Advisory Committee on Tax Exempt and Government Entities (ACT ...

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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesresponsibility and accountability by nonprofit boards that good governance entails in aworld of innumerable and unpredictable challenges.Some of the indicators that have become proxies for good governance concern thecomposition and structure of nonprofit boards and their committees, while others focuson board and committee responsibilities and operations. 35 The factors, varying withsource, can include: board size (focusing both on boards that are too small to provideproper oversight 36 and too large for meaningful participation); qualifications of directors,including their independence and whether they collectively bring the requisite talentsand resources; written expectations for directors, including board and committeeattendance requirements; agenda setting; executive board and committee sessions;board and committee orientation and continuing education programs; board committeeoversight of finance, audit, investment management, legal compliance, compensationand governance, and whether committees operate pursuant to written charters thatdelineate roles and responsibilities; 37 long-range strategic planning, with attention tomission statements, community or constituent needs assessments, and performancemetrics; periodic performance assessment of the organization, board, and individualdirectors; evaluation of CEO and determination of CEO compensation; approval of otherexecutive compensation; succession planning relating to the board and its leadership,as well as the CEO and key senior managers; selection and oversight of outsideauditors, auditor independence, and lead auditor rotation; supervision of internal auditprocesses; oversight of financial controls; setting parameters for acceptable investmentallocations and practices; development and implementation of various policies, includingconflict of interest policies, whistleblower policies, document retention and destructionpolicies, fundraising and gift acceptance policies, and codes of ethics; and practicesdesigned to promote transparency, including making publicly and readily available (suchas by posting on the organization’s website) an annual report, information aboutactivities, finances, structure and principals (officers, directors and senior managers),and disclosure of committee charters, policies, and documents reflecting governancepractices.Most of these proxies for a well-governed organization are not even indirectly rooted instate statutory obligations, let alone in the Internal Revenue Code, but rather derive atbest imprecisely from the duties of care and loyalty. While this collection of indicators,to a greater or lesser degree, may all appear to be reasonably related to the prudentand purposeful conduct of the affairs of nonprofit boards, as discussed immediately35No list intending to encompass every practice signifying superior governance can be complete, inasmuch as standards for goodgovernance evolve with the nonprofit sector. See, e.g., the 33 standards set forth in the Panel’s Principles, supra note 13. Althoughresponsibility for governance is typically discussed as a board function, many of the behaviors associated with superior governanceare, in fact, management functions; ultimate responsibility for ensuring implementation of those behaviors, however, rests with theboard. See, e.g., ALI Draft Nonprofit Principles, supra note 17, § 320 (Board Responsibilities, Functions and Composition).36Some state laws provide for a minimum number of directors, (see, e.g., New York Not-for-Profit Corporation Law § 702), whileothers set no minimum (see, e.g., Delaware General Corporation Law § 141(b)). State laws may impose other requirements foreligibility for board service, such as a minimum number of directors who are independent of family ties. See, e.g., New HampshireVoluntary Corporations and Associations § 292:6-a (“In the interests of encouraging diversity of discussion, connection with thepublic, and public confidence, the board of directors of a charitable nonprofit corporation shall have at least 5 voting members, whoare not of the same immediate family or related by blood or marriage.”).37See, e.g., ALI Draft Nonprofit Principles, supra note 17, § 325 (<strong>Committee</strong>s and Delegation).ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 14
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesbelow, the empirical evidence to date does not confirm the efficacy of specific nonprofitgovernance practices, much less compliance with the requirements for maintaining taxexemption. Under the circumstances, we must remain mindful that many of theseindicators of good governance are articles of faith and resist clinging to them withtalismanic certainty. While we do not mean to suggest that the adoption of specificpractices and policies are not useful for many organizations in providing a structure thatassists them in their decision-making and operational processes, humility necessitatesthat we respect the diverse and evolving nature of the nonprofit sector and continue tovalue flexibility in our expectations of the specific governance practices that may beessential to the health of the sector. Thus, we support the autonomy of anorganization’s governing body and its exercise of its business judgment as to what bestreflects the needs of its organization.C. What Empirical Evidence Exists About Governance?There is little or no empirical evidence with respect to nonprofit governance. 38 In 2007,the Urban Institute released what it described as “the first national representative studyof nonprofit governance.” 39 That study, based on “self-reports” from the over 5,000nonprofits that responded to a survey, looked principally at six Sarbanes-Oxley inspiredindicators—external audits, independent audit committees, rotating audit firms/partners,conflict of interest policies, whistleblower policies, and document retention policies—andthen at factors (such as board size, board composition, organization size, field, andfunding source) to determine which factors were associated with those indicators. Italso looked at specific self-reported practices, including the frequency andconsequences of financial transactions between organizations and their boardmembers, board compensation, levels of board activity in different roles, and thecorrelation between various factors and that activity, and board composition. Thestudy’s design, however, allows for only nominal analysis as to whether the six SOXtypepractices are effective.There are, however, a number of studies involving for-profit corporate practices. Thequestion then is what can the nonprofit sector learn from for-profit corporategovernance? Corporate governance “best practices” in the nonprofit sector haveborrowed heavily from the for-profit world. The history of regulation and the pressure forgreater self-regulation in both sectors have ebbed and flowed, emerging most stronglyin the face of public indignation over abuses and crises, real or perceived, and thebelief—or at least hope—that imposing additional “safeguards” can forestall similar38When asked which governance practices have been empirically established to be effective during an interview for this report,Marion R. Fremont Smith, Senior Research Fellow and Adjunct Lecturer at the Hauser Center for Nonprofit Organizations atHarvard University, observed: “We have anecdotes of what fails, but no evidence of what works.” Interview with Marion FremontSmith, September 27, 2007. See also Evelyn Brody, The Board of Nonprofit Organizations: Puzzling Through the Gaps BetweenLaw and Practice, 76 Fordham L. Rev. 521, particularly note 81 (2007).39Francie Ostrower, Nonprofit Governance in the United States (The Urban Institute 2007) (hereinafter 2007 Urban Institute Study”),at 21. There are organizations that survey nonprofit organizations from time to time about their governance practices. See, e.g.,The 2007 Grant Thornton LLP National Board Governance Survey for Not-for-Profit Organizations.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 15
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