DATELINE: July 15, 2011, Chicago
The New Jersey Division of Consumer Affairs Charitable Registration Unit has offered a proposal that demonstrates the problem with the law: Too many proposed laws and regulations address problems that either don't exist or don't need to be solved through another rule.
Under the New Jersey proposal, a charity that solicits funds for two or more programs would be required to tell donors that they have the option to designate how the funds are allocated among the programs. As currently written and as described in explanatory comments, the proposed regulation would prevent the charity from using any portion of an earmarked contribution for...
The Desktop Guide is Quickly Becoming the Must Have Guide for Nonprofit Executives
Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good, has quickly become the go-to guide for nonprofit executives and advisors. So what are people saying about the Guide? In the October 2007 edition of the The Federal Lawyer, New York lawyer George W. Gowen and nonprofit authority, wrote:
Some of our readers have followed the link to the Amazon.com Web site, but apparently have not bought the Guide. If they were turned off by the price, they should reconsider. One prominent attorney in the exempt organization field grabbed a review copy of the Guide and couldn't put it down. She has instructed a number of her clients to buy it, pointing out to them that for less than 1/2 hour of her billable time, they receive a lesson (and resource) that tells it like she would like it told. If you are starting a new charity, the Guide could save you thousands of dollars in legal fees by teaching you how to better utilize your legal counsel and framing the issues so you don't spin your wheels at $400 an hour.
administration or fundraising expenses. We arrive at that interpretation because there is a second provision providing that the notice provided to donors must also state that if a contribution is not earmarked for one or more programs, then the money can be used for any program " in furtherance of the organization's mission and for administrative and fundraising expenses." By negative implication, that means earmarked money cannot be used for administrative and fundraising expenses. The explanatory comment accompanying the proposal supports that interpretation, asking whether the final rule should permit a recovery of some overhead from a contribution otherwise earmarked for a particular program.
There are at least three major fallacies underlying this proposal. The first fallacy: Donors don't already have the right to earmark their funds. In fact, donors always have the right to designate that their donations be used for a particular purpose. So why do we need a rule that will require a charity to develop or expand systems to track the inevitable designations that will be made once earmarking becomes the default rule, particularly when this rule is aimed at what we refer to as retail contributions? This is just another example of government adding a cost to doing business without any meaningful benefit derived from that cost.
The second fallacy: Charities belong to the public and therefore New Jersey has an interest in dictating how they operate. In fact, charities are private entities, no different than IBM, Exxon, or General Electric. They should be free to enter into any type of voluntary contractual arrangement that they like without the state interfering. As noted, the parties to a charitable contribution already have the right to negotiate how the funds will be used. This proposal interferes with the charity's right to make an offer: "Give us money and we will use it for our mission." Now the charity must add additional terms to its offer. Instead of placing the burden on charities, why doesn't the proposal require donors to think before they give?
The third fallacy: The third fallacy is the most important one: Program service expenses are good, but administration and fundraising expenses are bad. Any thinking person cannot and should not distinguish between program and other expenses. It is impossible to draw that distinction and it is meaningless. You need accountants, HR people, and marketers to deliver human, health, educational or cultural services just as much as you need doctors, counselors, teachers, and curators. No regulator would be pleased if a food bank simply left a bag of money on its doorstep and said take what you need to buy food. Without security measures, the money would most likely be stolen. Without qualification measures, some people who can afford food would take the money believing they were the intended beneficiaries. Without people to disburse the money, some people in need of food would take more money than they should, leaving other people in need hungry. There is a place for administration.
As for fundraising expenses, why should the charity or other donors bear the burden? Any donor can eliminate all mailing costs and telemarketer fees with minimal effort. Send a check to the charity. Fundraising costs are necessary because the public is passive (lazy). We regularly send our contributions directly to the charities we have chosen to support, knowing that this reduces their fundraising costs and maximizes the amount of our dollars that does go to mission. Why should our contributions bear a disproportionate share of fundraising expenses when we were the ones who acted in a manner to minimize those costs? The New Jersey proposal creates a free-rider problem.
Returning to administrative expenses. We find the proposal to be hypocritical. State charity regulators are screaming that many charities are poorly governed and rightfully so. So what do they do? For the last decade, they, together with the IRS and many others, have been prodding charities to improve their governance. Sarbanes-Oxley and all that. Well, improving governance costs money. Audits, board training, more board meetings, compensation studies, the infrastructure to support whistleblowers, better accounting systems, and governance consultants all cost money--administration expense. But when it comes to funding those expenses, the State of New Jersey suddenly proposes a regulation that suggests that governance has no value. Governance is financed by administrative expenses, but without it, money designated for program services may be lost or stolen, or used in a less than efficient manner. This is another example of why separating mission from administration is both dumb and impossible.
In terms of standard or accepted practices, the New Jersey proposal runs counter to standard grantmaking practices. Universities regularly require faculty members who receive grants to contribute a percentage of each grant to general operations, recognizing that a research lab cannot exist without campus security, student admissions, and heat and light. The same holds true for charitable organizations receiving federal funding. The OMB circulars contain elaborate procedures to address the appropriate amount of organizational overhead that can be funded through government grants for specific programs.
No charity would be financially viable if all its funders required that their funds could not be used to cover overhead--or at least the charity would have to develop ridiculously complex cost allocation rules to convert every dollar of overhead into a program expense through cost allocations. Yet, that appears to be the direction in which New Jersey wants to take charities.
To bring home the point of just how wrong New Jersey gets it, we believe there is a strong case that any board that permits a donor to earmark funds for "pure" program expenses has breached its fiduciary duty. Doing so weakens the charity's financial capacity by failing to cover what are very real costs. Yet that is what New Jersey is mandating.
The New Jersey proposal also undercuts the function of a charity's board of directors. We look to boards to allocate resources because the board has information that the public doesn't have and it has the bigger picture in mind. To illustrate: Let's assume a charity has three distinct programs. The board has allocated 75% of resources to Program A, 20% to Program B, and 5% to Program C. Its fundraising materials refer to all three programs. Now we put the New Jersey proposal into effect. Now assume there is a tragedy that occurs and it receives massive amounts of media attention. Program C has the most relevance to assuring that similar tragedies don't occur. No one should be surprised that if offered the choice, the public, receiving the solicitations immediately following the tragedy, will designate that all their contributions go to Program C. Does the charity then close down the two larger programs, recognizing that a year from now, when the story is no longer front and center, people will probably not designate money for Program C?
We are not suggesting that charities should deceive the public. If they specifically solicit for Program C or people designate Program C, the charity should honor that designation. But why is New Jersey showing a preference for restricted rather than unrestricted money? Goodness knows, we have plenty of evidence that would more than justify outlawing restricted donations. You only need to look at the recent controversies involving Fisk University, the Hershey Trust, Princeton University, Brandeis University, and the Barnes Foundation to see the problems that donor-imposed restrictions can create. New Jersey is proposing to expand those problems by making restricted giving a way of life for retail donors.
Moreover, a good case can be made that unrestricted money should be preferred to restricted money. Unrestricted money permits the board to be more responsive as facts, circumstances, and need change. Organizations that are tasked to solve problems need the flexibility to refocus programs as better approaches to accomplishing mission become apparent.
We like charity regulators, but this proposal if adopted, will be another example of regulatory laziness. If a board raises money for the arts and then funds health care, the New Jersey regulators should bring an enforcement action. If a donor gives money for X and the charity accepts it with that restriction and then does Y, the New Jersey regulators should bring an enforcement action. But the New Jersey regulators should not develop rules that favor restricted money over unrestricted money. This is another case where consumers have the power to protect themselves. By unnecessarily showing a preference for restricted giving, the New Jersey regulators are creating problems for charities and substituting imagined donor-intent for the board's considered judgment. Consumers have duties, too. By bending over backwards to protect consumers, the New Jersey regulators encourage consumers to be lazy to the detriment of charities and missions they serve.
Having put a bad proposal out, the New Jersey regulators should follow the example offered by the IRS. In the original draft of the recently revised Form 990, the IRS proposed highlighting fundraising ratios on the first page of the return, thereby trying to draw a meaningless distinction between program service and other expenses. Following overwhelming opposition, the IRS dropped what it quickly realized was a bad idea.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
THE FOREGOING IS NOT AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. IF LEGAL ADVICE IS REQUIRED, THE NONPROFIT 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 training and consulting services. You will also want to acquire a copy of Jack Siegel's book, A Desktop Guide for Nonprofit Directors, Officers, and Advisors: Avoiding Trouble While Doing Good."
Copyright 2011, Charity Governance Consulting LLC. All Rights Reserved. You may not copy any portion of this post to a computer "clipboard" for re-posting anywhere or e-mailing, or otherwise reproduce this post. If you want others to review this post, you may provide them with a link to this web blog. Any use of the material or ideas in this post by reporters or other publishers shall make reference to Jack Siegel, author of "A Guide for Non-Profit Directors, Officers and Advisors: Avoiding Trouble While Doing Good" and this web blog. For additional information call 773-325-2124