(a) Forms of Nonprofit Organizations

Most nonprofit organizations are formed as one of three types: corporation,³ trust,⁴ or unincorporated association.⁵ It is possible to have a tax-exempt, nonprofit limited liability company.⁶ Occasionally, the U.S. Congress “charters” (that is, creates by legislation) a nonprofit organization.⁷

The application for recognition of tax exemption filed by most organizations seeking to be tax-exempt charitable entities⁸ (Form 1023⁹) graphically depicts these types. It asks if the filing organization is one of the four types, then, in bold print, directs the entity not to file the application if it is not.¹⁰

Nonprofit, tax-exempt organizations, as part of the process of their establishment, prepare (and sometimes file with a state) articles of organization.¹¹ The nature of these articles will depend, in large part, on the type of nonprofit organization. If the nonprofit organization wants to be tax exempt under the federal tax law, it usually will be required to meet an organizational test.¹²

(b) Nonprofit Corporation Acts

Nearly every state has a nonprofit corporation act. The few states that do not have such a statute require nonprofit corporations to fare as best they can by using what is applicable in the statutory law applicable to for-profit business corporations. Most of the states with a nonprofit corporation act have based their law on a model nonprofit corporation act.¹³

(c) Nonprofit Trust Statutes

Nearly every state has a body of statutory law applicable to charitable trusts. Many private foundations, for example, are trusts. These laws frequently impose fiduciary standards and practices that are more stringent than those for nonprofit corporations, and entail an annual filing requirement. A nonprofit organization that is a trust is formed by the execution of a trust agreement or a declaration of trust.

(d) Unincorporated Associations

To the uninitiated, a nonprofit corporation and a nonprofit unincorporated association look alike. An unincorporated association is formed by the preparation and adoption of a constitution. The contents of a constitution are much the same as those of articles of incorporation. Likewise, the bylaws of an unincorporated association are usually the same as those of a nonprofit corporation.

(e) Charitable Solicitation Acts

A majority of the states have adopted comprehensive charitable solicitation acts for the purpose of regulating fundraising for charitable purposes¹⁴ in their jurisdictions. A few states have not enacted any form of charitable solicitation act. The remaining states (including the District of Columbia) have elected to regulate charitable fundraising by means of differing approaches.

The various state charitable solicitation acts are (to substantially understate the situation) diverse. The content of these laws is so disparate that any implication that it is possible to neatly generalize their assorted terms, requirements, limitations, exceptions, and prohibitions would be misleading. Of even greater variance are the requirements imposed by the many regulations, rules, and forms promulgated to accompany and amplify the state statutes.¹⁵ Nonetheless, some basic commonalities can be found in the comprehensive charitable solicitation acts.

The fundamental features of many of these charitable fundraising regulation laws are a series of definitions of various terms; registration or similar requirements for charitable organizations; annual reporting requirements for charitable organizations; exemption of certain charitable organizations from all or a portion of the statutory requirements; registration and reporting requirements for professional fundraisers; registration and reporting requirements for professional solicitors; requirements with respect to the conduct of charitable sales promotions; recordkeeping and public disclosure requirements; requirements regarding the contents of contracts involving fundraising charitable organizations; a wide range of prohibited acts; registered agent requirements; rules pertaining to reciprocal agreements; investigatory and injunctive authority vested in enforcement officials; civil and criminal penalties; and other sanctions.¹⁶

(f) Tax Exemption Laws

State law typically provides for tax exemption, from income or ad valorum tax, for a variety of nonprofit entities in the jurisdiction. Usually, the criteria for this exemption are identical to the federal law requirements; some states impose qualifications in addition to the federal ones. Tax exemption may also be available in connection with sales,¹⁷ use, tangible personal property, intangible personal property, and real-estate taxes.

(g) Charitable Deduction Laws

Most states' laws provide for a charitable contribution deduction for the making of gifts of money or property to charitable organizations.¹⁸ Usually, the criteria for this deduction are identical to the federal law requirements; some states impose qualifications in addition to the federal ones.

(h) Other Statutory Law

In addition to the panoply of the foregoing bodies of law, nonprofit organizations may have to face other state statutory or other regulatory requirements. These include:

• A state's nonprofit corporation act, which has registration and annual reporting requirements for foreign (out-of-state) corporations that are doing business within the state.¹⁹ For example, it is not clear whether, as a matter of general law, the solicitation of charitable contributions in a foreign state constitutes doing business in the state. Some states provide, by statute, that fundraising is the conduct of business activities in their jurisdictions. If the solicitation of charitable contributions were declared, as a matter of general law, to be a business transaction in each of the states, the compliance consequences would be enormous, considering the fact that nearly every state has a nonprofit corporation act. This type of requirement would cause a charitable organization that is soliciting contributions in every state to register and report more than 90 times each year, not taking into account federal and local law requirements.
• A state insurance law, which may embody a requirement that a charitable organization writing charitable gift annuity contracts²⁰ obtains a permit to do so and subsequently files annual statements.
• A state's blue sky statute regulating securities offerings, which may be applicable to offers to sell and to sales of interests in, and the operation of, pooled income funds.²¹ These laws may also apply with respect to charitable remainder annuity trusts and unitrusts.²²
• A state's law prohibiting fraudulent advertising or other fraudulent or deceptive practices.
• A state's version of the Uniform Supervision of Trustees for Charitable Purposes Act, which requires a charitable trust to file, with the state attorney general, a copy of its governing instrument, an inventory of the charitable assets, and an annual report. Of similar scope and effect are the state laws that invest the state attorney general with plenary investigative power over charitable organizations.²³

(a) Nomenclature

State law generally refers to the individuals who are responsible for the affairs of nonprofit organizations as directors. Some tax-exempt organizations use other terms, such as trustees (popular with private foundations) or governors. Generally, organizations are free to use the terminology they wish; if the entity is a corporation, however, it may have to use the term director in its articles of incorporation, and then define it in the bylaws.

The choice of term is not usually a matter of law. Some organizations prefer to refer to their governing board as the board of trustees. (Technically, only a director of a trust can be a trustee, but that formality has long since disappeared.) This is particularly the case with charitable and educational institutions. Schools, colleges, and universities, for example, favor this approach.

This governing board may have within it a subset of individuals who oversee the operations of the organization more closely and frequently than the full board. This group of individuals is usually termed the executive committee. A few exempt organizations use this term to describe the full governing board.

(b) Number

A tax-exempt organization—irrespective of form—must have one or more directors or trustees. State law typically mandates at least three of these individuals, particularly in the case of nonprofit corporations. Some states require only one. Some nonprofit organizations have large governing boards, often to the point of being unwieldy. (State law does not set a maximum number of directors of nonprofit organizations.) Federal law does not address this subject.²⁴

The optimum size of a governing board of a nonprofit organization depends on many factors, including the type of organization involved, the nature and size of the organization's constituency, the way in which the directors are selected, and the role and effectiveness of an executive committee (if any). In some instances, particularly in the case of trusts, there may be an institutional trustee.

(c) Origin(s) of Positions

The board of directors of a nonprofit organization can be derived in several ways; in addition, these ways can be blended. The basic choices are election by the other directors (a self-perpetuating board), election by a membership, selection by the membership of another organization, selection by the board of another organization, ex officio positions, or a blend of two or more of the foregoing options.

If there are bona fide members of the organization (such as an association²⁵), it is likely that these members will elect some or all of the members of the governing board of the entity. This election may be conducted by mail ballot or voting at the annual meeting. It is possible, however, for a nonprofit organization with a membership to have a governing board that is not elected by that membership.

In the absence of a membership, or if the membership lacks a vote on the matter, the governing board of a nonprofit organization may be a self-perpetuating board. With this model, the initial board continues with those it elects and those elected by subsequent boards.

Some boards have one or more ex officio positions. This means that individuals are board members by virtue of other positions they hold. These other positions may be those of the organization itself, those of another organization, or a combination of the two.

In the case of many nonprofit organizations, the source of the membership of the board is preordained. Examples include the typical membership organization that elects the board (such as a trade association, social club,²⁶ or veterans' organization²⁷); a hospital,²⁸ college,²⁹ or museum³⁰ that has a governing board generally reflective of the community; and a private foundation that has one or more trustees who represent a particular family or corporation.

(d) Control Factor

With the rare exception of the stock-based nonprofit organization,³¹ no one owns a nonprofit entity. Control of a nonprofit organization, however, is another matter. Certainly, the governing board of a nonprofit organization controls the organization (at least from a legal standpoint).³²

There are, nonetheless, other manifestations of this matter of control. One is the situation where an individual or a close-knit group of individuals wants to control a nonprofit organization (obviously, quite common in the private foundation context). This can be of particular consequence in the case of a single-purpose organization that was founded by an individual or such a group. Those who launch and grow a nonprofit organization understandably do not want to put their efforts and funds into the formation and development of the organization, only to watch others assume control over it and remove them from the organization's management. Systems are available, such as membership terms and superterms (if lawful), to facilitate this type of control.

(e) Scope of Authority

The directors are those who set policy for the organization and oversee its affairs; the actual implementation of the plans and programs, and the day-to-day management, are left to officers and employees. In reality, however, it is difficult to mark a precise line of demarcation where the scope of authority of the board of directors stops and the authority of other managers begins. Frequently, authority of this nature is resolved in the political arena, not the legal one. It may vary, from time to time, as the culture of the entity changes. In some organizations, the directors do not have the time or do not want to take the time to micromanage; others restrain themselves from doing so (and still others do not). Often, the matter comes down to sheer force of personality. In some organizations, the most dominant manager is the executive director, rather than the president or chair of the board.

(f) Other Considerations

The board of directors of a nonprofit organization may decide to have a chair (or chairperson, chairman, or chairwoman) of the board. This individual presides over board meetings. The chair position is not usually an officer position (although it can be made one). The position may (but need not) be authorized in the organization's bylaws.

Some organizations find it useful to stagger the terms of office so that only a portion of the board needs to be elected or reelected at any one time, thereby providing continuity of service and expertise. A model in this regard is the nine-person board with three-year terms for members; one-third of the board is elected annually.

A board of directors of a tax-exempt organization usually acts by means of in person meetings, where a quorum is present. Where state law allows, the members of the board can meet via conference call (a call where all participants can hear each other) or by unanimous written consent. These alternative procedures should be authorized in the organization's bylaws (indeed, that may be a requirement of state law).

Unless there is authorization in the law (and there is not likely to be), the directors of a tax-exempt organization may not vote by proxy, mail ballot, e-mail, or telephone call (other than by a qualified conference call). Members of an organization have more flexibility as to voting than members of the board of the organization. For example, usually they can vote by mail ballot and by use of proxies.

(g) Relationship to Officers

Nearly every tax-exempt organization has officers. A prominent exception is the trust, which usually has only one or more trustees. As with the board of directors, the scope (or levels) of authority of the officers of an organization is difficult to articulate. In the case of a nonprofit organization that has members, directors, officers, and employees, setting a clear distinction as to who has the authority to do what is nearly impossible. General principles can be stated but will usually prove nearly useless in practice.

For example, it can be stated that the members of the organization (if any) set basic policy and the board of directors sets additional policy, albeit within the parameters established by the membership. The officers thereafter implement the policies, as do the employees, although this is more on a day-to-day basis. Yet the reality is that, at all levels, policy is established and implemented.

The officers of a tax-exempt organization are usually elected, either by a membership or by the board of directors. In some instances, the officers of an organization are ex officio with, or are selected by, another organization. The basic choices as to the origin(s) for officer positions are election by a membership; election by the directors, who are elected by the members; election by the directors, who are a self-perpetuating board; election (or appointment) by the board of another organization; or a blend of two or more of the foregoing options.

(a) Duty of Care

The duty of care requires that directors of a tax-exempt organization be reasonably informed about the organization's activities, participate in decision-making, and act in good faith and with the care of an ordinarily prudent person in comparable circumstances. In short, the duty of care requires the board—and its members individually—to pay attention to the organization's activities and operations.

The duty of care is satisfied by attendance at meetings of the board and appropriate committees; advance preparation for board meetings, such as reviewing reports and the agenda prior to meetings of the board; obtaining information, before voting, to make appropriate decisions; use of independent judgment; periodic examination of the credentials and performance of those who serve the organization; frequent review of the organization's finances and financial policies; and compliance with filing requirements, particularly annual information returns.

(b) Duty of Loyalty

The duty of loyalty requires board members to exercise their power in the interest of the tax-exempt organization and not in their own personal interest or the interest of another entity, particularly one with which they have a formal relationship. When acting on behalf of the exempt organization, board members are expected to place the interests of the organization before their own personal and professional interests.

The duty of loyalty is satisfied when board members disclose any conflicts of interest; otherwise adhere to the organization's conflict-of-interest policy; avoid the use of corporate opportunities for individual personal gain or other benefit; and do not disclose confidential information concerning the organization.

Conflicts of interest are not inherently illegal. Indeed, they can be common, because board members are often simultaneously affiliated with several entities, both for-profit and nonprofit. The important factor is the process by which the board copes with these conflicts. A conflict-of-interest policy can help protect the organization and its board members by establishing a procedure for disclosure and voting when situations arise where a board member may potentially derive personal or potential benefit from the organization's activities.

(c) Duty of Obedience

The duty of obedience requires that the directors of a tax-exempt organization comply with applicable federal, state, and local laws; adhere to the organization's governing documents; and remain guardians of the organization's mission. The duty of obedience is complied with when the board endeavors to be certain that the organization is in compliance with applicable regulatory requirements, complies with and periodically reviews all documents governing the operations of the organization, and makes decisions in advancement of the organization's mission and within the scope of the entity's governing documents.³⁶

(a) Governance Philosophy in General

In some quarters, the philosophy underlying the concept of governance of nonprofit organizations is changing. The traditional roles of the nonprofit board have been oversight of the organization's operations and policy determination; historically, the implementation of policy and management have been the responsibilities of the officers and key employees. An emerging view, sometimes referred to as best practices, imposes on the nonprofit board greater responsibilities and functions (and thus potentially greater liability), intended to immerse the board more deeply into management. This new view is nicely reflected in the characterization of the nonprofit board in the American National Red Cross Governance Modernization Act: the “governance and strategic oversight board.”⁵¹

The origins of this shift of view regarding the appropriate role of the governing board of a nonprofit organization are difficult to find. There has been the occasional scandal in the nonprofit management context, such as that involving the United Way of America;⁵² these scandals in the nonprofit realm have increased somewhat in recent years, due in large part to the greater focus by the media on charitable organizations and the various investigations conducted by the staff of the Senate Finance Committee.⁵³ These incidents alone, however, do not account for the contemporary magnitude of interest in nonprofit organization governance. Certainly, a major factor contributing to this phenomenon is the raft of recent scandals in the for-profit sector and the resulting enactment of the Sarbanes–Oxley Act, which has had an enormous impact on the evolution, over the past few years, of nonprofit organization governance principles and practices.⁵⁴

(b) Watchdog Agencies' Standards

Charitable organizations, particularly those that are engaged in fundraising, often become subject to standards set and enforced by a watchdog agency. Watchdog agencies, while not promulgators of law, can have a powerful impact on the public perception of a charitable organization and its ability to successfully generate gifts and grants. Indeed, watchdog agencies have long been at the forefront of standards setting for nonprofit organizations.⁵⁵

(c) Philanthropic Advisory Service Standards

The Philanthropic Advisory Service (PAS) was the division of the Council of Better Business Bureaus (CBBB) that monitored and reported on charitable organizations that solicit, nationwide, contributions and grants. The primary goal of the division, which began substantive operations in 1971, was to promote ethical standards of business practices and protect consumers through self-regulation and monitoring activities. The PAS standards, which have been superseded by the Wise Giving Alliance standards,⁵⁶ are recounted here because of their historical significance as the first of the efforts to disseminate and enforce a set of nonprofit governance principles.

The PAS evaluated charitable organizations according to the “CBBB Standards for Charitable Solicitations.” These standards covered five basic areas: public accountability, use of funds, solicitations and informational materials, fundraising practices, and governance.

(i) Public Accountability The PAS required that a charity provide, on request, an annual report that included various items of information about the charity's purposes, current activities, governance, and finances. Additionally, a charity was required to provide on request a complete annual financial statement, including an accounting of all income and fundraising costs of controlled or affiliated entities.

A charity was also required to “present adequate information [in financial statements] to serve as a basis for informed decisions.” According to the PAS, information needed as a basis for informed decisions included items such as significant categories of contributions or other income, expenses reported in categories corresponding to major programs and activities, a detailed description of expenses by “natural classification” (e.g., salaries, employee benefits, and postage), accurate presentation of fundraising and administrative costs, the total cost of multipurpose activities, and the method used for allocating costs among the activities.

Organizations that receive a substantial portion of their income as the result of fundraising activities of controlled or affiliated entities were required to provide, on request, an account of all income received by and fundraising costs incurred by these entities.

(ii) Use of Funds The PAS required that a charity spend a “reasonable percentage” of total income on programs, as well as a “reasonable percentage” of contributions on activities that are in accordance with donor expectations. In this context, PAS defined a “reasonable percentage” to mean “at least” 50 percent. Charities were also expected to ensure that their fundraising costs were “reasonable.” In this context, fundraising costs were reasonable if those costs did “not exceed” 35 percent of related contributions. In the area of total fundraising and administrative costs, PAS standards also provided that these costs be “reasonable.” In this latter context, these costs were reasonable if they did “not exceed” 50 percent of total income. A charity was expected to establish and exercise “adequate controls” over its disbursements.

Soliciting organizations were to substantiate, on request, their application of funds, in accordance with donor expectations, to the programs and other activities described in solicitations.

(iii) Governance The PAS standards required three elements as to governance. First, an “adequate governing structure” was required. This meant that the governing instruments must set forth the organization's goals and purposes, define the organization's structure, and identify the body having authority over policies and programs (including the authority to amend the governing instruments). A governing structure was considered inadequate if any policymaking decisions of the governing body or executive committee were made by “fewer than three persons.”

Second, there had to be an “active governing body.” To meet this standard, the governing body was required, among other things, to meet formally “at least three times annually, with meetings evenly spaced over the course of the year, and with a majority of the members in attendance (in person or by proxy) on average.” If the full board met only once annually, there had to be at least two additional, evenly spaced executive committee meetings during the year.

Third, adequate governance required that there be an “independent governing body.” Organizations did not meet this standard if “directly and/or indirectly compensated board members constitute more than one-fifth (20 percent) of the total voting membership of the board or of the executive committee.” (The ordained clergy of a “publicly soliciting church,” however, were excepted from this 20 percent limitation.) Organizations failed to meet this third standard if board members had material conflicting interests resulting from any relationship or business affiliation.

(d) BBB Wise Giving Alliance Standards

The BBB (Better Business Bureau) Wise Giving Alliance (Alliance) was formed in 2001, the product of the merger of the National Charities Information Bureau (another of the early watchdog agencies) into the CBBB Foundation and the PAS. The Alliance is affiliated with the CBBB.

According to its website, the Alliance “collects and distributes information on hundreds of nonprofit organizations that solicit [contributions] nationally or have national or international program services.” It “routinely asks such organizations for information about their programs, governance, fundraising practices, and finances when the charities have been the subject of inquiries.” The Alliance “selects charities for evaluation based on the volume of donor inquiries about individual organizations.” The organization serves “donors' information needs” and helps donors “make their own decisions regarding charitable giving.”

The Alliance developed its “Standards for Charity Accountability,” to “assist donors in making sound giving decisions and to foster public confidence in charitable organizations.” One of the purposes of these standards is to “promote ethical conduct” by charitable organizations. The BBB states that these standards are “voluntary.”⁵⁷

(i) Governance and Oversight These standards state that the governing board “has the ultimate oversight authority for any charitable organization.” The standards seek to ensure that the “volunteer board is active, independent and free of self-dealing.” A board must provide “adequate oversight of the charity's operations and staff.” This type of oversight is indicated by factors such as “regularly scheduled appraisals of the CEO's performance, evidence of disbursement controls such as board approval of the budget, fundraising practices, establishment of a conflict of interest policy, and establishment of accounting procedures sufficient to safeguard charity finances.”

A board is to be comprised of a “minimum of five voting members.” There is to be a “minimum of three evenly spaced meetings per year of the full governing body with a majority in attendance, with face-to-face participation,” although this standard is immediately somewhat tempered with the observation that a “conference call of the full board can substitute for one of the[se] three meetings.”

The standards provide that no more than 1 or 10 percent (whichever is greater) “directly or indirectly compensated person(s) [may] serv[e] as voting member(s) of the board.” Further, “[c]ompensated members shall not serve as the board's chair or treasurer.” The standards forbid “transaction(s) in which any board or staff members have material conflicting interests with the charity resulting from any relationship or business affiliation.” Factors that are considered in determining whether a transaction entails a conflict of interest and if so whether the conflict is material include “any arm's length procedures established by the charity; the size of the transaction relative to like expenses of the charity; whether the interested party participated in the board vote on the transaction; if competitive bids were sought[;] and whether the transaction is one-time, recurring or ongoing.”

(ii) Measuring Effectiveness The standards provide that an organization “should regularly assess its effectiveness in achieving its mission.” An organization should have “defined, measurable goals and objectives in place and a defined process in place to evaluate the success and impact of its program(s) in fulfilling the goals and objectives of the organization” and a process that “identifies ways to address any deficiencies.”

An organization should, according to these standards, “[h]ave a board policy of assessing, no less than every two years, the organization's performance and effectiveness and of determining future actions required to achieve the mission.” There should be submitted to the board, “for its approval, a written report that outlines the results of the aforementioned performance and effectiveness assessment and recommendations for future actions.”

(iii) Finances These standards require that an organization “[s]pend at least 65 percent of its total expenses on program activities,”⁵⁸ “[s]pend no more than 35 percent of related contributions on fundraising,” avoid unwarranted accumulation of funds, disclose the organization's annual financial statements, and have a board approved annual budget.⁵⁹

(e) Evangelical Council for Financial Accountability Standards

Religious organizations have established watchdog agencies that focus only on religious entities. Among them is the Evangelical Council for Financial Accountability (ECFA), which states that it is an “accreditation agency dedicated to helping Christian ministries earn the public's trust through adherence to seven Standards of Responsible Stewardship.” The ECFA states that these standards, “drawn from Scripture, are fundamental to operating with integrity.” In addition to these standards, ECFA has developed a series of best practices that are intended to “encourage [its] members to strive for the highest levels of excellence.” Founded in 1979, ECFA states that its constituency comprises more than 2,000 evangelical Christian organizations. An organization that cannot comply with one or more of the standards is ineligible for membership in ECFA.⁶⁰

(i) Use of Resources Every member of ECFA must “exercise the management and financial controls necessary to provide reasonable assurance that all resources are used (nationally and internationally) in conformity with applicable federal and state laws and regulations to accomplish the exempt purposes for which they are intended.” According to one of the best practices, a member organization should ensure, “by collaborating with the board and the CEO, Executive Director, or President (or similar position), that the organization has a clear financial plan that is aligned with strategic, operating, and development plans.”

(ii) Board of Directors A “responsible” board must, according to the ECFA standards, govern member organizations. These boards must have at least five individuals, a majority of whom must be “independent.”⁶¹ The board must meet at least semiannually to “establish policy and review its accomplishments.” The board, or a committee consisting of a majority of independent members, must “review the annual financial statements and maintain direct communication between the board and the independent certified public accountants.”

The ECFA best practices guidelines as to board members include the following: (1) board members should “annually pledge to carry out in a trustworthy and diligent manner their duties and obligations as a board member”; (2) the board “should understand the organization's financial health”; (3) in “linking budgeting to strategic planning,” the board “should approve the annual budget and key financial transactions, such as major asset acquisitions, that can be realistically financed with existing or attainable resources”; and (4) board time “should be spent on governance, not on management issues.”

The board should “utilize a committee, whose members have financial expertise, totally comprised of independent members to annually review the financial statements.” This committee should “[c]onduct at least a portion of the committee meeting to review the financial statements with the accounting firm in the absence of staff”; if the board “handles the financial review function, staff should be recused from a portion of the meeting with the representative(s) from the accounting firm.” The board should “[r]equest the periodic rotation of the lead or review partners, if this is feasible for the accounting firm.” The board should obtain “competitive fee quotes every few years.” If, however, the accountants are “independent, providing quality service at competitive fees, it is generally wise to continue with the current accounting firm.”

The board should “[a]pprove and document annually and in advance the compensation and fringe benefits of the CEO, Executive Director, or President (or similar position) unless there is a multi-year contract in force and there is no change in the compensation and fringe benefits except for an inflation or cost-of-living adjustment.”⁶² The board should “[a]nnually and formally evaluate the CEO, Executive Director, or President (or similar position).”

The board (or, in some instances, a board committee) should (1) “[r]outinely compare board actions and corporate bylaws”; (2) “[p]eriodically review organizational and governing documents”; (3) annually review the organization's annual information return; (4) “adequately communicate between board meetings”; (5) “[d]etermine and adjust the optimal board size by assessing organizational needs”; (6) “[s]tructure board membership and the board's voting with more than a mere majority of independent board members” (emphasis in original); (7) conduct meetings “with more than a mere majority of independent board members in attendance” (emphasis in original); (8) annually monitor “individual board performance against the board members' service commitments”; (9) develop an “effective process to plan ahead for recruiting new board members”; (10) implement a process for “[p]roperly orient[ing] new board members for their board service and provid[ing] ongoing education to ensure that the board carries out its oversight functions and that individual members are aware of their legal and ethical responsibilities”; (11) establish “clear policies and procedures on the length of terms and on the removal of board members”; (12) evaluate board member participation “before extending terms”; (13) “generally serve without compensation for board service other than reimbursement for expenses incurred to fulfill their board duties”;⁶³ (14) “understand clearly if they are expected to participate in stewardship activities and individual giving”; (15) use “routine and periodic board self-evaluations to improve meetings, restructure committees, and address individual board member performance”; and (16) “[f]ind opportunities to keep valuable individuals connected with the organization after their board terms expire.”

(iii) Financial Statements Every organization that is an accredited member of ECFA must obtain an annual audit performed by an independent certified public accounting firm, including a financial statement prepared in accordance with generally accepted accounting principles. ECFA may provide for an alternative category of membership that does not require audited financial statements, in which case the organization must have financial statements that are compiled or reviewed by an independent certified public accounting firm. An ECFA best practice has the organization ensuring that “all material related-party transactions are disclosed in the financial statements.”

(iv) Financial Disclosure Every member of the ECFA must provide a copy of its current financial statements (including audited financial statements if required) on written request and provide other disclosures “as the law may require.”⁶⁴ A member “must provide a report, on written request, including financial information, on any specific project for which it is soliciting gifts.” One of the ECFA best practices recommendations is that the organization post its most recent annual financial statement and annual information return (if the organization files such a return) on its website.

(v) Conflicts of Interest ECFA member organizations are to “avoid conflicts of interest.” Nonetheless, members may engage in transactions with related parties if (1) a material transaction is fully disclosed in the audited financial statements of the organization, (2) the related party is excluded from the discussion and approval of the transaction, (3) a competitive bid or comparable valuation exists, and (4) the organization's board has demonstrated that the transaction is in the best interest of the entity.

The ECFA best practices include the following: (1) a conflict-of-interest policy “relating to the governing board and key executives should be adopted”; (2) the governing board and key executives “should document annually any potential related-party transactions”; and (3) “[a]ll significant related-party transactions should be initially approved and, if continuing, reapproved annually by the governing board.”

(vi) Policies and Procedures According to the ECFA best practices, the following should be done:

• The organization should “[p]roperly document the proceedings of all board and board committee meetings in order to protect the organization.” Board minutes “should identify all voting board members as present or absent to clearly document a quorum.”
• The organization should develop a mission statement, “putting into words why the organization exists and what it hopes to accomplish.” This statement should be “[r]egularly reference[d]” to ensure that it is being “faithfully followed.” The organization should “[h]ave the courage to refocus the mission statement, if appropriate.”
• The organization should adopt a “stewardship philosophy statement.”
• The organization should adopt an “executive compensation philosophy statement.”
• The organization should adopt “appropriate policies,” such as policies with respect to conflicts of interest (including annual approval of all significant related-party transactions), whistleblowing, accountable expense reimbursements, record retention, board confidentiality, donor confidentiality, and ownership of intellectual property.
• Board policies should be reviewed regularly to determine whether revisions are needed. The organization's compliance with board policies should be monitored. All board policies should be maintained in a policy manual. The organization should develop a “vision statement communicating a compelling and inspirational hope for the future of the organization.”

(vii) Other Practices The ECFA's best practices state that an organization should spend a “reasonable percentage” of its annual expenditures “on programs in pursuance of the organization's mission.” An organization should “[p]rovide sufficient resources for effective administration and, if the organization solicits contributions, for appropriate fundraising activities.”

An organization should “[e]stablish and implement policies that provide clear guidance for paying or reimbursing expenses incurred when conducting business or traveling on behalf of the organization, including listing the types of expenses that can be paid for or reimbursed and the documentation required.” An organization should “[a]void loans or the equivalent to executives or board members.”

(f) Standards for Excellence Institute Standards

The Standards for Excellence Institute (Institute) is a membership organization of charitable entities that claims, in its marketing material, to uphold standards that are higher “than the minimal requirements imposed by local, state and federal laws and regulations.” This program was launched to “strengthen nonprofit governance and management, while also enhancing the public's trust in the nonprofit sector.” This organization “promotes widespread application of a comprehensive system of self-regulation in the nonprofit sector.” These standards are based on “fundamental values” such as “honesty, integrity, fairness, respect, trust, compassion, responsibility and accountability,” and provide guidelines for how nonprofit organizations should act to be “ethical and accountable in their programs operations, governance, human resources, financial management and fundraising.”⁶⁵

(i) Mission and Program The Institute's standards provide that an organization's “purpose, as defined and approved by the board of directors, should be formally and specifically stated.” The organization's “activities should be consistent with its stated purpose.”

A nonprofit organization “should periodically revisit its mission (e.g., every 3 to 5 years) to determine if the need for its programs continues to exist.” An organization “should evaluate whether the mission needs to be modified to reflect societal changes, its current programs should be revised or discontinued, or new programs need to be developed.”

A nonprofit organization “should have defined, cost-effective procedures for evaluating, both qualitatively and quantitatively, its programs and projects in relation to its mission.” These procedures “should address programmatic efficiency and effectiveness, the relationship of these impacts to the cost of achieving them, and the outcomes for program participants.” Evaluations, which “should include input from program participants,” should be “candid, be used to strengthen the effectiveness of the organization and, when necessary, be used to make programmatic changes.”

(ii) Board Responsibilities and Conduct The board of an organization “should engage in short-term and long-term planning activities as necessary to determine the mission of the organization, to define specific goals and objectives related to the mission, and to evaluate the success of the organization's programs toward achieving the mission.” The board “should establish policies for the effective management of the organization, including financial and, where applicable, personnel policies.”

The board “annually should approve the organization's budget and periodically should assess the organization's financial performance in relation to the budget.” As part of this annual budget process, the board “should review the percentages of the organization's resources spent on program, administration, and fundraising.” The full board “should also approve the findings of the organization's annual audit and management letter and plan to implement the recommendations of” that letter.

The board or a board committee “should hire the executive director, set the executive's compensation, and evaluate the director's performance at least annually.” Where a committee performs this role, details should be reported to the board. The board “should periodically review the appropriateness of the overall compensation structure of the organization.” The board should approve written personnel policies and procedures “governing the work and actions of all employees and volunteers of the organization.”

The board “is responsible for its own operations, including the education, training and development of board members, periodic (i.e., at least every two years) evaluation of its own performance, and[,] where appropriate, the selection of new board members.” The board “should establish stated expectations for board members, including expectations for participation in fundraising activities, committee service, and program activities.” The board “should meet as frequently as is needed to fully and adequately conduct the business of the organization”; the board should, at a minimum, meet four times a year.

The organization “should have written policies that address attendance and participation of board members at board meetings.” These policies “should include a process to address noncompliance.” Written meeting minutes “reflecting the actions of the board, including reports of board committees when acting in the place of the board, should be maintained and distributed to board and committee members.”

(iii) Board Composition The Institute's standards state that the governing board of an organization “should be composed of individuals who are personally committed to the mission of the organization and possess the specific skills needed to accomplish the mission.”

An organization's governing board should, under these standards, have at least five unrelated directors; seven or more directors are preferable. Where an employee of the organization is a voting member of the board, there must be assurance that that individual will “not be in a position to exercise undue influence.”

There should be term limits for the service of board members. Board membership should reflect the “diversity of the communities” served by the organization. Board members should serve without compensation for their service as board members; they “may only be reimbursed for expenses directly related to carrying out their board service.”

(iv) Conflict of Interest The Institute's standards state that a nonprofit organization should have a written conflict-of-interest policy. This policy “should be applicable to all board members and staff, and to volunteers who have significant independent decision making authority regarding the resources of the organization.” The policy “should identify the types of conduct or transactions that raise conflict of interest concerns, should set forth procedures for disclosure of actual or potential conflicts, and should provide for review of individual transactions by the uninvolved members of the board of directors.”

A nonprofit organization “should provide board members, staff, and volunteers with a conflict of interest statement that summarizes the key elements of the organization's conflict of interest policy.” This statement “should provide space for the board member, employee or volunteer to disclose any known interest that the individual, or a member of the individual's immediate family, has in any business entity which transacts business with the organization.” The statement should be provided to and signed by board members, staff, and volunteers, “both at the time of the individual's initial affiliation with the organization and at least annually thereafter.”

(v) Financial Accountability The Institute's standards require that an organization “operate in accordance with an annual budget that has been approved by the board of directors.” Accurate financial reports should be maintained on a timely basis. Internal financial statements “should be prepared no less frequently than quarterly, should be provided to the board of directors, and should identify and explain any material variation between actual and budgeted revenues and expenses.” The accuracy of the financial reports of an organization with annual revenue in excess of $300,000 should be audited by a certified public accountant.

Organizations “should provide employees a confidential means to report suspected financial impropriety or misuse of organization resources and should have in place a policy prohibiting retaliation against persons reporting improprieties.” They “should have written financial policies adequate for the size and complexity of their organization governing: (1) investment of the assets of the organization[,] (2) internal control procedures, (3) purchasing practices, and (4) unrestricted current net assets.”

(vi) Legal Compliance and Accountability Organizations must be “aware of and comply with all applicable Federal, state, and local laws.” These laws include those pertaining to fundraising, licensing, financial accountability, document retention and destruction, human resources, lobbying and political advocacy, and taxation.

Organizations “should periodically assess the need for insurance coverage in light of the nature and extent of the organization's activities and its financial capacity.” A decision to forgo general liability or directors' and officers' liability insurance coverage “shall only be made by the board of directors and shall be reflected in” the appropriate board minutes. An organization “should periodically conduct an internal review” of its compliance with “legal, regulatory and financial reporting requirements”; a summary of the results of this review should be provided to the organization's governing board.

(vii) Openness The Institute's standards require an organization to “prepare, and make available annually to the public, information about the organization's mission, program activities, and basic audited (if applicable) financial data.” This report should also “identify the names of the organization's board of directors and management staff.”

An organization “should provide members of the public who express an interest in the affairs of the organization with a meaningful opportunity to communicate with an appropriate representative of the organization.” An organization “should have at least one staff member who is responsible to assure that the organization is complying with both the letter and the spirit of Federal and state laws that require disclosure of information to members of the public.”

(viii) Public Education and Advocacy The Institute's standards state that a nonprofit organization “should assure that any educational information provided to the media or distributed to the public is factually accurate and provides sufficient contextual information to be understood.” An organization “should have a written policy on advocacy defining the process by which the organization determines positions on specific issues.” The standards add that nonprofit organizations “engaged in promoting public participation in community affairs shall be diligent in assuring that the activities of the organization are strictly nonpartisan.”⁶⁶

(g) Other Watchdog Agencies

Other charity watchdog organizations have come into being. One observer concluded that the number of them has “proliferated” and that each of them has its “own approach and mission.”⁶⁷ These recent entrants into the field include the American Institute of Philanthropy (AIP), Charity Navigator, and Ministry Watch. Another organization, the Philanthropy Group, provides customized research about charitable organizations for a fee.⁶⁸

These groups do not focus on governance issues; their emphasis is on program and fundraising. For example, Charity Navigator rates public charities on the basis of their organizational efficiency and organizational capacity. As to organizational efficiency, this rating process analyzes four categories of performance: program expenses, administrative expenses, fundraising expenses, and fundraising efficiency. (A charity that spends less than one-third of its annual revenue on program is automatically given an organizational efficiency score of zero.) Organizational capacity is rated on the basis of primary revenue growth, program expenses growth, and working capital ratio. Charities that are rated by Charity Navigator receive zero (exceptionally poor) to four (exceptional) stars. The AIP focuses only on fundraising costs and asset reserves; it provides ratings of charities, usually letter grades A–F.

(h) Senate Finance Committee Staff Paper

The Senate Committee on Finance, in 2004, held a hearing on a range of subjects pertaining to nonprofit, tax-exempt organizations.⁶⁹ In connection with that hearing, the staff of the committee prepared a paper as a discussion draft that contained a variety of proposals, including a section on “strong governance and best practices” for exempt organizations.⁷⁰

(i) Board Duties This paper stipulated that a charitable organization must be “managed” by its board of directors or trustees. The paper stated that, in performing board duties, a board member “has to perform his or her duties in good faith; with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and in a manner the director reasonably believes to be in the best interests of the mission, goals, and purposes of the corporation.” The paper added that an individual who has “special skills or expertise has a duty to use such skills or expertise” in his or her board service. Federal law liability for breach of these duties was recommended.

The paper states that any compensation consultant providing services to a charitable organization must be hired by and report to the board; the consultant must be independent. Compensation for all management positions would have to be approved by the board in advance and annually (unless there is no change in compensation other than an inflation adjustment). Compensation arrangements would have to be “explained and justified and publicly disclosed (with such explanation) in a manner that can be understood by an individual with a basic business background.”

This paper asserts that the governing board of a charitable organization must (1) “establish basic organizational and management policies and procedures of organization and review any proposed deviations”; (2) “establish, review, and approve program objectives and performance measures and review and approve significant transactions”; (3) “review and approve the auditing and accounting principles and practices used in preparing the organization's financial statements and must retain and replace the organization's independent auditor”;⁷¹ (4) “review and approve the organization's budget and financial objectives as well as significant investments, joint ventures, and business transactions”; (5) “oversee the conduct of the corporation's business and evaluate whether the business is being properly managed”; (6) “establish a conflict-of-interest policy which would be required to be disclosed with the [Form] 990, and require a summary of conflicts determinations made during the 990 reporting year”; (7) “establish and oversee a compliance program to address regulatory and liability concerns”; and (8) “establish procedures to address complaints and prevent retaliation against whistleblowers.”

(ii) Board Composition Boards of charitable organizations would have to be comprised of at least three members, with a maximum of 15 members. No more than one board member could be directly or indirectly compensated by the organization. A compensated board member could not serve as the chair of the board or treasurer of the organization. In the case of public charities, at least one board member or one-fifth of the board would have to be independent; a “higher number of independent board members might be required in limited cases.” An independent board member would be defined as an individual who is “free of any relationship with the corporation or its management that may impair or appear to impair the director's ability to make independent judgments.”

(iii) Board/Officer Removal In this paper, the Committee staff proposed that an individual who is not permitted to serve on the board of a publicly traded company, because of a law violation, be barred from serving on the board of a tax-exempt organization. A criminal conviction would preclude an individual from serving as a director or officer of an exempt organization for a five-year period following the conviction. An individual who has been convicted of a crime under a law enforced by the Federal Trade Commission, U.S. Postal Service, or state attorney general for actions related to service as an officer or director of an exempt organization (or where the crime arose from an organization that falsely presented itself as an exempt organization) could not serve as an officer or director of an exempt organization for five years. An organization, or its officers or members, that knowingly retained an individual who is not permitted to serve the organization, pursuant to one or more of these rules, would be subject to a penalty.

A proposal would accord the IRS the authority to require the removal of a board member, officer, or employee of a tax-exempt organization who violated self-dealing rules, conflict-of-interest standards, excess benefit transaction rules,⁷² private inurement rules,⁷³ or charitable solicitation laws.⁷⁴ The IRS would be able to require that such an individual not serve on any other exempt organization's board for a period of years. An organization that knowingly retained an individual who is not permitted to serve, pursuant to one or more of these rules, would have its exempt status revoked or be subject to a penalty.

(i) U.S. Treasury Department's Voluntary Best Practices

The Treasury Anti-Terrorist Financing Guidelines⁷⁵ provide that a charitable organization's governing instruments should (1) delineate the organization's basic goal(s) and purpose(s); (2) define the structure of the charity, including the composition of the board, how the board is selected and replaced, and the authority and responsibilities of the board; (3) set forth requirements concerning financial reporting, accountability, and practices for the solicitation and distribution of funds; and (4) state that the charity shall comply with all applicable federal, state, and local law.

These guidelines state that the board of directors of a charitable organization is responsible for the organization's compliance with relevant laws, and should (1) be an “active governing body”; (2) oversee implementation of the governance practices to be followed by the organization; (3) exercise “effective and independent” oversight of the charity's operations; (4) establish a conflict-of-interest policy for board members and employees; (5) establish procedures to be followed if a board member or employee has a conflict, or perceived conflict, of interest; and (6) maintain records of all decisions made, with these records available for inspection by the appropriate regulatory and law-enforcement authorities.

The guidelines contain other governance practices, including (1) an annual budget approved and overseen by the board; (2) a board-appointed financial/accounting officer who is responsible for day-to-day management of the charity's assets; (3) an audit of the finances of the organization, when annual gross income is in excess of $250,000, by an independent certified public accounting firm, with the audited financial statement available for public inspection; (4) accounting for all funds received and disbursed in accordance with generally accepted accounting principles, including the name of each recipient of funds, the amount disbursed, and the date of the disbursement; (5) the prompt deposit of all funds into an account maintained by the charity at a financial institution; and (6) the making of disbursements by check or wire transfer, rather than in currency, whenever that is reasonably feasible.

Pursuant to these guidelines, charities should (1) maintain and make publicly available a current list of their board members and the salaries they are paid; (2) maintain records (while fully respecting individual privacy rights) containing additional identifying information about their board members, such as home addresses, Social Security numbers, and citizenship; and (3) maintain records (while respecting individual privacy rights) identifying information about the board members of any subsidiaries or affiliates receiving funds from them. As to key employees, charities should (4) maintain and make publicly available a current list of their five highest paid or most influential employees and the salaries and/or other direct or indirect benefits they are provided; (5) maintain records (while respecting privacy rights) containing identifying information about their key, non-U.S. employees working abroad; and (6) maintain records (while respecting individual privacy rights) identifying information about the key employees of any subsidiaries or affiliates receiving funds from them.

Moreover, pursuant to these guidelines, charitable organizations should (1) maintain and make publicly available a current list of any branches, subsidiaries, and/or affiliates that receive resources and services from them; (2) make publicly available or provide to any member of the public, on request, an annual report, which describes the charity's purposes, programs, activities, tax-exempt status, structure and responsibility of the governing body, and financial information; and (3) make publicly available or provide to any member of the public, on request, complete annual financial statements, including a summary of the results of the most recent audit, which present the overall financial condition of the organization and its financial activities in accordance with generally accepted accounting principles and reporting practices.

(j) Committee for Purchase Proposed Best Practices

The Committee for Purchase from People Who Are Blind or Severely Disabled proposed various criteria and tests that it believes are “widely considered as benchmarks of good nonprofit agency governance practices.”⁷⁶ Pursuant to these proposed “best practices,” (1) a nonprofit organization's board of directors should be composed of individuals who are “personally committed to the mission of the organization and possess the specific skills needed to accomplish the mission”; (2) where an employee of the organization is a voting member of the board, the “circumstances must [e]nsure that the employee will not be in a position to exercise ‘undue influence’”; (3) the board should have at least five unrelated directors; (4) the chair of the board should not simultaneously be serving as the entity's chief executive officer/president; (5) there should be term limits for board members; (6) board membership should reflect the “diversity of the communities” served by the organization; (7) board members should serve without compensation; (8) the board or a designated committee of it should hire the executive director, establish the executive's compensation, and evaluate the director's performance at least annually; (9) the board should periodically review the “appropriateness of the overall compensation structure” of the organization; (10) the board should have at least one “financial expert” among its membership; (11) the board should approve the findings of the organization's annual audit and management letter; and (12) the board should approve a plan to implement the recommendations of the management letter.

According to these best practices, nonprofit organizations should (1) have a written conflict-of-interest policy that identifies the types of conflict or transactions that raise conflict-of-interest concerns, sets forth procedures for disclosure of actual or potential conflicts, and provides for review of individual transactions by the “uninvolved” members of the board of directors; (2) subject the accuracy of the organization's financial reports to audit by a certified public accountant; (3) periodically conduct an internal review of the organization's compliance with existing statutory, regulatory, and financial reporting requirements, and should provide a summary of the results of the review to the board; (4) prepare and make available annually to the public information about the organization's mission, program activities, and basic audit (if applicable) financial data; (5) require the board of directors to monitor compensation paid to the chief executive officer/president and “highly compensated individuals”; and (6) require the board to approve all compensation packages for the chief executive officer/president and all highly compensated employees through a “rebuttable presumption process”⁷⁷ to determine the reasonableness of the compensation.

(k) Draft of IRS Good Governance Principles

On February 7, 2007, the IRS posted on its website a preliminary discussion draft of the agency's “Good Governance Practices” for charitable organizations.⁷⁸ The IRS stressed that this draft document is “informal” and is “not an official IRS document,” and that the “recommendations” in it “are not legal requirements for federal tax exemption.”⁷⁹

In this draft of good governance recommendations, the IRS expressed its view that governing boards of charitable organizations “should be composed of persons who are informed and active in overseeing a charity's operations and finances.” If a governing board “tolerates a climate of secrecy or neglect, charitable assets are more likely to be used to advance an impermissible private interest.” Successful governing boards “include individuals [who are] not only knowledgeable and passionate about the organization's programs, but also those with expertise in critical areas involving accounting, finance, compensation, and ethics.”

Organizations with “very small or very large governing boards may be problematic: Small boards generally do not represent a public interest and large boards may be less attentive to oversight duties.” If an organization's governing board is “very large, it may want to establish an executive committee with delegated responsibilities or establish advisory committees.”

The IRS “strongly recommends” that charitable organizations review and consider the recommendations in this draft document “to help ensure that directors understand their roles and responsibilities and actively promote good governance practices.” While adopting a particular practice is “not a requirement for tax exemption,” the agency believes that an organization that “adopts some or all of these practices is more likely to be successful in pursuing its exempt purposes and earning public support.” At the same time (even though these recommendations are not requirements for tax exemption), the IRS warned charitable organizations that “any decision by the Service to conduct a review of operations subsequent to [recognition of] exemption…will be influenced by whether an organization has voluntarily adopted good governance practices.”⁸⁰

(i) Mission Statement The board of directors of a charitable organization should, according to these recommendations, adopt a “clearly articulated mission statement.” This statement should “explain and popularize the charity's purpose and serve as a guide to the organization's work.” A “well-written mission statement shows why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.”

(ii) Code of Ethics The IRS stated that the “public expects a charity to abide by ethical standards that promote the public good.” The board of directors of a charitable organization “bears the ultimate responsibility for setting ethical standards and ensuring [that] they permeate the organization and inform its practices.” To that end, the board “should consider adopting and regularly evaluating a code of ethics that describes behavior it wants to encourage and behavior it wants to discourage.” This code of ethics “should be a principal means of communicating to all personnel a strong culture of legal compliance and ethical integrity.”

(iii) Whistleblower Policy The board of directors of a charitable organization “should adopt an effective policy for handling employee complaints and establish procedures for employees to report in confidence suspected financial impropriety or misuse of the charity's resources.”

(iv) Due Diligence The directors of a charitable organization “must exercise due diligence consistent with a duty of care that requires a director to act in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in a manner the director reasonably believes to be in the charity's best interests.” Directors “should see to it that policies and procedures are in place to help them meet their duty of care,” such as by ensuring that each director is “familiar with the charity's activities and knows whether those activities promote the charity's mission and achieve its goals,” is “fully informed about the charity's financial status,” and has “full and accurate information to make informed decisions.”

(v) Duty of Loyalty The directors of a charity “owe it a duty of loyalty.”⁸¹ This duty requires a director to “act in the interest of the charity rather than in the personal interest of the director or some other person or organization.” In particular, the duty of loyalty “requires a director to avoid conflicts of interest that are detrimental to the charity.” The board of directors of a charitable organization “should adopt and regularly evaluate an effective conflict of interest policy” that “requires directors and staff to act solely in the interests of the charity without regard for personal interests,” includes “written procedures for determining whether a relationship, financial interest, or business affiliation” results in a conflict of interest, and prescribes a “certain course of action in the event a conflict of interest is identified.”

Directors and staff “should be required to disclose annually in writing any known financial interest that the individual, or a member of the individual's family, has in any business entity that transacts business with the charity.”

(vi) Transparency By making “full and accurate information about its mission, activities, and finances publicly available, a charity demonstrates transparency.” The board of directors of a charitable organization “should adopt and monitor procedures to ensure that the charity's Form 990, annual reports, and financial statements are complete and accurate, are posted on the organization's public website, and are made available to the public upon request.”

(vii) Financial Audits Directors “must be good stewards of a charity's financial resources.” A charitable organization “should operate in accordance with an annual budget approved by the board of directors.” The board “should ensure that financial resources are used to further charitable purpose[s] by regularly receiving and reading up-to-date financial statements including Form 990, auditor's letters, and finance and audit committee reports.”

If the charity has “substantial assets or annual revenue, its board of directors should ensure that an independent auditor conduct an annual audit.” The board “can establish an independent audit committee to select and oversee the independent auditor.” The auditing firm “should be changed periodically (e.g., every five years) to ensure a fresh look at the financial statements.” For a charity with “lesser assets or annual revenue, the board should ensure that an independent certified public accountant conduct an annual audit.”

The IRS observed that “[s]ubstitute practices for very small organizations would include volunteers who would review financial information and practices.” The agency suggested that “[t]rading volunteers between similarly situated organizations who would perform these tasks would also help maintain financial integrity without being too costly.”

(viii) Compensation Practices The IRS is of the view that a “successful charity pays no more than reasonable compensation for services rendered.” Charitable organizations “should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service.” Director compensation “should be allowed only when determined [to be] appropriate by a committee composed of persons who are not compensated by the charity and have no financial interest in the determination.” Charities “may pay reasonable compensation for services provided by officers and staff.”

(ix) Document Retention Policy An “effective charity” will, according to the IRS, “adopt a written policy establishing standards for document integrity, retention, and destruction.” This document retention policy “should include guidelines for handling electronic files.” The policy “should cover backup procedures, archiving of documents, and regular check-ups of the reliability of the system.”

(x) IRS Draft of Best Practices Jettisoned The IRS, in early 2008, quietly abandoned its draft of good governance practices for charitable organizations. The proffered reason for this development was said to be the issuance of the redesigned annual information return, in that, as the IRS stated, its positions on nonprofit governance “are best reflected in the reporting required by the revised Form 990.”⁸² The agency's views on governance principles for charitable organizations are also summarized in its LifeCycle Educational Tool.⁸³

(l) American National Red Cross Governance Modernization Act Principles

The American National Red Cross Governance Modernization Act of 2007 was signed into law on May 11, 2007.⁸⁴ This legislation amended the congressional charter of the Red Cross to modernize its structure and otherwise strengthen its governance. Changes include a substantial reduction in the size of the organization's board, delegation to management of the day-to-day operations of the organization, elimination of distinctions as to how board members are elected, and transition of some board members into an advisory council.

The essence of the legislation is unique to the National Red Cross entity. Yet, there are elements of the act with larger significance. For example, the legislation refers to the governing board as a “governance and strategic oversight board.”⁸⁵ It outlines the board's responsibilities (a checklist for boards in general): review and approve the organization's mission statement; approve and oversee the organization's strategic plan and maintain strategic oversight of operational matters; select, evaluate, and determine the level of compensation of the organization's chief executive officer; evaluate the performance and establish the compensation of the senior leadership team and provide for management succession; oversee the financial reporting and audit process, internal controls, and legal compliance; ensure that the chapters of the organization are geographically and regionally diverse; hold management accountable for performance; provide oversight of the financial stability of the organization; ensure the inclusiveness and diversity of the organization; provide oversight of the protection of the brand of the organization;⁸⁶ and assist with fundraising on behalf of the organization.⁸⁷

This legislation contains the following “sense of Congress” that (1) “charitable organizations are an indispensable part of American society, but these organizations can only fulfill their important roles by maintaining the trust of the American public”; (2) “trust is fostered by effective governance and transparency”; and (3) “Federal and State action play an important role in ensuring effective governance and transparency by setting standards, rooting out violations, and informing the public.”⁸⁸

(m) Independent Sector's Good Governance Principles

Independent Sector convened a Panel on the Nonprofit Sector (Panel). The Panel issued, on October 18, 2007, its “Principles for Good Governance and Ethical Practice” for public and private charitable organizations.⁸⁹ These principles are predicated on the need for a “careful balance between the two essential forms of regulation—that is, between prudent legal mandates to ensure that organizations do not abuse the privilege of their exempt status, and, for all other aspects of sound operations, well-informed selfgovernance and mutual awareness among nonprofit organizations.” The principles were updated and issued as Independent Sector's principles for good governance at the beginning of 2015. These principles include the following.

(i) Legal Compliance and Public Disclosure Independent Sector's first principle is that a charitable organization “must comply with all applicable federal laws and regulations, as well as applicable laws and regulations of the states and the local jurisdictions in which it is based or operates.” If the organization conducts programs outside the United States, it must abide by applicable international laws, regulations, and conventions. The Panel observed that an organization's governing board is “ultimately responsible for overseeing and ensuring that the organization complies with all its legal obligations and for detecting and remedying wrongdoing by management.” The Panel added that, “[w]hile board members are not required to have specialized legal knowledge, they should be familiar with the basic rules and requirements with which their organization must comply and should secure the necessary legal advice and assistance to structure appropriate monitoring and oversight mechanisms.”

The principles state that a charitable organization should “formally adopt a written code of ethics with which all of its directors or trustees, staff and volunteers are familiar and to which they adhere.” This principle is predicated on the thought that “[a]dherence to the law provides a minimum standard for an organization's behavior.”⁹⁰ Adoption of a code of ethics “helps demonstrate the organization's commitment to carry out its responsibilities ethically and effectively.” The code should be “built on the values that the organization embraces, and should highlight expectations of how those who work with the organization will conduct themselves in a number of areas, such as the confidentiality and respect that should be accorded to clients, consumers, donors, and fellow volunteers and board and staff members.”⁹¹

A charitable organization should “adopt and implement policies and procedures to ensure that all conflicts of interest (real and potential), or the appearance thereof, within the organization and the governing board are appropriately managed though disclosure, recusal, or other means.” A conflict-of-interest policy “must be consistent with the laws of the state in which the nonprofit is organized and should be tailored to specific organizational needs and characteristics.” This policy “should require full disclosure of all potential conflicts of interest within the organization” and “should apply to every person who has the ability to influence decisions of the organization, including board and staff members and parties related to them.”⁹²

A charitable organization “should establish and implement policies and procedures that enable individuals to come forward with information on illegal practices or violations of organizational policies.” This whistleblower policy “should specify that the organization will not retaliate against, and will protect the confidentiality of, individuals who make good-faith reports.” The Panel recommended that “[i]nformation on these policies … be widely distributed to staff, volunteers and clients, and should be incorporated both in new employee orientations and ongoing training programs for employees and volunteers.” These policies “can help boards and senior managers become aware of and address problems before serious harm is done to the organization” and “can also assist in complying with legal provisions that protect individuals working in charitable organizations from retaliation for engaging in certain whistle-blowing activities.”

A charitable organization should “establish and implement policies and procedures to protect and preserve the organization's important data, documents, and business records.” The Panel observed that a document-retention policy “is essential for protecting the organization's records of its governance and administration, as well as business records that are required to demonstrate legal compliance.” This type of policy “also helps to protect against allegations of wrongdoing by the organization or its directors and managers.”

A charitable organization's board “should ensure that the organization has adequate plans to protect its assets—its property, documents and data, financial and human resources, programmatic content and material, and its integrity and reputation—against damage or loss.” The board “should review regularly the organization's need for general liability and directors' and officers' liability insurance, as well as take other actions necessary to mitigate risks.” The Panel noted that the board is “responsible for understanding the major risks to which the organization is exposed, reviewing those risks on a periodic basis, and ensuring that systems have been established to manage them.” It was observed that the “level of risk to which the organization is exposed and the extent of the review and risk management process will vary considerably based on the size, programmatic focus, geographic location, and complexity of the organization's operations.”

A charitable organization “should make information about its operations, including its governance, finances, programs, and activities, widely available to the public.” Charitable organizations “also should consider making information available on the methods they use to evaluate the outcomes of their work and sharing the results of those evaluations.” The theme underlying this principle is that charities should “demonstrate their commitment to accountability and transparency” by offering additional information about their finances and operations to the public, such as by means of annual reports and websites, with the latter containing mission statements, codes of ethics, conflict-of-interest policies, whistleblower policies, and the like.

(ii) Effective Governance A charitable organization must have a governing body that is “responsible for reviewing and approving the organization's mission and strategic direction, annual budget and key financial transactions, compensation practices and policies, and fiscal and governance policies.” The board “bears the primary responsibility for ensuring that a charitable organization fulfills its obligations to the law, its donors, its staff and volunteers, its clients, and the public at large.” The board “must protect the assets of the organization and provide oversight to ensure that its financial, human and material resources are used appropriately to further the organization's mission.” The board “also sets the vision and mission for the organization and establishes the broad policies and strategic direction that enable the organization to fulfill its charitable purpose.”

The board of a charitable organization “should meet regularly enough to conduct its business and fulfill its duties.” Regular board meetings provide the “chief venue for board members to review the organization's financial situation and program activities, establish and monitor compliance with key organizational policies and procedures, and address issues that affect the organization's ability to fulfill its charitable mission.” The Panel observed: “While many charitable organizations find it prudent to meet at least three times a year to fulfill basic governance and oversight responsibilities, some with strong committee structures, including organizations with widely dispersed board membership, hold only one or two meetings of the full board each year.”

The board of a charitable organization “should establish its own size and structure and review these periodically.” The board “should have enough members to allow for full deliberation and diversity of thinking on governance and other organizational matters.” Except for very small organizations, “this generally means that the board should have at least five members.” Nonetheless, the Panel noted that the “ideal size of a board depends on many factors, such as the age of the organization, the nature and geographic scope of its mission and activities, and its funding needs.”

The board of a charitable organization should include members with the “diverse background (including, but not limited to, ethnicity, race, and gender perspectives), experience, and organizational and financial skills necessary to advance the organization's mission.” Boards of charitable organizations “generally strive to include members with expertise in budget and financial management, investments, personnel, fundraising, public relations and marketing, governance, advocacy, and leadership, as well as some members who are knowledgeable about the charitable organization's area of expertise or programs, or who have a special connection to its constituency.” Some organizations “seek to maintain a board that respects the culture of and reflects the community served by the organization.” An organization should “make every effort” to ensure that at least one member of the board has “financial literacy.”

A “substantial majority of the board of a public charity, usually meaning at least two-thirds of the members, should be independent.” “Independent” members are those who are not compensated by the organization, do not have their compensation determined by individuals who are compensated by the organization, do not receive material financial benefits from the organization (except as a member of the charitable class served by the organization), or are not related to or residing with any of the foregoing persons. An individual who is not independent is, in the view of the Panel, potentially in violation of the directors' duty of loyalty,⁹³ which requires the directors to “put the interests of the organization above their personal interests and to make decisions they believe are in the best interest of the nonprofit.” The Panel declared that it is “important to the long-term success and accountability of the organization that a sizeable majority of the individuals on the board be free of financial conflicts of interest.”

The board should “hire, oversee, and annually evaluate the performance of the chief executive officer of the organization, and should conduct such an evaluation prior to any change in that officer's compensation,” unless a multiyear contract is in force or the change consists solely of routine adjustments for inflation or the cost of living. The Panel stated that “[o]ne of the most important responsibilities of the board … is to select, supervise, and determine a compensation package that will attract and retain a qualified chief executive.” The organization's governing documents should require the full board to evaluate the executive's performance and approve his or her compensation.

The board of a charitable organization that has paid staff “should ensure that the positions of chief staff officer, board chair, and board treasurer are held by separate individuals.”⁹⁴ Organizations without paid staff should ensure that the positions of board chair and treasurer are separately held.⁹⁵ The Panel was of the view that “[c]oncentrating authority for the organization's governance and management practices in one or two people removes valuable checks and balances that help ensure that conflicts of interest and other personal concerns do not take precedence over the best interests of the organization.”

The board “should establish an effective, systematic process for educating and communicating with board members to ensure that they are aware of their legal and ethical responsibilities, are knowledgeable about the programs and [other] activities of the organization, and can carry out their oversight functions effectively.” The Panel observed that all board members “should receive oral and written instruction regarding the organization's governing documents, finances, program activities, and governing policies and practices.” Encompassed by this principle is the thought that board members should receive agendas and background materials well in advance of board meetings.

Board members “should evaluate their performance as a group and as individuals no less frequently than every three years, and should have clear procedures for removing board members who are unable to fulfill their responsibilities.” The Panel noted that a “regular process of evaluating the board's performance can help to identify strengths and weaknesses of its processes and procedures and to provide insights for strengthening orientation and educational programs, the conduct of board and committee meetings, and interactions with board and staff leadership.” The board “should establish clear guidelines for the duties and responsibilities of each member, including meeting attendance, preparation and participation; committee assignments; and the kinds of expertise board members are expected to have or develop in order to provide effective governance.”

The board “should establish clear policies and procedures setting the length of terms and the number of consecutive terms a board member may serve.” The matter of term limits continues to be controversial. The Panel stated the view in favor of term limits as follows: “Some organizations have found that such limits help in bringing fresh energy, ideas and expertise to the board through new members.” The contrary view: “Others have concluded that term limits may deprive the organization of valuable experience, continuity and, in some cases, needed support provided by board members.”

The board should review the “organizational and governing instruments no less frequently than every five years.” This process will “help boards ensure that the organization is abiding by the rules it has set for itself and determine whether changes need to be made to those instruments.” The board may elect to delegate some of this deliberation to a committee; if so, the “full board should consider and act upon the committee's recommendations.”

The board “should establish and review regularly the organization's mission and goals and should evaluate, no less frequently than every five years, the organization's programs, goals and [other] activities to be sure they advance its mission and make prudent use of its resources.” Every board should “set strategic goals and review them annually.” The Panel noted that, “[b]ecause organizations and their purposes differ, it is incumbent on each organization to develop its own process for evaluating effectiveness.” At a minimum, “interim benchmarks can be identified to assess whether the work is moving in the right direction.”

Board members are “generally expected to serve without compensation, other than reimbursement for expenses incurred to fulfill their board duties.”⁹⁶ An organization that provides compensation to its board members should use “appropriate comparability data” to determine the amount to be paid,⁹⁷ document the decision, and provide full disclosure to anyone, on request, of the amount of and rationale for the compensation. Board members of charitable organizations are responsible for “ascertaining that any compensation they receive does not exceed to a significant degree the compensation provided for positions in comparable organizations with similar responsibilities and qualifications.”⁹⁸ It was the view of the Panel that board members “of public charities often donate both time and funds to the organization, a practice that supports the sector's spirit of giving and volunteering.”

(iii) Strong Financial Oversight A charitable organization “must keep complete, current, and accurate financial records and ensure strong financial controls are in place.” Its board “should receive and review timely reports of the organization's financial activities and should have a qualified, independent financial expert audit or review these statements annually in a manner appropriate to the organization's size and scale of operations.” Each organization “must ensure that it has its annual financial statements audited or reviewed as required by law in the states in which it operates or raises funds or as required by government or private funders.” The Panel observed that a charitable organization “that has its financial statements independently audited, whether or not it is legally required to do so, should consider establishing an audit committee composed of independent board members with appropriate financial expertise.”

The board of a charitable organization “must institute policies and procedures to ensure that the organization (and, if applicable, its subsidiaries) manages and invests its funds responsibly, in accordance with all legal requirements.” The full board “should review and approve the organization's annual budget and should monitor actual performance against the budget.” The Panel observed that “[s]ound financial management is among the most important responsibilities of the board of directors,” which “should establish clear policies to protect the organization's financial assets and ensure that no one person bears the sole responsibility for receiving, depositing, and spending its funds.”

A charitable organization “should not provide loans (or the equivalent, such as loan guarantees, purchasing or transferring ownership of a residence or office, or relieving a debt or lease obligation) to directors, officers, or trustees.” These practices have “created both real and perceived problems for public charities.” (The Panel noted that the federal tax law has prohibitions in this regard in the case of private foundations, supporting organizations, and donor-advised funds.)⁹⁹

A charitable organization “should spend a significant amount of its annual budget on programs that pursue its mission while ensuring that the organization has sufficient administrative and fundraising capacity to deliver those programs responsibly and effectively.” The Panel, noting that some watchdog groups assert that public charities should (or must) spend at least 65 percent of their funds on program activities, found that standard to be “reasonable for most organizations,” yet also noted that “there can be extenuating circumstances that require an organization to devote more resources to administrative and fundraising activities.”

A charitable organization “should establish clear, written policies for paying or reimbursing expenses incurred by anyone conducting business or traveling on behalf of the organization, including the types of expenses that can be paid for or reimbursed and the documentation required.” These policies “should require that travel on behalf of the organization is to be undertaken cost-effectively.” The Panel advised that decisions as to travel expenditures “should be based on how best to further the organization's charitable purposes, rather than on the title or position of the person traveling,” noting that “lavish, extravagant or excessive” expenditures are to be avoided.

An organization “should neither pay for nor reimburse travel expenditures for spouses, dependents or others who are accompanying someone conducting business for the organization unless they, too, are conducting such business.” Nonetheless, the Panel added that, if an organization “deems it proper to cover expenses for a spouse, dependent, or other person accompanying someone on business travel, the payment generally must, by law, be treated as compensation to the individual traveling on behalf of the organization.”

(n) Redesigned Annual Information Return (Form 990)

The IRS significantly revised the principal annual information return (Form 990) filed by tax-exempt organizations. This return, applicable beginning with the 2008 filing season, includes a series of questions that directly reflect the agency's views as to governance principles applicable to exempt organizations, principally public charities.¹⁰⁰ Indeed, this return, particularly in Part VI, is designed to influence and modify exempt organizations' behavior, by in essence forcing them to adopt certain policies and procedures¹⁰¹ so they can check “yes” rather than “no” boxes. Almost none of these policies and procedures is required by the federal tax law.¹⁰²

(o) IRS LifeCycle Educational Tool Principles

The most recent formal views of the IRS on the matter of governance principles for tax-exempt organizations are found in the components of the agency's LifeCycle Educational Tool, posted on the IRS website on February 14, 2008.¹⁰³ The IRS stated: “Good governance is important to increase the likelihood that organizations will comply with the tax law, protect their charitable assets and, thereby, best serve their charitable beneficiaries.” The contents of this document follow, albeit condensed in places, with the stated text essentially verbatim.

(i) Introduction The IRS believes that a well-governed charity is more likely to obey the tax laws, safeguard charitable assets, and serve charitable interests than one with poor or lax governance. A charity that has clearly articulated purposes that describe its mission, a knowledgeable and committed governing body and management team, and sound management practices is more likely to operate effectively and consistent with tax-law requirements. Although the tax law generally does not mandate particular management structures, operational policies, or administrative practices, it is important that each charity be thoughtful about the management practices that are most appropriate for that charity in assuring sound operations and compliance with the tax law.

(ii) Mission The IRS encourages every charity to establish and regularly review its mission. A clearly articulated mission, adopted by the board of directors, serves to explain and popularize the charity's purpose and guide its work. It also addresses why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.¹⁰⁴

(iii) Organizational Documents Regardless of whether a charity is a corporation, trust, unincorporated association, or other type of organization, it must have organizational documents that provide the framework for its governance and management. State law often prescribes the type of organizational document and its content. State law may require corporations to adopt bylaws. Organizational documents must be filed with applications for recognition of exemption.¹⁰⁵

(iv) Governing Body The IRS encourages an active and engaged board, believing that it is important to the success of a charity and to its compliance with applicable tax-law requirements. Governing boards should be composed of persons who are informed and active in overseeing a charity's operations and finances. The IRS is concerned that if a governing board tolerates a climate of secrecy or neglect, charitable assets are more likely to be diverted to benefit the private interests of insiders at the expense of public and charitable interests. Successful governing boards include individuals who not only are knowledgeable and engaged but selected with the organization's needs in mind (e.g., accounting, finance, compensation, and ethics).

Attention should also be paid to the size of the board, ensuring that it is the appropriate size to effectively make sure that the organization obeys tax laws, safeguards its charitable assets, and furthers its charitable purposes. Small boards run the risk of not representing a sufficiently broad public interest, and of lacking the required skills and other resources required to effectively govern the organization. On the contrary, very large boards may have a more difficult time getting down to business and making decisions.

A governing board should include independent members and not be dominated by employees or others who are not independent individuals because of family or business relationships. The IRS reviews the board composition of charities to determine whether the board represents a broad public interest; to identify the potential for insider transactions that could result in misuse of charitable assets; to determine whether an organization has independent members, stockholders, or other persons with the authority to elect members of the board or approve or reject board decisions; and to ascertain whether the organization has delegated control or key management authority to a management company or other persons.¹⁰⁶

If an organization has local chapters, branches, or affiliates, the IRS encourages it to have procedures and policies in place to ensure that the activities and operations of these subordinates are consistent with those of the parent organization.¹⁰⁷

(v) Governance and Management Policies Although the federal tax law does not require charities to have governance and management policies, the IRS will nonetheless review an organization's application for recognition of exemption and annual information returns to determine whether it has implemented policies relating to executive compensation, conflicts of interest, investments, fundraising, documenting governance decisions, document retention and destruction, and whistleblower claims.

Persons who are knowledgeable in compensation matters and who have no financial interest in the determination should determine a charity's executive compensation. The federal tax law does not, however, require charities to follow a particular process in ascertaining the amount of this type of compensation. Organizations that file Form 990 will find that the return inquires as to whether the process used to determine the compensation of an organization's top management official and other officers and key employees included a review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision.¹⁰⁸ In addition, the return solicits compensation information for certain trustees, directors, officers, key employees, and highest compensated employees.¹⁰⁹

The IRS encourages reliance on the rebuttable presumption, which is part of the intermediate sanctions rules. Under this test, payments of compensation are presumed to be reasonable if the compensation arrangement is approved in advance by an authorized body composed entirely of individuals who do not have a conflict of interest with respect to the arrangement, if the authorized body obtained and relied on appropriate data as to comparability prior to making its determination, and if the authorized body adequately documented the basis for its determination concurrently with making the determination.¹¹⁰

The duty of loyalty, which requires a director to act in the interests of the charity,¹¹¹ requires a director to avoid conflicts of interest that are detrimental to the charity. The IRS encourages a charity's board of directors to adopt and regularly evaluate a written conflict-of-interest policy that requires directors and staff to act solely in the interests of the charity without regard for personal interests; includes written procedures for determining whether a relationship, financial interest, or business affiliation results in a conflict of interest; and prescribes a course of action in the event a conflict of interest is identified.¹¹²

Increasingly, charities are investing in joint ventures, for-profit entities, and complicated and sophisticated financial products or investments that require financial and investment expertise and, in some instances, the advice of outside investment advisors. The IRS encourages charities that make these types of investments to adopt written policies and procedures requiring the charity to evaluate its participation in these investments, and to take steps to safeguard the organization's assets and tax-exempt status if they could be affected by the investment arrangement. The return asks whether an organization has adopted this type of policy.¹¹³ Also, the return asks for detailed information about certain investments.¹¹⁴

The IRS encourages charities to adopt and monitor policies to ensure that fundraising solicitations meet federal- and state-law requirements, and that solicitation materials are accurate, truthful, and candid. Charities are encouraged to keep their fundraising costs reasonable, and to provide information about fundraising costs and practices to donors and the public. The return solicits information about fundraising activities, revenues, and expenses.¹¹⁵

The IRS encourages the governing bodies and subcommittees to take steps to ensure that the minutes of their meetings, and actions taken by written action or outside of meetings, are contemporaneously documented. The return asks whether an organization contemporaneously documents meetings or written actions undertaken during the year by its governing body and committees with authority to act on behalf of the governing body.¹¹⁶

The IRS encourages charities to adopt a written policy establishing standards for document integrity, retention, and destruction. This type of policy should include guidelines for handling electronic files; it should also cover backup procedures, archiving of documents, and regular checkups of the reliability of the system. The return asks whether an organization has a written document retention and destruction policy.¹¹⁷

The IRS also encourages a charity's board to consider adopting and regularly evaluating a code of ethics that describes behavior it wants to encourage and behavior it wants to discourage. A code of ethics, the agency asserts, will serve to communicate and further a strong culture of legal compliance and ethical integrity to all persons associated with the organization.¹¹⁸

The IRS further encourages the board to adopt an effective policy—a whistleblower policy—for handling employee complaints and to establish procedures for employees to report in confidence any suspected financial impropriety or misuse of the charity's resources. The return asks whether the organization became aware during the year of a material diversion of its assets and whether an organization has a written whistleblower policy.¹¹⁹

(vi) Financial Statements and Form 990 Reporting The IRS is of the view that a charity with substantial assets or revenue should consider obtaining an audit of its finances by an independent auditor. The board may establish an independent audit committee to select and oversee an auditor. The return asks whether the organization's financial statements were compiled or reviewed by an independent accountant, audited by an independent accountant, and subject to oversight by a committee within the organization.¹²⁰ Also, the return asks whether, as the result of a federal award, the organization was required to undergo an audit.¹²¹

Practices differ widely as to who sees the Form 990, when they see it (before or after its filing), and the extent of the reviewers' input, review, or approval. Some organizations provide copies of the return to members of the board and other governance or management officials. The return asks whether the organization provides a copy of the return to its governing body and requires the organization to explain any process of review by its directors or management.¹²²

(vii) Transparency and Accountability By making full and accurate information about its mission, activities, finances, and governance publicly available, a charity encourages transparency and accountability to its constituents. The IRS encourages every charity to adopt and monitor procedures to ensure that its Form 1023, Form 990, Form 990-T, annual reports, and financial statements are complete and accurate, are posted on its public website, and are made available to the public on request.¹²³

(a) Governing Board Size

As noted, some are exercised about the size of the governing board of a nonprofit organization. There is no federal law on the subject. Most state nonprofit corporation acts mandate a minimum of three directors; a few jurisdictions permit one director. For decades, it was understood that this is a setting where one size does not fit all, and certainly not a topic that requires heavy thinking, let alone more law.

This placid view of board member size changed suddenly in 2004, when the staff of the Senate Finance Committee published its discussion draft of a paper asserting in part that the board of directors of a tax-exempt, charitable organization should be comprised of at least three members and have no more than 15 members.¹²⁵ That proposal immediately stimulated (at least) two questions: (1) although the idea of three board members is, as noted, solidly embodied in the law, what is the magic inherent in the number 15? (2) Is it properly the province of the federal government to, as a condition of tax exemption, dictate nonprofit organizations' board size?

This matter of the size of a nonprofit organization's board has long been a focus of watchdog agency standards. Thus, the PAS standards proclaimed that a nonprofit organization (evaluated by these standards) had to have an “adequate governing structure”; a governing structure was considered inadequate if “fewer than three persons,” functioning as the governing body or executive committee, made any policymaking decisions on behalf of the organization.¹²⁶ Yet, when the PAS standards morphed into the BBB Wise Giving Alliance standards, the acceptable principle became a “minimum of five voting members.”¹²⁷ The ECFA standards mandate at least five directors, although they also provide that the board should “[d]etermine and adjust the optimal board size by assessing organizational needs.”¹²⁸ A minimum of five directors is also required by the Standards for Excellence Institute, although seven or more directors are “preferable.”¹²⁹

The Committee for Purchase's proposed best practice calls for at least five directors;¹³⁰ the good governance principles articulated by Independent Sector does likewise,¹³¹ although its prior recommendation was a minimum of three directors.¹³² The IRS draft of good governance principles¹³³ did not provide for a specific number of directors of tax-exempt organizations. Indeed, the IRS danced around the subject: organizations with “very small” or “very large” boards “may be problematic.” Small boards, the IRS continued, “generally do not represent a public interest”¹³⁴ and large boards “may be less attractive to oversight duties.”¹³⁵

As it happened, in the aftermath of issuance of the Senate Finance Committee staff paper and the Committee's investigation into the operations of the American National Red Cross,¹³⁶ Congress updated the Red Cross's federal charter. At the time, this organization had a 50-member board of directors.¹³⁷ Declaring that “[i]t is in the national interest to create a more efficient governance structure” of the Red Cross,¹³⁸ Congress legislated that, as of March 31, 2009, and thereafter, there shall be no fewer than 12 and no more than 25 members of the Red Cross board, and that, as of March 31, 2012, and thereafter, there shall be no fewer than 12 and no more than 20 members of this board.¹³⁹

The Panel on the Nonprofit Sector nicely summed up this state of affairs when it observed that experts in the realm of nonprofit organization board governance “are not of one mind as to the ideal maximum size of nonprofit boards.” It was noted that board size “may depend upon such factors as the age of the organization, the nature and geographic scope of its mission and activities, and its funding needs.”¹⁴⁰ Some experts believe that a “larger board may be necessary to ensure the range of perspectives and expertise required for some organizations or to share in fundraising responsibilities.” Others argue that “effective governance is best achieved by a smaller board, which then demands more active participation from each board member.” The Panel concluded that “each charitable organization must determine the most appropriate size for its board and the appropriate number and responsibilities of board committees to ensure that the board is able to fulfill its fiduciary and other governance duties responsibly and effectively.”¹⁴¹

The Panel, after first recommending a minimum of three board members,¹⁴² subsequently stated that generally there should be at least five members of a nonprofit organization's board, yet it also observed that the “board of an organization should establish its own size and structure, and review these periodically.” The Panel added that the board “should have enough members to allow for full deliberation and diversity of thinking on governance and other organizational matters.”¹⁴³

(b) Governing Board Composition

One of the more contentious issues surrounding the matter of nonprofit organizations' governing boards is their composition (a topic of more momentous concern than their size¹⁴⁴). The mantra of the day in many quarters (including, often, the IRS) is that board members, or at least a majority of them, must be independent. State law is silent on this point. Some good governance standards place limitations, in the form of numbers or percentages, on certain types of individuals who may be on the board. Occasionally, the rule as to independence also applies to an executive or comparable committee.

In the absence of much law, the concept of independence in this context is vague. The principal aspect concerns board members who, directly or indirectly, have family, business, and/or financial ties to each other and/or the nonprofit organization involved. This element of the analysis looks, for example, to individuals with conflicts of interest, who are employees of the organization, or who are otherwise compensated by the organization (or an affiliated entity). Another dimension of independence in this setting pertains to some external (usually ephemeral) grouping of individuals that a board member ostensibly represents (such as the public, the community, a charitable class, and the like). The third, and most recent, variation on this theme is that a nonprofit board must be diverse.

A different take on this matter of board composition looks at the expertise and talents of the individual board members, to determine whether certain professions and fields of interest are reflected in the makeup of the board of directors. Or, shifting this type of focus slightly, there are those who deem it appropriate to ascertain whether board members are qualified. Rotating this analysis a bit more, some rules have it that some categories of individuals are precluded from serving on a nonprofit organization's board.

(i) Federal Tax Law The federal tax law, in four instances, addresses the matter of the composition of the governing boards of tax-exempt organizations:

1. The most detailed rule of the federal tax law pertaining to the membership of nonprofit boards is the one applicable to tax-exempt credit counseling organizations. These entities must have a governing body (a) that is controlled by individuals who represent the “broad interests of the public,” such as public officials acting in their capacities as such, individuals having “special knowledge or expertise” in credit or financial education, and “community leaders”; (b) of which not more than 20 percent of the voting power is vested in individuals who are employed by the organization or who will benefit financially, directly or indirectly, from the organization's activities (other than through the receipt of reasonable directors' fees) or the repayment of consumer debt to creditors other than the credit counseling organization or its affiliates; and (c) of which not more than 49 percent of the voting power is vested in individuals who are employed by the organization or who will benefit financially, directly or indirectly, from the organization's activities (other than through the receipt of reasonable directors' fees).¹⁴⁵
2. Supporting organizations may not be controlled, directly or indirectly, by one or more disqualified persons¹⁴⁶ (other than its managers and supported organizations).¹⁴⁷
3. One way for an organization to qualify as a donative-type publicly supported charity¹⁴⁸ is to satisfy a facts-and-circumstances test.¹⁴⁹ One of the elements of this test is that the organization have a representative governing body (that is, a board that represents the broad interests of the public, rather than the personal or private interests of a limited number of individuals).¹⁵⁰ An organization can meet this component of the test if its board is comprised of (1) public officials acting in their capacities as such; (2) individuals selected by public officials acting in their capacities as such; (3) individuals having special knowledge or expertise in the field of discipline in which the organization is operating; (4) community leaders, such as elected or appointed officials, members of the clergy, educators, civic leaders, or other individuals representing a broad cross-section of the views and interests of the community; or (5) in the case of a membership organization, individuals elected pursuant to the organization's governing instruments by a broadly based membership.
4. Tax-exempt health care institutions must meet a community benefit standard. This includes a requirement that these institutions have governing boards that are representative of their communities.¹⁵¹

(ii) Summary of Standards The notion of an independent board of a nonprofit, particularly charitable, organization has been in good governance standards from the outset. (From time to time, the IRS, either when reviewing an application for recognition of exemption or when auditing a tax-exempt organization, will take the position that the organization's board must be independent, in the absence of any law or informal guidance on the subject.)¹⁵² Thus, the standards promulgated by the PAS, as part of a requirement that there be an “adequate governing structure,” required that there be an “independent governing body.” Organizations failed to meet this standard if “directly and/or indirectly compensated board members constitute more than one-fifth (20 percent) of the total voting membership of the board or of the executive committee.” An organization also did not meet this standard if its board members had material conflicting interests resulting from any relationship or business affiliation.¹⁵³

The BBB Wise Giving Alliance standards perpetuate this requirement by calling for a board that is “independent.” These standards provide that no more than 1 or 10 percent (whichever is greater) “directly or indirectly compensated person(s) [may] serv[e] as voting members of the board.” Additionally, “[c]ompensated members shall not serve as the board's chair or treasurer.” Further, these standards forbid “transaction(s) in which any board or staff members have material conflicting interests with the charity resulting from any relationship or business affiliation.”¹⁵⁴

The ECFA standards require that a majority of an organization's board be independent. That term is not defined in the standards; the ECFA best practices, however, state that “independent-minded” board members are “those with the ability to place the organization's interests first, apart from the interests of the staff and other board members.” These practices add that the board should “[s]tructure board membership and the board's voting with more than a mere majority of independent board members” and the board meetings should be conducted “with more than a mere majority of independent board members in attendance” (emphasis in original).¹⁵⁵

The standards of the Standards for Excellence Institute provide that an organization's board should consist of at least five unrelated directors; seven or more directors are preferable. If an employee of an organization is a voting member of the board, there must be assurance that that individual will “not be in a position to exercise undue influence.” Also, these standards stipulate that board membership should reflect the “diversity of the communities” served by the organization.¹⁵⁶ The Senate Finance Committee staff paper states that no more than one board member should be directly or indirectly compensated by the organization; a compensated board member could not serve as the chair of the board or treasurer of the organization. In the case of public charities, according to this paper, at least one board member or one-fifth of the board would have to be independent; a “higher number of independent board members might be required in limited cases.” For this purpose, an independent board member would be defined as an individual who is “free of any relationship with the corporation or its management that may impair or appear to impair the director's ability to make independent judgments.”¹⁵⁷ The Committee staff also proposed that an individual who is not permitted to serve on the board of a publicly traded company, because of a law violation, be barred from serving on the board of a tax-exempt organization.¹⁵⁸

The Treasury Department's voluntary best practices provide that the organization should define, in its governing instruments, its structure, including the composition of the board. The organization should establish procedures to be followed if a board member or employee has a conflict, or a perceived conflict, of interest. Organizations should maintain and make publicly available a current list of their board members and the salaries they are paid, and maintain records (albeit respecting individual privacy rights) identifying information about the board members of any subsidiaries or affiliates receiving funds from them.¹⁵⁹ According to the Committee for Purchase's proposed best practices, the board of an organization should have at least five unrelated directors; the chair of the board should not simultaneously serve as the entity's chief executive officer or president. Also, the board membership should reflect the “diversity of the communities” served by the organization and should include at least one “financial expert.”¹⁶⁰

Independent Sector has gone the furthest in ruminating about the composition of the nonprofit board.¹⁶¹ According to its principles, a board of a charitable organization should include members with the “diverse background (including, but not limited to, ethnicity, race and gender perspectives), experience, and organizational and financial skills necessary to advance the organization's mission.” Boards of charitable organizations “generally strive to include members with expertise in budget and financial management, investments, personnel, fundraising, public relations and marketing, governance, advocacy, and leadership, as well as some members who are knowledgeable about the charitable organization's area of expertise or programs, or who have a special connection to its constituency.” Some organizations “seek to maintain a board that respects the culture of and reflects the community served by the organization.” An organization should “make every effort” to ensure that at least one member of the board has “financial literacy.”¹⁶²

Independent Sector is of the view that a “substantial majority of the board of a public charity, usually meaning at least two-thirds of the members, should be independent.” “Independent” members are those who are not compensated by the organization, do not have their compensation determined by individuals who are compensated by the organization, do not receive material financial benefits from the organization (except as a member of the charitable class served by the organization), or are not related to or reside with any of the foregoing persons. An individual who is not independent is, in this view, potentially in violation of the directors' duty of loyalty,¹⁶³ which requires the directors to “put the interests of the organization above their personal interests and to make decisions they believe are in the best interest of the nonprofit.” The Panel declared that it is “important to the long-term success and accountability of the organization that a sizeable majority of the individuals on the board be free of financial conflicts of interest.”¹⁶⁴

Previously, however, the Panel recommended that, in general, at least one-third of the members of the board of a public charity be independent. Independent board members are defined as individuals (1) who have not been compensated as an employee or independent contractor (other than reasonable compensation for board service); (2) whose compensation (except for board service) is not determined by individuals who are compensated by the organization; (3) who do not receive, directly or indirectly, material financial benefits from the organization, except as a member of the charitable class served by the organization; and (4) who are not related to or living with any of the foregoing individuals.¹⁶⁵

(c) Role of Governing Board

Traditionally, the role of the nonprofit board was oversight of operations and establishment of the organization's policy. Much of governance and management was seen as the province of the officers and key employees. Attitudes about this line-drawing are shifting, with the trend being to ascribe more duties and responsibilities to board members. This is perfectly illustrated by the reference in the Red Cross legislation to the nonprofit board as a “governance and strategic oversight board” and its reference to the 11 responsibilities of these boards.¹⁶⁶

The BBB Wise Giving Alliance Standards state, in reflection of the traditional view, that the governing board “has the ultimate oversight authority for any charitable organization.” The board must provide “adequate oversight of the charity's operations and staff.” This type of oversight is indicated by factors such as “regularly scheduled appraisals of the CEO's performance, evidence of disbursement controls such as board approval of the budget, fundraising practices, establishment of a conflict of interest policy, and establishment of accounting procedures sufficient to safeguard charity finances.”¹⁶⁷

The ECFA standards call for a nonprofit board to establish policy and spend its time on “governance, not on management issues.” This is also the traditional view; today, some assert that effective governance entails at least some aspects of organization management. The board should “approve the annual budget and key financial transactions, such as major asset acquisitions, that can be realistically financed with existing or attainable resources.” The board should “[a]pprove and document annually and in advance the compensation and fringe benefits of the CEO, Executive Director, or President (or similar position) unless there is a multi-year contract in force and there is no change in the compensation and fringe benefits except for an inflation or cost-of-living adjustment.” Further, the board should (1) “[a]nnually and formally evaluate the CEO, Executive Director, or President (or similar position)”; (2) “[r]outinely compare board actions and corporate bylaws”; (3) “[p]eriodically review organizational and governing documents”; (4) (if it “handles the financial statement review responsibilities”) review the organization's annual information return (or have a board committee do it); (5) develop an “effective process to plan ahead for recruiting new board members; and (6) “understand clearly if they are expected to participate in stewardship activities and individual giving.”¹⁶⁸

The Standards for Excellence Institute Standards state that the board of a nonprofit organization (or, in some instances, a board committee) should (1) determine the organization's mission; (2) define the entity's “specific goals and objectives”; (3) establish policies for the “effective management” of the organization (including financial and personnel policies); (4) annually “approve the organization's budget and periodically should assess the organization's financial performance in relation to the budget”; (5) “review the percentages of the organization's resources spent on program, administration, and fundraising”; (6) “approve the findings of the organization's annual audit and management letter and plan to implement the recommendations” of that letter;¹⁶⁹ (7) “hire the executive director, see the executive's compensation, and evaluate the director's performance at least annually”; (8) “periodically review the appropriateness of the overall compensation structure” of the organization; and (9) meet “as frequently as needed to fully and adequately conduct the business” of the organization.¹⁷⁰

The Senate Finance Committee staff paper stipulated that a charitable organization must be “managed” by its board of directors. In performing their duties, board members must act “in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and in a manner the director[s] reasonably believe[] to be in the best interests of the mission, goals, and purposes of the organization.”¹⁷¹ Compensation for all management positions should be annually approved by the board (other than inflation adjustments); compensation consultants must be hired by and report to the board.

This Committee staff paper added that the board of a charitable organization must (1) “establish, review, and approve program objectives and performance measures”; (2) “review and approve significant transactions”; (3) “review and approve the auditing and accounting principles and practices used in preparing the organization's financial statements”¹⁷² and “retain and replace the organization's independent auditor”; (4) review and approve the organization's budget and financial objectives as well as significant investments, joint ventures, and business transactions”; and (5) oversee the conduct of the corporation's business and evaluate whether the business is being properly managed.”¹⁷³

The Treasury Department guidelines provide that the board of directors of a charitable organization should be an “active governing body” and should (1) oversee implementation of the governance practices to be followed by the organization, (2) exercise “effective and independent” oversight of the charity's operations, (3) approve and oversee the annual budget, (4) appoint a financial/accounting officer who is responsible for the day-to-day management of the charity's assets, and (5) see to an independent audit of the finances of the organization (where annual gross income is in excess of $250,000).¹⁷⁴

The Committee for Purchase proposal states that the board of directors of a nonprofit organization (or perhaps a board committee) should (1) hire the executive director, establish the executive's compensation, and evaluate the director's performance; (2) periodically review the “appropriateness of the overall compensation structure” of the organization; (3) approve the findings of the organization's annual audit and management letter; and (4) approve a plan to implement the recommendations of the management letter.¹⁷⁵

The IRS's draft of good governance principles did not have much to say about the role of the governing board. There was a recommendation that the board of a charitable organization adopt a “clearly articulated mission statement.” This statement should “explain and popularize the charity's purpose and serve as a guide to the organization's work.” A “well-written” mission statement, said the IRS, “shows why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.”¹⁷⁶

Independent Sector's good governance principles state that a governing board must be “responsible for reviewing and approving the organization's mission and strategic direction, annual budget and key financial transactions, compensation practices, and fiscal and governance policies.” The board “must protect the assets of the organization and provide oversight to ensure that its financial, human and material resources are used appropriately to further the organization's mission.” The board should (1) set the “vision and mission for the organization and establish[] the broad policies and strategic direction that enable the organization to fulfill its charitable purpose”; (2) “hire, oversee, and annually evaluate the performance [and compensation¹⁷⁷] of the chief executive officer of the organization”; (3) “ensure that the positions of chief staff officer, board chair, and board treasurer are held by separate individuals”; and (4) review the “organizational and governing instruments no less frequently than every five years.”¹⁷⁸

These principles add that the board should (1) “receive and review timely reports of the organization's financial activities and … have a qualified, independent financial expert audit or review these statements annually in a manner appropriate to the organization's size and scale of operations”; (2) institute “policies and procedures to ensure that the organization (and, if applicable, its subsidiaries) manages and invests its funds responsibly, in accordance with all legal requirements”; and (3) “review and approve the organization's annual budget and … monitor actual performance against the budget.”¹⁷⁹

The American National Red Cross Governance Modernization Act set forth 11 responsibilities of a “governance and strategic oversight board.”¹⁸⁰ The IRS's LifeCycle Educational Tool principles encourage an engaged board, composed of individuals who are active and informed in overseeing a charity's operations and finances.¹⁸¹

(d) Organization Effectiveness and Evaluation

Increasing emphasis is being placed on the effectiveness of nonprofit organizations and on ways for organizations to evaluate their performance. The BBB Wise Giving Alliance standards provide that an organization “should regularly assess its effectiveness in achieving its mission.” An organization should have, according to these standards, “defined, measurable goals and objectives in place and a defined process in place to evaluate the success and impact of its program(s) in fulfilling the goals and objectives of the organization” and a process that “identifies ways to address any deficiencies.” The board should have a policy of “assessing, no less than every two years, the organization's performance and effectiveness and of determining future actions required to achieve the mission.” There should be submitted to the board, “for its approval, a written report that outlines the results of the aforementioned performance and effectiveness assessment and recommendations for future actions.”¹⁸²

The Standards for Excellence Institute standards recommend that an organization “periodically revisit its mission,” and evaluate whether the mission “needs to be modified to reflect societal changes, its current programs should be revised or discontinued, or new programs need to be developed.” The Institute adds that a nonprofit organization should have “defined, cost-effective procedures for evaluating, both qualitatively and quantitatively, its programs and projects in relation to its mission.”¹⁸³ Independent Sector added that the board “should establish and review regularly the organization's mission and goals and … evaluate, no less frequently than every five years, the organization's programs, goals, and [other] activities to be sure they advance its mission and make prudent use of its resources.” Every board should set “strategic goals and review them annually.” At a minimum, “interim benchmarks can be identified to assess whether the work is moving in the right direction.”¹⁸⁴

(e) Board Effectiveness and Evaluation

More recently, emphasis is being placed on the effectiveness of the boards of nonprofit organizations and on ways for boards to evaluate their performance. The standards of the ECFA state that board members should “annually pledge to carry out in a trustworthy and diligent manner their duties and obligations as a board member.” There should be an annual monitoring of “individual board performance against the board members' service commitments.” Board member participation should be evaluated “before extending terms”; board member evaluation and/or term limits should be used to “ensure that the organization is only served by effective members.” There should be a process for “[p]roperly orient[ing] new board members for their board service and provid[ing] ongoing education to ensure that the board carries out its oversight functions and that individual members are aware of their legal and ethical responsibilities.” The board should use “routine and periodic board self-evaluations to improve meetings, restructure committees, and address individual board member performance.”¹⁸⁵

The Standards for Excellence Institute standards state that the nonprofit board is responsible for its operations, including the education, training, and development of its members, and recommends periodic evaluation of the board's performance.¹⁸⁶ The Panel on the Nonprofit Sector's principles expands on these points, stating that board members “should evaluate their performance as a group and as individuals no less frequently than every three years.” The Panel noted that a “regular process of evaluating the board's performance can help to identify strengths and weaknesses of its processes and procedures and to provide insights for strengthening orientation and educational programs, the conduct of board and committee meetings, and interactions with board and staff leadership.”¹⁸⁷

(f) Frequency of Board Meetings

Just as there is dissension in these ranks about board size¹⁸⁸ and board composition,¹⁸⁹ so are there differences in view as to the frequency of board meetings.

The PAS standards started this debate when, as part of the requirement that there be an “active governing body,” the rule was laid down that the board had to meet formally “at least three times annually, with meetings evenly spaced over the course of the year, and with a majority of the members in attendance (in person or by proxy) on average.”¹⁹⁰ This dictate, however, was tempered by this standard: the full board could meet only once annually if there were at least two other occasions when there were evenly spaced executive committee meetings during the year.¹⁹¹ When the BBB Wise Giving Alliance standards were developed, the rule became a mandate of a “minimum of three evenly spaced meetings per year of the full governing body with a majority in attendance, with face-to-face participation,” although this rule was softened by the rule that a “conference call of the full board can substitute for one of the[se] three meetings.”¹⁹²

Pursuant to the ECFA standards, the board must meet at least semiannually.¹⁹³ The Standards for Excellence Institute standards state that the board “should meet as frequently as is needed to fully and adequately conduct the business of the organization,” and then assert that the board should meet, at a minimum, four times a year.¹⁹⁴ The Independent Sector's standards provide that the board “should meet regularly enough to conduct its business and fulfill its duties.” The Panel observed that regular board meetings provide the “chief venue for board members to review the organization's financial situation and program activities, establish and monitor compliance with key organizational policies and procedures, and address issues that affect the organization's ability to fulfill its charitable purpose.” The Panel noted that “[w]hile many charitable organizations find it prudent to meet at least three times a year to fulfill basic governance and oversight responsibilities, some with strong committee structures, including organizations with widely dispersed board membership, hold only one or two meetings of the full board each year.”¹⁹⁵

(g) Term Limits

Term limits are inherently controversial rules. Term limits, for example, are imposed on the U.S. presidency¹⁹⁶ and many governorships; term limits are not imposed in connection with the terms of members of the House of Representatives and Senate. Term limits can lead to machinations, such as those that unfolded in Russia (where the presidency has a two-term limit), in that Vladimir V. Putin allegedly installed Dmitri A. Medvedev as (interim) president, so that Mr. Medvedev would resign and allow Mr. Putin to run for a third (and longer) term. A recent rule change allowed the mayor of New York City, Michael R. Bloomberg, to run for a third term, after the voters had approved a two-term limit, and the ensuing public controversy illustrates the emotions that surround this issue.

The theory underlying term limits is to avoid concentration of power over a multiyear period in any one individual and to regularly infuse elective positions with “new blood” (and perhaps new energy). Opponents of term limits assert that the voters should be allowed to select whom they want in a political position; the corollary is that government should not arbitrarily circumscribe the voters' right to choose.

The Panel on the Nonprofit Sector, avoiding a definitive stance on this issue, addressed the dichotomy of positions on the point. The view in favor of term limits: “Some organizations have found that such limits help in bringing fresh energy, ideas and expertise to the board through new members.” The opposite view: “Others have concluded that term limits may deprive the organization of valuable experience, continuity and, in some cases, needed support provided by board members.”¹⁹⁷

The issue in this context is whether the members of nonprofit boards should be subject to term limits. There is no federal or state law on the point; the matter is left to each organization to decide, and reflect the decision in its governing instruments.

The standards of the ECFA state that an organization should establish “clear policies and procedures on the length of terms and the removal of board members,” then add that board member evaluation and/or term limits should be used to “ensure that the organization is only served by effective members.”¹⁹⁸ The Standards for Excellence Institute and the Committee for Purchase state that there should be term limits for the service of board members.¹⁹⁹ The Panel on the Nonprofit Sector sidestepped the issue, echoing the first of the ECFA admonitions, stating that the board of a nonprofit organization “should establish clear policies and procedures setting the length of terms and the number of consecutive terms a board member may serve.”²⁰⁰

(h) Board Member Compensation

Traditionally, compensation of individuals for service on the governing boards of nonprofit organizations, particularly public charities, has been soundly rejected as being a “bad” governance practice. This line of thinking is reflected in today's best practices standards. Yet, as the duties and responsibilities of nonprofit board members multiply and intensify, and the potential for personal liability increases, a growing minority view is that members of nonprofit boards deserve compensation for their services, particularly where the individuals are executive board members.²⁰¹

The BBB Wise Giving Alliance standards obliquely address the matter of the compensated nonprofit board by referencing a “volunteer” board. Some organizations have board members who are compensated but for service other than as board members. Thus, the Alliance standards provide that no more than 1 or 10 percent (whichever is greater) “directly or indirectly compensated person(s) may serv[e] as voting members of the board.” Further, “[c]ompensated members shall not serve as the board's chair or treasurer.”²⁰²

The ECFA standards state that board members “should generally serve without compensation for board service.” If compensation is paid to board members, however, “information on the compensation should be provided by the charity, upon request, to allow an evaluation of the reasonableness of the compensation.”²⁰³ The Standards for Excellence Institute and the Committee for Purchase standards also prohibit compensation for board member service.²⁰⁴

The Senate Finance Committee staff paper states that no more than one board member can be directly or indirectly compensated by the organization. A compensated board member could not serve as the chair of the board or treasurer of the organization.²⁰⁵ Apparently, these rules would apply regardless of whether a board member is compensated for service as a board member or in some other capacity with the organization.

The Independent Sector's standards state that board members are “generally expected to serve without compensation.” Then, a big hole is opened in connection with the word generally, with the standards stating that an organization that provides compensation to its board members should use “appropriate comparability data” in determining the amount to be paid and document the decision,²⁰⁶ and provide full disclosure of the amount of and rationale for compensation. Indeed, board members of charitable organizations are responsible for “ascertaining that any compensation they receive does not exceed to a significant degree the compensation provided for positions in comparable organizations with similar responsibilities and qualifications.”²⁰⁷

The only body of law or standards that affirmatively references directors' compensation are the two references to “reasonable directors' fees” in the rules concerning the boards of tax-exempt credit counseling organizations.²⁰⁸ The IRS draft of good governance principles went both ways on this topic, first, by prohibiting board member compensation and, second, by allowing it “when determined [to be] appropriate by a committee composed of persons who are not compensated by the charity and have no financial interest in the determination.”²⁰⁹

(i) Audit Committees

The good governance standards generally say little about committee structure. The type of committee that is receiving the most attention today is the finance, or modernly termed audit, committee. The concept of the audit committee was reinforced (if not conceived) by enactment of the Sarbanes–Oxley Act.²¹⁰

The ECFA standards were the first to foresee this trend. They call for the utilization, by nonprofit boards, of a committee of members with “financial expertise” to “annually review the financial statements.” This committee should “[c]onduct at least a portion of the committee meeting to review the financial statements with the accounting firm in the absence of staff.” These standards also called for a board committee to annually review the organization's annual information return.²¹¹

California's Nonprofit Integrity Act, the only state law mandating an audit committee for nonprofit organizations, provides that charitable corporations that have gross revenues of at least $2 million, and are required to register and file reports with the state's attorney general, must establish and maintain an audit committee. This audit committee, which must be appointed by the organization's governing board, may include individuals who are not board members. The committee, however, cannot include members of the organization's staff or the organization's president, chief executive officer, treasurer, or chief financial officer. If the organization has a finance committee, members of that committee may serve on the audit committee, although those individuals cannot comprise more than one-half of the members of the audit committee.

According to the California law, the audit committee, under the supervision of the organization's board, is responsible for making recommendations to the board as to the hiring and dismissal of independent certified public accountants. The audit committee can negotiate the CPA firm's compensation, on behalf of the board. This committee must confer with the auditor to satisfy committee members that the financial affairs of the charitable organization are in order, review the audit and decide whether to accept it, approve non-audit services by the CPA firm, and ensure that the non-audit services conform to the standards issued by the U.S. Comptroller General.²¹²

The Panel on the Nonprofit Sector observed that a charitable organization “that has its financial statements independently audited, whether or not it is legally required to do so, should consider establishing an audit committee composed of independent board members with appropriate financial expertise.”²¹³

(j) Other Committees

As noted,²¹⁴ the good governance principles (and, for that matter, the law) say little about committee structure; occasional references are made to executive committees. For example, the IRS's draft of good governance principles stated that, if an organization's governing board is “very large, it may want to establish an executive committee with delegated responsibilities.”²¹⁵

Aside from executive and audit committees, there is potential for a nominating, long-range planning, and/or development committee.²¹⁶ This is not a matter for the law to address; this is a matter for each organization to determine, based principally on its size and the nature of its governing board.

(k) Compliance with Law

Some of the good governance or best practices principles insist that an organization comply with applicable law. This is somewhat ironic, inasmuch as these principles are often seen as being more stringent than the mandates of law²¹⁷ and frequently are inconsistent with what the law requires. Also, this principle is overly simplistic (notwithstanding the adage that “ignorance of the law is no excuse”).

According to the standards of the Standards for Excellence Institute, organizations must be “aware of and comply with all applicable Federal, state, and local laws.” These laws include those pertaining to fundraising, licensing, financial accountability, document retention and destruction, human resources, lobbying and political advocacy, and taxation.²¹⁸ Likewise, the Treasury Department's voluntary best practices state that the board of a charitable organization is responsible for the organization's compliance with relevant laws.²¹⁹ The Senate Finance Committee staff paper advised that the board of a charitable organization should “establish and oversee a compliance program to address regulatory and liability concerns.”²²⁰

The Committee for Purchase proposal provides that nonprofit organizations should periodically conduct an internal review of the organization's compliance with existing statutory, regulatory, and financial reporting requirements, and prepare a summary of the results of this review to the board.²²¹ The Treasury Department's voluntary guidelines state that a charity must comply with all applicable federal, state, and local law.²²² The IRS believes that an active and engaged board is important to a charity's compliance with applicable tax law requirements.²²³

The Independent Sector's first principle is that a charitable organization “must comply with all applicable federal laws and regulations, as well as applicable laws and regulations of the states and the local jurisdictions in which it is formed or operates.” If the organization conducts programs outside the United States, it must abide by applicable international laws, regulations, and conventions. The Panel observed that an organization's governing board is “ultimately responsible for overseeing and ensuring that the organization complies with all its legal obligations and for detecting and remedying wrongdoing by management.” The Panel added that, “[w]hile board members are not required to have specialized legal knowledge, they should be familiar with the basic rules and requirements with which their organization must comply and should secure the necessary legal advice and assistance to structure appropriate monitoring and oversight mechanisms.”²²⁴

(l) Disclosures to Public

Good governance principles have always stressed dissemination of information about the organization to the public. The federal tax law requires disclosure of certain information;²²⁵ these principles usually go beyond the requirements of law.

The PAS cast the topic of disclosure of information to the public as a matter of public accountability, requiring that a charity provide, on request, an annual report that includes various items of information about the charity's purposes, current activities, governance, and finances. A charity also was required to provide on request a complete annual financial statement, including an accounting of all income and fundraising costs of controlled or affiliated entities. A charity also was required to “present adequate information [in financial statements] to serve as a basis for informed decisions.” According to the PAS, information needed as a basis for informed decisions included items such as significant categories of contributions or other income, expenses reported in categories corresponding to major programs and activities, a detailed description of expenses by “natural classification” (e.g., salaries, employee benefits, and postage), accurate presentation of fundraising and administrative costs, the total cost of multipurpose activities, and the method used for allocating costs among the activities. Organizations that receive a substantial portion of their income as the result of fundraising activities of controlled or affiliated entities were required to provide, on request, an accounting of all income received by and fundraising costs incurred by these entities.²²⁶

The BBB Wise Giving Alliance requires that an organization prepare an annual report that is available to the public and that it post its annual information returns on its website.²²⁷ Every member of the ECFA is required to provide a copy of its current financial statements (including audited financial statements if required) on written request and provide other disclosures “as the law may require.”²²⁸ An ECFA member “must provide a report, on written request, including financial information, on any specific project for which it is soliciting gifts.” One of the ECFA best practices recommendations is that the member organization post its most recent annual financial statement and annual information return (Form 990) (if the organization files such a return) on its website.²²⁹

The Standards for Excellence Institute's standards require an organization to “prepare, and make available annually to the public, information about the organization's mission, program activities, and basic audited (if applicable) financial data.” This report should also “identify the names of the organization's board of directors and management staff.” An organization “should provide members of the public who express an interest in the affairs of the organization with a meaningful opportunity to communicate with an appropriate representative of the organization.” An organization “should have at least one staff member who is responsible to assure that the organization is complying with both the letter and the spirit of Federal and state laws that require disclosure of information to members of the public.”²³⁰ The Committee for Purchase's proposed best practices require an organization to prepare and make available annually to the public information about the organization's mission, program activities, and basic audit (if applicable) financial data.²³¹

The Treasury Department's voluntary best practices call on organizations to set forth their requirements as to financial reporting and accountability, and make their audited financial statements available for public inspection. Moreover, pursuant to these guidelines, charitable organizations should (1) maintain and make publicly available a current list of any branches, subsidiaries, and/or affiliates that receive resources and services from them; (2) make publicly available or provide to any member of the public, on request, an annual report, which describes the charity's purposes, programs, activities, tax-exempt status, structure and responsibility of the governing body, and financial information; and (3) make publicly available or provide to any member of the public, on request, complete annual financial statements, including a summary of the results of the most recent audit, which present the overall financial condition of the organization and its financial activities in accordance with generally accepted accounting principles and reporting practices.²³²

The IRS, in its draft of good governance principles, stated that, by making “full and accurate information about its mission, activities, and finances publicly available, a charity demonstrates transparency.” The board of directors of a charitable organization “should adopt and monitor procedures to ensure that the charity's Form 990, annual reports, and financial statements are complete and accurate, are posted on the organization's public website, and are made available to the public upon request.”²³³ The agency stated, in its LifeCycle Educational Tool principles, that by making full and accurate information about its mission, activities, finances, and governance publicly available, a charity encourages transparency and accountability to its constituents. The IRS encourages every charity to adopt and monitor procedures to ensure that its Form 1023, Form 990, Form 990-T, annual reports, and financial statements are complete and accurate, are posted on its public website, and are made available to the public on request.²³⁴

The Independent Sector's standards state that a charitable organization “should make information about its operations, including its governance, finances, programs and activities, widely available to the public.” Charitable organizations “also should consider making information available on the methods they use to evaluate the outcomes of their work and sharing the results of those evaluations.” The theme underlying this principle is that charities should “demonstrate their commitment to accountability and transparency” by offering additional information about their finances and operations to the public, such as by means of annual reports and websites, with the latter containing mission statements, codes of ethics, conflict-of-interest policies, whistleblower policies, and the like.²³⁵

(m) Mission Statements

As a matter of law, as part of its formation, a tax-exempt charitable organization has a statement of its purposes, as part of compliance with the organizational test.²³⁶ Some organizations, however, have developed a separate mission statement. This matter has become of greater importance because of the emphasis placed by the IRS on mission statements as part of the redesign of the annual information return.²³⁷

The standards of the ECFA started things out in this area by providing that each of its members should develop a mission statement, “putting into words why the organization exists and what it hopes to accomplish.” This statement should be “[r]egularly reference[d]” to assure that it is being “faithfully followed.” The organization should “[h]ave the courage to refocus the mission statement, if appropriate.”²³⁸

The Standards for Excellence Institute's standards provide that an organization's “purpose, as defined and approved by the board of directors, should be formally and specifically stated.” A nonprofit organization “should periodically revisit its mission (e.g., every 3 to 5 years) to determine if the need for its programs continues to exist.” An organization “should evaluate whether the mission needs to be modified to reflect societal changes, its current programs should be revised or discontinued, or new programs need to be developed.”²³⁹ The Treasury Department's voluntary best practices state simply that a charitable organization's governing instruments should delineate the organization's basic goal(s) and purpose(s).²⁴⁰

The IRS, in its draft of good governance principles, stated that the board of directors of a charitable organization should adopt a “clearly articulated mission statement.” This statement should “explain and popularize the charity's purpose and serve as a guide to the organization's work.” A “well-written mission statement shows why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.”²⁴¹

The Panel on the Nonprofit Sector wrote that the board “should establish and review regularly the organization's mission and goals and should evaluate, no less frequently than every five years, the organization's programs, goals and [other] activities to be sure they advance its mission and make prudent use of its resources.”²⁴² The IRS encourages every charity to establish and regularly review its mission. A clearly articulated mission, adopted by the board of directors, serves to explain and popularize the charity's purpose and guide its work. It also addresses why the charity exists, what it hopes to accomplish, and what activities it will undertake, where, and for whom.²⁴³

(n) Codes of Ethics

Initiated by the Sarbanes–Oxley Act²⁴⁴ and championed by the IRS,²⁴⁵ the matter of organizations' codes of ethics is now at the forefront of policies and the like to be considered by charitable and other nonprofit organizations.

The IRS stated, in its draft of good governance principles, that the “public expects a charity to abide by ethical standards that promote the public good.” The board of directors of a charitable organization “bears the ultimate responsibility for setting ethical standards and ensuring [that] they permeate the organization and inform its practices.” To that end, the board “should consider adopting and regularly evaluating a code of ethics that describes behavior it wants to encourage and behavior it wants to discourage.” This code of ethics “should be a principal means of communicating to all personnel a strong culture of legal compliance and ethical integrity.”²⁴⁶ The agency returned to this theme in its LifeCycle Educational Tool principles, when it stated that a charity's board should consider adopting and regularly evaluating a code of ethics that describes behavior it wants to encourage and behavior it wants to discourage. A code of ethics will, wrote the IRS, serve to communicate and further a strong culture of legal compliance and ethical integrity to all persons associated with the organization.²⁴⁷

The Independent Sector's principles state that a charitable organization should “formally adopt a written code of ethics with which all of its directors or trustees, staff, and volunteers are familiar and to which they adhere.” This principle is predicated on the thought that “[a]dherence to the law provides a minimum standard for an organization's behavior.” The adoption of a code of ethics “helps demonstrate the organization's commitment to carry out its responsibilities ethically and effectively.” The code should be “built on the values that the organization embraces, and should highlight expectations of how those who work with the organization will conduct themselves in a number of areas, such as the confidentiality and respect that should be accorded to clients, consumers, donors, and fellow volunteers and board and staff members.”²⁴⁸

(o) Conflict-of-Interest Policies

Although a conflict-of-interest policy is not generally required, as a matter of law, of nonprofit organizations, it is the policy that the IRS has been pushing the hardest. Indeed, today, it is difficult for an entity to achieve status as a tax-exempt charity without having adopted a conflict-of-interest policy,²⁴⁹ and this type of policy is prominently referenced in the redesigned annual information return.²⁵⁰

The PAS, while not advocating the adoption of a policy, observed that the governing body of an organization could not be considered independent if board members had material conflicting interests resulting from any relationship or business affiliation.²⁵¹ The BBB Wise Giving Alliance standards forbid “transaction(s) in which any board or staff members have material conflicting interests with the charity resulting from any relationship or business affiliation.” Factors that are considered in determining whether a transaction entails a conflict of interest and if so whether the conflict is material include “any arm's length procedures established by the charity; the size of the transaction relative to like expenses of the charity; whether the interested party participated in the board vote on the transaction; if competitive bids were sought[;] and whether the transaction is one-time, recurring or ongoing.”²⁵²

ECFA member organizations are to “avoid conflicts of interest.” Nonetheless, members may engage in transactions with related parties if (1) a material transaction is fully disclosed in the audited financial statements of the organization, (2) the related party is excluded from the discussion and approval of the transaction, (3) a competitive bid or comparable valuation exists, and (4) the organization's board has demonstrated that the transaction is in the best interest of the entity. The ECFA best practices include the following: (5) a conflict-of-interest policy “relating to the governing board and key executives should be adopted,” (6) the “governing board and key executives should document annually any potential related-party transactions,” and (7) “[a]ll significant related-party transactions should be initially approved and, if continuing, reapproved annually by the governing board.”²⁵³

The Standards of Excellence Institute's standards state that a nonprofit organization should have a written conflict-of-interest policy. This policy “should be applicable to all board members and staff, and to volunteers who have significant independent decision making authority regarding the resources of the organization.” The policy “should identify the types of conduct or transactions that raise conflict of interest concerns, should set forth procedures for disclosure of actual or potential conflicts, and should provide for review of individual transactions by the uninvolved members of the board of directors.” A nonprofit organization “should provide board members, staff, and volunteers with a conflict of interest statement that summarizes the key elements of the organization's conflict of interest policy.” This statement “should provide space for the board member, employee or volunteer to disclose any known interest that the individual, or a member of the individual's immediate family, has in any business entity which transacts business with the organization.” The statement should be provided to and signed by board members, staff, and volunteers, “both at the time of the individual's initial affiliation with the organization and at least annually thereafter.”²⁵⁴

The Senate Finance Committee staff paper states that the governing board of a charitable organization should “establish a conflicts of interest policy which would be required to be disclosed with the [Form] 990, and require a summary of conflicts determinations made during the 990 reporting year.”²⁵⁵ The Treasury Department's voluntary best practices provide that the board of directors of a charitable organization should establish a conflict-of-interest policy for board members and employees, and establish procedures to be followed if a board member or employee has a conflict, or a perceived conflict, of interest.²⁵⁶ According to the best practices proposed by the Committee for Purchase, nonprofit organizations should have a written conflict-of-interest policy that identifies the types of conflict or transactions that raise conflict-of-interest concerns, sets forth procedures for disclosure of actual or potential conflicts, and provides for review of individual transactions by the “uninvolved” members of the board of directors.²⁵⁷

The draft IRS good governance principles, observing that directors of a charity “owe it a duty of loyalty,”²⁵⁸ stated that this duty requires a director to “act in the interest of the charity rather than in the personal interest of the director or some other person or organization.” In particular, the duty of loyalty “requires a director to avoid conflicts of interest that are detrimental to the charity.” The board of directors of a charitable organization “should adopt and regularly evaluate an effective conflict of interest policy” that “requires directors and staff to act solely in the interests of the charity without regard for personal interests,” includes “written procedures for determining whether a relationship, financial interest, or business affiliation” results in a conflict of interest, and prescribes a “certain course of action in the event a conflict of interest is identified.” Directors and staff “should be required to disclose annually in writing any known financial interest that the individual, or a member of the individual's family, has in any business entity that transacts business with the charity.”²⁵⁹

The Independent Sector's principles state that an organization should “adopt and implement policies and procedures to ensure that all conflicts of interest (real and potential), or the appearance thereof, within the organization and the governing board are appropriately managed though disclosure, recusal, or other means.” A conflict-of-interest policy “must be consistent with the laws of the state in which the nonprofit is organized and should be tailored to specific organizational needs and characteristics.” This policy “should require full disclosure of all potential conflicts of interest within the organization” and “should apply to every person who has the ability to influence decisions of the organization, including board and staff members and parties related to them.”²⁶⁰

The IRS, in its LifeCycle Educational Tool principles, returned to the matter of the duty of loyalty, which requires a director to avoid conflicts of interest that are detrimental to the charity. The IRS encourages a charity's board of directors to adopt and regularly evaluate a written conflict-of-interest policy that requires directors and staff to act solely in the interests of the charity without regard for personal interests; includes written procedures for determining whether a relationship, financial interest, or business affiliation results in a conflict of interest; and prescribes a course of action in the event a conflict of interest is identified.²⁶¹

(p) Whistleblower Policies

Again, largely because of enactment of the Sarbanes–Oxley Act,²⁶² whistleblower policies for nonprofit organizations have become prevalent. The IRS is encouraging (although not with the vehemence with which it is insisting on conflict-of-interest policies) organizations, particularly charitable ones, to adopt and enforce these policies.

The standards of the ECFA state that an organization should adopt a whistleblower policy.²⁶³ The Senate Finance Committee staff paper provides that an organization should establish “procedures to address complaints and prevent retaliation against whistleblowers.”²⁶⁴ The draft of the IRS good governance principles stated that the board of directors of a charitable organization “should adopt an effective policy for handling employee complaints and establish procedures for employees to report in confidence suspected financial impropriety or misuse of the charity's resources.”²⁶⁵ The Standards for Excellence Institute standards provide that organizations “should provide employees a confidential means to report suspected financial impropriety or misuse of organization resources and should have in place a policy prohibiting retaliation against persons reporting improprieties.”²⁶⁶

The Independent Sector's principles state that an organization “should establish and implement policies and procedures that enable individuals to come forward with information on illegal practices or violations of organizational policies.” This whistleblower policy “should specify that the organization will not retaliate against, and will protect the confidentiality of, individuals who make good-faith reports.” The Panel recommended that “[i]nformation on these policies … be widely distributed to staff, volunteers and clients, and should be incorporated both in new employee orientations and ongoing training programs for employees and volunteers.” These policies “can help boards and senior managers become aware of and address problems before serious harm is done to the organization” and “can also assist in complying with legal provisions that protect individuals working in charitable organizations from retaliation for engaging in certain whistle-blowing activities.”²⁶⁷

The IRS, in its LifeCycle Educational Tool principles, encourages boards to adopt an effective whistleblower policy for handling employee complaints and to establish procedures for employees to report in confidence any suspected financial impropriety or misuse of the charity's resources.²⁶⁸ The redesigned annual information return asks whether the organization became aware during the year of a material diversion of its assets and whether an organization has a written whistleblower policy.²⁶⁹

(q) Document Retention and Destruction Policies

Likewise, largely because of enactment of the Sarbanes–Oxley Act, policies of nonprofit organizations concerning document retention and destruction practices have become prevalent. The IRS is encouraging (again, not to the extent it is insisting on conflict-of-interest policies) organizations, particularly charitable ones, to adopt and enforce these policies.

The standards of the ECFA state that an organization should adopt a policy with respect to retention of records.²⁷⁰ The IRS, in its draft of good governance principles, provided that an “effective charity” will “adopt a written policy establishing standards for document integrity, retention, and destruction.” This document retention policy should include “guidelines for handling electronic files” and “cover backup procedures, archiving of documents, and regular check-ups of the reliability of the system.”²⁷¹

The Independent Sector's principles stipulate that an organization should “establish and implement policies and procedures to protect and preserve the organization's important data, documents, and business records.” The Panel observed that a document-retention policy “is essential for protecting the organization's records of its governance and administration, as well as business records that are required to demonstrate legal compliance.” This type of policy “also helps to protect against allegations of wrongdoing by the organization or its directors and managers.”²⁷²

The IRS, in its LifeCycle Educational Tool principles, encourages charities to adopt a written policy establishing standards for document integrity, retention, and destruction. This type of policy should include guidelines for handling electronic files; it should also cover backup procedures, archiving of documents, and regular checkups of the reliability of the system.²⁷³

(a) TE/GE Commissioner Georgetown University 2007 Speech

Commissioner Miller, on April 26, 2007, opened the Georgetown University Law Center's annual conference on representing and managing tax-exempt organizations with an intriguing speech focusing on various “powerful and persistent forces” that are shaping today's nonprofit sector and could potentially cause the IRS to “significantly change or modify” the agency's approach to the sector.³⁰⁰ Commissioner Miller identified five of these forces.

One force is the rise of the Internet. He spoke of Web-based fundraising and the “possibility of virtual stateless charities.” He said that the Internet “blurs what now seems like the quaint concept of state and national borders, with all that means for local jurisdiction over the charity.”

Another force is the “continued concentration of wealth and the forthcoming transfer of that wealth to the next generation.” Large parts of this wealth will be contributed to charity, driving the “creation and marketing of a variety of new giving techniques, both good and bad.” This phenomenon caused the Commissioner to muse whether there should be concern with the level of annual charitable expenditures by charitable organizations, whether organizations created by single donors should exist in perpetuity, and the nature of the efficiency and effectiveness of exempt organizations.

The third force is the rise of the large nonprofit organization—what the Commissioner termed the “nation-sized nonprofits that are global in scope and scale.” The “vast wealth” of these organizations is changing the nature of public policy debates, “especially to the degree these organizations may be able to implement programs with significant social impact on their own say-so, without meaningful public input or debate.”

The fourth force is the “increasingly blurred line between the tax-exempt and the commercial sectors.” This is raising the specter of an increase in the tax expenditure for exempt organizations, the matter of unfair competition, and the potential for undermining the “precious good will” possessed by most charitable entities. There are issues, the Commissioner said, as to whether “there has been drift in the nonprofit sector toward the commercial sector, and if so, how much.”

The final (and most relevant) force is the “presence of abuse in the charitable sector.” In this context, the Commissioner spoke of the “three main pillars” of the IRS's compliance program for the tax-exempt sector: customer education and outreach, determinations, and examinations. The third of these pillars, he lamented, “still leaves much to chance.” Some of the problems in the sector are “insufficient transparency, lax management and a lack of meaningful ways to measure the effectiveness of an organization.”

The Commissioner suggested two new pillars for the IRS's exempt organizations division program. One is use of the resources of the agency to gather “significant and reliable information about the sector, and to make it broadly available to the public, in a timely user-friendly fashion.” Two obvious elements of this are the wholesale revamping of Form 990³⁰¹ and electronic filing.³⁰²

The second of these new pillars is promotion of “standards of good governance, management and accountability.” The Commissioner observed that “[w]hat precisely the Service should do with governance practice is an intriguing concept, in part because it's neither self-evident that we should get involved, nor obviously something we should avoid.” He made probably the best case that can be asserted for the intertwining of the matter of governance and tax-exempt organizations' compliance with the law: a “well-governed organization is more likely to be compliant, while poor governance can easily lead an exempt organization into trouble.” He spoke, for example, of an “engaged, informed, and independent board of directors accountable to the community [the exempt organization] serves.”

The Commissioner revealed that he was pondering this question: “whether it would benefit the public and the tax-exempt sector to require organizations to adopt and follow recognized principles of good governance.” He was, of course, thinking about whether the IRS can make a “meaningful contribution” in this area by “going beyond its traditional spheres of activity” by asking the exempt community to meet “accepted standards of good governance.” The Commissioner concluded these remarks by asserting that there is a “vacuum” that needs to be filled in the realm of education on “basic standards and practices of good governance and accountability.” Said the Commissioner: “Someone needs to lead the sector on this issue. If not the IRS, then whom?”

(b) TE/GE Commissioner Philanthropy Roundtable 2007 Speech

Commissioner Miller, on November 10, 2007, spoke at the Philanthropy Roundtable, revisiting many of the themes evoked at the Georgetown presentation earlier in that year.³⁰³ On this occasion, however, he referenced a trend not addressed in the Georgetown University presentation: the “constant increase in the number of tax-exempt organizations.” Seventy thousand or more (gross, not net) exempt organizations are added to the sector annually, raising the question “whether we now have, or will get to the point where we will have, too many exempt organizations?” He noted this entails the addition of over 175 new exempt entities every day (Saturdays, Sundays, and holidays included)—one exempt organization for every 228 Americans. The Commissioner stated that the presence of a “very large number of tax-exempt organizations” presents the question as to whether “Americans are spending too much on duplicative infrastructure.”

Returning to the matter of governance, the Commissioner expressed his view that the IRS “contributes to a compliant, healthy charitable sector by expecting the tax-exempt community to adhere to commonly accepted standards of good governance.” He said that IRS involvement in this area is “not new”; the agency has been “quietly but steadily promoting good governance for a long time.” He noted that “[o]ur determination agents ask governance-related questions” and “our agents assess an organization's internal controls as the agents decide how to pursue an examination.” He continued: “We are comfortable that we are well within our authority to act in these areas.” And: “To more clearly put our weight behind good governance may represent a small step beyond our traditional sphere of influence, but we believe the subject is well within our core responsibilities.”

(c) TE/GE Commissioner Georgetown University 2008 Speeches

On April 23 and 24, 2008, Commissioner Miller spoke at the Georgetown University Law Center annual conference on tax-exempt organizations.³⁰⁴ His remarks were a continuation of his thinking on governance issues and charitable organizations reflected in his speech at the conference the previous year and at the Philanthropy Roundtable 2007 meeting.

Mr. Miller, in his remarks on April 23, 2008, made three points clear: (1) the IRS is of the view that it has a “robust role” to play in the realm of charitable governance, (2) the IRS does not even entertain the thought that involvement in governance matters is beyond the sphere of the agency's jurisdiction, and (3) he cannot be convinced that “outside of very very small organizations and perhaps family foundations, the gold standard should not be to have an active, independent and engaged board of directors overseeing the organization.” Thus, the “question is no longer whether the IRS has a role to play in this area, but rather, what that role will be.” That role will be primarily dictated by the governance section of the new Form 990, what he termed the “crown jewel” of the return.

One of the areas of discussion in the April 24, 2008 speech was the application process that obviously forces the IRS to struggle with “competing goals”: “good customer service,” which requires the agency to be “expeditious in processing and approving an application for [recognition of] tax exemption” and “take sufficient care to identify those who are trying to game the system, so that we can properly deny their applications.”

As Mr. Miller noted, “organizations come to us inchoate.” These entities are “just getting started, and we are asked to grant them [recognition of] exemption based on suppositions, intentions and guesstimates.” This process, he said, “is not really built to ferret out all questionable organizations; it is built to get applicants to a favorable result within a reasonable period of time.”

(d) Commissioner of Internal Revenue Speech

The then-Commissioner of Internal Revenue, Douglas Shulman, spoke at the annual meeting of Independent Sector on November 10, 2008, with much to say about nonprofit governance.³⁰⁵ He said that he “admires” the tax-exempt sector: “[i]ts diversity, its creativity and its risk-taking.” This diversity “means many points of view are expressed, many problems are attacked in many ways, many solutions are found, and many benefits are created for the nation.” He continued: “I firmly believe that the IRS must recognize and allow for this diversity—and not become a barrier to it.” He added: “We shouldn't supplant the business judgment of organizational leaders, and certainly shouldn't determine how a nonprofit fulfills its individual mission. That's not our role.”

But then, he noted, the sector “has had its encounters with abuse and misuse.” He stated that the IRS “will continue to insist that the sector be squeaky clean, and that the high ideal of public benefit that underlies tax exemption is honored.” He said that he “clearly see[s] our role as working with you and others to promote good governance, beginning with the proposition that an active, engaged and independent board of directors helps assure that an organization is carrying out a tax-exempt purpose and acts as its best defense against abuse.” He said that “all of us must follow best practices in organizational leadership and management.” There must be, he added, “clearly articulated values, mission, goals and accountability.”

The Commissioner concluded his remarks with this: “We want to arm you with information and guidance you need to help you comply. We want to pay especially close attention to the largest segments of the exempt sector. And lastly, we want to protect the tax-exempt sector and the public by identifying and stopping those bad actors who misuse tax-exempt organizations or the privilege of tax-exempt status.”

(e) IRS Fiscal Year 2009 Annual Report

The IRS, late in 2008, issued an Exempt Organizations annual report, which included the agency's exempt organizations work plan for the government's fiscal year 2009. This report revealed that the IRS's Exempt Organizations Division is developing a checklist to be used by agents in examinations of tax-exempt organizations to determine whether an organization's governance practices “impacted the tax compliance issues identified in the examination” and to educate organizations “about possible governance considerations.” The Division will commence a training program to educate employees about “nonprofit governance implications” in the determinations, rulings and agreements, and education and outreach areas. The IRS is to begin identifying Form 990 governance questions that could be used in conjunction with other Form 990 information in possible compliance initiatives, such as those involving executive compensation, transactions with interested persons, solicitation of noncash contributions, or diversion or misuse of exempt assets.

(f) Commentary

There is thus this question: Should the IRS be as deeply involved as it is in the matter of nonprofit governance, particularly in the absence of any law in support of the agency's involvement? This is, in some respects, a moot question, inasmuch as the IRS is quite active in nonprofit governance and can be expected to intensify its efforts as the redesigned Form 990 is filed, data collected, and audits commence. Still, it is a legitimate question, one that might eventually be resolved in court.

(i) Answer: Yes A well-governed organization, that is, one that is adhering to good governance principles, is likely to be one that is compliant with the law. That rationale is being seen as sufficient justification for IRS regulation of nonprofit, particularly charitable, governance. As Commissioner Miller saw the point, the IRS's role in nonprofit good governance may be a “small step beyond our traditional sphere of influence, but we believe the subject is well within our core responsibilities.”

(ii) Answer: No Throughout the course of the Charles Dickens novel A Tale of Two Cities, Madame Defarge knits; she indefatigably knits. It can be said with confidence that she sticks to her knitting. According to the Dictionary of American Slang, the phrase stick to one's knitting means to “attend strictly to one's own affairs; not interfere with others; be singleminded.” The mission of the IRS is to “provide America's taxpayers with top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.”³⁰⁶ The mission of the Tax Exempt and Government Entities Division is the “uniform interpretation and application of the Federal tax laws on matters pertaining to the Division's customer base.”³⁰⁷ The mission of the IRS and this Division is not to make pronouncements on good governance principles applicable (ostensibly or otherwise) to nonprofit organizations. The agency should attend strictly to its own affairs and not interfere with others. The IRS should stick to its knitting.

Here is a government agency that has been way behind in the processing of applications for recognition of exemption, lacks the resources to respond in a timely fashion to ruling requests, is overwhelmed by the need to issue guidance in connection with recently enacted statutory law, and is lagging in the provision of other needed guidance. So, what does it do? Rather than devote time and energy to these important tasks, it wanders off into an area over which it has little or no jurisdiction or expertise.

According to the TE/GE Commissioner, the IRS expects the tax-exempt community to adhere to “commonly accepted standards of good governance.” The difficulty with this is that such standards do not exist. There are at least 14 of these standards, some in draft form.³⁰⁸ Many of these standards are inconsistent. The standard-setters cannot even agree on what size a nonprofit board should be, let alone how it should comport itself.

The IRS is sending the nonprofit community a mixed message on the topic of nonprofit governance. The TE/GE Commissioners have been quite adamant that the IRS is going to be playing a “robust role” in nonprofit governance and that the “gold standard” is an “active, independent and engaged board of directors.” A then-Commissioner of Internal Revenue echoed these words, yet also said that the IRS should not “supplant the business judgment of [nonprofit] organizational leaders”; he added that the IRS wants to “arm” the charitable sector “with information and guidance you need to help you comply,” suggesting an emphasis on education rather than dictation of governance modes and practices. The IRS fiscal year 2009 annual report recognizes the huge gap between its agents' rulings and examinations practices and applicable law,³⁰⁹ announcing a training program to educate its employees about “nonprofit governance implications.”³¹⁰

In a nation that prides itself on government based on “rules of law,” it is arbitrary and unfair for the IRS to be promoting good governance for nonprofit organizations in the absence of any law or even articulated informal standards that the agency may be using. The most we have are IRS-prepared forms and instructions. This hide-the-ball approach is a strange way for an administrative agency to be functioning, particularly one that is trumpeting “transparency.”³¹¹

(g) Application of Private Benefit Doctrine

IRS agents (at least some of them) are blindly adhering to the IRS's views as to what constitutes good governance, with particular emphasis on adoption of a conflict-of-interest policy and structuring of a charitable organization's board so that a majority of it is independent. These agents are refusing to grant recognition of exemption to an organization that refuses to capitulate on these points. The fact statement in a court opinion³¹² reflects the IRS's adamancy in this regard, resting its positions on the doctrine of private benefit.

Two categories of IRS private letter rulings principally constitute the basis for the policy of the IRS as to nonprofit governance. One category of these rulings concludes that the existence of a “small” board of an otherwise tax-exempt organization is inherently provision of a form of private benefit. The other category of these rulings holds that a board of an exempt organization dominated by related individuals is likewise inherently provision of a form of private benefit. (Often these two elements are combined in a single ruling because of the existence of small boards dominated by, or often consisting wholly of, related individuals.)

A third, smaller, category of these rulings consist of findings by the IRS that a public charity is not entitled to tax-exempt status because it refused to adopt a particular policy, such as a conflict-of-interest policy or an executive compensation policy. The IRS has stopped issuing rulings of the third type, presumably on the ground that to continue to do so would be blatantly inconsistent with the views of IRS officials as expressed in other contexts, such as the requirements inherent in the process for securing recognition of tax exemption, which clearly do not include adoption of certain policies.

In the first of the private letter rulings in the first category, issued in 2007, the IRS observed that the organization involved was controlled by one individual, who was the entity's “founder, [its] sole financial donor,…one of two related trustees, and one of two related officers.” Thus, the IRS ruled, “taking into account [the entity's] structure, governance and operations, [the organization's] activities result in the provision of more than an incidental level of private benefit to [this controlling individual] and his family.” Consequently, the organization was held to be violating the prohibition in the tax regulations against “impermissible private benefit.”³¹³

Therefore, with this private letter ruling, the IRS laid its claim to a basis for ruling as to a nonprofit organization's “structure” and “governance,” notwithstanding the fact that the federal tax law generally says nothing about the composition of an entity's governing board as a criterion for tax exemption, and placed the IRS on its path for taking the position that an organization's “small” board and/or its “related” board are bases for denying recognition of tax-exempt status. Moreover, it rested its authority for these sweeping propositions on application of the private benefit doctrine, even though there was no precedent for applying the doctrine in that manner.

In fact, the little precedent there was at the time (and still is) is quite different than the IRS's automatic private benefit approach. The rule is that control of an organization by a small number of individuals does not necessarily disqualify it for tax exemption, although it provides an obvious opportunity for abuse; these circumstances call for an “open and candid disclosure of all facts bearing upon [the entity's] organization, operations, and finances so that the Court, should it uphold the claimed exemption, can be assured that it is not sanctioning an abuse of the revenue laws.”³¹⁴

It did not take long for the IRS to begin approaching its analysis in this regard from a different standpoint, holding that, for an organization to be tax-exempt as a public charity, it must have board members “who are representatives of the community.”³¹⁵ Other rulings take the position that public charities' boards must be “independent”³¹⁶ or have a “system for public oversight.”³¹⁷ On one occasion, the IRS stated that tax exemption for public charities requires an “independent oversight board.”³¹⁸ In another instance, the IRS wrote that an organization “lack[s] the public support and public control that are characteristic of a charitable organization seeking to serve the public” and “shows none of the public involvement that characterizes organizations serving a public interest.”³¹⁹ A small (three-individual) board caused the IRS to deny recognition of tax exemption because “[n]one of [the organization's] officers or directors represent the broader interests of the community.”³²⁰

As of the close of 2015, the IRS has issued at least 28 private letter rulings taking the position that a small board of a nonprofit organization (almost always an entity seeking public charity status) is per se evidence of violation of the private benefit doctrine, thus precluding recognition of tax-exempt status of the entities.

The first of the IRS rulings in the second category was published in 2008, involving an organization that was denied status as a tax-exempt church, in part because the entity had a four-person board consisting of members of the same family.³²¹ Often, the IRS tried to force organizations to expand their boards as a condition of exemption.³²² In one case, the IRS wrote that “operating under the control of one person or a small, related group suggests that an organization operates for primarily for non-exempt private purposes.”³²³ In another instance involving a related board, the IRS wrote that the “potential for private benefit clouds every aspect of [the] organization's operations.”³²⁴ On another occasion, the IRS concluded that the “undue control of the organization by a related board causes the organization to serve private interests and thus fail the operational test.”³²⁵ The IRS ruled that an organization was violating the private benefit doctrine because it is governed by a “small group of [related] individuals who have exclusive control over the management of [the entity's] funds and operations.”³²⁶

The IRS ruled that organizations cannot qualify as exempt charitable entities because all of their board members are members of the same family.^326.1 The very existence of a governing board of a nonprofit organization with a majority of related individuals was ruled by the IRS to constitute per se evidence of violation of the private benefit doctrine.^326.2 An organization was said by the IRS to be controlled by members of a family, where the governing body of the entity consisted of its president's “family members or professional friends.”^326.3 An organization was denied recognition of tax exemption as a charitable entity in part because it refused to expand its three-person board of directors, two of whom were related, so as to “place control [of the organization] in the hands of unrelated individuals.”^326.4

In at least three rulings, the IRS has taken a position inconsistent with the vast majority of its rulings on nonprofit governance. The IRS issued a ruling concerning the board of directors of a nonprofit organization, which consisted of its founder, her brother, and her daughter. On the basis of this history of private letter rulings, the IRS would have been expected to rule that this—as characterized in the ruling—“small and closely related” board, by reason of its very existence, would amount to private benefit blocking exemption. But no, in a strikingly discrepant ruling, the IRS ruled that “this factor alone is not enough to deny exemption.”^326.5

In the most recent of these rulings, an organization was unsuccessful in its efforts to obtain recognition of tax exemption because the IRS held that it was not engaging in exempt functions and did not adequately respond to the agency's requests for additional information.^326.6 The IRS stated in this ruling: “While an organization will not be denied exemption merely because it is controlled by related individuals, such a situation provides an obvious opportunity for abuse and calls for an open and candid discussion of [the] organization and [its] operations.”^326.7

(h) Perspective

These private letter rulings, from the standpoint of tax-law analysis, denying recognition of tax exemption are incorrect. Indeed, in its zeal to preclude recognition of exemption on the basis of the private benefit doctrine, the IRS ruled that an organization could not be exempt in part because its three directors have “unfettered control” over the entity and its assets.³²⁷ The IRS is applying governance rules that are not reflective of the law and are based on pure speculation.

This attempt to invoke the private benefit doctrine is plain error. That doctrine is to be applied when there is actual private benefit—it is a sanction.³²⁸ It is not to be invoked on the basis of wild speculation, such as the possibility that the organization's assets “could” be used to benefit one or more board members. Were that the standard, there would be few tax-exempt charitable organizations.

(i) Does IRS Have Jurisdiction?

The U.S. Supreme Court declared that it is important to “tak[e] seriously, and apply[] rigorously, in all cases, statutory limits on [government] agencies' authority.”^328.1 It may be asserted that the role of and requisite authority in the IRS is to administer and enforce the federal tax laws.^328.2

At issue is whether the IRS has the statutory authority (jurisdiction) to regulate in the realm of nonprofit governance. The Supreme Court recognized the concept of an “assertion [by a government agency] of authority not conferred,” with the consequence being that the agency's action is ultra vires.^328.3 Recent cases involve the courts striking down IRS regulations on the ground that the agency exceeded its jurisdictional mandate.^328.4 At least one case suggests that the IRS is operating outside the boundaries of its jurisdiction when the agency attempts to dictate the number and/or composition of the governing boards of public charities and other types of tax-exempt organizations.^328.5

(a) Mission Statements

A private foundation, preferably at the board level, should decide whether it will have a mission statement. Many foundations have such a statement; a mission statement may be adopted in the spirit of good governance.³³⁴ Mission statements, which are not required by law, should be consistent with the foundation's statement of purposes as stated in its articles of organization.³³⁵

(b) Code of Ethics

The board of directors of a private foundation should consider a code of ethics for itself and for the foundation's employees (if any). The larger the foundation, the more compelling this type of code may be. The law does not mandate these codes of ethics; they may nonetheless be contemplated from the standpoint of good governance principles.³³⁶

(c) Governing Board Size

It is clear that this matter of the number of board members of a nonprofit organization, including a private foundation, cannot be properly quantified except in generalizations.³³⁷ The Panel on the Nonprofit Sector pointed out the advantages of small and large boards;³³⁸ the IRS noted the disadvantages.³³⁹ The number of board members that works for one foundation will not work for others. Indeed, even as to the same organization, the suitable number of board members may change from time to time. The Panel's judgment that “each charitable [and other type of nonprofit] organization must determine the most appropriate size for its board” is sound.

The Panel's understatement that experts in the realm of nonprofit organization board governance “are not of one mind as to the ideal maximum size of nonprofit boards” is notably accurate. There is no consensus on this point because there cannot be consensus; there are too many variables in play. This is a topic that should be left to organizations' judgment; the law should not dictate the size of private foundations' and other nonprofit organizations' boards (although there is no need to disturb the general state-law rule as to the minimum three-person standard).³⁴⁰ The Panel's recommendation is the best of the lot: the board of a nonprofit organization “should establish its own size and structure and review these periodically.”³⁴¹

(d) Governing Board Composition

The composition of governing boards is an aspect of good governance principles for nonprofit organizations as to which there is no consensus.³⁴² The IRS is stressing the need for independent boards of directors or trustees, which is not a requirement of law and obviously is a standard that is inapplicable in the private foundation context. Even more nonsensical in this setting is the current IRS view that a small board, comprised of related individuals, is automatically a form of private benefit, giving rise to loss or denial of tax-exempt status.³⁴³ If that were the state of the law, there would be very few exempt private foundations.

Many nonprofit organizations today are finding it difficult to attract and retain qualified board members.³⁴⁴ Others make the fundraising potential the prime criterion for board membership. Objectives such as diversity and representation of a community interest can be ephemeral. Rare is the nonprofit board that includes individuals who have professional experience in relation to the organization's programs and fundraising, and/or have formal expertise in budgeting, financial management, investments, personnel, public relations and marketing, governance, law, and advocacy.³⁴⁵ In most instances, about the most that can be realistically hoped for is what the IRS originally advocated: a governing board “composed of persons who are informed and active in overseeing [the organization's] operations and finances.”³⁴⁶

From a policy viewpoint, the notion that a majority of the governing board of a public charity (or any other type of nonprofit organization) must be independent (however defined) is plainly a bad idea. This is a free country; related persons should not be precluded from forming and managing charitable and other types of tax-exempt organizations. An independent board may be an ideal; a board that cannot meet that standard should not be absolutely prohibited. A board that is not independent may—properly—be subject to a higher degree of scrutiny.³⁴⁷

From a legal standpoint, the effort by the IRS to bootstrap its questionable position as to this “good governance” practice by invocation of the private benefit doctrine³⁴⁸ is based on an erroneous application of the law and should be discontinued (voluntarily by the agency or involuntarily as the result of a court order). The private benefit doctrine (like the private inurement doctrine and the excess benefit transactions rules) is to be applied as a sanction should there be a violation of the law. Application of the doctrine is not to be triggered merely because an IRS agent thinks private benefit “might” occur or “may” take place. Speculation by the IRS is insufficient to cause invocation of the doctrine.

(e) Role of Governing Board

It is clear that this matter of the duties and responsibilities of members of nonprofit governing boards is undergoing a dramatic evolution in thinking on the point.³⁴⁹ The role of the nonprofit board has shifted from a somewhat passive one of oversight and policymaking to much more involvement in management and governance (plus the oversight and policymaking functions). Again, the Red Cross legislation nicely summarizes the principles underlying the contemporaneous nonprofit board's duties and responsibilities.³⁵⁰

As, however, the duties and responsibilities of the nonprofit board accumulate, so, too, does the exposure (for commissions or omissions) to personal liability for board members increase. This phenomenon is causing existing and prospective board members to (1) think about whether they will serve or continue to serve on the board and (2) request or at least consider requesting reasonable compensation for their services.³⁵¹ Thus, just as the role of the nonprofit board is changing, likewise is the thinking by individual board members as to the legal and financial ramifications of board service. Private foundations are not immune from this phenomenon.

(f) Foundation Effectiveness and Evaluation

Development of criteria for determining whether a charitable (or other tax-exempt organization) is effective in its operations, and how to measure that effectiveness, are exercises available to private foundations, should they choose to undertake them.³⁵²

(g) Foundation Board Effectiveness and Evaluation

Likewise, emerging guidelines as to ways in which to determine whether the governing board of a tax-exempt organization is functioning effectively³⁵³ are applicable to private foundations' boards. Again, the larger the organization, the greater the likelihood that this type of undertaking makes any practical sense.

(h) Frequency of Board Meetings

The topic of the frequency of board meetings³⁵⁴ is not appropriate for embodiment in the law. Too many variables in this equation preclude a general statutory rule. The best standard in this area is that formulated by the Panel on the Nonprofit Sector: the board “should meet regularly enough to conduct its business and fulfill its duties.”³⁵⁵ That test is certainly applicable in the private foundation setting.

There is, moreover, an element (or a consequence) of this type of rule: the resulting expense. The various good governance principles that opine on this subject are silent on the matter of related expenses. This should be obvious, but here is an unavoidable fact: the more the number of board members, the greater the underlying administrative expense. This is particularly a problem for national boards that tend to meet frequently. Thus, board members generate costs for travel, lodging, meals, board packet (or notebook) preparation, other staff preparation functions, and the like. Every dollar spent for this element of management is a dollar not spent for tax-exempt purposes.

(i) Term Limits

On balance, the better view is not to mandate, by law, term limits on nonprofit board members,³⁵⁶ including those of private foundation boards. This is a matter best left to the discretion of each governing board. The type, size, and culture of an organization are likely to dictate the best practice. Also, for organizations that have difficulty finding and retaining board members, term limits only exacerbate the problem.

(j) Board Member Compensation

The ideal remains, particularly in the charitable organization context, that directors should serve only as volunteers.³⁵⁷ As, however, the duties and responsibilities of nonprofit board members increase, and the potential for personal liability correspondingly rises,³⁵⁸ the pressure for board member compensation (reasonable in scope) should not be surprising. Certainly, in the private foundation context, compensation of board members for their board functions is common.

(k) Audit Committee

Organizations of any appreciable size, including private foundations, should consider establishment of an audit committee, and follow the general precepts of the California statute and the Panel on the Nonprofit Sector standards.³⁵⁹

(l) Governance Policies

The governing boards of private foundations should consider adoption of at least a few of the governance policies, as a matter of effective and responsible management in the modern era. It should be reiterated, however, that none of these policies is required as a matter of law.³⁶⁰

(i) Conflict-of-Interest Policy A conflict-of-interest policy has become a staple of good governance policies.³⁶¹ Rarely required as a matter of law, the IRS has generally succeeded in making this type of policy mandatory, particularly for charitable organizations. A nonprofit organization may resist adoption of a conflict-of-interest policy as a matter of principle, but this has come down to the matter of picking battles—and avoidance of adoption of a conflict-of-interest policy is, today, probably a waste of time and effort. The way the IRS has gone about this process is not the correct approach, but what's done is done.

(ii) Whistleblower Policy Management of a nonprofit organization should decide whether to have a whistleblower policy. Again, while the law does not mandate this type of policy, adoption of one is a matter of good governance,³⁶² except for small organizations and those without employees.

(iii) Document Retention and Destruction Policy As a general principle, a private foundation should consider adoption of a document retention and destruction policy.³⁶³

(iv) Other Policies Other policies that are suitable for consideration by private foundations are those pertaining to travel and other expense reimbursements, and investments.

(m) Disclosure to the Public

There are certain documents that a tax-exempt organization must, by requirement of the federal tax law, disclose to the public. There are other documents that the good governance standards suggest or require be made available to the public.³⁶⁴ Boards of private foundations must decide which (if any) of the latter category of documents will be disclosed. Of greatest controversy is disclosure of financial statements.

(n) Law Compliance

Certainly, a private foundation, like any person, should be in compliance with all applicable law.³⁶⁵ It is possible, of course, for a board of directors of a nonprofit organization (and its officers and staff), acting in good faith, to be unaware of an applicable law. That may turn out to be not much of a defense (inasmuch as ignorance of the law is no excuse).