Statutes and Regulations - Module 3 of 5

Module 3: Statutes and Regulations

            In this module we will cover laws that govern the operation of nonprofit organizations and look at some cases involving nonprofit organizations.

State Laws

There is no standard approach among the states in their statutory treatment of nonprofit organizations.  Model statutes such as the Model Nonprofit Corporation Act and more recently, the Revised Model Nonprofit Corporation Act, have been adopted by some states.  The model acts provide language for the creation of statutes that cover major aspects of the formation, governance and dissolution of nonprofit and charitable organizations.[1]

There are some common themes in state statutes governing nonprofits. While states don’t prohibit the generation of profits or profit-making activities, all states prohibit the distribution of profits dividends to private stakeholders. Some states allow for the issuance of stock and all allow reasonable compensation for officers and directors of the organization. Some states permit distribution of remaining assets to members upon liquidation or final dissolution, except in the cases of charitable organizations.  Some states classify nonprofit corporations into categories, but most do not.  Some states have standards of conduct for officers and directors of nonprofits and some allow for member derivative actions to enforce these standards (analogous to shareholder derivative actions).[2]

The Revised Model Nonprofit Corporation Act allocates authority to the Secretary of State to regulate the formation of nonprofit corporations, defines proper nonprofit purposes and sets filing requirements such as bylaws and financial statements. It also contains rules for the roles and duties of nonprofit boards, governance provisions such as quorum, voting and annual meeting requirements and provides for judicial relief in the case of wrongdoing. These concepts codified in state statutes but vary widely from state to state.[3]

The board of directors of a nonprofit is the body that holds the prime responsibility for the organization. The board is saddled with “fiduciary duties,” which means that it must act loyally and reasonably for the benefit of the organization.[4]  In addition to the standard the duties of care and loyalty, a third fiduciary duty, the “duty of obedience,” is also sometimes referenced. These duties translate into acting in the best interests of the organization, providing sound financial oversight, making business and operational decisions without regard to personal gain, setting the strategic direction of the organization and responding to complaints and lawsuits that involve the organization.[5] For example, California nonprofit law provides:

A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner that director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.[6]

Nondiscrimination and Harassment

In addition to federal tax laws that impose certain requirements on obtaining and maintaining tax-exempt status, there are other federal laws that affect nonprofit organizations. Discrimination laws, anti-trust, health care privacy, education privacy rights, financial disclosure laws and federal lobbying laws all have potential impacts on nonprofits.

If the nonprofit is also an employer with over fifteen employees, employment discrimination laws under the Civil Rights Act apply to them. The Act prohibits discrimination based on race, religion, gender and various other criterial. The Equal Employment Opportunity Commission, enforces the Civil Rights Act on the federal level, though state employment laws may also apply.[7]

In addition to the Civil Rights Act of 1964, other federal statutes prohibiting various forms of employment discrimination include the Age Discrimination in Employment Act of 1967 and the Americans with Disabilities Act of 1990.

In addition to outright discrimination, employment discrimination rules also prohibit various forms of harassment and whistleblower retaliation.

Harassment is any unwelcome conduct that is based on a discriminatory reason. This behavior is unlawful where enduring the offensive conduct becomes a term or condition of continued employment, or when the conduct is severe or pervasive enough to create a work environment that a reasonable person would consider intimidating, hostile or abusive. 

The law also protects employees from retaliation for participating in any investigation of harassment, any proceeding under the anti-discrimination laws or for opposing policies that are discriminatory.[8]  All states and some municipalities also have employment related anti-harassment laws that, in some cases, go beyond federal law to protect additional classes of people and characteristics, such as gender identity and caregiver status.[9] For example, in California, it is unlawful for an employer to refuse employment based on the protected classes in Title VII, but also ancestry, medical condition, marital status, gender identity, gender expression, sexual orientation or military or veteran status.[10]

Though organizations are not required to have anti-harassment policies, adopting them can be prudent measures for nonprofits. An anti-harassment policy that defines harassment and outlines procedures for investigation and resolution of complaints can help reduce risk to the organization in several ways. First, it puts those who may engage in the behavior on notice and educates members of the organization on what constitutes harassment.

Second, a process can help ensure that targets of harassment have somewhere to go to report it.  Third, explaining the consequences for those who break the policy acts as a deterrent.  Fourth, with no policy in place, targets of harassment more likely to seek legal recourse in the courts as a matter of first instance, knowing that there’s no formal process to try to settle the issue internally. Finally, organizations with robust harassment policies can more easily show good faith compliance with harassment laws, even if the policy was not adhered to by one employee on occasion.[11]  

Federal Corporate and Business Laws

Antitrust laws can apply to some nonprofit organizations. The Sherman Antitrust Act aims to reduce concentrations of power that prevent competition from entering markets, and to preserve “free and unfettered competition” as a rule of trade to the benefit of consumers.[12] Anti-competitive practices may include price-fixing, boycotts and trade association rules that have a negative impact on others entering or competing in a market.  Nonprofit business leagues, membership and trade associations are particularly vulnerable to scrutiny under antitrust laws because they often represent large groups of professionals such as architects, engineers, doctors and lawyers. Their published rules can become models used for state or local laws.[13]

            One of the most notable cases against a professional association under the Sherman Act was United States vs American Institute of Architects.  The complaint alleged that the Institute engaged in a price fixing conspiracy by prohibiting architects from bidding on work based on fee alone, offering discounted fees or providing pro bono architectural services. 

The Justice Department and the Institute reached a settlement in 1990 that included required the Institute to execute a comprehensive antitrust compliance program and to refrain from making any statements that prohibited its members from competitively bidding based on price or providing discounted or free services. The consent decree allowed courts to impose fines on the Institute based on findings of violation of the Sherman Act.[14]

In American Society of Mechanical Engineers v Hydrolevel[15] the American Society of Mechanical Engineers, an engineering society with 90,000 members, was sued under the Sherman Act. The Society published important engineering related codes written by volunteers that are widely adopted by states.  

An executive from one of Hydrolevel’s competitors, M&M, sat as vice-chair of a code writing committee. M&M secured a letter from the Society declaring Hydrolevel’s product “unsafe” according to the code, which was then used by the competitor to push Hydrolevel out of the market. The court found that because the vice-chair acted on behalf of the Society, the letter carried the weight of the organization’s expertise and the organization constituted an antitrust violation.[16]

The American Competitiveness and Corporate Accountability Act of 2002, commonly referred to as “Sarbanes-Oxley,” was passed in response to the corporate and accounting scandals of the early 2000s. While the law primarily governs publicly traded companies, two criminal provisions in Sarbanes-Oxley apply to nonprofit organizations.

First, it is a crime under Section 802 of the Sarbanes-Oxley Act to “knowingly alter, destroy, conceal or falsify any record or document with intent to impede, obstruct, or influence a federal investigation or the administration of any other federal matter.” Since the law applies to documents that may apply to any matter of federal law, nonprofits should maintain document retention policies that aid compliance with all laws that apply to them, whether related to taxes, labor and employment or other matters.[17]

It is also a felony under Section 1107 of the Sarbanes-Oxley Act to retaliate against anyone for providing truthful information to federal law enforcement officials relating to any federal offense. For example, a nonprofit CEO who terminates its chief financial officer for reporting to federal officials that the organization filed false information on its tax return may be criminally liable under the whistleblower provision. Violations of Section 1107 are punishable by up to ten years imprisonment.[18]

For-profit and nonprofit healthcare providers alike are subject to the privacy rule in the Health Insurance Portability and Accountability Act. The HIPAA privacy rule established standards for the disclosure of healthcare related information and defined what constitutes a valid authorization. HIPAA applies to health plans, healthcare clearinghouses and healthcare providers that transmit specific information electronically – essentially, any and all healthcare providers.[19]

The Department of Health and Human Services enforces HIPAA through its Office of Civil Rights. Violating HIPAA can result in significant penalties, depending on the level of negligence, and range from $100 for ignorance of the applicable rules to $50,000 for a willful violation.[20]

For example, Boston Medical Center, Brigham and Women’s Hospital and Massachusetts General Hospital were fined $999,000 by HHS for allowing a film crew to record footage of patients as part of the “Boston Med” TV series, in violation of HIPAA Privacy Rules. A settlement of $2.2 million was reached with New York Presbyterian Hospital for its unlawful disclosure of patient information during a filming of the same series.[21] University of Texas MD Anderson Cancer Center was ordered to pay over $4,300,000 in civil liabilities to resolve HIPAA violations associated with three data breaches resulting from the use of unencrypted devices that exposed private patient data in 2012 and 2013.[22]

Education laws

            Title IX, renamed the Patsy T. Mink Equal Opportunity in Education Act in 2002, is designed to prevent discrimination on the basis of sex in any federally funded education program or activity. Nonprofit education institutions that receive federal funding are affected by this law.  The Department of Education’s Office for Civil Rights handles thousands of cases each year related to Title IX.

For example, in  2014, case, Murietta Valley Independent School District,[23] an investigation of an intermural sports league, the Office of Civil Rights required the league and its member school districts to equitably treat female and male students in “primetime” scheduling of athletic events, in scheduling of practice times and in providing publicity for their events.[24]

In Fort Scott Community College in 2016, it sought relief for female athletes at a university that was providing fewer and inferior resources to its women’s sports teams in comparison to the men’s programs. The investigation found that the college failed to maintain adequate equipment and locker room facilities for its female athletes and failed to treat the women’s program equally in promotion and advertisement. A resolution agreement between the university and Office of Civil Rights resulted in the construction of upgraded practice and competitive facilities, new and improved locker rooms, appropriately sized equipment and advertising for the women’s athletic program.[25]

Section 444 of the General Education Provisions, Act, known as The Family Educational Rights and Privacy Act, or FERPA,[26] protects the privacy of student education records. The law applies to any school that receives funds from the Department of Education. Nonprofit entities such as universities, private nonprofit K-12 schools and other nonprofit education providers are subject to the law and must rigorously apply internal privacy policies to maintain compliance.  FERPA affords parents and students certain rights, including the right to inspect and review their records, the right to seek amendment of their records and to have some control over the disclosure of their records.

Court cases involving FERPA may center on what constitutes an “education record” under FERPA. For example, in Bauer v Kincaid, a district court held that a student newspaper obtaining access to criminal investigations and reports conducted by campus police was not unlawful and did not require prior consent, because the criminal reports were not “education records” according to FERPA.[27]

Lobbying and Elections Laws

Nonprofits often try to educate the public on legislative issues or to lobby government officials. Those that lobby at the federal level are subject to the Lobbying Disclosure Act of 1995.[28]  Some non-profit organizations may not lobby, but even those authorized to engage in lobbying are subject to transparency and accountability requirements. A lobbyist is any paid person who makes at least one lobbying related contact with a covered government official and who spends 20 percent or more of his time on lobbying activities. The law requires that quarterly reports be submitted by lobbyists or their employers. While the non-profit organization would not itself be considered a lobbyist, it must register its employees that lobby on behalf of the organization.[29]

The Lobbying Disclosure Act, as amended by the Honest Leadership and Open Government Act of 2007, imposes disclosure requirements on committees that received political contributions or use of private transportation.[30] In addition, the Justice Against Corruption on K Street Act of 2018,[31] or “JACK” Act, requires all registrations and quarterly reports to include information on past convictions of federal lobbyists.

The IRS also has rules pertaining to lobbying by nonprofits. Nonprofit organizations who lobby must do so in compliance with the stated purpose of the organization, and keep activities nonpartisan, or risk losing exempt status.[32] Nonprofits that fail to submit timely reports on behalf of their registered lobbyists can face sanctions including fines up to $200,000 per violation, and for individuals, a potential prison sentence of up to five years.[33] For errors on registration or reporting, the U.S. Attorney does allow a registered lobbyist to take corrective action, but after four unsuccessful attempts, further action may be considered by federal prosecutors for “knowing and corrupt” errors.[34]

In addition, if the organization conducts government affairs activities at the state level, every state also has lobbying disclosure laws.[35]

Many nonprofit organizations engage in political activities on behalf of their members and may decide to start a Political Action Committee. Stand-alone Political Action Committees are themselves nonprofit organizations and are classified as Political Organizations under Section 527 of the Internal Revenue Code.[36]

A political organization is defined in the tax code as “a party, committee or association that is organized and operated primarily for the purpose of influencing the selection, nomination or appointment of any individual to any federal, state or local public office, or office in a political organization.”[37] 

PACs are regulated by the Federal Election Commission.  When a nonprofit starts a PAC, the PAC must be independently operated. Under the Federal Election Campaign Act, incorporated charitable organizations are prohibited from making contributions in connection with federal elections and cannot manage their PACs directly. Contributions may not be anonymous, so the nonprofit must track every cent that comes into the PAC.

Lobbying is distinct from participation in political campaigns. Though charitable organizations can participate in lobbying activities under very limited circumstances with special filing under the Internal Revenue Code, all tax-exempt charitable organizations are prohibited from directly or indirectly participating in any political campaign in support of or in opposition to any candidate for public office. They also may not contribute to political campaigns. Violating the prohibition may result in denial or revocation of the organization’s tax-exempt status and the imposition of certain excise taxes. Not all campaign activities violate the prohibition, however. Certain nonpartisan activities, such as “get out the vote” campaigns, are allowed.[38]

In our next module, we’ll look more closely at the legal issues related to leadership and governance of nonprofits.