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The Sarbanes-Oxley Act (the "Act") mandates sweeping changes in the governance and accounting practices of public companies. Although most provisions of the Act apply only to businesses that issue publicly-traded stock, the public policy principles supporting the Act apply regardless of organizational status. Since nonprofits are traditionally held to higher standards of conduct than public companies, due to their charitable nature, public benefit purposes and tax-exempt status, the emergence of corporate practices in response to the Act is expected to impact the nonprofit sector.

Government regulators are likely to incorporate the Act's corporate responsibility standards into their oversight of nonprofit health care organizations. The New York Attorney General has already introduced legislation aimed at extending many of the Act's requirements to nonprofit corporations. Other attorneys general have confirmed that their nonprofit oversight activities will incorporate these themes. Nonprofit entities considering major transactions such as bond issuances, mergers, acquisitions, and joint ventures should anticipate that underwriters, bond insurers, and opposing parties will insist on certification and reporting requirements similar to those imposed by the Act as part of the representations, warranties and post-closing obligations.

Courts are expected to extend to nonprofit health care organizations the duties that the Act imposes on officers and directors of public companies. If so, then the Act's "best practices" for corporate governance will become standards against which nonprofits will be judged. Heightened scrutiny is already accorded to nonprofit board determinations in light of the recent prominent financial oversight failures of HealthSouth, Allina Health and Allegheny Health, Education & Research Foundation. In these and other cases, officers and directors have faced charges of fraud, inadequate financial controls, conflicts of interest, improper use of charitable endowments, and corporate waste. Since the Act may change the duty of care owed by directors and officers of a nonprofit health care organization and increase their exposure to fines, criminal penalties, and personal liability, we recommend that nonprofit health care organizations and their legal counsel review their governance documents and policies and carefully consider adoption of the Act's corporate responsibility standards and accounting reforms.

The Act's requirements that will have the most significant impact on the operations and activities of nonprofit health care organizations include the role of independent directors and committees, financial disclosure obligations, audit committee composition and authority, accounting and auditor practice standards, executive compensation arrangements, and certain provisions applicable to all organizations. Provided below is a summary of the likely application of these requirements to nonprofit health care organizations.

The Role of Independent Directors and Committees. Nonprofit health care organizations should implement policies and procedures requiring a majority of its directors to be independent, and all of its audit committee, nominating committee, and compensation committee to be independent. A director is considered independent if the director does not accept any employment, consulting, advisory, or any other compensation or fee from the nonprofit, other than as a member of the board or a board committee. In addition, the board should assess the independence of directors, outside auditors, and outside advisors carefully and, if necessary, take measures to reduce conflicts of interest.

Financial Disclosure Obligations. Nonprofit health care organizations should take steps to implement measures ensuring the integrity and reliability of their financial statements, including an internal certification procedure and appropriate disclosures in any financial information made available to government agencies and outsiders. In addition, such organizations should adopt internal accounting controls and accounting practices that will facilitate the ability of nonprofit officers to personally certify the organization's financial statements.

Audit Committee Composition and Authority. Nonprofit health care organizations should consider establishing a dedicated, independent audit committee (separate and distinct from the finance committee) to oversee accounting and financial reporting matters and to review the adequacy of internal controls. Audit committees should consider including at least one "financial expert," have the authority to retain independent legal counsel, and have sole responsibility for hiring, firing and retaining corporate auditors.

Auditor Independence Standards. Nonprofits should consider taking an inventory of non-audit services performed by auditors and determine whether the performance of the non-audit services compromises the independence of the audit firm.

Executive Compensation. Boards of nonprofits should review their compensation systems in order to determine whether they are reasonable, provide appropriate and adequate documentation and are available for review by regulatory bodies. Nonprofit health care organizations should understand and compose a detailed description of executive compensation packages, including a clear explanation as to why such are in the best interest of the company. The board should also implement policies regarding public disclosure of the explanation of executive compensation arrangements and how they serve the best interests of the corporation.

Provisions Applicable to All Organizations. Two criminal provisions of the Act apply to all organizations. One makes it a crime to knowingly destroy a document with the intent to obstruct or influence the investigation of any matter. The second provides new protections for whistleblowers by making it a crime for anyone to take any action harmful to any person for providing truthful information relating to a federal offense to a law enforcement officer. To address these two provisions, nonprofit boards should establish a policy to guide employees in handling and disposing of documents, and establish a policy and procedure that encourages internal disclosure of misconduct or mishandling of funds and provides assurance that there will be no retaliation.

If you require our assistance or have any questions please contact Michael Dowell at mdowell@tocounsel.com or the lawyer in the firm who generally handles your health care legal matters.