Due-Diligence Redundancy

Flaw #8 from the Project Streamline report:

Since it is difficult to determine exactly what is needed for due diligence (and since the list regularly changes), grantmakers tend to play it safe at the recommendation of their legal and financial advisors, requiring redundant and often unnecessary documentation from grantseekers. According to one foundation focus group participant, the foundation’s auditors give such confusing and contradictory advice that “we just make everyone go through the same process just in case, even though it seems like a waste of time for some of these grants.”

For example, the Tax Determination Letter—the original letter from the Internal Revenue Service (IRS), establishing an organization’s tax status—does not prove that the organization is still in good standing with the IRS. The only real way for grantmakers to verify an organization’s standing is to research the nonprofit before each payment to be sure that the letter has not been rescinded. The IRS suggests that granting organizations either access the Business Master File (a file that is updated monthly) from the IRS, or rely on a third-party (such as GuideStar’s Charity Check) to verify that the organization remains in good standing. However, most grantmakers, often at the insistence of their legal and/or financial counsel, continue to collect the Tax Determination Letter for each grant request.

“I know that we could stop asking for the IRS letter, and could use a system like GuideStar. However, our auditors ask for the tax letter to be in each file!”

I’m an advisor to foundations and other grantmaking entities. I want to help them be as efficient and effective as possible. But more than anything, I want to make sure they do not get into any trouble. Even though my firm is not directly charged with managing their compliance, I do everything I can to help my clients gain access to the tools and services they need to insure they never run afoul of the IRS. So I understand why this “flaw” exists.

It seems to me that one of the solutions to this sort of issue rests in the idea of nonprofit “stock exchanges”. I’m not convinced that there is a viable concept behind the idea of nonprofits “trading” on an exchange. But I do think that an “exchange” could emerge that would essentially make the promise to funders that listed nonprofits had passed a level of due diligence to qualify and were required to submit regular documentation of their ongoing compliance. It would not be the responsibility of the exchange to judge the impact of the nonprofit (that would be the funders job, just like the New York Stock Exchange does not suggest that every company is a good investment). But at least funders could dispatch with all the run of the mill due diligence and the IRS could extend a sort of safe harbor to funders who gave to listed nonprofits.

I wrote more about this idea in the Financial Times column titled The Donor Landscape of 2033 is Bright.

One Comment

  1. Adin Miller says:

    Sean, I like the idea of the stock-exchange or some other platform that provides a sort of safe-harbor list to funder. Really, when it comes down to it, much of the difficulty rests in individual interpretations of what’s actually required. I’ve had one auditor tell me one thing that another auditor later contradicts. By default, I’d lean toward the more conservative approach in order to minimize my organization’s risk exposure. Unfortunately, the nonprofit applicants and grantees end up suffering.