Posted April 1st, 2006

Enron, Worldcom, and You

In recent months, the legal proceedings surrounding the collapses of Enron and WorldCom have once again been in the news as trials are underway for former executives charged in connection with past dealings. While these cases serve as a chilling reminder of the excesses and scandals associated with corporate America, what relevance might they have for those who work or volunteer in the nonprofit sector?

Playing by new rules

Highly publicized cases such as the Enron matter led to the enactment of what has come to be known as the Sarbanes-Oxley legislation in 2002. Congress enacted this legislation to help curtail or eliminate certain activities on the part of boards and management of publicly traded for-profit businesses. This legislation calls for greater accountability, transparency, and board oversight, and makes failure to comply with certain provisions of the law a criminal offense.

Since Sarbanes-Oxley was enacted, America’s corporate community has undergone a series of reforms affecting their boards, executives, employees, accountants, and attorneys and other advisors. Remember Arthur Andersen? One of the nation’s leading accounting firms was a casualty of the Enron scandal—28,000 employees and partners were displaced when Arthur Andersen was forced to close its doors in 2002.

How nonprofits fit in

If the Sarbanes-Oxley legislation focused primarily on publicly traded corporations, why should the nonprofit community be interested in its provisions? Actually, there are a number of reasons why you should be familiar with this legislation.

First, nonprofit boards frequently include corporate executives, board members, attorneys, accountants, and investment advisors who have been affected in their for-profit roles by the provisions of the law and expect well-run organizations—whether for-profit or nonprofit—to comply with the spirit if not the letter of Sarbanes-Oxley provisions.

Second, both federal and state governments are now visibly concerned about abuses within the charitable community. At the federal level, there have been congressional hearings on allegedly improper activities within the nonprofit sector. At a recent national meeting of state attorneys general the topic was high on the agenda.

Unfortunately, the charitable community has seen its fair share of abuses and scandals in recent years. Officials have questioned some museums about following donors’ restrictions on gifts or acquiring works of art or antiquities with little regard to their origin. Other charities have taken part in programs that have systematically encouraged non-cash gifts in which the property’s value has been inflated. These gifts have involved real estate, conservation easements, patents, and automobiles. Some charities have participated in transactions that are primarily designed to benefit non-charitable entities such as investors or insurance companies.

Instances of excessive compensation have also been reported. For example, a foundation board that was questioned about unreasonable compensation for trustees responded by raising the board compensation from $600,000 to $1 million per year. In another case, a nonprofit executive literally gambled away the organization’s gift annuity reserves in Las Vegas.

Ethical and legal lapses continue to be identified in the nonprofit sector with some regularity. Even though such cases are relatively rare given the sheer number of charities in the United States, they nonetheless should serve as a “wake-up call” for nonprofits in general to put their affairs in order.

What areas should be of concern?

While the provisions of Sarbanes-Oxley are extensive and complex, the general thrust is to provide stronger board governance and oversight in order to avoid financial and ethical problems. Among other measures, charities should make sure that their boards have the financial expertise and independence to provide proper governance. There should be policies in place to deal with potential conflicts of interest, and to make sure that executive compensation and fees paid to those associated with board members are not excessive. Consider establishing a formal audit committee and periodically change your accounting firms.

Charities that address these issues on their own are more likely to avoid potential problems than those that ignore them, or continue questionable practices. Steps are now well underway at the federal and state levels that may ultimately result in the enactment of statutes and regulations in the Sarbanes-Oxley vein. Now may be the time to anticipate these actions and take steps today to assure that your organization is “ahead of the curve” in this area.

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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