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									Sarbanes-Oxley and Corporate Compliance: What’s all the Fuss About?

The Ranney School Constance H. Baker, Esq. Venable LLP June 18, 2004

Corporate Scandals
• We have heard about – Enron – Arthur Anderson – Worldcom – Document destruction – Misleading and restated financial statements – Employees losing their retirement funds – CEO misconduct

Sarbanes-Oxley Act of 2002
• Landmark legislation made sweeping changes in governing and managing companies • Officially “American Competitiveness and Corporate Accountability Act of 2002” • Aimed at publicly traded companies, imposes obligations to disclose and certify to true and accurate financial condition, increase financial transparency and accountability, design internal financial controls • Criminal penalties, 10 years in prison, $1-5 million fine

Application to schools/other nonprofits
• Most provisions don’t apply to non-profits, but two provisions apply to all. • Other provisions that apply only to publicly traded companies will set new standards for corporate governance or “best practices”, some of which schools may consider adopting.


• Review school fraud case law • Calls for reform by NY AG, Mass. AG and IRS • Understand the two parts of Sarbanes-Oxley that apply to schools now • St. Paul’s School case • Directors’ duty of care, duty of loyalty, intermediate sanctions • 8 points to consider as you define Best Practices

Blumenthal v. Barnes
• Conn. AG in 2002 sued Pres, treasurer and director of Village Academy, a nonprofit school, alleging she breached her fiduciary duties by engaging in self-enriching and unfair activities. • Leased property to school, had 2 employment contracts for short time periods at excessive salaries.




Vacco v. Diamandopoulos
NY AG in 1998 sued former Pres, trustees of Adelphi U. alleging mismanagement of assets related to use of insurance brokerage services of former trustee, use of former trustee’s advertising firm without disclosing to Board the fees, failure of Pres. to disclose pertinent facts to audit committee, and failure of Board to take appropriate action once it was aware of conflicts of interest.

Vacco v. Diamandopoulos con’t.
• President traveled in first class with wife, but employment contract only provided for reimbursement for domestic travel. • Pres. reimbursed over $360,000 for travel and entertainment expenses for three years. • Pres. furnished and renovated Manhattan apartment at University expense and sought reimbursement for $4000 per year in holiday gratuities to apartment staff. • Court denied def’s motion to dismiss, advance indemnification. 8

Caravel Academy, Inc. v. Campbell
Delaware school sued principal, wife for damages for breach of fiduciary duty: – Purchased car with corporate funds for personal use – Purchased annuity with corporate funds for amount greater than authorized – Entered into employment contract with his wife for salary greater than authorized • Court found that defendants violated their fiduciary responsibilities


Court ruling in Caravel Academy
• “Defendants’ conduct must be measured against the requirements of fair dealing, honesty, loyalty and good faith imposed upon them by virtue of their position within the corporation.” • “Officers of a corporation owe the duties of honesty, loyalty, good faith and fairness.”

NY AG Corporate Reform Proposals
• NY AG Eliot Spitzer proposed reforms in 2003 to provide similar protections against abuses by non-for-profit organizations that have custody of billions of dollars in charitable funds. • Proposed legislation would apply the same Sarbanes -Oxley Act provisions to non-forprofit corporations “to ensure that charities are held accountable for the millions of dollars that New Yorkers donate each year.”

Mass. AG legislation
• AG Tom Reilly introduced Act to promote the financial integrity of public charities • To strengthen public’s trust in integrity of public charities by requiring them to certify accuracy of financial reports • Similar to Congress’ intent of SOA, to reestablish public’s trust in public charities. • To deter mismanagement and misconduct in financial oversight

Mass AG legislation
• Certifications of financial reports by managers • Audit committees, procedures for complaints and whistleblower protections • Related party transactions and compensation • New remedies for violations


IRS - Form 990
• IRS has recommended changes to Form 990 due to need for veracity in public information used by contributions in making decisions regarding exempt organizations. • IRS considering measures to increase public confidence in integrity of disclosures by exempt organizations.


IRS Form 990 Possible Changes
• Disclosure of adoption of conflicts of interest policies or independent audit committees • Disclose information about transactions with substantial contributors, officers, trustees and key employees


IRS to propose non-profit best practices guide
• IRS will issue best practices for nonprofit organization governing boards in 2004 Work Plan. • Bright light of corporate governance spotlight focusing more on large tax-exempt organizations • Guidance will focus on educating boards on corporate compliance oversight obligations regarding audit, compensation review • Board members need to have expertise to understand financial statements or find someone who does to advise them

Document Destruction
• Sarbanes-Oxley includes new criminal provisions regarding obstruction of justice by document destruction. • Applies to EVERYONE including schools. • Effect is to increase scope of potential criminal liability for a variety of conduct.

Document destruction (con’t)
• Crime to knowingly destroy document with intent to obstruct or influence “investigation or proper administration of any matter within jurisdiction of any department of agency of U.S. or in relation to or contemplation of any such matter or case.” • “Any matter…” interpreted by courts to include almost every conceivable area of interest by feds. Same language as in Federal False Statements Statute, 18 U.S.C. 1001. 18

Just suppose...
• School employee sends e-mail about school matter, stating: “If feds ever get wind of this, they’ll be all over us like a ________.” If subject matter of e-mail is properly within jurisdiction of federal agency, has school “contemplated” a “matter” under the Act? • E-mail is destroyed pursuant to routine document retention policy or otherwise. • Are school and employees exposed to criminal liability? We are virtually assured that this provision will be tested soon. 19

Whistleblower Protection
• Sec. 1107 makes it a crime for anyone, with intent to retaliate, to take any action harmful to anyone for providing to law enforcement officer any truthful information relating to commission of any federal offense.

Whistleblower Protection
• Maximum punishment is 10 years incarceration and fine. • Applies to everyone! • “Law enforcement officer” includes officer or employee of feds - includes IRS, EEOC, FTC, FBI, SEC, etc.


St. Paul’s School, Concord, NH
• WSJ article on compensation for Rector ($524,000) and Vice Rector ($316,000) • NH AG investigated; School announced voluntary reductions in compensation for 2 years, then tied future increases to % increases to faculty as a whole • School also established certain internal controls for Rector’s Discretionary Fund

Experts for AG and School opined on…
• • • • • • • • • Committees Term limits of trustees and officers Investment management Role of Exec. Committee Board approval of committee appointments Composition of certain Board committees Audit oversight practices Conflict of interest policy Training and orientation of trustees

Other recommendations
• SPS agreed to recommend that NAIS conduct seminar addressing importance of full disclosure on IRS Form 990 on industry-wide basis regarding reporting of non-salary compensation • School to meet annually for next five years with AG to discuss compliance issues

Points to consider: eight recommendations
• Consider certain recommendations as a thoughtful transition to a scheme of standards currently unfolding


1. Audit Committee
• establish Audit Committee, or subcommittee of Board finance committee, or introduce new discipline to existing Finance Committee. • most members independent of school management • one member should be “financial expert” • appoint, recommend compensation for, hold auditors accountable • set up internal procedures to receive, react to complaints regarding accounting, internal 26 control or auditing matters

2. Code of Ethics for financial matters
• Consider adopting code of ethics for Head, senior financial officer • Unethical for any officer or director to fraudulently influence auditor in performance of audit for purpose of rendering financial statements misleading

3. Establish Document Management Policy
• Establish document management policy to guide staff in handling and disposing of documents (including e-mail), focusing on document relating to “matters within the jurisdiction of any agency” of the federal government (e.g. tax matter of interest to IRS, employment matter of interest to EEOC, etc., or any grants or loans from federal agency.)

4. Establish policy for whistleblower protection
Adopt policy and procedure to prevent retaliation against employees who report problems or raise questions regarding school financial affairs.


5. Review corporate bylaws
• Make sure that committees are functioning properly, that the board properly oversees head of school, that committees are constituted properly, update committee charges • Revise Bylaws as necessary, every 3 years.


6. Review duty of care
Act with care an ordinary person would exercise under similar circumstances: -Informed, good faith (not perfect) decisions -Regular attendance at board and committee meetings -Can rely on reports and consultants, if reliable -Delegation is permissible -Monitor investments

and review duty of loyalty
-Act with undivided allegiance to the

school’s purpose -Prohibit conflict of interest or self-dealing with school (typically arises when director has independent financial interest in proposed transaction) -Conflict of interest policy/disclosure of conflicts should be routine.

7. Review other corporate compliance obligations
• • • • Lobbying restrictions, political activity Unrelated business income tax (UBIT) Liability protection (insurance, indemnification) Fundraising issues (registration requirements, raffles and auctions, planned giving tools) • Structure issues (use of subsidiaries, LLCs, title holding companies, supporting organizations) • Filing and disclosure issues (Form 990, personal property tax returns, charitable substantiation 33 rules)

8. Review intermediate sanctions
• Intermediate sanctions designed to penalize people who receive unreasonable compensation or other disproportionate benefits from tax-exempt organization. • Impose a 25% tax on the self-dealer or disqualified person (who exercised substantial influence) who receives an excess benefit from the school (200% if not corrected) • 10% tax on the Board personally (up to $10,000) • Comply with 3-step safe harbor of independent board relying on comparable data adequately documented. 34

Thank God she’s finished!


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