When New York Attorney General Eliot Spitzer sued former New York Stock Exchange Chairman Richard A. Grasso in late May, it seemed like just one more attempt to clean up self-dealing in Corporate America. But in fact, the NYSE is a nonprofit organization, and Spitzer is using an obscure state law that governs nonprofits -- not the 2002 Sarbanes-Oxley law passed to deal with public companies.
The NYSE is likely to have plenty of company among more traditional nonprofits such as universities and advocacy groups. After cracking down on Corporate America, lawmakers and enforcement officials are training their sights on the country's 1.8 million nonprofits (table). AGs from California to Massachusetts are pursuing nonprofits and their board members with allegations that sound every bit as unsavory as the charges leveled against Enron Corp. The Internal Revenue Service plans to examine executive compensation among nonprofits. And at least 13 states are mulling new laws that apply Sarbanes-Oxley-type regulations to them, while pols in Washington are contemplating legislation, too.
It's unlikely that a nonprofit scandal would reach the scale of the big corporate ones simply because there's usually less money at stake. But many of the problems are similar to those in corporate boardrooms, such as CEOs who pay themselves too much and directors -- often the CEOs themselves -- who cut sweetheart deals with the nonprofit they serve. Because nonprofits have no investors, they have operated with little scrutiny, leading many to adopt cozy board relations that offer potential for abuse, says Michael W. Peregrine, a law partner at McDermott, Will & Emery who works with nonprofits. Says Senate Finance Committee Chairman Charles E. Grassley (R-Iowa), who has been leading the charge in Congress: Nonprofit abuses "stem from a mind-set that doesn't put donors and the needy first, just as corporations didn't put employees and shareholders first."
Now such practices may start to change. The most sweeping reforms are likely to come from Washington. Grassley has probed questionable dealings at the Nature Conservancy, which buys land for nature preserves. A Washington Post investigation last year turned up a raft of insider real estate deals between the Conservancy and its board members. The Conservancy then solicited an external review of its policies. This year, Congress held hearings and the IRS launched an audit in January, which is still ongoing. Now the Conservancy has set up an audit committee with independent directors and banned land sales to related parties. The episode prompted "us to take seriously the notion of governance in a nonprofit organization -- I'd been a little superficial in my thinking," concedes Conservancy President Steven J. McCormick.
The experience has led Grassley to call for a cleanup of all nonprofits. He plans to introduce Sarbanes-Oxley-like legislation for the sector by yearend and has scheduled hearings for June 22. The bill would lay down rules for governance, transparency, and financial integrity and would broaden the reach of the IRS, which has oversight over nonprofits.
The IRS has already identified as many as 200 nonprofits that pay an exec or board member more than $1 million a year. The agency says it will investigate them over the summer and may follow up with audits. Meanwhile, Harvard University's management of its $19 billion endowment drew criticism when Harvard shelled out a total of $107.5 million to its top five money managers last year.
State AGs are on a campaign, too. Last fall, Boston University offered its presidency to former NASA chief Daniel S. Goldin, but BU's board of trustees dismissed him the day before he was to take over in November after objections from former President John Silber, who had handpicked most of the trustees over his 32 years at BU's helm. Silber's flip-flop embarrassed BU and stuck it with a $1.8 million severance package to which Goldin had been entitled. The Massachusetts AG's office decided not to investigate after BU moved on its own to clean up its board, but the AG is now focusing more on nonprofits, says Chief Public Protection Officer Alice Moore.
In Minnesota, AG Michael A. Hatch ordered an audit last year of Minneapolis-based HealthPartners Inc., a nonprofit healthcare company. It revealed inflated compensation packages, contracts between insiders, and excessive travel and entertainment costs. HealthPartners says it implemented all audit recommendations.
Meanwhile, independent groups are trying to head off lawmakers via self-regulation. The Maryland Association of Nonprofit Organizations is offering credentials to nonprofits that meet its financial-disclosure and governance standards. Five other state umbrella groups are launching similar efforts; 27 more are considering proposals. If their efforts gain credibility, that could help to satisfy lawmakers, says Grassley. But many regulators aren't waiting to see if it works.
By Jessi Hempel in New York and Amy Borrus in Washington