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Let's begin with a few scenarios. A nonprofit is a large national organization that solicits contributions across the country, including from residents of California. Perhaps only a small percentage of these contributions comes from California residents. Another nonprofit is headquartered in California but does not solicit contributions in the state. Yet another nonprofit is not headquartered in California but has an office located there. What do the nonprofits in these scenarios have in common? They all may well be subject to a new California law that imposes sweeping new requirements to improve financial accountability and corporate governance for charities and those that solicit contributions on their behalf.1

The California Nonprofit Integrity Act of 2004 (the "Act") will take effect on January 1, 2005, and applies to charitable corporations, unincorporated associations, trustees, commercial fundraisers, and fundraising counsel.2 It imposes significant new and burdensome requirements on all such entities subject to the Act. The new law amends the existing Supervision of Trustees and Fundraisers for Charitable Purposes Act, which requires charitable corporations, trustees, unincorporated associations, commercial fundraisers, commercial co-venturers, and fundraising counsel for charitable purposes to register with the Attorney General and file financial disclosure reports.3

I. What Entities Are Subject to the Act?

Many nonprofits will be surprised to learn that they may well be subject to both Acts' requirements because of the expansive manner in which those regulated by the Acts are defined. For example, both Acts apply to charitable corporations, defined as (1) those entities organized for "charitable purposes" under California law, and (2) similar foreign corporations doing business or holding property within the State.4 The Act applies to charitable corporations organized for charitable purposes under California law - even if the nonprofit does no business in the state itself. Furthermore, it is unclear what constitutes "doing business" in California under the Acts, but it could be read to reach not only charitable soliciting, but any business that the charity may conduct in the state. The California Attorney General's Office has provided the following examples:
  • Soliciting donations in California by mail, by advertisements in publications, or by any other means from outside of California;
  • Holding meetings of the board of directors or corporate members in the state;
  • Maintaining an office in the state;
  • Having officers or employees who perform work in the state;
  • Conducting charitable programs in the state; or
  • Maintaining financial accounts or investments at an office of a financial institution located in the state.5

"Doing business" may even include those charitable solicitations conducted over the Internet in which California residents are able to make charitable donations. However, this depends on a number of factors that include whether the charitable corporation is specifically targeting California residents or whether it is receiving contributions or donations from California residents on a repeated basis.6 Notably, a charitable corporation is not "doing business" in California if its sole contact with the state is making purely discretionary grants to persons or entities located in California.7

Notably, neither Act defines "charitable purpose"; but California common law defines the term broadly to include poverty relief, advancement of education or religion, promotion of health, governmental or municipal purposes, or other purposes that are beneficial to the community.8 Another indicator of whether a nonprofit is organized for a charitable purpose is whether it has received tax exemption recognition under Sections 501(c)(3) or 501(c)(4) of the Internal Revenue Code (the "Code").9

The Act also applies to trustees that, for example, hold property in trust pursuant to any charitable trust; accept property to be used for a charitable purpose; or administer a charitable trust.10 The Act retains exemptions under the Supervision of Trustees and Fundraisers for Charitable Purposes Act for certain types of trustees, such as religious corporations.11

Finally, the Act applies to commercial fundraisers and fundraising counsel. Commercial fundraisers are those entities that solicit, or receive or control, funds for charitable purposes.12 Fundraising counsel includes those entities that prepare material for the solicitation of funds or property for charitable purposes.13 Certain groups are excluded from this definition, such as attorneys and investment counselors.14

II. New Requirements under the Act

A. Charitable Corporations, Trustees and Unincorporated Associations

The Act imposes a number of new, and for many nonprofits, onerous financial accountability and governance requirements for those covered by the Act. These requirements appear to apply regardless of the amount of solicitation or business that the nonprofit conducts in California. For example, even if only a small percentage of the donations that the nonprofit receives comes from California residents, the Act's requirements may still apply.

Charitable corporations, trustees and unincorporated associations (collectively, "charitable organizations") subject to the Act must have their board of directors or an authorized committee of the board of directors review and approve the compensation, including benefits, of the president or chief executive officer, and the treasurer or chief financial officer, to ensure that it is "just and reasonable."15 This review must occur upon the hiring of the officer, whenever the term of employment is renewed or extended, and whenever the officer's compensation is modified. However, separate review is not required if a modification in compensation will be extended to "substantially all employees." Thus, if your nonprofit is providing a cost-of-living increase to all employees, the board will not need to undertake a review for the president or treasurer.

If a charitable organization is affiliated with other charitable organizations, the review requirements will be satisfied if review and approval is obtained from the board or an authorized committee of the board of the charitable corporation that makes retention and compensation decisions about a particular individual.

In addition, if financial statements are prepared by a certified public accountant, those statements must be made available to the Attorney General and/or the public.16 This requirement is in addition to the audited statements required under the Act, discussed below.

There are additional requirements imposed on those charitable organizations that receive or accrue in any fiscal year gross revenues of $2 million. Gross revenue would be the same as total revenue on Line 12 of the Internal Revenue Service ("IRS") Form 990 for public charities, and Line 12, Column (a) of the Form 990-PF for private foundations.17 Gross revenue does not include grants from, and contracts for services with, governmental entities for which the governmental entity requires an accounting of the funds. Charitable organizations also must prepare audited financial statements and establish an audit committee.

1. Audited Annual Financial Statements

The charitable organization must prepare an annual financial statement using generally accepted accounting principles ("GAAP") that are audited by an independent certified public accountant in conformity with generally accepted auditing standards.18 Non-audit services performed by the firm must adhere to the standards of auditor independence set forth in the latest revision of the Government Auditing Standards. If the organization is under the control of another organization ("controlling organization"), the controlling organization may prepare a consolidated financial statement. The audited financial statements must be available for inspection by the Attorney General and/or the public no later than nine months after the close of the fiscal year to which the statements relate. This financial statement must be made available to the public in the same manner as prescribed for the IRS Form 990 in Code Section 6401(d).

2. Audit Committee

Notably, the audit committee provisions are similar to those enacted in the federal Sarbanes-Oxley Act (applicable to large, publicly-traded corporations, with the exception of several provisions). Corporations must have an audit committee appointed by the board of directors.19 The committee may include directors, but cannot include staff members, particularly the president or chief executive officer and treasurer or chief financial officer. If the corporation has a finance committee, it must be separate from the audit committee. Members of the finance committee may serve on the audit committee; however, the chairperson of the audit committee may not be a member of the finance committee and finance committee members may only constitute less than one-half of the members of the audit committee. Audit committee members may not receive any compensation beyond what they receive as board members, if applicable.

The audit committee is responsible for recommending to the board the retention and termination of the independent auditor and may negotiate the auditor's compensation on behalf of the board. The committee also must "confer with the auditor to satisfy its members that the financial affairs of the corporation are in order," review and determine whether to accept the audit, assure that non-audit services conform to the Government Auditing Standards, and approve the performance of any non-audit services by the auditor.20

B. Commercial Fundraisers

Under the Act, commercial fundraisers may not solicit on behalf of a charitable organization in California unless that organization is registered or is exempt from the Attorney General's Registry of Charitable Trusts (the "Registry"). No person may act as a commercial fundraiser if that person or any officer or director of that person's business has been convicted of a crime arising from solicitations for charitable purposes. Commercial fundraisers also are required to provide the Attorney General with notice of each solicitation campaign, event or service they conduct. Moreover, there must be a written contract between commercial fundraisers and charitable organizations for each such campaign, event or service that must be signed by an authorized officer for the fundraiser and organization. This contract must be made available for inspection by the Attorney General. These requirements are discussed in more detail below.

1. Notice to the Attorney General

Not less than 10 days before the start of each solicitation campaign, event or service it conducts, a commercial fundraiser must provide notice21 to the Registry on a form prescribed by the Attorney General that sets forth the following:
  • The name, address, and telephone number of the commercial fundraiser for charitable purposes;
  • The name, address, and telephone number of the charitable organization with whom the commercial fundraiser has contracted;
  • The fundraising methods to be used;
  • The projected dates when performance under the contract will commence and terminate; and
  • The name, address, and telephone number of the person responsible for directing and supervising the work of the commercial fundraiser under the contract.

2. Written Contract with the Charitable Organization

Not only does the Act require a written contract between the charitable organization and commercial fundraiser for each campaign, service or event, it also prescribes provisions that must be included in the contract itself:22
  • The legal name and address of the charitable organization as registered with the Registry unless the charitable organization is exempt from registration;
  • A statement of the charitable purpose for which the solicitation campaign, event or service is being conducted;
  • A statement of the respective obligations of the commercial fundraiser and the charitable organization;
  • If the commercial fundraiser is to be paid a fixed fee, a statement of the fee to be paid to the commercial fundraiser and a good faith estimate of what percentage the fee will constitute of the total contributions received. The contract must clearly disclose the assumptions upon which the estimate is based;
  • If a percentage fee is to be paid to the commercial fundraiser, a statement of the percentage of the total contributions received that will be remitted to or retained by the charitable organization, or, if the solicitation involves the sale of goods or services or the sale of admissions to a fundraising event, the percentage of the purchase price that will be remitted to the charitable organization. The stated percentage must be calculated by subtracting from contributions received and sales receipts not only the commercial fundraiser's fee, but also any additional amounts that the charitable organization is obligated to pay as fundraising costs;
  • The effective and termination dates of the contract, and the date solicitation activity is to commence;
  • A provision that requires that each contribution in the control or custody of the commercial fundraiser within five working days of its receipt:
    - Be deposited in an account at a bank or other federally insured financial institution that is solely in the name of the charitable organization and over which the charitable organization has sole control of withdrawals; and
    - Be delivered to the charitable organization in person, by United States express mail, or by another method of delivery providing for overnight delivery.
  • A statement that the charitable organization exercises control and approval over the content and frequency of any solicitation;
  • If the commercial fundraiser proposes to make any payment in cash or in kind to any person or legal entity to secure any person's attendance at, or sponsorship, approval, or endorsement of, a charity fundraising event, the maximum dollar amount of those payments shall be set forth in the contract; and
  • The contract provisions pertaining to cancellation, which is discussed in Section II(D) below.

C. Fundraising Counsel

There are similar notice and contract provisions in the Act that govern the activities of fundraising counsel.23

1. Notice to the Attorney General

Not less than 10 days before the start of each solicitation campaign, event or service it conducts, a commercial fundraiser must provide notice to the Registry on a form prescribed by the Attorney General that sets forth the following:
  • The name, address, and telephone number of the commercial fundraiser for charitable purposes;
  • The name, address, and telephone number of the charitable organization with whom the commercial fundraiser has contracted;
  • The fundraising methods to be used;
  • The projected dates when performance under the contract will commence and terminate; and
  • The name, address, and telephone number of the person responsible for directing and supervising the work of the commercial fundraiser under the contract.

2. Written Contract with the Charitable Organization

There must be a written contract that is signed by authorized representatives of both the charitable organization and fundraising counsel prior to the start of each service to be performed by the fundraising counsel. The contract also must be made available to the Attorney General and must include the following provisions, many of which are similar to those required of commercial fundraisers:
  • The legal name and address of the charitable organization as registered with the Registry unless the charitable organization is exempt from registration;
  • A statement of the charitable purpose for which the solicitation campaign is being conducted;
  • A statement of the respective obligations of the fundraising counsel and the charitable organization;
  • A clear statement of the fees and any other form of compensation, including commissions and property that will be paid to the fundraising counsel;
  • The effective and termination dates of the contract and the date services will commence with respect to solicitation in California of contributions for a charitable organization;
  • A statement that the fundraising counsel will not at any time solicit funds, assets or property for charitable purposes, receive or control funds, assets or property solicited for charitable purposes, or employ, procure or engage any compensated person to solicit, receive or control funds, assets or property for charitable purposes;
  • A statement that the charitable organization exercises control and approval over the content and frequency of any solicitation; and
  • The contract provisions pertaining to cancellation, which is discussed in Section II(D) below.

D. Contract Provisions under the Act that Apply to both Commercial Fundraisers and Fundraising Counsel

There are additional provisions that are required to be included in contracts between charitable organizations and commercial fundraisers and fundraising counsel. These provisions were designed to ensure that the charitable organization has the right to cancel a contract; this right cannot be waived.24 If the organization does cancel the contract, it also must provide written notice of cancellation to the other party and mail a duplicate to the Registry. Any funds held by the commercial fundraiser or fundraising counsel must be held in trust without deduction for costs or expenses. Under the following conditions the charitable organization can cancel a contract:
  • If the commercial fundraiser or fundraising counsel is not registered with the Registry before the commencement of the solicitation;
  • The charitable organization may cancel without cost, liability or penalty any contract with a commercial fundraiser or fundraising counsel for a period of 10 days after the date it was executed. If the organization does cancel, it must also provide written notice of cancellation to the other party;
  • Any time by providing 30 days' written notice; or
  • Any time after the 10-day cancellation period without payment or compensation of any kind to the commercial fundraiser or fundraising counsel if they or their agents or employees:
    - Make any material misrepresentations in the course of solicitations or with respect to the charitable organization;
    - Are found by the charitable organization to have been convicted of a crime arising from the conduct of a solicitation for a charitable organization or purpose that is punishable as a felony or misdemeanor; or
    - Otherwise conduct fundraising activities in a manner that causes or could cause public disparagement of the charitable organization's good name or good will.

E. Act Provisions that Apply to Charitable Organizations, Commercial Fundraisers, and Fundraising Counsel

A number of provisions in the Act prohibit misrepresentations25 made by charitable organizations, commercial fundraisers, and fundraising counsel:
  • Charitable organizations and commercial fundraisers cannot misrepresent the nature, purpose or beneficiary of a solicitation.
  • Using any unfair or deceptive acts or practices or engaging in fraudulent conduct that creates a likelihood of confusion or misunderstanding.
  • Using any name, symbol, emblem, statement, or other material stating, suggesting or implying to a reasonable person that the contribution is to or for the benefit of a particular charitable organization when that is not the fact.
  • Misrepresenting or misleading anyone in any manner to believe that the person on whose behalf a solicitation or charitable sales promotion is being conducted is a charitable organization or that the proceeds of the solicitation or charitable sales promotion will be used for charitable purposes when that is not the fact.
  • Misrepresenting or misleading anyone in any manner to believe that any other person sponsors, endorses or approves a charitable solicitation or charitable sales promotion when that person has not given consent in writing to the use of the person's name for these purposes.
  • Misrepresenting or misleading anyone in any manner to believe that goods or services have endorsement, sponsorship, approval, characteristics, ingredients, uses, benefits, or qualities that they do not have or that a person has endorsement, sponsorship, approval, status, or affiliation that the person does not have.
  • Using or exploiting the fact of registration with the Registry so as to lead any person to believe that the registration in any manner constitutes an endorsement or approval by the Attorney General.
  • Representing directly or by implication that a charitable organization will receive an amount greater than the actual net proceeds reasonably estimated to be retained by the charity for its use.
  • Soliciting for advertising to appear in a for-profit publication that relates to, purports to relate to, or that could reasonably be construed to relate to, any charitable purpose without making the necessary disclosures at the time of solicitation.
  • Representing that any part of the contributions solicited by a charitable organization will be given or donated to any other charitable organization unless that organization has consented in writing to the use of its name prior to the solicitation. The written consent shall be signed by an authorized officer, director or trustee of the charitable organization.

III. Conclusion

Though the Act is less onerous than originally proposed, it still imposes significant new burdens on nonprofits in California - and around the country. Its sweeping requirements require the immediate attention of all charitable organizations, their fundraisers, and fundraising counsel. It is unclear whether other states will follow California's lead, though the New York and Massachusetts state legislatures have seen similar legislation introduced.26


 


1 See S.B. 1262, 2004 Leg., 2003-2004 Sess. (Ca. 2004) (enacted).
2See id.
3See CAL. GOV'T CODE §§ 12580-12599.5 (2004).
4See CAL. GOV'T CODE § 12582.1 (2004).
5See California Attorney General’s Office, Frequently Asked Questions: Nonprofit Integrity Act of 2004 at http://caag.state.ca.us/charities/faq.htm#no1 (last visited Nov. 22, 2004) (hereinafter California Attorney General FAQ).
6For further guidance, see National Association of State Charity Officials, Charleston Principles available at http://www.nasconet.org/public.php?pubsec=4&curdoc=10 (last visited Nov. 22, 2004). 
7See California Attorney General FAQ, at supra note 5.
8See CALIFORNIA ATTORNEY GENERAL'S OFFICE, ATTORNEY GENERAL'S GUIDE FOR CHARITIES 2 (1988).
9See CALIFORNIA ATTORNEY GENERAL'S OFFICE, ATTORNEY GENERAL'S GUIDE FOR CHARITIES 2 (1988); see also CALIFORNIA ATTORNEY GENERAL'S OFFICE, GUIDE TO CHARITABLE SOLICITATION 3 (1999).
10See S.B. 1262, 2004 Leg., 2003-2004 Sess., § 3 (Ca. 2004) (enacted).
11Id. at § 4.
12Id. at § 8(a).
13Id. at § 9(a).
14Id. at § 9(b).
15Id. at § 7(g).
16Id. at § 7(f). 
17See California Attorney General FAQ, at supra note 5.
18See S.B. 1262, 2004 Leg., 2003-2004 Sess., § 7(e)(1) (Ca. 2004) (enacted).
19Id. at § 7(e)(2).
20Id.
21Id. at § 8(h).
22Id. at § 8(i).
23Id. at § 9(e)-(f).
24Id. at § 10(e)(2).
25Id. at § 11.
26See, e.g., Andrew J. Demetriou, California Enacts Nonprofit Governance Reform, ABA HEALTH SOURCE (Oct. 2004) available at http://www.abanet.org/health/esource/vol1no2/sox.html.