Sarbanes-Oxley and How Recent Scrutiny Affects Hospices and NPOs

1. Saltmarsh, Cleaveland & Gund Sarbanes-OxleyandHow Recent Scrutiny AffectsHospices and NPOs November 17, 2005

2. Key Questions to be answered: • What has happened during past 5 years? • Will your organization be forced to change? • What type of changes may be imposed? • What are the benefits of change? • Why is Board Governance so important? • Should you change even if not required?

3. Brief Overview of conditions leading to Sarbanes-Oxley Act • Large publicly traded corporations collapsing due to fraud, abuse, greed and audit failure (Enron, WorldCom, Healthsouth, etc., etc.) • Others restate earnings and financial statements (No, we really did not make large profits during the past 3-5 years)

4. Brief Overview of conditions leading to Sarbanes-Oxley Act (cont.) • Large, well-known and successful companies involved • Grossly misleading financial statements • Corporate insiders who have lied, cheated and received huge personal benefit

5. Brief Overview of conditions leading to Sarbanes-Oxley Act (cont.) • Outsiders (bankers, shareholders, etc.) suffer large financial losses • Employees losing jobs and pension account balances • Public and private pension plans suffer large losses on stock

6. Brief Overview of conditions leading to Sarbanes-Oxley Act (cont.) • SEC, Congress and other regulators forced into action • Collapse of Arthur Andersen CPA firm • Desire to seek blame: • Management • Board of Directors, Officers • CPA auditors

7. Brief Overview of conditions leading to Sarbanes-Oxley Act (cont.) • Studies and analysis: • AICPA • Congress (led to Sarbanes-Oxley) • GAO (led to new rules) • IRS • Senate Finance Committee • Panel on the Nonprofit Sector (Report issued June 2005)

8. Sarbanes-Oxley Act – Overview • Most provisions apply only to publicly held companies (except for 2) • Requires establishment of an audit committee • Audit committee must have financial expert • Audit committee must hire the auditor • Audit committee must establish process for complaints, whistleblowers • Requires audit committee to meet with auditors without management present

9. Sarbanes-Oxley Act – Overview (cont.) • Establishes new controls over management • Prohibits management from coercing auditors • Prohibits loans to executives • Requires a code of conduct for financial officers • Requires CEO and CFO certification of financial reports and internal controls

10. Sarbanes-Oxley Act – Overview (cont.) • New rules for CPA auditors • Limits consulting services by “auditors” • Requires 5 year partner rotation • Two provisions apply to all companies • Establishes federal law protecting whistleblowers • Stiff penalties for document destruction

11. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others • SOX was designed to address public traded companies • Nonprofit organization are NOT required to follow SOX (confusion still exists)

12. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others (cont.) • Congress directed States to study and evaluate whether “SOX-like” rules should be applied to other entities being audited in the States • State and local governments • Nonprofit organizations • Privately held businesses

13. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others (cont.) • GAO conducted a study • GAO primarily has authority over state and local governments and nonprofit organizations that receive federal grants • GAO imposed strict new independence rules for auditors under their jurisdiction

14. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others (cont.) • GAO studied mandatory CPA firm rotation – Conclusions: • No evidence exists that this would reduce the risk of audit failure • Significant risk of audit failures during “first year” audits

15. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others (cont.) • IRS conducted studies • Concerned that Form 990 was not working • Concluded that Form 990 was fine, but large percentage of NPOs are not following the Form 990 information disclosure rules

16. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others (cont.) • IRS concerns (disclosure and other): • Excess compensation • Abuse of tax exempt status • Unreported taxable activity • Private inurement • Activities included in tax exempt application • Political activity and lobbying • Failure to file annual reports (Form 990) • Numerous others • Determined that major education campaign was needed

17. Congressional intent to extend Sarbanes-Oxley to States, local governments, nonprofits and others(cont.) • AICPA conducted studies and surveys • Surveys place significant blame on management and boards • New audit fraud rules issued – SAS #99

18. New York State Attorney General Spitzer’s reaction to Sarbanes-Oxley Act • Heavy focus on charitable entities • Allegations of nonprofit fraud and abuse by Attorney General Spitzer • Poor fiscal control and accountability • Lack of full disclosure of activities • Fraud, waste and abuse • Unreported activities • Waste of taxpayer funds (government grants) • Inappropriate use of donors’ funds

19. Potential impact on New York nonprofits if Spitzer bill was passed • Some level of certification by President/CEO and CFO • Simple certification for smaller NPOs • Broader certification for NPOs with more than $1 million in revenue or $3 million in assets • Financial report does not contain any false statements • NPO maintains adequate internal controls • Any known deficiencies in internal controls are reported to Board and auditors

20. Potential impact on New York nonprofits if Spitzer bill was passed • Establishes rules for approving contracts between NPO and any other entity where a Board member has a financial interest, such as full disclosure • Establishes new rules about Board and officer compensation

21. U.S. Senate Finance Committee Actions • New threat of forced change by U.S. Senate Finance Committee • Draft report meets with significant resistance (2004) • Panel on the Nonprofit Sector created

22. Panel on the Nonprofit Sector • Report issued June 2005: • “Strengthening Transparency, Governance and Accountability of Charitable Organizations” • Extensive recommendations • Executive Summary: • Federal and state enforcement • IRS 990 reporting • Periodic review of tax-exempt status

23. Panel on the Nonprofit Sector • Executive Summary (cont): • Financial audits and reviews • Disclosure of performance data • Donor-Advised funds • Type III Supporting Organizations • Abusive tax shelters • Non-cash contributions: Appreciated property

24. Panel on the Nonprofit Sector • Executive Summary (cont): • Board compensation • Executive compensation • Travel expenses • Structure, size and composition of governing boards

25. What are “Best Practices” for nonprofit board governance? • Consider the benefits of adopting Best Practices • Reduce the risk of fraud and abuse • Be well prepared if legislative changes do occur • Build stronger and more effective relationships between the Board, management and the auditors

26. What are “Best Practices” for nonprofit board governance? • Review Board member qualifications • Certain Board members should really understand accounting, finances, internal controls and the audit process

27. What are “Best Practices” for nonprofit board governance? • Review committee structure • One committee should have designated responsibility for audit issues • At least one financially savvy member • Review frequency of meeting – Quarterly may be needed • Meeting agenda should include “non-routine” duties such as reviewing monthly reports, budget, etc.

28. What are “Best Practices” for nonprofit board governance? • Review committee structure (cont.) • Committee should meet with auditors at least twice a year • Prior to start of audit • At conclusion of audit • Portion of meeting should be without management • Committee should recommend hiring and retention of auditors to Board

29. What are “Best Practices” for nonprofit board governance? • Review committee structure (cont.) • Committee members should truly be independent • May need training for Committee members

30. What are “Best Practices” for nonprofit board governance? • Do you need an Audit Committee and a Finance Committee, or both? • There are two separate functions to be performed: • Normal monitoring of financial statements, budgets, etc. • Audit, internal control, fraud and abuse issues

31. What are “Best Practices” for nonprofit board governance? • Audit, internal control fraud and abuse issues (cont.) • Build relationships with auditors • Monitor auditor relationship with management • Understand relationship with Board members and management that may not be “arms-length” • Understand unique fraud risk issues for your organization • Understand organization’s key internal control features • Understand organization’s key accounting policies

32. What are “Best Practices” for nonprofit board governance? • Audit, internal control, fraud and abuse issues (cont.) • Understand your organization’s reporting obligations • Bank or other third-party users • Funding sources • IRS • State

33. What are “Best Practices” for nonprofit board governance? • Perform an organizational fraud risk assessment • Consider a fraud and abuse hotline • Review process for handling complaints (from internal and external sources) • Mandatory vacation policy • Assess level of skepticism of Board and management

34. What are “Best Practices” for nonprofit board governance? • Review your tax return reporting procedures (Are you really disclosing all relevant information on your IRS and State tax returns?) • Establish Conflict of Interest policy for Board and management • Review record retention policies

35. What are “Best Practices” for nonprofit board governance? • Review hiring policies • Use of background and/or credit checks • Remain aware of other states that are adopting more stringent compliance • e.g., New York State’s “Internal Controls and Financial Accountability for Not-for-Profit Boards”

36. Do you want to implement “Best Practices” regardless of whether new regulations are imposed? • Questions