9th Annual Governance of Nonprofit Organizations
State Bar of Texas, August 2011, Austin,Texas
Increased public scrutiny of nonprofit organizations and state and federal regulatory changes in response to illegal and unethical activities require a closer examination of the policies, formal and informal, that should be considered in managing and advising a tax-exempt entity.
A number of federal and state statutory enactments mandate general guidelines of conduct and corporate governance but also leave to the individual organization the formulation of distinct policies. These mandates must be addressed with the adoption and observance of policies, usually board-adopted, to comply.
The Texas Attorney General’s Charitable Trusts Section has broad authority to investigate and oversee compliance with all applicable laws. That agency has publicly stated that one of its “red flag” issues in examining an organization’s conduct is whether it has failed to adopt or follow policies and procedures.
The Internal Revenue Service has embraced certain “good governance” policies and practices as likely indicators of tax law compliance.
General principles of sound organizational management, trends in the nonprofit sector, and “best practices” observed by various constituencies also suggest that other non-mandatory policies, when adopted, can make for a well-run organization and the avoidance of disputes, misconduct, enforcement actions and damaging public controversies.
II. “Required” Policies for NonProfit Organizations
• Sarbanes-Oxley Act Requirements
In response to the Enron scandal in the corporate world, the U.S. Congress enacted the so-called Sarbanes-Oxley Act, which contained two provisions applicable to all corporate entities, including tax-exempt nonprofit corporations:
Whistleblower protection is specified in 15 U.S.C.7201§806 and protects persons who report suspected illegal activities or fraud. An organization may not discharge, demote, suspend, threaten, harass or in any other manner discriminate against an employee in terms and conditions of employment as a result of a report submitted. Organizations must establish procedures for such reporting.
The organization’s board should formally adopt such a policy and designate officials in different levels to receive and act on a complaint or report.
Sources of a sample whistleblower policy and other policies are included in the Appendix.
The second Sarbanes-Oxley mandate concerns document retention and destruction policy and was intended to assure that corporate documents would not be destroyed in the wake of a pending or actual investigation or prosecution, or that their use would not be prevented for official purposes. 15 U.S.C. 7201 §802 provides criminal penalties for any person who knowingly alters, destroys conceals or otherwise mishandles a corporate document that may become the subject of an investigation by any department or agency of the United States government.
While the method of retention or destruction of corporate records and documents should be an ongoing management function, special attention must now be given to document retention and destruction. A board-adopted policy should be developed and is often done in tandem with the organization’s auditors and accountants. These policies are available from a number of sources and should be reviewed by professional accountants or auditors.
Once adopted, the document retention and destruction policy should be strictly observed and its importance communicated to all management and employees. It should be reviewed regularly for compliance.
• Internal Revenue Service Form 990 Requirements
Nonprofit organizations just getting accustomed to the revised I.R.S. Form 990 have taken particular note of Part VI of the form, which contains a number of reporting requirements that suggest several board-approved organizational policies are in place and have been observed by the filer. They include:
- Whether any officer, director, trustee or key employee has a family or business relationship with any other (Part VI, line 2);
- Whether the organization board and committees contemporaneously documented all meetings held or written actions undertaken (line 8);
- Whether the Form 990 was provided to board members before filing (line 10);
- Whether the organization has a written conflict of interest policy and whether it is consistently monitored and enforced (line 12);
- Whether the organization has a written whistleblower policy (line 13);
- Does the organization have a written document retention and destruction policy (line 14);
- Does the organization use the I.R.S.-directed procedure for determining the reasonable compensation of executives and key persons (line 15).
- A “no” answer to any of these questions requires a detailed response on a separate Schedule O. Thus, it is essential that the organization have formal policies in place to address each of these issues. A simple form given to each board member and executive or key employee each year can be used to have all persons involved disclose the information required and provide a record of compliance.
• Texas Nonprofit Corporation Law
Governance of nonprofit corporations in Texas is generally specified in Chapter 22 of the Business Organizations Code.
Among the Chapter 22 statutory directives are a number of issues that suggest and permit amplification of the statute by the entity’s own board-adopted bylaws or formal policies.
A comprehensive conflict of interest policy is a must for any well-managed organization, and
- 22.230, TEX.BUS.ORG.CODE, is a starter outline of such a policy. It describes generally the circumstances in which an interested director, officer or member must identify a potential conflict of interest, disclose the material facts of the interest or relationship, and then participates, or not, in the decision involving the matter in question. Thus, every nonprofit corporation in Texas already has a conflict of interest policy as stated in 22.230, but it is advisable to expand on it in the bylaws or a formal policy.
Section 22.210 provides for ex officio board members and generally defines their role. However, disputes and misunderstandings are rampant because of the vague use of the terms ex officio, or advisory, or honorary board members. Once such a supporting board is seated, it is wise to specify its role in detail with a board-adopted policy or resolution.
Disclosure of records to a nonprofit’s members or to the public is a constant source of misinformation and dispute. Section 22.351 et seq. details record keeping and public disclosure obligations of nonprofit entities in Texas, but all the practical answers are not necessarily specified. The Internal Revenue Code also specifies certain disclosure obligations. Therefore, it is wise to have in place a policy that persons in charge can follow when presented with a request to see the organization’s records.
• Auditing Standards
Managers and board members of nonprofit organizations are constantly surprised by the range of issues raised in a formal audit conducted by a professional in accordance with generally accepted accounting principles.
Annual or periodic audits protect the organization from fraud, confirm its financial status and generate confidence with donors, supporters and stakeholders. A nonprofit experiencing its initial audit will be surprised by the number of operational or risk management policy recommendations that will be generated by the auditors, whether in consultations, as an auditor’s note to the audit document, or in the management letter received with the audit.
The most common issues noted by auditors are faulty internal controls and the inability to segregate duties of employees with respect to financial transactions, or the use of volunteers in handling cash or funds. A common and serious breach is the failure to track the proper use of restricted grant or donor funds. Anticipating these questions by enacting organizational policies in advance can smooth the audit process.
• Other Sources Affecting Nonprofit Policies
Nonprofit organizations vary in complexity, size, scope and mission. Often they must comply with the external policies and procedures of other groups: the central organization with which they are affiliated; a central church hierarchy or denomination; a professional organization that mandates its standards, advocacy groups, a sports league, etc.
Organizations dealing with populations that have special legal protections will be required to observe and adopt special policies: persons with disabilities, the elderly, children, ex-offenders, clients of social services or counseling centers, and private schools, for example.
The nonprofit’s board, managers and counsel must be informed as to their obligations in this regard and enact appropriate policies tailored to their operations.
III. Important or Advisable Policies
• Risk Management-related Policies
A holistic look at any organization should consider its inherent risks and seek to minimize losses, damage or inconvenience to the entity.
Financial management issues, policies and procedures are at the forefront and are the main source of management challenges, misconduct, and controversies affecting charitable and nonprofit organizations. These can involve establishment of recognized internal accounting procedures and controls, financial overview by the board (referenced in §22.352,TEX.BUS. ORG. CODE), fraud prevention, periodic audits and other protections.
A formal risk management review by a professional will immediately identify areas for which a new organizational policy is needed. For growing organizations or those serving special-needs populations, preparing a formal risk evaluation with a consultant is advisable.
Volunteer recruiting and management can be a high-risk activity if not properly established. Ongoing use of volunteers and interns should be governed by a formal policy that specifies the terms of the arrangement and complies with the federal Volunteer Protection Act of 1997, 42 U.S.C. 14501 et seq.and TEX.CIV.PRAC.&REMEDIES CODE CH. 84, which provide certain protections from liability for a volunteer’s activities. Also, federal labor laws should be observed, and the organization’s employees cannot “volunteer” extra hours or overtime hours without pay.
Criminal background checks of volunteers and key managers are an ongoing issue in every community and have been the subject of numerous proposals in the Texas Legislature each session. While some types of organizations are required to obtain and review criminal background reports, many other groups use the reports as a precaution, often without considering all the risk factors. An organizational policy on this issue should include a determination as to the requirement or necessity of obtaining the background checks, proper disclosure to those consenting to the inquiry, strict controls of those reviewing the reports, standards for acting on report information, confidentiality in all matters relating to the reports, and a process for storing or disposing of the reports and documentation of the process.
A media relations policy adopted in advance of a public relations crisis can save an organization’s reputation. News outlets take particular relish in reporting the misconduct of officials of charitable or advocacy organizations. It is wise to have in place an orderly and focused response to an unexpected media inquiry that threatens the reputation of an organization. Primary elements of such a policy include the designation of an initial spokesperson, time for examination of the facts alleged and review by designated organizational representatives, the method of formal response, and follow-up. Thus, in a surprise situation, every board member or executive can defer to the designated plan of response without panic or mis-steps.
• Financial Management Policies
Financial management issues other than those listed above can include the following:
A gift acceptance policy can ensure that the mission of the organization is advanced with appropriate and sustainable gifts and that the good intentions of the donor are recognized. While cash gifts and other liquid assets are easily accepted, it is a mistake for any nonprofit organization to accept certain kinds of gifts without a formal review policy and process. Factors to include in such a policy include: kinds of gifts that must be put through an approval process; who makes the review and determination; whether the policy is public or confidential; use of outside consultants for evaluation and appraisal; review of restrictions and conditions accompanying the gift; and the donor’s motives behind the gift.
Improper redirecting of funds donated or raised for a specific purpose to another purpose is a “red flag” often identified by investigators. The good work of volunteers and supporters should not be compromised by lack of an organizational policy on this issue.
Misuse of the terms endowment, permanent fund, restricted fund and the like is rampant. If not prescribed in the organization’s bylaws, the board policy regarding creation and management of certain kinds of liquid assets must follow legal directives and generally accepted accounting principles.
An investment policy is essential, and in certain cases, required. See the Texas Uniform Management of Institutional Finances Act (“UMIFA”), TEX.PROP. CODE §163.001 et seq. and the Uniform Prudent Investor Act (“UPIA”), TEX.PROP.CODE§117.001 et seq. Section 22.224 TEX.BUS.ORG.CODE permits the board of a nonprofit entity to contract with a financial and investment adviser and rely in good faith and with ordinary care on that adviser’s recommendations.
Fundraising, raffles and gambling events can be a particular peril to the nonprofit not experienced in complying with Texas law and managing public events involving large sums of money. The Attorney General has identified this as one of its “red flag” issues in examining an organization’s conduct. A policy should be in place directing all involved in such an activity to comply with relevant laws and prudent practices, including the Charitable Raffle Enabling Act, TEX. OCC.CODE. CH. 2002 and the Bingo Enabling Act, TEX. OCC.CODE CH.2001. Volunteers or hired event planners should be restrained with respect to costs of an event in relation to the net proceeds to the charitable purpose.
Procurement policies should be in place if significant quantities of goods and services are regularly purchased. Issues addressed in such a policy are purchases from or by interested persons, bidding or price comparison procedures, gratuities or gifts from vendors, tracking use of restricted funds for purchases, personal purchases included as part of the purchase, and documentation of goods and services received. Long-term leases, service agreements and licensing agreements should be at fair market rates.
• Employee-related Policies
An employee handbook should be adopted by the board and maintained by every nonprofit organization that has even one employee. The multitude of issues covered in an employee handbook is beyond this scope of this paper, but the following are timely issues that an organization should address with a formal policy:
Spouse or partner travel expenses and first-class or luxury arrangements associated with the organization’s paid or reimbursed travel for an employee or board member should be strictly regulated and governed by a written policy. This is a particular red flag in an I.R.S. inquiry or audit and a frequent first place for examiners to look for improper financial activity by a tax-exempt organization.
Electronic devices, mobile phones, laptops or portable devices owned by the organization but also used for personal purposes by an employee or board member should be the subject of a formal policy.
Social media portals, blogging and Internet communications channels utilized by employees in their personal lives should not include excessive references to the organization that employs the participant or purport to represent the organization’s policies, except with specific approval.
IV. Tailor Policies to the Individual Organization
Nonprofit organizations differ widely depending on their mission, operations, size, complexity and scope of operations. A one-size-fits-all approach will not properly address all relevant compliance and management issues.
If the organization is the local chapter or branch of a national organization, policies must be in place to conform to that affiliation and be strictly observed.
In identifying possible legal or ethical mis-steps by the organization and whether a formal policy is needed to address the issue, consider the following:
How would this situation look on page one of the local newspaper or on the evening news? Would I give money to a charity that engaged in this activity? Finally, there is always one’s instincts or the “smell test” — if things don’t seem right, they probably aren’t right.
V. Implement and Monitor Policies
The nonprofit organization policies identified above will not serve the organization over time if a simple checklist approach is used. Good governance of a successful, respected and sustainable organization is a way of life, a “corporate culture”, and an everyday practice. It requires a top-to-bottom buy-in of ethical business practices, professional standards, and straightforward personal relations.
The board of directors can set the proper tone, followed by management and key personnel. Training of new board members gets a new leader off to a good start in the world of nonprofit leadership, which has many peculiar aspects not found in similar management positions in the business realm. Often, board members of nonprofits are chosen from the business and professional worlds, where decision-making approaches are quite different and personal connections and influence rule decisions.
Have all formal policies available and in an orderly written format. Short and easily understandable forms should be developed. Review for compliance with the organization’s bylaws.
Most policies can be placed in a comprehensive organizational policies and procedures manual that is to be followed by board, management, employees, volunteers, interns and supporters.
Dusting off a forgotten or stale corporate policy when there is a challenge or crisis will produce no good result. Don’t even think about making it up as you go along or after the fact. Be pro-active and anticipate situations. Expect understanding and cooperation from all involved.
VI. “Best Practices” Are Good But They Can Bite!
“Best practices” are models for conduct and management prevalent in a field that others look to in evaluating an organization’s status. These include internal policies, voluntarily-adopted standards, professional practice and ethical standards, conditions in funding grants (government and private), accounting standards, trade association standards, insurers’ and lenders’ underwriting standards, media perceptions of right and wrong, and other commonly-recognized guidelines. Not always clear or binding, best practices when ignored can have the same negative impact on a nonprofit as a violation of law, negligent act, or other culpable conduct.
The “best practices” movement is practically an industry to itself, given the growth of consultants, writers, professionals and managers involved in every sector, including the nonprofit realm. The origins of the term are unknown and worthy of a doctoral dissertation. And yet, they — the sometimes illusive “best practices” — surround us. Why worry?
Nonprofit organizations are increasingly scrutinized on all levels and are the subject of intense media scrutiny as well as Congressional investigations. A decade ago, leaders of charitable institutions could enter any room wearing the white hat, and a presumption of righteousness surrounded their activities. Too many instances of misconduct and illegal activity in the nonprofit sector changed everything, and today nonprofit leaders have to earn respect and special status in the community like anyone else.
Nonprofit directors are held to a higher standard than most, it is said. Yet, the standard prescribed by Texas law in §22.221, TEX.BUS.ORG.CODE, is general and forgiving:
A director shall discharge the director’s duties, including duties as a committee member, in good faith, with ordinary care, and in a manner the director reasonably believes to be in the best interest of the corporation.
Nonetheless, there is a familiar scenario: When a government investigator, critic, “whistleblower” or investigative reporter examines the conduct of a nonprofit organization, they look first for any violation of law or government regulation. Finding none, they look next to non-compliance with the organization’s own internal governance documents: articles of formation, bylaws, board resolutions, or formal policies. Finding none, they pore over the organization’s financial records and audits for irregularities. Finding none, they can roam among the rich field of “best practices” that can easily be found, for any subject or issue, from numerous sources. No organization can have acted in compliance with the myriad of best practices floating about.
Finally, there is a story to print or broadcast, and an accusation to toss: the organization has failed to observe best practices!
© 2011, Richard W. Meyer, All Rights Reserved