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Sweeping Changes to New York Laws Affect Hinckley Allen’s Nonprofit Clients in All States

New York has enacted sweeping reforms of nonprofit corporate law, which could apply to nonprofit corporations (“nonprofits”) organized, and operating, throughout the U.S. The New York Non-Profit Revitalization Act of 2013 (“NPRA”), signed into law by Gov. Cuomo on December 19, 2013, revises the laws on annual financial auditing requirements, corporate governance, related-party transactions, and governmental oversight for nonprofits. As described below, the new requirements apply to nonprofits incorporated in New York as well as those simply soliciting funds in the state. As the bar for “soliciting funds in New York” is extremely low (e.g., receiving funds through a website that is able to be seen from inside New York can constitute in-state solicitation), nonprofits nationwide should be aware of the state’s new restrictions. This alert highlights some of the major law changes effected by NPRA.

The requirements officially take effect July 1, 2014. In order to ensure continued compliance, you may want to take immediate action, such as reviewing your existing corporate policy statements, establishing an audit committee, or hiring an independent CPA. Also, the following new rules are
in addition to the federal tax law and IRS requirements.

Reforms Pertaining to All Nonprofits Soliciting Funds in New York

NPRA establishes certain new financial audit requirements for nonprofit corporations soliciting funds, by any means, in New York.

These requirements apply even if the nonprofits are incorporated in another state. Pursuant to the new law, corporate boards of nonprofits soliciting in New York must have increased financial management and oversight over financial audits.

A. Annual Financial Report or Audit

Charity nonprofits[1] soliciting funds in New York must hire an independent auditor to perform an annual report on the company’s finances. The corporation must file with the New York Attorney General its financial statements along with the auditor’s annual report. Through NPRA, New York created three reporting requirements. Which requirement is applicable is determined by the nonprofit’s annual gross revenue. For July 1, 2014 through June 30, 2017, these thresholds are as follows:

  1. Unaudited Financial Report: nonprofits with less than $250,000 of gross revenue;
  2. Independent CPA Review: nonprofits with $250,000 to $500,000 of gross revenue; and
  3. Independent CPA Audit: nonprofits with more than $500,000 of gross revenue.

The threshold for the Independent CPA Audit will rise to $750,000 starting July 1, 2017, then again to $1 million starting July 1, 2021. Also, the Attorney General may at his/her discretion require an audit of a nonprofit’s financial statements notwithstanding that gross revenue may be below the threshold.

B. Audit Oversight Requirements

In addition to hiring an independent CPA auditor, nonprofits with more than $500,000 in annual revenue have certain responsibilities to review the audit results. Pursuant to NPRA, boards of directors of nonprofit corporations, or their appointed audit committees, have a duty to oversee audits.[2]  Again, the level of responsibility depends upon the total revenue.

  1. For nonprofits with more than $500,000 of revenue, the board (or a designated audit committee) must:
    • Oversee the nonprofit’s accounting and financial-reporting processes;
    • Retain an independent auditor each year; and
    • Review the results of the audit with the auditor.
  2. For nonprofits with more than $1 million of revenue,[3]  the board (or a designated audit committee) must discuss:
    • The scope of the audit with the auditor before the audit begins;
    • Any material risks and weaknesses in internal controls identified by the auditor;
    • Any restrictions on the scope of the auditor’s activities or access to information;
    • Any significant disagreements between the auditor and management; and
    • The adequacy of the nonprofit’s accounting and financial reporting process.

Reforms Pertaining Only to Nonprofits Incorporated in New York

A. Stricter Controls on Interested Directors/Officers and Related-Party Transactions

Through NPRA, New York now restricts nonprofits’ abilities to enter into related-party transactions. A related-party transaction is any agreement between a nonprofit and another entity in which an officer, director, or key employee has a financial interest. Nonprofits may enter into a related-party transaction only where the transaction is determined by the board to be fair, reasonable, and in the nonprofit’s best interest. To meet these requirements, the interested director, officer, or key employee must disclose in good faith the material facts of the interest and the board or members must authorize the transaction (interested parties may not participate in the vote).

NPRA establishes an additional requirement for charitable corporations, stating that prior to approving a transaction in which a related party has a substantial financial interest, the nonprofit’s board must consider alternatives, approve the transaction by majority vote (interested parties may not participate in the vote), and document their basis for selecting the related-party transaction over disinterested alternatives.

B. New Attorney General Oversight of Nonprofits

The new framework created by NPRA provides the New York Attorney General (AG) with much greater powers to oversee nonprofits. NPRA grants the AG powers to:

  1. Bring judicial proceedings to unwind interested-party transactions, seek monetary relief, and remove directors or officers who approve improper transactions;
  2. Receive petitions for approval of asset transfers in mergers or consolidations (previously, such petitions could be brought only to the courts); and
  3. Bring judicial proceedings against a corporation which impermissibly solicits certain contributions (i.e., those requiring approval or notice).

With the AG’s increased participation and oversight of nonprofits, we expect increased litigation on related-party transactions in the coming years. Given this, special attention should be paid to all transactions potentially involving interested parties.

C. Enhanced Corporate Governance Requirements for Nonprofits

Although New York law often encourages corporate policy statements, such as Conflict of Interest and Whistleblower statements, it did not previously require them for nonprofits. After NPRA, nonprofits must now create Conflict of Interest policy statements that include, at a minimum:

  1. A definition of circumstances that constitute a conflict of interest;
  2. Procedures for disclosing a conflict of interest;
  3. A requirement that the person with the conflict of interest not be present or participate in deliberation or vote on the matter creating the conflict;
  4. A prohibition against the person with the conflict improperly influencing the deliberation or vote on the matter creating the conflict;
  5. A requirement that the existence and resolution of the conflict be documented in the corporation’s records;
  6. Procedures for disclosing, addressing, and documenting related-party transactions; and
  7. Any other provisions as required by state law.

Additionally, after NPRA, nonprofits with more than $1 million in annual revenue or 20 or more employees must now create a whistleblower policy statement that includes, at a minimum:

  1. Procedures for reporting violations or suspected violations of laws or corporate policies;
  2. A requirement to designate a person responsible for administering the whistleblower policy;
  3. A requirement that a copy of the policy be distributed to all directors, officers, employees, and volunteers who provide substantial services; and
  4. Any other provisions as required by state law.

Finally, pursuant to NPRA, New York no longer permits the chairman of the board of a nonprofit to also be an employee of the company.

[1] NPRA does away with the four categories of nonprofits. New York now only distinguishes between charity and noncharity nonprofits. This financial reporting requirement applies only to charity nonprofits.

[2] As NPRA requires oversight to be performed by independent directors, we expect that many nonprofits will opt to appoint special audit committees to satisfy this obligation.

[3] For 2014 only, this set of requirements will not apply for organizations with annual revenue of less than $10 million.