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Who should regulate nonprofits?

The following is excerpted from the March/April 2002 Advancing Philanthropy feature, Give and Take.

Nonprofit wrongdoing is a violation of the public trust and trust is the very foundation of the nonprofit-donor relationship. Some level of government regulation of the nonprofit sector is warranted; it benefits both the public and the sector. But should the states be primarily responsible for such regulation as they are now, or should the federal government assume chief responsibility? That is the issue. The views our contributors express do not necessarily represent those of this magazine's editors, or AFP, or the organizations with which the authors are affiliated.

The Federal Government Should Do Its Job

The present nonprofit regulatory system in the United States is neither effective nor efficient. Federal preemption of state law would certainly result in a system that improves the wretchedly weak protection vouchsafed the public by today's fragmented and ill-enforced regulations. And, not incidentally, federalization would reduce the costs of registration and compliance, freeing up millions for charitable purposes.

Today, nonprofit organizations spend tens of millions of dollars annually to comply with existing regulations. In exchange for this massive expenditure, we employ a nationwide network--although that word implies too much coordination--of file clerks who are required to pursue legitimate nonprofit organizations and professional solicitors/consultants when they merely fail to dot the 'i's and cross the 't's on registration documents and reports. Meanwhile, truly dishonest individuals and organizations go unchecked.

Nonprofit organizations must register in up to 39 states, but most states devote minimal resources to the regulation of nonprofits and their professional solicitors/consultants. Regulators are chronically understaffed and often spend more time making sure organizations file the paperwork correctly than enforcing the law against fraud and other misdeeds. Few states that require the registration of nonprofit organizations provide a dedicated staff of investigators and prosecutors.

Nor is there much coordination among states that require nonprofit registration. A national charity files essentially the same information (in a multitude of formats) to each of the states in which it solicits contributions. Assuming that documents are required in all states, 39 clerks will file the same information in 39 different and unrelated file cabinets and enter the same data into 39 separate computer systems. Even if states accept Internet filing of forms and reports, it will do little more than eliminate reams of paper. The system's problems will remain in an electronic format.

According to a recent Internet poll, only 38 percent of respondents believe that state regulations actually help prevent fraud (the Online Compendium of Federal and State Regulations for U.S. Nonprofit Organizations sponsored the unscientific poll). Is it any wonder?

This system of clerks does not come cheaply. 'For a small charity without major sources of income employing a small to medium-sized agency, the compliance costs may be as much as $25,000 per year,' according to Geoffrey W. Peters, PC (The Costs of Charitable Regulation, What Do Donors Pay?, 1998). 'For a large charity attempting to comply with regulatory requirements? the annual costs may easily surpass $150,000.' Even at its bureaucratic worst, the federal government could surely improve on that sorry situation.

The constitutionality of federalizing this area of the law is quite clear. The U.S. government has already established its jurisdiction over the sector by claiming the prerogative to grant the critical benefit of nonprofit status. The federal government already exercises jurisdiction over many nonprofits by virtue of its constitutional right to govern interstate commerce. Federal preemption of nonprofit regulation would simply be an extension of these established powers. To do the job right, the federal government will need to expand the IRS or the FTC so additional investigators, auditors, and prosecutors can be deployed.

The Canadian model, in contrast to the U.S. environment, focuses less on paperwork and more on auditing and prosecution of fraud and other misdeeds, according to Arthur Drache, an attorney specializing in charity and nonprofit law with the Canadian firm of Drache, Burke-Robertson and Buchmayer. In Canada, responsibility for overseeing charities is split between the provincial and federal governments. Revenue Canada gets the lion's share of authority by virtue of its power to certify organizations as charitable (as the IRS does in the United States).

Charities are required to file Public Information Returns with the federal government and to comply with certain federal rules to keep their certification active. One rule is that a charity must spend a percentage, determined by formula, of receipted gifts on the charity's purpose. This rule helps ensure that charities operate efficiently and do not fraudulently solicit funds. In Canada, the same fraud and theft laws that apply to any business are enforced on the charitable sector.

The Canadian system seems to work. While Canadian charities spend only a small fraction of what their U.S. counterparts do on compliance, polls show that citizen confidence in Canadian charities remains high, according to Drache. One reason for high confidence in the sector is that there have been few charity scandals in Canada. In the United States--despite all the paperwork, registrations, financial filings, and reporting--eliminating scandals remains a distant goal. Worse, when a scandal does erupt, there is virtually no way to protect citizens nationwide. If a fraudulent operator is prohibited from soliciting in one state as a result of misdeeds, it is still free to prey on the public elsewhere, until each additional state takes action.

The nonprofit sector should support a move to get rid of those file clerks in favor of a nationally empowered team of auditors, investigators, and prosecutors who truly protect the public interest. Federalization of charitable regulation will increase registration efficiency, reduce costs to the nonprofit sector, free millions of dollars for charitable purposes, and put fraudulent charities out of business nationwide.

Michael J. Rosen, CFRE, an independent direct-response consultant, is a board member of the AFP Foundation for Philanthropy, a member of the AFP Government Relations Committee, vice president of association and government relations of the AFP-Greater Philadelphia Chapter, and a board member of the Pennsbury Scholarship Foundation.

State and Federal Governments Should Both Do Their Jobs

Americans gave $203.45 billion to charities in 2000. Between 1975 and 1995, the number of tax-exempt organizations more than doubled to 1.2 million, their assets increased by 312 percent to $1.9 trillion, and their revenue increased by 380 percent to $899 billion. The nonprofit sector significantly outpaced the growth in U.S. GDP of 74 percent during the same period.

So that donors will continue to support the nonprofit sector's important work, it is critical that the sector as a whole consist of legitimate, fiscally prudent, and accountable organizations. And although most charities are worthy, legitimate organizations, many exist on paper only; accomplish little of actual value besides making their principals, fundraisers, and advisors lots of money; or use fraudulent and deceptive solicitation practices.

Yet, in most of the 39 states that regulate charities, and certainly at the federal level, the resources de-voted to oversight of the charitable sector have historically been minimal. Those who look to the federal government to effectively and exclusively oversee the exploding tax-exempt sector should read the August 23, 2001, Chronicle of Philanthropy article that concludes, 'The Internal Revenue Service is falling far short in its role as federal overseer of the nation's nonprofit organizations?. Lack of money, employees, and experience?have hindered the IRS's efforts to crack down on charities that run afoul of the law.'

The article points out that, while the number of charities increased to almost 820,000 over the past decade, the number of IRS employees who oversee them hardly increased. In 1990, a mere 501 IRS employees were responsible for monitoring 489,862 organizations. By 2000, there were only 23 more employees to monitor 819,008 organizations. Do the math: In 1990, one employee to oversee every 978 organizations; 10 years later, one employee to oversee every 1,563 organizations. It should come as no surprise that the IRS audited only 2 percent of all tax-exempt returns filed in 1995 and a mere 1.3 percent of those filed in 1999.

Another reason for the decreased audit rate is that the number of organizations applying for tax-exempt status each year more than doubled from approximately 40,000 in 1990 to almost 82,000 in 2001. In fact, so many organizations apply for tax-exempt status each year that the IRS now reluctantly assigns much of the application overflow to its auditors. Obviously, to the extent that auditors are processing applications for tax-exempt status, they can't be conducting audits.

So, in spite of the tax-exempt sector's unprecedented and explosive growth over the past several decades, the federal agency charged with oversight of this sector has not experienced proportionate increases in its resources. Those advocating federal preemption must acknowledge this reality and outline how they would generate the significantly increased resources needed for meaningful and exclusive federal oversight of the nonprofit sector. Given the understandable shift in federal budget priorities after September 11, it is unlikely that the political will exists to allocate any additional resources for this purpose.

Fortunately, 39 states also oversee the charitable sector to varying degrees. And while it is true that some state offices serve primarily as registration offices, many states, such as Pennsylvania, have investigators, auditors, and prosecutors who regularly pursue charitable solicitation fraud and other improprieties. Regardless of the amount of oversight provided, state registration requirements consume significant amounts of an organization's time and money.

Pennsylvania and other states are working with the National Center for Charitable Statistics on a project that will eventually allow charities to have one in-house person register their organizations in most states in just a few hours. Rapidly advancing technology and the Internet will make this possible. For example, charities can already complete their Pennsylvania registration electronically and will soon be able to do the same with 11 other states. (Note: the Pennsylvania Bureau of Charitable Organizations website is at When all states that require registration are participating in this project, no organization will have to file paperwork with any state office.

This is a far more promising solution to the current problem than federal preemption. Electronic registration will drastically reduce the costs and burdens of the current system for both charities and government. Simultaneously, this technological advance will free resources currently devoted to processing duplicative paperwork to do what donors and legitimate charities want government to do: aggressively pursue those who choose to make their living defrauding innocent donors and siphoning millions of dollars from legitimate charities.

Karl Emerson, director of the Pennsylvania Bureau of Charitable Organizations since September 1995, was recently appointed to the IRS' newly created Tax Exempt Advisory Committee and has also served as president of the National Association of State Charity Officials (NASCO) and a member of the NASCO board of directors.

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