Charitable Muscle
One year after Spitzer began his efforts, the reformers have made precious little headway. Nonprofits, it turns out, are a surprisingly powerful lobbying force. They have persuaded the attorneys general in states where proposals are the most onerous—New York, California and Massachusetts—to back off. Even the calls for voluntary compliance have attracted very few takers.

Regulators can point to a long series of scandals to justify greater oversight. The most commonly cited example is the American Red Cross, which wanted to divert contributions to help victims of the 2001 terrorist attacks to other projects. But there are many other examples of the governance problems nonprofits face. Two years ago, the foundation supporting Florida Atlantic University gave its departing president a $42,000 sports car. This February, when the Saratoga Performing Arts Center tried to cancel its summer ballet program owing to a lack of funds, a local newspaper revealed that the center was paying $100,000 a year for an insurance policy from a company that its chairman operated, along with other sloppy management tactics.

TOP VIEW Bills before 12 state legislatures will create Sarbanes-Oxley-style audit and certification laws for nonprofits. These will apply more stringent corporate governance standards to charities, to keep them from abusing their stakeholders and the public trust.

Unlike the for-profit world, where the coziness between corporations and their auditors led to many of the abuses which prompted the federal Sarbanes-Oxley law, recent failures in the nonprofit sector stem from trustees who are too close to their executive directors, or with one another. “Trustees are not acting like board members,” says Diane Aviv, president and CEO of Independent Sector, an association of nonprofits and foundations. “There’s no structure where they have to evaluate the executive director.” Sometimes executive directors sit as voting members of governing boards, and often they are the ones who find new trustees.

The nonprofit world complains that the state Sarbanes-Oxleys would drain precious resources from philanthropic pursuits in the name of more paperwork. A Minnesota bill would require organizations to rationalize any salary hike of more than 5 percent for the top five paid directors or employees. A Connecticut proposal would force nonprofits to file quarterly records of every outgoing check.

Critics say the bills in New York, California and Massachusetts would force nonprofit CEOs to vouch for the accuracy of financial statements they do not understand. “In for-profit organizations, the CEO is almost always a person with significant financial expertise,” says Deborah Hechinger, the CEO and president of BoardSource, a national organization for nonprofit board members. “The heads of nonprofit organizations are selected because of their knowledge of programs or policy, or their ability to fund raise.”

In the face of such resistance, attorneys general quickly softened their proposals, but they have already lost a lot of good will. Even after Spitzer revised the audit committee trigger to apply only to organizations with at least $1 million in revenue or, as in the case of foundations, $3 million in endowment assets, nonprofit leaders still grumble. (In any case, New York’s Republican-controlled state senate may block passage of the Democratic attorney general’s proposal.) Massachusetts Attorney General Tom Reilly first outlined his plan this past winter, but, given charities’ brusque feedback, he has yet to actually file a bill. In California, a packed public hearing in April prompted a legislative committee to water down its proposal and increase the trigger for an independent audit from $500,000 in annual revenue to $2 million.

Reinventing the Wheedle
“They were trying to kill a fly with a Mack truck,” says Florence Green, executive director of the California Association of Nonprofits. “We desperately want more oversight, but how many times do we have to prove that more laws do not lead to improved management practice?”

Green seems to have a point. California, unlike Massachusetts or New York, currently does not require charities of any size to undergo an audit by a certified accounting firm, and the proposed $2 million trigger would apply to a mere 5 percent of the state’s 90,000 nonprofits. Meanwhile, all California charities and foundations must already file standard IRS 990 tax forms, which are quite revealing. They require that an officer of the organization sign the form, attesting that it is “true, correct and complete.”

The 990s list salaries of an organization’s top officers, fees paid to directors, the names of the top five outside contractors and amounts paid. In other words, they contain most of the information the proposed state Sarbanes-Oxleys seek to unearth. For example, the fiscal 2000 tax form for Hale House Center showed that the scandal-tainted Harlem home for children of drug addicts, with a budget of $5 million a year, had spent three times more on consultants than on food and clothing, $474,000 on postage unrelated to fund-raising and carried a surplus equal to two years of operating expenses. Such mismanagement went undetected for years, until April 2001, when the New York Daily News exposed the charity—a favorite of Donald Trump, Patrick Ewing and Rosie O’Donnell—as a sham.

Brad Maione, a spokesman for Spitzer, refused to discuss Hale House or how the Sarbanes-Oxley proposal would have made detection any quicker. “We’d like to focus on the future,” he wrote in an email to Worth. That future, however, does not include any request for a larger enforcement budget. Spitzer’s office currently reviews randomly selected financial reports from 2,000 nonprofits a year. That means it will take 24 years for his staff to get through all of the state’s nonprofit organizations, by which time there will be many more.

Spitzer hopes that the very act of certifying financial statements, along with using an audit committee, will prompt charities to police themselves. Unfortunately, nonprofits would not have to hire independent auditors; one could also amend its bylaws so that its entire board acted as the audit committee. This sort of equivocation is what angers Sauer, the director of the upstate charity association. He holds that modeling nonprofit law on Sarbanes-Oxley misses the point. Spitzer’s proposal, he maintains, “does not go into situations in which board members are self-dealing and approving contracts where there is a conflict of interest.” He would like to see a law that would increase the minimum size of boards from three to seven members, ban trustee fees and forbid organizations from doing business with companies that their board members run—or, at the very least, add safeguards, such as prohibiting trustees from lobbying colleagues on contracts in which they have an interest.

This debate reflects the concern that governing board members do not know how to do their jobs properly. “There’s no orientation, no training,” says Aviv of Independent Sector. “They get a call: ‘Please help me. I need board members.’ ‘Well, what does it take?’ ‘Just come to two meetings a year, that’s all.’” Aviv believes trustees should receive training, though she would not want to see training mandated.

THREE SIGNS OF GOOD GOVERNANCE • The executive director and other senior managers are not voting members of the governing board, and the board is independent from the management. • The IRS 990 form shows that the organization has been paying reasonable salaries and directing its payouts to relevant charitable activities. • There are no contracts between the organization and companies in which its trustees have an interest.

Like other nonprofit leaders, Aviv would prefer to see charities and foundations adopt the Sarbanes-Oxley provisions voluntarily. However, that is not happening. Neither BoardSource nor Independent Sector could come up with examples of nonprofits that had actually adopted the provisions of Sarbanes-Oxley in the past two years.

Charities already face several incentives to improve their internal controls. Fitch, a credit rating agency, announced in January that it would award higher bond ratings to universities that adopt Sarbanes-Oxley provisions, allowing them to borrow more cheaply. The Better Business Bureau’s charity index, available at www.give.org, judges charities on a number of factors, including their governance policies. A higher score would presumably draw more donations.

Voluntary compliance has its drawbacks, however, as the reluctance of nonprofits to change their policies in the last two years proves. “If you run a soup kitchen and your choice is between having an audit done and giving out five more meals, the way people in the nonprofit world are, you are going to give out the five more meals,” says Dave Edwards, executive director of the San Luis Obispo County (Calif.) Community Foundation.