By Jay Dismukes, Simon Eskow and Kate Prouty

Eliot Spitzer’s bid to bring stronger governance oversight to the not-for-profit sector is viewed by many as a good step in the right direction, but some fear the state attorney general’s proposed legislation could jeopardize board volunteerism and strain the resources and capabilities of many of New York’s nonprofit organizations.

First introduced in January at a New York State Society of CPAs conference, Spitzer’s proposal imposes Sarbanes-Oxley–style regulations on the not-for-profit community in an effort to raise the bar of accountability and safeguard the sector’s substantial asset base, the second largest in the country behind California. Since that time the proposal has been the focus of several industry-wide discussions with the New York State Charities Bureau of the attorney general’s office, which has led to two formal responses by the Society.

In April, Sen. Vincent L. Leibell III introduced the legislation to the New York State Senate, where it was amended in June. The amended legislation, S4836-A, requires that not-for-profits, other than private foundations, with annual gross revenues less than $1 million and total assets less than $3 million verify that the annual report “fairly presents” the financial condition of the corporation. More-comprehensive verification requirements would affect nonprofits with annual gross revenues of at least $1 million or at least $3 million in assets.

For nonprofit entities (excluding private foundations and Type A corporations that do not register with the attorney general) that meet this second threshold, raised from an original proposal of $250,000 or more in gross revenues, S4836-A applies strict financial reporting standards. Among other provisions, these standards would require the president or CEO and the treasurer or CFO to certify the accuracy and validity of the annual report as well as the adequacy of the internal controls. The legislation also would tighten the reins on interested-party contracts and board compensation.

The establishment of an executive committee with three or more board members would be required of entities with boards of more than 25 directors. For nonprofits that meet the second threshold, or whose financial statements are audited by a public accountant, the legislation would mandate the establishment of an audit committee of three or more board members who lack any business ties to the organization. (State law currently requires that nonprofit organizations with revenues over $250,000 must file audited financial statements.)

The Need

The not-for-profit community is big business. According to 2003 data from the National Center for Charitable Statistics, there are 89,625 registered nonprofit organizations in New York state, with gross receipts of $219 billion and assets of $241 billion. Of those registered, 52,220 are public charities, with gross receipts of $135 billion and assets of $137 billion.

The corporate scandals that have shaken the foundation of the for-profit world have exposed the vulnerability of the not-for-profit sector, which has fewer checks and balances, thus leading to a demand for increased oversight and filings that are complete and accurate.

“Over the years, the general atmosphere toward nonprofits by the general public has evolved, and one of the ways it has evolved is a demand for more accountability,” said John E. Henley, executive director of Elmcrest Children’s Center in Syracuse, a 160-year-old child welfare organization. “I think people are wanting to know what is going on with not-for-profit dollars and I think that is all good…I think it is appropriate to put the highest levels of scrutiny on how charitable and voluntary dollars are being used.”

From an auditor’s point of view, the idea behind the legislation makes a lot of sense, according to NYSSCPA Not-for-Profit Organizations Committee Chair David Ashenfarb. Some CPAs feel nonprofits should have to make disclosures and be held accountable for financial reports in ways similar to Fortune 500s, he speculated. In that respect, the legislation appears to be a logical trickle-down from the Sarbanes-Oxley Act, applying to nonprofits the same responsibilities that for-profits now bear. By making board members sign off on reports, the legislation would “redefin(e) that they are responsible,” Ashenfarb said.

An added benefit of S4836-A is the donor’s enhanced comfort level in contributing funds to an organization. Ashenfarb points out that the legislation could give donors more comfort that their donations are being properly used.

Syracuse CPA Mark Hettler, whose firm has 100 nonprofit clients, including Elmcrest, also believes there is a need for legislation, but he believes it should be in a “tempered format” from the bill that currently exists. Similarly, Doug Sauer, executive director for the Council of Community Services, which provides support for more than a thousand small-to-medium-sized charities and nonprofits, says that while his organization supports much of what Spitzer seeks to remedy, the legislation could be better tailored in the context of today’s nonprofit environment.

Sauer said there is no doubt of the need for regulation, but pointed to crucial issues the Council wants to see addressed first. These include beefing up the understaffed and underfunded Charities Bureau to enforce existing laws, raising the minimum number of people mandated to establish a nonprofit board of directors from three to seven or more, and eliminating compensation for directors, all of which the Council believes could help tackle “self-dealing” and conflicts of interest.

Former NYSSCPA Vice President Allen L. Fetterman said he believes the financial reporting debacles of the last several years have demonstrated the importance of greater government oversight, but he thinks that the legislation should be limited to nonprofit organizations that solicit and receive contributions from the public.

Society board member Raymond P. Jones, a partner with Watson Rice LLP in New York City, which consults for many nonprofit organizations, said he could understand the rationale for the legislation, because nonprofits have the same potential for abuse as for-profit companies.

“Most prudent folks know that eventually whatever happens in for-profit, some of that will trickle down,” said Jones, referring to the Sarbanes-Oxley Act, which serves as a model for Spitzer’s bill.

A Preponderance of Evidence?

Though few, if any, would argue that the nonprofit community is immune from the financial reporting problems that have plagued major corporations, those interviewed either had not seen or did not believe there were a significant number of instances of fraud within the sector. Though they receive complaints of alleged fraudulent activity, the attorney general’s office does not maintain a comprehensive database of such instances, a representative from the office said.

According to Sauer, the potential for abuse is the exception, not the rule.

“Only 2 to 3 percent of these organizations have gross fraud issues,” Sauer said. “Many others may make mistakes, but they’re not defrauding…We’re in a situation where a lot of abuses happen in larger agencies where there is a lot of money and a lot of interests.”

Fetterman commented that his firm, Manhattan-based Loeb & Troeper, which represents 600 nonprofit clients, has in the last few years uncovered more instances of defalcation, but usually in small amounts, and has seen very little fraudulent financial reporting.

Ashenfarb, a partner with Schall & Ashenfarb CPAs LLC in New York City, acknowledges that nonprofit fraud exists and believes that if the legislation passes, boards and managers would have greater opportunity to enhance their internal control structures.

Hettler, a partner with Fagliarone Group CPAs P.C., pointed out that because of the nature of nonprofits and the public funding they receive, problems that do arise tend to receive a great deal of attention even though they may concern a relatively small amount of money.

The Heart of the Matter

Volunteers Wanted

“I think the flip side of this whole thing is, how difficult is it going to be to attract good people to the boards with these levels of scrutiny,” Henley said. “Probably a lot of directors of boards of voluntary agencies or other kinds of entities aren’t that aware of the ins and outs of the financial structures and runnings…Are good people going to shy away from the responsibility?”

Henley’s question is a frequently asked one that almost always seems to have the same answer, despite the absence of any hard-and-fast data to back it up.

In his view, Hettler believes the legislation would discourage board participation, especially individuals in leadership roles, because of what they would be asked to attest to.

He noted that by having the president and treasurer sign off on the sufficiency of the internal controls, they would be given a more hands-on role, interacting more with auditors and brought into more of the daily routine of the nonprofit. The extra time that could be involved, which could present additional audit costs for nonprofits, also may deter individuals from serving, Hettler said.

“I think if people look at this in terms of ‘I am now signing a certification saying that I have looked at this’ and this could come back to haunt them, I think it’s going to bother them. If not financially, then psychologically,” Hettler observed.

According to Sauer, for some organizations in the nonprofit sector, the kind of abuses that invite stricter regulation happen where there are more resources at play and the stakes are much higher than the $3 million assets threshold Spitzer seeks. Such organizations account for only a small percentage of the total number of registered nonprofits in the state, and the fear among those working with organizations that run on shoestring budgets with skeleton crews, is that new statutory obligations will become too expensive, too burdensome and so overwrought that they would chase away the volunteers who might otherwise serve on a board of directors.

Although a decrease in board volunteerism is a potential burden from this legislation, Ashenfarb said there is no way to know how likely it is. Regardless of the legislation, everything in today’s news about increased board responsibility for nonprofits and for-profits alike could be said to contribute to a decline of this nature, he pointed out.
Fetterman said he also believes the legislation could hinder board volunteerism.

Big Shoes to Fill

Organizations with “shoestring budgets” and “skeleton crews” raise another major concern with S4836-A: the revenue and assets threshold figures are still too low and would impact a significant number of nonprofits that are not sophisticated enough or large enough to readily meet the bill’s requirements.

Ashenfarb said small nonprofits would have a very difficult time identifying weaknesses within their internal controls before an audit starts.

“They simply do not have the skills to determine these weaknesses prior to the audit,” he said.
Sauer’s remarks bolstered Ashenfarb’s claim.

“How does a board president or an executive who is a bachelor-level social worker attest that their internal controls are up to snuff?” Sauer asked. “That forces digging up more money, either for staff to do it, or for an auditor.”

Small nonprofits that lack board members or management with sophisticated financial acumen would have to seek assistance, possibly in the form of an independent CPA, to develop the abilities and knowledge that is necessary to carry out the proposed regulations, Fetterman said. He added that it is not unheard of to have boards of small nonprofits comprised of as few as three directors.

In Hettler’s view, the board members, regardless of their background, could grasp the overall idea of the legislation, but some of the details would present difficult challenges.

“I don’t think it’s a bad thing that people have education, and certainly the boards do need to be educated about what goes on with the entities,” Hettler said. “I just think some of this might be a little bit of overkill in terms of having them sign off specifically for this.”

In contrast to a small nonprofit that lacks financial expertise or an existing structure, Elmcrest, the Syracuse child welfare organization, has a $12 million budget, 270 employees, 30 seats for its board of directors, and a finance committee led by a CPA director that reviews statements on a monthly basis and has an ongoing relationship with its auditors. For these reasons, Henley said he does not foresee the legislation putting much additional time, strain or cost on Elmcrest, unlike certain small agencies that do not have financially savvy board members or professional staffs that can carry out certain financial functions.

“We have enough mass and enough competence to present these statements…For us the structure is already there,” said Henley of the legislation’s impact on Elmcrest. “…I wouldn’t see what we’d actually be doing differently.”

Henley did note, however, that if the proposal went into effect, board members would still need some level of training on the specific requirements.

Education and Awareness

Ashenfarb and Hettler both said they have made their clients aware of Spitzer’s proposal by sending letters to them about the details and ongoing developments with the legislation. The nonprofits that have high-profile auditors are more likely to be versed in S4836-A, Ashenfarb added. Fetterman has taken similar steps, holding face-to-face meetings with his clients on the proposal.

Henley added that it will be especially important that the “word gets out” to all agencies should the proposal continue to advance. Taking the time to explain the spirit and implications of the legislation could be particularly helpful to mitigating a drop-off in volunteerism, he said.

Because no one is certain what the final legislation will look like, Jones said it would be a little premature to go into specifics with his clients. In the meantime, he said it’s standard for his firm to emphasize internal controls as part of the firm’s audit process, telling directors to review things like statements and bank records before handing them over to bookkeepers.

Regardless of whether Spitzer’s legislation, or some form of it, comes to pass, individual and institutional actions like those taken by Jones’ firm to foster greater governance oversight are growing in significance and number in the nonprofit world. There appears to be universal support and emphasis on increased board education and participation.

Currently, “boards have the ultimate responsibility, but are very removed from actual day-to-day operations,” said Ashenfarb, quashing any illusions about a high level of participation by boards.

Representatives from the Council said the majority of the nonprofits it supports have staffs of 10 or less, with 10 to 15 directors, out of whom perhaps four to seven are active. To help members become more involved and familiar with their responsibilities, the Community Council engages in education initiatives. Three years ago, it joined a consortium of state agencies and service providers to instruct boards of directors in accountability, such as how to read an audit.

Efforts like these are crucial ones. Many members don’t know what internal controls are, the representatives said.
“What is really necessary is greater board involvement. The board should not just be a rubber stamp,” Fetterman said.

“The board needs to interact with the auditors and really develop an understanding of what their financial statements portray and how effective are the organization’s internal controls.”

To view the proposed legislation, go to www.nysscpa.org and click on S4836-A under the Gov’t Center banner.