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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesoccurrences in the future. 40 As noted previously, the current period of intense scrutinywith respect to governance relates back to Enron and other corporate scandals andCongress’ subsequent enactment of SOX. In fact, much of the discussion of “bestpractices” in the nonprofit sector since that time has focused on the extent to whichSOX-type reforms (sometimes broadened to include related changes to the exchangerules) should be adopted—or required—of nonprofit corporations. 41Professor Robert Clark of Harvard University, in a 2005 paper, 42 reviewed the empiricalstudies then to date involving publicly-traded corporations and their adoption of SOXtypegovernance measures, such as independent directors, section 404 internalcontrols, an independent audit committee, and restricting non-audit services provided bythe auditing firm, and concluded that “the search for strong empirical evidencesupporting a belief that key items in the recent wave of corporate governance changeswill have a major positive impact is generally disappointing.” 43 He also examined thespecific “good governance practices” advocated by the rating agencies, such as asupermajority of independent directors, a relatively small board size, a separate (i.e.,independent, non-CEO) board chairman, a specified number and length of meetings,regular executive sessions (at which company officers are not present), regularevaluations of the CEO, regular self-evaluations of the board, minimum stock ownershiprequirements for directors, and limits on director tenure (term limits and/or retirementages). Citing a plethora of studies examining these and similar “good practices,”Professor Clark concluded: “For most of these practices, the empirical evidence bearingon their correlation with shareholder value is limited or mixed or both, and does notprove decisively that they cause increases in value.” 44In some sense, this is not surprising. For example, on paper, Enron had in place arigorous conflict of interest policy and other controls. The problems at Enron related toimplementation, including the board not demanding or ensuring it understood thepertinent information, the board waiving conflicts that should not have been waived, andthe board not responding appropriately once problems began to emerge. 45 Anecdotal40See Appendix 2 for a discussion of for-profit corporate governance. The enactment of groundbreaking federal securities lawsoften was prompted by profound failure or crisis.41See, e.g., Paul D. Brode & Richard L. Prebil, The Impact of Sarbanes-Oxley on Private & Nonprofit Companies (National DirectorsInstitute 2005); Carl Oxholm III, Sarbanes-Oxley in Higher Education: Bringing Corporate America’s “Best Practices” to Academia,31 J.C. & U.L. 351 (2005); Moody’s Investor Services, Governance of Not-for-Profit Healthcare Organization (2005); Fitch Ratings,Sarbanes-Oxley and Not-For-Profit Hospitals: Increased Transparency and Improved Accountability (2005); Standard & Poor’s,Under Legislative Scrutiny, The U.S. Nonprofit Sector Embraces Corporate-Style Oversight (2005) and “Research: U.S. Not-for-Profit Health Care Sector Explores the Benefits of Sarbanes-Oxley Compliance (2005). See also ABA Coordinating <strong>Committee</strong> onNonprofit Governance, supra note 16.42Robert Charles Clark, Corporate Governance Changes in the Wake of the Sarbanes-Oxley Act: A Morality Tale for PolicymakersToo, 22 Ga. St. U.L. Rev. 251 (2005). See also Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack CorporateGovernance, 114 Yale L.J. 1521 (2005).43Clark, supra note 43, at 308. The one exception involved disclosure, which he found to be positively correlated with reducing thevolatility of stocks. Id. at 304-05.44Id. at 303.45See William Powers, Jr., Chairman of the Special Investigation <strong>Committee</strong>, Report of Investigation by the Special Investigative<strong>Committee</strong> of the Board of Directors of Enron Corp. (Feb. 1, 2002), at 148:ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 16
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesevidence such as this may indicate that good governance in the end is a question of thevalues, active engagement, and accountability of those in charge, rather than theadoption of specific practices or policies.Even if empirical evidence suggested that certain “best practices” were “best” forbusiness corporations, it is not at all clear that this would translate to nonprofitcorporations. 46 One dramatic difference between business corporations and nonprofitsis that the former has almost a singular purpose—the overarching purpose of businesscorporations is to promote the welfare of shareholders, specifically to maximizeshareholder value. The objective of corporate governance initiatives in this sector thenis to protect investors and promote fair and efficient markets that both encourageinvestors to provide capital and protect investors who do so. For example, suchinitiatives endeavor to protect shareholders from attempts by management to benefititself to the detriment of shareholders, to prevent insiders from trading on non-publicinformation, and to require timely public release of accurate financial information thatinvestors should have in determining whether to buy, sell, or hold securities. But evenwith that more limited and approachable standard, the empirical data either fails tosupport or is inconclusive or controversial with respect to the efficacy of many “goodgovernance practices” in the for-profit setting. The purposes of nonprofit organizationsare more diverse and complicated and, concomitantly, the roles of their boards arebroader and more nuanced than in the for-profit sector. This diversity and complexity inthe nonprofit sector may suggest that specific good governance practices are even lesslikely to be effective in the nonprofit context.VI. REGULATION AND SELF-REGULATION OF NONPROFIT GOVERNANCEOUTSIDE OF THE IRSA. IntroductionOne of the issues that arises is whether there is a need for the IRS to be more involvedin nonprofit governance beyond the specific statutory requirements in the tax laws.Nonprofit organizations can be regulated by many—and sometimes conflicting—authorities. Because nonprofit organizations are established under state law, stateshistorically have had the principal responsibility and greatest authority to regulate in thearea. Organizations with offices in more than one state or that solicit contributions inmultiple jurisdictions may be subject to the laws of a number of states. There also areindustry-specific accreditation agencies, standards relating to participation in particularOversight of the related-party transactions by Enron’s Board of Directors and Management failed for many reasons. As athreshold matter, in our opinion the very concept of related-party transactions of this magnitude with the CFO was flawed.The Board put many controls in place, but the controls were not adequate, and they were not adequately implemented.Some senior members of Management did not exercise sufficient oversight, and did not respond adequately when issuesarose that required a vigorous response. The Board assigned the Audit and Compliance <strong>Committee</strong> an expanded duty toreview the transactions, but the <strong>Committee</strong> carried out the reviews only in a cursory way. The Board of Directors wasdenied important information that might have led it to take action, but the Board also did not fully appreciate thesignificance of some of the specific information that came before it. Enron’s outside auditors supposedly examinedEnron’s internal controls, but did not identify or bring to the Audit <strong>Committee</strong>’s attention the inadequacies in theirimplementation.46See Dana Brakman Reiser, Enron.org: Why Sarbanes-Oxley Will Not Ensure Comprehensive Nonprofit Accountability, 38 U.C.Davis L. Rev. 205 (2004).ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 17
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