Corporate Governance for Non-Profits; Dealing with the Effects of Sarbanes-Oxley in the Charitable Context Michael J. Cooney, Esq. February 25, 2004 Copyright 2004 Nixon Peabody LLP. All Rights Reserved.
Purpose Review of legal responsibilities of New York not-for-profit Board members Implications of Sarbanes-Oxley Attorney General proposal to adopt SOX for NY charities What next?
Applicable Law Not-for-Profit Corporation Law ( N-PCL ) sets out rules for governance of NFPs operated in New York authorizes NFPs to implement certain organizational structures or procedures
N-PCL (Continued) articulates the rights and responsibilities of officers, directors and members applies through Education Law and Religious Corporation Law provides legal standing to members, other directors and the Attorney General
Organizational Mandates Generally, NFP must be managed by its Board of Directors in accordance with the law and its governing documents Corporation may create executive committee and other standing committees NFP may indemnify officers and directors and purchase D&O liability insurance
Three Duties of the Director Duty of Care Duty of Loyalty Duty of Obedience
Duty of Care Directors and officers shall discharge the duties of their respective positions in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. N-PCL Section 717
Duty of Care (cont d) Adopted from for-profit, corporate law Corporate standard defers to directors good faith judgments Concept of fiduciary responsibility suggests a more rigorous standard Dispute over applying business judgment rule to decisions of NFP directors
Duty of Care (cont d) Directors required to: Be familiar with important corporate documents Monitor finances, directly or through standing committees Directly review corporate books and records
Duty of Care (cont d) Directors required to: Regularly attend Board and committee meetings Review any written materials disseminated in advance of meetings Delegate to qualified professionals tasks requiring specialized expertise
Investment of Assets When making investments, directors are required to consider... the long and short term needs of the corporation in carrying out its purposes, its present and anticipated financial requirements, expected total return on its investments, price level trends, and general economic conditions. N-PCL Section 717(a)
Delegation of Investment Management Board is permitted to delegate certain management responsibilities Board is entitled to rely on reports and other information prepared or presented by committees of the board, officers and employees, or outside experts
Delegation of Investment Management (cont d) Delegation must be done in a clear fashion to qualified delegates and with a critical eye to the reliability and competence of the reports and the delegates under N-PCL Section 717(b) Very few matters cannot be delegated, see N-PCL Section 712(a)
Summary of the Duty of Care Pay attention Relate action to mission Govern, don t manage Document, document, document
Duty of Loyalty Director required to pursue the interests and mission of NFP with undivided allegiance No statutory formulation of duty
Duty of Loyalty (cont d) Case law: Directors must subordinate their individual and private interests to their duty to the corporation Directors prohibited from using their fiduciary position to usurp a business opportunity or advantage available to the corporation N- PCL Section 716 explicitly prohibits loans from the not-for-profit to an officer or director
Duty of Loyalty (cont d) Interested party transactions allowed if: Directors /officers interest in transaction is fully disclosed to Board and transaction is authorized by a Board vote, without vote of interested director OR Transaction is authorized by a vote of members, if the material facts of the interest are disclosed to the members or known to them
Duty of Loyalty/ Internal Revenue Code Charitable organizations must be operated exclusively for tax-exempt purposes; no part of [its] net earnings... inures to the benefit of any private shareholder or individual... Organizations classified as private foundations are subject to special, stringent rules concerning self-dealing
Duty of Loyalty/ Internal Revenue Code Code imposes monetary penalties on a disqualified person who engages in act of self-dealing and any foundation manager who knowingly participates in the transaction, whether or not the act causes harm to the private foundation
Common Dual Loyalty Issues Be careful when: Setting compensation for Board members who are also employees of the organization Contracting for goods or services with a firm owned/controlled by a Board member
Common Dual Loyalty Issues Be careful when: Investing entity funds where Board members are also investors or otherwise have an interest Board is comprised of individuals in same substantive field as entity or affiliated with entities that seek funding from the entity or the same sources as entity
Dealing with Conflicts Procedures for detailed documentation of Board approval of interested party transactions or other arrangements having even the appearance of conflicting interests Form to be completed by each Board member annually, indicating compliance and disclosing any relationships or financial interests they or family members may have
Summary of the Duty of Loyalty Mechanisms to identify and address conflicts Be vigilant Disclose, disclose, disclose
Duty of Obedience Not-for-profit board members must be faithful to the purposes and goals of the corporation because perpetuation of particular activities are central to the raison d'être of the organization. The Manhattan Eye, Ear & Throat Hospital v. Spitzer
Duty of Obedience (cont d) Charter controls Limitations on the use of assets Especially important when selling all or substantially all of an organization s assets
Corporate Fraud Scandals Enron, Global Crossing, Ltd., WorldCom, Arthur Andersen, Adelphia Senate Government Affairs Committee Permanent Subcommittee on Investigations (S. Rep. No. 107-70) The board witnessed numerous indications of questionable practices by Enron management over several years, but chose to ignore them to the detriment of Enron shareholders, employees, and business associates.
Public Company Accounting Reform and Investor Protection Act of 2002 Requires publicly traded company to establish an audit committee as a committee of the Board Auditor reports to audit committee Authority to engage independent counsel and any other advisers
Audit Committee (cont.) Procedures for the receipt, retention, and treatment of accounting complaints Auditor rotation
CEO and CFO Certification of Financial Statements All periodic financial statements filed with the SEC accompanied by a written statement by the chief executive officer and the chief financial officer
CEO and CFO Certification of Financial Statements CEO and CFO shall reimburse the corporation for any bonus or other incentive-based or stock-based compensation received during the 12- month period following the first public issuance or filing of financial documents that are required to be restated
Applicable to NFPs Destruction or falsification of records in a federal investigation a crime. Broader language against retaliation against informants. Separate provisions on the destruction of corporate audit records and whistleblower protection specific to publicly traded companies.
Summary of the Environment Atmosphere of distrust Emphasis on publicly traded companies, not non-profits Basis of H.R. 7 Foundation Trustee Fees: Uses and Abuses
New York Senate Bill 4836A Crafted by Attorney General Charities Bureau; later co-sponsored Revised May 20, 2003 Given credence by non-profit community Originally effective January 1, 2004
Verification of Financial Reports N-PCL Section 519 report and audited financials President/treasurer or chief executive officer/ chief financial officer No private right of action based on verifications
Verification of Financial Reports (cont.) Officers must sign annual report; deemed verified Financial information in the annual report fairly presents financial condition in all material respects Dropped certification on untrue statement or omission of material fact
Verification of Financial Reports (cont d) Gross revenue of $1 million or assets of $3 million; not Type A corporations Officers verify based on their personal knowledge: Maintained adequate internal financial controls Effectiveness has been reviewed within 90 days prior Any deficiencies in the financial controls, and any fraud whether or not material that involves management or other employees who have a significant role in internal controls, have been disclosed to the Board of Directors and organization s outside auditors
Private Foundation Verification Officers of a private foundation sign the annual report and verify: Financial information fairly presents the financial condition of the corporation for the periods presented Corporation has complied with the Certificate of Incorporation pursuant to N- PCL Section 406
Establishment of Executive Committee Currently not required Mandated for large Boards more than 25 members No specific duties set forth in the law Certificate/By-laws could prohibit
Establishment of Audit Committee Mandated for large not-for-profits at least $1 million in revenues or $3 million in assets or with audited financial statements Responsible for the oversight of the outside auditors, including appointment and compensation, resolution of disputes
Establishment of Audit Committee (cont d) Each member must also be a member of the Board of directors, and not: Accept any consulting, advisory, or other compensatory fee from the corporation; or Have participated in any interested party transactions within the previous year Must establish procedures for handling complaints regarding accounting/auditing matters
Filing of Annual Reports Requirement growing out of Membership Corporations Law Willful or persistent failure to file any NYS mandated report provides basis for removal of directors and officers or other remedies as may be provided by law Failure to disclose resulting in liability under N-PCL Section 521
Interested Director and Officer Transactions Corporation and AG may void any transaction unless the director or officer (or any approving director) can establish affirmatively that such contract or transaction was fair and reasonable Contract or transaction must be disclosed to the members Overlay of Internal Revenue Code Section 4958 Special rule for charitable grants
Director and Officer Compensation Committee approval permitted for other compensation Board compensation subject to approval of majority of the entire Board Officer compensation subject to approval of majority of quorum
Notice to AG on Indemnification by a Court Notice required for court initiated indemnification Other indemnification amendments dropped
Review Importance of the current environment Duties of care, loyalty and obedience Review proposed changes and best practices Incorporate into governance structure Advocate on behalf of New York charities
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