Non-profit dilemma

A series of well-publicized corporate scandals and corruption led Congress to pass the most far-reaching corporate accountability and accounting reform legislation in decades — the Sarbanes-Oxley Act of 2002.

Although this law subjects only public companies to its tight new governance requirements, savvy nonprofit organizations are bracing themselves for heightened scrutiny and accountability as similar reforms surface from the Internal Revenue Service and states’ attorneys general.

Sarbanes-Oxley established, in part, new corporate responsibility rules and procedures addressing the conduct of corporate executives, directors and legal counsel. The public policy principles supporting the law clearly also have applicability to nonprofit organizations. In addition, there has been a flurry of federal and state actions against nonprofit corporations and their officers and directors in recent years, particularly in the health care industry. For these reasons, nonprofit organizations may want to seriously consider voluntarily adopting rules similar to those contained in Sarbanes-Oxley to bolster public confidence in their financial integrity and pre-emptively prepare for the enactment of corporate reform and accountability measures aimed at nonprofits.

In their effort to comply with the spirit of Sarbanes-Oxley, nonprofit organizations may want to consider voluntarily implementing policies and procedures addressing the following areas.

* Establish an independent audit committee (composed of at least one financial expert) that is responsible for hiring, compensating and overseeing the work of the organization’s outside auditor

* Provide whistleblower access to the audit committee

* Refrain from purchasing certain prohibited services from an outside auditor

* Adopt requirements that an outside auditor designate a new lead audit partner and a new audit review partner at least every five years

* Adopt a code of ethics for senior financial officials that also applies to principle financial officers, comptrollers, principal accounting officers and others who perform similar functions

* Implement the nonprofit equivalent of financial statement certification whereby the nonprofit organization’s CEO or CFO signs its Form 990 or Form 990-PF (even though the IRS permits any officer to sign these documents)

* Adopt internal control systems similar to those required for public companies and issue an annual statement evaluating the effectiveness of those controls

* Disclose, if applicable, all material transactions and all relationships with unconsolidated entities or other persons that may materially affect the organization’s current or future financial condition, liquidity, capital resources and so forth

* Prohibit personal loans or other extensions of credit to directors or executive officers

Despite the potential cost of implementing these measures, nonprofit organizations may soon have little or no choice regarding compliance with these and other requirements given the current increasing drive for corporate reform and greater accountability.

On a federal level, the IRS recently signaled its concern about the financial integrity of nonprofit organizations by announcing its intent to release of a set of best practices for the governing boards of tax-exempt organizations as part of the Service’s 2004 work plan. The IRS guidance will focus primarily on nonprofit board members’ corporate compliance oversight obligations, as well as their audit and compensation review responsibilities.

In addition, several states have recently signaled that nonprofit organizations will be subject to heightened scrutiny and accountability. Legislation has been drafted in both New York and Massachusetts that imposes Sarbanes-Oxley-type requirements on nonprofit organizations. Some sources indicate that California’s Attorney General is considering similar measures. The proposed legislation from New York and Massachusetts includes requirements relative to independent audit committees, financial certifications, related party transactions and compensation and the protection of whistleblowers.

There is no doubt that nonprofit organizations, like public companies, are and will continue to be under increased public and governmental scrutiny. It also appears only a matter of time before the spirit of Sarbanes-Oxley reform migrates to the nonprofit arena. Sophisticated nonprofit organizations would benefit from a proactive evaluation of their circumstances and voluntary implementation of relevant corporate accountability and governance protections.

Shawn M. Lyden ([email protected]) is a partner at the law firm of Brouse McDowell. Patricia M. Ochmann ([email protected]) is an associate with Brouse McDowell. Reach them at (330) 535-5711.