October 16, 2008 | Read Time: 6 minutes
Growing questions about the recent actions and responsibilities of boards of deeply troubled U.S. banks and companies will eventually also be directed at nonprofit organizations and their leaders, an expert on governance matters told the annual meeting of the National Association of State Charity Officials.
A “spillover” to charities from “some of the events going on in Wall Street and Washington” is probable, Michael W. Peregrine, a Chicago lawyer, told state officials in charge of regulating nonprofit organizations.
Boards of tax-exempt organizations “are beginning to brace themselves for the spillover: this climate of responsibility and possibly recrimination,” he said.
Mr. Peregrine noted that nonprofit groups and their trustees have spent recent years successfully adjusting to the 2002 Sarbanes-Oxley Act, which was written by Congress to improve governance and accountability of publicly traded companies and which was embraced by many charities.
“Sophisticated [charity] boards — if they are reading the paper, if they ‘get it’ — are now worried,” said Mr. Peregrine.
“When this all shakes out,” he said, “will there be greater finger-pointing at boards, not just in the for-profit sector but in the not-for-profit sector? I am concerned that [nonprofit] people will sit back and say, Wait a minute, I thought we had fixed all this stuff with the board with Sarbanes-Oxley, and that was only six years ago.”
Mr. Peregrine added: “Will this result in a loss of people serving on charitable boards? It will be something that we have to deal with and we have to worry about as volunteer board members begin to be concerned. It would be a shame if they respond to this [new climate] by saying, I’m not going to go through this again, I’m just going to have to resign from the board.”
Expanded Disclosure
As the focus on governance intensifies, the Internal Revenue Service will be pushing charities to disclose far more information than before to regulators and the public.
Lois G. Lerner, director of the tax agency’s Exempt Organizations Division, said she was grateful for the advice the tax agency got from charities and their lawyers as it worked over many months to redesign its Form 990 informational tax return, the primary tax document that nonprofit organizations file each year. The revamped form, which includes new schedules, will first be used by charities for the 2008 tax year.
“People are wondering what we’re going to do with the new 990 now that we have it,” said Ms. Lerner. “And the answer is: We’re not really sure yet,” she said with a laugh.
“The reality is we’ve asked for a lot of information and we don’t know what we’re going to get,” said Ms. Lerner. “We know what we’ve asked for, but we don’t know what’s going to happen when the forms are actually filed.”
Ms. Lerner said that, when the returns do eventually come in, the IRS will be “looking to see if there are questions that people didn’t answer or they answered in a way that was very different than what we anticipated. We’ll be looking to see if people are actually attaching the schedules that they are supposed to be attaching. And we’ll probably try to have some focus groups — to speak to people who have filled out the form and find out where they found the most trouble, where they thought we could make it better.”
She added: “This is a continuing process. Now that the 990 is out, that doesn’t mean it’s over.”
Ms. Lerner said she often is asked about a governance question the IRS asks charities on both the current and revised Form 990: “Does the organization have a written conflict-of-interest policy?”
“People say to me, If you answer No, does that mean you’ll be audited?” said Ms. Lerner. “The answer is No. That question is there because we want to focus people on governance, we want them to think about governance, but we don’t want to punish them.”
However, Ms. Lerner said, if an organization answered No but also reported that it had made a lot of loans to officers, the IRS could “pair” the two answers and decide “to go and look at that organization and ask questions.”
Internal Controls
During a conference session on internal controls for charities, Jack B. Siegel, a Chicago lawyer and author, said he was pleased that the IRS’s new Form 990 for 2008 has a particular new governance question for charities. (“It’s my favorite question because I suggested it,” he quipped.)
The question reads: “Did the organization become aware during the year of a material diversion of the organization’s assets?”
A group that said Yes would have to describe the diversion — included but not limited to an embezzlement or theft — as well as the amount of money or property involved and the corrective actions that were taken. “What are the benefits of this? Why do I like this?” asked Mr. Siegel. “It gives [charities] a strong incentive to look at their financial controls to avoid getting trapped in a fraud and having to answer Yes. It provides the public with important information. It encourages groups to prosecute” an embezzlement or theft rather than ignore it or settle out of court “because they can’t cover it up and they are going to look stupid if they don’t prosecute.”
Mr. Siegel was asked if this Form 990 question was unfair to charities that are themselves victims of fraud, often beyond their control, and would essentially punish organizations a second time by making them look bad to the public. “The reason I initially gravitated to the new question is: If you view the 990 as a disclosure document for members of the public to make a decision whether they are going to donate to a charity, what could be more relevant than knowing whether the place has rotten internal controls? Why should I give my money to a charity that doesn’t have financial controls in place?”
Mr. Siegel continued, “You can look at it from the charity’s standpoint and say it’s unfair and it hurts them reputationally, but at the same time why, as a donor, shouldn’t I know that?”
“Beyond that is the notion that a board facing this question is going to recognize that a charity has good will. That is a fundamental asset of a charity besides the cash which is stolen. And that when cash is stolen, you are putting the good will on the line and that is an incentive to put in better financial controls.”
Mr. Siegel concluded: “Fraud can happen to anyone, even with the best financial controls in place.” But, he noted, a charity in such a situation would be able to explain, on a new Schedule O devised for the Form 990 for 2008, that “we had all these things done and these were the circumstances. And the public can then make their judgment if it was just one of those things that happens — or whether the controls were lousy.”
