Sarbanes-Oxley Act and Legal Accountability
Alliance for Children and Families, June 15, 2006
The Sarbanes-Oxley Act of 2002 includes requirements that apply to Nonprofits as well as For-Profit entities. Understand the mandates regarding whistleblower and document destruction provisions of “SOX”.
Adopting the Best Policies
Sarbanes-Oxley Includes Nonprofit Legal Accountability
When Congress passed the Sarbanes-Oxley Act of 20021, it intended to restore public trust in America’s corporate leaders, a trust that had been shattered by highly visible scandals at Enron, Arthur Andersen, Global Crossing, and other major for-profit corporations.
Most nonprofits breathed a sigh of relief that its reforms appeared to focus exclusively on for-profit corporations and had little to do with them. But our sector has suffered its own loss of confidence2, and it is only a matter of time before the Sarbanes-Oxley requirements filter their way into our nonprofit organizations.
Sarbanes-Oxley represents a fundamental shift in enforcement methodologies. It seeks to ensure that corporations make good financial decisions by mandating certain practices: establishing responsible review structures, making financial information more easily available, and providing sanctions against those who intentionally misstate financial information, hide important transactions, or engage in self-dealing to the detriment of the company and its shareholders.
There are only two provisions in Sarbanes-Oxley that directly and specifically affect nonprofits. However, there are a number of changes in for-profit financial reporting requirements that are making their way into the nonprofit sector. And, like ripples on a pond, these changes are likely to spread much further than one might expect—and to bring significant changes in our sector as well.
California, as usual, has led the way with its own state legislation, the Nonprofit Integrity Act of 2004. See the sidebar for comment made in the nonprofit bar at the time, while one of the comments made then is worth repeating here:
“It is no longer sufficient for a charitable organization merely to comply with the letter of the law or even the spirit of the law. The charity must go beyond the law. The public now looks to charities to act as moral agents.”
Let’s look at some aspects of the Sarbanes-Oxley Act and how it directly affects your operations.
Whistle-Blower Protection. Sarbanes-Oxley provides new protections for whistleblowers and criminal penalties for actions taken in retaliation against whistle-blowers—those who report suspected illegal activities in the organization. It is illegal for any corporate entity (nonprofit or for-profit) to punish a whistle-blower in any manner.
Recommendations for Nonprofit Organizations: Develop, adopt, and disclose a formal process within your organization to deal with complaints and prevent retaliation. The process should make it clear that you take employee complaints seriously, and that you intend staff leadership to investigate the situation thoroughly and fix any problems they find. If the investigators decide that no action is necessary, your policy should require that they provide written justification as to why corrections are not needed.
Document Destruction. Sarbanes-Oxley makes it a crime for any corporate entity (nonprofit or for-profit) to alter, cover up, falsify, or destroy any document (or persuade someone else to do so) to prevent its use in an official proceeding (e.g., federal investigation or bankruptcy proceedings). The act turns intentional document destruction into a process that must be monitored, justified, and carefully administered.
Recommendations for Nonprofit Organizations: Develop a written,mandatory document retention and periodic destruction policy that will provide clear guidelines for approved disposal of your organization’s many documents. The guidelines should address the handling of paper files, electronic files, and voicemail. Remember that electronic documents and voicemail messages have the same status as paper files in litigation-related cases. A key element of any such policy must provide that, if an official investigation is underway or even suspected, your staff must stop any document purging in order to avoid criminal obstruction charges.
Governance and Operations. There are a number of ways that Sarbanes-Oxley mandates changes in a for-profit’s governance and operational activities. I will not go into them here as most have been widely publicized and will not be new to you. These provisions are not imposed on nonprofit organizations.
However, good governance often means that you get out ahead of governmental mandates, and the fundraising world is asserting ever-more pressure on nonprofits to prove by their actions that they understand and endorse best practice in this area.
The American Bar Association’s Coordinating Committee on Nonprofit Governance developed 10 principles that incorporate Sarbanes-Oxley “understandings.” They are included here in their entirety for your convenience. I encourage you to give this article to your board governance chair, and assist them in getting these principles implemented to the greatest extent possible.
1. Public Law 107-204, 116 Stat 745 (2002). The Act established a number of provisions in the Exchange Act and its regulations.
2. Most notably in the spending excesses of executives at the United Way, the self-dealing by directors at The Nature Conservancy, and the Ponzi schemes foisted by founders of the Foundation for New Era Philanthropy and the Baptist Foundation of Arizona.