On January 1, 2005, a sweeping new law
comes into effect that impacts almost every charitable organization that
operates or has assets in California. The Nonprofit Integrity Act,
signed by Governor Schwarzenegger in September, imposes new rules in
five areas: (1) Accounting standards, (2)
Registration with the Registry
of Charitable Trusts, (3) Audit requirements (Sarbanes-Oxley for
nonprofits), (4) Compensation of key executives, and (5)
Fundraising.
The Act also imposes new rules on commercial fundraiser and fundraising
counsel, which will not be addressed here except as they relate to the
rules imposed on charitable organizations.
This article provides an
overview of the Nonprofit Integrity Act, including the requirements of
the Act in each of the above areas and which nonprofits they apply to.
Every nonprofit that does any business in California is strongly
encouraged to be familiar with and heed these rules. Failure to do so
may result in scrutiny and, in the worst case, take over by the
California Attorney General.
1. ACCOUNTING STANDARDS
This may be the easiest of the Act's new requirements
to implement but is also probably the one that is most likely to be
violated. The new requirement is that the financial records of any
organization that seeks charitable contributions (including grants,
donations, etc.) must be maintained on the basis of generally accepted
accounting principles or "GAAP." In its essence, this means that
effected organizations must maintain a chart of accounts and use
standard double-entry accounting to record all of their transactions.
Too many nonprofits, and perhaps most small ones,
utilize Quicken to maintain their financial accounting records. Quicken
IS NOT an accounting program and should not be used by any nonprofit.
Even QuickBooks is insufficient if the organization has the program's
audit trail feature turned off.
Board members, who have fiduciary duty with regard to
the charity's affairs and finances, may have to take it upon themselves
to insist and insure that their charity's follow these new rules. If a
charity is unfamiliar with these requirements it must seek the
assistance of an accountant familiar and experienced with the GAAP rules
that apply to nonprofits (which often are different than those
that apply to commercial businesses) or , at the very least, consult a
book on the subject.
2.
REGISTRATION WITH THE REGISTRY OF CHARITABLE TRUSTS
With some exceptions (educational institutions,
religious organizations, hospitals and cemeteries), all organizations
that hold charitable assets in the state of California are required to
register and file annual statements with the Registry of Charitable
Trusts, a branch of the Office of the Attorney General. This requirement
applies regardless of the organization's form, whether it be a nonprofit
corporation, charitable trust or unincorporated association.
Prior to enactment of the new law, charities were required
to register within six months of receipt of any property or other
charitable assets. The only change effective January 1, 2005 is that
they must now register within 30 days of first receipt of assets. It is
very simple to avoid violating this rule. Any new charitable
organization should register with the Registry immediately after it is
incorporated. That is what this office is now doing for all of its
start-up clients.
3.
AUDIT REQUIREMENTS
The Nonprofit Integrity Act imposes a new audit
requirement on all nonprofits holding assets or doing business in
California that are required to register with the Registry (i.e., all
but educational institutions, religious organizations, hospitals and
cemeteries). This new requirement is effective for fiscal years ending
June 30, 2005 or later. Audited financial statements required under the
Act must be completed no later than nine months after the entity's
fiscal year end. This is earlier than the extended tax filing deadline.
The audit requirement has several components:
A minimum threshold.
An exclusion for certain government grants;
Auditor independence;
Public disclosure of audits; and
Requirements for an audit committee.
Effective June 30, 2005, all covered charitable
entities that have $2 million or more in gross revenue in any fiscal
year are required to have prepared an audit conducted by a certified
public accountant. Excluded from gross revenue for purposes of
determining whether an organization has crossed the $2 million threshold
are grants (but not fees for services) the organization receives
from government agencies if that government agency requires an
accounting of how the organization uses those funds.
CPA firms that audit nonprofits that also perform
other services for a given nonprofit must follow the standards for
auditor independence specified in the "Yellow Book," a manual for
auditor independence published by Comptroller of the Currency of the
United States.
All audited financial statements prepared by any
nonprofit that are required to register with the Registry (regardless
whether an audit is required under the Act) must be made available for
(1) inspection by the Attorney General and (2) any member of the general
public upon request. This means the audit must be made available to the
public at the charity's principal, regional and district offices during
normal business hours. Posting it to a freely available website
will also satisfy this requirement. (The audit letter need not be included
with the public disclosure.) Audited financial statements must be
available for no less than three years.
Audit Committee
Nonprofit corporations (but not other
types of entities) subject to the audit requirement must have an audit
committee. The Act specifies who may and may not serve on the audit
committee and it specifies minimum duties of the audit committee. The
corporation's governing body (e.g., board of directors) must appoint the
audit committee. Interestingly, the audit committee may consist of just
one person and its members need not be directors of the corporation.
The corporation's president/chief executive officer,
treasurer/chief financial officer, any paid staff, and anyone who does
business or has any financial interest in any entity that does business
with the nonprofit may not be on the audit committee. If the nonprofit
corporation has a finance committee its members must comprise less than
50% of the audit committee and the chair of the audit committee may not
be a member of the finance committee.
The Act specifies five duties of the audit committee:
- Recommend to the board of directors the retention
and termination of the independent auditor;
- May negotiate the compensation of the auditor on
behalf of the board;
- Confer with the auditor to satisfy the committee
members that the financial affairs of the charitable organization are
in order;
- Review and determine whether to accept the audit;
and
- Approve performance of any non-audit services to be
provided by the auditing firm.
4. COMPENSATION OF KEY
EXECUTIVES
The Act requires the governing board or an authorized
committee of the board to review and approve the compensation of a
charity's chief executive officer (e.g., president or executive
director) and chief financial officer. Approvals are required when the
(1) employee is hired or (2) when the employee's employment agreement or
terms of employed are renewed, extended or modified (unless the
modification applies to substantially all employees). These requirements
will be met if the organization complies with safe harbor guidelines the
IRS has issued with regard to its Excessive Benefit Transaction rules
(4958 of the Internal Revenue Code and regulations thereunder). For a
thorough discussion of these rules see the Management Memo "Board Members Beware" by clicking on the Articles tab, above.
Note that any committee delegated with this
responsibility must consist exclusively of governing board members and
may not include any person whose compensation the committee is to
review, anyone related to such persons by blood or marriage, or any
person who may have a direct or indirect financial interest in such
person's compensation or employment.
5. FUNDRAISING
By far the most detailed
provisions of the new law – and perhaps the most onerous – have to do
with fundraising by and for charitable organizations. The Nonprofit
Integrity Act outlines new requirements for charitable organizations
that work with commercial fundraisers or fundraising counsel. A "commercial
fundraiser" is any individual or entity that: (1) is paid to solicit
funds, assets or property in California for charitable purposes; (2)
receives or controls such items; or (3) engages for pay another person
to do so. A "fundraising counsel" is any person or entity that is
paid to manage, advise, counsel, consult, or prepare material for the
solicitation in California of funds, assets, or property for charitable
purposes, but who does not solicit, receive or control funds, and who
does not engage or pay someone else to do so. Attorneys, employees and
trustees of a charitable organization are not fundraising
counsel, and employees of charities are not commercial fundraisers.
The Act establishes
rules with regard to:
Control over fundraisers by
charities;
Rules for the engagement of
commercial fundraisers and fundraising counsel, and
Specific prohibitions with regard to
commercial fundraisers and fundraising counsel.
The Act also gives
charities substantial requirements and rights with regard to fundraisers
and fundraising counsel they engage. For example:
Neither a
charity, on the one hand, nor a fundraising counsel or commercial
fundraiser, on the other, may enter into a fundraising contract with
the other unless it has registered with the Attorney General or agrees
to do so prior to the start of any solicitation.
A contract with a fundraiser or
fundraising counsel is voidable by the charity if the fundraiser or
fundraising counsel has not registered with the Attorney General prior
to the start of the solicitation.
All work performed by commercial
fundraisers and fundraising counsel must be undertaken pursuant to a
written contract signed by the fundraiser or fundraising counsel's
authorized officer and an official of the charity authorized by its
governing body to do so.
The charity may cancel any such
contract within 10 days for any reason without liability.
A charity may cancel any such
contract upon 30 days written notice. (It must pay for the services
provided per the contract's terms during that 30 day period.)
After the 10-day period, the charity
may cancel the contract without liability if the commercial fundraiser
or fundraising counsel have made any material representations, harm
the charity's reputation or are found to have been convicted of a crime
arising from charitable solicitations.
Commercial fundraisers may not
control or retain funds they collect on behalf of the charitable
organization.
Note that if a charity
cancels any fundraising contract under the Act it is required to mail a
copy of the cancellation notice to the Registry of Charitable Trusts.
Contracts with
Commercial Fundraisers
A charitable organization that engages the services
of a commercial fundraiser must "establish and exercise control" over
the fundraising activities conducted for their benefit. For every
solicitation campaign or event produced by a commercial fundraiser,
there must be a written contract between the fundraiser and the
charitable organization. The commercial fundraiser or fundraising
counsel must file a notice with the Registry of Charitable Trusts at
least 10 days before the start of any solicitation campaign or event (or
no later than the start of a campaign to raise funds for victims of
disasters or emergencies).
The contract between
charity and a commercial fundraising must include provisions that set
forth all of the rights and responsibilities listed immediately above,
plus the following:
The charitable
purpose for which the solicitation campaign or event is being
conducted;
The respective obligations of the
commercial fundraiser and charity;
The effective date and termination
date of the contract, and the date the solicitation will start in the
state;
The requirement that all
contributions received by the commercial fundraiser must, within five
working days of receipt, either be deposited in a bank account
controlled by the charitable organization or delivered in person to
the charitable organization;
The charitable organization controls
and approves the content and frequency of any solicitation.
The maximum amount the commercial
fundraiser plans to pay individuals or entities to secure any person’
attendance at, or approval, sponsorship or endorsement of, a
fundraising event (e.g., amounts paid to celebrities to "endorse" or
attend a fundraising event);
The amount of the fee to be to the
commercial fundraiser. If the fee is a set amount (fixed fee), the
contract must provide a good faith estimate the percent of total
contributions the fee will comprise as well as the assumptions upon
which that good faith estimate is based. If the commercial fundraiser
will be paid a percentage fee, the contract must state the percent of
total contributions the charitable organization will retain. If the
solicitation involves the sale of goods or services, or sale of
admission to an event, the contract must state the percentage of the
purchase price the charitable organization will retain. The
percentages to be retained by the charity stated in the contract must
take into account not only the commercial fundraiser's fee but also
any additional fundraising costs the charity must pay; and
Any other information required by
regulations adopted by the Attorney General.
The Act also imposes a
number of requirements on commercial fundraisers. Those of particular
relevance to charitable organizations specify that:
-
A commercial
fundraiser is required to disclose what percentage of total
fundraising their expenses account for immediately when asked verbally
and within 5 working days when queried in writing.
-
A commercial
fundraiser must maintain specified campaign records for each
solicitation and retain them for 10 years following the end of each
solicitation. They must be made available for inspection upon demand
by the Attorney General.
-
Commercial fundraisers must file an
annual financial report of funds solicited on behalf of each
tax-exempt organization or for each charitable purpose with the
Attorney General.
-
A person may not act as a commercial
fundraiser, or an officer, director or owner of a controlling interest
in a commercial fundraising entity, if he or she has been convicted in
state or federal court of a crime, punishable as a misdemeanor or
felony, arising from the conduct of charitable solicitation.
Contracts with
Fundraising Counsel
A contract between a charity and a fundraising
counsel must include provisions with regard to the charitable
organization's rights to cancel the contract as listed above, as well as
provisions that set forth the following:
The charitable
purpose for which the solicitation campaign or event is being
conducted;
The respective obligations of the
commercial fundraiser and charity;
The effective date and termination
date of the contract, and the date the solicitation will start in the
state;
That the fundraising counsel will
neither solicit, review nor control donated items or employ any other
person to do so;
That the charity exercises control
and approval over the content and frequency of solicitations; and
The compensation to be paid the
fundraising counsel.
12 Prohibitions
The Act prohibits the following twelve
acts and practices with regard to the planning, conduct, or execution of
any solicitation or charitable sales promotion. The prohibitions apply
to, "regardless of injury":
-
Operating in violation
of this Act or order of the Attorney General, or after registration is
no long valid.
-
Engaging in fraud or
using any unfair or deceptive act or practice that creates a
likelihood of confusion or misunderstanding.
-
Using any name or any
other representation that misleads a reasonable person as to the
identity of the charitable beneficiary.
-
Misrepresenting or
misleading anyone to believe that the beneficiary of a solicitation or
sales promotion is a charitable organization when it is not.
-
Misrepresenting or
misleading anyone to believe that another person sponsors, endorses,
or approves a charitable solicitation or sales promotion when that
person has not given consent in writing to the use of the person’ s
name.
-
Misrepresenting or
misleading anyone to believe that goods or services have endorsement,
sponsorship, approval, characteristics, ingredients, uses, qualities,
or benefits that they do not have, or that any person has any
endorsement, sponsorship, approval, status, or affiliation that the
person does not have.
-
Exploiting registration
required by law to imply endorsement or approval by the Attorney
General.
-
Representing that a
charitable organization will receive more than the amount reasonably
estimated.
-
Distributing or
offering to distribute – in connection with charitable solicitations
by commercial fundraisers for police, fire, and other public safety
personnel – membership cards or stickers, emblems, plates, or other
items that could be used for display on a motor vehicle and that
suggest affiliation with or endorsement by any public safety personnel
or group.
-
Soliciting for
advertising related to a charitable purpose to appear in a for profit
publication without making, at the time of solicitation, these
disclosures: (a) the publication is for-profit, (b) the name of the
solicitor and the fact that the solicitor is a professional solicitor,
and (c) the publication is not affiliated with any charitable
organization.
-
Representing that any
part of contributions solicited by a given charity will be given to
another charity unless the other charity has agreed in writing prior
to the solicitation to the use of its name.
-
Representing that
tickets to events will be donated for use by another unless certain
requirements are met to prevent abuse.
The Law Firm
for Non-Profits, P.C. has prepared this site to enable you to learn more
about our firm and the services it provides. These materials do not, and
are not intended to, constitute legal advice. The information we make
available at this site does not create an attorney-client relationship,
nor does it substitute for obtaining legal advice.
