California’s new charity oversight regulations, which include personal Director liability and forced asset transfer provisions, among others, could represent the beginning of a trend of more forceful state regulation of charities, particularly as states struggle with enforcing charitable registration requirements. On October 27, 2015, the California Office of Administrative Law approved amendments proposed by the California Attorney General’s Office (the “AG’s Office”) to the regulations regarding enforcement of the California Supervision of Trustees and Fundraisers for Charitable Purposes Act (the “Act”). The final amendments to the regulations are to become effective on January 1, 2016.
The AG’s Office introduced the proposed regulations rather quietly in September 2014. After receiving feedback from the public during the initial comment period, the AG’s Office made a few minor changes and introduced a modified version of the proposed regulations in June 2015. Following an additional comment period, the AG Office submitted the modified version of the regulations to the Office of Administrative Law without further modification.
The revised regulations contain several provisions that are particularly troubling. Specifically, Section 999.9.3 of the regulations provides that, if an entity that is required to register with the California Attorney General’s Registry of Charitable Trusts has had its registration suspended or revoked, “[m]embers of the board of directors or any person directly involved in distributing or expending charitable assets [while the organization is suspended or revoked without the written approval of the Attorney General] may be held personally liable” for the amounts of such expenditures. The same Section goes on to provide that “[t]he Attorney General may direct a registrant whose registration has been suspended or revoked to distribute some or all of its charitable assets…to another charitable organization or into a blocked bank account.”
The AG’s Office has repeatedly asserted that these revised regulations represent a procedural change rather than a policy change and are intended to clarify the powers already afforded to the AG’s Office under the Act. Unfortunately, the plain text of the regulations presents a different message.
In its Initial Statement of Reasons for the then-proposed amendments to the regulations, the AG’s Office stated that the prohibition on expending charitable assets while suspended or revoked is intended to prevent an organization “from improperly diverting charitable assets.” According to the AG’s Office, the provision explicitly providing for the personal liability of Directors for impermissible expenditures is necessary because “such conduct [presumably referring to the diversion of charitable assets], by definition, constitutes a breach of trust.” The Initial Statement of Reasons goes on to explain that the provision permitting the AG’s Office to require a suspended or revoked organization, which is not allowed to make expenditures while it is suspended or revoked, to transfer its assets to a restricted account or to another organization that is able to expend them provides “a formalized approach to the accounting and distribution of assets for an organization that ceases to operate due to a revocation rather than through the dissolution process.”
These statements, however, seem predicated on the assumption that only a nonprofit that has ceased operating or is misusing (or is poised to misuse) charitable assets would be suspended or revoked. While these assumptions may be accurate with respect to some suspended or revoked organizations, it is also safe to assume that a number of actively operating, otherwise compliant nonprofits will be suspended or revoked for reasons having much more to do with procedures, including the failure to file a complete annual registration and renewal report with the California Registry of Charitable Trusts. The regulations state that the grounds for which a registration may be suspended or revoked include making false or misleading statements in a document required by law to be filed with a government agency (including the omission of material information in response to a question in such a document) and the failure to prepare annual financial statements using generally accepted accounting principles that are audited by an independent certified public accountant (if required). The regulations further provide that a registrant that fails to file the required annual registration and renewal report for three consecutive years will be automatically suspended. Small nonprofits without paid staff face a significant risk of suspension or revocation for the inadvertent failure to file such statements or comply with other procedural matters.
Since introducing the regulations, the AG’s Office has on several occasions echoed its intent to use these powers sparingly and only with respect to the worst actors. But that limitation is not written into the regulations. Under the plain text of the regulations, volunteer directors whose organizations expend any charitable assets while suspended or revoked may be held personally liable for such expenditures, regardless of whether the expenditures were fraudulent or in furtherance of the organization’s exempt purposes, the basis for the suspension or revocation, or whether the directors were even aware of the suspension or revoca