Last month, the news broke that the Statue of Liberty remained shuttered for nearly three years, while the Statue of Libertyâ€“Ellis Island Foundation guarded a $30 million endowment and paid its top executive annual salaries of nearly $300,000. Press reports questioned why--instead of dipping into its assets to reopen the symbol of freedom as quickly as possible in the wake of 9/11--the foundation launched a $7 million campaign to improve security. The foundation’s fundraising and spending activities are now under federal investigation.
This is just the latest act in government efforts to increase the financial accountability of foundations and other nonprofits, including many grantmaking organizations with cultural programs as well as museums, dance companies, and theaters. In 2003, the House and Senate passed proposals that would create tax incentives to spur charitable donations, but also would force foundations to increase the amount they give away each year as a percentage of their assets. The legislation was widely viewed as spillover from congressional efforts to tighten regulations of the for-profit sector.
After these proposals stalled in Congress, New York State Attorney General Eliot Spitzer appealed to the statehouse to introduce legislation for nonprofits similar to the Sarbanes-Oxley Act, which Congress passed in 2002 in the wake of Enron and other corporate accounting scandals. The legislation passed in different versions in New York’s State Senate and Assembly, but remains in committee. If it becomes law, it would affect most of the city’s foundations and larger nonprofits.
Sarbanes-Oxley applies to publicly traded companies and their auditors, and is designed to protect the interest of the shareholding public. The proposed nonprofit reforms ostensibly would protect the interests of private, government, and corporate donors. After press reports about nonprofit mismanagement, there is some evidence that donor faith has eroded. According to Charity Navigator, a watchdog group, 42 percent of Americans now say they have less confidence in charities than they did before 9/11. In announcing the legislation last January, Spitzer argued for the need “to ensure the integrity of this sector or else people’s contributions will decline.” The legislation would require nonprofits to certify their financial data, appoint audit and executive committees, and demonstrate that members of these committees are free of contracting relationships with the nonprofits they serve.
But while Spitzer cites a “crisis of accountability” in the nonprofit sector, many perceive excessive zeal on the part of a man who has gained power and fame as the state’s top-cop. “There is some flaky management [in the nonprofit sector],” says Norma Munn, chair of the New York City Arts Coalition. “Some very talented managers have less accounting knowledge than is needed when they are in jobs where they have to take on every task. But I have only encountered one instance of dishonest management.” As director of an artists’ credit union, Munn cites extensive experience in certifying the financial records of nonprofits. “The proposed state legislation sets up further regulating apparatus for which I don’t see a need—I don’t see problems, don’t hear about problems, and don’t perceive problems in my dealings with nonprofit groups.”
Spitzer’s supporters argue that, while most nonprofits operate within the boundaries, some engage in questionable accounting practices that the public would find inappropriate. “After Sarbanes-Oxley and the attention being given to the financial dealings of for-profits, we anticipated that this would happen,” says Jonathan Small, executive director of the Nonprofit Coordinating Committee of New York (NPCC), an umbrella organization with 1,200 member groups. “Rather than attacking the proposal wholesale, as some were urging us to do—saying that the nonprofit sector is already regulated enough—we felt that it would be wise to comment on the proposal, and try to shape it in a constructive way.”
Some nonprofits have very large boards, and some members of those boards may take only occasional interest in management practices. The proposed legislation seeks to create smaller numbers of individuals who feel greater responsibility for the governance of the organization. It would mandate the creation of audit committees or require that nonprofits change their by-laws to have full boards serve as such. It also would require the creation of executive committees when there are more than 25 board members.
Nonprofits already go through many layers of financial review—for their own auditors, the auditors of grantmaking organizations, the IRS, and annual reports. Some argue that further review would prove too burdensome on organizations in which resources are often stretched thin. Originally, the proposed legislation would have required verification of financial information for organizations with annual revenues in excess of $250,000, but after comment from the Nonprofit Coordinating Committee of New York and others the ceiling was raised to apply to groups with annual revenues over $1 million or assets over $3 million.
“Our concern was that nonprofits that already have adequate procedures in place to certify their financial controls will—because of their concern to abide by new regulations—spend extra money to do further review, hire experts, and thus divert money from their programs,” says Small. “We were concerned that the cost-benefit of this may not be worth it.”
The legislation would strengthen regulations relating to interested party transactions, or transactions between a nonprofit and a director doing business with a nonprofit. A statement on the Nonprofit Coordinating Committee website expressing support for this regulation points to such transactions as “the area in which the worst nonprofit board conduct occurs.”
“Say a board member sees that a nonprofit needs to rent some office space, and says that he has some available for $35 a square foot,” Small explains. “The nonprofit director might think, â€He says that’s a good price, he’s a good person, let’s take it.’ But maybe it isn’t a good price, and the nonprofit has been taken advantage of. This legislation gives the attorney general the ability to ask the board for evidence that the transaction was â€fair and reasonable’ and to overturn it if it isn’t.” Under current regulations, if a board approves an interested party transaction, it’s very difficult for the attorney general to overturn it.
But some argue that this regulation will have a chilling effect on board development. “The interested party regulation seems to offer the possibility that relations between personal donors on boards and organizations will be viewed as suspect,” Munn says. “This has the potential to scare away board members.” In the still-tough fundraising environment, strong boards are crucial to the stability and long-term planning of nonprofits. Particularly for arts groups, board members often bring much-needed financial or legal expertise.
Given the fact that Albany lawmakers may not be inclined to do Spitzer’s bidding, there may not be action on this legislation in the near future. But the threat of action already has spurred change. In February, Independent Sector, a national coalition of nonprofit organizations and foundations, released a code of ethics to its members as a model for members in their governance and operations. Many groups have adopted versions of the code.
And, though foundation executives and nonprofit directors argue that further regulation of their sector is not needed, they acknowledge that they need to do a better job of explaining their financial realities and management practices, and the benefits they offer, to the public. Arts groups can draw on a decade of research—undertaken since the culture wars put culture on the defensive—showing that the arts reaps significant tangible rewards to communities and local economies.