Sarbanes-Oxley and Corporate Compliance: What

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Sarbanes-Oxley and Corporate Compliance Whats
all the Fuss About?

• The Ranney School
• Constance H. Baker, Esq.
• Venable LLP
• June 18, 2004
• chbaker_at_venable.com

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Corporate Scandals

• We have heard about
• Enron
• Arthur Anderson
• Worldcom
• Document destruction
• Misleading and restated financial statements
• Employees losing their retirement funds
• CEO misconduct

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Sarbanes-Oxley Act of 2002

• Landmark legislation made sweeping changes in
  governing and managing companies
• Officially American Competitiveness and
  Corporate Accountability Act of 2002
• Aimed at publicly traded companies, imposes
  obligations to disclose and certify to true and
  accurate financial condition, increase financial
  transparency and accountability, design internal
  financial controls
• Criminal penalties, 10 years in prison, 1-5
  million fine

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Application to schools/other nonprofits

• Most provisions dont apply to non-profits, but
  two provisions apply to all.
• Other provisions that apply only to publicly
  traded companies will set new standards for
  corporate governance or best practices, some of
  which schools may consider adopting.

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Agenda

• Review school fraud case law
• Calls for reform by NY AG, Mass. AG and IRS
• Understand the two parts of Sarbanes-Oxley that
  apply to schools now
• St. Pauls School case
• Directors duty of care, duty of loyalty,
  intermediate sanctions
• 8 points to consider as you define Best Practices

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Blumenthal v. Barnes

• Conn. AG in 2002 sued Pres, treasurer and
  director of Village Academy, a non-profit school,
  alleging she breached her fiduciary duties by
  engaging in self-enriching and unfair activities.
  
• Leased property to school, had 2 employment
  contracts for short time periods at excessive
  salaries.

5 YEAR LEASE
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Vacco v. Diamandopoulos

• NY AG in 1998 sued former Pres, trustees of
  Adelphi U. alleging mismanagement of assets
  related to use of insurance brokerage services of
  former trustee, use of former trustees
  advertising firm without disclosing to Board the
  fees, failure of Pres. to disclose pertinent
  facts to audit committee, and failure of Board to
  take appropriate action once it was aware of
  conflicts of interest.

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Vacco v. Diamandopoulos cont.

• President traveled in first class with wife, but
  employment contract only provided for
  reimbursement for domestic travel.
• Pres. reimbursed over 360,000 for travel and
  entertainment expenses for three years.
• Pres. furnished and renovated Manhattan apartment
  at University expense and sought reimbursement
  for 4000 per year in holiday gratuities to
  apartment staff.
• Court denied defs motion to dismiss, advance
  indemnification.

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Caravel Academy, Inc. v. Campbell

• Delaware school sued principal, wife for damages
  for breach of fiduciary duty
• Purchased car with corporate funds for personal
  use
• Purchased annuity with corporate funds for amount
  greater than authorized
• Entered into employment contract with his wife
  for salary greater than authorized
• Court found that defendants violated their
  fiduciary responsibilities

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Court ruling in Caravel Academy

• Defendants conduct must be measured against the
  requirements of fair dealing, honesty, loyalty
  and good faith imposed upon them by virtue of
  their position within the corporation.
• Officers of a corporation owe the duties of
  honesty, loyalty, good faith and fairness.

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NY AG Corporate Reform Proposals

• NY AG Eliot Spitzer proposed reforms in 2003 to
  provide similar protections against abuses by
  non-for-profit organizations that have custody of
  billions of dollars in charitable funds.
• Proposed legislation would apply the same
  Sarbanes -Oxley Act provisions to non-for-profit
  corporations to ensure that charities are held
  accountable for the millions of dollars that New
  Yorkers donate each year.

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Mass. AG legislation

• AG Tom Reilly introduced Act to promote the
  financial integrity of public charities
• To strengthen publics trust in integrity of
  public charities by requiring them to certify
  accuracy of financial reports
• Similar to Congress intent of SOA, to
  re-establish publics trust in public charities.
• To deter mismanagement and misconduct in
  financial oversight

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Mass AG legislation

• Certifications of financial reports by managers
• Audit committees, procedures for complaints and
  whistleblower protections
• Related party transactions and compensation
• New remedies for violations

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IRS - Form 990

• IRS has recommended changes to Form 990 due to
  need for veracity in public information used by
  contributions in making decisions regarding
  exempt organizations.
• IRS considering measures to increase public
  confidence in integrity of disclosures by exempt
  organizations.

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IRS Form 990 Possible Changes

• Disclosure of adoption of conflicts of interest
  policies or independent audit committees
• Disclose information about transactions with
  substantial contributors, officers, trustees and
  key employees

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IRS to propose non-profit best practices guide

• IRS will issue best practices for nonprofit
  organization governing boards in 2004 Work Plan.
• Bright light of corporate governance spotlight
  focusing more on large tax-exempt organizations
• Guidance will focus on educating boards on
  corporate compliance oversight obligations
  regarding audit, compensation review
• Board members need to have expertise to
  understand financial statements or find someone
  who does to advise them

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Document Destruction

• Sarbanes-Oxley includes new criminal provisions
  regarding obstruction of justice by document
  destruction.
• Applies to EVERYONE including schools.
• Effect is to increase scope of potential criminal
  liability for a variety of conduct.

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Document destruction (cont)

• Crime to knowingly destroy document with intent
  to obstruct or influence investigation or proper
  administration of any matter within jurisdiction
  of any department of agency of U.S. or in
  relation to or contemplation of any such matter
  or case.
• Any matter interpreted by courts to include
  almost every conceivable area of interest by
  feds. Same language as in Federal False
  Statements Statute, 18 U.S.C. 1001.

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Just suppose...

• School employee sends e-mail about school matter,
  stating If feds ever get wind of this,
  theyll be all over us like a ________. If
  subject matter of e-mail is properly within
  jurisdiction of federal agency, has school
  contemplated a matter under the Act?
• E-mail is destroyed pursuant to routine document
  retention policy or otherwise.
• Are school and employees exposed to criminal
  liability? We are virtually assured that this
  provision will be tested soon.

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Whistleblower Protection

• Sec. 1107 makes it a crime for anyone, with
  intent to retaliate, to take any action harmful
  to anyone for providing to law enforcement
  officer any truthful information relating to
  commission of any federal offense.

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Whistleblower Protection

• Maximum punishment is 10 years incarceration and
  fine.
• Applies to everyone!
• Law enforcement officer includes officer or
  employee of feds - includes IRS, EEOC, FTC, FBI,
  SEC, etc.

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St. Pauls School, Concord, NH

• WSJ article on compensation for Rector (524,000)
  and Vice Rector (316,000)
• NH AG investigated School announced voluntary
  reductions in compensation for 2 years, then tied
  future increases to increases to faculty as a
  whole
• School also established certain internal controls
  for Rectors Discretionary Fund

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Experts for AG and School opined on

• Committees
• Term limits of trustees and officers
• Investment management
• Role of Exec. Committee
• Board approval of committee appointments
• Composition of certain Board committees
• Audit oversight practices
• Conflict of interest policy
• Training and orientation of trustees

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Other recommendations

• SPS agreed to recommend that NAIS conduct seminar
  addressing importance of full disclosure on IRS
  Form 990 on industry-wide basis regarding
  reporting of non-salary compensation
• School to meet annually for next five years with
  AG to discuss compliance issues

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Points to consider eight recommendations

• Consider certain recommendations as a thoughtful
  transition to a scheme of standards currently
  unfolding

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1. Audit Committee

• establish Audit Committee, or subcommittee of
  Board finance committee, or introduce new
  discipline to existing Finance Committee.
• most members independent of school management
• one member should be financial expert
• appoint, recommend compensation for, hold
  auditors accountable
• set up internal procedures to receive, react to
  complaints regarding accounting, internal control
  or auditing matters

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2. Code of Ethics for financial matters

• Consider adopting code of ethics for Head, senior
  financial officer
• Unethical for any officer or director to
  fraudulently influence auditor in performance of
  audit for purpose of rendering financial
  statements misleading

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3. Establish Document Management Policy

• Establish document management policy to guide
  staff in handling and disposing of documents
  (including e-mail), focusing on document relating
  to matters within the jurisdiction of any
  agency of the federal government (e.g. tax
  matter of interest to IRS, employment matter of
  interest to EEOC, etc., or any grants or loans
  from federal agency.)

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4. Establish policy for whistleblower protection

• Adopt policy and procedure to prevent
  retaliation against employees who report problems
  or raise questions regarding school financial
  affairs.

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5. Review corporate bylaws

• Make sure that committees are functioning
  properly, that the board properly oversees head
  of school, that committees are constituted
  properly, update committee charges
• Revise Bylaws as necessary, every 3 years.

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6. Review duty of care

• Act with care an ordinary person would exercise
  under similar circumstances -Informed, good
  faith (not perfect) decisions
• -Regular attendance at board and committee
  meetings
• -Can rely on reports and consultants, if
  reliable
• -Delegation is permissible
• -Monitor investments

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and review duty of loyalty

• -Act with undivided allegiance to the schools
  purpose
• -Prohibit conflict of interest or self-dealing
  with school (typically arises when director has
  independent financial interest in proposed
  transaction)
• -Conflict of interest policy/disclosure of
  conflicts should be routine.

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7. Review other corporate compliance obligations

• Lobbying restrictions, political activity
• Unrelated business income tax (UBIT)
• Liability protection (insurance, indemnification)
• Fundraising issues (registration requirements,
  raffles and auctions, planned giving tools)
• Structure issues (use of subsidiaries, LLCs,
  title holding companies, supporting
  organizations)
• Filing and disclosure issues (Form 990, personal
  property tax returns, charitable substantiation
  rules)

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8. Review intermediate sanctions

• Intermediate sanctions designed to penalize
  people who receive unreasonable compensation or
  other disproportionate benefits from tax-exempt
  organization.
• Impose a 25 tax on the self-dealer or
  disqualified person (who exercised substantial
  influence) who receives an excess benefit from
  the school (200 if not corrected)
• 10 tax on the Board personally (up to 10,000)
• Comply with 3-step safe harbor of independent
  board relying on comparable data adequately
  documented.

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Thank God shes finished!