American Red Cross Governance

Transcription

1 American Red Cross Governance by William Josephson William Josephson is former assistant attorney general in charge, Charities Bureau, New York State Law Department; retired partner, Fried, Frank, Harris, Shriver & Jacobson LLP, New York. This article is based on my submission to the Senate Finance Committee and on testimony at the committee s March 3, 2006, roundtable by William Josephson photo by Chris Lee All rights reserved William Josephson For the second time in four years, each time coincident with congressional hearings, two presidents of the American Red Cross have resigned. The first was Bernadine Healy, a renowned physician, in November 2001, in the aftermath of the September 11, 2001, terrorist attacks. The second, in December 2005, was Marsha Johnson Evans, a retired Navy rear admiral and former chief executive officer of the Girl Scouts. The Washington Post reported February 25 that the Red Cross has had five presidents or acting presidents in the last five years and has paid more than $2.8 million in various severance payments. 1 In March 2006 the Red Cross established an independent governance advisory panel, and on November 3 its board of governors released a 127-page report, American Red Cross Governance for the 21st Century. 2 This article will discuss how well that report responds to good corporate governance concerns and standards. I. Introduction The Red Cross and Disaster Relief New York State Attorney General Eliot Spitzer exercised extraordinary leadership in the days and weeks following September 11, He established a database for survivors and a database for the frontline charities. 1 Salmon, Red Cross Gave Ousted Executive $780,000 Deal, The Washington Post, Feb. 25, 2006, at A (hereinafter governance report). On October 30 the Red Cross posted a press release and other summary documents, distributed them to the press, and held a telephone conference call about the coming report. Shortly afterward, a coordinating agency, the 9/11 United Services Group, 3 was established. Initially, some of the frontline charities declined to participate in the coordinated effort, including the Red Cross. Nancy Anthony and other representatives of Oklahoma charities, who created a coordinating group after the 1995 Oklahoma City bombing, told us that initially the Red Cross also refused to participate in its work. Ultimately, the Red Cross participated in New York s efforts. It should be added that the participation of the Federal Emergency Management Agency, at least initially, also left much to be desired. The Charities Bureau s research revealed that not all money raised by the Red Cross for specific disaster relief was spent for that relief. For example, there was a critical 1998 report by the attorney general of Minnesota on the Red Cross s response to the Mississippi River floods in 1997, 4 and 60 Minutes did a program on funds raised by the San Diego Red Cross Chapter for wildfire relief. 5 The Red Cross s 9/11 Liberty Fund, overseen by former Senate Majority Leader George Mitchell, was established in response to donors concerns that their gifts be used for 9/11 relief. Many of the points in this article will be keyed to statements made by Senate Finance Committee Chair Chuck Grassley, R-Iowa, in a February 27, 2006, letter to the principal officer of the Red Cross. 3 National Voluntary Organizations Active in Disaster (NOVAD) has useful member tools and other information on its Web site, 4 Minnesota Attorney General Herbert H. Humprey III, After the Floods: Unmet Needs and Unspent Donations, (1998) (copy on file with the author). 5 Copy on file with the author. The San Diego chapter s chair apologized for misleading the public about use of donations for victims of the January 2001 Alpine fire. Santana, et al. Red Cross Chairman Issues Apology for Alpine Fire Missteps, San Diego Union-Tribune, Nov. 9, 2001, at A1. More than half a year later the head of the chapter received a quit-or-be-fired letter. Santana, Local Red Cross Leader Refuses to Exit Quietly, San Diego Union-Tribune, May 31, 2002, at A1. According to Dr. Healy, a factor in the ending of her Red Cross employment was the investigation of a Jersey City, N.J., chapter embezzlement. Strom, Red Cross Quietly Settles Case for $120,000 Theft, The New York Times, April 25, 2006, at A16. She also believed, after reading a September 2001 audit report, that the San Diego chapter head should be removed. Santana, Red Cross Chief Firing Spotlights Clout of Chapters, San Diego Union-Tribune, Dec. 23, 2001, at A1. The Exempt Organization Tax Review January 2007 Vol. 55, No. 1 71

2 Grassley wrote: For the Red Cross to succeed in its mission of disaster relief, it must work in concert with the entire charitable community. I have been concerned about comments I ve received from local charities in the Katrina area that have expressed frustration about their relationship with the Red Cross. 6 Thus, in the aftermath of Hurricane Katrina, despite the Red Cross s experiences before and after September 11, 2001, questions were again raised about the effectiveness of the organization s participation in federal, state, local, and private disaster relief efforts. 7 II. Congressional Reforms Red Cross oversight reform should start with the congressional committees that have legislative jurisdiction over the Red Cross, disaster relief, the Food and 6 On February 28, 2003, President Bush issued a homeland security presidential directive that ordered the Department of Homeland Security to create a national incident management system and a national response plan. According to The Federal Response to Hurricane Katrina: Lessons Learned 49 (2006) (hereafter Lessons Learned), transmitted to the president by Frances Fragos Townsend, assistant to the president for homeland security and counterterrorism: The Federal response should better integrate the contributions of volunteers and non-governmental organizations into the broader national effort. This integration would be best achieved at the State and local levels, prior to future incidents. In particular, State and local governments must engage NGOs in the planning process, credential their personnel, and provide them the necessary resource support for their involvement in a joint response. Under the national response plan, at least one of the Red Cross s responsibilities is mass care and sheltering. Lessons Learned at 60. On February 15, 2006, the Select Bipartisan Committee to Investigate the Preparation for and Response to Hurricane Katrina issued H.R. Rep. No , 109th Cong., 2d Sess. (2006). The Red Cross s response is discussed throughout the committee s report. In June 2006 the Government Accountability Office issued a report to congressional committees titled Coordination Between FEMA and the Red Cross Should Be Improved for the 2006 Hurricane Season (GAO-06-72). Section (4) of Title 36 of the United States Code states that a purpose of the Red Cross is to carry out a system of national and international relief in times of peace, and to apply that system in mitigating the suffering caused by pestilence, famine, fire, floods, and other great natural calamities, and to dispense and carry out measures for preventing those calamities. This Red Cross responsibility may be unique among the approximately 185 national Red Cross and Red Crescent societies. Under chapter 68 of Title 42 of the United States Code, which relates to public health and welfare, the president is authorized to enter into coordination agreements with the Red Cross and other disaster assistance organizations. 42 U.S.C. section 5152(a); cf. 42 U.S.C. section 5143(b)(2). 7 See Strom, Red Cross Sifting Internal Changes Over Katrina Aid, The New York Times, March 24, 2006, at A1, col. 6; Strom, Red Cross Fires Two Managers in New Orleans Amid Audit, The New York Times, March 25, 2006, at A9. Drug Administration, national defense, and foreign relations issues. 8 In the Senate that jurisdiction is divided between two committees: Foreign Relations 9 and Health, Education, Labor and Pensions. 10 In the House, the International Affairs Committee seems to have sole jurisdiction. 11 Presumably, that reflects the historical origins of the Red Cross in its relationship to the International Red Cross under various treaties and other international acts. 12 But except in time of war, nearly all the money earned or raised by the Red Cross is spent to maintain the domestic blood supply 13 and then for domestic disaster relief. 14 The blood supply issues are worthy of special mention. Because of Food and Drug Administration concerns over the Red Cross s management of the blood supply, the United States sued the Red Cross. To settle the suit, the Red Cross entered into two consent decrees; it entered the second, the Amended Consent Decree, only after the United States moved in federal court to punish it for contempt of the first decree. The Red Cross had on June 10, 2005, to pay $3.4 million in penalties for violating this consent decree, 15 and in September 2006 it paid a third fine of $4.2 million. 16 The Senate Finance and House Ways and Means committees, with jurisdiction over tax-exempt organizations like the Red Cross, also have substantial interests Lessons Learned supra note 7 at 74 implicitly recognizes this, but no legislative or executive branch proposals have been forthcoming. 9 Senate Rule XXV in Senate Manual, S. Doc , 106th Cong., 1st Sess. section 25.1(j)(1)6 (2000). 10 Id. at section. (l)(1)8. 11 H.R. Rule X, cl.1(i)(15) in Constitution Jefferson s Manual and Rules of the House of Representatives, H. Doc. No , 103d Cong., 2d Sess. section 678, p. 390 (1995) U.S.C. section (1)-(3). 13 American Red Cross 2003 Form 990 Part I line 2 (copy on file with author); Beaty, Red Cross Clarifies Its Governance, The Wall Street Journal, Oct. 31, 2006, at A11, col Form 990 supra note 14 at line 1d. 15 See letter dated June 10, 2005, to John R. McGuire, executive vice president, Biomedical Services, American Red Cross, from Evelyn Bonnin, acting director, Baltimore District, Food and Drug Administration (copy on file with author). 16 Salmon, Red Cross Tightening Command, The Washington Post, Oct. 31, 2006, at A6; Harris, FDA Adds $4 Million Fine for Red Cross Blood System, The New York Times, Sept. 9, 2006, at A11; Stein, FDA Fines Red Cross $4 Million for Blood Safety Lapses, The Washington Post, Sept. 9, 2006, at A2. Wilke, Red Cross Receives New Scrutiny As Blood Unit Faces Suit, Focus Turns to Violations That Set $5 Million in Fines, The Wall Street Journal, April 27, 2006, at D3. 17 Specific provisions in 36 United States Code often require the corporation to maintain its federal income tax exemption under the Internal Revenue Code. E.g., 36 U.S.C. section (b). Title 36 does not explicitly so provide for the Red Cross, but the Red Cross is exempt from federal income taxation as an organization described under section 501(c)(3). The Supreme Court held in Dep t of Employment v. United States, 385 U.S. 355 (1966), that the Red Cross is an instrumentality of the United States for purposes of immunity from a state unemployment compensation tax. Accord, United States v. Spokane, 918 F.2d 84 (9th Cir. 1990), cert. denied, 501 U.S (1991). (Footnote continued on next page.) 72 January 2007 Vol. 55, No. 1 The Exempt Organization Tax Review

3 The Senate and House Homeland Security committees have jurisdiction over the Department of Homeland Security and its Federal Emergency Management Agency, which works with the Red Cross on disaster relief. Perhaps what is required for effective Red Cross legislative reform and authorizing committee oversight is a joint or special committee reflecting the interests of all the concerned congressional authorizing committees. III. Transparency As a federally chartered corporation, the Red Cross and its endowment fund 18 are exempted from registration and annual disclosure filings by most, if not all, of the 39 states that have those requirements for charities that have assets or fundraise in their states. 19 Perhaps those exemptions reflect a legal opinion that the states cannot regulate federally chartered corporations, as a United States district court recently held regarding national banks. 20 However, national banks are nationally regulated. The Red Cross 21 is not. Given the more than 90 organizations federally chartered under Title 36 of the United States Code, ranging from the Former Members of Congress and the National The Red Cross was represented by the Justice Department in both cases. As we shall see, apparently when the Red Cross wishes to invoke a federal shield, it is represented by the United States. When it wishes to blunt a federal sword, it is privately represented. See infra note U.S.C. section Marion R. Fremont-Smith does not state the extent to which the 39 states that now require charitable registration exempt congressionally chartered charities. Fremont-Smith, Governing Nonprofit Organizations: Federal and State Law and Regulation (2004). But she agrees that generally they are exempt. During the September 11, 2001, crisis, the New York State Law Department s Charities Bureau assumed that the Red Cross was statutorily exempt from New York s charitable asset and fundraising registration statutes. A close look at those exemptions suggests that that assumption may not have been well founded, because the Red Cross was not required to report to Congress. See N.Y. Estates, Powers & Trusts Law section 8-1.4(b)(1); N.Y. Executive Law section 172-a. In a 1954 opinion, the New York attorney general conceded that what is now the executive law fundraising exemption did not embrace the Red Cross, but he nevertheless opined that the Red Cross, as an agency under federal supervision, and its chapters were exempt from such registration Ops. N.Y. Att y Gen Because of the lack of supervision, that opinion should be revisited. See infra text at note 43. Indeed, with the repeal by Public Law of most of the Title 36 congressional reporting requirements for other federally chartered corporations, all of the 39 charity registration and reporting states should take another look at exemptions for the Red Cross and the other Title 36 organizations, especially those whose state of incorporation Title 36 specifies. 20 Office of the Comptroller of the Currency v. Spitzer, 396 F. Supp.2d 383 (S.D.N.Y. 2005); cf. Dep t of Employment v. United States, 385 U.S. at 360 (dictum). 21 See infra note 43. Special Report Yeoman F to icons like the Boy Scouts and Girl Scouts, 22 state exemptions are questionable also as a matter of public policy. Congress should consider legislation that would make clear that the states in which those organizations operate or raise funds have registration, reporting, and antifraud jurisdiction over the organizations activities, just as those states have jurisdiction over other state-created charities, at least until Congress enacts a national law as some have advocated. 23 Even then good arguments can be made that the Red Cross s local chapters should comply with their states fundraising, registration, and disclosure laws, so that donors, the press, and the public will have ready local access to the chapter s current financial information. Reporters tell me that getting information from the Red Cross is very difficult. Congress should consider making the Red Cross subject to the federal Freedom of Information 24 and Open Meetings 25 laws. The Red Cross has successfully resisted being subject to the Freedom of Information Act. 26 IV. Governing Body Grassley: I have found again and again in my oversight work that many organizations can trace their problems to board governance. The Red Cross s governing body is far too large for effective management and for fixing fiduciary responsibility. By statute it has 50 members. 27 In June 2004 the Senate Finance Committee s staff proposed a limit of 15 members for the fiduciary boards of tax-exempt organizations. 28 For 11 of the corporations federally chartered in Title 36, Congress has specified the number of governing body members generally from 9 to 15, 29 although 1 corporation may have 10 to 23. Publicly held company boards of more than 15 members are rare. 30 Whatever is the right limit, 50 is surely too large for effective fiduciary responsibility. Grassley noted that the troubled Nature Conservancy is reducing its board from 41 members to 18. The Red Cross s bylaws indicate that the organization understands how difficult it is to govern with a board of 50. Its quorum under section 2.17 of the bylaws is not the U.S.C. (passim) 23 Cf. Independent Sector, Panel on the Nonprofit Sector, Strengthening Transparency, Governance, Accountability of Charitable Organizations, a Final Report to Congress and the Nonprofit Sector 83 (2005) U.S.C. section U.S.C. sections 551, 552, 552b, 556 & 557; 5 U.S.C. App. section 10; 39 U.S.C. section The Ninth Circuit held the Red Cross exempt from the Freedom of Information Act in Irwin Memorial Blood Bank v. American National Red Cross, 640 F.2d 1051 (9th Cir. 1981). The Red Cross was not represented by U.S. government counsel in that case U.S.C. section Staff discussion draft, Senate Finance Committee 13 (2004) U.S.C. (passim). 30 Cf. Paul E. MacAvoy and Ira M. Millstein, The Recurrent Crisis in Corporate Governance 131 (2003). Governance Report, supra note 2 at 45 & nn ; cf. The Exempt Organization Tax Review January 2007 Vol. 55, No. 1 73

4 customary majority, but only 20, and 15 under section 4.4 in case of emergencies. Section 2.17 of the bylaws says the vote of a majority of the board of governors who are at a meeting at which a quorum is present and who are entitled to vote is required for the adoption of any matters voted on by the governors except as otherwise provided. Does that mean a majority of a quorum, established at 20 or 15 or a majority of the board, 26? Almost certainly a majority of 20, which means only 11 votes could take an action. The governors authority can also be exercised by an executive committee of at least about one-fifth of the board of which the chair and the chairs of 7 standing committees are members under section of the bylaws. Section of the bylaws provides that a majority vote of the committee members who are at a meeting at which a quorum is present and who are entitled to vote is required for any actions taken. So major Red Cross issues can be, and have been, 32 decided on by only six governors. Fundamental to internal corporate affairs matters is the source of law. State-chartered corporations operate under comprehensive statutory and common law rules, but Congress has not provided comprehensive federal rules of decision for federally chartered corporations The executive committee is statutorily authorized. 36 U.S.C. section (c)(1). The board of governors is specifically authorized to appoint and remove Red Cross officers and employees, the only exception being the principal officer, who is appointed by the president of the United States. 36 U.S.C. section (a)(1)(A). The executive committee also can provide for the appointment and removal of officers and employees. Section of the Red Cross s bylaws states that the executive committee generally has the powers of the board of governors when it is not in session. This would not seem to include the power to remove the president and chief executive officer. Under section 6.3 of the bylaws, the president and CEO is elected by the board of governors. Section 6.10 states: The officers of the Corporation appointed with the approval of the Board of Governors shall be subject to removal by the appointing officer with the approval of the Board of Governors. The appointing officer of the general counsel (section 6.4), chief financial officer (section 6.5), and secretary (section 6.6) is the president and CEO with the approval of the board. So there is no appointing officer for the president and CEO, and that officer s appointment would not seem to have been approved by the board of governors who elected her. While the president and CEO can be removed by the board, whether the board has provided for any other removal of that officer is not at all clear. The Red Cross s proposals state that its executive committee will have a reduced role in light of the smaller Board [of Governors] size. See governance report, supra note 2 at The New York Times reported that Evans was removed by five members of the Red Cross executive committee. See Strom, Senator Urges Red Cross to Overhaul Its Board, The New York Times, Feb. 28, 2006, at A12, col. 5. Of course, the size and composition of the Red Cross s board can be overhauled only by federal legislation. See supra note L. H. Tribe, American Constitutional Law section 6-33 (3d ed. 2000); R.C. Moe and K. R. Kosar, CRS [Congressional Research Service] report for Congress, Congressionally Chartered Nonprofit Organizations (Order Code R.L ). However, for 58 of the congressionally chartered corporations, Congress has specified the District of Columbia or other named states as the states of incorporation. 34 Under section (a) of United States Code Title 36, the Red Cross is a body corporate and political in the District of Columbia (emphasis added), as it was so described in section 8 of the Act of May 8, 1947, Public Law 80-47, 61 Stat. 83 (1947), which amended the original act of January 5, 1905, 31 Stat. 599, which had not been previously amended. Does this mean that the District of Columbia s nonprofit corporate and other statutes and regulations and decisions thereunder apply to the Red Cross? Given the clarity with which Congress has addressed this issue in the 58 cases mentioned above, the answer is unclear. The many cases interpreting section (a) have focused on whether the Red Cross is a citizen of the District of Columbia for federal court diversity jurisdiction purposes. 35 Originally, the Red Cross was incorporated and reincorporated in the District by Congress under the corporation laws of the District of Columbia. 36 While that might lead one to assume that the District s laws govern the Red Cross s internal affairs, that is hardly certain. 37 If the Red Cross is a District of Columbia corporation, then U.S.C. (passim). 35 See annotations to 36 U.S.C.A. section ; M.T. Maloan, Federal Jurisdiction and Practice: The American National Red Cross and the Interpretation of Sue and Be Sued Clauses, 445 Okla. L. Rev. 739 (1992); cf. American Nat l Red Cross v. S.G. & A.E.: Open Door to the Federal Courts for Federally Chartered Corporations, 45Emory L. J. 771 (1996). 36 W.A. Sturges, The Legal Status of the Red Cross, 56Mich. L. Rev. 1, 10 (1957). 37 See Osborn v. Oklahoma Tax Comm n, 1954 Okla. 315, 279 P.2d 1096, 1098 (Sup. Ct. 1954). Section 3 of the Act of June 6, 1900, ch Stat. 279, provided in relevant part: Third. To succeed to all the rights and property which have been hitherto held and to all the duties which have been heretofore performed by the American National Red Cross as a corporation duly organized and existing under the laws of the United States relating to the District of Columbia, which organization is hereby dissolved. (emphasis added) As a recent Congressional Research Service report notes, the Red Cross s ambiguous public-private nature has led to legal conflicts. K.R. Kosar, The Congressional Charter of the American Red Cross: Overview, History and Analysis 7 (Order Code RL ). The Red Cross s general counsel and corporate secretary submitted to the March 3, 2006, Senate Finance Committee roundtable a paper, Corporate Governance and the American Red Cross. It did not address these issues. Nor does the Red Cross s governance report, even though the issues were raised at the roundtable. The District of Columbia Model Nonprofit Corporation Act, originally enacted by the Act of August 6, 1962, Public Law , 76 Stat 265, provides in section that a foreign corporation...shall not include a corporation created by special act of Congress, but the definitions of corporation and domestic corporation in that section do not expressly include special act corporations. Sections of the act authorize special act corporations to avail themselves of its provisions. 74 January 2007 Vol. 55, No. 1 The Exempt Organization Tax Review

5 are some of the bylaw provisions discussed above, such as the quorum provisions, valid? IV. Presidential Responsibility Grassley: I am troubled by the number of the board of governors, particularly government-appointed board members, who rarely attend board meetings and often send [non-voting] representatives who do little more than sit in a chair. By statute the president appoints the Red Cross s principal officer and seven other members of its governing board, all of the latter of whom must be officials of U.S. government departments and agencies and at least one of whom must hold a position in the armed forces. 38 They were, as of October 31, 2004, the chair of the Joint Chiefs of Staff and the secretaries of commerce, education, state, veterans affairs, homeland security, and health and human services. 39 It is hard to believe that these officials have much time to devote to Red Cross issues. As Grassley said, rarely do they attend governing board meetings, and representatives cannot vote. Nevertheless, the Red Cross s bylaws do not seem to require that any of the presidential or public members constitute part of a quorum or part of a vote of the board or any committee. As long as the current governing board structure remains in place and the Red Cross remains the chief U.S. private agency responsible for disaster relief, the president must take far more seriously his responsibility for appointing Red Cross governing board members, and his appointees must take seriously their responsibilities as members of the governing board. V. Responsibility of the Red Cross Governing Board Chair to the President The statute does not specify any qualifications or duties for the principal officer. Section 2.10 of the Red Cross s bylaws contains a strange provision: The Chairman shall raise with the President of the United States any conflicts with governors appointed by the President which the chairman feels are detrimental to the board of governors or the American Red Cross. Surely this provision has it backwards. Conflicts with the president s governors will almost certainly involve the interests of the United States. Most people would think the interests of the president and his appointed governors are more important than the interests of the rest of the governors or of the Red Cross itself and that that is the issue the presidential appointees, including the principal officer of the Red Cross, should raise with the president. VI. The Tail Wags the Dog Grassley: I encourage you to consider the issues of independence... andwhether the chapters involvement seems to protect individuals or chapters U.S.C. section (a)(1)A. 39 American Red Cross, 2004 Report to the American People 10 (2004); Lipman, President s Appointees Shun Red Cross Board Meetings, The Chronicle of Philanthropy, March 23, Special Report Thirty of the 50 governing board members are elected by the chartered units, i.e., the chapters and the blood services regions. 40 The 30, with the 8 presidential appointees, if voting, also elect 12 members at large. 41 So the chartered units with 60 percent of the board can effectively govern themselves. This structure may not be uncommon in federated nonprofit corporations. But they do not have the national and international responsibilities of the Red Cross. 42 And, as indicated above, the bylaws require neither the president s appointees nor the public governors to constitute any portion of any board or committee quorum or majority. This is not in the public interest. VII. Accountability By statute the Red Cross annually reported to the secretary of defense, another historical artifact of its wartime relief origins. 43 The secretary is to audit its report, 44 but in reality the U.S. Army Audit Agency review[s] the principal auditor s work and expresses what securities lawyers would call a cold comfort opinion. 45 The Red Cross has an annual audit by an independent certified public accountant. But the auditor s 2004 report states: We did not audit the financial statements of certain chapters, which statements reflect total assets constituting 26 percent and total revenues and gains constituting 16 percent, respectively, of the consolidated totals. Those statements were audited by U.S.C. section (a)(1)(B). Originally, the Red Cross s Central Committee, under its 1905 congressional charter, consisted of only 18 persons. Six were appointed by the president. Another 6 were appointed by the 55 incorporators under the 1900 congressional charter. The final six were representatives of the state and territorial Red Cross societies. Act of Jan. 5, 1905, section 4a, 33 Stat This seems to have been a sensible arrangement. The current governance structure was created by the Act of May 8, 1947, ch. 50, Pub.L , 61 Stat. 83, and codified in See H.R. Rep. No , 105th Cong., 2d Sess. (1998). The cryptic 1947 Senate Foreign Relations Committee report said: Among other things, the membership of this governing board is enlarged and the method of electing it is made more democratic. The local chapters of the Red Cross are officially recognized as the local units of the corporation in the States and Territories of the United States and the importance of their role in the organization is augmented. S. Rep. No , 80th Cong., 2d Sess. (1947), printed in 1947 U.S.C.C.A.N U.S.C. section (a)(1)(C). 42 See supra note U.S.C. section (a). This requirement was repealed effective May 15, 2000, by Pub. L , section See Historical and Statutory Notes, 36 U.S.C.A. section , 2006 Cumulative Annual Pocket Part 20 (2006). The Red Cross now reports to no one U.S.C. section (b). 45 See independent auditor s report A FFG, dated December 2004, from Joyce W. Morrow, CPA, auditor general, U.S. Army Audit Agency (copy on file with author). The Exempt Organization Tax Review January 2007 Vol. 55, No. 1 75

6 other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for such chapters, is based solely upon the reports of the other auditors. 46 The accounting profession permits such reliance, but who knows how consistent or thorough the many audits of the chartered units are? VIII. Red Cross s Proposed Governance Changes On October 30, 2006, the Red Cross issued a press release; its principal officer, Bonnie McElveen-Hunter, issued a message; and it issued a document, Transforming Red Cross Governance, summarizing its governing board actions. On November 3 it posted on its Web site a 127-page report entitled American Red Cross Governance for the 21st Century. The report said the Red Cross will seek legislation to reduce the size of the board from 50 members to a minimum of 12 and a maximum of 20 by March 31, No explanation is given for the date or why there should be any delay. 47 In their 2003 book, The Recurrent Crisis in Corporate Governance, Paul W. MacAvoy, an economist, and Ira M. Millstein, a lawyer, summarize current corporate governance reforms required by the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission, the national stock exchanges, and their own proposals. Although the authors focus on publicly held for-profit corporations, their principles for internal corporate governance are pertinent to major nonprofit institutions like the Red Cross. Those principles are: 1. a majority of independent directors; 2. rigorous standards for director independence; 3. compensation, nominating, and governance committees wholly independent of management and specific responsibilities for these committees; 4. regular board and committee self- and independent evaluations; 46 See KPMG LLP independent auditor s report, dated Oct. 1, 2004 (copy on file with author). The 2005 KPMG LLP Report (copy on file with author) is to similar effect, but the total assets not audited is 24 percent. It also contains the following sentences which did not appear in the 2004 report: An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the American Red Cross s internal controls over financial reporting. Accordingly, we express no such opinion. Were the Red Cross a publicly held corporation, section 404(b) of the Public Company Accounting Reform and Investor Protection Act (popularly known as the Sarbanes-Oxley Act of 2002), Act of July 30, 2002, Pub. L , 116 Stat. 789, the auditor would have had...to attest to, and report on, the [internal control] assessment made by the management A New York Times editorial raises the same question. The New York Times, Nov. 4, 2006, at A periodic reports disclosing whether a code of ethics for the board, CEO, and senior financial and other officers has been adopted or amended, and if not, an explanation for not doing so, what the code provides, and what steps have been taken in response to any violations; 6. separate and defined roles of chair and CEO; 7. board responsibility for strategy, risk management, compensation arrangements, and financial reporting based on sufficient knowledge of the corporation s environment, challenges, and opportunities; 8. board meetings structured to ensure that issues central to the corporation s performance are given sufficient attention and that management presentations on those issues present options; 9. assurance that board agendas prioritize and carry out the foregoing rules of practice; and 10. internal auditors that are hired by and report to the board. The Red Cross s October 30 statements and November 3 governance report say there will be only one category of governing board members, who will be elected by delegates at the Red Cross annual meeting. Obviously, a board of governors, all of whom are still to be elected by the chartered units whom the board is supposed to govern, does not meet the standard of a majority of independent directors or rigorous standards for director independence. It is as if General Motors wholly owned subsidiaries elected the General Motors board to manage them. The Red Cross s documents say a new Governance and Board Development Committee will replace the current nominations process. That is a step in the right direction as far as it goes, because the board s current lack of independence is perpetuated by section 7.6 of the bylaws, which make the Nominations Committee consist of 19 members, 17 of whom are elected for two-year terms by the chartered units, and 2 of whom are appointed by the chair from among the governors elected by the chartered units whose terms are ending. Thus, the subsidiaries can perpetuate their control of their governance. Moreover, the documents do not state how the new Governance Committee will be constituted, nor do they state what will be the qualifications for the prospective governors the committee is to actively recruit and nominate. An important innovation advocated by Millstein and MacAvoy is the responsibility of the board chair or lead director, as follows: 1. ensuring the board s effectiveness and setting its agenda; 2. ensuring the provision of accurate, timely, and clear information to directors; 3. ensuring effective communication with stakeholders in the Red Cross s case the president, Congress, and the American people; 4. arranging regular evaluations of the board, its committees, and individual directors; and 76 January 2007 Vol. 55, No. 1 The Exempt Organization Tax Review

7 5. aiding the effective contribution of nonexecutive directors and ensuring constructive relations between executive and nonexecutive directors. Under the Red Cross s proposals, the chair or principal officer of the board of governors will continue to be appointed by the president, and the responsibilities of the chair and the chief executive officer will be clarified. But the document does not say what those responsibilities will be. The Red Cross s bylaws separate, and purport to define, the roles of the chair (the statutory principal officer) and the president and CEO, but the provisions of section 6.1(c) of the bylaws that define the duties of the chair include the function of reporting to the board of governors the conduct and management of the affairs of the entire organization. Neither section 6.3, which provides that the president and the CEO shall be the CEO of the corporation, nor any other provision of the bylaws gives that officer necessary access to the board of governors, and the role of the president and CEO is also circumscribed by other provisions of the bylaws, particularly in relation to the chartered units, and may even be circumscribed by the board regarding the appointment of administrative officers. IX. Whistle-Blowing Grassley: I am particularly troubled that several volunteers have told me that when they tried to raise concerns or issues about possible misuse of donated funds and property including suspected criminal activity the volunteers were ignored, told to leave or otherwise made to feel like the skunk at the picnic. The Red Cross s documents state that whistleblower processes will be publicized more widely among Red Cross employees, and the appointment of an ombudsman will be considered. They say nothing about records retention. Records retention and whistle-blower protection from retaliation are key Sarbanes-Oxley corporate governance principles. Although they may create difficulties, in the long run they make for a healthier corporate culture. X. Other Presidential Appointees The Red Cross s proposals would eliminate the presidential appointees to the board of governors except for the principal officer chair. Instead, a cabinet council composed of senior governmental officials appointed by the president would provide the board of governors with governmental input. That would require legislation. The Red Cross has important international and national disaster relief blood supply responsibilities. It would make more sense to keep on the board of governors the secretaries of state, defense, homeland security, and health and human services and give each of them authority to appoint specified, high-level voting deputies to the board whose attendance would be statutorily required whenever their principal officers cannot attend. Special Report The governance report perhaps suggests that the presence of these cabinet officers on the Red Cross board might constitute a conflict of interest. 48 It does not indicate whether or not any conflict arises as a consquence of the federal statutes regulating the conduct of United States officers and employees, 49 officers or as a matter of common law principles. In the former case the Department of Justice s Office of Legal Counsel has opined that the attorney general s service ex officio on the board of the National Trust for Historic Preservation 50 is not objectionable. 51 The opinion also considered whether or not the Code of Professional Responsibility was implicated and concluded that it was not. The opinion finally considered common law fiduciary duties and concluded, When Congress established the National Trust, it could have foreseen that the Attorney General might be placed in a position in which there could be a conflict of interest between the interests of the Trust and the interests of the United States. 52 Thus, any conflicts concern would appear to be without merit. 48 Governance Report, supra note 2 at & U.S.C. sections (2000) U.S.C. sections d (2000) Op. Off. Legal Counsel 443, (1982): Section 208 is premised on the concern that a federal officer or employee who is also an officer, director, or trustee of an organization may act in the interests of that organization, rather than in the interests of the United States, in any matter that he, acting as a federal officer or employee, can influence. An ex officio member of an organization, however, serves only by virtue of his holding a particular office. When the office from which his service derives is not an office in the organization itself, and is in fact a public office of trust, the reasonable inference to be drawn is that the ex officio member serves only in the interest of his outside office, and not in the interest of the organization, except to the extent that those interests are consistent. Therefore, it is the position of the Office of Legal Counsel that officer, director, [or] trustee, as used in section 208, should not be read to include an ex officio member of an essentially private body, whose service in that body derives only from a public office of trust. That is, the Attorney General, as an ex officio member of the National Trust, is charged with the responsibility of representing the interests of the United States in matters that come before the Trust. If the Trust s interests and those of the United States are the same with respect to a particular matter coming before the Board, the Attorney General can, in effect, further the interests of the Trust. However, if those interests conflict, the responsibility of the Attorney General is clear; he must represent the interests of the United States in accordance with his responsibilities as chief federal law enforcement officer. No question of divided loyalties is presented, and we believe therefore that the proscriptions of section 208 do not apply. (footnote omitted) 52 Id. at 448; accord, Beverly Ross Campbell and William Josephson, Public Pension Trustees Pursuit of Social Goals, 24 J. Urb. & Contemp. J. 43, & nn (1983). The Exempt Organization Tax Review January 2007 Vol. 55, No. 1 77

8 XI. Audit Committee The Red Cross s documents state that a chief audit executive would report to the audit committee and would be recruited vigorously. But as we have seen, by statute the Red Cross submits annual financial reports to the secretary of defense, who audits the report, and that audit by the U.S. Army Audit Agency is only a review and not an audit. It would make more sense for the Red Cross to submit its entire audit to the Government Accountability Office, and separately to submit the audits of its blood supply regions to the secretary of health and human services for audit by that department s internal auditor. Unfortunately, the Red Cross s proposals do not address these independent audit issues. Nor do the Red Cross s bylaws contain any specific charter for the audit committee or any requirement that its members be independent or even qualified by Sarbanes-Oxley standards, except that the committee cannot include the chair or any governors who are also members of the Finance or Governance committees. Millstein and MacAvoy call for rigorous independence standards for audit committee directors, including the authority to hire and dismiss independent auditors and to preapprove all nonaudit services to be provided by the independent auditor. The audit committee must also establish a mechanism for addressing complaints concerning accounting and compliance. Disclosure is required concerning committee activities and responsibilities, including all nonaudit activities the audit committee may allow the independent auditor to provide and disclosure of the auditor s management letter, management s response, and material reportable events. The Red Cross s bylaws could be amended to implement those requirements. The governance report, however, is silent on those issues. XII. Actions the Red Cross Could Take Now The Red Cross could take many actions to improve its governance that do not require legislation. The governance report acknowledges this. 53 The Red Cross s bylaws do not seem to require that any of the presidential or public governors constitute part of a quorum or part of a vote of the board or any of its committees. The Red Cross could amend its bylaws to require that, for example, its 12 public members roughly one-quarter of the board constitute onequarter of the membership of each committee, statutory or special, including the nominating committee. Similarly, the Red Cross s bylaws could require that two of the seven presidential appointees be members of each committee, and it could recommend to the president that he appoint government officials who will actually participate or at least require that some of the existing cabinet officers participate. The Red Cross s bylaws contain no qualifications for elected governors. The Red Cross could adopt bylaw 53 November 1, 2006, letter from the chair of the American Red Cross, fifth paragraph, page 2. qualifications for both the public members and the governors elected by the chapters and blood services regions. While section 2.19 of the bylaws requires the board of governors periodically to assess the Red Cross s performance and effectiveness, nothing requires the board or any of its committees to have self- or independent evaluations, and obviously the assessment of the Red Cross s performance and effectiveness by a board elected by the chartered units is not independent. To the extent elected governors do not participate, the principle that if a fiduciary misses three meetings, the office is vacant enjoys wide support. Although the statutory term of office of a Red Cross governor is three years, nothing in the statute prevents the board from defining when a vacancy arises or from providing for a vacancy if an elected governor has poor attendance. The statute authorizes the board to make a temporary appointment to fill a vacancy occurring in an elected position on the board. Section 2.9 of the Red Cross s bylaws also authorizes the executive committee to fill vacancies temporarily. The Red Cross could adopt audit committee, whistleblower protection, and records retention bylaws, consistent with Sarbanes-Oxley and other accepted corporate governance standards, and it could appoint an ombudsman or inspector general without waiting for legislation. XIII. Red Cross Reform and the International Federation Governance reform must also be consistent with the seven fundamental principles of the International Federation of Red Cross and Red Crescent societies. Fortunately, those principles are flexible. Among them is independence, i.e., autonomy so that they may be able at all times to act in accordance with the principles of the Movement. The other principles are humanity, impartiality, neutrality, voluntary service, and unity. As to independence: In its broadest sense, the principle of independence is understood as meaning that the Red Cross and Red Crescent must resist any interference, whether political, ideological or economic, capable of diverting it from the course of action laid down by the requirements of humanity, impartiality and neutrality. The federation s discussion of independence acknowledges that: The degree of autonomy necessary to a National Society cannot be defined uniformly and absolutely, since it depends partly on the political, economic and social conditions of the country. Independence does not only relate to the relationship between the Red Crosses and Red Crescents and their nations. It 78 January 2007 Vol. 55, No. 1 The Exempt Organization Tax Review

9 is also related to its independence vis-à-vis other forms of power whether religious, political, economic, etc. So the Red Cross Red Crescent needs to be independent from religious, political parties, companies and so on. 54 (emphasis added) XIV. Conclusion At the November 2001 congressional hearing, Spitzer said, I think it almost necessarily the case that there is some appropriate not only Federal oversight but potentially a legislative role...should it become clear that there is a larger structural problem 55 It was clear then, and now it is abundantly clear. Unfortunately, H.R. 6343, introduced on December 5, 2006 by Rep. George P. Radanovich, R-Calif., with Rep. Jane Harman, D-Calif., meets far too few of the standards discussed in this article On April 14, 2006, Secretary of State Condoleeza Rice wrote that the Magen David Adom Society of Israel is not being denied participation in the activities of the International Red Cross and Red Crescent Movement. 71 Federal Register (April 24, 2006). The basis for that determination was not stated. As late as June 21, 2006, the issue was still in doubt. Israelis Blocked on Red Cross Emblem, International Herald Tribune, June 21, 2006, at 3. Not until June 22 was a plan to allow Israel to join approved. Red Cross Admits Israel, Though Muslim Group Objects, The New York Times, June 22, 2006, at A8; Goldfarb, For Israel Aid Group, Long Road to Inclusion, The Washington Post, Aug. 31, 2006, at A Serial No , Response by Charitable Organization to the Recent Terrorist Attacks, hearing before House Ways and Means Subcommittee on Oversight, 107th Cong., 1st Sess. 64 (2004). The Exempt Organization Tax Review January 2007 Vol. 55, No. 1 79