While the philanthropic community’s attention has recently focused on the threat of restrictive new laws coming from Washington, D.C., much has been happening at state levels that may place significant new burdens on donors, foundations, and charities. From Massachusetts to California, state policymakers are proposing, and in some cases have enacted, new restrictions and penalties on tax-exempt organizations.
Following on the heels of some well-publicized scandals in the tax-exempt sector, leaders in many statehouses say new rules are needed to ensure tax-exempt organizations operate in a more transparent manner and adhere to appropriate standards of behavior. But many donors fear the states’ zeal to layer new rules on charitable work could backfire. “Regulatory regimes that impose burdens on everyone are far more costly than they are effective,” argues Heather Higgins, president of the Randolph Foundation in New York. “Clear boundaries of what is acceptable and what is not, and enforcement of those rules, is what is most effective.”
Furthermore, many of the proposals that have emerged take a one-size-fits-all approach to nonprofits, creating detailed mandates on such matters as the make-up of an entity’s board and significantly limiting charitable freedom and discretion. This kind of cookie-cutter policymaking, says Higgins, a founding board member of the Alliance for Charitable Reform, is what most threatens charitable giving.
In Texas, where charitable giving exceeds $32 billion annually and provides jobs for nearly 4 percent of the state workforce, several reform measures were introduced in the state’s legislature this year. Without consulting with the relevant committee chairmen or legislative leadership, State Senator Kevin Eltife (R) surprised the Texas nonprofit sector by introducing a bill that would impose new requirements and liabilities on nonprofits along the lines of the controversial Sarbanes-Oxley rules that now apply nationally to for-profit companies. (Compliance with Sarbanes-Oxley red tape typically costs a business millions of dollars.)
Bob Weiss, an executive at the Meadows Foundation in Dallas, says he is concerned by the bill’s micro-managing approach to nonprofit governance, particularly because it could conflict with the terms of donors’ wills. He questions the need for further reforms because Texas already “has an attorney general’s office that is willing to go after egregious behavior in the nonprofit sector.” Existing laws, he notes, allowed the successful prosecution of two recent cases of fraud in charitable organizations.
In Massachusetts, State Attorney General Thomas Reilly has pushed for new and aggressive oversight legislation, prompted, he claims, by a growing number of financially troubled charitable entities coming to his attention. Reilly, who sought and won the return of $4 million to the Cabot Foundation, a Massachusetts family trust, after a family member misappropriated funds, has urged state legislators to apply rules to nonprofits akin to Sarbanes-Oxley regulations. A recent proposal designed by Reilly curbs executive compensation, establishes new rules for audit committees on boards, and raises penalties for violations tenfold. The measure was introduced on May 5 of this year in both chambers of the state legislature; on May 14, Reilly declared himself a candidate for governor.
No wonder some critics speculate that many politicians pushing for charitable reforms in the states are disingenuous when they claim new regulations are urgently needed. But whether or not campaigns for tougher oversight of the nonprofit community are politically motivated, new restrictions on charities and foundations are emerging left and right, quite literally, as Democrats and Republicans alike work to enact new rules in nine states—Hawaii, Iowa, Massachusetts, Maine, New Hampshire, Colorado, Connecticut, Kansas, and California—and are pushing for further reforms in these states and elsewhere.
Perhaps the most stringent new charitable governance rules are in California, where the Nonprofit Integrity Act of 2004 was signed into law by Governor Schwarzenegger last September. The new rules on California’s 150,000 nonprofit organizations set strict standards on everything from fundraising consultants to audit committees and compensation reviews. They also mandated a publicly disclosed, independent audit for any organization whose revenues exceed $2 million. Any organization that fails to comply is threatened with a state takeover. At the University of San Francisco, public management professor Michael O’Neill likens the new law to “attacking mosquitoes with nuclear weapons.”
Some in the donor community worry that even the best-intended restrictions could chill charitable giving and board volunteerism. Dan Peters, president of the Ruth and Lovett Peters Foundation in Massachusetts and chairman of the Alliance for Charitable Reform, observes, “As state regulators choose to pass more burdensome, costly, and complex regulations, it is more likely that foundations will be forced to move to more charitable-friendly states. Misconduct in the nonprofit sector certainly should be punished, but the tools for identifying and punishing improper behavior already exist,” says Peters. “More rules are not needed,” he adds, “only better implementation of state and federal laws already on the books.”
In the Cabot case cited by Massachusetts’ Reilly as evidence of the need for new laws, the information that prompted the state’s action was identified from news reports and from the foundation’s tax forms, submitted to both federal and state authorities and publicly available on the Internet. Similarly, two widely touted cases of charitable malfeasance in California fueled support for new legislation. Yet a criminal conviction and $13 million settlement (including the shutdown of Pipevine, Inc.) were obtained using laws already in effect and information provided under current rules. None of the new California laws were needed to identify, prosecute, and convict the malefactors.
New York Attorney General Eliot Spitzer has previously supported legislation that would have enacted the same sort of new rules California passed and added still more—like enhanced powers for the state’s attorney general to challenge certain board-approved transactions in court, as well as a provision holding top officials of a nonprofit liable for the accuracy of its financial report.
Spitzer surprised many when he announced in November, with his bill pending before the legislature, “I’m not sure applying Sarbanes-Oxley to the not-for-profit world is the right thing to do. I think that we need to make sure the boards of directors of not-for-profits appreciate their very significant responsibilities and obligations, and that is a process of educating and working with not-for-profit boards.”
Most observers believe Spitzer’s about-face indicated he did not expect the legislation to pass, rather than that he had reconsidered the proposal’s underlying approach. Even so, hope remains that in at least one state, a more balanced effort to improve the environment for charitable giving may prevail.
Donors who want to protect America’s flourishing charitable sector will need to exercise much vigilance in their state capitals—and states that don’t want to lose charitable dollars had best beware hasty “reforms” that could drive donors away.
Stephanie Silverman is a principal with Stakeholder Strategies, a division of Venn Strategies, LLC, outside counsel to the Alliance for Charitable Reform.