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In early 2003, Barron “Buzz” Tenny, the executive vice president and general counsel of the New York-based Ford Foundation, sat down with the text of the Sarbanes-Oxley Act, the 2002 corporate governance reform law passed in the wake of the Enron Corp. and WorldCom Inc. meltdowns. The law primarily applies to public companies, but two provisions in it were also incorporated into the criminal section of the United States Code: the expanded protections for internal whistleblowers and new standards on document retention. Tenny thought that other sections of the law might make sense for his organization too, such as the requirement that audit committee members are completely “independent”-governance-speak for no business ties with the foundation. He spoke with other Ford Foundation executives and board members about implementing some Sarbanes-Oxley provisions. “[The topic] was in the air,” Tenny said. “[New York Attorney General Eliot] Spitzer had been making noises about cracking down on nonprofits, and everywhere there was talk of increased scrutiny. It became obvious to me that it would be good for us to do something.” Shortly thereafter, Tenny initiated a governance overhaul at the $10 billion charity. A team of lawyers from Morgan, Lewis & Bockius helped him figure out what needed to be done. Then Tenny set to work. He established an audit committee, mandating that each of its five members be completely independent. He also created a code of ethics for the entire board’s 14 members, set up an annual review process to evaluate the directors’ performance and wrote a new code of conduct for the whole foundation staff. The process took close to 16 months. Tenny won’t reveal what the overhaul cost, saying only that, because he used outside counsel mostly in an “advisory” role, the price was “quite modest.” Half make changes Tenny’s experience isn’t unique. In November the accounting firm Grant Thornton reported that nearly half-48%-of the nation’s nonprofits have made voluntary changes to their governance practices since the passage of Sarbanes-Oxley. The statistic represents nearly a 60% increase from the year before. The reforms are a “validation that people think Sarbanes-Oxley’s principles make good sense,” said Michael Peregrine, a partner at McDermott, Will & Emery, and a leading practitioner on governance at nonprofits. “But it’s also a sign that [GCs] want to keep their organizations out of trouble.” The nonprofit sector is comprised of some 1.8 million institutions. Each of them has made a deal with the U.S. government: In exchange for federal tax exemption, executives at nonprofits pledge to forgo profits and to serve the public good by, for example, managing cultural institutions, educating students or funding projects for the underprivileged. Nonprofits don’t sell stock, so they don’t have shareholders or Securities and Exchange Commission reporting duties. The most significant financial regulatory burden for most is submitting an annual federal tax return to the Internal Revenue Service (IRS). But recently, federal and state regulators have taken a harder line. In November, California passed the nation’s first governance law for nonprofits, which, among other things, requires charities that do business in the state, and have revenues greater than $2 million, to form audit and compensation committees. And last summer, in an ironic turn of events for an agency that has cut its oversight of charities in recent years, the IRS announced that it was launching an investigation into nearly 2,000 nonprofits. (Although Congress hasn’t yet approved the $300 million the IRS has requested for the audits.) Shock waves The largest shock waves hit the sec-tor in early 2003, when Charles Grassley, R-Iowa, chairman of the Senate Finance Committee, announced that he was considering legislation to regulate tax-exempt organizations. Last June, he held hearings on the topic. Currently, his committee is working on a bill that would impose several governance reforms on nonprofits; the legislation is expected to come up for a full committee vote early this year. “That’s a near certainty,” said Jill Gerber, the press secretary of the Finance Committee. In the meantime, nonprofits aren’t sitting still. They’re lobbying Congress, chiefly through a Washington-based trade association called Independent Sector. They’re also hoping that by showing that they can address their own problems, Congress will apply a soft touch if it does pass a law. At the same time, the charities want to prepare for the worst: a law full of reporting requirements. So, with general counsel taking the lead in many cases, they’re getting their houses in order. Top in-house lawyers at universities, foundations, health care organizations and other charitable organizations are acting like Fortune 500 GCs of, well, two years ago. They’re rewriting corporate charters, redrafting conflict-of-interest policies, and, in some instances, performing costly examinations of their internal controls. “The buzzards are swirling around the industry. You’ve got the IRS talking about beefing up their audits, states passing laws and Congress about to get involved,” said Thomas Hyatt, a Washington-based partner in Baltimore’s Ober, Kaler, Grimes & Shriver and an expert on nonprofit taxation and governance. “Governance is something that all responsible nonprofits should be thinking about.” The nonprofit world greeted the passage of Sarbanes-Oxley two years ago largely with relief. “We were all just happy it didn’t apply to us,” said Christopher Holmes, the assistant general counsel at Baylor University in Waco, Texas. While Capitol Hill lawmakers hadn’t proposed extending Sarbanes-Oxley to charities, the nonprofit scandals of the 1990s-chiefly at the United Way of America, in which two executives embezzled $2.5 million over a 10-year period-were still fresh in many of their minds. (William Aramony, the former head of the organization, was convicted on fraud charges in 1995; Jacquelyn Allen-MacGregor, the former vice president of finance of the organization’s Lansing, Mich., branch, pleaded guilty to embezzlement charges in 2003.) Still, because two modifications of the federal code that were passed in conjunction with Sarbanes-Oxley do apply to nonprofits, lawyers at charities couldn’t totally ignore the law. And at many nonprofits, board members, many of whom had vast corporate experience, were quick to propose changes. “A lot of us started getting tougher, asking more questions of management if we didn’t see something that looked quite right,” said F. George Davitt, the managing partner at Boston’s now-defunct Testa, Hurwitz & Thibeault and a board member at the Massachusetts branch of Volunteers of America. “Most of us had firsthand knowledge of what the for-profit world was doing, and we figured there was no reason why some best practices outlined by [Sarbanes-Oxley] couldn’t work at nonprofits,” Davitt said.

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