Nonprofit Organizations' Cost Allocations

By Tinkelman, Daniel | The CPA Journal, July 2005 | Go to article overview
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Nonprofit Organizations' Cost Allocations


Tinkelman, Daniel, The CPA Journal


The Implications of Madigan

Americans give tremendous sums to charity every year. According to the American Association of Fundraising Counsel, total donations in 2003 were over $241 billion, accounting for about 2% of gross domestic product Donors, however, can find it difficult to determine whether their gifts are being used properly. A 2001 survey by the Better Business Bureau Wise Giving Alliance and Princeton Research Associates found that 70% of people surveyed found it difficult to determine whether a charity is legitimate.

While most charities use donor money wisely, sometimes abuses come to light. Some charities are merely inefficient; a rare few are basically fronts formed to raise money for the enrichment of their organizers or consultants. State and local governments have tried a variety of methods to protect the public from inefficient or unscrupulous solicitations. Various states are now considering stricter rules-incorporating some aspects of the Sarbanes-Oxley Act's rules-for nonprofit organizations, and the Senate Finance Committee has held hearings on possible changes in federal regulations.

The Supreme Court has frowned upon attempts to legislate against inefficiency. Some states presumed that high fundraising costs, as a percentage of donations, were in some ways a fraud on the public. These states forbade organizations from soliciting if they spent more than a specified percentage of donations on fundraising. In two decisions, Schaumberg v. Citizens for a Better Environment (444 U.S. 620, 1978) and Maryland v. Munson (467 U.S. 947, 1984), the U.S. Supreme Court struck down such laws as unconstitutional restrictions on freedom of speech. The Court noted in Munson that "there is no necessary connection between fraud and high solicitation and administrative costs. A number of other factors may result in high costs; the most important of these is that charities often are combining solicitation with dissemination of information, discussion, and advocacy of public issues, an activity clearly protected by the First Amendment." In a third decision, Riley v. National Federation of the Blind ofN.C. (487 U.S. 781, 1988), the Court noted that small or unpopular charities would tend to have higher fundraising cost ratios. In Riley, the Court held that a state could not compel charities or professional fundraisers to include a statement about their fundraising cost percentages in their solicitations.

While in these three decisions the Court struck down laws it considered overly broad, it showed some sympathy for states' desires to protect the public. It noted that states could require charities and fundraisers to make certain information, such as financial information, publicly available, so that donors could compare charities. It also noted that states had the ability to prosecute cases of fraud. In Riley the Court said: "We do not suggest that States must sit idly by and allow their citizens to be defrauded. North Carolina has an antifraud law, and we presume that law enforcement officers are ready and able to enforce it." In Madigan v. Telemarketing Associates (538 U.S. 600, 2003), Illinois took the Court at its word.

Madigan v. Telemarketing Associates

Telemarketing Associates, Inc., had a series of contracts from 1987 to 1995 to conduct telemarketing campaigns for VietNow National Headquarters, a nonprofit organization whose stated purpose was to aid Vietnam veterans. Telemarketing Associates also performed some other services for VietNow, such as producing a magazine with about 2,000 subscribers. As compensation for its efforts, the contracts provided that Telemarketing Associates would keep 85% of all funds raised in Illinois. Telemarketing Associates also acted as a broker for fundraising efforts by other telemarketing firms in other states. Telemarketing Associates was entitled to keep between 70% and 80% of all funds raised by these firms. After considering these commissions, VietNow was, by contract, entitled to receive only 15% of Illinois donations and 10% of out-of-state donations.

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