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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesdisproportionately hold the assets. Trying to craft governance models that areas appropriate for urban hospitals as they are for rural soup kitchens fails toappreciate that the diversity of the sector calls for differences in governancepractices. An effort to identify standard governance practices for the entiresector is bound to result in a set of common denominators that are too basicfor large and complex organizations and unduly burdensome for smallvolunteer-driven organizations. 137• Conventional wisdom is not empirical evidence. Reliance on certainindicators of good governance as proxies for more accountable and legallycompliant exempt organizations is premised upon a faith that a board’sappreciation of its duties of care and loyalty will be enhanced if those specificbehaviors are encouraged. While that may be correctly assumed aboutcertain practices, it is not supported by empirical research. 138 Moreover,standards for what constitutes good governance are not static; best practicesevolve as the nonprofit sector changes and as new governance innovationsare conceived. 139 Behavior in untested directions may be wasteful andcounterproductive when the particular governance indicator is not explicitlyfound in the tax code and has not been empirically evaluated—and all toooften the only cited support is isolated anecdotal examples of scandalousbehavior, which assume that had specific governance practices been in placethe problems would have been avoided.• Good governance cannot be captured in a “punch list.” No matter howextensive, a list of indicators offers only limited examples of what should beexpected of nonprofit boards, and the conceptual underpinning—the duty ofcare and the duty of loyalty—must be absorbed, understood, and applied ininnumerable circumstances that cannot be anticipated in advance. Promotinggovernance indicators without emphasizing those underlying conceptualpremises, although they are matters of state law and not derived from the taxcode, may inadvertently send an incomplete message to nonprofit boards andleave them unprepared for governing in the real world, or cause them tobelieve that governance is more a question of specific policies andprocedures than of values, will, and commitment.137See, for example, the discussion of the sample conflict of interest policy included as Appendix A to the Form 1023 instructions,infra at notes 142 and 151 and accompanying text. Similarly, the Governance and Related Topics – 501(c) Organizations, supranote 22, suffers from trying to address a broad swath of public charities so that it is too complex for some charities and insufficientlysophisticated for others.138Assumptions about even the correlation between commonly accepted indicators of good governance and effective governancemay prove to be misplaced when subjected to empirical scrutiny. For example, the recent study by the Urban Institute found,contrary to popular convention, that larger nonprofit boards were not less engaged than smaller governing bodies See 2007 UrbanInstitute Study, supra note 40 (“While large board size may contribute to problems at some nonprofits, our findings do not indicatethat larger board size per se detracts from board engagement. Indeed, to the extent that it had any association with activity levels(and usually it did not), it was a positive one: board size was positively associated with board activity in fundraising, educating thepublic about the organization and its mission, and trying to influence public policy.”). See also Section V.C. above.139For example, in 1996 the IRS considered requiring reporting a change of accounting firm on the Form 990 because it believedthat suggested there might have been a disagreement on an audit opinion. See 15 EXEMPT ORG. TAX REV. 219-20 (1996). In itsGood Governance Practices Discussion Draft (Feb. 7, 2007), the IRS suggested the advisability of changing audit firms every fiveyears. Yet, the empirical evidence does not yet support either position. See Appendix 6.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 44
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issues• Policies are not practices. Many of the good governance indicators uponwhich the IRS has focused call for policies to be adopted, but do not examinethe practices in which an exempt organization engages in adhering to thosepolicies, or in otherwise meeting the underlying objectives of the policies.Unless implemented and applied in circumstances that warrant thatapplication, those polices may be no more than pieces of paper left in a filecabinet. One challenge for the IRS in promoting good governance outsidethe boundaries of practices specified in the tax code is in inquiring aboutconduct in ways that will prompt more than self-serving and generalaffirmative responses.• Bad policies can lead to bad practices. Adopting and implementing aparticular policy that promotes more attentive board governance may actuallybe counterproductive if that policy is misguided or even legally defective.Whether that policy correctly reflects IRS and state legal requirements is athreshold question. While raising consciousness about governance issues byasking about the existence (but not the content) of policies may have a valueof its own, it may lead organizations to check off a box without actuallyimproving their governance, either by adopting flawed policies or by adoptingpolicies that are not effectively implemented. Additionally, in a world wherethe majority of smaller tax-exempt organizations simply do not have access toqualified counsel, the right answers may be elusive for them and the wrongones may create liability.• The bully pulpit is a form of regulation. The IRS’s ability to shapegovernance behavior informally may be its most flexible tool, but also carriesthe potential for unintended consequences. In raising consciousness in thesector through the use of the “bully pulpit” in speeches and other forms ofpublic comment, representatives of the IRS should consider the extraordinarydiversity of the sector, how its message will be received, and whether it mayhave any counterproductive effects.• Exempt organizations are governed by boards, not by the IRS. Finally,increasing concerns about the adequacy of nonprofit governance and thelengthening list of indicators that are advocated as the solution to thoseproblems may, at some level, serve to undermine the autonomy of nonprofitboards and blunt the critical exercise of their judgment. While mostgovernance indicators are process prescriptions that do not obviouslyencroach upon decision-making, even choices about governance practicesare and should be an area for the exercise of business judgment by a boardand reflect the needs of the specific organization. Discouraging that exerciseof discretion by prescribing extensive lists of preferred practices may suggestthat boards have no obligation to consider which policies and practices areappropriate for their organization. Substituting the judgment of the regulatorsundermines board autonomy and may discourage board recruitment.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 45
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