Raul Larios

Will Changes in N.Y. Non-profit Laws Cause Board Resignations?

Revitalization ActNew York governor Andrew Cuomo recently signed into law the “Non-Profit Revitalization Act,” which totally overhauls our State’s antiquated nonprofit regulations. Most of the reforms will go into effect July 1st of this year. Applauded by many, the new provisions will eliminate unnecessary and outdated bureaucratic burdens. More importantly, the Act should reduce some of the fraud prevalent in the industry (see my blog post dated 01-21-2014).

However, one thing that the Act did not do, is to reduce the personal liability that non-profit Board directors take on in New York for their philanthropic service. Quite the contrary, not only does the Revitalization Act place all the responsibility on Board directors to carry out the stricter provisions, but it also grants the Attorney General sweeping new powers to prosecute them for negligence and even incompetence. Although the intention to crush fraud is laudable, I believe it will cause some un-intended consequences.

Keep in mind that unlike the for-profit world where most Board members are experts in their fields (such as risk management, audit, finance, legal, etc. — and are compensated for that expertise), Board directors for tax-exempt organizations (TEOs) are mostly un-paid volunteers who care about doing good. This is not to say that TEO board members do not have any expertise in corporate governance (many do). However, the culture at many TEOs is more easy-going and casual, the type that focuses on social benefits such as how many trees were planted, how many scholarships were awarded or how many whales were saved — and not on designing and administering a whistleblower policy, for example, that includes procedures for the reporting and handling of suspected violations of law. Does the average volunteer director even have the expertise for this type of work?

In many ways, non-profit directors are at much greater risk for personal liability than for-profit Boards because the volunteers have at their disposal smaller budgets and staffs, and worse yet, limited access to experts such as lawyers and accountants.

The Revitalization Act puts the volunteers’ existing personal liability on steroids. Consequently, some volunteer directors may choose to resign to avoid the additional burdens and risks being placed on them. After all, they can continue to do good by simply donating money to their favorite causes, but without any of the personal liability.

So what can you do if you’re the Executive Director or the Board Chair to prevent resignations? Start with a careful and thorough review of your Director and Officer (D&O) liability insurance policy. Since there is no such thing as a “standard” D&O policy, you should hire an expert (usually “fee-only” insurance consultants) to help you. Be sure to have your Board participate in the discussions, so that their concerns are heard and acted upon. At the very least you want to know if your aggregate coverage limit is still adequate considering the new law; whether certain sneaky exclusions (such as “failure to provide insurance”) can be removed; whether the cost of legal representation falls in or out of the aggregate coverage limit; and whether the policy offers “tail” (or extended reporting period) coverage. Based upon your Board’s reaction, you may have to change underwriters.

You also want to determine whether to hire a consultant to train two key volunteers on your team: the Chair of the Finance Committee (i.e., the Treasurer) and the Chair of the Audit Committee.  Ask them if they want/need a training or refresher course on their duties. Among their many responsibilities (and depending on the size of the non-profit), the Treasurer should be reconciling the organization’s bank accounts monthly, insuring that month-end cash balances are correct, and reviewing/co-signing all out-going checks above a certain amount. And the Audit Committee should be double-checking that work on a quarterly basis.

Although the Revitalization Act does not specifically require that each tax-exempt organization have an Audit committee, you should have one. However, if your non-profit is too small to have both a Finance and an Audit committee, don’t be tempted to merge both functions into one “Finance and Audit Committee” for the sake of expediency. That’s because one of the primary duties of the Audit Committee is to carefully examine the Treasurer’s work. And it has to be able to do that independently of the Treasurer.

If an Audit committee is not feasible, then the responsibility falls on the entire Board of Directors to evaluate and approve/disapprove the Finance committee’s output. When directors realize that the Revitalization Act makes them even more financially and criminally liable for this work, you may find that some of them may want additional training. Give it to them!

Hopefully, if you respond proactively to the new legal landscape, you should be able to keep all your directors. Good luck!

 

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April 21, 2014 - Posted by | New York | , , , , , , , , , , , ,

10 Comments »

  1. Thanks Raul,

    I think we should take this up at our next Board meeting and get a copy of the new laws printed. This makes me think twice about the board members of the non-profit I founded also. Thanks for discussing this.

    Comment by Helene | April 21, 2014 | Reply

  2. You’re quite welcome, Helene!

    I’m glad I got you to recognize this potential problem. That’s the first step towards a solution.

    Comment by Raul Larios | April 21, 2014 | Reply

  3. Excellent advice Raul. Having the right directors and officers liability insurance is crucial for a nonprofit to attract prominent businessmen/women and professionals to serve on their board. I would add that every NPO should also establish strong internal controls that are consistent with its size, economic environment, overall business risks (such as competition for funding, limited availability for specialized labor, liquidity issues, increased government regulations, etc), and corporate objectives. NPOs should also have a risk management program in place to address processes, procedures, and risks on an entity-wide basis to enable its leadership to: (a) make appropriate decisions based on a clear understanding of risks faced; and (b) plan appropriate strategies to achieve the entity’s objectives.

    Comment by Fred Sandoval | April 24, 2014 | Reply

    • Great feedback, Fred, and great advice! Thanks.

      Comment by Raul Larios | April 25, 2014 | Reply

  4. SOURCE — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    ANDREA COHEN (Executive Management | Strategic Planning | Organizational Development | Project Management | P&L & Resource Development) — Raul:

    I applaud New York for being so proactive! I appreciate the fact that NPO board members are volunteers and willing to serve and help make the world a better place. I also appreciate the fact that as NPO’s we are stewards of the public’s trust and our board members are the public’s representatives and advocates. As such they are responsible for oversight to ensure our NPO’s are carrying out their mission in an exemplary manner deserving of such trust. Understanding this puts additional legal responsibility on board members, isn’t that their job?

    Comment by Raul Larios | May 8, 2014 | Reply

    • Thanks Andrea, for your comments.

      I do indeed understand “the additional legal responsibility on board members” and that is precisely what has been weighing on my mind lately.

      It is a “job” in the sense that it will take up even more of our time and effort to carry out the stricter provisions in New York State. But it is not a “job” in the sense of a paycheck (or lack thereof). In fact, for most director volunteers like me, the only compensation we get is the personal satisfaction of making our communities better.

      Yet it begs the question of all volunteer directors: can we not accomplish the same results, just as effectively, by simply donating money to our favorite causes, without taking on the increased PERSONAL risk (both financial and criminal) that New York State is wanting to heap on us?

      Comment by Raul Larios | May 8, 2014 | Reply

  5. SOURCE — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    MICHAEL WYLAND (Nonprofit Governance Expert | Owner/Partner, Sumption & Wyland | Newswire Contributor, The Nonprofit Quarterly) —

    I’m conflicted; I both agree and disagree with Raul. Nonprofit board members need to be more proactive about their governance role and responsibilities, and nonprofit staffs need to improve efforts to support and strengthen their boards. New York’s actions are well-intentioned, but, like much “reform” legislation, laden with unintended consequences.

    I take strong issue with Larios’s assertion that fraud is “rampant” in nonprofit organizations. Rick Cohen has done excellent reporting in The Nonprofit Quarterly (NPQ) analyzing the defects in the Washington Post’s analysis of IRS Form 990 information on significant diversions of assets, refuting the assertions the Post made in its stories. There is no reliable information about the incidence of fraud and embezzlement affecting either nonprofit organizations or for-profit corporations and businesses. Most assumptions of “rampant” abuse – in either sector – are usually based on anecdotal personal experiences and/or media reports. Mr. Larios might be correct, but the Washington Post’s analysis and a brief summary of incidents are not sufficient proof of the assertion.

    Comment by Raul Larios | May 8, 2014 | Reply

    • Michael, your response is much appreciated — especially pointing out my use of the word “rampant”. Unfortunately, I was not aware of Rick Cohen’s rebuttal in the Nonprofit Quarterly to the Washington Post analysis prior to writing my blog post.

      Now that I’ve had a chance to read it, I can certainly see your point and Rick’s, and I should have chosen my words more carefully. In hindsight, the word I would have chosen is “considerable” because the facts about the significant diversions are not in question. The thefts, fraud and embezzlement at these tax-exempt organizations (TEOs) did actually happen, and they add up to hundreds of millions of dollars in losses. They are not anecdotal.

      But I do concede that most of the TEOs were probably not directly or intentionally victimizing their donors, but were instead being victimized by the fraudsters. This is an important distinction, and I thank you for pointing it out.

      Comment by Raul Larios | May 8, 2014 | Reply

  6. SOURCE — The ‘Alliance for Nonprofit Management’ LinkedIn Group:

    MICHAEL WYLAND (Nonprofit Governance Expert | Owner/Partner, Sumption & Wyland | Newswire Contributor, The Nonprofit Quarterly) —

    Raul:

    Thanks for your response. You’re right in that fraud and embezzlement involving charities and those doing business with charities certainly occurs. The Form 990 reports are an imperfect first effort by the IRS to assess the incidence of asset diversions.

    In my experience, there are three challenges to discussing the issue.

    First, it’s common for nonprofits, like for-profits, to conceal theft and misappropriation by corporate insiders. No bank wishes to scare depositors, and no nonprofit wishes to scare funders. There are many instances of quiet dismissals and forced resignations, wither with or without restitution, for reasons stated to be having no relation to financial crimes or torts.

    Second, even where we can accumulate data on asset diversions by nonprofits, we don’t know how it compares to either for-profits or governments. This makes it impossible to say that what happens in nonprofit organizations is better or worse than what happens elsewhere in the economy.

    Third, accountants talk about “materiality,” or whether a financial event is a significant portion of an entity’s total financial picture. Various definitions of materiality range from 1% to 3% of the total financial picture. Reported nonprofit asset diversions in the nine-figure range would fit below or near the materiality threshold when one considers that the nonprofit sector accounts for well over $1 trillion of GDP. If asset diversions are $300 million a year, that’s a huge amount of money. However, it also means that 97%+ of nonprofit revenues and expenses are free from asset diversions. It’s crucial to squeeze the 3%, but it’s misleading to focus on the 3% and ignore the 97%.

    Until the Form 990 reports of asset diversions become more accurate, until organizations – nonprofit, for-profit, and governmental alike – become candid about asset diversions, and when there is some identified basis for determining what is an acceptable price for economic activity carried on by human beings, we won’t know what is and is not reasonable. That can’t – and shouldn’t – stop us from chasing down asset diversions and demanding good stewardship. We just need to acknowledge that, while we know a few things, there are other relevant facts that remain unknown, and perhaps unknowable. That realization calls for both pragmatism and humility.

    Comment by Raul Larios | May 9, 2014 | Reply

    • You make some excellent points, Michael, all of which are spot-on!

      I’m glad that my initial blog post (pointing out the additional personal risk — both financial and criminal — that New York State is piling up on volunteer directors with the new nonprofit law, and whether this will cause Board resignations) has shone the spotlight on all of these other collateral issues of great importance.

      It tells me that smart people are paying attention, and therefore, that we will resolve them eventually. Michael, thank you for all you do!

      Comment by Raul Larios | May 9, 2014 | Reply


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