Fall 2004

Self-Auditing—A Futile Endeavor or a Credible Safeguard against Scandal for New York Nonprofits?


Written by: Sarah S. Miller

Date: November 30, 2004

After several financial improprieties were exposed at national and New York-based nonprofit organizations, New York Attorney General Elliot Spitzer encouraged legislation mandating that nonprofit organizations establish audit committees. It is the expectation that the audit committees would act as a self-monitoring mechanism and deter any potentially inappropriate financial transactions from taking place that could violate the integrity of the organizations.

Recent events such as the Statue of Liberty Foundation paying its executives excessive amounts of money while the Statue of Liberty remained unopened and the unethical financial transactions by the former leader of the United Way of the National Capital Area added to the public’s faltering confidence in nonprofit accounting procedures. The exorbitant compensation given to Richard Grasso, the former chief executive officer of the New York Stock Exchange, a registered nonprofit organization, was the latest transaction that spurred the New York state Attorney General to propose new mandates in auditing procedures for nonprofits. The proposed changes were brought to the chairs of the Corporations, Authorities, and Commissions Committee in both the New York State Senate and Assembly. The chair of the committee in the Senate, Vincent L. Leibell III, and the chair of the committee in the Assembly, Richard L. Brodsky, sponsored the attorney general’s proposed bill, SR 4836.

SR 4836 would require nonprofit corporations with at least $3 million in assets or those that receive more than $1 million in annual revenue to create an audit committee. The president or chief executive officer, and the treasurer or chief financial officer, would have to sign the annual report and verify the financial information presented. The legislation, as it stands, is for the most part positive, but its effectiveness and enforceability remain uncertain should the bill pass the New York Legislature and become law.

The proposed legislation places increased responsibility on nonprofit board members to be knowledgeable about the organization’s financial transactions and controls. In particular, the members chosen for the audit committee need to be aware of an organization’s staff compensation, paid professional services and other financial matters. Such requirements appear to be good, basic board practices that should already be in place.

But all too often, boards are unaware of their organization’s financial situation and transactions. Members may serve on a board because they feel the organization’s mission is worthwhile for the community, without paying attention to the board’s internal activities that could potentially take away from that mission. A mandate for the establishment of an audit committee emphasizes the vital role board members can play in ensuring the longevity and good reputation of an organization through sound financial practices. Fiscal accountability is vital to a strong organization if it is to operate effectively and efficiently to meet its target goals. Strengthening the internal controls of the organization would strengthen the organization as a whole and instill confidence in the organization’s charitable mission.

Other states have introduced legislation similar to SR4836, with varying requirements for nonprofit corporations. The proposed legislation in New York could benefit from incorporating some of those requirements, including rotating audit committee members every three to five years and barring chief executive officers and chief financial officers from serving on the committee. While chief executive officers and chief financial officers should approve audit committee reports, barring them from sitting on the committees would serve as a check and balance to prevent any inappropriate financial transactions from taking place at the executive level.

Some critics may argue that such legislation would place additional stress on nonprofit organizations that already have stretched resources and are held accountable to other standards. The establishment of audit committees, however, should not require any large additional outlay of resources. In addition, the proposed legislation in New York is directed at nonprofit corporations of a certain size—those with at least $3 million in assets or that receive more than $1 million in annual revenue. In nonprofit organizations of that size, any additional outlay of time, energy or funds would be minimal compared with the potential benefits of establishing an audit committee. An audit committee would safeguard an organization from inappropriate financial transactions that could potentially hurt the integrity of the organization’s mission and its fiscal health and sustainability.

If the proposed legislation is to be effective, it must also be enforceable. While the mandate alone should help to at least partially restore the public’s confidence in New York’s charitable sector, few nonprofit corporations may actually follow through with the new law if they believe it will not be enforced. It is highly possible that this will be the case, as the New York State Charities Bureau, like most state-level nonprofit regulatory agencies, is severely understaffed and lacking in resources comparable with the number of charitable corporations it is required to monitor. William Josephson, the assistant attorney general for oversight of charities in New York, operates on a shoestring budget and outdated resources.

If the attorney general’s proposals regarding the financial accountability of nonprofit corporations are to be taken seriously, additional resources will be needed to bolster the efficacy of the Charities Bureau and instill public confidence in its watchdog capabilities.

Of course, the attorney general’s recent actions to bring attention to nonprofit organizations’ financial accounting practices may quickly dissipate if the legislation is not passed. As it currently stands, the legislation is still in the Corporations, Authorities, and Commissions Committee of both the New York State Senate and Assembly. It is unlikely, however, that the bill will move forward this year.

If the bill is to gain any momentum, it would most likely be at next year’s general legislative session, where it would have to be reintroduced. Perhaps by that time, additional discussion among other charity watchdog groups and nonprofit corporations themselves can enhance the proposed legislation to ensure its efficacy in strengthening the integrity of nonprofit fiscal accountability and accounting practices in New York state.

Sarah S. Miller is an independent nonprofit consultant.