2649
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Section 2(d) of the act would require the annual information returns filed with the Service by such public charities to include (1) a statement of gross revenue for the year, on a fund-accounting basis, distinguishing between restriced and un- restricted sources of revenue; (2) a statement of total expenses for the year, reported on a functional basis, distinguishing between program costs, administrative and fund-raising expenses, and other categories prescribed by the Service; (3) a statement of analysis of functional expenses; (4) a balance sheet; and (5) such other information as determined by the Service to be "necessary to inform prospective contributors of the activities and fiscal policies of the public charity." The informa- tion return would be required to include a statement by a certified public accountant that the return had been prepared in accordance with accounting principles and standards to be prescribed by the Service.
Under section 2(e), public charities would also be required to file annual reports with the Service including (1) a copy of the prior year's information return, (2) the names and amount of compensation paid to its 10 most highly compensated officers or employees and to each employee or consultant paid more than $20,000, and (3) such other information as the Service may require. These annual reports would be required to be prepared by a certified public accountant in accordance with the accounting principles or standards to be prescribed by the Service; copies would be filed with appropriate officials of all states in which the charity solicits contribu- tions and also be available for public inspection at the principal office of the organization during regular business hours by any individual who requests it.
Section 2(e) of the act would also require organizations subject to the act to file a "disclosure statement" with the Service at least 30 days prior to using such statement in soliciting contributions. Public charities would be required to furnish a copy of the disclosure statement to all persons from whom contributions are solicited, at the time of such solicitation, without regard to whether the solicitation is conducted in person, by mail, by broadcast, by publication, or otherwise.
However, the disclosure statement could not be used unless it has been approved by the Service or has not been disapproved within 30 days after submission to the Service. The Service would disapprove disclosure statements that do not comply with regulations to be prescribed by the Service governing their contents. A copy of the most recent disclosure statement would be mailed by the public charity to any individual who requests a copy, within 15 days after receipt of such request, and would be furnished to the officials to whom the annual report is furnished.
A disclosure statement would have to contain (but is not limited to) (1) a statement of gross revenue for the year covered by the annual report; (2) a statement of the amounts expended during the year, and the percentage of gross revenue represented by such expenditures, for charitable purposes, fund-raising expenses, and administrative costs; and (3) such other information as the Service may prescribe.
Section 2(a) of the act would amend chapter 42 of the Code to impose two
levels of penalty taxes on public charities which do not, within 12 months following
the close of the year in question, distribute at least 50 percent of their gross
revenue for the year for charitable purposes. The tax is not to be imposed for the
first four years after enactment of the act, nor during the first four years of
operation of newly created charities. Distributions qualifying to meet the 50 percent
test would be defined, under accounting principles or standards to be prescribed by
the Service, to include (1) expenditures for "the active conduct of the activities
constituting the purpose or function for which the public charity is organized and
operated"; (2) acquisition of assets directly devoted to such active conduct; and (3)
transfers to other public charities (with safeguards to prevent the transfer of the
same amounts back and forth to avoid penalty tax). Amounts obligated for specific
projects would be treated as expended for charitable purposes if actual expenditure
would be so treated and if the entire amount obligated is to be expended within
2651 five years and the project is of a nature which is best accomplished by the obliga- tion rather than by immediate expenditures. Expenditures for office facilities or other administrative expenses, for fund raising, or for wages or salaries (except for those persons "engaged personally in performing services provided under a charitable program carried out by a public charity") would not be considered to qualify as expended for charitable purposes under the 50 percent test.
For any year in which the organization did not meet the 50 percent test, a two-level tax would be imposed: (1) an initial tax of 15 percent of the amount that should have been distributed to meet the 50-percent-of-revenue test; and (2) a second-level tax of 100 percent of the amount still undistributed if corrective action had not been taken within 90 days after receipt of a deficiency notice with respect to the original violation.
Tax penalties of $10 per day (maximum $5,000) would be imposed on the persons responsible without reasonable cause for failure to file a public charity's annual information returns, annual reports, or disclosure statements on time. For willful failures, including willful failure to issue to all prospective contributors at the time of solicitation an approved disclosure statement (or one that has not been disapproved within 30 days after filing), a penalty of $1,000 would be imposed,!
Section 2(b)(1) of the act would apply to public charities provisions on termina- tion of public-charity status that are similar to those now relating to termination of private-foundation status. Voluntary termination of public-charity status would be permitted upon notice to the Service and payment of a "termination tax" equal to either the "aggregate tax benefit" (the total amount of taxes that would have been collected from substantial contributors and from the charity had the charity not been tax exempt, plus interest to the date of termination) or the value of the public charity's net assets, whichever is lower.
Status as a public charity could be involuntarily terminated by the Service if the charity or its officers committed willful repeated violations (or committed a willful and flagrant violation) of the 50-percent-of-revenue test for charitable expenditures resulting in imposition of the penalty taxes described above, and if the Service, after consultation with the U.S. Attorney General with respect to the duties of the Attorney General under section 4 of the act, determined that such termination is
"appropriate and in accordance with the purposes" of the act. Under section 4, the Attorney General, upon notification by the Service that an involuntary termination of public charity status was under consideration, would have to take "whatever action may be necessary to insure that assets consisting of, or derived from, contributions solicited from the public are preserved and expended only for s u b s t a n t i a l l y the same charitable purposes as those for which they were contributed." The Attorney General would be required to carry out this provision by seeking voluntary compliance and, if necessary, by instituting civil actions for appropriate relief in the federal district court where the charity is soliciting contributions or has an office. Upon a proper showing that such public charity "is engaged, or is about to engage, in acts or practices which would cause the dissipation of such assets or their diversion to noncharitable purposes (or to significantly different purposes)," an injunction or other order would be granted without bond by the court.3 1 0
Section 6 of the act would make it a crime, punishable by a fine up to $5,000 or imprisonment for not more than one year, or both, for any officer or employee of a public charity to knowingly commit any act or series of acts resulting in the involuntary termination of the organization's public-charity status.
Under section 5, any organization registered with the Advisory Committee on Voluntary Foreign Aid would be prohibited from stating that it is so registered in solicitation material distributed to the public. Violations would be penalized by a fine of up to $1,000 for the organization and for any officer or director who causes or consents to such violation, with the latter subject also to imprisonment for up to one year.3 *1
2652
Some Comments on These Proposals
If the press obtained and monitored the required disclosures, the Van Deerlin bill might be likely to expose the worst abuses. And it would undoubtedly be helpful for the limited number of sophisticated donors who could be expected to request information.312 But unlike the proposed Truth in Contributions Act, it would not provide most donors with information at the critical time — when they receive the solicitation and decide whether to respond. Because charitable appeals often have emotional overtones, the techniques of some fund raisers are questionable, and many donors are unsophisticated, we believe that the proposals in H.R. 1123 — although helpful — are insufficient.
Moreover, federal regulation of charitable solicitations will require adequate funding and staff, both of which should be dealt with in the enabling legislation.
Lack of flexible remedies is a drawback in both proposals. The Van Deerlin bill provides only criminal penalties. The Truth in Contributions Bill, although not so limited in this respect and more effectively framed in numerous other respects as well, relies primarily on tax penalties (like the private foundation provisions of Code chapter 42 on which it is largely modeled). Neither proposal provides equitable remedies to enjoin solicitations or to mandate disclosures.
The Truth in Contributions Bill would provide disclosure at the critical time, and the requirement for prior submission of the disclosure statement to the government should help to assure meaningful disclosure. The principal defects of the Truth in Contributions Bill, in our view, are the 50 percent pay-out provision and the use of penalty taxes as sanctions.
Reliance on mandatory disclosure, without substantive rules such as the pay-out provision, seems more consistent with traditional federal regulation in analogous areas. It would interfere less with private conduct, requiring that donors be adequately informed before making their decisions but leaving both charities and donors with the flexibility and the responsibility to make their own well-informed choices among otherwise unrestricted alternatives. It would also be simpler to administer; experience under the Tax Reform Act of 1969 suggests that it would be time-consuming and expensive to determine what distributions qualify under the 50 percent test. Moreover, although the 50 percent limit is intended to discourage excessive administrative and fund-raising costs, it may become a negative incentive for the many charities whose non-program costs are much lower than that. For both philosophic and practical reasons, we thus prefer to rely on full disclosure to correct abuses, rather than on governmentally prescribed pay-out requirements.
The two levels of penalty taxes are in fact civil fines for disobeying the law (as are the current chapter 42 taxes in many respects). Despite the precedent of chapter 42, it seems to us wrong to burden the Internal Revenue Code with such fines. The tax sanctions also penalize charitable beneficiaries by further reducing the funds available for charitable programs, which is ironic since the tax would only be imposed on organizations already spending too little for such programs.
Finally, if a new regulatory function is to be lodged in an existing department, the Department of Treasury or of Justice (or perhaps the Federal Trade Commission) would seem preferable to the Commerce Department as proposed by the Van Deerlin bill or to the Internal Revenue Service as proposed by the Truth in Contributions Bill. The Commerce Department has no functions relating to exempt organizations and has few, if any, basic enforcement responsibilities. While assigning this function to the Internal Revenue Service may be logical if regulation is to be structured upon tax sanctions, as in the Truth in Contributions Bill, we think, as noted above, that tax sanctions are an undesirable enforcement mechanism and that other factors discussed below also weigh against assigning this additional function to the Service.
2653
A Recommendation for Federal Regulation of Charitable Solicitations and Professional Fund Raisers
We recommend that a new agency be established within the Department of Treasury (or alternatively within the Justice Department) to regulate interstate charitable solicitation by compelling full disclosure to contributors when they are solicited and by prohibiting fraudulent solicitation practices. The scope of coverage would be carefully designed to exempt small solicitations, where the expense of compliance would be burdensome, as well as essentially private, membership, and church solicitations.
The new agency would be authorized to compel disclosures in a manner similar to that provided in the Truth in Contributions Bill, but it would not be authorized to regulate the substantive conduct of solicitations or the relationships between charitable organizations and the professional fund raisers employed by them. The premise is that if soliciting organizations provide full disclosure concurrently with a solicitation, and if fraudulent practices are prohibited, the market place can decide substantive questions such as how much should be spent for fund raising.
Full disclosure is also the premise of the securities laws and of the Interstate Land Sales Full Disclosure A c t ;3 1 3 it seems useful to draw upon experience with those laws because, in many respects, the positions of the investor or purchaser and the donor are similar. The analogy should not be overstated; solicitations are a small enterprise compared with publicly traded securities and real estate development sales; but we have found it helpful to use the securities and land sales disclosure laws as a starting point in developing our proposal. The new agency would be authorized to obtain injunctive and similar equitable relief to compel disclosure and prevent or stop fraud.
Location of the New Agency
We see these three practical alternatives:
First, the functions of the new agency might be lodged with the Internal Revenue Service;
Second, the new agency might be an independent regulatory agency along the lines of the Securities and Exchange Commission;
Third, the new agency might be established as a bureau or service within the Department of Treasury (like the Customs Bureau and the Internal Revenue Service) or the Justice Department (like the Immigration and Naturalization Service).
We prefer the third approach. This was the alternative chosen in assigning administration of the Interstate Land Sales Full Disclosure Act to the Department of Housing and Urban Development, where it is headed by an administrator equivalent to an Assistant Secretary.
We see no logical reason to combine disclosure requirements with functions now performed by the Internal Revenue Service. The Service has no present functions similar to the disclosure and anti-fraud functions here proposed for the new agency.
That the Service presently deals with exempt organizations in one context provides no warrant for assigning to it all regulatory functions with respect to such organiza- tions, any more than the Service's experience with business transactions and finance has warranted assigning antitrust or securities regulatory functions to the Service.
Indeed, the Service's valuable objectivity and impartiality in the vital rulings and determinations areas might be subtly affected if the Service simultaneously undertook to police solicitations practices of the same exempt organizations.
2654
A sizable staff - perhaps as many as several hundred persons - is likely to be required to regulate solicitation disclosures.314 It would be no easier to engraft such a staff on the Service than to establish it separately. Moreover, the status of the proposed functions would be reduced by assigning them to an administrative unit under an organization which is itself merely a bureau or service under the Treasury Department. We propose that the new agency be established as a bureau or service on the same level as the Internal Revenue Service. Responsibility to more than one federal agency would impose no undue burden on charities. The data
„ required to be disclosed may overlap in some respects with data collected by the Service, but in many respects it will be different; most business firms are obliged to respond to several agencies.
Finally, the Service is currently reorganizing its administration in the exempt organization area under the new Assistant Commissioner as mandated by very recent legislation. This includes a deliberate effort by the Service to reorient its approach from traditional tax collection objectives. New lines of authority and new organiza- tional loyalties are in the midst of being forged. It could place a severe administra- tive strain on the Service to undertake the substantial new responsibilities proposed for regulating solicitations, concurrently with the reorganization efforts already in progress. In this respect consideration should be given also to the budgetary and personnel requirements of the data dissemination program recommended below (pages 2661-64) under the Service's present statutory authority.315
The choice between a new bureau or service within the Department of Treasury and an independent regulatory agency is less clear. Regulatory and quasi- adjudicatory responsibilities are normally entrusted to independent agencies, such as the Securities and Exchange Commission, but they have also been entrusted to agencies within the executive branch, such as the Food and Drug Administration (part of the Department of Health, Education and Welfare), the Comptroller of the Currency (Department of Treasury), and the Interstate Land Sales Administrator (Department of Housing and Urban Development).
Some may prefer an independent regulatory agency on the ground that federal regulation, even though limited to disclosure, will impinge on sensitive areas in which organizational independence from the executive branch may be helpful.
Independent agencies may not, however, be much more independent of the executive branch than agencies lodged within Cabinet departments, and they are likely to be less independent of the Congress.
Operationally, it is likely to be quicker and more economical to establish the new agency as a bureau within the Treasury, headed by a commissioner appointed by the President and confirmed by the Senate. Placing the new agency within Treasury should also facilitate cooperation with the Service and provide, through the Secretary, greater support within the government.
Scope of the Disclosure Regulation
As noted above, H.R. 1123 would apply to all charitable organizations, including churches, although the provisions for announcing availability of information would apparently apply to very few. The Truth in Contributions Bill would apply only to publicly supported charities and their support organizations, having annual gross revenue of at least $25,000, specifically excluding churches, educationaJ institutions, hospitals and medical research organizations. Its sponsor, Senator Mondale, noted that the bill as introduced aims only to cover the kinds of organizations whose operations were studied by the Subcommittee on Children and Youth, and that broader coverage deserves consideration.316
The CBBB Standards for Charitable Solicitations excludes from its definition of charitable solicitations "an appeal conducted by a church, fraternal, civic, profes- sional or training group or any other organization, if the appeal (1) is confined and