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Navigating Nonprofit Governance

July 3, 2024 Category: Continuing Coverage

In recent years, the Philadelphia community has been rocked by a series of nonprofit hardships. Nonprofits, from universities to national institutions and community organizations, have closed their doors, filed for bankruptcy, or suffered from financial mismanagement. These cases highlight a critical weakness: the importance of effective nonprofit governance.

 

The importance of governance

The board of a nonprofit organization holds a position of trust. It is tasked with protecting the organization’s mission while upholding ethical and legal standards. This includes financial oversight, strategic planning, selecting and overseeing the executive director, being stewards of the mission, and serving as an ambassador for the organization they represent.

When nonprofit organizations are faced with poor governance, public trust and accountability often fail.

“Nonprofits are tax-exempt entities that operate for the public good and their missions address community needs or societal issues,” states Sulaiman Rahman, President / CEO of Diverseforce. “Therefore, they are in some cases legally, and in other cases, morally obligated to transparency, accountability, and ethical behavior. Any mismanagement should be shared with all stakeholders, and be transparent about how it may impact people and the organization.”

When there is a lack of accountability, essential services are lost, leaving vulnerable populations without support, and donations that were intended for positive change disappear. Furthermore, public trust erodes, making it more difficult for future nonprofit organizations to raise funds and achieve their goals.

 

When there are cracks in the system

Governance starts with the Board of Directors of a nonprofit and encompasses clear relationships and processes with the Senior Management of an organization. While the Executive Director and Senior management handle the day-to-day activities, the board has a “duty of care” to inquire about activities and analyze business operations to ensure they are operating effectively and in the best interest of the mission and organization.  According to the PA Attorney General’s “Handbook for Charitable Organizations”, this includes “diligently reading, reviewing, and inquiring about material that affects the corporation; keeping abreast of the affairs and finances of the corporation; and using independent judgment when analyzing matters.” 

From our Partners

When it comes to duty of care and a board’s financial management, Morgen Cheshire, ESQ, Managing Attorney Cheshire Law Group sees capacity as a common challenge faced.

“Governance capacity and the capacity of the financial teams (outside and inside organizations) to stay on top of the work, to communicate well, and to create healthy systems that keep the organization in compliance and its assets safeguarded and well managed.” She continues, “recordkeeping is also a challenge for nonprofits, especially when there is turnover or organizational change. Often organizations don’t have adequate records for properly managing their financial matters (is this truly a permanently restricted fund and if so do we have the details?) and to evaluate program effectiveness by making data-driven decisions about continued programming when there are limited resources.  And there are always limited resources in this sector.”

Rahman agrees with this need for healthy systems, “ [a] major red flag is a lack of clearly documented financial controls with separation of duties and multiple signers at appropriate dollar amounts for the size of the organization. A few others include unusual transactions, excessive spending on overhead as a percentage of budget, and/or high turnover of financial staff.”

While these healthy systems are the sign of proper governance, legal requirements for financial reporting and transparency within nonprofit boards are not entirely as direct as one would imagine.

“Regarding financial reporting requirements, most tax-exempt 501(c)(3) nonprofits must generally file the IRS Form 990 (or some variation thereof) with the IRS yearly. The full-length form 990 has a lot of questions about financials but also about governance, to encourage good governance. The IRS even developed a Governance Check Sheet and other guidance (https://www.irs.gov/pub/irs-tege/governance_practices.pdf) back in 2008-2009,” says Cheshire, “but there was a lot of pushback at the time challenging the IRS’s authority to enforce good governance principles. What we did get in that era of reflection was a revised IRS Form 990 that asks a lot more questions, with the intention of guiding nonprofits toward best practices and making their reporting more transparent.”

She continues, “Pennsylvania also has reporting requirements, enforced by its Bureau of Charitable Organizations, but the law is focused on regulating nonprofits that solicit charitable funds, and educational institutions (the curricula of which in whole or in part are registered with or approved by the Department of Education, either directly or by acceptance of accreditation by an accrediting body recognized by the Department of Education) are exempt from these.”

Cheshire further points out that, “even if registration is not required, larger organizations that receive significant charitable contributions or that receive state and federal funding are getting audits. Pennsylvania’s charitable solicitation law requires that the financial report of every charitable organization which receives annual contributions of $750,000 or more shall be audited by an independent certified public accountant or public accountant. These audits must be performed in accordance with generally accepted auditing standards, including the Statements on Auditing Standards of the American Institute of Certified Public Accountants.”

In accordance with the generally accepted accounting principles, a best practice that Rahman shares to ensure strong financial oversight and proper governance is “establish a board finance committee which includes experienced and engaged finance and accounting professionals. Ensure that best practices for internal controls are being implemented. Conduct annual audits by an independent firm that reports directly to the board, and rotate auditing firms or professionals within the firm every few years. Develop a conflict of interest policy, whistleblower policy, and align financial planning with the organization’s strategic plan and goals.”

In the next installment of our series, we will dive into the 990s,  audits, and reports of several nonprofits that have experienced hardships to better understand the role governance or the lack there of played.

 

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