Nonprofit Integrity Act Comes to California: Will Nation Follow?

Nonprofit Integrity Act Comes to California: Will Nation Follow?

Article posted in Legislative on 28 October 2004| 5 comments
audience: National Publication | last updated: 18 May 2011
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Summary

During the past few years corporate and nonprofit management and financial scandals have been at the top of the news. In the wake of federal Sarbanes-Oxley legislation, California has enacted a new law to bring increased accountability to nonprofits and commercial fundraisers doing business in California. PGDC received two independently authored commentaries on the new law from Lynda S. Moerschbaecher, Esq. and Jill S. Dodd, Esq. They complemented one another so well, we have combined them for this report.

by Lynda S. Moerschbaecher, Esq.

In the last few years in both corporations and nonprofits, financial scandals have rocked their worlds and made headlines for all to read. This caused observers to wonder where the oversight is that boards of directors are required to fulfill in carrying out their fiduciary obligations to the corporate entity. While management of both for profit and nonprofit entities do not want to be hog tied by boards that persist in involving themselves in daily operations, the other end of the spectrum may be worse for the public-passive, uninquiring boards from whom unpleasant facts can easily be dissimulated.

In 2002 the Sarbanes-Oxley legislation brought in the most sweeping changes since 1933 and a new regime of financial and accounting standards for federally regulated corporate issuers of securities. Since this federal legislation was passed, the nonprofit world has felt the shockwave of Sarbanes-Oxley. As the shockwave passed through the businesses of their boards, members, professional advisors and CPAs, these constituents of the nonprofits have asked how this will be applied to the nonprofit world. As to California, we got the first taste of it with the Nonprofit Integrity Act passed in September 2004, with an effective date of January 1, 2005. But this may be just the beginning.

Even before the passage of this Act, nonprofit directors, management, advisors and umbrella associations began looking inward at the industry with the hope that it could come to grips with potential abuses and scandals to devise industry self-regulation and stave off government rules and restrictions. Buzzwords abounded, the most used of which were "best practices" and "financial transparency." Industry action did not follow quickly enough, however.

The first state to propose Sarbanes-Oxley type legislation for nonprofits was New York where Attorney General Elliot Spitzer led the cause. As would later occur in California, nonprofits in New York reacted, complaining that the rules would be too onerous and costly for organizations already strapped for money, staff, and volunteer time. If independent audit committees were required, where would the nonprofit find yet more talented individuals to volunteer countless hours to serve on an audit committee and oversee the auditors? For most nonprofits, it is difficult enough to find good, reliable board members who will devote sufficient time to board meetings.

If new audit committee members needed the qualifications of expertise required by Sarbanes-Oxley, and had to take on the legal liability required under that law, the nonprofit world quickly responded that qualified individuals would not likely voluntarily serve. Attorney General Spitzer in New York was proposing that organizations with annual revenues of $500,000 would be required to have independents audit each year and the first version of the California Nonprofit Integrity Act would have lowered that threshold to $250,000. Far too many small organizations would have been ensnared in onerous requirements.

Additionally, this past summer Senators Grassley and Baucus and the Senate Finance Committee held hearings to ensure that charities "keep their trust with the American people" according to Senator Grassley. The Senate and the IRS produced different drafts of proposed reforms designed to prevent private individuals from lining their pockets and setting up charities to evade taxes, among other perceived abuses. They are promising federal legislation to correct what they believe to be sloppy or lax practices. In this regard Senator Grassley has said that some charities are blinded by their own mission and the need for dollars and others, even big-named ones seem to just have the wheels fall off.

Any new federal legislation that results will be in addition to our new state legislation in California, and at this point, no one knows how other state's legislation may affect California-based nonprofits doing business elsewhere in the nation and the world. So we are truly at the beginning of a new era (no bad pun intended re New Era, one of the charities accused of abuses) for nonprofit governance and accounting.

The author of the new Nonprofit Integrity Act, S.B. 1262, Senator Byron Sher (D.-Stanford) and the bill's sponsor, Attorney General Bill Lockyer, hope to minimize nonprofit accounting scandals and incidents of abuse by some commercial fundraising outfits. The California Association of Nonprofits has published on its website commentary, including its opposition to the new law, stating that it believed nonprofit integrity should be based on a comprehensive examination of issues by all stakeholders in the industry. It has also stated that "[W]e remain concerned that SB 1262 sets a dangerous precedent, detailing the composition and operations of nonprofit boards of directors, dictating the contents of contracts, and establishing government mandates for practices that are best left to the discretion of individual organizations."

Upon signing the bill into law, Governor Schwarzenegger gave this message to the members of the California State Senate:

"I am signing Senate Bill 1262 with the understanding that while I support transparency, accountability and curbing unscrupulous activities, I encourage the Legislature to ensure the non-profit community is not subjected to needless bureaucracy thereby potentially hampering the work and contribution made by non-profits who are serving California communities in need...Therefore, if this bill results in unnecessary expense to the non-profit community I encourage the Legislature to revisit this issue."

We are only at the beginning of this type of legislation statewide and federally. The Nonprofit Integrity Act is not the sweeping, overarching legislation that Sarbanes-Oxley is, but it is quite significant in its mandates. The new law fairly breaks into two subjects--financial reporting and governance, and charitable fundraising regulation.

The following is a summary of the most important provisions of the new law.

Summary of California Nonprofit Integrity Act of 2004:

by Jill S. Dodd, Esq.

Following is a summary of the Nonprofit Integrity Act of 2004, which was recently signed into law by the Governor of the State of California. The Act takes effect on January 1, 2005.

Organizations Covered by the Act

Charitable corporations, charitable trusts, charitable unincorporated associations, commercial fundraisers, and fundraising counsel. Charitable remainder trusts are covered by the Act only upon the termination of the income interest. Hospitals, educational institutions and religious organizations are not subject to the Act.

Charitable Corporations, Associations and Trusts with Gross Revenues of $2 Million or More

Charitable corporations, charitable unincorporated associations, and charitable trusts that receive or accrue gross revenue of $2 million or more in any fiscal year are subject to the requirements described below. Government grants and contracts for services with governmental entities do not count toward the $2 million threshold, so long as the governmental entity requires an accounting of the funds as a grant or contract condition.

Financial Statements

  • Annual financial statements must be prepared using generally accepted accounting principles.
  • Annual auditing of financial statements is required to be made by an independent certified public accountant in conformity with generally accepted auditing standards.
  • In the case of a charitable corporation or a charitable unincorporated association that is controlled by another organization, the controlling organization may prepare a consolidated financial statement meeting the above requirements.

Auditing Firm

  • The auditing firm may provide nonaudit services to the charitable organization, but may only do so in accordance with standards for auditor independence set forth in the Government Auditing Standards, issued by the U.S. Comptroller General (the Yellow Book).

Disclosure

  • The audited financial statements must be made available for inspection by the Attorney General and the public, no later than nine months after the close of the fiscal year to which the statements relate, in the manner prescribed for the disclosure of IRS Form 990.

Audit Committee (Charitable Corporations Only)

  • In the case of charitable corporations, there must be an audit committee appointed by the board of directors. Audit committee members may include directors or other persons, but cannot consist of any staff (including the president or CEO, or the treasurer or CFO). Audit committee members may not receive any compensation for service (other than stipends as directors). Further, they may not have any material financial interest in any entity doing business with the corporation.
  • The audit committee has responsibility for: recommending to the board the retention and termination of the independent auditor; conferring with the auditor to ensure that the financial affairs of the corporation are in order; reviewing and determining whether to accept the audit; assuring that any nonaudit services performed by the auditing firm conform to standards for independence; and approving performance of nonaudit services by the auditing firm.
  • If there is a finance committee, some overlapping of membership may occur, so long as members of the finance committee constitute less than 50% of the membership of the audit committee. Moreover, the chair of the audit committee is precluded from serving on the finance committee.

All Charitable Corporations, Associations and Trusts (Regardless of Gross Revenue)

  • All charitable corporations, charitable unincorporated associations, and charitable trusts must comply with the following requirements, regardless of their revenue levels.

Financial Statements

  • If a charitable corporation, unincorporated association, or trust prepares financial statements that are audited by a certified public accountant, the financial statements are subject to inspection by the Attorney General and the public, even if its annual gross revenue is below $2 million.

Officer Compensation

  • Reviews are required to make sure that the compensation (including benefits) paid to the president (or CEO) and the treasurer (or CFO) is reasonable.
  • Reviews are required on hiring and whenever the officer's employment is renewed or extended or the officer's compensation is modified, except for compensation modifications that extend to substantially all employees.
  • Reviews are to be conducted by the board of directors or a board committee (in the case of charitable corporations or unincorporated associations) or by the trustees (in the case of charitable trusts).

Registration

  • Charitable corporations, unincorporated associations, and trusts must register with the Attorney General within 30 days (instead of six months under prior law) after they first acquire or accrue assets.

Contracts with Commercial Fundraisers and Fundraising Counsel

  • Each contract between a charitable corporation, unincorporated association, or trust and a commercial fundraiser must be in writing and signed by an official authorized by the governing board of directors (or trustees). The contract must include: (a) the legal name and address of the charitable organization; (b) a statement of the charitable purpose for which the solicitation campaign, event, or service is being conducted; (c) a statement of the respective obligations of the commercial fundraiser and the charitable organization; (d) if the commercial fundraiser is to be paid a fixed fee, a statement of the fee to be paid to the commercial fundraiser and a good faith estimate of what percentage the fee will constitute of the total contributions received; (e) if a percentage fee is to be paid to the commercial fundraiser, a statement of the percentage of the total contributions received that will be remitted to or retained by the charitable organization, or, if the solicitation involves the sale of goods or services or the sale of admissions to a fundraising event, the percentage of the purchase price that will be remitted to the charitable organization; (f) the effective and termination dates of the contract and the date solicitation activity is to commence in California; (g) a provision that requires that each contribution in the control or custody of the commercial fundraiser shall be either delivered to the charitable organization or deposited to a bank account over which the charitable organization has sole control, in either case within five days of receipt; (h) a statement that the charitable organization exercises control and approval over the content and frequency of any solicitation; (i) if the commercial fundraiser proposes to make any payment in cash or in kind to any person or legal entity to secure any person's attendance at, or sponsorship, approval, or endorsement of, a charity fundraising event, the maximum dollar amount of those payments must be specified in the contract; and (j) a provision that the charitable organization has the right to cancel the contract without cost, penalty, or liability within ten days after the contract is signed, or cancel with thirty days notice after the initial ten-day period, or cancel for cause at any time after the initial ten-day period.
  • Each contract between a charitable corporation, unincorporated association, or trust and a "fundraising counsel" must be in writing and signed by an official authorized by the governing board of directors (or trustees). The contract must include provisions similar to those described above for contracts with commercial fundraisers. A fundraising counsel is a consultant who plans campaigns but does not itself raise money. The term "fundraising counsel" does not include employees, directors or trustees of the charity, nor its attorneys, bankers and investment counselors. In addition, there is a de minimus exception for a fundraising counsel whose total annual gross compensation does not exceed $25,000.
  • A charitable organization may cancel a contract with a commercial fundraiser or a fundraising counsel as described in clause (j) above. If a charitable organization cancels a contract during the initial ten-day period, a copy of that cancellation notice must be provided to the Attorney General.
  • A contract between a charitable organization and either a commercial fundraiser or fundraising counsel is voidable by the charity unless the commercial fundraiser or fundraising counsel is registered with the Attorney General's Registry of Charitable Trusts prior to the commencement of the solicitation.

Charitable Solicitation

  • A charitable organization may not enter into a contract with commercial fundraiser unless the latter has registered, or agreed to register prior to commencing solicitation, with the Attorney General.
  • The charitable organization and the commercial fundraiser cannot misrepresent the purpose of the charitable organization or the nature or purpose or beneficiary of a solicitation.
  • The charitable organization must establish and exercise control over the fundraising activities conducted for its benefit, including approval of all written contracts and agreements, and must assure that fundraising activities are conducted without coercion.
  • No representation may be made to the effect that a contribution is to or for the benefit of a particular charitable organization when that is not the case.
  • No representation may be made to the effect that the person on whose behalf a solicitation or charitable sales promotion is being conducted is a charitable organization or that the proceeds of the solicitation or charitable sales promotion will be used for charitable purposes when that is not the case.
  • No representation may be made to the effect that any other person sponsors, endorses, or approves a charitable solicitation or charitable sales promotion when that person has not given consent in writing to the use of the person's name for such purposes.
  • No representation may be made to the effect that goods or services have endorsement, sponsorship, approval, characteristics, ingredients, uses, benefits, or qualities that they do not have or that a person has endorsement, sponsorship, approval, status, or affiliation that the person does not have.
  • No representation may be made to the effect that the Attorney General has approved the solicitation.
  • No representation may be made to the effect that a charitable organization will receive an amount greater than the actual net proceeds reasonably estimated to be retained by the charity for its use.
  • No representation may be made to the effect that any part of the contributions will be given or donated to any other charitable organization unless that organization has consented in writing to the use of its name prior to the solicitation.

Commercial Fundraisers

  • Commercial fundraisers must register and file annual reports with the Attorney General.
  • Commercial fundraisers may raise funds for only those charitable organizations that are registered with the Attorney General (or are exempt from the registration requirement).
  • Commercial fundraisers must notify the Attorney General at least ten days in advance of a solicitation campaign for charitable purposes (except in cases of disasters or emergencies). The notice must include: (a) the name, address, and telephone number of the charitable organization; (b) the name, address, and telephone number of the commercial fundraiser; (c) the fundraising methods to be used; (d) the projected dates when performance under the contract will commence and terminate; and (e) the name, address, and telephone number of the person responsible for directing and supervising the work of the commercial fundraiser under the contract.
  • If requested by a solicited person, a commercial fundraiser must disclose the percentage of the total expenses of the fundraiser to the total revenue received by the fundraiser. If the request is made in writing, the commercial fundraiser must disclose in writing within five days. Disclosure must be made immediately if verbally requested, followed in writing within five days.
  • Commercial fundraisers must maintain records relating to solicitation campaigns for ten years after the end of each campaign. Records are subject to inspection by the Attorney General.

Fundraising Counsel

  • Fundraising counsel must register and file annual reports with the Attorney General.
  • Fundraising counsel must notify the Attorney General at least ten days in advance of a solicitation campaign for charitable purposes (except in cases of disasters or emergencies). The notice must include: (a) the name, address, and telephone number of the charitable organization; (b) the name, address, and telephone number of the fundraising counsel; (c) the projected dates when performance under the contract will commence and terminate; and (d) the name, address, and telephone number of the person responsible for directing and supervising the work of the fundraising counsel under the contract.

Penalties for Non-Compliance

  • Failure to comply with the annual reporting and annual registration renewal requirements generally result in late fees being imposed.
  • Failures to comply with the other requirements could result in civil penalties (up to $1,000 on the first offense and up to $2,500 on each subsequent offense).
  • In addition to civil penalties, commercial fundraisers who fail to register, renew the registration, file the annual reports, or disclose the percentage of the total expenses to the total revenue received could be barred from fundraising in California.

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Comments

Fundraising counsel from outside of California

How will this apply to fundraising counsel who are based in another state, but are doing work in California?

Note to Hospitals and Educational Organizations

The statement made above that xc2xbfhospitals, educational institutions and religious organizations are not subject to the Actxc2xbf is a little overbroad. It appears that certain charities that are otherwise exempt from Attorney General registration and reporting requirements, including hospitals and educational institutions, are nevertheless subject to certain parts of the new Nonprofit Integrity Act. The key language is in Government Code Section 12583, which provides that the "filing, registration, and reporting provisions of this article do not apply to . . .a charitable corporation or unincorporated association organized and operated primarily as a . . .educational institution, hospital. . .". This language has always exempted hospitals and educational institutions from the registration and annual reporting requirements with the Attorney General. The requirements in the Nonprofit Integrity Act regarding financial audits, disclosure of audited statements, and audit committees explicitly apply only to entities required to file reports with the Attorney General; thus hospitals and educational institutions are exempt (Section 12586(e) and (f)). However, the compensation review requirement (Section 12586(g)) is not "a filing, registration, and reporting provision", and is not limited only to entities required to file with the Attorney General. Thus, the exemption of Section 12583 does not apply to this requirement. Similarly, the parts of the fundraising provisions of the Act that apply to charities do not involve "filing, registration, or reporting provisions"; thus, hospitals and educational institutions are subject to these provisions as well.

CA Nonprofit Integrity Act

A comment on the ASAE Executive Digest indicates that if a non-profit holds an annual meeting or convention in CA, it becomes subject to the CA NonProfit Integrity Act and must file and fully comply with the provisions. From what I have read our organization would be fully compliant but it seems outside the jurisdiction of CA to apply a law to an organization that is simply holding a meeting within its borders. Is the person that posted this interpretation reading something into the law that is not there or is this a correct interpretation. We are holding our Annual Conference in San Diego in September and thus would need to know if there is some legal obligation that attaches. Thanks for your assistance.

CA Nonprofit Integrity Act and out of state FR

My take is that you are required to register and follow the rules of the new law. It states thata "commercial fundraiser for charitable purposes" is an individual (or any legal entity) who for compensation solicits funds, assets or property in this state for charitable purposes, receives or controls such solicited funds or who employs any compensated person to do those things. There are some exemptions. You should go to www.leginfo.ca.gov and pull it up. Lynda

CA NP Integrity Act

The prior comment was to Doug, and this is to Robert. Please see the prior comment. I don't think incorporating in Delaware or elsewhere is the issue. If you come into California and act as paid fundraiser, or receive or control those funds from CA, it seems to say you are in fact governed by this law. Check out the language yourself at the site I listed.

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