BOARD ISSUES AND ACCOUNTABILITY
Sarbanes-Oxley and the Consumer Confidence Crisis in Nonprofit Governance

Sarbanes-Oxley, "affectionately" referred to as SOX, was signed into law on July 30, 2002. Its objective was to rebuild public trust in corporate America, with new governance standards that emphasized accountability, disclosure, transparency, and oversight. [As brief background, Paul S. Sarbanes, Maryland's Democratic senior Senator, is the ranking member of the Senate Banking, Housing and Urban Affairs Committee, along with being the senior member of the Foreign Relations, Budget, and Joint Economic committees. After the failure of Enron Corporation in 2001, which—at the time—was the seventh largest corporation in the United States, Sarbanes (in his capacity as Chairman of the Banking, Housing and Urban Affairs Committee), began a series of comprehensive hearings. They resulted in the passage of this bipartisan bill, which was designed to reform the accounting industry and restore the investor confidence that had been eroded following the collapse of Enron. Congressman Michael Oxley, coauthor of the act and a Republican from Ohio, is serving his twelfth term in the House of Representatives and is chairman of the House Committee on Financial Services.

The SOX provisions covered independent and competent audit committees, auditor responsibilities and rotation, certified financial statements, insider transactions and conflicts of interest, whistle-blower protection, and document destruction policies. The Sarbanes-Oxley Act survived its first court test, brought about when a corporate CEO, fired in part under its provisions, challenged SOX as unconstitutionally vague.

Later, the Brookings Institution Report of September 13, 2004, stated that confidence in charities was languishing well below pre-9/11 levels. It also said that confidence in charities stood approximately 10%-15% lower than in the summer of 2001. “…Americans continue to express serious doubts about the performance of charitable organizations in exercising their fiduciary responsibilities. Only 11%…believe that …[nonprofits] “do a very good job spending money wisely. This figure is almost 2/3’s lower than the percentage (31%) who believe that charities do a good job helping people.” Just 15% of Americans express a great deal of confidence in charities, a number barely ahead of confidence in labor, news, big business, HMOs, and Congress. Only 19% state that charities do a very good job running their programs; and only 17% believe that nonprofits are fair in their decisions. “Even Americans who have a great deal of confidence in charitable organizations, and who believe that these organizations do a very good job helping people, have come to wonder about [their] fiduciary and administrative performance, which (in turn) affects discretionary giving and volunteering.” This Brookings Institution Report then called for reform, for nonprofit investment in core operating improvements, and policing of poor performers.

In June and July of 2004, there were Senate hearings on the governance, transparency, and financial integrity of nonprofit organizations. In his opening statement, Senator Chuck Grassley [Republican, from Iowa, and chairman of the Committee on Finance] said: “Today the Finance Committee considers a very serious matter—ensuring that charities keep their trust with the American people. …” The Discussion Draft issued by the Committee, on July 22nd, proposed reforms in the following areas: exempt status, insider and disqualified persons, grants and expenses, federal/state coordination of actions and proceedings, improvements in the Form 990, and public availability of documents. It also encouraged strong governance and best practices. As for the role of the board, it stated that special expertise or skill should be required to serve and that breach while serving should involve federal liability. In addition, it advised that board size, as well as the participation of compensated directors, be limited. As with corporate law, it also addressed board/officer removal.

However before we in the charitable community become too concerned, the majority of the responses to these federal hearings made clear the sentiment that there is no evidence of widespread abuse in the not-for-profit world. Some of the Senate Finance proposals were deemed beneficial; others were thought too burdensome for nonprofits. Especially important was the reaction that the costs of implementation would be prohibitive and would take away from charities’ abilities to pursue their missions/visions. In addition, it was felt that current laws governing nonprofits already cover existing abuses. Moreover, the IRS does not even have enough resources to enforce the current laws. From the charitable community’s point of view, the drawbacks to the Finance Committee Discussion Draft are: higher auditing and insurance costs, increased responsibilities of board members, and the costs of record management—besides the drawbacks stated earlier.

Despite all these, Goodwill Industries established an internal task force in response to the Discussion Draft. As a result, they stated: “proactive establishment of effective fiscal management and a voluntary compliance program makes good business sense. We support strong corporate governance.” Here’s what their task force recommended: financial statements should be issued quarterly to audit committee and board; internal controls should be established for member agencies; annual audit should be established for member agencies (i.e., an independent exam); audit committee should be established for each member agency, with RFP process for selection of auditors every five years; whistle-blower protection policy should be created for member agencies; conflict of interest policy should be implemented for member agencies’ governing officers, employees, and volunteers; document destruction policy should be established; certifications by CEO and CFO of 990 and financials should be implemented.

Senator Grassley’s statement, after his committee’s hearings, was strongly worded: “This …[process] has been very sobering. It’s sad that in a hearing about charities, we have to [learn]…about million-dollar insider contracts; about middlemen who purposely cheat charities to make an extra buck; and about the fact that over half of all new tax shelters used a tax-exempt party. …We particularly need to think about balancing the requirements that might be placed on charities, especially smaller charities, and not overwhelming the ability of charities to achieve their important missions.”

In late summer that year, Senator Grassley issued comments on the IRS’s new enforcement effort to identify and halt abuses by tax-exempt organizations in paying excessive compensation and benefits to their officers as well as other insiders. “Given the weak regulations and guidance that exist today, what’s actually legal when it comes to executive compensation and insider deals is likely to be surprising. The closer we look at charities…the stronger the case gets for meaningful legislative reforms.”

Subsequently, in September 2004, he responded to the aforementioned Brookings Institution study by saying: it’s telling that public confidence in charities hasn’t recovered, and that people don’t always trust charities to spend their money wisely. …Oversight has been poor. No one’s minding the store, and a lot of hands are in the till. Good, targeted reforms, including better transparency will improve the way charities operate and the way people perceive them. Restored public confidence should lead to more donations and continued good works from the nation’s nonprofits.”

When the Treasury Inspector General for Tax Administration released a report on tax shelters in the tax-exempt area, Senator Grassley made comments (in a 2004 Fall press release). And he also listed the closing of loopholes for charities that abuse the tax code as an important priority for the Finance Committee in 2005. [Clearly, the governance of nonprofits is not likely to lose his attention any time soon.]

Meanwhile, there were 20 state corporate governance proposals on the docket in 2004, in 18 states. Five states have passed charity integrity bills, as of October 7, 2004. They include California, Iowa, Massachusetts, Maine, and New Hampshire. The following trends occur in all the state governance proposals: independent audits, audit committees, registration with financial statements, reporting to state entities, conflicts of interest policies for directors and officers, compensation approvals/procedures, certification of financial statements, disclosure and internal controls. [Please see the January ADO Insider, available on our website, for the article covering New York State Attorney General Eliot Spitzer’s efforts regarding corporate governance, as it relates to nonprofits. He described them at our National Philanthropy Day event in November 2004.]