IOWA GOVERNANCE PRINCIPLES The Davis Brown Law Firm

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1 Last Updated: January 2010 IOWA GOVERNANCE PRINCIPLES The Davis Brown Law Firm Table of Contents 1. The Sarbanes-Oxley Good Governance Principles 2. IRS Encourages Good Governance Policies 3. Good Governance Under Iowa Law 4. Resources Following revelations concerning the Enron and WorldCom scandals in , the issue of corporate governance rose to the top of the national agenda in the United States. To curb the practices that led to these and similar scandals by publicly held corporations, Congress enacted the Sarbanes-Oxley Act of Moreover, since nonprofit organizations also had their share of scandals involving conflicts of interest, self-dealing by insiders, excessive compensation and the like, several states have proposed laws to extend Sarbanes-Oxley-type provisions to nonprofit entities, with California being the first to actually enact such legislation and several other states doing so shortly after. Given this legal landscape, organizations devoted to positive social change should institute and maintain good governance practices, including transparent decision making, accurate financial reporting and accepted auditing practices. In the discussion below, we outline the good governance principles embodied in the Sarbanes-Oxley Act and in state legislation applicable to nonprofit social sector entities. 1. The Sarbanes-Oxley Good Governance Principles Except for provisions concerning document destruction and whistleblower protection, the governance provisions required by the Sarbanes-Oxley Act apply only to public companies and thus do not apply to nonprofit social sector organizations. Nevertheless, the reforms prescribed by the Act have become the de facto standard for the governance of all entities. Consequently, most social sector entities, both for-profit and nonprofit, are voluntarily incorporating Sarbanes-Oxley principles into their own governance structures as a way of instilling confidence and trust among their members, donors/grantors, and other constituents. In 2005, the ABA Coordinating Committee on Nonprofit Governance published a Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley in which it set forth 10

2 general principles worthy of consideration for the governance of nonprofit organizations. Those principles, which may or may not be appropriate for a particular social sector organization, are summarized as follows: a. Role of Board: The organization s governing board should oversee the operations of the organization in such manner as will assure effective and ethical management. b. Importance of Independent Directors: The independent and non-management board members are an organizational resource that should be used to assure the exercise of independent judgment in key committees and general board decision-making. For suggestions on how to form an independent, effective board please visit: c. Audit Committee: An organization with significant financial resources should have an audit committee composed solely of independent directors that should assure the independence of the organization s financial auditors, review the organization s critical accounting policies and decisions and the adequacy of its internal control systems, and oversee the accuracy of its financial statements and reports. d. Governance and Nominating Committee: An organization should have one or more committees, composed solely of independent directors, that focus on core governance and board composition issues, including: the governing documents of the organization and the board; the criteria, evaluation, and nomination of directors; the appropriateness of board size, leadership, composition, and committee structure; and codes of ethical conduct. e. Compensation Committee: An organization should have a committee composed of independent directors that determines the compensation of the chief executive officer and determines or reviews the compensation of other executive officers, and assures that compensation decisions are tied to the executives actual performance in meeting predetermined goals and objectives. f. Disclosure and Integrity of Institutional Information: Disclosures made by an organization regarding its assets, activities, liabilities, and results of operations should be accurate and complete, and include all material information. Financial and other information should fairly reflect the condition of the organization, and be presented in a manner that promotes rather than obscures understanding. CEOs and CFOs should be able to certify the accuracy of financial and other disclosures, and the adequacy of their organizations internal controls. g. Ethics and Business Conduct Codes: An organization should adopt and implement ethics and business conduct codes applicable to directors, senior management, agents, and employees that reflect a commitment to operating in the best interests of the organization and in compliance with applicable law, ethical business standards, and the organization s governing documents

3 h. Executive and Director Compensation: Executives (and directors if appropriate) should be compensated fairly and in a manner that reflects their contribution to the organization. Such compensation should not include loans, but may include incentives that correspond to success or failure in meeting performance goals. i. Monitoring Compliance and Investigating Complaints: An organization should have procedures for receiving, investigating, and taking appropriate action regarding fraud or noncompliance with law or organization policy, and should protect whistleblowers against retaliation. j. Document Destruction and Retention: An organization should have document retention policies that comply with applicable laws and are implemented in a manner that does not result in the destruction of documents that may be relevant to an actual or anticipated legal proceeding or governmental investigation. Many of these principles now intersect with, and to some extent overlap with, the IRS Form 990 policies and procedures disclosures described below. 2. IRS Encourages Good Governance Policies The IRS is actively involved in nonprofit compliance initiatives, in part based on its publicly stated position that well-governed and well-managed organizations are more likely to be transparent with regard to their operations, finances, fundraising practices, and use of assets for exempt and unrelated purposes. The new IRS Form 990, effective for the 2008 tax year (tax returns filed in 2009), requires each nonprofit filer to provide certain information regarding the composition of its board of directors or governing body, certain of its governance policies and practices, and the means by which it is held accountable by making governance and financial information publicly available. Consistent with the IRS's position that good governance practices and public accountability provide safeguards to ensure that an organization's assets are used consistently with its tax-exempt purposes, many of the questions on the new Form 990 request information on governance policies and practices that are not required by federal tax law. A nonprofit organization's board of directors and management should be familiar with Form 990, Part VI, Governance, Management and Disclosure, in order to understand these enhanced reporting requirements (and the role organizational governance plays in tax compliance) and to determine whether the organization wishes to make any changes to its existing policies and practices in response to IRS compliance initiatives. More information and resources regarding the IRS and good governance are available at: 3. Good Governance Under Iowa Law Nonprofit organizations in Iowa are bound by the whistleblower and document retention provisions of the Sarbanes-Oxley Act. In addition, the Iowa Governor s Nonprofit Task Force developed the Iowa Principles and Practices for Charitable Nonprofit Excellence in - 3 -

4 2006 available at Although these principles and practices are not mandatory, they are closely associated with legal and tax compliance issues and are intended to promote ethical conduct, good management practices, and public accountability in nonprofit organizations. The principles and practices recommend organizations create an active and independent board of directors that maintains good communication (but not undue interference) with management. With regards to financial activities, all nonprofits in Iowa are encouraged to obtain outside assistance in preparing and reviewing an annual audit and to make that audit publicly available. This is particularly emphasized for organizations with total annual gross revenues above $250,000. Additionally, to prevent fraud and embezzlement, organizations are encouraged to adopt internal controls assuring no single person is responsible for receiving, depositing and spending funds. In 2004, the Iowa General Assembly passed the Revised Iowa Nonprofit Corporation Act (RINCA). This act is based on the Revised Model Nonprofit Corporation Act developed by the American Bar Association (RMNCA). RINCA recognizes that nonprofit corporations hold themselves out as: (i) operating for public or charitable purposes (public benefit corporations); (ii) benefiting their members or a group of people they serve or represent (mutual benefit corporations); and (iii) operating primarily or exclusively for religious purposes (religious corporations). Under RINCA and RMNCA, the distinction in the type of nonprofit corporation is important because it affects certain requirements relating to nonprofit corporations, such as members' rights, duties imposed on directors, and merger/sale of assets/dissolution procedures. RINCA departs from RMNCA by not requiring nonprofit corporations to affirmatively elect whether they are public benefit, mutual benefit or religious corporations. In addition, some of the distinctions RMNCA makes with regard to the different type of nonprofits are not incorporated in RINCA. RINCA addresses many governance issues involving directors and officers. For example, all directors and officers have a duty of care to act in good faith and in the best interests of the corporation. The Act also incorporates a conflict of interest policy for transactions involving directors, making transactions in which there was a conflict of interest voidable. The transaction is not voidable if either the transaction was fair at the time or such transaction is approved by a majority of the board who did not have any interest in the transaction and were aware of the material facts of the transaction. Iowa specifically prohibits a corporation from lending money to a director or officer of the corporation. The Iowa Nonprofit Resource Center ( INRC ) has a mission to strengthen the organizational capacity of Iowa nonprofit organizations. The INRC website, provides many resources for nonprofits in Iowa, including a how-to section guiding nonprofits in governance related issues

5 4. Resources ABA Coordinating Committee on Nonprofit Governance, Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley (American Bar Association, Section of Business Law, 2005). Form 990 Filing Tips: Governance (Part VI) IRS Training Materials-Governance Governance and Tax-Exempt Organizations Examination Materials Guidebook for Directors of Nonprofit Corporations, Second Edition (Committee on Nonprofit Corporations, Section of Business Law of American Bar Association, edited by George W. Overton and Jeanne Carmedelle Frey, 2002). Iowa Nonprofit Resource Center, Jacobs, Association Law Handbook, 4 th edition (ASAE & The Center for Association Leadership, 2007). Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations, Panel on the Nonprofit Sector (2007), available at Sarbanes-Oxley and Implications for Nonprofit Organizations: A Checklist for Charities and Foundations (2009), available at SarbanesOxley.html. U.S. Office of Personnel Management, CFC Glossary, available at