What's good for the goose is not good for the gander: Sarbanes-Oxley style nonprofit reforms.

• Author: Mulligan, Lumen N.

In this Article, I contend that the Sarbanes-Oxley-inspired nonprofit reforms currently being put forward in seven states, particularly the costly disclosure requirements, will be of little value in the effort to improve ethical nonprofit board governance. After providing a primer on the oversight of nonprofit organizations and highlighting the unique difficulties facing the nonprofit sector, the Article reviews the recent Sarbanes-Oxley-like nonprofit reforms introduced in seven states. It then contends that the disclosure-focused reforms that form the bulwark of these initiatives will not foster improved ethical nonprofit board governance. It also argues that this failure stems from the inappropriate application of a stockholder-based normative perspective in the nonprofit sector. The Article concludes by noting that appropriating a normative construct more tailored to the nonprofit community, namely stakeholder theory, is essential to drafting effective nonprofit sector reforms in the future.

TABLE OF CONTENTS INTRODUCTION I. PRIMER ON NONPROFIT CORPORATE OVERSIGHT A. Board of Directors Oversight of Nonprofit Corporations B. Third-Party Oversight of Nonprofit Corporations C. Governmental Oversight of Nonprofit Corporations II. STATE REFORMS FOR NONPROFITS--SARBANES-OXLEY-STYLE A. Disclosure Reforms B. Governance Reforms C. Auditing Reforms III. DUBIOUS EFFICACY OF DISCLOSURE A. Mandatory Disclosures Unlikely to Be Used B. Disclosure as an Instrumental Value C. Compliance Focused IV. MISTAKEN MORAL PREMISE A. Nonprofit Corporations and Stakeholder Theory B. Stakeholder Theory and Future Nonprofit Reforms CONCLUSION INTRODUCTION

The United States boasts the largest nonprofit sector in the world, and that sector continues to grow. (1) The Internal Revenue Service, the primary federal regulator of nonprofit organizations, (2) currently oversees 1.6 million tax-exempt organizations holding $2.4 trillion in assets. (3) Unfortunately, this huge sector of the economy recently has been pummeled with a spate of now all-too-familiar corporate scandals. (4) In the seven years preceding 2002, officers and directors of major charitable organizations misappropriated at least $1.28 billion from 152 nonprofit organizations. (5) To make matters worse, a recent Chronicle of Philanthropy study contends that this figure, which is based upon newspaper reports, significantly underestimates the scope of abuses within the nonprofit community. (6) Congress responded to similar misdeeds in the for-profit sector with the Sarbanes-Oxley Act, which imposes, inter alia, a series of disclosure, corporate governance, and auditing requirements upon enumerated, publicly traded corporations. (7) But, with the notable exceptions of the whistleblower and document-retention provisions, Sarbanes-Oxley does not apply to nonprofit corporations. (8)

Nevertheless, the recent incidents of nonprofit malfeasance have not escaped state legislative notice. This attention has spawned a host of Sarbanes-Oxley-like proposals for nonprofit organizations, which are the focus of this Article. Immediately following the passage of Sarbanes-Oxley, the New York Legislature led the way by taking up a wide-ranging bill, championed by the state attorney general, that would mandate Sarbanes-Oxley-like reforms for the nonprofit sector. (9) The Massachusetts attorney general soon proposed his own bill similar to New York's. (10) Neither bill passed. Numerous other states have followed suit by introducing comparable Sarbanes-Oxley-like bills that ultimately failed to pass. (11) Several states, however, have passed acts codifying some Sarbanes-Oxley-like reforms for nonprofit organizations--California's Nonprofit Integrity Act of 2004 being, perhaps, the most well-known. (12) The unifying theme of these Sarbanes-Oxley-inspired bills is their reliance upon disclosure mechanisms (e.g., officer-certified financial statements), governance mandates (e.g., audit committees), and auditing requirements (e.g., independent audits performed by CPAs) to induce corporate integrity. (13)

In this Article, I contend that these state reforms, particularly the costly disclosure requirements, will be of little value in the effort to improve non-profit governance. (14) The Article proceeds as follows. Part I provides a primer on the oversight of nonprofit organizations. Part II reviews the recent Sarbanes-Oxley-like nonprofit reforms introduced in seven states. Part III contends that the disclosure-focused reforms, which form the bulwark of these bills, will not foster ethical nonprofit board governance. Part IV argues that this failure stems from the inappropriate application of a stockholder-based normative perspective in the nonprofit sector. The Article concludes by noting that appropriating a normative construct more tailored to the nonprofit community, namely stakeholder theory, is essential to drafting effective nonprofit sector reforms in the future.

1. PRIMER ON NONPROFIT CORPORATE OVERSIGHT

   The nonprofit corporation, with 501(c)(3) public charity tax-exempt status, is the predominant organizational form for nonprofit organizations. (15) These organizations constitute the focus of this Article. The recently introduced, state-based, Sarbanes-Oxley-like reforms that attempt to affect the governance of these nonprofit corporations are best understood against the backdrop of the current state of nonprofit board governance and regulation. While many of these features will be familiar to lawyers who work in the for-profit corporate sector, there are numerous factors unique to the nonprofit sector that significantly affect nonprofit board governance and the regulation of nonprofits by third parties and governmental authorities.

   1. Board of Directors Oversight of Nonprofit Corporations

      The legal principles that frame for-profit board governance generally apply to nonprofit corporations. (16) As with for-profit corporations, nonprofit corporations are governed by a board of directors. (17) As with for-profit corporations, the board must monitor management, make decisions regarding the high-level direction of the organization, and approve its major transactions. (18) Again, like for-profit directors, nonprofit directors are subject to the fiduciary duties of loyalty and care, which are applied by the courts with the same rigor (or lack thereof) as is done in the for-profit context. (19)

      Nonprofit directors have a unique legal fiduciary duty as well. Specifically, nonprofit directors have a duty of obedience to the mission of the nonprofit organization. (20) As one court put it, "nonprofit directors ... must be 'principally concerned about the effective performance of the nonprofit's mission.'" (21) In addition to this duty of obedience to the mission, several other key features of nonprofit corporations differentiate them from their for-profit cousins and significantly affect nonprofit board governance.

      First, and most important, nonprofit organizations are subject to a nondistributional constraint. That is to say, nonprofit organizations may earn net profits, but they may not distribute these profits to persons who exercise control over the organization (i.e. directors, officers, employees, and other members of the organization). (22) This nondistributional constraint has wideranging implications for board governance, not the least of which is the lack of a commonly accepted metric of performance. (23) Because nonprofit organizations lack the sort of financial indicators that provide a measure of success in the for-profit context, nonprofit directors often face considerable difficulty evaluating the performance of their own organizations. (24) Further, this inability to distribute profits stymies the creation of market-based regulatory regimes like those found in the for-profit sector. (25)

      Second, while it is possible for nonprofit corporations to have members with voting rights--persons who would hold similar rights and duties as shareholders in a for-profit corporation--the overwhelming majority of nonprofit corporations do not have voting members. (26) As a result, most nonprofit boards are self-perpetuating--new members of the board are appointed by the board itself. (27) This affects board governance in several dimensions. Most dramatically, the lack of voting members significantly contributes to an accountability vacuum that plagues nonprofit boards. (28) A recent study by Professor Judith L. Miller, for instance, found that nonprofit board members had difficulty identifying any group to whom they were accountable. (29) This lack of accountability to shareholders (or anyone else) leads nonprofit boards to explain their conduct to a broad range of constituents who often have competing agendas (e.g., donors, governmental authorities, clients, and staff). (30) These competing constituencies often push nonprofit corporations to seek differing goals. As nonprofit corporations accommodate these constituencies, articulating and striving toward a coherent mission becomes more difficult. (31)

      Third, the lack of both a clear performance metric and board accountability, combined with other factors, has led most nonprofit scholars to note that the role of the nonprofit director is more complex than that of for-profit board members. (32) Yet the task of nonprofit director is predominantly performed by volunteers (33) who spend significantly less time at the task than their for-profit counterparts. (34) Again, this has ramifications for board governance. For instance, nonprofit directors typically lack sufficient information to make informed decisions. (35) This inability to invest directors' time into making informed decisions is exacerbated by the informal, yet ubiquitous, requirement that nonprofit directors do much more than oversee managers. "The common folklore is that board members should bring to an organization the three W's: wealth (donations and fundraising), wisdom...