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Congressional committees, state attorneys general and now the Internal Revenue Service (IRS) are placing nonprofit organizations under scrutiny and sending them scrambling for legal advice on sound governance practices. The Sarbanes-Oxley Act of 2002 heightened awareness about governance at all kinds of organizations, from the public companies at which it was directed, to private firms and nonprofit groups. Subsequent scandals involving financial practices at nonprofits prompted government agencies increasingly to view such organizations with skepticism. A 2003 media expose of the Nature Conservancy’s governance, executive compensation and land sale practices led to a Senate Finance Committee investigation and reforms at the group. The finance committee also catalyzed change at the American Red Cross, sparked by donor concerns about how the charity spent donations that poured in after the Sept. 11, 2001, terrorist attacks. Nonprofit groups responded by enhancing corporate governance, and proposed IRS reporting changes are stimulating change at even more organizations. Compliance reviews and legal audits by organizations that want to assess their potential exposure are up by at least a third over the past couple of years, said Dan Kurtz, a partner at the New York office of Holland & Knight who chairs the firm’s tax-exempt organizations practice group. Old-line nonprofits that used to rely on the informal advice of an attorney board member are now seeking a different kind of legal relationship, Kurtz said. “Lots of nonprofits [traditionally] paid little for legal services,” Kurtz said. “Now they pay lawyers to look at things, and that’s been a real sea change.” Legal work for nonprofits enhancing their governance structure includes a wide range of activities that mimic corporate law, including: working on legal and compliance audits, reviews of conflict of interest policies, bylaw revisions, creating audit committee procedures, crafting whistleblower polices and generally educating boards about their fiduciary duties. No organization wants to be the next one publicly exposed for poor governance practices, said Arthur Rieman, managing director of the Studio City, Calif.-based Law Firm for Non-Profits. At least a dozen new or existing clients have asked Rieman’s firm to scrutinize their governance practices or potential director liability this year, Rieman said. “There’s enough scuttlebutt so that people who are board members who pay attention want to make sure [they don't] have exposure or liability,” Rieman said. Thomas Silk, a nonprofit expert at Silk, Adler & Colvin in San Francisco, is now a senior counsel to his firm, but he finds himself “working more than part- time” to meet demand from nonprofit boards of directors clamoring for advice. “They want to know all about governance issues and what they can do to stay out of trouble,” Silk said. Transparency model The old model of nonprofit organizations’ being satisfied with minimum legal requirements is giving way to a new paradigm of nonprofits that want to be viewed by outsiders as a model of transparency, Silk said. Nonprofit board members who are also public company executives have lived through their corporation’s governance overhauls, and they are realizing that the organizations they volunteer for need to make changes, he said. “There’s a demand from organizations with sophisticated board members,” Silk said. One of Silk’s clients, the San Francisco Opera, has been moving toward the new model starting with adopting a conflict of interest policy a couple of years ago. In July, the opera amended its bylaws to create a governor’s board that handles business and governance issues such as finance and compliance. A larger board of directors, including some members who are more interested in fund raising than governance, don’t need to attend the governor’s board meetings, Silk said. The opera has also become more transparent by posting its audited financial statements, its code of ethics and conflict of interest policy on its Web site. Silk wrote an opinion letter for the opera and they adopted some of his suggested changes. ASAE & The Center for Association Leadership also recently overhauled its governance structure, with help from Jerry Jacobs, a Washington-based partner who heads Pillsbury Winthrop Shaw Pittman’s nonprofit practice team. “He clarified for us what was typically best practices,” said society President and Chief Executive 0fficer John Graham. “He [also] did the heavy lifting in terms of the total rewrite of our bylaws.” The Washington-based center, an advocacy and membership group for other associations, is trimming a 38-member elected board to 15 as members’ terms expire. It also eliminated an executive committee and shifted its duties to the board and altered the bylaws to boost the board’s authority to make future changes. Under the previous structure, some board members felt like they were a “rubber stamp” for the executive committee, while the new board has a stronger governance structure and is more transparent, Graham said. “We’re operating in an atmosphere now, and an environment right now, where increased transparency is important,” Graham said. “Because of the type of organization we are, we should be a model of good governance.” All nonprofits pay far more attention to governance issues since Sarbanes-Oxley, and congressional oversight activity has only highlighted the importance of governance for many organizations, Jacobs said. “All of this has added up to raise the awareness, of those who sit on the boards of nonprofits, of governance issues,” he said. Pillsbury has five attorneys dedicated to its nonprofit practice, but another 55 around the firm do some work with the group, Jacobs said. Other nonprofits, like Cambridge College in Massachusetts, are opting to add a general counsel to ramp up corporate governance. The college’s board has had more legal information since the school hired the general counsel during the last academic year, said President Mahesh Sharma. “Having outside counsel, we had to select what issues we’d focus on because of the cost factor,” Sharma said. With campuses in four states and Puerto Rico, and plans on the drawing board to open campuses in three more states, the school also needs to comply with state laws, including any future laws directed at nonprofits. “[Sarbanes-Oxley] doesn’t apply to nonprofits, but the best practices are the ones we want to follow,” Sharma said. “Sooner or later, the attorney general will make a corresponding [law] for nonprofits also. We want to make sure that we are well prepared for that eventuality.” Taxing changes States have shone the spotlight on nonprofits governance practices through state attorney general investigations and new laws. In January 2005, the California Nonprofit Integrity Act of 2004 kicked in, and, this year, Arkansas and Virginia passed broad laws increasing governance requirements for nonprofits, while the District of Columbia expanded the attorney general’s oversight authority. Federal oversight has been on the upswing, particularly with a recent House Ways and Means Committee hearing and positions taken by Senate Finance Committee leaders. This spring, Senator Charles Grassley, R-Iowa, ranking member of the Senate Finance Committee, asked the Congressional Budget Office to review the university practice of borrowing tax-exempt debt while maintaining a portfolio of untaxed assets and the economic benefits universities receive from tax-exempt athletic programs. Grassley characterized his request as one prong of his “broad look at the non-profit sector” to ensure that nonprofits “provide public benefits in exchange for their nonprofit status.” Officials at the Association of American Universities were not available for comment. Grassley and Finance Committee Chairman Max Bacchus, D-Mont., have also been reviewing the practices of tax-exempt organizations and seeking input from the Internal Revenue Service about charitable organizations’ abuses of tax-exempt status. The IRS jumped into the governance fray with a good governance practices “discussion draft” earlier this year and proposals for changes to Form 990, an annual financial document that many tax-exempt organizations must file with the IRS. The changes include a new governance section requiring information about an organization’s board, governance practices and financial statement practices. The IRS is seeking comment on the proposed changes � which it hopes to roll out for the 2008 tax-reporting season � through Sept. 14. Tax-exempt concerns There’s a growing concern about practices in the tax-exempt area and an increased emphasis on how those organizations report activity to the IRS and comply with the law, said IRS spokesman Eric Smith. “The IRS isn’t the only player, others have a role too, but we’re part of the mix and the 990 filings is a part of it,” Smith said. “Our real interest is helping organizations stay within the law.” The IRS reporting changes will force nonprofit organizations to become more transparent and even more sensitive to governance issues, Rieman said. “It will compel organizations to be more aware of and more attentive to those new topics that the IRS is forcing organizations to address in more detail on their 990,” Rieman said. “It’s going to be more work for the organizations and more work for accountants and lawyers.” In a June 28 letter to the Senate Finance Committee, the IRS Acting Commissioner Kevin Brown said that the agency is requesting a higher enforcement budget in 2008 to study reporting compliance by the tax-exempt sector and to add 109 staffers to its tax-exempt and government entities division to increase examinations. Smith said the tax-exempt sector’s growth is prompting the increased compliance and enforcement efforts. “Any efforts we have in that area are tied toward matching our monitoring efforts with the importance and reach of that important sector,” Smith said.

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