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Attorney General Focusing On Fiduciary Responsibilities

While long-established charities are seeing donations drop and more are shuttering their doors because of a tough U.S. economy, according to Terry Knowles, assistant director of the New Hampshire Department of Justice Charitable Trusts Unit, her office is seeing an increase in filings for nonprofit status.

“There is this persistent urban legend that there are millions and millions of dollars in grant money that no one claims, both from the federal government and from the private funding sources,” she said. “When we have people calling us about establishing new charities, we immediately say to them, ‘Why do you want to do that?’ The number one answer is ‘Well, there is grant money available that I can get if I become a charity.’ The number two answer, for us is, ‘I need a job, so I’m going to start a charity.’ So you have this disconnect between perception and reality.”

The reality is that charity regulators started 2009 with a full workload, everything from potential fraud to questions and concerns about the new federal Form 990 filings. There’s plenty of regulatory work without urban legends of a nonprofit financial haven.

And while nonprofits often talk about their ratings on charity watchdog Web sites, like the BBB Wise Giving Alliance, Charity Navigator or GuideStar, the state and federal regulators wield the power to legally pursue offending nonprofits. The National Association of State Charity Officials (NASCO) does not aggregate national statistics on complaints filed with members, but some state charity regulators are reporting increased complaints.

The Georgia Office of Secretary of State, Securities and Business Regulation Division, reported 34 complaints in 2008, a 44 percent decrease from the 61 complaints made in 2007. While Georgia saw a decrease, Florida Department of Agriculture & Consumer Services, Consumer Affairs division had more than a 26 percent increase – from 147 complaints in 2007 to 186 complaints in 2008. The Ohio attorney general’s office had 1,325 complaints in 2008, a more than 5 percent increase from 2007, but not all the logged complaints fit under the office’s jurisdiction. The Colorado Secretary of State reported 28 complaints against charities in 2008, resulting in two prosecutions, one from the Boulder district attorney and the other by the Colorado attorney general, and seven still under investigation.

Chris Cash, NASCO president and Colorado Department of State charities program manager, explained that state charity officials realize that nonprofits tend to receive a small amount of consumer complaints, and disgruntled former employees or volunteers file some complaints. “We investigate all complaints, but not all complaints require agency action beyond a simple inquiry to verify facts,” he said about the Colorado program.

The retooled Form 990 adds an extra punch to the charity regulator arsenal. It includes questions about policies regarding governance, management and disclosure, which some regulators are hoping will give more insight to a nonprofit’s operations. The Internal Revenue Service (IRS) worked with NASCO to develop the new Form 990 and received feedback from the organization before releasing the draft to the public in June 2007.

“It’s a big interest to the sector because, of course, it’s new and it’s much bigger and broader in scope so that presents challenges to them on how they are going to fill that out,” said Tracy McCurdy, director of the Pennsylvania Bureau of Charitable Organizations. “I think it presents challenges to the accounting professionals because they have to have a higher level of expertise to work on these things. But it’s also really great for the regulators because the IRS has given us a lot with the governance questions and some of the other things, they have really allowed the states to have to play a bigger role in the information that comes out of the 990s.”

Overall, the Form 900 is going to provide state charity regulators with a lot more information, “particularly in the areas of governance and also compensation issues because although the states and the IRS have two different jurisdictions, many of the things that we are looking at are important to the states for different reasons because of their areas of charitable oversight,” said Lois G. Lerner, director of the Exempt Organizations (EO) Division of the IRS. “When you look at the facts we look at to determine whether an organization meets the requirements for tax-exemption, those same facts can also give rise to some of the violations at the state level.”

Lerner explained that the IRS expected to have regular interaction with NASCO about the new filing and monitor trends that arise with the new Form 990 and hoped the feedback would help shape future adjustments. The IRS and state regulators already have a compliance relationship — the IRS can give some information to state regulators about enforcement activities under the Pension Protection Act of 2006, while the state regulators can lead the IRS to potential tax violations. In 2008, EO disclosed nearly 200 enforcement activities to state agencies, including terminations and revocations, and state officials made 83 referrals to EO, including political activities, employment tax and failures in operating within designated exemption status.

The EO Examinations office, with the Exempt Organization Compliance Unit (EOCU) that conducts compliance checks and Review of Operations (ROO) that manages follow-up reviews of organizations, has increased its compliance checks steadily during the past few years. EO examined 7,861 returns in FY 2008, a slight increase from 7,580 in FY 2007 and 7,079 in FY 2006. Compliance contacts, made to ensure nonprofits are consistent with tax-exemption and reporting responsibilities, jumped from 1,475 in FY 2004 to 7,466 in FY 2008. EO has improved its compliance check percentage by using modeling to target nonprofits that would be at a higher risk for noncompliance, which increased its corrective action cases from 63 percent of its examinations in FY 2004 to 80 percent in FY 2008.

The EO also plans to launch a long-range study this year about funds and charities as part of its new Fiscal Year 2009 compliance initiatives, which should provide more information about nonprofit spending.

Some nonprofits are seeing increased fundraising costs trying to chase discretionary donor dollars, which regulators are keeping on their radar screens. U.S. Supreme Court cases, such as Schaumburg v. Citizens for a Better Environment decided in 1980, have upheld that high fundraising costs alone do not prove fraud, yet regulators are keeping watch for other red flags. “The charitable watchdogs are going to have an issue here because they have percentage-based accountability standards and nonprofits are going to have a harder time meeting that kind of standard as their fundraising percentages increase due to the collapsing economy,” said Seth Perlman, senior partner at Perlman & Perlman in New York City, who advises in nonprofit legal matters.

“This year we’re really focusing on organizations that have unusual fundraising levels and on organizations that report that they have unrelated trade or business activities but have pretty low levels of program service expenditures. We just want to know what that means and I want to caution here – my world is never black and white. It’s always grey,” said Lerner.

“Some things may raise questions for us. But when you look behind them, oftentimes things are perfectly fine. But we think when you see those kinds of disconnects, it’s important for us to go in and take a look and report out to the public about what we’re finding because it’s important for the public to understand that even if we find there is no problem — or if we do see there is a problem, we think that’s important for the public to know as well,” said Lerner. “At the end of the day, what I’m hoping the new form does is to leave us with fewer noncompliant organizations and give us a better tool to pursue those who are not compliant and I think the states are looking at it the same way,” said Lerner.

And some state regulators say that some nonprofits are already asking questions about the form and if they will be penalized for their answers, which includes information about an organization’s governing body, conflict of interest policies and compensation reviews for top officials. “We often find nonprofit organizations don’t want to call the regulator because they are afraid that the regulator will then take action against their organization, and in our case nothing could be further from the truth. We try to be as proactive as possible and deal with things before they become a real problem,” said Knowles.

“[The new 990] will change internal procedures for the nonprofits in respect to their financial reporting,” said Perlman. He thought the changes could be relatively positive and explained that regulators and nonprofits alike were “holding their breath” about it and how the results will shape the sector. “Public charities need to be very aware of what their obligations will be under this new 990, which will include ensuring that they have the appropriate policies in place to respond affirmatively to those best practices questions because it can be embarrassing to an organization to have to answer Ôno’ to a question about whether they have appropriate policies in place when that document will be a public document reviewed by the public and state regulators,” he said.

“There’s information required on this form in a format that has not been required before and you really need to have a conversation within the organization to be able to provide the right information and tell a good story, because this form really allows the exempt organizations to tell the story of what they do to the public and the IRS and they should take advantage of it,” said Lerner, who recommended different departments should review the 990 together.

While the Form 990 goes into more detail, state charity officials are losing some filers during the three-year, phase-in period. The thresholds for Form 990 filing will begin at more than $1 million gross receipts or more than $2.5 million in assets beginning in tax year 2008, a significant jump from the 2007 Form 990 threshold of $100,00 gross receipts and/or $250,000 in total assets. The threshold will decrease to more than $500,000 in gross receipts and/or $1.25 million in assets in tax year 2009 and then $200,000 in gross receipts and/or $500,000 in assets for tax year 2010 and beyond.

“This is problematic for state charity regulators because we have so many charities that are under the new IRS filing threshold we would be losing a great deal of valuable information if we raised our filing thresholds as well,” said Knowles. “So we as state regulators, through NASCO, are trying to work together to come up with an alternative for those charities who have to file with the states but not necessarily with the federal government. We don’t want to overburden charities with additional filing requirements but this information is vital for what we do as regulators in our own states.”

Some regulators are hoping electronic reporting will speed up the process and make information on charities easier to handle. California recently implemented the electronic Registry of Charitable Trusts, an improvement compared to paper-based filing. “Honestly, when you have a limited staff and 94,000 charities in your state, without an automated registry, it sometimes feels like we’ve just have a few fingers in the dike,” said Belinda Johns, senior assistant attorney general in the Charitable Trusts Section of the California Attorney General’s office. Johns said that 460 complaints were logged for the Fiscal Year 2007 to 2008, with 206 logged so far for FY 2008 to 2009 — and that electronic reporting helps her department weed out offending charities more efficiently.

Cash said that while smaller organizations wouldn’t need to post their Form 990, state regulators ideally still want to hear from everyone. “We would like to just know if a charity is in existence and taking donations, if nothing else,” he said, while one of the options NASCO is exploring is creating a uniform reporting form across the states for nonprofits.

Reporting information will be key since several state regulators said they expect an increase in embezzlement and financial diversion allegations in response to the struggling national economy. According to a study by Association of Certified Fraud Examiners, nonprofits had the smallest percentage of fraud, 14 percent, compared to privately owned companies (nearly 40 percent), public companies (28 percent), and government agencies (18 percent), based on 959 cases of occupational fraud investigated between January 2006 and February 2008. In the study, nonprofit fraud was unearthed mostly by tips, more than 48 percent, a huge majority compared to internal controls (24.8 percent), external audit (14.9 percent), internal audit (13.2 percent), accidental instances (10.7 percent), and police notification (1.7 percent).

Cash said that if nonprofits increased internal scrutiny slightly, like sending bank statements to another address or clear separation of employee financial duties, it may have a dramatic positive effect in the fraud controls. “We (state regulators) were very struck by the ease in which fraud is perpetrated against a charity and how much there is,” he said. “We are also stuck by how easily it can be prevented and I think what we are going to try to do is start really stressing this to charities during any educational outreach we do.”

Knowles, who has worked in charity regulation for 28 years, said she’s seen an upswing in embezzlement allegations during down markets and is currently investigating four to six allegations. She explained that in New Hampshire it’s the youth sports organizations that seem to have the most trouble handling the nonprofit reins.

“Day-after-day, you see newspaper articles nationwide reporting embezzlements from charities, and especially from youth sports organizations. In my opinion, the reason for the thefts from youth sports organizations is primarily because the motivation for those particular board members to serve is different than the motivations of board members who serve other sorts of charities,” said Knowles. “Well-meaning parents certainly want to do the right thing, but they often don’t understand that along with choosing the coach and insuring their child will play on the team there are other fiduciary responsibilities inherent in being a board member.”

The Pennsylvania Bureau of Charitable Organizations received 373 complaints in 2008. Of those complaints, 30 were referred to the prosecuting attorney for action with 14 final actions executed, while the others are in different stages of prosecutorial action. McCurdy agreed that smaller organizations, like youth sports, volunteer firefighter organizations or parent-teacher organizations, are more vulnerable to embezzlement. “The nature and structure of that kind of organization is one where there’s typically a high level of trust among the people because of their relationships,” she said. “They don’t necessarily look over the shoulder of somebody who may be handling the money.”

Regulators said while they are taking a harder look at organizational transparency and asking tough questions, charities should not be afraid to ask questions or for help. NPT