Latham & Watkins Tax Department

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1 Number 410 October 4, 2004 Client Alert Latham & Watkins Tax Department... the Act imposes additional requirements on California charitable organizations by incorporating many of the so-called corporate accountability aspects of the recently enacted federal Sarbanes- Oxley legislation and by creating new registration, reporting and disclosure requirements for charitable organizations and commercial fundraisers and counselors. California Legislation Affecting Nonprofits The Nonprofit Integrity Act of 2004 On September 30, Governor Arnold Schwarzenegger signed California Senate Bill 1262 (S.B. 1262), pertaining to charitable organizations and fundraising, into law. The Nonprofit Integrity Act of 2004 (as amended on August 23, the Act ) will go into effect on January 1, Approved by both bodies of the California Legislature with solid majorities, the Act imposes additional requirements on California charitable organizations by incorporating many of the so-called corporate accountability aspects of the recently enacted federal Sarbanes- Oxley legislation and by creating new registration, reporting and disclosure requirements for charitable organizations and commercial fundraisers and counselors. State Senator Sher introduced S.B on February 13, and California Attorney General Bill Lockyer sponsored it. Over the last few months, several amendments were made to S.B to minimize its impact on legitimate organizations, and the scope of the bill was drastically narrowed in Assembly on August 23. The final version of the Act creates regulations that allow the California Attorney General to pursue fraudulent organizations while affecting legitimate charities as little as possible. In signing the bill, Governor Schwarzenegger encouraged the Legislature to ensure that the nonprofit community is not subjected to needless bureaucracy and to revisit this issue if the bill results in unnecessary expense to the nonprofit community. The Act does not apply to (1) government entities, (2) religious corporations or organizations that hold property for religious purposes, or to any officer, director or trustee thereof who holds property for like purposes, (3) cemetery corporations separately regulated under the California Business and Professions Code, (4) political action committees separately required to file and actually filing statements under the California Government Code, and (5) charitable corporations or unincorporated associations organized and operated primarily as religious organizations, educational institutions, hospitals or licensed health care service plans. Otherwise, the Act is generally applicable to all charitable corporations, unincorporated associations, trustees, and other legal entities holding property for charitable purposes, commercial fundraisers for charitable purposes, fundraising counsel for charitable purposes and commercial coventurers, over which the state of California or the California Attorney General has enforcement or supervisory powers. Corporate Accountability As an initial matter, the Act requires charitable organizations that receive or accrue gross revenue of $2,000,000 or more 1 annually to: Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership. Copyright 2004 Latham & Watkins. All Rights Reserved.

2 Prepare annual financial statements in accordance with generally accepted accounting principals (or GAAP) that are audited by an independent certified public accountant pursuant to standards for auditor independence; and If organized as a corporation, have an audit committee appointed by the board of directors. The resulting audited financial statements are required to be made available for inspection by the California Attorney General and to members of the public in the same manner that is currently prescribed for IRS Form 990 upon request and no later than nine months after the close of the fiscal year. For any nonaudit services performed by the firm conducting the audit, the firm and its individual auditors are required to adhere to the standards for auditor independence set forth in the Government Auditing Standards (2003 Revision), issued by the Comptroller General of the United States (the 2003 Yellow Book ). Under the Act, the California Attorney General may, by regulation, prescribe standards for auditor independence in the performance of nonaudit services, including standards different from those set forth in the 2003 Yellow Book. Under the Act, audit committee members may include individuals who are not members of the board of directors but may not include any members of the staff, including the president or CEO and the treasurer or CFO. Audit committee members are not permitted to receive any compensation (other than as board members) from the corporation or have any material financial interest in any entity doing business with the corporation. If the corporation has a finance committee, a certain degree of separation between it and the audit committee is required. Finance committee members may serve on the audit committee; however, the chairperson of the audit committee may not be a finance committee member, and finance committee members may only constitute a minority of the membership of the audit committee. The audit committee is responsible, subject to the supervision of the board, for retaining, terminating and settling the compensation of the firm acting as auditor. The audit committee is also required to confer with the auditor to satisfy its members that the financial affairs of the corporation are in good order and to review and determine whether to accept the audits. The audit committee is further required to assure that any nonaudit services performed by the auditing firm conform with the standards for auditor independence referred to above and to approve the performance of nonaudit services by the auditing firm. Further, the Act provides that all charitable organizations and commercial fundraisers required to register with the California Attorney General maintain records of their activities, including electronic records, for a ten year period. Those records are required to be available for inspection upon demand by the California Attorney General. Finally, the Act requires that the board of directors of each charitable corporation or unincorporated association and the trustee(s) of a charitable trust review and approve the compensation and benefits offered to its president or CEO and its treasurer or CFO to assure that it is just and reasonable. Such review and approval is required with each new employment contract and with any renewal or extension of an existing employment contract unless modification of compensation extends to substantially all employees. Additional Registration, Reporting and Disclosure Requirements Under the Act, the California Attorney General is required to establish and maintain a register of charitable corporations and trustees subject to the 2 Number 410 October 4, 2004

3 Act. Charitable organizations, including unincorporated associations and other legal entities holding property for charitable purposes subject to the Act, are required to file a copy of their charters or articles of incorporation with the California Attorney General within 30 days of initially receiving property to be held for charitable purposes, except as to future interests in a charitable trust. The Act requires that every charitable organization exercise control over all fundraising activities conducted for the organization s benefit and insure that such activities are conducted without coercion. In addition, the Act requires commercial fundraisers to include specified written disclosures in conspicuous type in soliciting for advertising to appear in a for-profit publication that relates to a charitable purpose. In particular, all such solicitations must include the following disclosures: the publication is a for-profit, commercial enterprise; the true name of the solicitor and the fact that the solicitor is a professional solicitor; and the publication is not affiliated with or sponsored by any charitable organization. Under the Act, charitable organizations and fundraisers can accept and employ contributions only for a charitable purpose expressed in the solicitation and conforming to the charitable purpose expressed in the charitable organization s charter or articles of incorporation. Commercial fundraisers are required to deposit all funds raised into a federally insured bank, savings, or other account solely in the name of the charitable organization on whose behalf such funds were solicited within five working days of receipt (or deliver such funds in person, by Express Mail, or by another overnight delivery method to the charitable organization). The Act specifically prohibits fundraisers acting on behalf of law enforcement personnel, firefighters or similar persons who protect the public safety from issuing or offering membership cards, stickers or other such items that could be used for display on a motor vehicle and that suggest affiliation with or endorsement by any such public safety personnel or a group thereof. Finally, in connection with any charitable solicitation or charitable promotion, the Act bans any unfair, deceptive or fraudulent behavior on the part of charitable organizations and fundraisers and prohibits a variety of specifically listed practices. Commercial Fundraiser Regulations Under the Act, it is unlawful for any commercial fundraiser to solicit funds unless it has complied with registration as well as annual renewal and financial reporting requirements. The Act requires commercial fundraisers to file annual registration forms with the California Attorney General by January 15 of each calendar year and to pay a registration/renewal fee of $200. They must also file annual financial reports, accounting for all funds collected during the prior calendar year, with the California Attorney General no later than 30 days after the close of the calendar year. Commercial fundraisers are required to maintain specified financial reports and records for a minimum of ten years following the completion of each solicitation campaign and are required to make those records available to the California Attorney General upon demand. Contracts entered into with any unregistered commercial fundraiser are voidable by the charitable organization under the Act. Not less than 10 working days prior to the commencement of each solicitation campaign, or not later than commencement of solicitation for solicitation campaigns to aid victims of emergency hardship or disasters, commercial fundraisers must file a notice on a form prescribed by the Attorney General setting forth, among other information, the person 3 Number 410 October 4, 2004

4 responsible for directing and supervising the work of the commercial fundraiser and the fundraising methods to be used. In addition, for each solicitation campaign, a commercial fundraiser must have entered into a written contract with the charitable organization. All such contracts are required to include (among other things) the following provisions: Certain basic information, including the legal name and address of the charity, the effective and termination dates of the contract, and the date solicitation activity is to commence in California; Statements (a) regarding the charitable purpose for which the solicitation campaign is being conducted, (b) setting forth the respective obligations of the parties to the agreement, and (c) indicating that the charitable organization exercises control and approval over the content and frequency of any solicitation; Specified information regarding the fee to be received by the fundraiser, including (a) if the fundraiser is to be paid a fixed fee, a statement of the fee, a good faith estimate of the percentage such fee will constitute of the total contributions received and the assumptions upon which that estimate is based or (b) if the fundraiser is to be paid a percentage fee, a statement of the percentage of total contributions (or purchase price) that will be retained by the charity, calculated in accordance with the rules set forth in the statute; A requirement that all funds received by the fundraiser shall, within five days of receipt, be deposited in a federally insured bank account solely in the name of and controlled by the charitable organization, or be delivered to the charitable organization directly; A provision setting forth the maximum dollar amount of payments in cash or in kind that are made to secure any person s attendance at, or endorsement of, a charity fundraising event; and Certain rights afforded the charitable organization to cancel the contract. Under the Act, any such cancellation must be filed with the Registry of Charitable Trusts. The Act requires a commercial fundraiser to disclose the percentage of total fundraising expenses (or the ratio of its total expenses to the total revenue received) upon receiving a written or oral request from a person solicited for a charitable contribution. The Act also prohibits certain conduct in connection with solicitations and charitable promotions, such as using unfair or deceptive practices; misrepresenting that a particular person endorses the charity without the person s written consent; misrepresenting the amount of money the charity will receive; and representing that tickets will be donated for use unless certain conditions are satisfied. The Act prevents any person from acting as a commercial fundraiser if they, or any person employed by them are found by the charitable organization to have been convicted of a crime punishable as a misdemeanor or felony arising from the conduct of a charitable solicitation. The Act also prohibits commercial fundraisers from soliciting in California on behalf of a charitable organization unless the organization is registered or exempt from registration with the California Attorney General. The Act imposes restrictions similar to those outlined above on persons acting as fundraising counsel, defined generally as a person who assists a charitable organization in its fundraising activities for compensation, but subject to a number of important exclusions, including certain professional service providers (i.e., attorneys, investment counselors, and bankers engaged and acting in such capacities), charitable corporations and their employees, and certain trustees, independent contractors and minimally compensated persons. 4 Number 410 October 4, 2004

5 Conclusion The proposed Nonprofit Integrity Act of 2004, as amended, imposes new administrative and legal burdens on charitable organizations. Many charitable organizations will be subject to new corporate accountability provisions similar to those imposed on public companies under the federal Sarbanes-Oxley legislation. The Act also imposes significant registration, reporting and disclosure requirements on charitable organizations and regulates their relationships with commercial fundraisers and counsel. At present, it is not possible to predict whether California s lead in this area will be followed in other jurisdictions. Given recently expressed concerns regarding perceived abuses in the taxexempt sector, it would not, however, be surprising if this or other similar legislation were eventually to be enacted into law elsewhere. Affected charitable organizations are advised to consult their tax advisors with respect to the implications and applicability of this legislation to their specific situation and activities. Endnotes 1 This amount excludes grants from, and contracts for services with, governmental entities requiring an accounting of funds received. 5 Number 410 October 4, 2004

6 Office locations: Boston Brussels Chicago Frankfurt Hamburg Hong Kong London Los Angeles Milan Moscow New Jersey New York Northern Virginia Orange County Paris San Diego San Francisco Silicon Valley Singapore Tokyo Washington, D.C. Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the attorneys listed below or the attorney whom you normally consult. A complete list of our Client Alerts can be found on our Web site at If you have any questions about this Client Alert, please contact Stephen M. Burgin or Khrista M. McCarden in our Los Angeles office or any of the following attorneys. Boston David A. Gordon Brussels John P. Lynch +32 (0) Chicago Robert G. Goldman Frankfurt Joerg P. Soehring Hamburg Goetz Wiese Hong Kong Mitchell D. Stocks London Oonagh Whitty Los Angeles Stephen M. Burgin Khrista M. McCarden Milan Michael S. Immordino Moscow Anya Goldin New Jersey David J. McLean New York Jed W. Brickner David S. Raab Orange County David W. Barby Paris Christian Nouel +33 (0) San Diego David C. Boatwright San Francisco Gregory P. Lindstrom Silicon Valley Joseph M. Yaffe Singapore Mark A. Nelson Tokyo David L. Shapiro Washington, D.C. McGee Grigsby Number 410 October 4, 2004