On March 1, 2005, the Panel On The Nonprofit Sector submitted its Interim Report to the Senate Finance Committee, setting forth a series of recommendations and comments regarding proposed changes in the way America’s nonprofit and charitable organizations are regulated and governed.

The Panel was created at the encouragement of the Finance Committee, which has been evaluating proposals for significant legislative change in the regulation of the burgeoning nonprofit sector. The Panel is comprised of two dozen leaders from a broad range of U.S. public charities and private foundations. Spearheading the formation of the Panel was the Independent Sector, a nonprofit, nonpartisan coalition of approximately 500 national public charities, private foundations, and corporate philanthropy programs.

As members of this nation’s vital and important nonprofit sector, you are well aware that increased regulatory and legislative scrutiny of American corporations in the wake of Enron and WorldCom has not been limited to publicly-traded companies. While nonprofit entities were only affected by certain of the sweeping corporate governance reforms enacted in the Sarbanes Oxley Act of 2002, it now appears likely that nonprofit entities, and their members, managers, directors and volunteers, will soon be subjected to greatly enhanced corporate governance, financial disclosure and other obligations. Most of these proposed changes focus on revising the way charities and foundations operate, although some of the proposed changes extend to nonprofit organizations of all kinds.

In the Summer of 2004, we issued an Alert that we had been contacted by representatives of the Senate Finance Committee to comment (and encourage our clients to comment) on the Committee’s draft initiatives aimed at reforming nonprofit governance and accountability. After a series of roundtable discussions among the Committee and many members of the legal community and their nonprofit clients, the Committee’s Chairman, Senator Charles Grassley, encouraged a broader review of the proposed initiatives by the nonprofit sector.

During the Fall of 2004, the Independent Sector convened the Panel. The Interim Report is the culmination of the Panel’s ongoing work with experts from various fields to evaluate nonprofit governance and accountability, including within the rubric of the Committee’s proposed draft initiatives.

The Panel’s own recommendations contained within the Interim Report largely reaffirm many of the positions set forth in the Committee’s earlier draft initiatives. A Final Report is expected later this Spring, although the Panel expects to continue its work into the Fall of 2005. The Panel has expressed its intention to also share its reports with the House Ways and Means Committee, other Congressional leaders and members of the Administration.

Moreover, the Finance Committee has scheduled public hearings beginning April 5, 2005, and the Panel has been actively urging members of the nonprofit sector to participate, including by endorsing the Interim Report, which can be found on the Panel’s website, www.NonprofitPanel.org.

By virtue of these developments, it appears that many of the Committee’s proposals have achieved sufficient momentum – including through the endorsement of the Panel – to suggest that these recommended reforms either will soon become law or, at a minimum, will enhance the existing and evolving “best practices” that many nonprofit entities already have adopted or are in the planning stages to adopt.

The full text of the Interim Report can be accessed from the Panel’s website, www.NonprofitPanel.org. For your convenience, we have summarized the key provisions of the Interim Report below.

Overview of the Interim Report

The Panel’s Interim Report first recognizes the tension between the critical need for a vital, effective and independent nonprofit sector, on the one hand, and the acknowledgement that the success of nonprofits is largely dependent upon their perceived integrity and credibility, on the other. This delicate balance provides the framework for the Interim Report’s recommendations directed at transparency, self-regulation, and appropriate means of government regulation aimed at deterring abuses without discouraging critical legitimate charitable activities.

Thus, the Panel’s fifteen separately enumerated recommendations are grouped into three categories: (i) Recommendations to Improve Transparency of Charitable Organizations; (ii) Recommendations to Enhance Governance in Charitable Organizations; and (iii) Recommendations to Strengthen Government Oversight of Charitable Organizations.

Highlights From The Panel’s Recommendations

Transparency Recommendations (For IRS Action)

1. IRS Information Returns (Forms 990)

• Recommend a requirement that Form 990 be signed, under penalty of perjury, by CEO, CFO or other highest ranking officer (or trustee of trust), who also would be required to attest to the accuracy and completeness of the report;
• Does not recommend an increase in existing financial penalties imposed on organizations or managers for failure to file complete and/or accurate returns (thus, the Panel does not support the Committee’s draft proposal to increase penalties);
• Recommend authorizing the IRS to suspend (but not revoke) tax-exempt status for failure to file after two years of noncompliance (again departing from the Committee’s draft, which proposed revocation);
• Recommend extending existing penalties imposed on income tax preparers of personal and corporate returns for omissions/misrepresentations to preparers of Form 990;
• Recommend requiring electronic filing of Form 990, subject to certain modifications in the filing system to allow for separate attachments, and other accommodations for smaller entities;
• Recommend coordinating proposed federal e-filing with state filing requirements;
• Recommend also requiring the electronic filing of Form 1023 (application for recognition as tax-exempt organization under IRC Section 501(c)(3).

2. Financial Audits and Reviews

• Recommend requiring Form 990 filers with $2 million or more in annual revenues to have financial statements audited, and to attach financials to their Form 990; while filers with revenues between $500,000 and $2 million would be required to have financial statements reviewed by independent public accountant;
• Recommend as “best practice” – but NOT require – rotation of outside auditors every five years.

3. Annual Notification Requirements For Non-Filers of Form 990

• Recommend requiring entities not otherwise obligated to file Form 990 (including where revenues fall below $25,000) to file annual notice with IRS setting forth certain information regarding ongoing or terminated status, contact information, and current revenues, among other things.
• Enhanced Corporate Governance Recommendations (Self-Regulatory Action)

4. Conflict Of Interest Disclosure

• Recommend as “best practice” every nonprofit’s adoption and enforcement of a conflict of interest policy;
• Recommend and advocate sector-wide effort to encourage all charitable organizations to adopt and enforce conflict of interest policies;
• Recommend that Form 990 require disclosure of whether entity has a conflict of interest policy.

5. Audit Committees

• Does not recommend a federal requirement or definition of audit committees for charitable organizations;
• Recommend that Board of directors should continue to have oversight responsibility of audit function (which the Panel describes in some detail the Interim Report), and should have discretion to delegate that responsibility to a board committee;
• HOWEVER, Panel recommends that (i) organizations should include individuals with “some financial literacy” on boards, (ii) every charitable organization that has its statements audited should consider establishing audit committees, and (iii) there should be a sector-wide effort to educate charitable organizations about the importance of the auditing function.

6. Reporting Suspected Misconduct or Malfeasance

• Does not recommend any additional legal protections for whistleblowers in view of existing federal and state laws (including Sarbanes-Oxley);
• HOWEVER, Panel recommends all charitable organizations establish policies and procedures that encourage individuals to come forward, and set forth the manner and form of reporting misconduct, and protections to whistleblowers; and that there be a sector-wide effort to educate organizations about such policies and procedures.

Recommendations To Strengthen Government Oversight (Legislative Action)

7. Donor-Advised Funds

• Recommend a statutory definition of “donor advised fund” (being considered for later comment);
• Recommend prohibiting public charities from making grants to private non-operating foundations from assets held in donor-advised funds;
• Recommend adoption of “minimum activity rules” for public charities holding donor-advised funds to ensure such funds do not remain in inactive accounts indefinitely;
• Recommend prohibiting public charities from knowingly using assets held in a donor-advised fund to (i) reimburse donors/advisors for expenses incurred in advising the selection of grantees, (ii) compensate donor/advisor for services rendered (unless compensation is mostly paid from other sources), (iii) make grants to donor/advisor;
• Recommend requiring public charities that own and administer donor-advised funds to include on grantee recommendation forms a certification that grants will not substantially benefit the donor/advisor
• Recommend prohibiting knowing grants from donor-advised fund to satisfy a pledge of the donor/advisor.

8. Rules For Valuation Of Property Contributions

• No recommendation yet; Panel is still studying “complex issue” of appropriate valuation and disposition of non-cash contributions.
  

9. Penalty Taxes On Self-Dealing And Other Violations

• Recommend increasing first-tier excise taxes on foundation managers and disqualified persons who knowingly participate in self-dealing (although nature and amount of penalties is still being studied);
• Recommend extending IRS authority to abate first-tier taxes on managers in cases of self-dealing;
• Recommend modifying standards for imposing first-tier excise taxes to provide realistic possibility that such penalties will be imposed on managers who fail to meet their fiduciary duties in connection with prohibited transactions (still being studied).

10. Type III Supporting Organizations

• Recommend enactment of ‘targeted anti-abuse rules’ to eliminate inappropriate use of Type III Supporting Organizations, while maintaining availability of such organizations for legitimate charitable purposes (still being studied, although Panel does NOT support proposals for elimination of such organizations entirely).

11. Tax Shelters

• Recommend enactment of appropriate anti-abuse provisions sufficient to deter charitable organizations from participating in “listed” tax shelter transactions (still being studied).

12. State Enforcement Of Federal Laws

• Recommend that states be urged to incorporate federal tax standards into state law rather than granting states authority to enforce federal tax laws (as recommended by Senate Finance Committee) (still under consideration).

13. Funding For Federal And State Enforcement

• Recommend that Congress increase resources allocated to IRS for oversight and enforcement of charitable organizations, and overall tax enforcement;
• Recommend that funds derived from penalties, fees and excise taxes be earmarked for improved oversight and education.

14. Information Sharing Between Federal And State Officials

• Recommend supporting “responsible” sharing of information, although the Panel noted its concern about potential for improper disclosure of shared information absent appropriate safeguards.

15. Public Disclosure Of IRS Determinations

• No recommendation yet, as the Panel was unable to reach consensus as to whether IRS should be required to publicly disclose closing agreements between IRS and charitable organizations and related audit results.

Expected Scope Of The Panel’s Final Report

The Interim Report also contains a discussion of the issues it currently expects will be included in its Final Report, expected to be released later this Spring. In addition to addressing the various unresolved issues noted in the Interim Report (see above), the Panel expects to address a host of additional “transparency,” “governance” and “government oversight” issues, ranging from revisions to existing reporting, disclosure and auditing standards, to criteria affecting the structure, size and composition of boards of directors (and related issues of “independence” and compensation), to executive compensation and expense policies, to additional regulations governing valuation/disposition of non-cash contributions, prudent investing standards and other activities. Finally, the Panel expects to consider the Senate Finance Committee’s draft proposal to extend the powers of the US Tax Court to include enforcement of fiduciary duties of boards and to allow action to be taken against charitable organizations and individual directors for fiduciary breaches – including the allowance of private rights of action by a director or trusty against a charity, and to allow any member of the public to bring a complaint to the IRS for review and adjudication, among other things.

* * *

We will continue to follow these developments throughout the year and will keep you informed through our Alerts, mailings and on our redesigned website, www.arentfox.com. Obviously, we welcome any specific inquiries or questions concerning these and any other matters of interest to you, and are always prepared to assist you in planning for these and other changes in the regulatory landscape ahead.

For further information or to arrange for a consultation, contact:

Marc Fleischaker

Deanne Ottaviano