Internal-Controls System May Prove Costly

By Michael Anft and Grant Williams

As a growing number of nonprofit groups choose to follow the Sarbanes-Oxley Act — the two-year-old landmark

law on corporate accountability — many charity leaders say one aspect would be particularly expensive and difficult to put in place: new checks and balances that protect a group’s assets and create reliable financial reporting.

Among the types of financial controls Sarbanes-Oxley urges companies to institute: tightening procedures to verify that a company’s funds are used for intended purposes, and making sure appropriate systems are in place to generate accurate financial information for board members.

Although many charities have various internal controls in place, Sarbanes-Oxley raises the bar. Some charities worry that lawmakers and regulators who want to adapt the legislation to cover nonprofit groups might force them to put more controls in place.

The Sarbanes-Oxley law requires senior managers of a publicly traded company to certify that they have set up — and continually assess — internal controls in the company’s financial operations. What’s more, a company’s auditor must regularly report on the senior managers’ assessment as a way to ensure that the policies are really being followed.

Many charities say that following these requirements and related provisions would force them to hire additional auditing firms and staff members.

“Our audit committee has decided that these measures would be too costly,” says Vickie L. Tesmer, director of audit and consulting services at the American Heart Association, in Dallas. Ms. Tesmer estimates that the cost of fulfilling internal-control requirements of the law could stretch into seven figures.

Time and Money

At the American Red Cross, officials say they will use Sarbanes-Oxley as a model to strengthen the charity’s internal controls, but it will take time, as well as millions of dollars. In order to pass muster with Sarbanes-Oxley, the Red Cross must first overhaul the financial systems for the charity’s headquarters, its national divisions, and chapters — something that could take three years or more to pull together.

Each chapter has its own board and budget and chooses which accounting software and other tools to use, says Robert P. McDonald, the national office’s chief financial officer. Small chapters (many with annual budgets of less than $100,000) have not historically had the resources to provide frequent financial reports, making national consolidation difficult.

“It could cost us millions of dollars to make sure each of our chapters has the proper control mechanisms,” says Mr. McDonald.

Even so, the charity does see ways to improve accountability throughout its network, and it plans to reorganize its nationwide financial system, Mr. McDonald says. Such a retooling would have its advantages, he says, including helping the national headquarters see more quickly when a chapter is in financial trouble so that it can take action to help.

Internal-Control Audit

The California Endowment, in Woodland Hills — as part of its decision a year ago to voluntarily follow provisions of the Sarbanes-Oxley law — paid for an internal-controls audit. The goal was to see how closely the group’s staff members were abiding by its established policies in such areas as grant making, contract management, and travel and entertainment expenses — “all that boring nitty-gritty stuff that can end up getting you in trouble” if not handled properly, says Robert K. Ross, chief executive of the endowment.

The auditor’s review found no major problems, but it did identify areas for improvement. Based on the findings, for example, the organization is revising the way it documents grant decisions “so that an outside person coming in could better understand what the rationale was for either an approval or a denial of a grant,” says Dr. Ross.

With the auditor’s work complete, Dr. Ross says he plans to hold a series of brown-bag lunches with small groups of staff members to talk about the review and other changes the California Endowment is making in light of the Sarbanes-Oxley law.

“Because we’d had the auditor traipsing through the office, opening up grant files and asking people a lot of questions, we wanted the staff to understand that this was not an attack on them and was not driven by some event or scandal,” he says. “Rather, it was part of a broader effort to strengthen our standards of accountability and governance.”

Says Dr. Ross of the entire process: “I likened it to a root canal. It was damned uncomfortable at times, but in the end was very healthy for us.”