Sarbanes Oxley and Nonprofits
By Tom Silk
Does Sarbanes-Oxley (SOX for short) apply to nonprofits? SOX was passed in 2002 by Congress to apply to publicly traded companies, in response to corporate scandals. Since nonprofits are not publicly traded, SOX has not been applied to nonprofits. In fact, many of the efforts to reform for-profit corporate boards include provisions that are already nearly universal in the nonprofit sector, such as having a majority of board members who are not on staff, or a finance committee with a majority of non-staff members. This article is in digest form; the full text and other articles can be found at www.silklaw.com
In response to the corporate scandals at Enron, Arthur Andersen, Global Crossing, and other major corporations, Congress passed the Sarbanes-Oxley Act of 2002. Corporate watchdog organizations and professional associations of business and law have advocated and adopted more rigorous best practice codes of corporate governance.¹ Meanwhile, the press has reported on scandals within the nonprofit sector as well. So far nonprofit organizations have not been the target of reform legislation by Congress. States have been the first to act. New York's Attorney General was first to propose legislation patterned after Sarbanes-Oxley, and in California SB 1262 has been introduced.
My intent is not to hazard a prediction about the likelihood of federal or state legislation or regulations but to recognize and reflect the emergence of a fundamental shift. Whether or not additional legislation is enacted, community customs and practices are changing. Moreover, a higher level of public expectation may prompt increased media scrutiny of nonprofit sector organizations.
The ten principles of governance are derived primarily from four sources: the Sarbanes-Oxley Act and three corporate governance codes published after the Act became effective - the Report of the Task Force on Corporate Responsibility of the American Bar Association; the Findings and Recommendations of the Commission on Public Trust and Private Enterprise of The Conference Board, and Principles of Corporate Governance of The Business Roundtable.
- The board of directors of a nonprofit corporation must engage in active, independent, and informed oversight of the activities of the corporation, particularly those of senior management.
- Directors with information and analysis relevant to the board's decision making and oversight responsibilities are obligated to disclose that information and analysis to the board and not sit passively. Senior management should recognize and fulfill an obligation to disclose - to a supervising officer, to a committee of the board, or to the board of directors - information and analysis relevant to such person's decision making and oversight responsibilities.
- Every nonprofit corporation should have a nominating/governance committee composed entirely of directors who are not part of the (staff) management team. The committee is responsible for nominating qualified candidates to the board, monitoring all matters involving corporate governance, overseeing compliance with ethical standards, and making recommendations to the full board for action in governance matters.
- Every nonprofit corporation with substantial assets or annual revenues should develop and implement a three-tier annual board evaluation process whereby the performance of the board as a whole, each board committee,and each board member are evaluated annually. The board should also develop and implement a process for review and evaluation of the chief executive officer on an annual basis.
- 5. Each board of directors is responsible for overseeing corporate ethics, and consider the following actions: a)communicate to all personnel a strong, ethical tone from the top, b) adopt a Conflicts of Interest policy; c) include ethics-related criteria in employee qualification standards and in employees' annual performance reviews.
- Every nonprofit corporation with substantial assets or annual revenue should be audited annually by an independent auditing firm.
- The chief executive officer and the chief financial officer of every nonprofit corporation should review Form 990 or Form 990-PF and other annual information returns filed with federal and state agencies.
- Any attorney providing legal services to a nonprofit corporation who learns of evidence that indicates a material breach of fiduciary duty or similar violation shall report that evidence to the chief executive officer of the nonprofit corporation and, if warranted by the seriousness of the matter, to the board of directors.
- Every nonprofit corporation should adopt a written policy setting forth standards for document integrity, retention, and destruction. Section 1102 of the Sarbanes-Oxley Act provides that whoever alters or destroys any document with the intent to obstruct the investigation or proper administration of any matter within the jurisdiction of any federal agency or department is guilty of a felony. This provision applies to individuals within nonprofit corporations as well as business corporations.
- Every nonprofit corporation should adopt a written policy to permit and encourage employees to alert management and the board to ethical issues and potential violations of law without fear of retribution. This is based on Section 1107 of the Sarbanes-Oxley Act which treats as a felony any discharge, demotion, or harassment of any employee who provides to a law enforcement official true information about the potential commission of a federal offense. This provision also applies to individuals within nonprofit corporations as well as business corporations.
Editor's note: This article can help boards in three ways: by reassuring them that Sarbanes-Oxley is not directly applicable to nonprofits (except for principles 9 and 10), by alerting us to principles that are likely to apply in the future, and by making clear that however much the precise governance provisions may vary from nonprofit to nonprofit depending on the mission and size of the charitable organization, there is one overarching principle that does apply to every charity -- to ensure that the conduct of its directors, officers, and employees satisfies the highest ethical standard. This article and others can be found at www.silklaw.com.
Original publication date: 04-30-2004
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