The Texas State Legislature is currently considering legislation that would impose new audit requirements on Texas non-profits. Texas Senate Bill 1215 would:
| Our Guide, Avoiding Trouble While Doing Good, A Guide for the Non-Profit Director and Officer, will prove very helpful to those grappling with the sorts of changes being proposed by the Texas Sentate. You should buy a copy of our Guide today. Call us at 773-325-2124 for additional information, or visit our website at http://www.charitygovernance.com. We also do on site training. In June, we will be speaking at two conferences on non-profit governance, including one where will be leading an all-day training session. You can bet we will be talking about these proposals as part of our presentations. |
A. Definition of Financial Statements. Change requirements for financial statements by eliminating the references to long obsolete fund accounting. Under the legislation, the board would be required to annually prepare and approve financial statements that include: (i) a statement of financial position; (ii) the related statement of activities by functional classification; (iii) a statement of cash flow; (iv) and a statement of expenses by functional classification. The bill sponsor has it wrong. As every certified public accountant will tell you, the financial statements are the responsibility of management. That means the officers and employees of the entity. The board might be able to approve the statements, but it clearly is not supposed to be preparing financial statements. We do like the notion inherent in this proposal of a thorough board review, but the language needs to be changed to properly reflect the relationship between management and the board. It should be noted that a latter portion of the bill contains similar language, but focuses on approving financial statements rather than preparing them. It also seems to change the "prepare and approve" language to "prepare or approve." Something needs fixing.
B. Audit and Reviews. Mandate an annual outside audit by an independent certified public accountant if a charitable corporation receives or accrues total gross revenue of $750,000 or more. A review would be required for a charitable corporation that receives or accrues total gross revenue of $500,000 or more but less than $750,000.
For purposes of these requirements, a corporation's total gross revenue would not include grants from and proceeds of contracts with a governmental agency or entity that requires an accounting for money received. Once again, the drafter got the actual language wrong. The bill provides the audit is to be conducted in accordance with generally accepted accounting principles (“GAAP”). While financial statements are prepared in accordance with GAAP, audits are conducted in accordance with Generally Accepted Auditing Standards.
C. Public Disclosure. Require public disclosure of the financial statements described in B above, as well as the related audit or review.
D. Review and Acceptance of the Audit. Require the board of directors to review and accept the audit or review described in B above. It bill might make more sense if it mandated an audit committee with an independence requirement.
E. Penalties. Fine a charitable corporation that fails to satisfy the audit/review requirements not less than $100, nor more than $1,000 for each day that the requirements go unsatisfied. We like the penalty, but there should be a reasonable cause exception. There are cases where audits are not completed on a timely basis because of extraordinary circumstances--although the bill does provide a nine-month period for completion of the audit.
California has already passed mandatory audit legislation and New York is currently considering such legislation. As regular readers of this blog know, we are generally opposed to many of the proposals put forth by the Staff of the Senate Finance Committee. At this point, we might agree with Federal legislation setting forth one audit standard and a set of thresholds that applies to all non-profits. As the law is developing at the state level, we are going to end up with a patchwork of audit requirements, creating additional expense and compliance burdens for national charities. When three of the nation’s largest states impose audit requirements, it is clear that a trend is developing. While one can philosophically disagree with audit requirements (we don’t happen to), if there is going to be a requirement, a uniform one that applies consistently to charities operating on the national scene makes the most sense.
THEY'RE COMING TO GET YOU TEXAS DIRECTORS. We talk a lot about the duties of care and loyalty. If passed, the Texas legislation would impose a new duty on the board. Texas board members who fail to comply with the proposed audit/review legislation may find that they lose the benefit of the shield from personal liability set out in Texas Statute Section 22.221, which provides:
GENERAL STANDARDS FOR DIRECTORS. (a) A
director shall discharge the director's duties, including duties as
a committee member, in good faith, with ordinary care, and in a
manner the director reasonably believes to be in the best interest
of the corporation.
(b) A director is not liable to the corporation, a member,
or another person for an action taken or not taken as a director if
the director acted in compliance with this section. A person
seeking to establish liability of a director must prove that the
director did not act:
(1) in good faith;
(2) with ordinary care; and
(3) in a manner the director reasonably believed to be
in the best interest of the corporation.One only need take a look at the case law coming out of the Delaware Chancery and Supreme Court over the last decade to realize that the direction the corporate law bell cows are headed is one that no longer permits directors to escape liability for breaches of duties resulting from inaction. With very specific duties imposed with respect to financial statements, any inaction will be much easier to demonstrate. According to the Delaware courts, inaction equates with a lack of good faith, which would remove the first pillar in the statutory shield. It is not all that hard once good faith is gone to argue that failure to review and approve financial statements demonstrates a lack of ordinary care and that nobody could reasonably believe that such failure is in the best interests of the charity.
Those who want to debate us on this point should first take a look at the Disney, Caremark, and Emerging Communications cases.
HE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NON-PROFIT OR OTHER PARTY IN QUESTION SHOULD SEEK THE ADVICE OF QUALIFIED LEGAL COUNSEL. If you liked this post, please visit http://www.charitygovernance.com for a description of our Guide/Tutorial for non-profit directors and officers entitled “Avoiding Trouble While Doing Good: A Guide for the Non-Profit Director and Officer.”
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