Sarbanes-Oxley Act's Effect on Nonprofits

The Sarbanes-Oxley Act (the "Act") is a 2002 federal law that applies to companies that have registered equity or debt securities with the U.S. Securities and Exchange Commission ("SEC"). This law was enacted by Congress to improve standards of corporate governance in the wake of numerous corporate scandals.

So how does this apply to nonprofits?

While not subject to SEC oversight, nonprofits do have numerous constituents to which they must routinely answer. Examples include accrediting agencies, their own governing boards, donors, members, customers, volunteers and employees.

In addition to constituents, nonprofits must also answer to sources of authority. One of the primary sources of authority to which nonprofits must answer is their State attorney general. Where an organization exists for the stated purpose of providing for the public good, attorneys general are charged with representing the public and ensuring nonprofits fulfill their purpose. For example, Colorado’s attorney general may bring an action to have a court dissolve a nonprofit if the nonprofit exceeds or abuses its authority.

Coincident with the Sarbanes-Oxley Act, the attorneys general in several States, including New York, have recently announced proposed State laws similar to the Act that would be applicable to nonprofits or their auditors:

• Corporate officers of nonprofits with annual revenues over $250,000 will be required to attest to the fairness and completeness of financial reports; and affirm that they have established and maintained adequate internal controls;
• Nonprofits must have an audit or finance committee composed entirely of non-management directors. If there is not at least one committee member who is a "financial expert", that fact and the reasons therefore, must be disclosed;
• Loans by the nonprofit to directors and executive officers will be prohibited;
• The nonprofit must disclose whether or not it has adopted a code of ethics applicable to its senior financial officers;
• Whistleblower protection from retaliation will apply to employees who report wrongdoing (it is still unknown whether this protection will apply to volunteers);
• Regulations similar to those of Sarbanes-Oxley will apply to accountants who audit nonprofits. In addition to existing requirements, audit firms must:

· Retain audit workpapers for at least seven years;

· Have every financial report reviewed by a second (concurring) reviewer prior to issuance;

· Report on the nonprofit's internal controls, including a description of any material noncompliance noted;

· Be subject to periodic inspections of their work, and to disciplinary procedures if deficiencies are found;

· Rotate partners assigned to a nonprofit engagement every five years.

Most States, including Colorado, are observing the progress of the New York legislation. Nevertheless, there is no doubt that the above recommendations represent the wave of the future for nonprofits and their auditors.

Directors of nonprofits owe a certain duty of care to the organizations that they serve. Therefore, implementing certain relevant provisions of this proposed legislation might serve to anticipate public or donor expectations. Changes that nonprofits may wish to consider in the era of the Sarbanes-Oxley Act include:

• Creating an audit or finance committee and ensuring it is active and aware of operations;
• Having your CEO and CFO publicly attest to the accuracy, completeness and fairness of your financial statements and to the adequacy of your internal accounting controls;
• Publicly disclosing that you have adopted, and follow, a code of ethics for senior management and your governing board;
• Having all non-audit work by your outside auditors approved by your audit or finance committee, and ensuring it does not appear to compromise their independence;
• Carefully considering all transactions between your nonprofit and any "insider" - including those concerning executive compensation and benefits. Insiders generally include officers, directors, trustees, management in decision-making positions, major donors and members of the immediate families of any of the preceding.

Nonprofits are dependent on goodwill with the public to accomplish their mission. Certainly the public and legislative mood that gave rise to the Act has renewed vigor to identify misbehavior in all organizations. In light of the current environment, it makes sense for nonprofit directors to evaluate how they exercise their oversight responsibilities and how they can respond to these legislative initiatives and to consider implementing some elements of the Sarbanes-Oxley Act that are now required of public companies.