New York State Attorney General Issues Guidance on the Audit Oversight Provisions of the New York Nonprofit Revitalization Act of 2013

The New York State Attorney General’s Charities Bureau recently issued guidance on one of the key provisions of the New York Non-Profit Revitalization Act of 2013 (the “Act”).¹ That guidance, titled Audit Committees and the Nonprofit Revitalization Act of 2013 (the “guidance”), summarizes the audit oversight provisions of the Act,² and presents the attorney general’s interpretation of those provisions as well as certain best practice recommendations that go beyond the scope of the Act. While the guidance does not have the weight of law or regulation, it provides organizations with insight into how the attorney general interprets and may enforce the audit provisions of the Act.

Independence of audit committees and directors carrying out audit oversight functions
Under the Act, an organization required to file an independent certified public accountant’s audit report with the attorney general must ensure that its accounting and financial reporting processes, as well as the audit of its financial statements, are overseen by either an audit committee comprised solely of “independent directors” or the board of directors, with only the “independent directors” participating in the deliberations and voting.³

DEFINITION OF INDEPENDENT DIRECTOR An “independent director” is a director who (i) is not and has not been within the last three years an employee of the corporation or any affiliate, and does not have a relative who is, or has been within the last three years, a key employee of the corporation or any affiliate; (ii) has not received and does not have a relative who has received, in any of the last three fiscal years, more than $10,000 in direct compensation from the corporation or any affiliate (other than reasonable compensation for services as a director or reimbursement for expenses reasonably incurred as a director); and (iii) is not an employee of or does not have a substantial financial interest in any entity that has made payments to or received payments from the corporation or an affiliate for property or services which, in any of the last three fiscal years, exceeds the lesser of $25,000 or two percent of such entity’s consolidated gross revenues, or have a relative who is an officer of or has a substantial financial interest in any such entity.

The guidance addresses several issues related to the requirement that only “independent directors” may carry out the audit oversight functions.

• Use of advisors - The guidance clarifies that audit committees and independent directors carrying out the audit oversight functions may seek assistance and advice from non-board or committee members who have accounting or financial expertise or have such advisors serve the committee or the independent board members in a non-voting or honorary capacity, provided that: (i) participation in formal deliberations and voting is limited to independent directors, and (ii) members of current management who are responsible for financial controls are not involved in the audit committee’s or board’s performance of its audit oversight duties.


• Role of non-independent directors - The guidance also clarifies that while only independent directors may participate in deliberations and voting related to audit oversight duties, non-independent directors still may receive or hear the audit committee’s report to the board on the committee’s activities.

Selection of an independent auditor
Under the Act, either the independent directors or the audit committee must annually retain or renew the retention of an “independent” certified public accountant (“CPA”) to prepare the annual audit report. The guidance clarifies the meaning of “independent” in this context by providing that an “independent” CPA is an individual or company that “does not have a financial or familial relationship with the nonprofit.” The guidance notes, by way of example, that an independent CPA cannot be a member of the nonprofit’s board of directors, a paid employee or relative of a paid employee of the nonprofit or have any other professional or financial transactions with the nonprofit.

Also included in the guidance is a list of factors, other than independence, that an audit committee or the independent directors “should” consider when hiring or re-appointing an auditor. They include:

• The reputation of the CPA (both the firm and the individuals assigned to the engagement);
• References provided;
• Expertise and familiarity with nonprofit accounting;
• Fees;
• Staff continuity of the audit team;
• Expected timeline and delivery of services; and
• Any other benefits of engaging a particular firm.

The Charities Bureau also advises that the nonprofit should request the CPA’s most recent peer review report to ensure that its standing with AICPA and in the marketplace is solid. We note that while the guidance states that these factors “should” be considered when retaining an independent auditor, consideration of the factors is not required by the Act.

Role of the audit committee or independent directors
The audit committee or independent directors must annually retain or renew the retention of the independent auditor and, upon completion of the audit, review with the auditor the results of the audit and any related management letter. The guidance clarifies that while such “review” requires a conversation between the auditor and audit committee members or independent directors overseeing the audit, it does not require a face-to-face meeting, which can be costly.

If the nonprofit had in the prior fiscal year—or reasonably expects to have during its current fiscal year—annual revenue exceeding $ 1 million, the audit committee or independent board members must carry out the following additional duties:

• Review with the independent auditor the scope and planning of the audit prior to the audit’s commencement;
• Upon completion of the audit, review and discuss with the independent auditor (i) any material risks and weaknesses in internal controls identified by the auditor; (ii) any restrictions on the scope of the auditor’s activities or access to requested information; (iii) any significant disagreements between the auditor and management; and (iv) the adequacy of the corporation’s accounting and financial reporting processes; and
• Consider annually the performance and independence of the independent auditor.

In addition to these duties, which are prescribed by the Act, the guidance provides a list of other responsibilities that the Charities Bureau believes the audit committee or independent directors also should carry out. They include:

• Ensuring that proper federal and state compliance and filings are submitted timely and that any taxes due have been paid or provided for;
• Reviewing the nonprofit’s internal and financial controls on a periodic basis;
• Assuring the conduct of appropriate risk assessments and risk response plans;
• Identifying and monitoring related party transactions and reviewing conflicts of interest, ethics, whistleblower and related party disclosure policies periodically and updating as needed;⁴
• Monitoring any legal matters that could impact the reputation and financial health and reporting of the organization;
• Instituting and overseeing any special investigatory work as needed, and assuring responses to investigations; and
• Periodically reviewing the organization’s insurance coverage and determining its adequacy.

The Charities Bureau also notes that the audit committee or the independent directors carrying out the audit oversight functions should maintain minutes of their meetings.

Role of the CPA
The guidance also advises nonprofits on the role that the CPA should play in the audit process. In that regard, the guidance provides that the CPA, in addition to certifying the financial statements, should:

• Communicate to the board or audit committee any internal control or other issues identified during the audit that concern the “processing”⁵ of the nonprofit’s financial information; and
• Revisit with the board or audit committee any issues identified in the prior year’s communication to the board to ensure they have been addressed to the auditor’s satisfaction.

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In the guidance, the Charities Bureau states that it understands that nonprofits may need time to come into compliance with the Act’s audit oversight requirements, particularly the independent director requirement. The guidance notes, however, that nonprofits that are not yet in compliance with the Act’s audit oversight provisions “should have a written plan with a timetable to achieve compliance.” With respect to the independent director requirement, the Charities Bureau stresses that nonprofits should be taking steps to ensure that they can fulfill the independent director requirement by the next election or selection of board or audit committee members. The Charities Bureau advises that, in evaluating a nonprofit’s compliance with the audit oversight requirements, it will consider whether a nonprofit “has made timely and good faith efforts to make any necessary changes to its board structure and implement procedures to comply with the new requirements.” 

FOOTNOTES 
1 The Charities Bureau also recently issued guidance on the conflict of interest policy and whistleblower policy provisions of the Act. We will provide a summary of that guidance in a separate alert.
2 The audit oversight provisions of the Act are codified in Section 712-a of the Not-for-Profit Corporation Law (the “N-PCL”) and, with respect to charitable trusts, in Section 8-1.9 of the Estates, Powers and Trusts Law (the “EPTL”). The guidance is available on the Charities Bureau website at www.charitiesnys.com/pdfs/AuditCommittees.pdf. Our prior alert discussing the Act can be found at www.dwt.com/Exempt-and-Nonprofit-Organizations-Alert-New-York-Non-Profit-Revitalization-Act-12-16-2013/.
3 “Independent director” is defined in N-PCL § 102(a)(21); “independent trustee” is defined in EPTL § 8-1.9(a)(7). References herein to “independent directors” generally encompass both independent directors and independent trustees.
4 Under the Act, oversight of the conflict of interest policy and whistleblower policy may be carried out by another board committee comprised solely of independent directors. The audit committee does not have to perform those functions. In addition, while we agree that the responsibilities listed above are important functions that should be carried out by board committees, a number of the responsibilities, such as reviewing insurance coverage and overseeing special investigatory work, need not, and typically are not, carried out by an audit committee.
5 It is not clear to us what the Charities Bureau’s use of the word “processing” means in this context.