On February 2, 2007, the Internal Revenue Service released a summary entitled “Good Governance Practices for 501(c)(3) Organizations.” In an informal presentation by Marv Friedlander of the IRS National Office to members of the IRS Tax- Exempt Government Entities Council, Mr. Friedlander distributed the new guidelines. While acknowledging that the guidelines do not have the force of law, the IRS’s position is that charitable organizations that adopt these practices will be more likely to succeed in achieving their stated exempt purposes and in attracting public support. In his presentation, Mr. Friedlander used what he described as the “bowling analogy,” i.e., if the form is right, the pins should go down. Presumably, such guidelines will facilitate the receipt of IRS determination letters for newly-formed organizations seeking recognition of exempt status, and may also be benefi cial to charitable organizations undergoing an audit. While bond rating agencies have not yet weighed in on the new guidelines, it is reasonable to anticipate that such agencies may add part or all of the guidelines’ substance to their standard inquiries in connection with due diligence for bond fi nancing transactions.
The guidelines first address the issue of board size, observing that problems may arise with boards that are either very small or those that are very large. The IRS’s position on this refl ects a more fl exible approach when compared to the stances taken by certain other groups in recent years, with some of those groups advocating an outright cap on board size.
The guidelines go on to cover a wide range of governance issues, including the following:
- Mission Statement
- Code of Ethics and Whistleblower Policies
- Due Diligence
- Duty of Loyalty
- Fundraising Policy
- Financial Audits
- Compensation Practices
- Document Retention Policy
We have included a copy of the guidelines, but offer a few observations.
First, in several respects, the guidelines tread on territory that historically has been the purview of state corporate laws and within the oversight of state charity offi cials, rather than the IRS.
Second, in discussing the need for transparency, Mr. Friedlander noted that organizations may enhance their credibility by “showing the warts” to external audiences, and presumably will be more effective at addressing defi ciencies if they are exposed for analysis and discussion. In this regard, the guidelines state that a charitable organization’s Form 990, annual reports, and fi nancial statements should be posted on the organization’s website. This goes well beyond the public inspection and disclosure requirements for exemption applications and annual information returns under current law.
Third, on the topic of fi nancial audits, the guidelines emphasize the need for a charitable organization’s board of directors to receive regular fi nance and audit committee reports, and that an independent audit committee be charged with the task of selecting and overseeing the independent auditor. This of course suggests that charitable organizations that do not already have a designated “audit committee” ought to establish one, whether as an expansion of the tasks of an existing fi nance committee or as a separate body. The guidelines also suggest that organizations change their auditing fi rm periodically (such as every fi ve years). This latter suggestion may catch many organizations by surprise, since it goes beyond the Sarbanes-Oxley standard for public companies, which mandates only a periodic change in the audit partner.
Fourth, arguably the most eyebrow-raising aspect of the guidelines, is the statement that charities generally should not compensate board members except to reimburse direct expenses for their service. This statement represents a substantial leap from historic conventional wisdom, i.e., that directors may be paid for their services at fair market value. While it is true that the majority of charitable organizations even today do not compensate board members for their services, a signifi cant number do, for example, provide fi xed stipends for each meeting, a practice that would appear to be inconsistent with the new guidelines. Moreover, for particularly large and complex charitable organizations, the payment of reasonable compensation may be the most effective means of attracting to the board table the types of highly-qualifi ed and experienced individuals required for the task.
Perhaps for this reason, the guidelines go on to provide that, if an organization is going to compensate its directors, that decision should be made “by a committee composed of persons who are not compensated by the charity and have no fi nancial interest in the determination.” This would appear to contemplate a “super-board” of sorts, effectively a group of persons who are not themselves directors but have some sort of authority to determine whether the services being provided by directors to an organization are worthy of compensation and therefore refl ect an appropriate use of the organization’s charitable assets. The guidelines do not offer any supporting authority for this position. Moreover, such a “super-board” may be of questionable validity under the nonstock and/or nonprofi t corporation statutes of many states’ laws.
The boards of all charitable organizations should be encouraged to review the new IRS guidelines and consider implementing some or all of the suggested practices. For the reasons set forth above and others, many charitable organizations undoubtedly will fi nd that certain of the guidelines are not effective or workable for their particular circumstances. Even those organizations may be well-served by having a dialogue about the recommendations and documenting that fact.