Recently, the Panel on the Nonprofit Sector and the IRS have developed a series of “best practices” guidelines for nonprofit charitable organizations. Like most rules affecting charitable organizations, these guidelines evolved out of real and perceived problems with charitable organizations.
The Panel on the Nonprofit Sector released its Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations in October 2007. The Nonprofit Sector released both a summary and reference edition of its conclusions,which can be found at http://www.nonprofitpanel.org. The Nonprofit Sector developed thirty-three principles divided into four categories: legal compliance and public disclosure, effective governance, strong financial oversight, and responsible fundraising. These principles are excerpted below; the guide itself provides a more detailed discussion of each principle.
Legal Compliance and Public Disclosure
- A charitable organization must comply with all applicable federal laws and regulations, as well as applicable laws and regulations of the states and local jurisdictions in which it is based or operates. If the organization conducts programs outside the United States, it must also abide by applicable international laws, regulations, and conventions that are legally binding on the United States.
- A charitable organization should have a formally adopted, written code of ethics with which all of its directors or trustees, staff and volunteers are familiar and to which they adhere.
- A charitable organization should adopt and implement policies and procedures to ensure that all conflicts of interest, or the appearance thereof, within the organization and the board are appropriately managed through disclosure, recusal, or other means.
- A charitable organization should establish and implement policies and procedures that enable individuals to come forward with information on illegal practices or violations of organizational policies. This “whistleblower” policy should specify that the organization will not retaliate against, and will protect the confidentiality of, individuals who make good faith reports.
- A charitable organization should establish and implement policies and procedures to protect and preserve the organization’s important documents and business records.
- A charitable organization’s board should ensure that the organization has adequate plans to protect its assets – its property, financial and human resources, programmatic content and material, and its integrity and reputation – against damages or loss. The board should review regularly the organization’s need for general liability and directors’ and officers’ liability insurance, as well as take other actions necessary to mitigate risks.
- A charitable organization should make information about its operations, including its governance, finances, programs and activities, widely available to the public. Charitable organizations also should consider making information available on the methods they use to evaluate the outcomes of their work and sharing the results of those evaluations.
Effective Governance
- A charitable organization must have a governing body that is responsible for reviewing and approving the organization’s mission and strategic direction, annual budget and key financial transactions, compensation practices and polices, and fiscal and governance policies.
- The board of a charitable organization should meet regularly enough to conduct its business and fulfill its duties.
- The board of a charitable organization should establish its own size and structure and review these periodically.
- The board should have enough members to allow for full deliberation and diversity of thinking on governance and other organizational matters. Except for very small organizations, this generally means the board should have at lease five members.
- The board of a charitable organization should include members with the diverse background (including, but not limited to, ethnic, racial and gender perspectives), experience, and organizational and financial skills necessary to advance the organization’s mission.
- A substantial majority of the board of a public charity, usually meaning at least two-thirds of the members, should be independent. Independent members should not: (1) be compensated by the organization as employees or independent contractors; (2) have their compensation determined by individuals who are compensated by the organization; (3) receive, directly or indirectly, material financial benefits from the organization except as a member of the charitable class served by the organization; or (4) be related to anyone described above (as a spouse, sibling, parent or child), or reside with any person so described.
- The board should hire, oversee, and annually evaluate the performance of the chief executive officer of the organization, and should conduct such an evaluation prior to any change in that officer’s compensation, unless there is a multi-year contract in force or the change consists solely of routine adjustments for inflation or cost of living.
- The board of a charitable organization that has paid staff should endures that the positions of chief staff officer, board chair, and board treasurer are held by separate individuals. Organizations without paid staff should ensure that the positions of board chair and treasurer are held by separate individuals.
- The board should establish an effective, systematic process for educating and communicating with board members to ensure that they are aware of their legal and ethical responsibilities, are knowledgeable about the programs and activities of the organization, and can carry out their oversight functions effectively.
Board members should evaluate their performance as a group and as individuals no less frequently than every three years, and should have clear procedures for removing board members who are unable to fulfill their responsibilities.
- The board should establish clear policies and procedures setting the length of terms and the number of consecutive terms a board member may serve.
- The board should review organizational and governing instruments no less frequently than every five years.
- The board should establish and review regularly the organization’s mission and goals and should evaluate, no less frequently than every five years, the organization’s programs, goals and activities to be sure they advance its mission and make prudent use of its resources.
- Board members are generally expected to serve without compensation, other than reimbursement for expenses incurred to fulfill their board duties. A charitable organization that provides compensation to its board members should use appropriate comparability data to determine the amount to be paid, document the decision and provide full disclosure to anyone, upon request, of the amount and rationale of the decision.
Strong Financial Oversight
- A charitable organization must keep complete, current, and accurate financial records. Its board should receive and review timely reports of the organization’s financial activities and should have a qualified, independent financial expert audit or review these statements annually in a manner appropriate to the organization’s size and scale of operations.
- The board of a charitable organization must institute policies and procedures to ensure that the organization (and, if applicable, it subsidiaries) manages and invests its funds responsibly, in accordance with all legal requirements. The full board should review and approve the organization’s annual budget and should monitor actual performance against the budget.
- A charitable organization should not provide loans (or the equivalent, such as loan guarantees, purchasing or transferring ownership of a residence or office, or relieving a debt or lease obligation) to directors, officers, or trustees.
- A charitable organization should spend a significant portion of its annual budget on programs that pursue its mission. The budget should also provide sufficient resources for effective administration of the organization, and, if it solicits contributions, for appropriate fundraising activities.
- A charitable organization should establish clear, written policies for paying or reimbursing expenses incurred by anyone conducting business or traveling on behalf of the organization, including the types of expenses that can be paid for or reimbursed and the documentation required. Such policies should require that travel on behalf of the organization is to be undertaken in a cost effective manner.
- A charitable organization should neither pay for nor reimburse travel expenditures for spouses, dependents or others who are accompanying someone conducting business for the organization unless they, too, are conducting such business.
Responsible Fundraising
- Solicitation materials and other communications addressed to donors and the public must clearly identify the organization and be accurate and truthful.
- Contributions must be used for purposed consistent with the donor’s intent, whether as described in the relevant solicitation materials or as specifically directed by the donor.
- A charitable organization must provide donors with specific acknowledgements of charitable contributions, in accordance with IRS requirements, as well as information to facilitate the donor’s compliance with tax law requirements.
- A charitable organization should adopt clear policies, based on its specific exempt purpose, to determine whether accepting a gift would compromise its ethics, financial circumstances, program focus, or other interests.
- A charitable organization should provide appropriate training and supervision of the people soliciting funds on its behalf to ensure that they understand their responsibilities and applicable federal, state and local laws, and do not employ techniques that are coercive, intimidating, or intended to harass potential donors.
- A charitable organization should not compensate internal or external fundraisers based on a commission or a percentage of the amount raised.
- A charitable organization should respect the privacy of individual donors and, except where disclosure is required by law, should not sell or otherwise make available the names and contact information of its donors without providing them an opportunity at least once a year to opt of out of the use of their names.
These “best practices” aren’t part of any law or regulation. But they are potentially much more important than simple advisory guidelines. First, in any lawsuit, administrative proceeding or other claim, evidence of compliance or noncompliance with these best practices standards is likely to be important evidence. Credible national organizations have determined that these best practices are the way things should be done. To the extent your nonprofit hasn’t complied, that lapse may hurt your case.
Second, the people with whom your nonprofit contracts may increasingly require compliance with some or all of these best practice principles as a condition to dong business. For example, a granting agency might require proof of compliance as a condition to a grant being made. Or an insurer might require compliance as a condition to issuing insurance policies.
Third, and hardly least, the IRS released a similar set of draft “good governance” principles in 2007. These governance principles focused on developing clear policies within charitable organizations to improve governance based on the idea that good governance will foster better compliance with Federal tax law. For example, the IRS recommended that charitable organizations develop a clear mission statement, a code of ethics, and a whistleblower policy, among other recommendations. However, these good governance principles have essentially been subsumed by the new Form 990 information return.
The revised Form 990 asks a series of questions that relate directly to tax-exempt organization governance principles. The Form 990 basically forces tax exempt organizations to adopt certain policies and principles by providing “yes” and “no” check boxes. Specifically, the Form 990 asks whether a tax exempt organizations has a:
- Conflict of interest policy.
- Whistleblower policy.
- Document retention and destruction policy.
- Policies and procedure governing activities of chapters, branches and affiliates, if any.
- Policy or procedure requiring evaluation of participation in joint ventures with taxable entities under federal tax law and steps to safeguard exempt status.
- Policy or procedure for determining compensation for the chief executive officer or other top executive along with other officers and key employees, including a review by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision.
- Policy or procedure for the periodic monitoring, inspection, and enforcement of conservation easements, if any.
- Procedure for monitory the use of grant funds made to recipients outside the United States.
- Charity care policy and debt collection policy if the organization is operating as a hospital.
- Policy regarding repayment or reimbursement of expenses incurred by trustees, directors, officers and key employees for travel and other expenses.
Many of the policies and procedure about which the Form 990 inquires are not required by Federal tax law. However, they do represent the IRS’s idea of what policies and procedures are required for good tax exempt entity governance.
The IRS developed a Life Cycle educational tool to help educate tax exempt charitable organizations through the IRS website. The portions of the Life Cycle tool discussing good governance can be accessed through http://www.irs.gov/charities/article/0,,id=178221,00.html. Most recently, the IRS has moved toward education about good governance principles rather than mandating changes for tax exempt organizations. However, the effect of answering any of the new questions with a “no” on the new Form 990 is unknown. The “best practice” for tax exempt charitable organizations currently is to follow the IRS governance guidance.
It seems likely that the area of “best practices” will have an increasingly important role in nonprofit governance, even if they never have the full force of law. We urge your nonprofit work to bring itself into compliance, starting with the specific issues the IRS currently requires be described in Form 990, and eventually addressing all of the best practice principles that apply to your nonprofit.