We are nearing the 20th anniversary of the enactment of Sarbanes-Oxley Act.
The WHAT?
The act, which focuses on financial transparency and corporate accountability, addresses specific questions relating to nonprofits on the Form 990 about conflict of interest, whistle-blower, document retention and compensation setting policies and procedures of 501(c)(3) public charities.
It may be tempting to forge forward with running your nonprofit and leave all this super dry, back-end administration until later… or never. Don’t give into temptation because you will not win this game of chicken! The consequences of ignoring these important policies could result in your organization losing your reputation, your donor base and eventually your 501c3 status.
The following are policies and practices that your nonprofit may want to consider adopting prior to the start of your new fiscal year.
1. Conflict of interest policy
Most nonprofits have a conflict of interest policy that helps to enforce nonprofit directors’ duty of loyalty under state law. The Form 990 asks (a) whether the organization has a written policy, (b) whether officers, directors and key employees are required to disclose annually interests that could give rise to conflicts, and (c) asks the organization to describe how it regularly and consistently monitors and enforces the policy. The essence of most conflict policies is a disclosure procedure, where the director, officer or employee of the organization reports as to whether he or she, or any related individual or entity, has a financial interest in any vendor of goods or services to, or recipient of goods or services from, the organization. If such an interest exists, the interested party does not participate in the decision to purchase or provide the goods or services and might be asked to leave the room during the discussion and decision.
2. Code of ethics/whistle-blower policies
One of the two narrow provisions of Sarbanes-Oxley that applies directly to nonprofits creates penalties for retaliating against whistle-blowers during a federal investigation. The Form 990 asks if the organization has a whistle-blower policy, and this question has spurred nonprofits to adopt a written policy. Some organizations do this by adopting a code of ethical conduct that encourages directors, officers and employees to report unethical or illegal conduct and provides that there will be no retaliation for reporting pursuant to the policy.
3. Document retention
Sarbanes-Oxley prohibits the destruction of documents that may be material to a federal investigation. This provision applies to nonprofit as well as for-profit organizations. The Form 990 asks whether the organization has a document retention policy. Some statutes require certain types of records to be kept for a stated period. For the most part, however, the periods for which documents are to be retained are based on the statute of limitations for a lawsuit. For example, because the Internal Revenue Service (IRS) has six years after the filing of an action to bring a claim for taxes if there has been an underreporting of income by 25 percent or more, most policies require retention of tax returns for seven years. And, of course, the policies state that no documents may be destroyed or altered where there is pending, threatened or reasonably foreseeable governmental investigation.
4. Compensation setting procedure
The Form 990 asks whether the organization is using a procedure for setting compensation in which an independent portion of the board is using comparable data and making a determination based on that data that compensation for officers and key employees is reasonable. It also asks whether the determination that compensation is reasonable is put in writing at the same time. Nonprofit organizations need to pay attention to all elements of compensation, be sure to treat them as compensation and be sure that the total compensation paid does not exceed what is reasonable.
5. Charity care/debt collection
Charity care relates directly to healthcare organizations and the value of services that they provide to the community for free. Many states have begun to look at the value of real estate and sales tax exemptions and some have made a specific level of charity care a requirement for state and local tax exemption. These discussions have prompted many nonprofit organizations that charge fees for services to think about the level of charity care they provide and to begin to document it. Even if the organization is not required to provide a stated level of charity care and does not wish to have a policy of providing a stated level of care, the board should know how it measures against the practices of similar organizations. A discussion at the board level about how collections will be handled is also appropriate.
6. Spending policy
Organizations have a budget, but sometimes unexpected expenses or opportunities come up. This is where you should have a policy about the amount of spending by the Executive Director above budget is authorized before coming to the board for approval. Private foundations are required to spend annually for charitable purposes an amount equal to 5 percent of the value of their net investment assets. Changes in the state laws governing true endowments (funds restricted by the donor to the expenditure of income only), permit flexibility in the definition of income. This leaves the organization’s governing board with choices to make about what the level of spending from the endowment will be. Even if the organization’s funds are not donor restricted, the board needs to balance the current needs of the organization with anticipated future needs and setting a spending policy gives the board an opportunity to consider those competing needs.
7. Investment policy
Every organization with investment assets should have an investment policy. The existence of the policy and procedures provide the board or investment committee the opportunity to address how assets are invested and think about what allocations should serve the organization best.
8. Gift acceptance policy
Even a simple gift acceptance policy can provide guidance for a development officer or board member when a gift prospect offers to gift an interest in a partnership or limited liability company. The policy can be as simple as a statement that gifts other than cash and publicly traded stock are subject to an acceptance procedure considered by the board.
A policy may help the organization avoid offending potential donors. The policy makes it clear that the extra level of review is something that is a general practice and not directed at the specific situation.
9. Restricted gifts
A charitable organization is required to use restricted gifts for the purposes for which they are given. This requires the organization to be thoughtful in its solicitations, and once it has accepted a restricted gift, to be diligent in documenting its use of the gift. An accounting system that classifies restricted investment assets on their receipt and records expenditures attributed to those assets is necessary. Because of the administrative burden, the organization may only want to accept permanently restricted investments assets in excess of a stated level.
10. Joint ventures
The Form 990 asks any charity that has participated in a joint venture with a for profit entity during the year whether it has a written policy governing participation in such ventures. If an organization is entering into an arrangement which could be viewed as a sharing of profits with a for profit entity, it should become familiar with the IRS’s views on joint ventures, and it may wish to adopt a policy about participation in such ventures.
Wading through important requirements and developing policies can be daunting and likely not at the top of your list. Are you a new board chair or in charge of the governance committee? Call me to discuss drafting policies that work for your organization, keep you in compliance and provide the trust and transparency your donors expect and deserve.
