Governance and Accountability

Governance and Accountability

Along with the benefits of being a board member—the opportunity to affect social change, personal and professional growth, camaraderie, and prestige—come duties and responsibilities. Many board members don't realize the extent of their responsibilities, the potential liabilities they assume, or to whom they are accountable.

This special report, which grew out of discussions held during a conference on governance and accountability at the National Center on Philanthropy and the Law at the New York University School of Law, addresses three important topics that board members must understand in order to effectively fulfill their duties. To best protect themselves and the interests of their organizations, all board members should be knowledgeable about:

• the effectiveness of the IRS Form 990 as a mechanism for disclosure and accountability,
• the capacity of government regulators to monitor nonprofit activities, and
• standing to sue and its impact on governance.

While each of these issues is broad and complex, we've tried to provide a basic primer to brief board members on the serious implications their work can have.

Smaller Organizations Need Not File 990s Nonprofits with annual budgets of less than $25,000 are not required to file the 990. These organizations are not always equipped with legal counsel or accounting services to offer solid advice and guidance on completing the form. In addition, faith-based groups are not required to file, based on the principle of separation of church and state. Many congregations file voluntarily, however, and charities that are religiously affiliated but serve other purposes than solely the promotion of a religious faith must file with the IRS. When the 990 was created in 1969, the minimum budget required to file was only $5,000. That was adjusted to the current figure about 15 years ago. In 1997 the IRS proposed an increase for inflation to $40,000. After a year of consideration and public comments, the proposal was dropped by the IRS. Marcus Owens, director of the IRS' Exempt Organization Division, says the IRS is investigating ways to reduce paperwork for smaller organizations.

Form 990 as a mechanism for accountability

The Internal Revenue Service (IRS) Form 990 is the most universal tool available to provide information on the finances and activities of nonprofit organizations, both to the IRS and to the general public. As more nonprofit constituents and donors have become aware of the form and its potential uses and as tax law has recently increased its availability to the public, the 990 is often cited as the most easily accessible method of keeping nonprofit organizations and their boards accountable.

Although the form has been around for 30 years, only recently has Congress mandated its wider availability for public consumption. Now 990s from the past three years must be made available to anyone who visits a nonprofit and asks for them.

Under impending law, requests made in writing for copies of the form must be honored. If an organization posts its 990 on the World Wide Web, however, it is exempt from other disclosure requirements. Cyber-accountability, a continually expanding term that deals with possible uses of information technology to enhance nonprofit accountability, is now a watchword in the sector. (For more information on cyber-accountability, visit www.bway.net/~hbograd/cyb-acc.html.)

Proponents offer up as a model the website of the Securities and Exchange Commission, www.sec.gov, which provides access to financials for all publicly traded companies. Not all nonprofits, however, have Web access or expertise. Creating an equivalent site for the nonprofit sector is an admirable and ambitious goal.

Those who point out that the 990 was designed as a law enforcement tool question whether the form is well-suited to ensuring accountability in a broader context. The answer, according to Peter Swords, head of the Nonprofit Coordinating Committee of New York, depends on one's definition of accountability. In a paper about the usefulness of the 990 to improve nonprofit accountability, Swords makes a distinction between positive and negative accountability. Negative accountability, the type more easily and accurately assessed by the 990, refers primarily to the financial and business transactions of the nonprofit and whether they fall within the confines of the law. Positive accountability, which is more difficult to measure, relates to whether a nonprofit is doing its job—providing programs and services that add value to society.

Are Volunteers Protected by Law? When Rep. John Porter of Illinois introduced the Volunteer Protection Act (VPA) to Congress, his intent was to "shield volunteers from being sued except in cases of willful or wanton misconduct." Although critics claim that the VPA was a blow to accountability for board members, its reach is limited and the strictness of its interpretation still lies with state courts. The passage of the Volunteer Protection Act of 1997 changed the legal environment for board members by granting volunteers immunity from litigation under certain circumstances. Under the VPA, if harm results from the actions of a volunteer, he or she is not personally liable, provided that he or she was acting in the context of volunteer activity and the harm was not caused by willful, criminal, or reckless misconduct; gross negligence; or a conscious indifference to the rights or safety of the individual claiming harm. The charity, however, may be held liable for the individual's behavior. The VPA only applies to 501(c)(3)s. While sponsors of the VPA argued that fear of liability diminished volunteer participation and that the law would encourage service, proponents of the expanded liability of board members believe that the law diminishes individual accountability. The VPA does not prohibit lawsuits against volunteers, but serves only to immunize volunteers from liability under certain circumstances. Whether the board member can still be held accountable for misdeeds depends now on the court's interpretation of willful misconduct and negligence, which varies by state. The VPA does not provide blanket protection for all volunteers, nor should it. Risk management experts still recommend that nonprofits purchase liability insurance for their board members, and that all volunteers, including board members, be trained for service and educated on risk management.

Because the 990 was designed as a tool to monitor compliance with the Internal Revenue Code, it is not surprising that it's most useful in measuring negative accountability. Nevertheless, state charity offices still use it to demonstrate positive accountability. Recently those served by nonprofits, as well as donors and even some nonprofits themselves, have demanded total availability of all 990s on the World Wide Web.

Fortunately for those hungry for information, Philanthropic Research Inc. (PRI), in Williamsburg, Virginia, has created www.guidestar.org. This website compiles listings on all 501(c)(3) organizations, almost 700,000 in all. PRI, in collaboration with the National Center for Charitable Statistics at the Urban Institute, hopes to eventually maintain extensive reports on all public charities that file 990s, which currently number close to 200,000. These reports will be based on the 990 as well as supplemental program and outcome information supplied by the nonprofit.

Despite its shortcomings, for the foreseeable future the 990 is likely to remain a primary source of information and accountability for nonprofits. For that reason, critics are urging the IRS to revise the form to make it more useful and accessible.

What the 990 doesn't reveal to the satisfaction of many nonprofits is how successful a nonprofit is at accomplishing its mission. The 990 only allows two and a half lines each in which to describe a maximum of three programs, and discourages the use of attachments. The form asks an organization to state its primary purpose in no more than half a line. To use the IRS form as a comprehensive evaluative tool is to neglect the human impact of an organization in favor of relying on financial health as a measure of success.

Suggestions to the IRS for revising the 990 include:

• Developing a greater capacity for substantive, program-related information, such as a larger section in which the organization may discuss its mission and its impact in a substantive way or the approved inclusion of attachments.

• Increasing access to the form to provide more opportunities to detect wrongdoing. Most action taken by regulatory agencies against errant nonprofit board and staff members stems from tips received from outside parties.

• Making the 990 easier to understand. Critics contend the 990 is not sufficiently decipherable to nonprofits or members of the public. Many nonprofit law experts find the form difficult to understand, complete, or even read.

Advocates for modifications to the 990 can address their concerns to Sheldon Schwartz, national director for tax forms and publications at the IRS, at 1111 Constitution Avenue NW, Washington, DC 20224.

Unfortunately, because the 990 is so complex, because it doesn't offer adequate opportunity for an organization to describe its accomplishments in a qualitative way, and because disclosure laws are relatively new and not well-publicized, some nonprofits don't take completion of the form seriously. For the IRS to consider modifying the form would require much greater advocacy from the sector itself.

Intentionally preparing a 990 in a false or fraudulent way is a federal crime. The liability for mispreparing the form is just as significant as the underlying abuse or crime the form is trying to hide.

The board should feel confident that the 990 has been accurately and fully completed. Generally, a staff member, usually working with the organization's accountants, prepares the form, which is then signed by an officer and submitted to the IRS. The board may wish to delegate to a committee or subcommittee of the board, such as the audit committee, the responsibility to review the drafted 990 with the officers and staff members responsible for completing and signing it. Otherwise, the board should discuss with the officers or staff members completing the form any issues they may have and ask for their assurances of its accuracy. It is important that the board has a sense of responsibility and feels accountable for the careful and truthful completion of Form 990.

Government's ability to ensure accountability

Not unlike many nonprofits themselves, the agencies empowered to regulate nonprofits—the IRS and state charity regulators—are understaffed and overworked. The Exempt Organization Division of the IRS has suffered in recent years from cuts in budget and personnel, although expansion is now on the horizon. While a few states employ individuals in the attorney general's office dedicated exclusively to monitoring nonprofits, most do not. As a result, these bodies, collectively responsible for oversight of the activities of a million nonprofits, don't necessarily have enough eyes to keep track of all of them.

No Rights for Donors The standing to sue of donors was tested last year when the Connecticut Supreme Court ruled that donors to Connecticut colleges who feel their gifts have been improperly used have no inherent right to sue. The decision came from a case in which the Carl J. Herzog Foundation sought to reclaim part of its $250,000 donation to the University of Bridgeport. The money was earmarked for medical education scholarships but had been reallocated after the school's nursing program closed down. The court noted that donors could include language in their gift agreements granting them the right to sue in that particular instance, but that such a clause could compromise the tax deductibility of the donation. One justice wrote in dissent that the decision opened the door to "double-crossing" of donors by universities or other nonprofit organizations. This article was based primarily on a conference held at the National Center on Philanthropy and the Law, part of the New York University School of Law. The conference was called "Governance of Nonprofit Organizations: Standards and Enforcement." Visit www.law.nyu.edu/ncpl/ for information.

From the perspective of a representative of one attorney general's office, the goal of state regulators is to serve their constituents, however broad a group that may be. As one staff member put it, as elected officers, attorneys general are "here to serve the general public and serve at their pleasure." While attorneys general are obligated to represent the interests of citizens they serve, state offices must also act on behalf of the greater good. Because state charity regulators themselves are accountable to so wide an audience, they are necessarily more conservative in the battles they choose than the average zealous nonprofit advocate might be.

In the effort to regulate charities, most state attorneys general can:

• Take corrective action—change or implement bylaws or regulations to prevent future improper behavior.

• Remove a board member—this can damage the reputations of board members in the community (perhaps the point), and have a chilling effect on recruitment.

• Impose criminal sanctions—the most difficult to levy because of the standard of proof required, and the most onerous to the charity.

In lieu of more omniscient oversight, Congress has stepped in with harsh monetary punishments for misdeeds. Intermediate sanctions, developed by Congress and currently published as proposed regulations, are designed to give the IRS greater ammunition against nonprofit board and staff members who step outside the lines of ethical behavior. Previously the only option available to the IRS was revocation of a nonprofit's tax-exempt status, which couldn't reach any individuals who had done damage, only the charity.

Intermediate sanctions allow the IRS to levy significant excise taxes against individuals who have engaged in "excess benefit transactions" in their work with the organization. For a detailed explanation of intermediate sanctions regulations, see page 11.

Until the IRS releases finalized regulations, debate over the sanctions continues. Critics are reluctant to support individual monetary damage claims against board members in most circumstances because such action could easily bankrupt a board member. The board member's organization, which provides a vital community service, might also be destroyed by the publicity. Many agree that intermediate sanctions may only be used effectively against large organizations with resources to respond to charges and pay compensation if necessary.

Social and ethical forces must be strengthened to prevent abuses, but in cases where these are not effective, legal sanctions must be effectively applied. Education on the importance of the 990 and the gravity of intermediate sanctions is a first step.

With the help of a variety of national, regional, and local nonprofit resource organizations, more boards are emphasizing education for their members. With sufficient board training on such issues as board members' legal obligations, understanding financial statements and IRS forms, ethics, and even basic roles and responsibilities, an organization can operate more effectively; demonstrate accountability to constituents, donors, and the IRS; and spend less time worrying about legal action and more time accomplishing its mission.

Standing to sue and the expansion of board member liability

Over the past year, board members of educational trusts, animal rescue organizations, and condo associations, among others across the country, have been sued. They were most often sued for breach of their fiduciary duties—paying themselves when they weren't supposed to, paying themselves too much, paying others too much, not disclosing their finances, and other, similar charges—although accusations of other misdeeds were sometimes made. They were sued by state attorneys general, by other board members, and by private citizens. They were sued as individuals, not just as a board or as an organization. Board members need to know that they can be held liable for their actions in a court of law, and that their liability may be increasing.

In the private sector, customers who've been harmed by a product and shareholders who haven't received adequate return on their investments can bring a civil claim against a for-profit corporation. In the nonprofit world, clients or beneficiaries who have been ill-served by an organization, or donors who believe their gifts have been misused, have limited standing (or legal eligibility) to bring a civil suit against the organization.

Practically speaking, anyone can sue a nonprofit. Individuals frequently sue nonprofit hospitals with grievance claims. In some cases, an individual may ask the state attorney general to investigate a case. The main criterion for individual standing to sue is the plaintiff's perception of the reason for the case. If an organization has done something that resulted in harm to an individual, he or she can sue. If the individual perceives that an organization has done something wrong or made an error in management, unless it has caused harm to the individual, he or she has no case. For example, if you go to an art museum and are offended by the art, you have no grounds to sue the museum. If, while you are looking at the paintings, you slip and fall on a wet floor and consequently break your arm, you can sue.

This limitation has not prevented individual clients, beneficiaries, or donors from bringing suits against nonprofits, but only in the rare cases where the nonprofit's action is particularly egregious have courts admitted the suits. Indeed there are cases in which an individual beneficiary or donor who feels harmed by a nonprofit has won recompense against the organization, but these are the exception rather than the rule.

Proponents of expanded standing argue that charities exist to meet a demand for goods and services left unfilled because of market failure. They contend that constituents of charities should have a mechanism for holding their service providers accountable for delivery of services and thus have standing to sue. The implication is that boards would govern more carefully and organizations operate more accountably under the threat of lawsuits from dissatisfied constituents. Another group with a vested interest in charitable accountability is donors, who proponents believe should have increased standing, but with restrictions corresponding to the parameters of the gifts. (Imagine the potential headaches for organizations like the American Red Cross or the United Way if every $25 donor becomes a potential litigant.)

Other experts argue that the analogy between nonprofit patrons and beneficiaries and for-profit shareholders breaks down at fundamental points. One case against the comparison is that constituents, unlike shareholders, have no proprietary interest in the nonprofit organization because they don't actually own anything and cannot expect any profits to come to them. When for-profit shareholders bring suits against a corporation, they are acting as owners of the company, which is why they have standing to sue.

Legal authorities are reluctant to endorse expanded standing because they know how consuming litigation can be, and how potentially disruptive a lawsuit (or multiple lawsuits) could be to an already overburdened nonprofit organization. In the words of one expert, expanding standing would unleash "a great mischief" on the nonprofit sector. Arguing that the movement to expand standing is based on a flawed premise—that increased standing to sue will necessarily increase accountability—opponents insist greater standing isn't the solution.

Still others suggest a compromise: expanded standing with certain safeguards, such as limits on the length of time after a gift is given that a donor can sue, or capping the percentage of the gift for which the donor can sue.

Proponents of increased accountability suggest that additional energy should go toward supplying both the IRS and the states with funds and legislation where needed, to let them do the job that should be done by government. Instead of opening up the floodgates to litigation, the sector should enforce strict compliance with the duties of loyalty and care.