Health Care Legal Update December 2004
California's New Registration, Reporting and Governance Measures for Nonprofit Charitable Organizations
On January 1, 2005, nonprofits that are doing business in California as "charities" will become subject to the Nonprofit Integrity Act of 2004 (the "Act"). Virtually all charitable organizations that operate in California are subject to the Act. It expressly covers all entities that must register with the Attorney General's Registry of Charitable Trusts, including: California nonprofit public benefit corporations; California mutual benefit corporations that hold assets for charitable purposes; out-of-State charities that do business or hold assets for charitable purposes in California; charitable trusts; and unincorporated associations holding assets for charitable purposes in California. Specifically exempted are entities primarily organized as hospitals, licensed health care service plans, educational institutions, or religious organizations.
Registration and Reporting Requirements
The Act would extend the current law's registration requirements to certain unincorporated associations and other legal entities holding property for charitable purposes. Charitable organizations subject to the registration requirements are required to register by filing a copy of their organizational documents with the Attorney General's Registry of Charitable Trusts by January 30, 2005, but not later than 30 days after the initial receipt of property for charitable purposes if the January 30, 2005 registration date is not applicable. The 30-day time period is substantially shorter than the current law's requirement to register within six months of initial receipt of property.
All charitable organizations that are required to register must provide information to the Attorney General as to the nature of the assets held for charitable purposes and how the organization is administered. The Attorney General is granted broad authority under the Act to adopt rules governing the nature and content of the reports. Other reporting requirements are imposed on commercial fundraisers, who must notify the Registry of Charitable Trusts ten days in advance of the start of a fundraising campaign. Reporting requirements are also imposed on fundraising counsel.
Audit, Governance and Executive Compensation Requirements
Audited Financial Statements. Every registered charitable organization (including any corporation, trust and unincorporated association) that has annual "gross revenues" in excess of $2,000,000 must comply with several additional governance requirements. It must have its annual financial statements prepared in accordance with generally accepted accounting principles ("GAAP") and audited by independent certified public accountants pursuant to generally accepted auditing standards not later than nine months after the close of the fiscal year covered by the statements. The audited financial statements must be made available for inspection by the Attorney General. The auditors must meet the independence standards that are set forth in the U.S. Comptroller General's Yellow Book if they provide any non-audit services for the nonprofit they are auditing.
Audit Committee. The board of any registered charitable corporation (this does not apply to trusts and unincorporated associations) that has $2,000,000 or more in annual gross revenues must appoint an Audit Committee that may not include members who are executives or staff of the nonprofit. Members of the nonprofit's Finance Committee cannot comprise 50% or more of the Audit Committee, but the Audit Committee may have members who are not on the charitable corporation's board. The Audit Committee is responsible under the Act for a) determining the independence of the auditors, b) making recommendations to the board for the retention or termination of the independent auditors, c) conferring with the auditors to determine if the financial affairs of the corporation are in order, d) reviewing and determining whether to accept the annual audit, and e) approving the performance of any non-audit services by the independent auditors. There are no restrictions on delegating additional duties to the Audit Committee.
Executive Compensation. All registered charitable organizations must have the compensation of their President or Chief Executive Officer and their Chief Financial Officer and Treasurer reviewed and approved by their governing board or a board committee to ensure that the compensation and benefits packages are "just and reasonable." This process must be conducted at the time of hiring and whenever the compensation is renewed, extended or modified.
Compliance Considerations
Gross Revenue Test. Once a determination has been made that the registration and reporting requirements apply, the organization must determine if the $2,000,000 gross revenue threshold has been exceeded. Gross revenues are calculated on the accrual basis and include, in addition to cash contributions or receipts, the value of property contributed or earned. All revenue that is reportable on the IRS Form 990 is included in determining the gross revenue.
Audited Financial Statements. All charitable organizations that are required to have audited financial statements must comply for all fiscal years ending on or after June 30, 2005. This provides the organizations with at least six months to retain independent auditors and prepare for the audits in cases where audits have not been conducted for prior years.
Audit Committee. Charitable corporations that exceed the gross revenue threshold must lay the groundwork for an Audit Committee. This should start with the adoption of an Audit Committee Charter (or similar document) by the governing board that is consistent with the requirements of the Act. Audit Committee members may not receive any extra compensation for service on the committee, nor may committee members have any material financial interest in any entity that does business with the corporation. Finding qualified people who are willing to serve may be a challenge, so consideration should be given to the size of the Audit Committee (the Act permits a single-person committee) and providing sufficient time for identifying and screening eligible candidates.
Insurance Coverage. Insurance policies that provide fiduciary liability coverage for board members should be reviewed to make sure that the added responsibilities of board members and Audit Committee members (who may not all be board members) are within the scope of the insurance declarations. Coverage limits may be increased as well, since prospective Audit Committee members may require higher limits as a condition to service on the committee.
Governance Policies and Procedures. A complete review of governance policies and procedures should be considered at this time. Are clearer standards needed for determining eligibility for hiring of executives and staff? Should background checks be required as part of the hiring process? Are the organization's systems of internal controls adequate? Have internal controls deficiencies that have been identified in the past been eliminated? Are all members of the governing board qualified for their expanded responsibilities as a result of the Act?
Federal and State Privacy Laws. HIPAA and recently enacted Federal and California privacy regulations impose additional compliance challenges for charitable organizations that may be subject to their regulatory reach. Governing boards should use this opportunity to obtain assurances that existing compliance measures are in place and are providing effective controls against the occurrence of security breaches and unauthorized disclosures.
Records Management. All charitable organizations that must register and report under the Act are required to retain records of their activities and make them available for inspection by the Attorney General for ten years. The governing board should review and oversee, if needed, modification of the records management policies and procedures of the organization to ensure compliance with this aspect of the Act.
Fundraising Contracts. Finally, charitable organizations should review their contracts with fundraisers and fundraising counsel to ensure compliance with the Act's requirements. The Act contains additional measures that define the contractual relationships that charitable organizations may have with commercial fundraisers and counsel.
If you require our assistance or have any questions please contact Michael Dowell at mdowell@tocounsel.com or the lawyer in the firm who generally handles your health care legal matters.