Here are the 5 draft principles falling within the category of "Principles for Strong Financial Oversight" developed by the Panel on the Nonprofit Sector’s Advisory Committee on Self-Regulation of the Charitable Sector (note that today is the last day for public comment):
- The board of a charitable organization must institute policies and procedures to ensure that the organization and, if applicable, its subsidiaries, manages and invests its funds responsibly and prudently. The full board must review and approve the organization’s annual budget and should monitor actual performance against the budget.
- A charitable organization must keep complete and accurate financial records and should have a qualified, independent financial expert audit or review them annually in a manner appropriate to the organization’s size and scale of operations.
- A charitable organization must not provide loans (or the equivalent) to directors or trustees.
- A charitable organization must spend a reasonable percentage of its annual budget on programs in pursuance of its mission. An organization must also provide sufficient resources for effective administration of the organization, and, if the organization solicits contributions, for appropriate fundraising activities.
- A charitable organization must establish and implement policies that provide clear guidance on its rules for paying or reimbursing expenses incurred when 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.
Here are some of my observations:
- California nonprofit public benefit corporations must comply with Corporations Code Section 5240, which provides that with certain stated exceptions, in investing and managing the corporation’s investments, the board shall (a) avoid speculation, looking instead to the probable income, as well as the probable safety of the corporation’s capital, and (b) comply with additional standards, if any, imposed by the articles, bylaws or express terms of an instrument or agreement to which the assets were contributed to the corporation. While this does not appear precisely consistent with the modern prudent investor standard to which charitable organizations established as trusts in California are subject, it seems unlikely that the Attorney General would take action against the board of a nonprofit public benefit corporation that adheres to the modern prudent investor standard (where individual investments are assessed for appropriateness with regard to the whole portfolio of investments and not independently). Accordingly, having a portion of the corporation’s investments in a particular stock, which might by itself be speculative, may not be speculative if viewed as part of a diverse portfolio. Whether the portfolio is speculative depends on a number of factors outside the scope of this commentary. Boards of California religious corporations do not have the same standard of care with respect to investments; they must simply meet their duties of care and loyalty.
In managing an endowment fund, a charitable organization must comply with California’s Uniform Management of Institutional Funds Act (UMIFA), which governs how such funds must be invested (modern prudent investor standard) and how much the organization can spend and for what purposes.
Boards should approve the organization’s annual budget at a meeting before the start of the new fiscal year. The board must be educated to be able to determine whether the budget is appropriate in light of the circumstances. At minimum, the board must understand if the budget doesn’t balance (projected expenses are greater than projected revenues), why this is the case and how will the organization manage the shortfall.
Boards must also monitor performance against the budget. This involves, among other things, receiving and reviewing appropriate financial statements, asking questions where there are significant differences, and determining whether actions must be taken in light of changing circumstances.
- California law requires charitable organizations (other than educational institutions, religious organizations, cemeteries, hospitals, and licensed health care service plans) with gross revenues of $2 million or more to prepare annual financial statements audited by an independent CPA. The Panel is recommending a $1 million audit requirement threshold to be part of federal law which would preempt California law. The Panel is further recommending a $250,000 financial review threshold. Reviews and audits are costly, and boards of organizations that may become subject to such new requirements, if passed, should begin planning ahead and considering whether a review or audit already would be prudent. Smaller organizations should not discount the benefits of a financial review and should at minimum ensure that they have adequate systems and practices for the production of complete and accurate financial records.
- No brainer. While loans to directors may not be expressly prohibited if documented and subject to market rate interest, this just looks and smells bad. It is important to note that a charitable organization is not to be operated for private interests.
- This principle doesn’t appear to offer much guidance. A reasonable percentage of a charity’s annual budget must be spent on programs in pursuance of its mission, and a sufficient amount should be spent for effective administration and fundraising. What is a reasonable percentage? What is a sufficient amount? Of course, how such concepts are defined will depend on the specific facts and circumstances, and perhaps, such broad guidance is the only possible.
Beware of charities ratings services that base their evaluations solely on how rated charities reports their own numbers. Some comparisons may not be valid. For example, more sophisticated charities may know how to properly apportion certain shared expenses (like the E.D.’s salary) to program, administration and fundraising, while less sophisticated charities may simply book such expenses to administration. Newer organizations or those starting up a new program may book greater administration and fundraising costs in early years to build up capacity to run their programs effectively, efficiently and in compliance with the law. Accordingly, any comparisons to more mature organizations or other start-ups that overspend on programs at the expense of necessary administration and fundraising may not be fair.
- Boards should adopt written policies for payment or reimbursement of reasonable expenses to employees, volunteers, committee members, officers, and directors. They should determine what is reasonable within the standards of the organization and applicable law (not lavish or extravagant under the circumstances). The policies should cover travel expenses, entertainment expenses and other expenses where the individual makes personal use of the property involved (e.g., cell phone).
You can view the Advisory Committee’s Draft Principles for Strong Financial Oversight here.