Earning the Public Trust

Print Share on LinkedIn More

America’s nonprofit sector has been defined in large part by the actions it has taken to advance the common good. Since this country’s earliest days, the voluntary sector has played a critical role in strengthening community life. It has worked independently of and in conjunction with government, serving as the instrument through which many of the public sector’s health and social responsibilities have been discharged. Through its collaborative work with the public sector, its mobilization for policy change, and the private actions of countless educational, social, and religious organizations, in addition to many others, the voluntary sector has advanced knowledge and improved the quality of life for generations of people. There are virtually no pockets in any community landscape that have not been shaped and enriched by nonprofits.

Today, the actions by some in the voluntary sector have called into question the trust that underwrites that support. Negative media stories all over the country have detailed examples of alleged excessive compensation of executives, self-dealing, questionable fundraising practices, conflicts of interest and lavish expenditures. While these stories refer only to a very limited number of organizations, the public’s perception of the whole sector is colored by them. Thus, the sector as a whole is called upon to address these issues in order to maintain public confidence in its work.

There are a growing number of sector leaders adding their voices to calls for better practice, greater transparency, and proper governance. Achieving these goals will require recognition throughout our broad sector that remedies are needed and that we all have an important role to play in developing and implementing them. A growing body of organizations is dedicating time to improving governance as it relates to the accountability and integrity of nonprofits. But the larger field would be well served by involving itself actively in these activities, and at the same time by encouraging government to fulfill its obligations toward the nonprofit sector, addressing areas that require additional attention.

Sector Growth. Over the last two decades the charitable sector has grown tremendously. The availability of resources, both public and private, has made possible a growth rate at double the pace of its for-profit counterpart, and the nonprofit sector now stands at an estimated 1.4 million organizations employing nearly 12 million people. The sector’s growth was neither planned nor adequately managed, and the qualifications needed to serve at the helm of these organizations have not always been based on knowledge of sound governance procedures. In fact, many executives and board trustees, especially of smaller charities and foundations, are not knowledgeable about either their legal responsibilities or the requirements for good practice and governance.

No Single Set of Standards. The voluntary sector is comprised of a vastly diverse range of organizations with different missions, operations, and spheres of endeavor. Organizations defined by their 501(c)(3) tax-exempt status include (but are not limited to) educational institutions and research centers, hospitals and health clinics, arts and cultural organizations, environmental groups, age- and gender-specific entities, foundations and philanthropic public charities, public interest and civil rights groups, religious organizations, infrastructure support groups, and social service organizations. Some have standards that are specific to their fields of practice, while others do not. Some have sophisticated board orientation programs and training programs for staff. Others do not. Some have very large boards; others have a handful of trustees. Some boards include family members, while other boards draw members from their fields of endeavor and still others from the business and public arenas. Some organizational budgets are well over $100 million, others scarcely at $100,000. In this very diverse landscape, imposing a one-size-fits-all set of standards on all aspects of governance and practice is very difficult to accomplish in a way that makes sense across the sector. It is possible that such standards would have the unintended consequence of spiraling down to the lowest common denominator, or risk being irrelevant to many important segments of the sector.

Doing “Business” in Today’s Fiscal Climate. Many public charities today are scrambling to generate enough income to cover their operational and programming costs. Overall, the nonprofit sector depends on the public sector for 31% of its budget. In social service organizations, public funding accounts for over 50% of revenues. These organizations have had to contend with two years of state budget reductions and are facing a third year of probable cuts. Whereas Washington was once seen as a possible source of relief, the federal deficit now stands at $477 billion for fiscal year 2005 and a projected $5 trillion over the next decade. Individual donor and foundation support has not closed the gap and some organizations, to meet their budgets, have resorted to alternative forms of fundraising. These include partnerships with for-profit corporations, which in some instances have realized substantial disproportionate benefit for the corporation and have risked damaging the reputation of the nonprofit.

Inadequate Oversight and Structural Problems. A major problem for the entire nonprofit and philanthropic sector is that existing federal and state laws pertaining to oversight of the voluntary sector are not adequately enforced. Congress has not provided adequate funding for this purpose at the federal level, and state legislative bodies have not done so at the state level. State charity officials estimate that over 50% of their limited resources for oversight and enforcement of charitable nonprofits are consumed by processing paper copies of the Form 990 and other registration materials, an expense that could be greatly reduced by electronic filing of those forms. Federal legal restrictions on information sharing between the Internal Revenue Service and state charity regulators further inhibits effective oversight and enforcement.

Inadequate Reporting on the Sector. The 990 and 990PF tax filing forms have not provided the kind of clear, consistent information that allows regulators and the public to identify abusers. There are significant differences in the accounting methods used by some nonprofits to record fundraising and administrative expenses, and the forms often make it difficult to explain variances caused by financial transactions, such as restricted funds received in prior years or pledges for contributions that have not yet been received. The forms also do not require that organizations clearly distinguish transactions between related parties and those that that involve other potential conflicts of interest. With this information, regulators and donors could identify and address problems more clearly, before they escalate.

Media Scrutiny. The heightened scrutiny of nonprofits by the media can be traced back to two major events in the past two years. First was the press coverage of the way nonprofits dealt with the rush of donations that flowed into their coffers after the September 11, 2001 terrorist attacks. Several news stories alleged that some of the donated funds were being diverted for other purposes.

Second was the coverage of corporate accounting scandals that made the nonprofit sector a natural sector to investigate, as well. Its sheer size, a $665 billion industry, and its influence made it the subject of interest. The ready access of information via the Internet made it possible for investigative journalists to ferret out stories of abuse by some within the nonprofit sector.

The large number of media stations operating as part of a 24-hour news machine made it likely that the more egregious stories extended the reach and duration of these accounts and allowed reporters in all corners of the country to think about investigating charities and foundations in their own backyards.

These stories have become the prism through which individuals and public officials view the sector, especially when they may have otherwise limited knowledge about nonprofits. People may be aware of and indeed support their congregation’s charitable work or that of other local groups, but after hearing the steady drumbeat of stories that have chronicled spectacular misconduct, the same individuals may not view the charitable sector as a whole in a positive light. The most telling evidence of the potential scope of the problem is the anger expressed by state charity officials and national lawmakers in reaction to these stories, and the fact that these officials are now seriously considering additional ways in which they might regulate the sector.

Getting Our Houses in Order

Limiting the damage caused to the whole voluntary sector by the misconduct of a few will require a comprehensive approach that includes actions by Congress and by the sector itself. To be successful, this strategy must include steps designed to curb existing abuse, and it must show publicly what is valuable and honorable in the sector. Some steps require urgent attention. Others will take some time to implement. But critical to the strategy is public acknowledgement of the problem by our sector and a willingness to come together to achieve the goal of strengthening public confidence in the work of nonprofits.

Promoting Transparency. In order to promote effective governance and more fully understand the nonprofit sector’s problem areas, the public and regulators require better instruments to separate the bad actors from the good. Forms 990 and 990-PF should be revised to make them clearer, easier to complete, and more useful to IRS auditors and the public. Supplemental questions on governance might be added to offer an unambiguous picture of board attendance, conflict-of-interest policy and other critical governance issues. Congress would enhance transparency if it were to make the electronic filing of these forms mandatory. Time is of the essence. Efforts to review and improve these forms are already underway and should be expedited, particularly because these forms have become an important tool that members of the public, the media and government officials rely upon for information on individual organizations. In addition, Federal Accounting Standards Board (FASB) rules should be amended so that financial statements more accurately convey an organization’s financial standing.

Stronger Enforcement and Oversight. Much can be done to strengthen federal and state oversight and enforcement. Congress, with the help of the sector, should increase funding for the IRS’s Tax-Exempt and Government Entities Division. To get there, nonprofit leaders must conduct a serious campaign to encourage political support for increased funding of oversight bodies. Nonprofit organizations should champion voluntary standards of excellence, though such efforts are strengthened when law enforcement is applying the appropriate consequences to those violating the law. State regulators also require adequate funding, and the laws should change to facilitate better communication and information sharing between the IRS and these regulatory bodies.

Policymakers and nonprofit leaders should work together to explore possible changes in the law to curb abuses that may not be adequately addressed through existing law. For example, it may be time to consider stronger penalties for illegal transactions between related parties. The key is to review carefully the scope and potential impact of current laws, identify gaps and carefully construct proposals that meet the need.

Improving Self-Regulation. Currently, there is a patchwork of standards for good practice, accreditation and other self-regulatory mechanisms run by various local, regional and national groups. Some are sub-sector specific, while others are focused on a particular membership or geographical region. There are also substantial segments of the sector with no organized self-regulation. Although the sector has a number of very helpful initiatives, these do not add up to a holistic system that provides systematic, consistent standards of practice or effective disincentives to wrongdoing. There is much that can be done to connect this patchwork of initiatives, including investing further in existing successful programs and filling gaps. A national effort might concentrate on sharing uniform standards of good practice where they apply, reconciling different standards of practice when they are contradictory, and still recognizing the diversity that exists among sector organizations.

Improving the Practice of Individual Nonprofits. There are actions that all nonprofits can and should take immediately to improve their practices related to good governance, transparency, responsible stewardship of resources, fundraising practices, and managing conflicts of interest. Efforts to address issues of ethics and accountability have been developed and can be adopted or adapted to meet the requirements of a particular field. Adopting a useful code of ethics must include educating staff and board members about good governance, transparency and responsible stewardship to ensure that ethical practice becomes a part of the organization’s culture.

Nonprofits and foundations can learn from and voluntarily adopt some of the provisions of the Sarbanes-Oxley legislation,1 which was developed to correct malfeasance within the corporate sector. These might include adopting a conflict of interest policy and a regular and rigorous means of enforcing it; establishing an audit committee of independent members that is separate from the board; avoiding loans to executives; and requiring the CEO and CFO to certify financial documents.
Given the large number of organizations that do not know enough about good practice and some who might respond favorably to skillful peer outreach, establishing a network of technical assistance centers to assist charities in implementing best practices and troubleshooting should be explored.

Increasing Awareness. Nonprofits can raise awareness about the sector by developing and implementing a campaign to educate public officials and targeted influential groups within the general public about the value of various types of nonprofits. The sector’s commitment to accountability must be communicated to the public and through consistent media outreach.

The good news for the nonprofit sector is that many leaders and supporters recognize that the time is ripe to improve governance and practice. By working together, current challenges can be overcome so that the important work that is the core mission of America’s voluntary sector can continue to benefit communities across this nation and around the globe.

1. The American Competitiveness and Corporate Accountability Act of 2002, commonly known as the Sarbanes Oxley Act and enacted in 2002, requires publicly traded companies to adhere to significant new governance standards that broaden board members’ roles in overseeing financial transactions and auditing procedures.

Diana Aviv is president and CEO of Independent Sector.