Taming the Legal Lion: Critical Compliance Issues for Smart Nonprofits


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Frances Leos Martinez, Director, Texas C-BAR

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Taming the Legal Lion: Critical Compliance Issues for Smart Nonprofits

  1. 1. Taming the Legal Lion: CriticalCompliance Issues For SmartNonprofits Texas Nonprofit Summit September 2012 Frances Leos Martinez, Texas C-BAR
  2. 2. Purpose of Training• Identify potential issues to avoid liability or loss of tax exempt status• Address strategies to handle these issues• Discuss basic laws applicable to nonprofits
  3. 3. What’s Our Potential for Risk?• Our assets• Our activities• Who could be liable• To whom could we be liable
  4. 4. Critical Areas • Legal Compliance • Human Resources • Insurance Protection
  5. 5. Legal Compliance
  6. 6. Board Governance• An active, attentive board may be the most important way to avoid major threats to an organization. Board members should have a wide range of skills and perform duties.• Board members are legally responsible for the management of the affairs of the organization.
  7. 7. Fiduciary Duties of Board ofDirectors• Duty of Care• Duty of Loyalty• Duty of Obedience
  8. 8. Duty of Care• Good faith• Ordinary care• Best interest of the corporation
  9. 9. Duty of Loyalty• Undivided allegiance to the corporation and its mission• Conflict of Interest• Corporate opportunity• Confidentiality
  10. 10. Duty of Obedience• Mission and purposes of the corporation• State and federal laws• Governing documents• Implementing donor restrictions• Appropriate using of charitable assets• Compliance with laws and regulations imposed on tax-exempt non-profit corporations
  11. 11. Excess Benefits • Paying someone for personal benefits in excess of the value of services they give to the organization. • 25% tax on excess benefits and return excess payment. • 200% tax if excess returned too slowly.
  12. 12. Reasonable Compensation• Approval by authorized body• Independent persons• Comparisons to other organizations• Documentation of process
  13. 13. Board Liability for Excess Benefits• Decision makers who permit the excess benefits payments must pay 10% tax on excess benefits.• Decision maker includes a person who by her silence allows excess benefits to be paid to a person.
  14. 14. Personal Liability of BoardMembers• Loans to directors;• Excess benefits/private inurement;• Employment taxes;• Distribution of assets if insolvent; and• Actions not taken in good faith, with ordinary care, or in the best interests of the organization. 22.235
  15. 15. Protections for Board MembersFollow Basic Governance PracticesMaintain Engaged Officers and DirectorsConduct Meetings ProperlyKnow How and When to Take Action Without a MeetingAdopt Corporate Resolutions When Necessary
  16. 16. Protections for Board Members• If the director relied in good faith and with ordinary care on information supplied by others including: • Officers and employees; • Accountants; • Attorneys (22.228); • Investment bankers; • Persons reasonably believed to have professional expertise; and • Duly authorized board committees acting within the scope of their authority of which the director is not a member.
  17. 17. Protections for Board Members • BUT-a director cannot rely on this information if the director has knowledge of a matter that makes the reliance unwarranted. • A director who dissents to an action must have the dissent entered into the minutes of the meeting or send a written dissent to the organization. Sec. 22.226
  18. 18. Financial Practices
  19. 19. Build a Strong Foundation for FinancialOversight• Organizations that sell merchandise should take periodic inventories.• Establish internal controls for cash and deposits.• Adopt a gift acceptance policy.• Document all donations at the time they are received.• Establish policies for in-kind donations and acknowledgements.• Budget fundraising expenses.
  20. 20. REMEMBER!• It is the opportunity that gives rise to fraud.• Do not become lax because you trust the person in charge of finances.• Conduct surprise audits.• Reward employee reporting.• Have a hotline for whistleblowers.• Monitor lifestyle changes-don’t ignore the Mercedes and the boat.
  21. 21. Red Flags• Financial information is incomplete or confusing• The management letter notes serious areas of improvement or is not included with the audit report• The board does not know the agencies overall budget without looking it up• The organization claims goodwill as an income item• The budget does not match past actual expenditures• There is not two month’s operating capital of reserves• There is not mandatory vacations for employees performing key control functions
  22. 22. Notification• Notify the Attorney General if the nonprofit faces possible financial mismanagement issues.• Notify funders• Notify insurance carriers
  23. 23. Written PoliciesNonprofits should adopt written policies addressing key danger zones:• Conflict of Interest• Expense Reimbursement• Executive Compensation• Board reimbursement• Whistleblower• Document Retention• Public Availability of Documents
  24. 24. Conflicts of Interest• Have a conflicts of interest policy.• Disclose material facts.• Obtain more than one bid for an interested director transactions.• Interested director should abstain.• Majority of disinterested directors should approve in good faith and with ordinary care.• The policy should be reviewed by each board and staff member annually.
  25. 25. Expense Reimbursement Policy• Approval by an independent person• Contemporaneous receipts• Restrictions on first class travel• Restrictions on companion travel• Restrictions on personal services and alcohol
  26. 26. Executive Compensation Policy• Use of comparability data• Review and approval by independent persons• Contemporaneous substantiation of the decision and a description of the process.
  27. 27. Board Reimbursement Policy• Approval by an independent person• Contemporaneous receipts• Restrictions on first class travel• Restrictions on companion travel• Restrictions on personal services and alcohol• All expenses should be found necessary for the organization’s tax exempt purpose.
  28. 28. Whistleblower Policy• Federal law imposes criminal liability against whistleblowers.• The policy should establish procedures for the communication of and response to employee complaints regarding any misuse of the organization’s resources or a violation of the internal rules of operation.• No Retaliation
  29. 29. Document Retention Policy• The policies should include guidelines for maintaining, storing and destroying electronic and paper copies of documents.• Backup policies also protect the organization in the event of a computer malfunction.• Keep in mind existing or potential legal obligations
  30. 30. Public Availability of DocumentsPolicy• Federal and state law require that certain documents be made available to the public.• A written policy helps avoid confusion over these requirements.• Failure to comply with these laws may have criminal consequences.
  31. 31. Fiscal Policies• Financial Reporting to Board of Directors• Annual Audit• Annual Budget• Bank Account Authorized Signatures• Control Procedures for Cash Receipts• Donated Goods, Materials, Equipment or other Assets• Purchasing
  32. 32. Employment Risks
  33. 33. Personnel/Volunteer Risks• Hiring;• Background checks;• Handbooks;• Sexual harassment;• Terminations; and• Whistleblower issues.
  34. 34. Hiring• Nonprofits should carefully scrutinize new hires.• Obtain an information release.• Check references, including former supervisors not listed as references.• Background checks may be helpful in a small percentage of cases.
  35. 35. Hiring• Prepare a written job description, identifying minimum qualifications including: necessary education, skills, experience and essential job functions.• For staff with financial responsibilities include a job qualification that the employee obtains a fidelity bond.
  36. 36. Background Checks• Many nonprofits do not regularly conduct background checks.• ACFE found that 87% of fraud perpetrators had never before been convicted of a crime. It is not the new hire, but someone with an average tenure of 6 years with the organization.• When the Family Connections director was hired in 1990, she was still on parole for two theft convictions in the 1980’s.
  37. 37. Key Role Employees• Make sure someone else understands the person’s job duties.• Create current job descriptions and how-to lists.• Prepare regular status reports.• Mandate vacation or job rotation
  38. 38. Records and Computers• Make sure more than one person knows how to access the information.• Keep records in central location and labeled.• Follow document retention schedules.• Keep passwords in a secure location.• Backup computers regularly and keep disk offsite.• Keep blank checks and bank records in a secure location.
  39. 39. Modifying Risk: Hiring• Prepare a written job description, identifying minimum qualifications including: necessary education, skills, experience and essential job functions.• Prepare a job advertisement and distribute the ad to a variety of distributors.• Develop an application form that includes important information and avoids questions that raise discriminatory issues.
  40. 40. Modifying Risk: Hiring• Review applications for minimum qualifications.• Schedule interviews for best candidates.• Prepare interview questions to ask of all candidates.• Use a panel to conduct interviews.• Obtain an information release.• Check references.
  41. 41. Avoid Claims of Negligent Hiring• Conduct interviews• Check references• Have written job descriptions• Screen volunteers like employees
  42. 42. Best Practices Tip • Employment decisions should be based on job- related criteria.
  43. 43. True or False? • An organization is not liable for sexual harassment committed by managers as long as it is not aware of the conduct. • An organization is not liable for sexual harassment of an employee committed by a client of the company. • A person cannot make a claim of sexual harassment against a person of the same gender.
  44. 44. Sexual Harassment• Unwelcome sexual advances, requests for sexual favors where submission to the conduct becomes a term or condition of employment;• Unwelcome sexual conduct that creates a hostile work environment;• Express or implied demands for sexual favors.
  45. 45. Establishing an Anti-Discrimination Program• Adopt and communicate a policy of no tolerance.• Train supervisory and non-supervisory employees.• Adopt grievance procedures.• Investigate complaints promptly and confidentially.• Monitor compliance with policies.
  46. 46. Why should nonprofits care aboutthe difference between employeesand independent contractors? Because penalties for making the wrong determination are severe. Employers may be liable for past employment taxes and penalties. Microsoft settled for $97 million for misclassified workers.
  47. 47. Background Checks• A conviction, by itself, cannot be an absolute bar to employment.• However, an employer may consider the relationship between a conviction and the applicant’s fitness for a particular job.
  48. 48. Factors to Consider• The nature, gravity, and number of the applicant’s criminal acts;• The length of time since the convictions; and• The nature of the job sought.
  49. 49. Employment Policies• Provide to all employees and apply policies consistently.• Provides employees with useful and necessary information.• Include a disclaimer that the handbook is not a contract, may be changed at any time, does not create a property interest in continued employment.
  50. 50. Questions to Ask BeforeTermination• What is the reason for termination?• How has the employer treated similar situations?• Is there a policy that adversely impacts a protected group?• Is there a procedure in a handbook that governs terminations?• Has the employer documented the reasons for termination at the time the behaviors occurred?
  51. 51. All the Wrong Reasons to Fire anEmployee• Refuses to take a lie detector test• Is subject to court-ordered garnishment• Is pregnant• Is black, a woman, or from a foreign country• Has AIDS• Filed a discrimination complaint• Is a veteran
  52. 52. All the Wrong Reasons to Fire anEmployee• Is called to jury service• Complies with a subpoena• Attends a political convention• Complained about safety rules• Refused to commit an illegal act• Joined a union
  53. 53. Terminating an Employee Over 40 YearsOld• Under the OWBPA, if a nonprofit seeks a release of claims from a terminated employee, the release must be knowing and voluntary and contain specific language.• The release must include: • a 21-day review period and a seven-day revocation period; • be understandable; and • advise that the employee has the right to consult an attorney prior to signing the release.
  54. 54. Safe Termination Procedures• Document, document, document• Don’t withhold money owed from final pay• Obtain written authorization for employment references• Provide COBRA information
  55. 55. Employment References• Obtain waiver of liability before providing information to prospective employers.• Otherwise, give dates of employment and position.• Good references are not something an employer would usually get sued for giving.
  56. 56. Affordable Health Care Act• Number of employees determines: • Obligations • Resources • Penalties
  57. 57. Best Practices Tip • Be fair and consistent with all employees • Confine comments to job-related criteria • Let the employee respond • Document performance • Give employee reasonable time to correct • Follow policies and procedures
  58. 58. Main Insurance Issues • Broad definition of insured. • Requirement to advance defense costs. • Broad coverage for employment practices.
  59. 59. Common Exclusions• Intentional acts• Physical abuse• Sexual abuse• Abuse
  60. 60. Types of Insurance• Commercial Liability: • Protects against negligent wrongful acts causing personal injury or property damage; • Pays for legal defense and money damages; • Need minimum coverage for state cap on liability to apply.
  61. 61. D&O• Protects against intentional wrongful acts if not illegal or actions beyond authority;• Pays for legal defense and reimburses nonprofit for amounts paid to indemnify directors; and• Pays directors for amounts not covered by indemnification.
  62. 62. Employment Practices Liability • Protects nonprofits, directors, and employees for employment-related actions; and • Pays for legal defense and damages.
  63. 63. Workers’ Compensation Insurance• Protects nonprofit and provides benefits to workers injured on the job; and• Limits recovery.• If nonprofit doesn’t carry insurance there is no limit on amount of damages an injured worker can recover.
  64. 64. Other Important Insurance • Property • Automobile • Special Event
  65. 65. Best Practices Tip • Have the board annually review the nonprofit’s insurance policies and scope of coverage.
  66. 66. Income Generating Activities• UBIT concerns• Alliances with for profits• Role of corporate sponsorships
  67. 67. Internet Fundraising• Most states regulated solicitation by charities.• 39 states regulate solicitation; 35 states accept a uniform registration form (URS). • Requirements vary, but most require: • Registration required before solicitation begins. • Annual reporting with an emphasis on fundraising outcomes and practices. • Disclosure to potential donors about where to find more information or file complaints.• Charleston Principles: Organization whose place of business is not in the State must register if: • Specifically targets persons physically in state; or • Receives contribution from individuals in state on a repeated and ongoing basis or on a substantial basis.
  68. 68. Intellectual Property • Copyright • Make sure you own what you think you own • Be careful to understand other’s rights • Trademark • Do your research before naming and branding
  69. 69. Transportation Risks • Vehicle safety and maintenance; • Screening and supervision of drivers; • Licensing requirements/15 person vans; and • Insurance and accident reporting.
  70. 70. Lobbying and Political Campaigns There is an absolute prohibition against endorsement or participation in any political campaign on behalf of a candidate.
  71. 71. Advocacy• Certain activities will not count as political campaign activities: • Inviting a candidate to speak to nonprofit members, as long as the opposing candidate is invited to speak as well. • Organizing nonpartisan voter registration or voter education drives; and • Publishing voting records on certain issues as long as there is no intent to target an election campaign.
  72. 72. Lobbying• Definition of Lobbying: • Any intent to influence specific legislation in any legislative body • City council; • State legislature; • Congress; • Administrative agency.
  73. 73. Lobbying by the Rules The IRS has two tests to measure whether a nonprofit’s amount of lobbying is at a permissible level: • Substantial Part Test • 501(h) Expenditure Test
  74. 74. 501(h) Election• A nonprofit can spend resources to influence legislation without jeopardizing tax-exempt status if: • It makes a 501(h) election, and • Expenditure test not exceeded.
  75. 75. Exclusions Under 501(h)• Technical advice to a governmental body in response to a written communication;• Nonpartisan analysis that presents all sides of an issue;• Support or opposition to proposals that would change the organization’s rights or impact its right to exist;• Discussions about broad social or economic problems; and• Informing your members of issues without a call to action.
  76. 76. Record Keeping and Filing Requirements
  77. 77. Books and Records • Keep accurate and complete meeting minutes and resolutions for board and committees having board authority. • Keep records at registered office or principal place of business. • On written demand stating the purpose of the demand, a member has the right to inspect and copy the books and records of an organization relevant to the purpose. Sec. 22.351
  78. 78. Financial Records and AnnualReport• An organization must maintain current and accurate financial records in accordance with GAAP.• The board must annually approve an annual financial report for the preceding year to conform with the American Institute of Certified Accountants. Sec. 22.352
  79. 79. Public Inspection• If over $10,000 in outside contributions, an organization must keep records, books, and annual reports of the financial activity at the registered or principal office for at least 3 years.• The public has a right to inspect these records during normal business hours. An organization may charge a reasonable copy fee.• Failure to do so is a Class B misdemeanor. Sec. 22.354
  80. 80. Other Penalties for Failure toProvide Access• A member or director may file suit to have access to the books and records of an organization.• A court may award attorney’s fees and any other relief to permit the inspection.• The Attorney General may inspect at any time to insure that an organization is operating in accordance with the law and governing documents of organization.• Failure to permit inspection by AG may result in termination, criminal offense, and lien on all property of organization.
  81. 81. State Filing Requirements• SOS: Form 802 every 4 years(22.357).Failure to file this report can result in forfeiture.• SOS: Changes to the name, address, registered agent, and articles of incorporation.• SOS: Articles of Dissolution.• Comptroller: Changes to the address and that affect tax exempt status.• Comptroller: Sales tax permits.
  82. 82. Employment Filings• Texas New Hire Report• Employee Status Report: Form C-1• Workers’ Compensation coverage: notify employee and TWCC (Insurance Dept)• Workplace injuries: TDI and OSHA• Over 4 employees: Form C-3 and election to pay reimbursements• Over 15 employees: Drug abuse policy
  83. 83. Other State Laws• Special requirements to hold raffles or obtain a bingo license.• Notify the Attorney General if the nonprofit is involved in a lawsuit.• Pay property taxes or obtain an exemption.• Obtain charitable solicitation permits from selected cities.• Obtain a sales tax permit and collect taxes.
  84. 84. IRS Filing Requirements • Annual Form 990 (Organizational changes) • Income tax-Form 941 • W-2s,W-3s, & 1099 Misc • Tax for unrelated business income- Form 990-T • Lobbying expenditures-Form 5768 • Donee information return-Form 8282 • Cash donations over $10,000-Form 8300
  85. 85. Best Practices Tip • Create a checklist of different reporting requirements and annually review compliance with the requirements.
  86. 86. Other Tips• Keep track of filing requirements• Monitor employment practices and compensation• Comply with good board governance policies and internal financial controls• Maintain safe facilities and operations• Read the fine print• Respect copyrights
  87. 87. Don’t risk it!• Anticipate events• Plan a response• Obtain insurance• And remember-by promoting safety, following procedures, complying with regulations, and protecting your assets, your organization can maximize efforts to fulfill its mission.
  88. 88. www.texascbar.orgtexascbar@trla.org