SOX: An Opportunity to Reinvent Your Non-Profit Board

By Franck Schuurmans
Director of Non-Profit Practice, DSI

“Every problem is an opportunity in disguise”

The Sarbanes Oxley Act of 2002 (SOX) is now a well established reality for publicly traded firms that fall under the jurisdiction of the SEC. But what are the implications for non-profits of this attempt to clean up the Aegean stables of corporate America? After all, non-profits do not report to the SEC, and are not scrutinized by the Elliott Spitzers of this world – at least not yet. While it is true that SOX does not pertain to non-profits directly, with the exception of rules on document retention and whistle blower policies, its impact is being felt in a number of ways. First, a growing number of corporate directors will bring with them the ideas and principles of SOX concerning transparency and accountability. Second, organizations that depend on capital markets or outside investors will find that these lenders will require divulging information at the level of SOX regulations. Third, the IRS and other regulatory bodies will also want to see the level of reporting required in SOX for non-profits that wish to maintain their non-profit status.  While much of the letter of the law may not apply, its spirit will clearly affect the work of non-profits.

The Reason for SOX

SOX was created in response to a stream of corporate scandals that rocked boardrooms, Wall Street, investors and the public. Congress enacted far-reaching regulations to put a stop to the cavalier disrespect for the law demonstrated by some of the more brazen CEOs and executives of failed companies. Sarbanes Oxley is not the first attempt to improve the transparency of publicly traded companies. The history of the United States presents a long narrative of efforts to impose ethical standards on industries, with varying degrees of success. However, SOX reaches deeper and strikes harder at misconduct and criminal wrongdoing than previous legislative initiatives. For instance, SOX makes the willful destruction or manipulation of documents that may be needed during an investigation a serious criminal offense. It is punishable by up to 20 years imprisonment plus fines, "approximately the same penalty that applies to involuntary manslaughter in most states" according to a study by Foley and Lardner.^[1] No question about it, SOX has teeth. SOX also presents Draconian sanctions for retaliation against whistleblowers, whether employees or contractors.

In addition to penalties, SOX also increased reporting requirements. It demands auditing and transparencies in financial record keeping, including the requirement that officers sign off on financial statements. The regulations also demand that directors demonstrate that they understand at least the general principles of financial constructions and strategic decisions independent from the coaching of the “C suite.” In this sense, SOX is part of an effort to reform the “cozy culture” that has long dominated America’s boardroom culture. Michael Eisner and the Disney board were repeatedly held up in the popular press as one of the worst examples of corporate governance in publicly traded companies. Mr. Eisner allegedly had stacked his boardroom with cronies and yea-sayers who would not cross his strong ego, or challenge his pertinent sense of direction. With a strong relationship between the CEO and the internal board members, many outside directors were left in the dark about the performance of the company and its strategic goals. Even audit committees were too often merely window dressing for the benefit of public relations but not of good governance.

A Broader Impact

While the goal of SOX was to help guarantee transparency in the accounting of corporations so that investors have a better chance of making realistic valuations of companies, its impact is much broader. The sweeping scope and stiff penalties that SOX can impose, as well as the current climate that favors greater legislation of organizations ranging from the Fortune 100 to the non-profit sector, are having an impact well beyond the boardroom of publicly traded companies. In addition to the SEC and the new accounting board that SOX has initiated, many regulatory organizations are taking their lead from the SOX principles. These organizations include, among others, the IRS, district attorneys, and trade associations.

Credit Unions and the Potential of Non-Profit Governance

While non-profits have had their share of scandals, many established non-profits have a set of internal controls, oversight and a common set of values that have helped them avoid some of the most severe governance problems. Credit unions, for example, have managed to dodge the financial debacles that undid their cousins in the Savings & Loan industry. They may offer insights on governance for other non-profit organizations.

Credit unions are not-for-profit, member-owned financial cooperatives that have been active in the US financial service industry since the first decade of the 19^th century. In the last two decades they have morphed from “plain vanilla” institutions to complex organizations with impressive growth potential, at least at the high end of the segment. They are more tightly regulated than other non-profits and do not face the quarterly earning pressures of for-profit banks. But there also are a variety of best practices that contribute to their effectiveness:

·         Self assessment:  A growing number of credit unions engage in a bi-annual self assessment and debrief that allows for a candid discussion of the board’s performance as a whole, of individual members as well as the relationship of the board with the CEO. The self assessment allows for the development of a list of priorities and action items to further improve the working of the board.

·         Board practices and oversight:  Since they are member-owned, credit union boards are primarily made up of unpaid volunteers. By regulatory requirement, they are bound to meet 12 times a year and, according to the 1934 Credit Union Act, they are ultimately responsible for the safety and soundness of the organization. Credit union boards are small compared to their many counterparts in the non-profit sector, on average 7 to 9 members. Again, by law, they require an independent supervisory committee and an audit committee. While volunteer board members may often have the least amount of knowledge of their particular industry, they all appear to share a common commitment to the interests of the membership.

·       Focus on impact through vision and strategy: The board’s role is not to make endless meaningless motions followed by seconds and “all say ‘aye.’ ” While Robert’s Rules are important from a legal perspective to address the fiduciary obligations of the board, the real power of the board lies in the opportunity to shape the organization’s vision and strategy. The vision should consider, among other questions: What does the potential external world look like? Whom do we want to serve and whom can we serve? What are our strengths? What have been the pillars of our success? What additional resources do we need to be successful in the future? Strategies to enable the vision are the purview of the CEO and management, with the help and input of the board, which ultimately agrees with a set of strategies to reach the goals – or rejects them.

·         Monitoring:  Monitoring involves both internal and external tracking of information. Internal monitoring assesses the progress the CEO makes toward achieving the vision through various strategies. It also entails ethical and legal monitoring, in other words, the auditing of the CEO and the organization. At credit unions, this is done through the audit committee, often with an internal auditor and an external auditor. SOX will unquestionably make this monitoring more mission critical. External monitoring entails tracking the assumptions that went into the vision to see if these assumptions still hold true. External monitoring especially requires good peripheral vision to identify weak signals and to distinguish them from random noise. The guiding principle here is: Never believe your own story 100% and always be on the lookout for developments that disconfirm your original thinking.

While SOX has placed a tremendous burden on for-profit companies and, to a lesser extent, non-profits, it also presents opportunities. It is a time when organizations can look closely at their own governance and explore ways to improve it. The best practices from credit unions described above might suggest a few approaches. While initiatives to improve governance may require more work in the short run, they can have tremendous payoffs for the organization in the long run.  In this sense, the problem of SOX may be an opportunity in disguise.

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