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

The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuesthe organization to improve internal financial controls 170 and to make prompter andmore comprehensive public disclosures, particularly with respect to financial reportingproblems. 171 Public company boards are required, among other things, to form an auditcommittee comprised wholly of independent directors to hire, supervise, and review theperformance of outside auditors and to disclose whether there is a financial expert onthe audit committee. Public company executives must certify responsibility for financialreports; disclose material weaknesses; and assess the internal controls on financialreporting. Outside auditors are prohibited from providing most non-audit services; leadauditors must rotate every five years, and the audit firm must report directly to the auditcommittee. The corporation must adopt a code of conduct applicable to its CEO andfinancial personnel and personal loans to executives and directors are prohibited.SOX also required the exchanges to implement certain changes in their rules. Perhapsbecause of the magnitude of the failures, the NYSE 172 and other exchanges went wellbeyond what was required and imposed landmark governance reforms on theirmembers. For example, the NYSE requires that the boards of most publicly-tradedcompanies be comprised of a majority of independent directors, have audit,governance, and compensation committees comprised solely of independent members,and undertake specified tasks, including conducting an annual self-evaluation, that mustbe set forth in a charter that is posted on the corporation’s website.Two questions then are: (1) what empirical data exists about the efficacy of thesevarious corporate “best practices;” and (2) assuming there is evidence of theireffectiveness in the for-profit world, will adoption of those “best practices” by nonprofitorganizations similarly achieve positive results.Professor Robert Clark, in a 2005 paper, 173 considered the empirical studies involvingSOX-type governance measures and publicly-traded corporations then to date andconcluded that “the search for strong empirical evidence supporting a belief that keyitems in the recent wave of corporate governance changes will have a major positiveimpact is generally disappointing.” 174 For example:• Internal Controls – Section 404. Regarding the internal controlsrequirements of section 404 of SOX, the analysis suggested that the benefitsof lower-level fraud detection are modest and he questioned whether theseinternal control provisions would indeed prevent the high-level fraud seen in170Based on our experience and interviews for this report, public accountants representing both publicly-traded corporations andexempt organizations that the financial requirements of SOX, particularly involving internal controls, have impacted exemptorganizations; while exempt organizations are not expected to meet the strict requirements of section 404 of SOX, accountants aremuch more focused on their internal controls, including in management letters.171See, e.g., Oxholm, supra note 42, at 357.172The NYSE final governance rules enacted in response to the corporate failures beginning with Enron and the passage of SOXcan be found at http://www.nyse.com/pdfs/finalcorpgovrules.pdf. Other NYSE rules and regulations can be found athttp://www.nyse.com/regulation/rules/1145486472038.html.173See Clark, supra note 43.174Id. at 308.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 81