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Nonprofits Face Regulation, Enforcement From Several Areas.

A big scandal always grabs attention. But when nonprofits fall under the gun of the state charity official, attorney general or other regulators, they can be slapped with any number of infractions.

While state charity officials claim that a national compilation of fines and enforcement is not kept, a spot check by The NonProfit Times shows states being aggressive.

For example, The Connecticut attorney general's office recovered $827,314 for the fiscal year between July, 2000 and June, 2001. Of that, $86,000 was paid in the form of civil penalties while $741,000 represents other fines and reimbursements. Part is money paid to rightful charities due to some misrepresentation by a third party. The second big area was funds raised but spent for purposes other than the donor's intent.

Some cases include large amounts. "We defended a will from an heirs' contest that saved a $7.7 million charitable bequest," said David Ormstedt, an assistant attorney general in Hartford, Conn. "In June, a final action on the funding of a $134 million health care conversion foundatio took place."

Misrepresentation of solicitation can be exemplified by a case against a children's charity. The charity raised funds by mail and reported its need to buy medical equipment for sick children. However, according to the nonprofit's IRS Form 990, the major activity of the organization was for public education. "The total money they reported on medical expenses was only 2 percent," Ormstedt said.

The attorney general's office settled the case by having the charity pay $40,000 divided evenly between a civil penalty and the balance to other child-oriented charities.

"Most of the time we try to work things out without the court system," he said. "Sometimes they get caught red-handed and agree to settle up."

In one case, the Connecticut attorney general's office went after a board president who started a building scheme with a contractor. The contractor never completed the work and no bids had been taken on the proposed work.

"Money was exchanged and the contractor split it with the board president," Ormstedt said. "That infraction would not have happened if the board paid attention to what was going on."

But such blatant action is not the norm. Most of Ormstedt's activity is heavily weighted on the negligence side, he said.

Ormstedt explained it's hard to know the extent to which the state's intervention works. Many boards are weak and miss areas of conflict of interest. The actual work done by the state could represent just a fraction of the problems because many never get reported.

These examples of legal activity only portray Connecticut. Other regions may face different issues.

One area starting to affect organizations is the new accounting standard SOP 98-2 from the American Institution of Certified Public Accountants (AICPA). The procedure deals with filing financial reports of joint allocation of programming and fundraising that records direct response expenses.

The accounting calls for certain portions applied to fundraising and a certain portion for program, explained Seth Penman, principle at Penman & Perlman, New York City-based attorneys who defend nonprofits around the country.

The legal problems aren't in the form of a penalty. "The infraction becomes a lawsuit because it's considered fraudulent," he said. "The state is taking a position that if you don't apply the accounting appropriately, the result is misstating your financial position."

While no court actions have yet hit, investigations are going on. Should an organization fail in the suit, the results could require some assurance that the organization would operate differently. "It's possible the organization could pay tens of thousands of dollars with significant fines on top of that," he said.

This depends on the focus of the attorney general's office. "We don't pay much attention to the SOP 98-2," Ormstedt said. "No one can control it, but there's nothing you can do about it. For us, it is a waste of time and we have other things to work on."

Daniel Moore, registrar of charitable organizations for the attorney general's office in New Mexico and president of the National Association of State Charity Officials (NASCO), expects to see the SOP 98-2 as a critical issue for the NASCO's upcoming conference.

"SOP 98-2 has always been an issue for state charity people," he said. "This is an accountability issue since we have the IRS Form 990 on the 'Net. The numbers should stand for something."

Moore explained that NASCO wants to see how other states are reacting before it determines the approaches that will work best.

New Mexico's office focuses on registration and charitable oversight. With a concentration on solicitation misrepresentation issues or directors' misuse, its attention has eyed a number of hospital conversions from nonprofit to for-profit. The area is known for a volatile business activity in healthcare.

"We have a Blue Cross being sold as a nonprofit," he said. "We want to make sure a fair value helps the beneficiaries such as the Medicaid population and that the funds continue to be devoted to the healthcare mission."

Possible changes in such situations could turn assets from health care dollars into funds for other uses. Moore explained that some nonprofits could use incoming funds for the arts or culture.

Enforcement issues could really be different than what is usually perceived, explained Geoffrey Peters, a volunteer general counsel for the American Charities for Reasonable Fundraising Regulation. The organization is known as the Litigation Coalition made up of 400 charities and fundraisers in Arlington, Va.

Peters's office once requested a list of nonprofits prosecuted in Pinellas County, Florida. Peters expected to find charity fundraisers prosecuted for failure to registrar, or for late registration. He also expected to find many citations for fraud.

Peters said that he received back nine citations for soliciting in a road way and all nine pertained to the same organization. A church was asking people to go into the street for donations and failed to obtain a license.

"No one ever got prosecuted for fraud, or misuse of funds," he said. "What you perceive to be the issues and what issues are being addressed can be very different."

One of the least expected places of enforcement activity is with the United States Postal Service (USPS), yet some of the biggest cases are with cooperative mailing that involves millions of dollars.

The USPS claims ineligible mailings at the nonprofit rate happen when a for-profit fundraiser takes the risk of the mailing. The for-profit company then can not use the nonprofit rate.

"I see more and more of this type of action:' he said."The Post Office has gotten so bad there's some legislation in Congress that would remove the ability of bringing these cases."

Peters explained that the intermediate sanctions enforcement from the Internal Revenue Code Section 4958 is taking shape. That section applies to an excess in benefit transactions, defined as transactions where a disqualified person receives a more than fair market economic benefit from taxes under Section 501(c)(3) or (4).

Recently, the IRS requested additional authority that it could use short of the "death penalty" that revokes the exemption for nonprofits. The Internal Revenue Service (IRS) would impose a tax equal to 10 percent of the excess benefit. This would be levied on any organization manager who knowingly participated in excesses. An "organization manager" specifically includes members of its board or trustees.

The intermediate sanctions regulations are getting a lot of attention from IRS enforcement officials. Peters reports that the IRS has assessed more than $40 million in intermediate sanctions excise taxes against one individual who was an officer in several nonprofit home health agencies. These organizations were converted from nonprofit to for-profit status.The IRS would not confli-m the figure.

This type of action is separate from those done by the state's charity officials. A nonprofit hospital conversion could have problems with both the state and the IRS. In the case of the New Mexico activity, the state is looking at the hospital conversion because of a state law dealing with fiduciary issues. The state might not even be aware of the IRS activity because of Section 6103 which declares that the IRS does not have to let the state know about its investigation until the conclusion.

"A number of cases are now under investigation," Peters said. "This is not widespread but the amount of money is large. The penalty is technically not a fine but an excise tax that depends on the size of the transaction."

Legal pitfalls are affecting organizations that use sweepstakes for fundraising. Perlman explained this area stems from problems that hit several for-profits. However, the law suits dealing with consumer protection statutes are being applied. In most cases, states want to recover the money raised during the sweepstakes along with the cost of investigation.

"I think this is an unconstitutional application of a statute," he said. "The statutes are very vague although most say that any tendency to mislead the warrants an action."

Peters explained that sweepstakes mailings have dropped substantially because changes in the rules virtually makes them unfunctional. New rules require a specific language with disclaimers, along with restrictions on the size of the typeface.

"Any organization that raised 50 percent of its funds from sweepstakes feels a major impact today," he said "Revenue has dropped 20 to 25 percent with at least three charities."

Back in Connecticut, the breach of fiduciary issues by board members leads Ormstedt to say that most nonprofit board members need experience to foresee potential conflicts of interest.

Ormstedt participates with a group started by a local United Way that conducts training sessions for board members." Some people sit on boards without training," he said. "They need to read the minutes, follow the financial statements, attend meetings and view the IRS Form 990."

Enforcement strikes many organizations with fines and penalties for late registrations, explained Perlman. "This is becoming a bigger problem especially since many states don't allow extensions to file," he said.

The sizes of such penalties for failure to register range between $250 to $1,000.

Nonprofits should be aware of the types of regulations from the multiple players involved with enforcement. "I'm sorry we're in an industry so heavily regulated," Peters said. "But it comes with the job description to pay attention to the various levels of restrictions."

Tom Pope is a New Yorks City-based journalist who writes about management issues.

IRS Is Not The Only Federal Watchdog

The Federal Trade Commission (FTC) should also be included on the list of agencies that regulate nonprofits. While its enforcement of the Telephone Sales Act and other FTC rules explicitly exempt nonprofits, some legal minds believe that rules may affect charities.

Some attorneys general have expressed concern that commercial-nonprofit product advertisements often send misleading messages. They complain that products often are endorsed by the nonprofit partner.

The attorneys general are concerned that some joint advertising campaigns using a respected non-profit's name and logo often fail to inform consumers enough. Information is crucial about whether the commercial sponsor has paid the nonprofit organization for use of its name and logo.

Some 43 states along with many local jurisdictions have a version of the "charitable solicitation regulation" as part of statutes and ordinances.

Some of these regulations are enforced by the state attorneys general. Others are enforced by the Secretary of State or other organs of state government. While these statutes are rarely used to prosecute for misleading statements, fraud or abuse, they apply fines for "failure to register" or failure to file reports on time.
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Author:POPE, TOM
Publication:The Non-profit Times
Date:Aug 1, 2001
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