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October 15, 2004
From Wall Street To Your Nonprofit's Office

By Beverly Goodman

Financial oversight is here

Much ado has been made of New York State Attorney General Eliot Spitzer's systematic attack on Wall Street -- the proxy for corporate greed everywhere. But Spitzer's latest battle has unexpectedly drawn attention to a vastly different area: nonprofit compensation.

In his well-publicized battle with the former head of the New York Stock Exchange (NYSE) Richard Grasso, Spitzer is arguing that the $190 million Grasso collected from 1995 through 2003 was excessive compensation. In the rarefied realm of Wall Street, such pay may not seem outrageous, but NYSE is technically a nonprofit. Spitzer is basing his suit on a largely ignored -- and vaguely worded -- state statute, the Not for Profit Corporation Law. This case is just one salvo in what's becoming a larger (albeit still somewhat haphazard) effort to subject nonprofits to greater oversight.

Essentially, the Not for Profit Corporation Law orders that an officer's compensation should be "reasonable" and "commensurate with services performed." This statute was used in 1998 to force Adelphi University President Peter Diamandopoulos to refund part of his 1996 compensation of $837,000.

But the statute has never been truly tested, and there's no actual precedent for Spitzer to use, said John Coffee, a professor at Columbia Law School and director of its Center for Corporate Governance in New York City. All the judge in the Adelphi case did was refuse to dismiss the case, a move that encouraged Diamandopoulos to settle.

"The argument was that the compensation was excessive for a struggling, poor university," Coffee said. "NYSE is certainly not struggling or poor, but it was paying Grasso ... That's hard to justify. GM doesn't do that. If a hospital with $20 million in revenue wanted to pay its chief $25 million, that's unreasonable."

Spitzer, whose office did not return calls seeking comment, will need to prove that the pay was indeed unreasonable or that there was not sufficient disclosure of the terms of his compensation to the NYSE board members who approved it.

Another distinction is that, while the NYSE is a nonprofit, it is not a public charity. Like most unions, trade associations for example, the NYSE is set up as a 501(c)(6) organization. It's exempt from federal taxes and member dues are generally tax-deductible, but donations are not. That's a significant distinction from 501(c)(3) nonprofits, which are charities with a public mission, often educational, cultural or scientific.

The distinction is important according to the many people critical of the suit against Grasso. "The NYSE is clearly not a charity, so why is Spitzer doing this at all?," Evelyn Brody, a professor at Chicago's Kent College of Law, asked rhetorically. "I don't understand why he's fighting this with New York taxpayer dollars. If the members of the stock exchange have a problem with it, then they can bring a lawsuit."

While this battle rages in New York (Grasso has filed a counter-suit; both sides seem equally unwilling to settle), the federal government has also roused itself from the relentless policing of corporate scandal to start looking for misdeeds in the nonprofit sector.

To begin, the Internal Revenue Service (IRS) has just launched its "Tax Exempt Compensation Initiative," which will contact hundreds of public charities and private foundations regarding compensation practices. "This is an aggressive program that will include both traditional examinations and correspondence compliance checks," IRS Commissioner Mark Everson told Congress this past June. In other words: Nonprofits, expect audits -- particularly those that filed Form 990 without proper compensation information and the nearly 200 organizations that pay an executive or board member more than $1 million a year.

This interest isn't totally new. The IRS has been able to fine nonprofit executives who collected oversized compensation packages, as well as the boards that approved them, since 1996. Prior to that, the IRS could only revoke a nonprofit's tax-exempt status. But the corporate malfeasance that has been dredged and put on public display has encouraged the IRS to do similar work in the nonprofit area.

Even beyond launching its examination of nonprofit compensation, the IRS seems to be reaching out to Congress more for assistance. "It's natural for the IRS to see a corporate tax shelter and come to us and say they need help closing it," said a staffer on the Senate Finance Committee. "But we're beginning to see more of that kind of back and forth in the nonprofit arena as well."

Congress, for its part, has also stepped up its interest in nonprofits. The Senate's Committee on Finance, chaired by Charles Grassley, R-Iowa, has introduced a series of suggestions for greater oversight of the nonprofit sector. The bills would lay down explicit rules for governance and financial transparency. The IRS would be responsible for enforcing the new regulations. Grassley's committee would like to clarify what it considers to be a broad gray area in terms of proper compensation practices, and allow for greater punishment for infractions, according to a committee staffer.

As a result of this burgeoning regulation, slivers of the nonprofit community are responding by trying to craft a form of self-regulation, much like how the medical and law professions operate.

The Maryland Association of Nonprofits, which represents 1,500 Maryland charities, six years ago began awarding a "seal of excellence" to groups that exceed regulatory minimum requirements. This past summer, though, the program was expanded to cover charities nationwide. The seal goes to charities that do better than legally required in monitoring their operations.

In addition, Independent Sector, a Washington-based nonprofit association, devised a code of ethics earlier this year. The code includes a section that requires nonprofits to ensure it's compensation practices are reasonable and appropriate.

Clearly, these early attempts at self-regulation and implementation of universal ethics policies are purely voluntary and hardly foolproof in terms of rooting out problem areas. But even as the nonprofit industry mobilizes to prevent federal regulation, it will have to contend with Washington's increased interest.