Corporate governance reform: what it means for associations.

Everyone is well aware of the corporate governance scandals among major U.S. corporations during the past few years--Enron, Worldcom, Tyco, to name a few. And those in the nonprofit community have observed examples closer to home: united way's problems with its former CEO, the U.S. Olympic Committee's tensions between board and CEO, and recently the New York stock exchange's nine-figure compensation of its senior executive (yes, NYSE is a nonprofit corporation). As a result, new legislation has been enacted to require increased accountability and regulation of corporate boards. While nonprofit boards are not required to follow most of these regulations, this column points out both direct and indirect implications of the legislation for nonprofit organizations.

Concerned about investor confidence, which was shaken in recent years by numerous high-profile corporate scandals, Congress reacted swiftly and sternly. It passed the Sarbanes-Oxley Act of 2002, signed into law on July 30, revolutionizing the governance of publicly traded corporations regulated by the Securities and Exchange Commission (SEC). The law provides clarity and certainty on many long-debated corporate governance issues. It also has implications for nonprofit boards.

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Corporate governance changes

Following are the major ramifications of the Sarbanes-Oxley Act on large businesses:

* Banning loans to directors and officers.

* Disgorging compensation already paid to corporate CEOs and chief financial officers in cases of financial misconduct.

* Directing corporate CEOs and CFOs to personally certify their familiarity with reports, legal compliance, material accuracy, and disclosures to the public and to the audit committee.

* Requiring the audit committee to preapprove outside auditors, avoid some nonaudit services such as consulting, rotate the responsible partner reporting directly to the audit committee, and avoid conflicts and coercion.

* Requiring the audit committee to have sole authority over auditors, consist of only nonmanagement directors, establish protections for whistle-blowers (those who call attention to potentially fraudulent activities), and disclose the identity of financial experts on the committee and board.

* Calling for attorneys who practice before the SEC to report "up the management line" any violations by their corporate clients and, if there's no action, to report violations to the SEC directly.

Sarbanes-Oxley also calls for

* additional or accelerated SEC filings, reviews, and disclosures;

* corporate disclosure of a code of ethics governing conduct of management and financial personnel; and

* extensively increased SEC enforcement and penalties.

Ramifications for nonprofit organizations

The association community, well aware of the revolution in corporate governance, has largely assumed that associations are not affected. That is a false assumption. The act has direct and indirect impacts on association governance.

* Direct application. Two features of the Sarbanes-Oxley Act apply to all people and entities. Section 802 of the act prohibits destruction of documents to thwart a federal government investigation; and Section 1107 prohibits retaliation against whistle-blowers. Both provisions carry criminal penalties--including jail terms--for violators. Every association should provide clear direction to staff, and perhaps even adopt written policies, to ensure that neither provision is violated.

* Indirect implications. Association executives and boards of directors must not underestimate the indirect effects of Sarbanes-Oxley. The law has focused a spotlight on corporate governance practices and policies, raising expectations for everyone who deals with corporations of every kind. And because nonprofit membership organizations often have volunteer board members who work full-time for major corporate entities, the expectations of nonprofit boards have dramatically increased as well. It is the rare association that has not begun to consider how the Sarbanes-Oxley reforms might be adapted for its use. And many adaptations are under way.

A new reality

Nonprofit organizations, of course, are already subject to considerable law and precedent that mirror the principles of Sarbanes-Oxley. All nonprofit corporations are chartered by state governments and subject to state authority; some state laws require financial disclosures to members. Courts have consistently said that volunteers for nonprofit organizations have the legal duties of remaining loyal avoiding conflicts of interest, and maintaining the confidentialities of the organizations they serve. Most nonprofit organizations are subject to Internal Revenue Code tax exemption requirements; Section 501(c)(3) organizations must observe the intermediate sanctions rules; and all tax-exempt organizations must avoid inurement (dividend-like payments) to individuals and must provide Form 990 annual reports and exemption determination correspondence to requesters.

In addition, pressure is building for nonprofit organizations to adopt Sarbanes-Oxley's standards to the maximum extent feasible given an organization's size and nature. Two areas in particular demand the attention of associations:

1. Financial monitoring and disclosure.

Principles of good management and governance combined with pressure from the Sarbanes-Oxley Act demand accurate and complete financial reporting to officers and governing boards. And the expectation is growing that dues-paying members have a right to at least some financial reporting. Also, associations will want to replicate the audit committee feature of Sarbanes-Oxley to the extent feasible--a board committee whose function is to ensure that appropriate financial controls are in place and that reliable accounting and auditing are conducted. Many organizations also will want to ask their CEOs and CFOs to personally certify that financial reports are accurate and complete.

2. Codes of ethics and conflicts of interest. Sarbanes-Oxley effectively mandates avoiding conflicts; and separately it requires that investors be told whether the corporation has a code of ethics for management, effectively compelling a code. Many associations, especially professional societies, already have codes of ethics and policies on conflicts of interest; but these tend to provide direction for the conduct of volunteers, not for association management. Executives should consider establishing or expanding their organizations' codes to address financial management, responsibility, and disclosure. Codes of ethics and conflict of interest policies, which can be combined where appropriate, should also be subject to written procedures for enforcement.

Jerald A. Jacobs, a partner in the Nonprofit Organizations Practice of Shaw Pittman, Washington, D.C., is general counsel to ASAE.