by Thomas R. Dyer

As the Bob Dylan song says, you don’t need a weatherman to know which way the wind blows. Newspapers, magazines, and other media outlets have published numerous stories about the impact of the Sarbanes-Oxley Act on for-profit companies. As a reminder, Sarbanes-Oxley is the federal legislation that was passed as a result of ineffective or conflicted officers and directors whose actions or inactions caused the highly-publicized failure of such forprofit entities as Enron, WorldCom, and others.

While Sarbanes-Oxley does not specifically address the governance of charitable entities, it is having an impact on the activities of not-for-profits and the attitude of regulators, both at the state and federal levels. Many notforprofit board members have been affected by Sarbanes-Oxley and are thus becoming increasingly sensitive to the regulatory environment in the for-profit world. Now more than ever, they are bringing questions about their fiduciary responsibilities to nonprofit boards on which they serve and are asking what they should do as board members to fulfill their duties.

Duties as a board member

I remember my first involvement as a board member of a local charitable foundation. As a young attorney in the mid-1970s, I was asked by a friend to join the board because he thought it would be a good thing for me to get involved in the community, and he knew the mission of the organization was very important to me. The first meeting I attended was quite memorable.

One of our tasks that day was to review the financial statements of the foundation. One of the older, wiser members of the board began to voice concern about the foundation’s investments and how they were being handled by the financial services provider we had hired. He pointed out that, as board members, we were responsible for these assets, and he wanted to make certain we had selected the right party to manage them. Furthermore, he wanted to be sure we had a record of why we selected them and how the funds were to be allocated. It became clear to me at that point that if our group of directors was sued for failure to perform our fiduciary duties, this man would be at the top of the list because he had sufficient funds to pay whatever judgment was handed down! It was definitely in his best interest to keep us focused on our duty of making prudent investments.

In order to make wise investments for the foundation, we decided we needed the following:

• An investment policy, which spelled out the allocation of the assets, e.g. 50% in equity and 50% in fixed income 
• Ongoing due diligence overseeing the performance of our investment advisors and asset managers
• Regular monitoring of the existing investments to assure they were appropriate in light of our mission, ability to take risk, and other factors

Thankfully, we heeded the advice of this wise man who was ahead of his time in the mid-1970s. Since that time, the enforcement and accountability for boards of directors have only increased.

Attorneys general and charitable giving

You may be questioning how attorneys general or other state agencies got involved in the regulation of charitable organizations and institutions. Dating from the Elizabethan period in England, the Chancery, or equity, courts heard disputes regarding whether charities were properly using their gifts as intended by the donors. These cases would be presented by the chief attorney for the government, which today would be the state attorney general of the individual state. Under the common law doctrine of parens patriae, state attorneys general could assert and protect the interests of charities under this legal doctrine.

Centuries later, similar processes are still being employed. In the 1970s and ’80s throughout the United States, there was sweeping legislation regarding consumer protection movements. Various departments of state agencies now handle these matters, but usually they are under the control of the state attorney general’s office. According to sources within various attorneys general’s offices, the trend for attorneys general to handle consumer protection issues greatly increased when the Reagan Administration’s Justice Department became less proactive in these matters. The activists within the state legislatures and regulatory agencies stepped in to more aggressively assert their influence in order to fill what they considered a void in regulation. Most of the regulations established as a result of their efforts are still in place today.

Some of these activities on the part of the attorneys general were and continue to be politically motivated. If you are an elected attorney general, you already have a statewide name, and what better way to build your reputation for your next political step, e.g. governor or U.S. senator, than to be a consumer advocate who protects the rights of all types of charitable causes? Recent elections in New York and other states have shown us that a proactive attorney general can be elected to the office of governor or even higher. For example, Bill Clinton was at one time an aggressive attorney general in Arkansas.

Eliot Spitzer, former attorney general and current governor of the state of New York, published a booklet titled “Right from the Start: Responsibilities of Directors and Officers of Not-For-Profit Corporations.” As many are aware, Eliot Spitzer was the attorney general responsible for the indictment of a number of people who violated their fiduciary responsibilities as officers or directors of for-profit companies.

The following quote from this booklet should give readers a flavor for Mr. Spitzer’s attitude regarding the duties of board members: “Whatever their mission or size, all organizations should have policies and procedures established so that, (1) Boards and officers understand their fiduciary responsibility, (2) Assets are managed properly, and (3) The charitable purposes of the organization are carried out. A failure to meet these obligations is a breach of fiduciary duty and can result in financial and other liability for the board of directors and the officers.” The booklet then establishes guidelines for the many responsibilities of a board member. It is interesting reading, especially for organizations subject to the jurisdiction of the state of New York.

Other examples

The Massachusetts Supreme Judicial Court has even more narrowly construed the duties of officers of charitable or nonprofit corporations due to the “heightened public interest in the affairs of those organizations” as “the management of funds dedicated to charitable purposes and donated out of a sense of social or moral responsibility owe an especially high degree of accountability to the individual donors as well as the community.” ¹

There are other indications of how attorneys general have become more active at a conference of state attorneys general held in February 2006. The conference, held at Columbia University Law School, was named “Conference of State Attorneys General: Oversight and Regulation of Charitable Organizations.” The conference attendance roster and agenda reveal the interest that is now being shown by state regulators, and specifically attorneys general, in the activities of charitable organizations. Included in the conference material was a publication titled “A Handbook for Attorneys General,” which outlined highly publicized cases where trustees and other parties have improperly handled the trusts of well-known individuals. The publication featured the Bishop Trust in Hawaii, the Kauffman Foundation in Kansas City, and the Milton Hershey School Trust in Pennsylvania.

In addition to reporting on prior cases, the material also contained what were referred to as “Scholarly Articles.” In the field of law, as in many other fields, consumer activism is often triggered by academia and their efforts to push the courts and/or the regulators toward a more active role in a particular area. It is clear now that many strong voices in the academic community believe that the state attorneys general need to take a more active role in protecting the public’s interest.

The attorneys general held a follow-up meeting in October 2006. I attended the first day of the meeting, which was the last one open to the public. Again, the attorneys general, other state officials, and members of the press addressed abuses that they saw in the charitable area, and they discussed their efforts to correct these abuses. Stephanie Strom of The New York Times, one of the leading journalists focusing on the nonprofit sector, discussed her concerns about whether some charities are fulfilling their missions. When a person with Strom’s credibility raises questions, you can be assured that government entities will be listening.

Spirit of the law prevails

The fact that charitable organizations are not directly impacted by the Sarbanes-Oxley legislation should not provide nonprofits with a level of comfort. Whether or not there is a letter of law governing charitable organizations, there is definitely a trend among regulators for more oversight at both the state and federal level. The principal areas of concern are:

• Excessive compensation
• Failure to adopt an investment policy which sets out, among other things, the proper allocation of assets
• Use of funds for unintended purposes
• Conflicts of interest where board members or their affiliates profit from the organization

As noted above, one of the most notable cases regarding intervention from a state attorney general involves the Milton Hershey School Trust in Hershey, Pennsylvania. In the Hershey Trust case, the attorney general of Pennsylvania filed an injunction to enjoin the sale of stock held by the Hershey Trust because it would create a change in control in the ownership of the Hershey candy company and thereby possibly create a hardship for the people of Hershey, Pennsylvania.

The court granted an injunction requested by the attorney general; the case was appealed and the appellate court upheld the lower court. The Pennsylvania court stated, “The attorney general has the power and duty to oversee the administration of the Trust and consequently has standing in any case involving a charity. In fact, no trust can declare itself charitable without submitting to the supervision and the inspection of the attorney general, and the attorney general may intervene in any action involving charitable bequest and trust.” As a result of the litigation, the attorney general and the Milton Hershey School Trust entered into a “Reform Agreement,” which provides for an end of all conflicts of interest and requires bi-annual status reports to the attorney general.

The attorney general of Pennsylvania is not the only attorney general who has questioned the intended sale of an asset owned by a charity under donor restrictions. The Tennessee attorney general has delayed a sale of artwork requested by Fisk University, but has agreed to the sale subject to a 30-day delay to allow the art to be purchased by a party that will not remove the art from Tennessee. The attorney general weighed the issue and approved the sale, although the donor’s actual stated intent was that the art should never be sold.

Final analysis

While the attorneys general will often be your allies, their primary duty is to serve the public interest as perceived today, and sometimes this will not even conform to the intent of the donor or to what the board believes to be the nonprofit’s best interests. In any event, the attorneys general across the country can be expected to step up efforts to ensure your board has no conflicts and that assets are properly allocated and invested.

Editor’s note: Next month, we will explore the responsibilities of nonprofit board members in greater detail.

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