Strong Measures Are Needed to Prevent Nonprofit Abuses

Leaders of the nonprofit world frequently proclaim that they want to clean up the scandals that have been rippling through foundations and charities with alarming regularity. But it is hard to believe that many of them are sincere about the desire to change, at least if the draft of a new report to Congress is any indication.

Last month, Independent Sector, a coalition of charities and foundations, issued the preliminary version of a report it plans to submit to the Senate Finance Committee by the end of June (The Chronicle, May 26). The draft was based on submissions by five committees, composed primarily of nonprofit executives, that are focusing on specific topics, such as financial accountability and governance. Over the next several weeks, another committee, this one made up of 24 representatives of the nation’s largest foundations and charities, will be weighing the draft and deciding what it wants its final message to lawmakers to be.

The draft report is not a blueprint for senators who want to prevent wrongdoing by nonprofit organizations, donors, and board members. Instead, it amounts to little more than a plea to lawmakers to leave nonprofit groups alone. It is a baseless plea for self-reform. The report emphasizes what nonprofit groups can do voluntarily to improve their management and governance — steps that are unlikely to make a difference.

The final report should make clear that Congress needs to impose tough new measures that would assure public accountability. Otherwise, the same excesses and abuses will continue.

The draft report is particularly weak in its suggestions for improving the management and spending patterns of foundations. For example, the report does not suggest prohibiting foundation trustees from getting undue financial benefits, and does not seek to prohibit foundations from paying for luxury travel for their donors, trustees, and staff members and spending money in other inappropriate ways.

While Internal Revenue Service regulations prohibit “self dealing” by foundation trustees and other insiders, the report notes, they permit those very same people to receive compensation for personal services to the foundations that are deemed “reasonable and necessary to carrying out the exempt purpose of the foundation if the compensation is not excessive.”

What the report does not say is that that loophole has enabled many foundation trustees to receive not only fees for board service but enormous payments for other services, such as offering investment and legal advice to the foundations they oversee.

The report should have urged Congress to eliminate the loophole. It did not even try to spell out what expenses might be considered “reasonable and necessary.” Instead, the draft report urges Congress to leave that determination up to each foundation. Wow, what an effective deterrent.

Many foundations pay their trustees fees for board service, and a large number pay them significant sums, sometimes as much as $100,000 per person annually. Those fees do not fit the definition of reasonable and necessary expense, since most foundation trustees are affluent people. The spending on foundation trustees probably totals several hundred million dollars a year, money that would be far better spent on charitable programs.

Making matters even worse, the report urges Congress to allow foundations to include fees to trustees when they calculate whether they have met the legal requirement to distribute at least 5 percent of their assets to charities annually. In effect, that would lower the amount of grants that foundations would have to provide each year — further siphoning money for charities into the pockets of wealthy foundation trustees.

The final report should recommend a cap on the amount a single foundation could spend on its trustees for any services they provide to the foundation — say $8,000 to $10,000 a year. That would eliminate almost all of the abuses while permitting foundations to reimburse less-affluent trustees for the time they put into foundation work.

While the lack of attention to self-dealing by foundation trustees is especially egregious, it is also discouraging that the report does nothing to deter self-dealing by board members of charities. Instead, the report says “nonprofit organizations must make every reasonable effort to ensure that at least half of its board members are independent and free from inherent conflicts of interest.”

The historic strength of nonprofit groups has come from the fact that, in all but a few cases, all board members are volunteers — people who receive not a penny for their contributions of time and energy. Making it easier to pay members of charity boards for their services is not a step in the right direction.

The draft report is lax not just in matters of self-dealing, but also in discussing travel expenses by charities and foundations, the subject of numerous exposés by the news media.

The report merely suggests that all charitable organizations establish their own reasonable travel standards, which, in general, should not authorize “premium travel,” whatever that means. It does not call for new regulations that would prohibit first-class travel for both board members and employees of nonprofit groups. To be sure, some exceptions should be allowed — a board member with a severe disability might need to fly first class. But stringent rules on travel costs are the only way to stop foundations and charities from spending excessively on travel.

It is the lack of tough regulations and limits on improper behavior that have caused the scandals in the nonprofit world. Without strict limits on compensation and travel, the scandals will continue. Many foundation trustees and executives continue to abuse the system. They do not appear to have learned their lesson and they will not until they are faced with restraints they can’t circumvent and penalties they can’t avoid.

Regulations are also needed to ensure that charities take seriously the duty to report to the public on their spending practices and their accomplishments. The draft report includes numerous recommendations on additional information that charities could provide to become more transparent, but the report in most cases says those steps should be voluntary. Instead, all nonprofit groups should be required by law to provide additional information that would help the public evaluate whether the organizations are spending money wisely and making a difference.

Accountability isn’t all about managing perks to nonprofit executives or increasing the amount of data reported to the public. Real accountability means serving society and paying it back for the hefty tax subsidies donors and organizations receive from the government.

For that reason, the Independent Sector committee report should be urging Congress to require foundations to increase the amount of money they are required to give to charities each year. The committees involved in drafting the report were told from the start not to consider that issue, something that is not surprising given that 14 of the 24 people responsible for preparing the final report represent grant makers and other institutions that give away money.

But at least the report does recommend that community foundations and other charities with donor-advised funds be required to distribute at least 5 percent of the total amount of those funds’ assets every year.

That is a good approach for avoiding the hassles that would be involved in requiring a lot of small funds to distribute a minimum amount each year. Nevertheless, the final version of the report should recommend that each donor-advised fund of at least a certain size — say $1-million — be required to distribute its assets every year.

Strangely absent from the report is the issue of enforcement of nonprofit laws and regulations. While nonprofit leaders disagree strenuously about whether new laws and regulations are needed, almost everyone seems to believe that more effective enforcement of nonprofit statutes is the key to improved public accountability.

But better policing and enforcement will require much more money for the Internal Revenue Service and the state attorneys general, organizations that currently don’t have the funds to fulfill their oversight functions.

Given Congress’s concerns about federal spending, the Independent Sector committee will need to make a forceful argument on this topic, much stronger than the mild appeals previously made by charity and foundation coalitions.

The final report should demand that the IRSbe required to use the excise tax paid by private foundations to increase oversight of charities and foundations or that Congress must find another source of revenue for that purpose. All the efforts to strengthen the accountability of charities and foundations will amount to nothing if the IRS and state attorneys general are not given the money they need to monitor the nonprofit world and punish the bad guys.

Pablo Eisenberg, a regular contributor to these pages, is senior fellow at the Georgetown University Public Policy Institute. His e-mail address is pseisenberg@erols.com.