United States: Nonprofit Governance Reform; The Fitch Report and Other Updates

Last Updated: September 29 2005
Article by Mark Schieble

Summary

Action: Fitch Ratings issues report that urges nonprofit health care providers ("providers") to adopt nine specific provisions of Sarbannes-Oxley ("SOX").

Impact: Compliance with the SOX provisions will likely be a point of inquiry for providers seeking a credit rating from Fitch and, possibly, other credit rating agencies as well. In view of the burden of adopting SOX compliance measures, the likelihood of federal nonprofit governance reform legislation in at least some form, and the possibility of a conflict between such legislation and SOX, providers which will not be seeking a credit rating in the near term may wish to assume a "waitand- see" approach to avoid the need to modify or abandon SOX compliance measures previously adopted. Alternatively, providers might consider adopting some of the lesser SOX provisions that would not be difficult to change or modify should future legislation require it.

Effective Date: Immediately.

Nonprofit governance reform continues to draw the spotlight. With Congress back in session, word is that Senate Finance Committee ("Finance Committee") and the Joint Committee on Taxation ("Joint Committee") staffers are hard at work on a bill that will include both the governance issues that were the subject of prior Finance Committee attention, and curbs on non-cash charitable contribution deductions previously identified by the Joint Committee. A separate bill by Senator Santorum, intended to be a less drastic alternative to the Finance Committee.Joint Committee measure, is being revised for introduction later this month. At the state level, a number of them have already adopted measures mandating nonprofit governance reform.

Governmental action, both past and potential, comes on the heels of several private sector studies that call for reform. This past summer, The Panel on the Nonprofit Sector released its report, prepared at the behest of the Finance Committee, containing some 120 recommendations for nonprofit reform. The American Bar Association’s Coordinating Committee on Nonprofit Governance published its Guide to Nonprofit Corporate Governance in the Wake of Sarbanes-Oxley, setting out ten "best practices" for nonprofit governance.

While it may be too soon, owing to the possibility of competing legislation, to predict the scope and content of Congressional action, legislation of some sort is likely, if only because of the sheer number of actors that have aligned themselves in the need for reform.

Nowhere has the call for action been more forcefully articulated than the Health Care Special Report issued last month by Fitch Ratings, the nationally recognized credit rating agency that rates many of the nation’s tax exempt health care securities. Entitled Sarbannes-Oxley and Not-For-Profit Hospitals, the report expresses Fitch's apparently strongly held belief that nonprofit health care providers ("providers") should adopt and observe nine specific provisions of Sarbanes-Oxley ("SOX"). Fitch argues, in its report, that these reforms will improve the accuracy and credibility of financial statements (on which Fitch heavily relies in making credit assessments), including, in at least a modified or watered- down version, the somewhat controversial internal controls evaluation provisions of Section 404 of SOX. More than any other provision, Section 404 has elicited a host of comments that question its worth from a cost/benefit perspective.

In all, Fitch proposes that providers adopt the following SOX requirements:

  • Prohibition of Non-Audit Services by Auditors. Prohibits an auditor from performing specified non-audit services for the audit client, including bookkeeping, financial system design, appraisal and similar valuation services, and investment banking. It allows auditors to perform non-specified nonaudit services only as expressly permitted by the client.s audit committee.
  • Audit Partner Rotation. Requires rotation of the lead and reviewing audit partners every five years.
  • Auditor Communications. Requires that an auditor report on certain matters directly to the client.s audit committee, including all critical accounting practices and policies, alternative treatments and material communications between the auditor and client management.
  • Audit Committee Standards. Requires that the audit committee, composed solely of independent board members, have direct responsibility for the appointment, compensation and oversight of the auditor.
  • Management Certification of Financial Statements. Requires the Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") to certify that the financial statements present in all material respects the financial condition of the company, and that they have evaluated the effectiveness of the company’s internal controls.
  • Bonus Forfeiture. In the event that a company’s financial statements are subject to restatement, SOX requires the CEO and CFO to forfeit any bonus or other incentive- based or equity-based compensation earned in the prior twelve months.
  • Internal Control Evaluation. Requires that each annual financial statement contain an internal control report setting out management’s assessment of the effectiveness of the company’s internal controls, together with the auditor’s attestation of management’s assessment. As noted above and as Fitch recognizes in its report, this provision is generally regarded as the most onerous and costly of the various SOX reforms. It could be particularly burdensome for providers with a limited revenue base or profitability. As a consequence, Fitch recommends that, while wholesale adoption may be impractical in some cases, providers should undertake at least an annual internal control assessment designed to detect irregular reporting and potential misstatements in financial reporting, and limit the possibility of fraud, and the loss of assets or a revenue source such as Medicare. Because of the complexity of a typical provider’s revenue recognition (due to the pervasiveness of contractual allowances, bad debt write-offs, third party payor settlements and the like), Fitch recommends that the internal control assessment should begin in those areas.
  • Adoption of a Code of Ethics. Requires companies to disclose whether they have a code of ethics. Fitch believes that providers should adopt a code of ethics that, at a minimum, is designed to identify and resolve conflicts of interest.
  • Financial Expert. Requires a company to disclose whether it has at least one financial expert on its audit committee. Fitch believes that, given the complexity of financial accounting, providers should have one or more experts on the audit committee.

The Fitch report is not altogether clear, however, as to how credit rating may be affected by a health care provider which fails to adopt one or more of the foregoing SOX provisions. The report states that in its evaluation of the creditworthiness of a provider, Fitch will expect that the board and management will have addressed a level of SOX compliance appropriate for the organization. In addition, the report announces Fitch’s intent to ask certain questions of providers in its evaluation of their credit, "which will factor into Fitch’s evaluation of the overall quality of governance."

Among such questions are whether the provider has an audit committee, whether the committee has as a member an expert on financial matters, and whether the committee has a policy or practice on audit partner rotation. Other questions are directed at the existence and content of policies on ethics (or conflicts), whistleblower protection and, finally, the evaluation and assessment of internal controls.

Fitch also notes that it will look for management’s certification of financial statements. The apparent implication is that a lack of SOX compliance will be viewed as adversely affecting the reliability and credibility of financial statements, with potential consequences to the credit rating.

An obvious concern, however, is whether a provider should now move aggressively to adopt SOX-like provisions when there is a strong likelihood for federal legislation, which, potentially, may establish an altogether new scheme for nonprofit governance and might require modification or jettisoning of reforms previously adopted. The Fitch report concludes that federal legislation is a virtual certainty, and that SOX-like reforms are altogether likely to be mandated. Fitch thus counsels providers to take a "head start" approach.

Judging from the seemingly universal anecdotal evidence, SOX compliance is neither easy nor inexpensive. Moreover, once started down the road of SOX compliance, there may be little opportunity for turning back. For providers with publicly traded bonds, the abandonment of SOX-like proce dures, once implemented, would likely be very adversely perceived. Given the current environment, caution would seem to have much to recommend it.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions