(a) Public Accountability

In the area of public accountability, PAS required that a charity provide, on request, an annual report that includes various items of information about the charity's purposes, current activities, governance, and finances. A charity also was required to provide on request a complete annual financial statement, including an accounting of all income and fundraising costs of controlled or affiliated entities.

A charity also was required to provide “present adequate information [in financial statements] to serve as a basis for informed decisions.” According to the PAS, information needed as a basis for informed decisions includes items such as significant categories of contributions and other income, expenses reported in categories corresponding to major programs and activities, a detailed description of expenses by “natural classification” (e.g., salaries, employee benefits, and postage), accurate presentation of fundraising and administrative costs, the total cost of multipurpose activities, and the method used for allocating costs among the activities.

Organizations that received a substantial portion of their income as the result of fundraising activities of controlled or affiliated entities were required to provide, on request, an accounting of all income received by and fundraising costs incurred by these entities.

(b) Use of Funds

As to “use of funds,” PAS required that a charity spend a “reasonable percentage” of total income on programs, as well as a “reasonable percentage” of contributions on activities that are in accordance with donor expectations. In this context, PAS defined a “reasonable percentage” to mean “at least” 50 percent. Charities were also expected to ensure that their fundraising costs were “reasonable.” In this context, fundraising costs are reasonable if those costs do “not exceed” 35 percent of related contributions. In the area of total fundraising and administrative costs, PAS standards also provided that these costs be “reasonable.” In this latter context, these costs were reasonable if they do “not exceed” 50 percent of total income. A charity was required to establish and exercise “adequate controls” over its disbursements.

Soliciting organizations were required to substantiate, on request, their application of funds, in accordance with donor expectations, to the programs and other activities described in solicitations.

(c) Solicitations and Informational Materials

In the area of “solicitations and informational materials,” PAS standards required that these materials be “accurate, truthful and not misleading, both in whole or in part.” These terms were not defined. Solicitation materials also were required to include a “clear description” of the program and other activities for which funds are requested. Solicitations that describe an issue, problem, need, or event but do not clearly describe the programs or other activities for which funds are requested did not meet the standard for accuracy and truthfulness.

Direct contact solicitations (including telephone appeals) were required to identify the solicitor and his or her relationship to the benefiting organization, the benefiting organization or cause, and the programs or other activities for which funds are requested. Solicitations in conjunction with the sale of goods, services, or admissions were required to identify, among other things, the “actual or anticipated portion” of the sales or admission price that will benefit the charitable organization or cause.

(d) Fundraising Practices

As to fundraising practices, PAS standards provided that soliciting organizations must “establish and exercise controls” over fundraising activities by their staff, employees, volunteers, consultants, and contractors, including the use of written contracts and agreements. Organizations must establish and exercise “adequate controls” over the contributions they receive. Donor requests for confidentiality were required to be honored, including requests that a donor's name not be exchanged, rented, or sold. Fundraising was required to be conducted “without excessive pressure.” Examples of excessive pressure included solicitations in the guise of invoices, harassment, intimidation, coercion, threats of public disclosure or economic retaliation, and “strongly emotional appeals which distort the organization's activities or beneficiaries.”

(e) Governance

In the category of “governance,” PAS standards required three elements. First, an “adequate governing structure” was required. This meant that the governing instruments must set forth the organization's goals and purposes, define the organization's structure, and identify the body having authority over policies and programs (including the authority to amend the governing instruments). A governing structure was defined to be inadequate if any policymaking decisions of the governing body or executive committee were made by “fewer than three persons.”

Second, an “active governing body” was required. To meet this standard, the governing body was mandated to, among other things, meet formally “at least three times annually, with meetings evenly spaced over the course of the year, and with a majority of the members in attendance (in person or by proxy) on average.” If the full board met only once annually, at least two additional, evenly spaced executive committee meetings during the year were required.

Third, adequate governance required that there be an “independent governing body.” Organizations did not meet this standard if “directly and/or indirectly compensated board members constitute[d] more than one-fifth of the total voting membership of the board or of the executive committee.” (The ordained clergy of a “publicly soliciting church,” however, were excepted from this 20 percent limitation.) Organizations did not meet this third standard if board members had material conflicting interests resulting from any relationship or business affiliation.

(a) Board Oversight

The Alliance standards seek to ensure that the governing boards of charitable organizations are “active, independent and free of self-dealing.” To meet these standards, an organization must have a governing board that “provides adequate oversight of the charity's operations and its staff.” Evidence of this oversight includes “regularly scheduled appraisals of the CEO's performance, evidence of disbursement controls such as board approval of the budget, fund raising practices, establishment of a conflict of interest policy, and establishment of accounting procedures sufficient to safeguard charity finances.”

(b) Finances

The Alliance is of the view that a charity's finances can “identify organizations that may be demonstrating poor financial management and/or questionable accounting practices.” It seeks to ensure that the charity is “financially transparent and spends its funds in accordance with its mission and donor expectations.” Acknowledging that there may be cases where an organization may not meet certain of these standards, the Alliance leaves open the possibility that an organization may nonetheless demonstrate that its use of funds is reasonable and complies with these standards.

One standard is that an organization must expend at least 65 percent of its funds for program. Another standard requires that an organization spend no more than 35 percent of contributions, derived from fundraising, on fundraising efforts. Still another standard mandates that the charity's unrestricted net assets available for use should not be more than three times the size of the previous year's expenses or three times the size of the current year's budget, whichever is higher.

A charitable organization should include in its financial statements a breakdown of expenses, such as salaries and travel, that shows the portions of these expenses that were allocated to program, fundraising, and administrative activities. If the organization has more than one major program category, there should be a breakdown for each category.

A charitable organization must accurately report its expenses, including any joint cost allocations, in its financial statements. The Alliance notes that financial statements that “inaccurately claim zero fund raising expenses or otherwise understate the amount a charity spends on fund raising, and/or overstates the amount it spends on programs[,]” do not meet these standards.

(c) Solicitation Materials

The Alliance observes that a “fundraising appeal is often the only contact a donor has with a charity and may be the sole impetus for giving.” Thus, the standards “seek[] to ensure that a charity's representations to the public are accurate, complete and respectful.”

One Alliance standard requires that solicitations and informational materials be “accurate, truthful and not misleading, both in whole and in part.” It is said that “[a]ppeals that omit a clear description of program(s) for which contributions are sought will not meet this standard.” Also, a charity should be able to “substantiate that the timing and nature of its expenditures are in accordance with what is stated, expressed, or implied in the charity's solicitations.”

A charitable organization should have an annual report, available to all, and website disclosures that include the entity's mission statement, a summary of its prior year's program service accomplishments, a roster of the members of the governing board and its officers, and financial information that includes total income for the prior year, expenses in the program, fundraising, administration categories, and ending net assets.

(a) Governing Board

ECFA standards require that member organizations have “responsible” boards consisting of at least five individuals. A majority of this board must be “independent,” defined to exclude employees of the organization, those who are related by blood or marriage, and those who receive “significant” remuneration from the organization. The board must meet at least semiannually to “establish policy and review its accomplishments.”

(b) Financial Statements

Every ECFA organization is required to have complete and accurate financial statements. The governing board or a committee consisting of a majority of independent members must approve engagement of an independent certified public accountant, review the financial statements, and maintain “appropriate communication” with the CPA. The board is to be advised of any “material weaknesses in internal control or other significant risks.”

(c) Fundraising

The ECFA standards state that, in securing charitable gifts, “all representations of fact, descriptions of the financial condition of the organization, or narratives about events must be current, complete, and accurate.” References to past activities or events must be appropriately dated. There must be “no material omissions or exaggerations of fact, use of misleading photographs, or any other communication which would tend to create a false impression or misunderstanding.”

An appeal for charitable gifts should only contain information that is specifically relevant to the purpose of the appeal. The appeal should provide financial information that is as current and timely as possible. The appeal should “include all the information necessary for the prospective giver to gain a full and total understanding of the facts related to the appeal.”

Statements made about the use of gifts by an organization in its charitable gift appeals must be honored. A donor's intent relates both to what was communicated in the appeal and to any instructions accompanying the gift, if accepted by the organization. Appeals for charitable gifts must not create unrealistic expectations of what a gift will in fact accomplish.

ECFA organizations must issue appropriate gift acknowledgments for charitable gifts and must refrain from issuing gift acknowledgments for transactions that do not represent charitable contributions. It is said that “[p]roviding proper gift acknowledgments for cash and noncash contributions is a fundamental way for organizations to comply with the law and demonstrate integrity with givers.”

When dealing with persons regarding commitments on major gifts, an ECFA organization's representatives must seek to guide and advise donors to “adequately consider their broad interests.” An organization must make every effort to avoid knowingly accepting a gift from, or entering into a contract with, a contributor that “would place a hardship on the giver or place the giver's future well-being in jeopardy.”

An ECFA organization may not base compensation of outside “stewardship resource consultants” or its staff, directly or indirectly, on a percentage of charitable contributions raised. ECFA states that percentage-based payments “have the potential to place the self-interest of the person raising the funds above the donor's.”

(a) Legal Compliance

The Institute states that nonprofit organizations must be “aware of and comply with all applicable federal, state, and local laws.” This includes laws pertaining to “IRS filing requirements, governance, human resources, licensing, financial accountability, taxation, valuation of in-kind gifts, unrelated business income, document retention and destruction, related entities, data security, accessibility, fundraising, lobbying, and advocacy.”

(b) Financial Reporting and Monitoring

The Institute states that nonprofit organizations should, on a timely basis, create and maintain reports that accurately reflect the financial activity of the organization. Internal financial statements should be prepared at least quarterly, be provided to the members of the governing board, and identify and explain any material variation between actual and budgeted revenue and expenses. The board should annually review the percentages of the organization's resources expended for program, administration, and fundraising.

(c) Resource Development Plans

The Institute requires a resource development plan, namely, a plan in the nature of a “framework for ensuring appropriate financial resources for the organization, and a reasonable process to evaluate cost effectiveness of all resource development activities.” This plan should be board-approved, regularly reviewed, and be in accordance with the organization's budget.

(d) Fundraising Costs and Activities

The Institute's view is that an organization's fundraising costs should be “reasonable over time.” On average, over a five-year period, an organization should “realize revenues from fundraising that are at least three times the amount spent on conducting them.” Organizations with a fundraising ratio of less than 3:1 should “demonstrate that they are making steady progress toward achieving this goal, or should be able to justify why a 3:1 ratio is not appropriate for their organization.”

The Institute states that solicitation and promotional materials should be “accurate and truthful and should correctly identify the organization, its mission, and the intended uses of the solicited funds.” All statements made by the organization in its fundraising appeals “about the use of a contribution should be honored.” Solicitations should be “free from undue influence or excessive pressure, and should be respectful of the needs and interest of the donor or potential donor.”

When using the services of a paid professional fundraising consultant, organizations should only use the services of professional solicitors and fundraising consultants who are “properly registered with the appropriate state authorities.” Organizations should exercise control over staff, volunteers, consultants, contractors, other organizations, or businesses that are known to be soliciting contributions on behalf of the organization. Resource development personnel, whether employees or independent consultants, should not be compensated on the basis of a percentage of the amount raised or other commission formula.

(e) Donor Relationships and Privacy

The Institute states that nonprofit organizations should “respect the donor's right to determine how their name and contact information is used, including providing opportunities to remain anonymous, request that the organization curtail repeated mailings or telephone solicitations from in-house lists, and have their names removed from any mailing lists which are sold, rented, or exchanged.” Organizations must “honor the known intentions of a donor regarding the use of any and all types of donation,” including cash, securities, cryptocurrency, and in-kind gifts.

(f) Acceptance of Gifts

An organization should have policies in place to govern the acceptance and disposition of charitable gifts. These policies should include “procedures to determine any limits on individuals or entities from which the organization will accept a gift, the purposes for which donations will be accepted, the type of property which will be accepted, and whether to accept an unusual or unexpected gift in light of the organization's mission and organizational capacity.”

(a) Rating Criteria

Generally, Charity Navigator rates public charities¹³ that file a Form 990 annual information return.¹⁴ It, however, does not rate schools (including colleges and universities) and their foundations, hospitals and their foundations, donor-advised funds,¹⁵ sorority and fraternity foundations, and fiscal sponsors.

This agency utilizes the following criteria for the charitable organizations it rates; they must be (1) charities that generate at least $1 million in revenue for two consecutive years; (2) organizations that have been in existence for at least seven years;¹⁶ (3) organizations that have at least $500,000 in public support, which accounts for at least 40 percent of their total revenue for at least two consecutive years; (4) organizations with at least 1 percent of their expenses allocated to fundraising for three consecutive years; and (5) organizations that have at least 1 percent of their expenses allocated to administration for three consecutive years.

(b) Standards

Charity Navigator employs a two-tiered charity classification system. There are 11 widely used categories of charitable activity, with 38 causes under these categories. It uses the activity codes that charities select in their filings with the IRS, it determines the charities' activities, and it examines the charities' financial information to determine their financial functionality.

Charity Navigator states that its “ratings show donors how efficiently a charity will use their support, how well it has sustained its programs and services over time, and their level of commitment to accountability and transparency.” It notes that its “ratings aren't rankings—we designate charities' specific ratings based on their score in our two categories of evaluation.”

This organization believes its ratings “improve the quality and quantity if information available to intelligent givers.” Its ratings are said to provide “clear, objective, and reliable assessments of both the Financial Health and Accountability & Transparency of charities.” By using its ratings, Charity Navigator states, “donors can learn how a charity compares on these performance metrics with other charities throughout the country.”

Other information, outside its ratings, is provided by Charity Navigator. The items include compensation of charities' chief executive officers, an income statement, total net assets, and the organizations' mission statement.

(c) Advisories

Charity Navigator states that, when it learns of information (presumably adverse) about the operations of a charity or an alleged charity, the information is reviewed by the CN Advisory Issuance Committee. This can lead to publication of a CN Advisory. When considering publication of an advisory, this committee considers (1) the credibility and timeliness of the information; (2) the nature, scope, and seriousness of the allegations or convictions; (3) whether the allegations have been proven; and (4) other factors on a case-by-case basis. The CN Advisory System categorizes advisories into three levels of concern: low, moderate, and high. The committee lacks the capability to independently assess the accuracy of the information. The committee, Charity Navigator states, “views its role as determining if a donor might find such information helpful when considering a contribution to the organization.”

If a charity's contact information is accessible, Charity Navigator notifies the organization in advance of publication of an advisory to provide the charity an opportunity to submit information about the issue(s) that gave rise to the proposed advisory. Charities with a CN Advisory may provide information concerning it at any time. Even if the information does not warrant revocation of the advisory, Charity Navigator “reserves the right to make the information available to ensure donors have access to all recent and relevant information.”

Low Concern CN Advisories generally remain in place at least six months; High-to-Moderate Concern CN Advisories generally are in place for a minimum of 12 months. If a charity can provide reliable and accessible documentation to demonstrate that the issues identified have been resolved and steps have been taken to prevent the issue from recurring, an advisory may be removed sooner. If a rated charity has a CN Advisory for failing to report fundraising costs, Charity Navigator will consider removing the advisory if it receives an amended Form 990 detailing the charity's fundraising expenses, along with evidence that the IRS has also received the amended return. If a charity in this circumstance does not amend its return, Charity Navigator will consider removing the advisory if the charity reports fundraising expenses on its Form 990 for three consecutive years going forward. For a CN Advisory to be lifted in this instance, fundraising expenses must amount to no less than 1 percent of the charity's total functional expenses.

When Charity Navigator removes a CN Advisory, an archived version of the advisory will remain in the historical section of the charity profile page. An archived advisory will include information that caused removal of the advisory. Thus, Charity Navigator states, “donors have an opportunity to learn about and understand the issues the charity previously faced and how it resolved those issues.”

(a) Evaluation Procedure

CharityWatch states that its analysts perform “in-depth evaluations of complex charity financial reporting,” including audited financial statements, annual information returns, and state filings. Once this analysis is complete and “any required adjustments are made,” CharityWatch engages in two “end calculations.” One calculation focuses on the percentage of funds a charity expended during the year involved on its charitable programs. The other calculation determines an organization's fundraising costs percentage. Thereafter, CharityWatch assigns the charities it evaluates a “letter grade efficiency rating” on an A+ to F scale.

CharityWatch considers a charity to be “highly efficient” when its end calculations produce a program percentage of at least 75 percent and a fundraising cost percentage of no more than 25 percent. A charity is bestowed a rating of A+ when, for the year involved, its program percentage is in the range of 90–100 percent and its fundraising cost percentage is no more than 4 percent. A charity receives a grade of F where, for the year, its program expenditure is 35 percent or less and its fundraising cost percentage is in the 60–100 percent range.

In making its determinations, when computing fundraising cost percentages, CharityWatch compares fundraising costs to only related contributions. That is, in computing this percentage, revenue sources such as investment income, sales proceeds, and program service revenue are disregarded.

(b) “Required” Adjustments

As to the matter of “required adjustments,” there are at least four warranting mention. In making these percentage calculations, CharityWatch does not take into account value of noncash gifts and gifts of services. (This is said to be the case because charities “have incentive to inflate the values they place on” these types of contributions.) Likewise, CharityWatch does not adhere to the accounting profession's rules concerning “joint costs”¹⁷ and, in that context, reallocates the amount the charity allocated to program to the fundraising category in making its “end calculations.” When a charity's available assets in reserve exceed the amount of its annual budget for three years, CharityWatch downgrades its final letter grade rating. Where a complex organizational structure requires several entities, CharityWatch's audits may eliminate related-party transactions.

(c) Publication Policy

CharityWatch states that it publishes its ratings to “help donors understand how efficiently their contributions to charities are being raised and spent.” It stresses that the letter grade ratings “represent the opinion of CharityWatch and are based solely on financial efficiency measurements.” It states that it “encourages donors to consider a charity's financial efficiency along with other qualitative factors when making their giving decisions.”

(a) General Principles

Courts are reluctant to intervene in the matter of independent standards enforcement. Thus, one court observed that “[c]ourts ordinarily ought not to intrude upon areas of associational decision involving specialized knowledge” and that “[p]rivate associations must have considerable latitude in rule-making in order to accomplish their objectives and their private law generally is binding on those who wish to remain members.”¹⁸ The organizations that are rated by the watchdog agencies usually are not members of the agencies, but the courts—in the absence of compelling circumstances—are likely to avoid passing on the merits of watchdog agency fundraising standards.

Similarly, there is no legal obstacle to the promulgation of such standards. Again, to allude to the law of membership associations, it is clear that these organizations have the power to establish operating rules and to set guidelines for the expulsion of members.¹⁹

Associations also possess the inherent right to suspend or expel a member or otherwise to enforce disciplinary rules.²⁰ Again, the point of the analogy is that watchdog agencies have the authority not only to establish standards, but also to apply them.

Just as disciplinary action by an association against one of its members must be reasonable,²¹ however, so must enforcement of watchdog agency fundraising standards be fair. If there ever is intervention in this field by a court, it will undoubtedly be in this context to preclude the application of standards in a manner that will unjustly cause damage or otherwise be unfair to those to whom the standard is being applied. Thus, courts “will relieve against any expulsion based on rules which are in conflict with public policy.”²²

(b) Fair Enforcement of Standards

Fair enforcement of these standards includes the following elements:

1. The standards must be understandable, so that an organization will have an authentic opportunity to comply with them and be on notice that certain consequences will follow where this compliance is not achieved. For example, the PAS standards require fundraising costs to be reasonable. As noted, this raises substantive questions as to definition and computation.²³ Yet there were no public pronouncements by the PAS as to the meaning of this requirement, although there were cases in which organizations were on the PAS “Do Not Meet Standards” list because their fundraising costs were said to not meet the standards. Needless to say, it is difficult for any organization to rebut such a finding when it is not provided with the reasons for the finding.
2. Before any adverse action (such as publication of ratings), the agency should afford the charitable organization the opportunity to refute the charges against it. An ex parte investigation alone is insufficient in relation to the requirements of a fair procedure.²⁴ An organization in these circumstances “should fashion its procedure to insure a fair opportunity for an applicant to present his position.”²⁵
3. An organization must be provided with a written explanation of the reason or reasons underlying a conclusion that it does not meet one or more standards. While this is an element of the first point, it also goes beyond it. The law requires—as elements of a fair procedure—that a charitable organization be provided with a reasonably adequate written statement of the basis for the decision, a reasonably adequate description of the manner in which the decision was arrived at, and a reasonably adequate disclosure of the information and data upon which the agency relied.²⁶ That is, aside from the inherent fairness of knowing why a particular standard is ostensibly violated, this knowledge—in writing from the source—can be used to educate the organization's governing groups and perhaps be used in a process of remedying the situation. Also, a written explanation helps narrow the issue and enables the organization effectively to frame an appeal.
4. Some form of meaningful appeal mechanism should be available. This mechanism does not have to be adorned with all the trappings of appellate court procedure, but there should be an opportunity for an organization—having been advised that a standard has ostensibly been violated and why—to obtain reconsideration of that decision by an objective reviewer (or review group) or at least by one who was not a participant in the decision. Thus, in one case, after observing that these matters call for “the minimal requisites of a fair procedure required by established common law principles,” a court stated that (in the face of adverse association action) “an affected individual must at least be provided with some meaningful opportunity to respond to the ‘charges’ against him.”²⁷ Another court stated that “[i]t is a fundamental principle of justice that no man may be condemned or prejudiced in his rights without an opportunity to make his defense, and this principle is applicable not only to courts but also to labor unions and similar organizations.”²⁸
5. There must be a reasonable interval between the time a decision about a standards violation is announced to the organization and the time the next rating list of organizations is published. During this interim, the organization can review and perhaps revise or otherwise rectify the practice in question or pursue a more formal type of appeal. In too many cases, an organization is, for example, rotated from a “Meets Standards” listing to a “Does Not Meet Standards” listing at the same time it is notified of the change of status.
6. In interpreting standards, a watchdog agency should not substitute its judgment on a technical matter for that of professional advisors. One of the most egregious examples of lack of adherence to this principle is where, in a situation involving a standard requiring an organization to report its finances in conformance with generally accepted accounting principles, and the organization's financial statements are accompanied by an opinion of a certified public accountant that these principles have been satisfied, the enforcers of watchdog agency standards take issue with the organization on a matter involving one or more accounting principles or reporting practices.
7. Some watchdog agencies, in addition to formulating and enforcing standards, prepare and circulate to the public analytical reports on the programs and practices of charitable organizations. When this is done, the agency should be certain that the information contained in the report is accurate and reasonably current. While this may seem an obvious precaution, in one instance a major watchdog agency was—in one year—circulating critical information about a charitable organization taken from the organization's financial statement for its fiscal year ending four years before, even though the matter involved was rectified in subsequent fiscal years.

A watchdog agency that attempts to apply unreasonable standards or that fails to afford procedural safeguards to an organization that is the subject of its ratings may find that it is liable for damages. As one court observed: “Groups that wield economic power or exist solely for economic purposes have almost uniformly been held to a higher standard of procedural formality and regularity than voluntary noneconomic organizations.”²⁹ While the matter may come down to a question of proof, the agency may well be found to have acted irrationally (i.e., without a reasonable basis), acted in violation of judicially protected rights of “fairness,” and maligned the organization's reputation in the philanthropic community and hence impaired its ability to attract contributions and grants. Further, it is not inconceivable that the members of the governing boards of these agencies may be found personally liable as the result of the agency's standards enforcement efforts, such as for knowingly permitting the dissemination of derogatory and damaging information known to be misleading and/or derived pursuant to illegal procedures, knowingly violating an organization's rights to a fair procedure, and otherwise willfully causing injury and damage.

(c) Litigation Potential—A Case Study

Little litigation has been initiated by fundraising charitable organizations against watchdog agencies by reason of application of one or more elements of their standards.³⁰

The strict position of CharityWatch (then, the AIP) on the amount of assets a charitable organization should hold and its rating scheme in this context³¹ has been detrimental to some large, well-respected charitable organizations, including Father Flanagan's Boys Town. This case illustrated how the AIP influenced donor reactions. In 1994, the AIP assigned Father Flanagan's Boys Town an “F” grade in its Charity Guide. AIP's Charity Guide did not inform the reader that the “F” grade was automatic because Boys Town held $567 million in assets (about a five-year reserve), much of which were held in a foundation, nor did the Charity Guide provide any illuminating data regarding that foundation. Rather, the Charity Guide contained statements about illicit foundations, widespread abuse, and creative mismanagement of monies in the nonprofit world.³²

The Charity Guide stated: “Some charities do a great job of ‘juggling the numbers.’ They exaggerate how much they actually spend on their charitable mission by keeping large sums of money in phony endowments or shell corporations, hoarding enough funds to operate for years, and still asking you for more … AIP is not afraid to challenge the wrongdoing of shady operators … AIP also serves as an advocate for the charitable giver by pushing nonprofit organizations and their fundraisers, attorneys and accountants to stop corrupt and wasteful practices.”³³ The guide characterized Boys Town as one of the “least needy charities.”

Consequently, many donors to Boys Town understood the AIP's statements, along with its “F” rating of Boys Town, to mean that Boys Town was linked to corrupt conduct.³⁴ The following provides some examples of the outraged responses that Boys Town received from its donor base:

“After reading the rating you received … I am surprised you would have the nerve to ask for another contribution from anyone. All these years I thought Boys Town [was] one really good charity and now it is just another rip-off.…” —Crown Point, IN

“[I've] learned that you got an F.… Too bad [Father Flanagan's] values have been abandoned.” —North Hills, CA

“Please take me off your mailing list. After reading this, I'll not be sending any more money.” —Indianapolis, IN

“Remove me from your mailing list. I will not support your fraudulent practices.” —Topeka, KS

“We cannot in good conscience send money this year because of the enclosed article. We want to support the children, not high salaries and perks for those who really don't care. We were so sorry to read this about Boys Town.” —Indianapolis, IN

“You have the nerve to ask for funds when you have a rating of F. Please don't ask me for any more funds.” —San Jose, CA

“Shame! Shame! Shame! … Enclosed is an article that opened my eyes to how you continually fleece your supporters.” —Fairfield, CT³⁵

In response, Boys Town sued the AIP for defamation, an injunction prohibiting dissemination of the guide, and damages for the impact that the AIP's statements and implications had on Boys Town's past and potential donors. The president of the AIP was quoted as saying that the “donating public has a right to know [the facts and] … could be the big loser if we stop publishing this guide.”³⁶ By contrast, the executive director of Boys Town said that this “watchdog has become an attack dog” and “[s]omebody has to muzzle it” because it “is causing great harm to worthy charities.”³⁷ The parties settled the case, however, with the AIP agreeing to include a separate ranking for charities that held large asset reserves.

(a) Watchdog Agencies in General

There is nothing inherently inappropriate with the concept of watchdog agencies evaluating the processes of fundraising for charitable purposes. Some find this form of regulation preferable to regulation by government, but government regulation of fundraising has hardly been abated by watchdog groups or any other force.

The fact is, however, that these watchdog agencies have too frequently squandered the opportunities presented them and abused the trust they have aggregated. Mysteriously, the public, media, governments, donors, and grantors—almost without exception—unquestioningly accept the pronouncements of these organizations. For example, their proclamations on the potential for deception in charitable giving and their positions on individual charitable organizations are touted in the media; they are accepted without challenge and repeated as if objective truth.³⁹

These agencies disseminate the ratings far and wide with statements such as “does not meet standards” or “failed to submit adequate information.” Most recipients of this material do not parse the details—an individual sees “does not meet standards” and makes his or her gift to another charity, even though the failure to meet the standards may hinge on some technicality. Thus, for example, as noted, CharityWatch, not liking a charity's level of endowment, once gave it an “F” rating and disseminated the classification to the public. These actions can cause great damage to charities that depend on public goodwill and financial support.

(b) Watchdog Agency Functions

A review of watchdog agencies' functions is warranted. Without question, the most vexing function of these entities is the rating system. It simply is not possible to, in a fair manner, condense and compare the characteristics of charitable organizations on such a simplistic plane. The standards, as well, are often so flawed—and inconsistent with legal requirements and good management practices. There is nothing wrong with reports on charitable organizations, as long as they are objective and current. Overall, however, the most useful assignment for the agencies would be the publication of educational materials about charitable giving and fundraising, largely directed at prospective donors, rather than efforts to target specific charitable organizations and to demean the sector.

One of the many ironies associated with the operation of these watchdog agencies is that their portrayal of themselves is less than forthright—indeed, is most misleading to the public. That is, they loftily characterize themselves as voluntary organizations and their standards as voluntary ones. Yet, this is blatantly false. There is nothing voluntary about adherence to these standards; charitable organizations are coerced into compliance out of fear of the otherwise adverse publicity that can quickly be unleashed by these agencies, which can whip up a material negative impression of a charity in a quote to a reporter or in a single mailing.⁴⁰

Another dimension to this distressing dilemma is the enormous amount of credibility these groups have acquired, even though it is not warranted. Overzealous reporting and rating, often coupled with outright or subtle bias against the sector,⁴¹ does not deter these entities from substituting their judgment for that of accountants, fundraising executives, and lawyers, and from asserting rules that contravene sound management and legal principles for charitable organizations. It is by no means clear how this state of affairs has developed—that is, how these watchdog groups became invested with this aura of ultimate and overriding knowledge and invincibility. (The summary of the origins of the PAS observes that its image in the public mind became extrapolated from the positive reputation engendered by the CBBB because of its consumer protection services.)⁴²

A final thought on this matter of nonproductivity. It is sad but true that the watchdog agencies, as a justification for their existence, must constantly portray the charitable sector in the darkest of terms. For example, the PAS aggressively discussed the results of a survey containing a variety of conclusions, including these: one-third of the respondents believed that charities had become less trustworthy during the previous year, 74 percent of them believed that more regulation of public charities is needed, and 49 percent said they were very concerned about levels of fundraising costs.

As another illustration, in the fall of 1994, the president of the NCIB gave a speech in which he painted a disheartening picture of the charitable sector, replete with case studies and statistics showing all manner of wrongdoing (such as excessive fundraising costs) and manipulation (such as rapacious officers) involving the nation's charitable organizations. The true impact of this portrayal was to depress everyone in the room; the listeners felt somewhat cheapened and ashamed for being associated, no matter how remotely, with such nefarious activities. Fortunately, the next segment of this program provided a tonic. That speaker observed that there is no empirical evidence to back up the immense breadth and depth of the problem as it is being depicted by the watchdog groups. He asked: “Does all of this activity amount to hunting flies with an elephant gun or chasing elephants with a flyswatter?”⁴³ It is the former, and perhaps some day a study of the “problem” will be undertaken. It would show that only a tiny minority of charities (or ostensible charities) are causing difficulties.⁴⁴

The believability of these groups has evolved to the point that few charitable organizations possess the fortitude to challenge them; charities meekly—and involuntarily—struggle to conform with the standards because of the immense power, including the ability to swiftly decrease giving to targeted charitable organizations, that the watchdog agencies have amassed. Attracted by its simplicity, these organizations tend to highlight the subject of fundraising costs, despite the unfairness of the approach; this seems to be where public charities are the most vulnerable, which contributes to their obsequiousness.⁴⁵

In the meantime, the standards-setting “voluntary” agencies seize on the perception (which they assiduously foment) that much wrongdoing is occurring in charitable fundraising. Their ratings and reports continue to flow. Some day, some court—it may be hoped—will intercede and portray these groups as they really are and trim the scope of what they do.

There may come a time when an enterprising reporter or perceptive and bold judge will see through the watchdog agencies' skein of standards and ratings and expose the misleading rationale for the existence of these groups and the often harmful and counterproductive outcomes they thrust on the charitable sector.

(c) Comments on Standards

Watchdog agencies' standards pose three principal difficulties, in some instances, for fundraising charitable organizations and their advisors: (1) the continuing puerile insistence on application of percentages as to permissible or minimum expenditures for program and fundraising, (2) substitution of their views on topics for those addressed by law or accounting standards, and (3) inconsistencies within sets of standards.

As has been seen, many of these standards perpetuate the tiresome requirements that at least a certain percentage of expenditures be for program (e.g., 65, 75, or 80 percent) and that a certain percentage of expenditures be the maximum that may be expended for fundraising (e.g., 35 or 20 percent). Organizations that fail these arbitrary and capricious percentages may be permitted to demonstrate that their use of funds is nonetheless reasonable. The use of percentages in this fashion persists, even though the U.S. Supreme Court, beginning over 40 years ago, proclaimed that they are improperly used as proxies for ascertainment of the merits of fundraising charities. The Court's pronouncements struck down laws invoking these percentages and presumptions as being unconstitutional violations of free speech principles;⁴⁶ these principles almost always do not apply with respect to watchdog agencies' standards.⁴⁷ But the underlying rationale articulated by the Court for denigrating this use of these percentages is equally applicable in the watchdog setting.

In the first of the cases decided by the Supreme Court, the governmental entity involved regulated on the premise that any charitable organization “using more than 25 percent of its receipts on fundraising, salaries and overhead is not a charitable, but a commercial, for-profit enterprise and that to permit it to represent itself as a charity is fraudulent.”⁴⁸ The Court, however, stated that this is not the proper conclusion to be drawn from these facts and that “this cannot be true of those organizations that are primarily engaged in research, advocacy or public education and that use their own paid staff to carry out these functions as well as to solicit financial support.”⁴⁹ Four years later, the Court reiterated the point, observing that “there is no necessary connection between fraud and high solicitation and administrative costs.”⁵⁰

It is rather astounding, then, that some watchdog agencies persist with this percentage approach even though the reasoning undergirding the practice has been so thoroughly and repeatedly discredited in the law.

These standards often meander into areas of charitable organizations' operations that are addressed by federal and/or state law. Some of this overlap is outside the realm of fundraising, such as the size and composition of governing boards, the role of these boards, term limits, and conflicts of interest. As to the latter, conflicts of interest are not inherently derogatory or illegal; sometimes these conflicts are unavoidable or even beneficial to a charitable organization. Yet, some of these standards prohibit “material conflicting interests.” That is overreaching; the emphasis should be on disclosure.

Here are some instances where watchdog agencies' standards meddle in matters involving fundraising that are best left to laws and accounting standards:

• Some of these standards place restrictions on (or even punish for) accumulations of funds, the notion being that the monies involved should instead be currently used for programs. Some fund accumulations are in fact used for current programs, such as funds supporting scholarships, fellowships, research, and college and university chairs. These standards, however, target accumulations in the nature of reserves, endowment funds, and related “foundations,” dictating the number of years' reserves that are needed for prudent financial management. CharityWatch has a strict position on this point.⁵¹ The matter of fund accumulations should be the province of legal and financial requirements and practices, not the whims of standard-setters conjuring absolute, inflexible restrictions.
• The federal tax law imposes detailed rules concerning charitable gift substantiation.⁵² Some watchdog agency standards also concern themselves with gift substantiation matters. The federal law places the responsibility for securing the requisite written acknowledgment on the donor. The ECFA standards and the Panel on Nonprofit Sector principles, however, require the organizations to provide the gift substantiation to donors. The ECFA and the Panel state that it is a federal tax law requirement for charitable organizations to provide this substantiation, although there is no such requirement. The ECFA states that its standard “is in harmony with the U.S. tax rules and does not purport to establish requirements for acknowledgments to givers beyond these rules.” But the standards do just that—impose a requirement not in the law. The standards conclude with the observation that “[p]roviding proper gift acknowledgments for cash and noncash contributions is a fundamental way for organizations to comply with the law and demonstrate integrity with donors.” The second element of this observation is correct; the first element is not.
• The PAS standards allowed board members to vote by proxy, even though this is contrary to common law principles and is permitted by statute in only a few states.

As noted, a third problem with these watchdog standards is inconsistency within them. The ECFA standards, for example, state that, to be deductible, a charitable gift must be an “unconditional transfer of cash or property.” Elsewhere in these standards, however, it is recognized that donors may impose “restrictions” on gifts; indeed, it is added that an organization must “fulfill its responsibility to honor donor stipulations for particular exempt purposes.”

As another illustration of this point, the ECFA standards prohibit use of tax-deductible gifts to “pass money or benefits to any named individual for personal use.” Yet donor-restricted gifts are permissible. Since every individual has a name, this rule, read literally, would prohibit an ECFA organization from making scholarships, fellowships, and awards. Presumably, this standard (warranting an improvement in writing) frowns on the naming of recipients by donors.

Most of these standards state that an organization must be in compliance with all applicable federal, state, and local laws. Certainly, ignorance of the law is no defense to a violation. Yet, in the context of charitable fundraising, how many charitable entities that fundraise nationally and are in compliance with federal law and applicable state law are also in compliance with the charitable fundraising ordinances of all of the nation's counties, cities, and towns?

Guess what the last of these transgressions is: failure to respond promptly to matters brought to the organization's attention by the watchdog agencies involved. That amply illustrates just how voluntary these standards are.⁵³