Sarbanes-Oxley: Guidance for Nonprofit Governance: In Recent Years, America Watched in Shock as Corporate Executives Were Removed from Their Workplaces and Homes in Handcuffs, Charged with Misappropriating and Misusing Corporate Funds, among Other Things

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As employees of the companies under the leadership of these executives realized that their retirement funds had disappeared, Americans demanded swift action. In response, Congress passed the American Competitive and Corporate Accountability Act of 2002, commonly known as the Sarbanes-Oxley Act ("Sarbanes-Oxley"), (1) hoping to rebuild Americans' trust in corporate governance.

Initially, Sarbanes-Oxley focused on the for-profit sector, but recently, this focus has expanded to include the nonprofit community. Some nonprofit organizations raise millions of dollars each year; wine others raise only tens of thousands of dollars or even less. Regardless of the size of a nonprofit's budget, these organizations are often governed by volunteers who are not well-versed in methods of accounting and financial matters. The possibility that such volunteers may contribute to the appearance of impropriety is considerable. While many of the provisions of Sarbanes-Oxley do not apply to nonprofits, voluntary adoption of some of the governance practices it recommends can significantly reduce the potential for inadvertent impropriety. Two of the provisions of the new legislation are binding for nonprofits, as well.

Drexel University, a nonprofit educational institution in Philadelphia, recognized the need to safeguard nonprofits aim recently adopted ninny of the governance practices prescribed by Sarbanes-Oxley for profit-based entities. (2) The State of New York is also considering legislation that will make nonprofit corporations subject to the requirements of Sarbanes-Oxley. (3) What do the provisions recommend, and how might their voluntary adoption improve nonprofit governance?

Independent, competent audit committees

Sarbanes-Oxley requires an entity to maintain an audit committee comprised of members who are (1) pan of the board of directors and (2) independent, insofar as they are not a part of the management (4) team and not compensated as a consultant or for other professional services. (5) The members may, however, be compensated for serving on the board of directors. Organizations must also disclose whether the audit committee includes a financial professional; if it does not, the corporation must explain the rationale for this omission. (6)

Although nonprofit entities are not yet required to comply with this provision, the legislation recommends that even small nonprofit organizations at the very least have their financial statements compiled by a professional accountant. Those nonprofits with minimal budgets usually can obtain the services of a professional accountant on a pro bono basis.

For nonprofit organizations with larger budgets ($500,000 or more) or those nonprofits receiving federal funding, the Act recommends formation of an audit committee separate from its finance committee, consisting of members who have expertise and knowledge in financial matters. This committee should conduct annual audits and obtain the services of a financial expert to guide its activities. Members of the audit committee should not be compensated specifically for serving on the committee and should be free of financial interests in the organization and of conflicts of interest that might result from relationships with any entity doing business with the nonprofit organization. Staff members should not serve on the audit committee; at most, they might stove as consultants to it.

Ensuring that auditors are responsible

Sarbanes-Oxley requires that the partner of the auditing firm hired to assess an organization's accountability rotate off of the job every five years to provide a periodic check on the auditing process. (7) The legislation expressly prohibits all auditing firm from performing other work for the organization, such as providing legal services, investment services, or management services. (8) The auditing firm is required to report all accounting policies and practices used by the entity. …