Acton Commentary

Washington Pushes for Charity Regulation - A Sarbanes-Oxley for the Nonprofit World?


With a reflex motion that would impress Pavlov, lawmakers in Washington are considering sweeping new regulatory schemes to curb financial abuses in the nonprofit world. On June 22, Senate Finance Chairman Charles Grassley held hearings where a long line of experts testified to the various scams perpetrated in the nonprofit world and proposed “reforms” - Washington-speak for more oversight and control. And the Internal Revenue Service is angling for a huge FY 2005 budget increase, largely to police the nation's 3 million tax-exempt organizations.

Much of the discussion at the Grassley hearings focused on the more egregious instances of nonprofit fraud - car donation scammers, abusive investment-and-insurance shelters, excessive CEO compensation and perks, and the fast-buck artists who use charities as a front to enrich themselves. “Too many well-meaning charities have fallen prey to the charlatans' pitch about easy money,” Grassley said.

A casual observer - that is, someone who didn't know much about the nonprofit world - would have come away from the Grassley hearings thinking that the people who formerly ran Enron and WorldCom had all migrated to the local mission center and soup kitchen to seek their fortune. Frankly, the hearings were a confusing grab bag of unrelated issues and anecdotal horror stories, which communicated a gross misunderstanding of how the nonprofit world really works, especially at the grass roots level. And the truly troubling implication of this ignorance is that these are the people who would write new nonprofit regulations.

At the Grassley hearings, there was no serious consideration of the scope or contribution of smaller community charities and religious humanitarian efforts, all of which would come under any new federal oversight. Of the 3 million tax-exempts in the United States, some 1.3 million are charities, and 79 percent of those operate on budgets of less than $100,000. There was some lip service given to exemption from new regulation for the smaller nonprofits, but nothing defining exactly what “small” is. Derek Bok, former Harvard president and now faculty chair of the Hauser Center on Non-Profits and Philanthropy, told the committee that small charities should face “more manageable requirements, given their size.”

But if, as IRS Commissioner Mark Everson testified, the IRS can show a 5-to-1 return on every enforcement dollar expended, then it's to the government's advantage to expand definitions rather than narrow them. Small may actually get pretty big, when it comes to laying out the IRS dragnet. Everson is also seeking a $490 million increase over the current $10.7 billion budget to expand nonprofit enforcement and audits.

Now, imagine you are the underpaid, overworked director of a “grassroots” charity working to clean up drug addicts or help single moms find decent jobs. Your staff is largely comprised of volunteers. Your funding sources are, at best, uncertain. The office copier has broken down and the passenger van won't start. Then, in the mail, you get notice of an IRS audit. You are, by the way, your own bookkeeper because you can't afford outside help. But that's OK because Derek Bok has assured you that this will be manageable and Charles Grassley is only on the lookout for charlatans.

Give Locally

What's more, it is morally dangerous to seize the authority and responsibility for governance from the charitable world en masse and upstream it to Washington. Charities work best that connect in real ways to local communities. This truth is expressed in the Catholic tradition as the principle of subsidiarity and, in Reformed Protestant theology, as sphere sovereignty.

Free societies are messy because citizens don't always make virtuous decisions, and that includes the human beings who choose to work in the nonprofit world. It's healthy to air concerns, especially those that threaten the public trust of charities. But lumping together issues such as abusive investments, nonprofit salaries, and car donations just confuses a public that gave $241 billion to charities last year. Americans believe, like no other people, in charitable giving. And they need their government, which is ever alert to new sources of revenue for the Treasury, to be clear and honest about the true scope of the problems.

Would-be nonprofit reformers should be wary of the unintended consequences of new regulations. Lawmakers should consider the tremendous compliance-cost consequences of new regulations that could put neighborhood or church-based nonprofits out of business. In the corporate world, the Sarbanes-Oxley law was designed to stem the abuses of high-profile scandals at a few large companies. As a result, public companies in America got a blanket of regulation. A February survey of 321 companies by Financial Executives International showed that the average compliance costs under Sarbanes-Oxley were almost $2 million. One of the witnesses at the Grassley hearings, California investment adviser Jay D. Adkisson, said: “The reforms of Sarbanes-Oxley should be applied to directors of charities and foundations.” But last I checked, these reforms have not abolished corporate wrongdoing.

Here's a solution: How about addressing specific nonprofit abuses in a highly-targeted approach, limited in scope, that does not attempt to use a sledge-hammer where a flyswatter will do? A case in point is the IRS's laudable curbing of the car donation scam, which set forth specific guidelines for both donor and recipient charities. This has not only chased many of the charity predators out of the scene, but protected charities that were, in many cases, victimized by them.

And how will more federal regulation of nonprofits change the role of directors? Currently, states make the rules by which nonprofit directors govern. At the Grassley hearings, a number of people, including New York Assistant Attorney General William Josephson and National Association of State Charity Officials Mark Pacella, emphasized the importance of local governance and oversight responsibility at the board level. And that makes perfect sense.

Let's put the brakes on Sen. Grassley's nonprofit regulation campaign. Let's ask the IRS to use a rifle instead of a shotgun. And, for those of us in the nonprofit world, let's clean up our own act before Washington makes life much more complicated for us and for those we serve.