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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Remarks before the Annual Conference of Independent Sector


William H. Donaldson

U.S. Securities and Exchange Commission

Chicago, IL
November 8, 2004

Thanks, John, for that introduction, and thanks for giving me the opportunity to address this important conference. Independent Sector's work is central as you act to bring together non-profit and philanthropic leaders around common issues of concern.

But why am I, the Chairman of the Securities and Exchange Commission -- which has no direct responsibilities connected to the non-profit sector -- here today? First, because of my personal concern about these issues. I come to you with a long background and interest in the non-profit sector. I have served as a former trustee of foundations, Chairman of several, board member of a number of major non-profit organizations, and trustee for several universities. Out of these experiences has grown a great appreciation for the work of the non-profit sector, as well as a strong, personal commitment to see the sector grow and prosper.

I am also pleased to be here because I believe Independent Sector and the constituents you represent can continue to benefit from the reforms that have been enacted in the wake of the ethical breakdowns that infected the private sector in recent years.

Before I go any further, let me issue the obligatory standard disclaimer that the views I express here are my own and do not necessarily represent those of the Commission or its staff.

The work that all of you do to improve lives and communities represents an essential and uniquely American element in the fabric of our society. But your ability to meet the needs of such a cross-section of this society is threatened by the actions of a small number of those in your ranks who have abused or tarnished their privileges. As you more than likely know, Independent Sector has compiled 350 news articles in just the last 16 months that raise serious questions about non-profit governance, stewardship of resources, and integrity. I know you are also concerned with the public questioning of the appropriateness of compensation schemes for certain non-profits, or the allegations and characterization of excessive costs associated with things like director fact-finding trips. After all this negative publicity, it's not a total surprise that a Brookings Institution poll released in September found that just 15 percent of those surveyed said they had a "great deal" of confidence in charities - down from an already troublesome 25 percent in July 2001. Only 11 percent believed that charities spend their money wisely.

It's not just the public that is devoting heightened scrutiny to the non-profit sector. As you likely know, the IRS has also launched a comprehensive enforcement project to explore the subject of high compensation levels at some non-profits. The head of the IRS, Mark Everson, has testified before Congress that non-profits "need to know that their [compensation] decisions will be reviewed by regulatory authorities." The IRS has also increased funding for examinations devoted to tax-exempt and government entities. In the coming year, they will be reviewing at least 400 foundations.

Wrongdoing by some non-profits of course has also attracted the attention of the U.S. Senate. As you know, Senator Grassley has been leading an effort to improve the public disclosure of tax-exempt organizations. And a new law in California requires charities reporting more than $2 million in revenue to carry out annual audits and establish audit committees.

These proposals reflect the erosion of confidence in the non-profit sector, a situation more acute because it follows widespread corruption in the for-profit sector - corruption that started with Enron, and followed with a hall of shame that includes WorldCom, Adelphia, and others. Beyond that, there were compelling signs that shortcomings in the performance of corporate leaders were widespread - making the numbers, managing earnings, and other troublesome practices. These abuses did not arise from the behavior of just a few "bad apples." Rather, the practices seemed to be evidence of a more pervasive erosion of professional and ethical standards in the for-profit corporate sector.

The revelation of these practices had an impact. The latest UBS/Gallup index of investor optimism remains lower today than it was at any point in the five years before the September 11th terrorist attacks. A Harris Interactive poll taken earlier this year found 30 percent of those surveyed saying they had "hardly any" confidence in people running major companies - a figure that has barely changed in two years, and is higher than at any point since 1974.

This created a demand for corrective action and led Congress to pass, and the President to sign, the Sarbanes-Oxley Act. This legislation instituted important new measures that have helped to overhaul the accounting profession, dramatically improve corporate reporting, and inaugurate a new era for American business. For all the benefits of Sarbanes-Oxley, the fact remains that it arose out of disgust and anger that the system of corporate governance had broken down and needed drastic repairs.

I believe that the non-profit sector now finds itself at the stage when the erosion of confidence in its own institutions is reaching a low point, but Congress luckily has not yet acted to remedy the situation. I hope you will see that reaching this point represents not an impending disaster, but rather an extraordinary opportunity for the independent sector institutions. If you take the right steps, you can restore the confidence of donors, the public, and the Congress. And you have the advantage of starting with a blank slate to create a framework with which to address these issues.

I believe there are parallels between the crisis of investor confidence in the for-profit corporate sector and the difficulties you face today. There are lessons we have learned that may be valuable to you.

One of those lessons has been the value of self-regulation. Following the stock market crash in 1929, laws were passed in 1933 and 1934 that created the Securities and Exchange Commission. Later, a system was established whereby standard setting, and compliance with statutes and rules, was directed by self-regulatory organizations, which in turn were supervised by the Commission.

The classic self-regulatory organization is the National Association of Securities Dealers (NASD), whose membership includes all of the broker-dealers in the country. The NASD writes standards and rules for broker-dealer governance and behavior, and then examines and enforces those standards and rules among their own members. The SEC provides regulatory oversight of the NASD and all U.S. stock exchanges, approving their proposed rules and examining their performance in maintaining the standards and rules. In turn, the Congress writes statutes under which the SEC operates, and generally those statutes provide the Commission with broad rulemaking authority. Thus, we at the SEC can adopt rules, or approve self-regulatory organization proposed rules, that are appropriate to the size, circumstances, and times in which their members find themselves.

For 65 years the private-sector system worked pretty well - in bull markets and bear markets alike - as self-regulatory organizations set standards, policed their members, and punished wrongdoers. Rules could be modified when needed, in part because of the absence of any overarching government "one-size-fits-all" bureaucracy and the reliance on self-regulatory mechanisms that can adjust to specific needs of diverse constituent organizations. The SEC of course retained its authority to oversee or initiate penalties where self-regulatory organizations have failed to act.

But during the bull market of the 1990s, the sheer magnitude of the economic boom with attendant temptation to ignore rules, coupled with an erosion of corporate ethics, led to a breakdown in the system. This gave rise to a modern-day version of the 1930s legislation, the Sarbanes-Oxley Act I mentioned earlier. But once again, the new legislation gave the SEC enhanced authority to write appropriate rules under the legislative mandates, and permitted us to implement much of the intent of the statute by approving tailored rules proposed by self-regulatory organizations.

This self-regulation model may well be worth your consideration given the size, breadth, and diversity of America's independent sector. With 1.4 million non-profit organizations that are extremely diverse in their missions, their constituencies, and their size; with 12 million people employed in the sector; and more than $2 trillion in assets; the non-profit sector does not need one-size-fits-all regulations imposed on it.

So what to do? If I can offer some unsolicited advice - "free advice is worth the price" - I think you should take a measured and wise approach that starts with the "low-hanging fruit" of an informal self-regulation process: endorsing, for example, "best practices" in non-profit governance, such as audited financial statements, and full transparency of your Form 990s. And I know that you are already making significant progress in this vein.

In addition, you have already begun the process of identifying some structural flaws in the non-profit sector, and proposing reforms, by publishing the Independent Sector report on the implications of Sarbanes-Oxley for non-profit organizations. The report makes some excellent points on the importance of independent boards, CEO certification of Form 990, and the prohibition of loans to directors and executives. I understand there is also a movement afoot to evaluate non-profit groups in a range of categories, such as governance and fundraising practices, and then to assign them an overall grade or rating.

In conjunction with each of these moves, I think it is important to acknowledge what's gone wrong, and demonstrate a readiness to remedy problems with long-term solutions that will help prevent these problems from recurring. Use the full power of your bully pulpit. Advocate for stronger leadership, stronger internal controls, and best practices in the management of non-profits. And continue your educational efforts.

In effect, I am arguing that you should begin a very informal process of self-regulation, without government mandate. Not only will this help underscore the importance to the non-profit sector of recognizing the highest possible ethical standards, but this process will also send a very important message to your legislators and your regulators. Your efforts in this incremental approach to self-regulation will demonstrate to them that the non-profit sector recognizes problems with prevailing practices, and is committed to implementing solutions to these problems. Moreover, a self-regulatory approach allows you to implement these solutions in a way that addresses that phenomenal diversity of more than a million non-profit organizations of different missions, constituencies, and sizes. It allows you to implement solutions in a way that a detailed, one-size-fits-all legislative or regulatory scheme simply could not. Finally, this incremental approach to self-regulation gives you the time to examine thoughtfully whether any more formal self-regulation mechanisms may be required to achieve the goals that legislators or regulators may insist upon.

Very Serious Situation

I was asked before coming here to Chicago how seriously non-profits should take the current situation, and I gave a simple answer: "very seriously." You are in an age of transparency, and the non-profit sector appears to be a bit behind the times in this regard. For this reason, and others, you run the risk of losing the support of not just the government, but as Diana Aviv has highlighted, you also run the risk of losing your most valuable asset: public trust. If that trust is violated, everyone pays a price.

Regaining the confidence of the public and, when pertinent, donors and potential donors, won't be easy. But as I noted earlier, I do see a recognition that some prevailing practices must be changed, and that self-regulation - which can accommodate the diversity that defines the non-profit sector - is the preferred route.

That is an important first step, but more steps must lie ahead. I hope you will all view these next steps not as burdens, but as opportunities - opportunities to show legislators, regulators, and the broader public that you are prepared to pursue the reforms that will prevent a repeat of recent problems in the non-profit sector. The goal should be not simply to avoid unwanted legislation, but rather to advance a regime of self-regulation that produces better results than any congressional proposal or regulatory overseer can achieve.

The ultimate goal of a self-regulatory approach should be for leaders throughout the non-profit sector to mobilize in support of improved governance standards, greater accountability, and a higher ethical code - one that goes beyond just compliance and draws a firm line between what is right and what is wrong.

Indeed, what any self-regulation process should support is a change in mindset - a non-profit culture that fosters ethical behavior and decision-making. Creating that culture means doing more than developing good policies and procedures, doing more than demanding competent legal and accounting work, and doing more than giving your staffs training resources and up-to-date technology. It means instilling a commitment to do the right thing, this time and every time - so much so that it becomes the core of what I call the essential "DNA" of the entities in which you all operate.

Non-profit managers, their professional consultants and advisers, and their directors must look beyond just conforming to the letter of the law and regulations. You all must redefine governance with practices that reflect more than mere adherence to any new rules. They should also demonstrate ethics, integrity, honesty, and transparency.


I want to thank Independent Sector again for giving me this opportunity to speak today. I would be happy to take your questions or hear your observations.


Modified: 11/08/2004