Posted December 1st, 2007

Corporate Governance Update: Part I

In the April 2007 issue of Give & Take, we published an article entitled “You and Your State Attorney General,” which examined the impact of state regulators and recent case law as it relates to the nonprofit community. The article was based on information I obtained during attendance at the National Association of Attorneys General (NAAG)/National Association of State Charity Officials (NASCO) Conference held in October 2006, as well as on my personal experience as a nonprofit board member.

This October the NAAG/NASCO Conference reconvened. After attending concurrent conferences, it is clear, this year as well as last, that corporate governance remains in the spotlight for both the for-profit and nonprofit sectors.

Board responsibility still key

Based on personal experience chairing nonprofit boards, I have been asked by donors about various corporate governance issues. Many of these persons are from the business world, where the Sarbanes-Oxley Act dictates that the members of a corporate board of directors assume a great responsibility when they accept their position. Because of their familiarity with for-profit law, many donors now feel more compelled to ensure that donated funds are used and managed properly and that nonprofits are held accountable.

Two words that continually surface in the area of corporate governance are transparency and accountability. These words or their synonyms appear not only in media stories about the failure of boards or CEOs to fulfill their fiduciary responsibilities, but are also the cornerstone of judicial opinions and jury verdicts in courts throughout the land.

One of the best examples of the importance of transparency and accountability is found in the remarks of Steven T. Miller, the commissioner of tax exempt and government entities at the Internal Revenue Service. In his speech at a Georgetown Continuing Legal Education Seminar on April 26, 2007, Miller addressed concerns about the “presence of abuse in the charitable sector.” He outlined the three historical “pillars” of IRS oversight:

  • customer education and outreach
  • upfront compliance work
  • examinations

He then suggested two new pillars:

  • to use the resources of the Internal Revenue Service to gather significant and reliable information about the sector, and to make it broadly available to the public in a timely, user-friendly fashion
  • to promote standards of good governance, management, and accountability

In examining his position on corporate governance, Miller stated, “In this environment, I think it is fair to ask if some of the problems that beset parts of the tax-exempt sector might effectively be addressed not by IRS agents arriving on the scene, but by the twin tonics of full-spectrum sunshine—the enhanced transparency I referred to in the first new pillar—and the existence of an engaged, informed, and independent board of directors accountable to the community it serves.”

It is thus clear that the IRS is moving toward the position that transparency and accountability are not only important, but are the mainstays of their ongoing compliance program.

What is transparency?

Webster defines transparency as “transmitting rays of light through its substance so that objects beyond can be distinctly seen.”

It is clear that regulatory agencies at both the state and federal level expect a charity’s mission and financial structure to be readily accessible and understandable. They want the nonprofit to be “transparent,” such as in the full disclosure of the compensation of executives, whether the charity has a conflict of interest policy and how it is enforced, the tension between the charity’s mission and operation, and proof that there is no existence of self-dealing.

The media has been quick to point out to the public when they believe a nonprofit has acted improperly, even if the charity has done nothing illegal or even immoral.

For instance, the New York Times reported in an October 12, 2007 article titled “Chairman’s Kin Hired as Architect for Carnegie” that Natan B. Bibliowicz, the son-in-law of the chairman of the Carnegie board, Sanford I. Weill, had been hired as the architect to oversee the $150 million expansion of Carnegie Hall. According to the article, one of the reasons Bibliowicz’s firm was chosen was due to “the design of the well-regarded new home of Alvin Ailey American Dance Theater.” Coincidently, however, the Theater’s chairwoman of the board happens to be Bibliowicz’s mother-in-law, Joan H. Weill.

It should be noted that the Times article quoted experts in the nonprofit sector, who weighed in that the transaction is not illegal as long as the firm’s compensation was reasonable in relation to the scope of the project. However, in litigation involving Carnegie Hall and its tenants who will be relocated as a result of the renovation, the attorney for the tenants said, “We are now in court fighting for these tenants’ lives. ‘The Sandy Weill Carnegie Hall’ is evicting these tenants in their 70s and 80s, and his son-in-law is getting paid countless millions of dollars.”

Regardless of the legality of hiring Bibliowicz, or the efforts made by the Carnegie board to prevent a conflict, the events were deemed newsworthy by the New York Times. A reader of the article will almost certainly come to the conclusion that an apparent, if not actual, conflict of interest existed in this situation.

It is this type of media attention that reinforces to state regulators, and perhaps the general public, that more oversight is needed in the nonprofit sector.

What is accountability?

Webster defines accountability as “responsibility; being answerable.” It is clear that state regulators expect the board and the paid staff to be accountable for the actions of the charity. They also expect the board to take its responsibilities seriously.

Accountability came to the forefront in the national media and the halls of Congress when questions were raised about the activities of Lawrence Small, chief executive, and Shelia P. Burke, deputy secretary and chief operating officer of one of America’s oldest and best known museums, The Smithsonian Institution.

The Washington Post reported that the Inspector General of the Smithsonian had discovered unauthorized expenditures by Small. Further investigation by Congress, the news media, the Inspector General, and an independent committee appointed by the board revealed that Small and Burke served on the board of directors of the Chubb Group, an insurance company that, according to The Chronicle of Philanthropy, provided “more than half of the Smithsonian’s insurance coverage.” The Chronicle further reported that Small received $169,675 in cash and stocks from Chubb in 2006 plus stock options, and that Burke received $194,676 in cash and stock plus additional stock options. Small and Burke each served on one other outside board.

Senator Charles E. Grassley, the senior Republican on the Senate Finance Committee, not only criticized the “champagne lifestyle” of Small, he also has been critical of the activities of the Smithsonian’s board and the audit committee, including retroactively approving the unauthorized expenses of Small. However, this is not a partisan issue—Democrats in Congress have also been critical of the oversight at the Smithsonian Institution.

In an opinion published in the May 3, 2007 issue, the Chronicle also suggested that the Smithsonian would be better served with the resignation of volunteer leadership as well.

New Form 990

The overall emphasis on the importance of corporate governance may be best illustrated by the changes proposed by the IRS for their Form 990. The new form has a special section highlighting corporate governance. The new Form 990 is out for comment and, according to IRS officials, the final Form will be ready by December 31, 2007, in time for the 2008 tax year. The proposed form as it is now being circulated contains important new requirement that, if adopted, will have a far-reaching impact on the future governance of America’s nonprofit community.

Next month we will look at the corporate governance issues which will be raised by the new Form 990.

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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