The U.S. nonprofit sector is at a crossroads. It has lost the public’s trust in its ability to carry out its mission. This ebbing trust stems largely from the sector’s fundamental lack of accountability, where existing mechanisms have been ineffective at routing out real and perceived corruption, fraud, governance and ethics problems and in ensuring that nonprofits fulfill their mission to those they serve.

To date, we have relied largely on external forces to check nonprofits’ behavior; and certainly, nonprofits cannot ensure accountability on their own. But now, after years of nonprofit scandals and abuse, task forces, and reports, the time has come for the sector to willingly adopt more effective internal controls. With existing models to draw on, the sector must turn inward and begin to incorporate the principles of existing external watchdogs. To that end, this article is a call to action, where the key to success is to combine internally adopted mechanisms with the pressure of external oversight. In what follows, we propose new mechanisms, including the adoption of enforceable sanctions for unethical nonprofit behavior, developing joint partnerships between existing agencies, and the establishment of a new position of inspector general to oversee nonprofit adherence to regulation. If the sector willingly adopts this combined approach to internal and external oversight, it can begin to restore discipline and accountability and reaffirm its compact to ensure the public good.

According to the 2008 Report on Charitable Confidence, only 25 percent of Americans believe that charitable organizations do a “very good” job of helping people, which is a decrease from 34 percent in 2003. In the latest Ethics Resource Center report, National Nonprofit Ethics Survey: An Inside View of Nonprofit Sector Ethics, survey respondents reported observing more financial fraud than their counterparts in business, and 42 percent of respondents characterized their organizations as “weak” or “weak leaning” ethical cultures, compared with about 38 percent in the 2000, 2003, and 2005 surveys. The significant decline in the public’s and insiders’ confidence in the nonprofit sector has been driven by scandals such as the Red Cross’s massive mishandling of its response to Hurricane Katrina, the embezzlement of nearly $1 million from the Association of Community Organizations for Reform Now (ACORN), the Smithsonian Institution’s highly publicized management and governance crisis, and other high-visibility incidents. Nonprofit sector leaders tend to shrug off such scandals as the bad acts of an isolated few that have only marginal impact on the sector as a whole. The mere existence of these scandals, however, should be deeply troubling to the nonprofit sector because scandals, whatever their size and shape, have had a broad and lasting impact on the levels of public trust and, thus, on levels of charitable giving. The connection between confidence and giving is that basic. Now is the time for action. The nonprofit sector must acknowledge its scandals and shortcomings; institute mechanisms to expose, discipline, and guard against illegal and unethical behavior; and challenge itself to take deep and wide-reaching action to restore the public trust.

Existing External Models

Strides have been made to create new, and improve on existing, governance mechanisms to monitor the nonprofit sector. Externally, there are multiple avenues to guide and check the nonprofit sector. Below we explore some of the existing mechanisms to ensure nonprofit accountability.

The Internal Revenue Service. In exchange for charitable missions, nonprofit organizations and foundations receive the benefit of tax-exempt status under federal and state tax codes. Considering the approximately $300 billion donated to the nonprofit sector annually, this is a windfall of sorts from the public till. Because of the financial advantage of tax-exempt status and the filing processes required to receive it, the IRS, therefore, is perhaps the sector’s most vital watchdog.

The IRS’s filing and auditing system provides an annual opportunity to review a nonprofit’s financials and ensure compliance with the requirements of tax exemption. The IRS’s primary enforcement mechanism is the right to impose potentially substantial civil penalties for late or incomplete filings as well as, of course, the threat of losing tax-exempt status altogether.1 In 2008 the IRS expanded its filing requirements to compel many small organizations with less than $25,000 in gross receipts to submit an abbreviated return.2 In 2007 the IRS issued a revised Form 990 to help improve transparency and compliance. The new form included major changes, such as the addition of a governance section and schedules relating to executive compensation, related organizations, and foreign activities, among others. The agency also provides educational support in the form of tutorials, published guidance, and other platforms to further counsel the sector.

The federal government. The federal government also uses its legislative and budgetary powers to impose oversight on the nonprofit sector. Quite successfully, the government has linked the granting of federal funds to regulatory compliance, such as by requiring proper accreditation before public universities can receive federal funds and, similarly, before nonprofit hospitals can be eligible for Medicare reimbursement. Further, Congress uses its legislative authority to institute meaningful investigation of the sector. Senator Chuck Grassley of Iowa, the senior Republican member of the Senate Committee on Finance, has aggressively monitored the nonprofit sector, including by spearheading investigations into executive compensation and spending abuses.

State attorneys general. At the state level, much of the governmental watchdog responsibility falls heavily on the public charities division of the attorney general’s office. The attorney general’s role is to protect the public interest by overseeing the use of charitable funds and the fundraising process, investigating specific complaints lodged against nonprofit organizations, and enforcing the laws and regulations affecting the sector. Attorneys general carry out their mission by imposing civil and criminal penalties, although the practices and resources of the attorneys general diverge greatly from state to state.

The media. The nonprofit sector has also relied on the media to be its watchdog and to highlight instances of bad behavior. But the nonprofit sector’s reliance on the media has serious shortcomings. The media can be effective in exposing corruption and illegal and unethical behavior by those charged with safeguarding the public trust. But what happens after an article has been published and public outrage dissipates over time?

Internal Controls Needed

While all of these external mechanisms help to provide oversight to the sector, they are limited in their ability to cause real and lasting change through oversight, enforcement, and sanctions. But the nonprofit sector remains resistant to adopting internal mechanisms that have teeth rather than merely offering aspirational and voluntary guidelines that organizations can choose to follow or disregard.

At root, the nonprofit sector has exhibited a fundamental “Not in my backyard” resistance to policing itself. In spite of its expertise, leadership, and clear identification of its internal challenges, the nonprofit sector has yet to truly stand up on the watchdog issue. Ironically, nonprofits continually support and demand watchdogs to oversee other sectors; consider Common Cause, inspectors general of agencies, independent state and federal ethics commissions and congressional panels, and major federal and state oversight and watchdogs of every kind for the private and corporate sector. But nonprofits haven’t been champions of the same principles on their home turf.

Some argue that the complexity and diversity of the nonprofit sector renders substantive, sector-wide reform impossible, not to mention the costs and concerns about unintended consequences. Thus, our recommendations for meaningful implementation that extend beyond education, technical assistance, and other aspirational changes, and toward greater enforcement and sanction-driven oversight, will likely be and have been hard fought. Nonetheless, the nonprofit sector must move beyond voluntary internal controls and accept that with the benefits of the tax code come the burdens of accountability and good governance. Enforcement and sanction capacities should be used to ensure that all nonprofits responsibly fulfill their charitable missions. If encouraged and implemented directly by the nonprofit sector itself, such substantive reinforcements could bolster its reputation in these difficult economic times, when the public is even more likely to require that its donations have been put to good use.

Accordingly, an internal nonprofit sector watchdog could be the guardian of the public trust that the sector so desperately needs. And some strides have been made to devise a uniform and standardized list of “best practices.” In October 2007, for example, the Panel on the Nonprofit Sector, made up of 24 nonprofit and philanthropic leaders from a range of organiza