Is California Regulating the Barrel to Eliminate the Spoiled Apple?

Does one rotten apple actually spoil the whole barrel?  According to science, the answer is yes and according to the California legislature, the answer also appears to be yes, at least when it comes to pharmaceutical donations.  Largely in response to the high-profile Giving Children Hope scandal (where a charitable organization, via subsidiaries, purchased $225,000 in pharmaceuticals from a Netherlands wholesaler and then recorded those purchases as a $34.9 million pharmaceutical donation), the California legislature passed Assembly Bill 1181 in September of 2019.  And while the bill was vetoed by California Governor Gavin Newsome in mid-October, the bill passed by overwhelming bipartisan support, setting up a potential veto override later this year.

AB 1181 seeks to require any charitable organization soliciting donations in California to value drug and medical supply donations based upon the fair market value of where the drugs will ultimately be utilized.  Currently, under U.S. GAAP, a non-cash contribution, also known as a gift-in-kind, is required to be recognized at fair value.  The problem, however, is that while many donated pharmaceuticals are utilized for international purposes, most pharmaceuticals are valued based on U.S. fair market value.  It should come as no surprise that drug prices in the U.S. tend to be significantly higher than in the rest of the world, and are especially higher than where most of the drugs and supplies get utilized. 

Proponents of AB 1181 believe that this discrepancy leads to an over-valuation of pharmaceuticals, and allows certain bad actors to “pad” administrative costs, offer higher executive salaries, and mislead the donating public about charitable efficiency.  Proponents of the bill are lauding California for attempting to correct what both the Federal government and many states have long viewed as a loophole in US GAAP, leading to abuse and misrepresentation. 

Opponents, however, argue that valuing donations based on county of distribution becomes an administrative nightmare, which will lead to higher accounting costs, divert funds away from programming, and could require separate records for GAAP and California compliance.  Opponents argue that the rules of AB 1181 are difficult to implement and that additional guidance is needed.  Finally, opponents wonder if the regulation goes too far in trying to correct one-off bad actors by regulating all charities that take contributions from California sources.

While AB 1181 is a California bill, it has the potential to impact any organization soliciting donations, nationwide.  Generally speaking, once a charity obtains donations from California donors, it becomes subject to AB 1181 and will need to comply on all pharmaceutical donations. 

For now, though, charitable organizations have gotten a bit of a reprieve thanks to the Governor’s veto, but should remain vigilant to the extent the bill comes around again.  We will continue to monitor the progress of AB 1181, but in the meantime, if you have any questions or are seeking additional information related to AB 1181, please feel free to contact us at Schneider Downs and we will be more than happy to assist!

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