. 26, 2000, and which was approved by the SEC on Oct. 5, 2000, granting registration (and transferability) for the majority of their Citigroup holdings.

Additionally, there is the quality of the foundations’ disclosures.

If, as the Karfunkels warrant, there was a substantial difference between the date of every stock donation the brothers made to Hod and Chesed and the receipt of the shares, then the IRS filings should reflect that the date the foundation received those shares is the formal date of donation. The IRS rules on the issue leave little to the imagination.

In late July, the Southern Investigative Reporting Foundation attempted to contact Henry Reinhold, the Brooklyn accountant who is paid around $40,000 annually to prepare the Karfunkel foundation annual filings (he also prepares the filings for Barry Zyskind’s Teferes foundation) and served as an officer of American Stock Transfer & Trust and an AmTrust subsidiary. Samuel Reinhold, Henry’s son, declined comment on his behalf.

————————

Per Alexander Pope, if mighty contests really do rise from trivial things, then the Karfunkels may someday wish they had given a different answer to question 3a on page 5, part VIIB in the Hod and Chesed foundations’ annual filings.

The question, “Did the foundation hold more than a 2 percent direct or indirect interest in any business enterprise at any time during the year?” was checked off in the negative but each foundation’s filings say otherwise.

The Karfunkel brother’s foundations are chock-full of AmTrust shares; Hod and Chesed, respectively, hold 9.6 percent and 10.5 percent of the shares outstanding.

In case there is any doubt, according to the most recent proxy agreement, the Karfunkel family controls 59 percent, or 44.4 million of AmTrust’s 75.3 million shares outstanding. The Hod Foundation controls just over 7.2 million of these shares and Chesed has 7.9 million.

Keeping their economic good fortune closely wrapped in a series of family trusts and foundations was an understandable strategy by the Karfunkel brothers. AmTrust is literally a family business — apart from Barry Zyskind, several of Michael’s and George’s children hold important positions in its subsidiaries — and their massive stake in the company makes it immune to takeover or raids from activist investors. Moreover, Wall Street’s analysts and money managers often find attractive a company whose founders have maintained a large equity stake once they have publicly listed the stock.

So it is an irony of cosmic proportions that their moves to insure the effective Karfunkel family control of AmTrust may well lead to that iron grip being forcibly shattered.

The problem, in a nutshell, isn’t so much that the annual filings don’t reflect the truth so much as it is that the U.S. government has some unmistakable rules in place to prevent private foundations from holding that much stock in an enterprise.

A quick history lesson: In the 1960s, officials from the Department of the Treasury began to cast a skeptical eye on the use of private foundations to warehouse large corporate ownership positions company on the view that it was a distortion of both free market and nonprofit principles. The rule that emerged to combat this is Internal Revenue Code Section 4943, and it is primarily concerned with the idea of excess business holdings, or the amount of stock a private foundation can own when so-called disqualified persons (the founder, directors, their family members and key donors) have significant holdings too. (View a primer on key aspects of the rule.)

Traditionally the IRS mandates a bit of arithmetic to get to the foundations “permitted holdings” figure — the formula being 20 percent of the shares outstanding less the percentage of stock held by disqualified persons. In this case the Karfunkel family and its controlled entities own about 59 percent, making the point moot.

Under a provision of Section 4943 there is a second approach, known as the “de minimus rule,” with each foundation permitted to hold 2 percent of the shares outstanding, meaning that Hod and Chesed could hold slightly more than 1.5 million each.

It is difficult to interpret the IRS rules as meaning anything other than a lot of AmTrust stock needs to be sold or donated away — about 6.4 million shares for Chesed and 5.7 million shares for Hod, nearly 16 percent of the shares outstanding.

There is a catch, and as catches go, it is a significant one: The AmTrust stock that Hod and Chesed need to sell cannot be sold to those same disqualified persons, meaning that neither of the brothers (nor their families) can bid for any shares that the other’s foundation is forced to sell. (A second option is for the shares to be donated to an unaffiliated public charity, like the Red Cross, who would almost certainly begin selling the shares upon delivery.)

That’s news no AmTrust investor, even with the stock price on a tear, likely wants to hear.

For the Karfunkels and, seemingly, AmTrust investors, this headache has been a long time brewing.

Hod and Chesed began to build up their massive position in AmTrust stock at the end of 2007 when an otherwise unmemorable SEC filing disclosed a transfer of AmTrust shares on Dec. 31, 2007 from New Gulf Holdings, a holding company the brothers jointly owned, to Hod and Chesed. An additional transfer took place on Aug. 1, 2008. When the dust settled, the foundations owned more than 5.6 percent of the then nearly 60 million shares outstanding and had crossed the 2 percent de minimus threshold the IRS had laid down.

2007 2008 2009 2010 2011 2012 2013 2014 Hod 669,643 1,819,643 5,812,500 5,812,500 5,964,277 5,964,277 6,560,704 7,216,773 Chesed 401,786 1,551,786 5,544,643 5,544,643 6,551,786 6,551,786 7,206,964 7,927,660 Shares Outstanding 59,959,000 59,989,839 59,330,836 59,349,202 59,638,526 60,210,356 67,326,549 75,320,865 % Shares Hod 1.1% 3.0% 9.8% 9.8% 10.0% 9.9% 9.7% 9.6% Chesed 0.7% 2.6% 9.3% 9.3% 11.0% 10.9% 10.7% 10.5%

An outside observer, aware of the Karfunkels’ business successes, can be forgiven for struggling to understand how basic guardrails of nonprofit law like the IRS’ permitted holdings rule were blown through.

The brothers certainly had enough time to comply, since the IRS gives foundations a five-year window to dispose of gifted shares. So in Chesed’s case, after receiving 6.15 million AmTrust shares from George Karfunkel on July 1, 2009, the foundation had until this Jul. 1 to whittle down the stake to the requisite 2 percent of the shares outstanding. Hod, having received its AmTrust stock from Michael Karfunkel on Dec. 31, 2009, has until Dec. 31 to meet the requirements.

Being tax law, of course, no rule would be complete without footnotes and buried exceptions, and Internal Revenue Code Section 4943 is no different, providing foundations an additional five-year window to sell down excess business holdings but even this has a proviso to be hurdled: The foundations can only qualify if they demonstrate that “diligent efforts to dispose of such holdings have been made within the initial 5-year period.” This is going to be a tough sell since the past five years saw the brothers actively adding AmTrust shares into their foundations.

To put some teeth into the rules, the IRS taxes those foundations not in compliance 10 percent on the excess holdings of shares; lest that message not be received, the IRS levies an additional 200 percent tax penalty for any excess holdings not disposed of by the end of the foundation’s tax year.

In this case, that’s June 30, 2015, and the size of a prospective fine, even with a back of the envelope calculation, rapidly crosses into $100 million territory if the IRS isn’t satisfied.

In a reply to SIRFs request for comment regarding the foundation’s AmTrust holdings, the Karfunkel’s spokesman wrote, “The Karfunkels are highly-sophisticated successful investors. They are the founders of AmTrust, its largest shareholders and extremely confident about the Company’s long-term potential. They are confident as well in the profile of their respective Foundations’ investment portfolios.”

————————

The Southern Investigative Reporting Foundation approached the Karfunkels through their spokesman Robert Siegfried of Kekst on July 25 and, because of the brothers’ religious observances, subsequent vacation travel and related business obligations, was unable to begin a formal dialogue with a representative of theirs until an Aug. 5 phone call.

On that call and through a series of emails, the Southern Investigative Reporting Foundation provided the Karfunkels’ spokesman a set of questions, as well as source documents central to its investigation and any necessary context surrounding the questions. On Aug. 13 the Karfunkels replied. Seeking additional clarification, the Southern Investigative Reporting Foundation asked follow-up questions. View the Karfunkels’ response to those questions.

With respect to the amount of AmTrust stock held in Hod and Chesed, seemingly in the face of IRS regulations, the Southern Investigative Reporting Foundation found the Karfunkels’ response puzzling and asked their spokesmen in an Aug. 15 follow-up email if they stood by their statement. They did, with the added remark that they did not know what “IRS rules and regulations” the Southern Investigative Reporting Foundation was referencing. See their full reply.

Editor’s note: The Southern Investigative Reporting Foundation, in phone calls and email (including an hour-plus conversation with the Karfunkels’ longtime attorney) repeatedly mentioned “excess business holdings” and the foundations’ holdings of AmTrust stock as lines of inquiry.

Read a disclosure about the Southern Investigative Reporting Foundation and a donor during the preparation of this story.