Pillsbury Winthrop Shaw Pittman LLP

WMACCA February 7, 2008 Jerald A. Jacobs Pillsbury Winthrop Shaw Pittman LLP Washington, D.C.

2007 ANNUAL UPDATE OF NONPROFIT ORGANIZATION LAW

ANTITRUST

Antitrust Modernization Commission Delivers Final Report. April 2, 2007. The 12-member Antitrust Modernization Commission (AMC) delivered its final 500- page report four years after AMC was created to assess the state of antitrust law. Seven of the Commissioners issued a three-page separate statement finding that, overall, the antitrust laws are working reasonably well due in part to the willingness of the courts and antitrust enforcers to revisit and re-interpret antitrust issues. The Commission then offered 80 pages of recommendations. General recommendations included a call to repeal the Robinson-Patman Act (RPA) and wholly new treatment of indirect purchaser litigation, including overruling Illinois Brick and Hanover Shoe and removing indirect purchaser actions brought under state “repealer” laws to federal court. Although the AMC did not take a strong stand against all antitrust exemptions, it did state that statutory exemptions from antitrust laws should be disfavored and “granted only rarely,” and listed several pieces of information Congress should have on hand when considering exemption statutes. With reference to the Federal Trade Commission (“FTC”), the AMC voted to keep the FTC involved in antitrust enforcement along with the DOJ, voted to de-link funding for the FTC and the Antitrust Division of DOJ from the Hart-Scott-Rodino (HSR) Act filing fee revenues, asked the FTC and DOJ to work out a new agreement for determining which HSR deals go to which agency for approval, and recommended that the FTC and DOJ continue to expand the issuance of closing statements to include not only prominent enforcement actions, but any actions that include significant investigation. The AMC also recommended that antitrust agencies study the relationship between market concentration and market performance, and undertake retrospective studies of merger enforcement decisions.

Broadcom Corp. v. Qualcomm Inc., 2007 US App. LEXIS 21092 (3d Cir. 2007). September 4, 2007. The Third Circuit held that a patent-holder’s violation of promises given to standards development organizations is anticompetitive conduct actionable under the Sherman Act. The Court stated that standards developing organizations (“SDOs”) often require firms supplying essential technologies to commit to licensing their technologies on fair, reasonable, and nondiscriminatory (“FRAND”) terms. Thus, a firm’s FRAND commitment is an important factor considered by an SDO

in evaluating the suitability of a given proprietary technology versus that of competing technologies. In this case, Broadcom Corp. filed a complaint against Qualcomm, Inc. accusing the latter of violating a commitment to industry standard-setting groups studying a technology called wideband code-division multiple access (WCDMA) to license its technology on FRAND terms. The European Telecommunications Standards Institute (ETSI) and its SDO counterparts in the United States created the standard called the Universal Mobile Telecommunications Systems (UMTS) standard. Some of the essential technology that ETSI included in the UMTS standard is supplied by Qualcomm, which holds intellectual property rights (IPR) in this technology. The ETSI requires a commitment from vendors supplying technology used in ETSI standards to license the vendors’ technology on FRAND terms. However, after ETSI issued the standard including Qualcomm’s technology, Qualcomm proceeded to license the technology on non-FRAND terms.

In August 2006 the District Court granted Qualcomm’s motion to dismiss the case, stating that Qualcomm enjoyed a legally-sanctioned monopoly in its patented technology, and that this monopoly conferred the right to exclude competition and set the terms by which that technology was distributed. Broadcom appealed and the Third Circuit held first that the District Court erred in its ruling that abuse of a private standard- setting process does not state a claim under antitrust law; it found that conduct undermining the pro-competitive benefits of private standard setting may be considered anticompetitive. The Court found that “(1) in a consensus-oriented private standard setting environment, (2) a patent holder’s intentionally false promise to license essential proprietary technology on FRAND terms, (3) coupled with an SDO’s reliance on that promise when including the technology in standard, and (4) the patent holder’s subsequent breach of that promise, is actionable anticompetitive conduct. Based on this, the Court concluded that Broadcom had stated a claim for monopolization under §2 of the Sherman Act. Qualcomm possessed monopoly power in the relevant market, and Qualcomm obtained and maintained its market power willfully, not as a consequence of superior product, business acumen, or historic accident. The Court also held that the District Court impermissibly applied a heightened pleading requirement when it dismissed its attempted monopolization claim for failure to allege specific facts regarding the composition and dynamics of the UMTS chipset market. The Court found that dismissal of Broadcom’s monopoly maintenance claim was not improper.

DOJ Approval of VITA Standards Plan. October 30, 2006. The Department of Justice Antitrust Division approved a proposal submitted by VMEbus International Trade Association (VITA), a nonprofit international trade organization that develops standards. The proposed standard would require participants in the VITA Standards Organization (VSO) standards-setting process to disclose patents that are essential to implement a draft VSO standard, to commit to license on FRAND (fair, reasonable and non-discriminatory) terms, and unilaterally to declare the most restrictive licensing terms that will be required. The proposed policy also establishes an arbitration process that may be used to resolve compliance disputes. According to the Justice Department, VITA standards enable competition in the VME industry, avoid unreasonable patent licensing terms that might threaten the success of future standards, and avoid disputes over

licensing terms that can delay adoption and implementation after standards are set. The Department also said the policy would enable VITA to make better informed decisions.

Donnelly Commodities Incorporated v. Association of American Railroads, et. al., Class Action Complaint filed August 24, 2007 in United States District Court for the District of Columbia. Donnelly Commodities filed a complaint on behalf of itself individually, and on behalf of a plaintiff class of those who purchased unregulated rail freight transportation services from Defendants between July 1, 2003 to the present, alleging that Defendants conspired to fix, raise, maintain, or stabilize prices of unregulated rail freight transportation services sold in the United States by imposing agreed-upon Rail Fuel Surcharges on rail freight shipments. The plaintiff brought the action pursuant to Sections 4 and 16 of the Clayton Act for treble damages and injunctive relief, as well as reasonable attorneys’ fees and costs. Donnelly is a freight consolidator who purchased unregulated rail freight transportation services directly from the Defendants. The Defendant Association of American Railroads (“AAR”) is a trade association located in Washington, D.C. The AAR publishes key indices used to compute unregulated rail freight charges, engages in lobbying on behalf of its members, gathers and maintains a variety of information relating to rail freight service, and issues publications. The additional named defendants are railway companies (collectively, the “Railroad Defendants”). The railroad freight industry became highly concentrated after Congress passed legislation in 1976 and 1980 which together largely deregulated the railroad industry. Currently, the five Railroad Defendants operate more than 90 percent of all domestic railroad track and are responsible for more than 90 percent of the total ton- miles of Class I freight shipped in the United States. As the railroads contracted for freight transportation services, they increasingly required shippers to enter freight contracts with cost escalation provisions tied to the Rail Cost Adjustment Factor (“RCAF”), which is published by the AAR’s Policy and Economics committee, and includes fuel prices as a component of the cost escalation factor.

The Plaintiff alleges that Defendants agreed upon the use of common indices and trigger points for setting Rail Fuel Surcharges and adjusting the percentages monthly. Defendants also published Rail Fuel Surcharges on the Internet to facilitate coordination and the detection of any deviation from collusive pricing. Plaintiff alleged that Defendants maintained uniformity of Rail Fuel Surcharges by agreeing to compute the surcharges as a percentage of the rail freight transport base rate and by agreeing upon common indices, timing, and trigger points for adjusting the percentages. The complaint states that Defendants, by working in concert, were able to use Rail Fuel Surcharges as revenue generators and profit centers. In a meeting around April 2003, top executives of the Railroad Defendants met and entered into an agreement to act in concert with one another in demanding the Rail Fuel Surcharges from shippers. The Defendants implemented and maintained their agreement by publicly announcing surcharge increases and posting the monthly fuel surcharge percentages on their internet sites. The complaint alleges that because the Railroad Defendants are geographically dispersed and acquire fuel at different prices at different times, the parallel behavior could not have resulted from chance. The complaint further alleges several antitrust “plus factors” such as: the railroad industry is highly concentrated, there are significant barriers to entry, the rail fuel surcharges were highly standardized, the railroad industry has a history of price fixing

and anti-competitive behavior, the CEOs of the Defendants are all board members of AAR, and Defendants acted in contravention of their individual economic interests.

FTC Docket Number 9311. June 20, 2007. A professional certification rule that kept dental hygienists from giving underprivileged children preventive dental care without a dentist’s examination was reversed. In this case, the South Carolina Board of Dentistry (the “Board”) had maintained that dental hygienists could not give dental care without a dentist’s examination. In 2002, a state administrative law judge concluded that the Board’s regulation was unreasonable and contravened state policy. The Board took the case to the Supreme Court, arguing that its actions were exempt from FTC review because of the State Action Doctrine. The South Carolina legislature intervened by enacting the Dental Practice Act in May of 2003, which expressly provided that dentist examination requirements applicable in some settings do not apply to dental hygienists’ provision of preventive care services developed in public health settings under the direction of the state health department. However, after a four year long administrative trial at the Federal Trade Commission and after the Chief Administrative Law Judge issued a scheduling order, the Board executed a consent agreement and the commissioners accepted the settlement. In total, the dentist-exam requirement has been reversed three times. Finally, under the 2007 consent order, the Board agrees to support the state’s Dental Practice Act, which prevents the Board from requiring a dentist examination as a condition of dental hygienists in public health settings.

In the Matter of Rambus Inc., Final Order, 2007 FTC LEXIS 13, FTC Docket No. 9302. February 2, 2007. The Federal Trade Commission issued a final order Feb. 7, 2007 determining the remedy for computer technology developer Rambus, Inc’s violation of antitrust law. Rambus was found guilty of unlawfully monopolizing markets by failing to disclose its own patents and patent applications for DRAM chips while participating as a member of the Joint Electron Device Engineering Council (JEDEC), a standard-setting organization. The Commission not only ordered Rambus to cease and desist its deceptive behavior, but required Rambus to license its SDRAM and DDR-SDRAM technology and also set maximum allowable rates it could collect from companies that had already incorporated DRAM technology. The Commission also required Rambus to hire a Commission-approved compliance officer. The Commission rejected Rambus’s assertion that cease-and-desist orders are the only appropriate remedy the Commission is authorized to issue and held that it has “wide latitude for judgment,” and that its authority extends to “restoring, to the extent possible, the competitive conditions that would have been present absent Rambus’s unlawful conduct.” The only requirement is that the remedy have a reasonable relationship to the violation. The court further held that a remedy that places the party in the “’but for’ world—i.e. the circumstances that would exist had Rambus not engaged in its deceptive course of conduct,” does not constitute punitive relief and that requiring Rambus to license certain products would reverse the “anticompetitive effects of the deceptive course of conduct.” The Commission also established that it is entitled to require royalty-free licensing, but that this remedy is subject to “special proof,” which, although not yet defined, requires at a minimum that the relief is necessary to restore the competitive conditions that would have existed absent the misconduct. The Commission held that Complaint Counsel did not meet this minimum standard, because, although counsel submitted substantial

evidence, Rambus’s argument that it would have contracted with JEDEC subject to a RAND licensing agreement was sufficiently plausible. The Commission therefore held that the remedy of requiring royalty-free licensing is excessively harsh, but that instead, limits on the royalties Rambus could charge would be imposed.

Justice Department Business Review Letter Approving Patent Disclosure and Licensing Policy . April 30, 2007. The Institute of Electrical and Electronics Engineers, Inc. (IEEE) sought the approval from the Antitrust Division of the Department of Justice for a new policy designed to improve the efficiency of its standard-setting activities. IEEE requested a business review letter from the Antitrust Division concerning its plans for enforcement regarding the proposed policy. The policy would allow holders of patents essential to IEEE standards a number of options: 1) not to provide any licensing information; 2) to state the belief that its patents are not essential to the IEEE standard; 3) to state that it will not assert essential patent claims against implementers of the standard; 4) to commit to license its essential patent claims on reasonable and nondiscriminatory terms. Such a policy would permit IEEE standard-setters to determine the relative costs of competing technologies. In approving the IEEE policy conditionally, the Antitrust Division cautioned that antitrust review under the rule of reason would be applicable, that joint cost discussions could raise antitrust concerns, and that discussion of specific licensing terms was prohibited.

Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007). June 28, 2007. The U.S. Supreme Court held, by a five-to-four vote that minimum resale price maintenance, commonly called “RPM,” would no longer constitute a per se violation of the antitrust laws. The ruling overturns a nearly one-hundred-year-old precedent forbidding sellers to establish and enforce minimum pricing among re-sellers such as wholesalers or retailers. Henceforth, each challenged situation of RPM must be examined by a court on its individual merits under a “rule of reason” test to determine if the situation harms competition. In this case, based on its policy of refusing to sell to retailers that discount its goods below suggested prices, Leegin stopped selling to PSKS. PSKS filed suit alleging that Leegin violated the antitrust laws by entering into vertical agreements with its retailers to set minimum resale prices. Prior to this ruling, manufacturers or wholesalers could and did establish and promulgate “suggested” retail prices to retailers; but they had to carefully avoid enforcing their suggested prices. The sellers could terminate re-sellers that did not follow the suggested prices, but sellers could not engage in any conduct which suggested an agreement existed with the re-sellers. In this decision, the Court recognized that prior RPM jurisprudence is a flawed doctrine that creates legal distinctions that operate as traps. This ruling should also protect most minimum advertised price (“MAP”) policies, under which the manufacturer requires the retailer to advertise prices no lower than a specified minimum unless the policies are the product of a horizontal cartel. Leegin further holds that RPM arrangements used to facilitate manufacturer or retail cartels are unlawful under the rule of reason.

As a result, many manufacturers will be able to implement resale price maintenance and establish the retail prices of their products. However, the final results of

this ruling are unclear. States may interpret their own antitrust laws differently; and some plaintiffs may allege narrow market definitions. This ruling addresses a two-party distribution system; its application to the equally-common three-party distribution has not yet been fully discussed. This ruling will almost certainly lead to an increase in antitrust lawsuits in this area which will require protracted antitrust litigation to determine how the “rule of reason” applies. The circumstances of when and how RPM damages competition remain unclear.

COMMUNICATIONS

Federal Trade Commissioner J. Thomas Rosch’s Speech: The Importance of Self-Regulation. April 24, 2007. In a speech at the American Teleservices Association (“ATA”) Washington Summit on April 24, 2007, Commissioner Rosch emphasized the importance of a third-party review process to supplement the internal compliance mechanisms promulgated by the ATA. Commissioner Rosch expressed his appreciation for the ATA’s efforts at self-regulation but suggested implementing an independent auditing component to augment the ATA’s existing compliance efforts. According to Commissioner Rosch’s recommendations, an effective third-party review system would: 1) be impartial and objective; 2) be public; and 3) apply standards consistently. Commissioner Rosch offered the National Funeral Directors Association (NFDA) as an example of a successful industry self-regulation. The NFDA developed a program jointly with the Federal Trade Commission that offered offenders the opportunity to avoid litigation by making voluntary penalty payments to the U.S. Treasury in the event of an offense.

Omega World Travel v. Mummagraphics, Inc., 469 F.3d 348 (4th Cir. 2006). November 17, 2006. The 4th U.S. Circuit Court of Appeals held that a 2003 federal law, the Controlling the Assault on Non-Solicited Pornography and Marketing Act of 2003, known as the CAN-SPAM Act, pre-empts state laws that allow suits for false information in junk emails if the misrepresentation is immaterial. In this case, Mummagraphics received eleven emails from Cruise.com offering travel deals, and Mummagraphics claimed that these emails contained several inaccuracies, including a statement that the recipient had signed up for the mailing list, as well as an Internet domain name not linked to Cruise.com. Mark Mumma, the President of Mummagraphics, contacted Omega World Travel to complain, but refused to provide his email for removal from the mailing list. Instead, Mumma demanded that Omega Travel remove all 347 Internet domain names listed on Mumma’s website, which was devoted to opposing spam messages. The owners of these 347 domain names had indicated, by registering on Mumma’s website that they did not wish to receive spam email. When Omega Travel refused to remove all 347 names, Mumma threatened to sue and demanded a settlement. Omega Travel declined to pay the settlement and Mumma posted information on Mumma’s website referring to the company as spammers. Omega Travel sued for defamation and Mumma counterclaimed stating that the Cruise.com emails contained actionable inaccuracies and that Omega Travel failed to comply with federal and state requirements that they stop sending messages to recipients who opted out through special procedures.

The Court held that spam is a serious and pervasive problem, but the federal law does not impose liability at the mere drop of a hat. The Court stated, “Congress did not intend ‘falsity’ to encompass bare error because such a reading would upset the Act’s careful balance between preserving a potentially useful commercial tool and preventing its abuse.” This decision is significant for entities that use mass email to reach likely customers, but face potentially costly legal judgments if they conceal the source of transmission or contain false information. Most states have laws restricting mass junk email, known as “spam”, and allow suits for damages for violations. The Fourth Circuit held that the federal act partially pre-empts Oklahoma’s laws allowing damages if email misrepresents who transmits it, omits the point of origin or contains false information, “insofar as state laws applied to immaterial misrepresentations.” Therefore, if commercial emailers simply comply with the federal act, they need not worry about state actions for immaterial misrepresentations.

EMPLOYMENT

People ex rel Spitzer v. Grasso, Slip Op. No. 52019(U), 2006 WL 3016952 (N.Y. Sup. Oct. 18, 2006). The Supreme Court of New York County found that Richard Grasso, former Chairman of the Board and CEO of the New York Stock Exchange (NYSE), received unreasonable and unlawful annual compensation and Supplemental Executive Retirement Plan (SERP) payments in violation of the New York Not-for-Profit Law (N-PCL) and breached his fiduciary duty by accepting those payments and failing to disclose the amount of the plan. Additionally, the Court found against the NYSE for making those payments; but, because the NYSE has merged into a for-profit corporation, the court acknowledged that it could not order the NYSE to implement safeguards to ensure compliance with the N-PCL in the future. Grasso argued that, because the NYSE governing board asked him to tender his resignation rather than merely accept a tendered resignation, he was therefore involuntarily terminated and was due $48 million in termination benefits, an amount that only weeks before he had stated that he would forego. Because there was no written notice of termination (or written notice of a waiver of the writing requirement), §15-301 of General Obligations Law states that it could not have been an involuntary termination; and therefore Grasso was not due those benefits. Further, Grasso argued that because the NYSE was merged into a for-profit corporation the New York Attorney general no longer had standing to pursue the matter. The Court held that the Attorney General brings suit directly, for the benefit of the People of New York; and therefore he does not lose standing following a merger. The court determined that the amount and timing of disbursements from the SERP were improper, especially since early distributions could only be made after a hardship determination is made, which was not the case for Grasso. Further, the Court claimed to be “shocked” that Grasso defended the SERP deferred compensation payments in part by saying that he did not know the value of the plan until it reached $100 million. The Court acknowledges the “fundamental duty of each member of a board to understand the business of the company upon whose board they sit.” As such, the Court ordered an accounting to determine how much of the SERP actually represents deferred income actually earned or vested prior to departure and how much interest Grasso owes on prematurely paid SERP advances.

ETHICS

Honest Leadership and Open Government Act of 2007, 110 Pub. L. No. 81, 121 Stat. 735 (2007). September 14, 2007. On September 14, 2007, President Bush signed into law the Honest Leadership and Open Government Act of 2007. This Act strengthens the ethical standards that govern lobbying activities. The Act amends the Lobbying and Disclosure Act to require quarterly instead of semi-annual filing of lobbying disclosure reports and also requires electronic filing. The Act mandates semiannual reports on certain contributions, including any contributions of $200 or above to any Federal candidate or officeholder, leadership PAC, or political party committee. Finally, the Act requires candidates, PACs and political party committees to reveal whether they received two or more political contributions in an aggregate of $15,000 or above from a lobbyist. The contents of lobbyist registrations is revised by the Act, requiring disclosure of any organization other than the client, that contributes over $5,000 toward the registrant’s lobbying activities in a quarterly period, and actively participates in the planning, supervision, or control of the lobbying activities.

The Act bans the provision of gifts or travel to legislative branch officials by registered lobbyists. The Act amends the Lobbying Disclosure Act to increase from $50,000 to $200,000 the penalty for failure to comply with lobbying disclosure requirements, and adds criminal penalties for anyone who knowingly and corruptly fails to comply with the Act.

Revisions to Rules of the Supreme Court of the United States, US Orders 2007-27. Adopted June 25, 2007. Effective Date August 1, 2007. The proposed Revised Rule 37.6 requires that a brief filed must indicate whether counsel for a party authored the brief in whole or in part, whether such counsel or party is a member of the amicus curiae, or friend-of-the-court, or made a monetary contribution to the preparation or submission of the brief. Additionally, such brief must disclose every person other than the amicus curiae, its members, or its counsel, who made such a monetary contribution. This disclosure must be made in the first footnote on the first page of the text. Essentially, this change would require the disclosure that a party made a monetary contribution to the preparation or submission of an amicus curiae brief in the capacity of a member of the entity filing as amicus curiae.

INTELLECTUAL PROPERTY

In re National Council for Therapeutic Recreation Certification, Inc., Trademark Trial and Appeal Board, Serial No. 75701344. September 15, 2006. The Trademark Trial and Appeal Board reversed the ruling of the trademark examining attorney and permitted registration of the mark “Certified Therapeutic Recreation Specialist” as a certification mark. The examining attorney believed that either the phrase was merely a generic term for the services that the National Council for Therapeutic Recreation Certification (NCTRC) provided, or that the NCTRC did not make a proper showing of “acquired distinctiveness” for the phrase. The Appeal Board

disagreed: simply because “certified” and “therapeutic recreation specialist” are generic when analyzed individually does not mean that the combined phrase is generic. The examining attorney conducted a Nexus search for the phrase used without capitalization and found several instances that seemed to argue against registration. On further review, however, it was determined by the Appeal Board that many of those instances actually referred to persons who had indeed been certified by NCTRC; and there were many other references to the phrase in proper capitalized form. The Appeal Board found that while the examining attorney had evidence arguing for the phrase being generic, that evidence was offset by the applicant’s evidence showing proper use of a certification mark and recognition of that mark within the field, including in universities, hospitals, rehabilitation centers, and state regulations. Finally, the Appeal Board found that the phrase had acquired distinctiveness: the NCTRC had been the only organization certifying recreational therapists for over twenty years, had spent money advertising and protecting the phrase, and had submitted accompanying declarations from people within the recreational therapy field who acknowledged the distinctiveness of the phrase. The Board was not bothered by the fact that many of these declarations were evidently drafted by NCTRC’s counsel. In re The Council on Certification of Nurse Anesthetists, Trademark Trial and Appeal Board, Serial No. 75722091, March 22, 2007. The Council on Certification of Nurse Anesthetists (CCNA) sought registration on the Principal Register of the designation CRNA as a certification mark. The trademark examining attorney refused registration on the ground that applicant’s use of the designation CRNA on the specimens of record conveys only the commercial impression of a title or degree and, thus, does not function as a certification mark. The examining attorney also refused registration on the ground that the designation CRNA is either a generic term for the identified services, or in the alternative, that the designation is at least merely descriptive of such services and the showing of acquired distinctiveness furnished by applicant is insufficient to establish that CRNA has become distinctive of the services. CCNA appealed and submitted several items as evidence of the use of CRNA as a certification mark, rather than just a title including materials used to study for certification, as well as a certificate given to nurse anesthetists upon certification. The Appeal Board decided that the specimens submitted by CCNA were evidence merely of applicant’s promotion of use of the term CRNA, but without any indication of what the term is identifying. However, the certificate issued to certified registered nurses is often displayed by certified registered nurses at their places of business; and the record shows that a nurse anesthetist must meet certain eligibility requirements set by CCNA and pass a certification exam conducted by CCNA. Based on these specimens, the Appeal Board reversed the refusal on the ground that the CRNA designation fails to function as a certification mark. The examining attorney had taken the position that the CRNA was merely a generic designation for a certified registered nurse anesthetist. However, because the evidence relied on by the examining attorney does not demonstrate interchangeable use of CRNA and certified registered nurse anesthetist, there is no third party use of CRNA. Rather the evidence points to the uniqueness of the applicant and its certification program in the field. The Appeal Board found that the examining attorney did not establish by clear evidence that CRNA has come to be understood as substantially synonymous with certified registered nurse anesthetist. However, the Board held that

CCNA did not offer enough evidence to establish the acquired distinctiveness of the designation. The final decision of the Appeal Board was that the refusals to register on the grounds that CRNA does not function as a certification mark, and that the mark is generic, are reversed. The refusal to register on the ground that CRNA is merely descriptive and applicant’s showing of acquired distinctiveness is insufficient is affirmed.

Internal Revenue Service Exempt Organizations Office: Report on Exempt Organizations Executive Compensation Compliance Project , March 2007. The IRS released a report in 2007 that detailed the findings and conclusions of its Executive Compensation Compliance Initiative (the “Initiative”), which it began in 2004. The Initiative included education and outreach components complemented by an examination program focusing on executive compensation paid by a broad range of public charities as well as private foundations. The Initiative encompassed Forms 990 and related returns for tax years beginning in 2002 and was comprised of three parts. Part I consisted of compliance check letters sent to 1,223 organizations whose Forms 990 and 990-PF fit within discrete categories of missing information indicating they warranted follow-up. Part II involved an examination of 782 organizations and approximately 10% of these examinations remain open. The purpose of Part II of the Initiative was to determine whether the compensation of disqualified persons was reasonable in accordance with Internal Revenue Code Chapter 42 and other Code requirements. Part III, which is ongoing, draws on the information obtained in the first two parts of the Initiative and includes 200 compliance checks and 50 additional single issue examinations focusing on organizations with loans to executives.

The Report summarized the findings from Parts I and II of the Initiative. Among these findings was the existence of major reporting issues, particularly in the areas of excess benefit transactions and transactions with disqualified persons. More than 30% of the compliance check letter recipients filed amended returns or schedules as a result of the compliance check contact. Where problems with reporting were found, significant dollar amounts were assessed; 25 examinations resulted in proposed excise tax assessments under Chapter 42, aggregating in excess of $21 million, against 40 disqualified persons or organization managers. While high compensation amounts were prevalent in the organizations involved in the initiative, for the most part the salaries were substantiated. The IRS additionally determined that additional education and guidance are needed for examiners and that changes in the Form 990 series are necessary to reduce reporting errors and allow the IRS to identify compensation issues.

Internal Revenue Service Form 990 Return of Organization Exempt from Income Tax. June 2007. Form 990 is used to report the income, assets, liabilities and other information of IRC § 501(c) tax-exempt organizations and is a critical component of the IRS oversight of such organizations. The Instructions for this form were revised and augmented for 2006, and in 2007 the IRS released further revisions.

Changes to the 2006 IRS Form 990. Several changes were made to the 2006 Form 990 based on legislation passed in 2006. The following items reflect changes in

Form 990 made by the Pension Protection Act of 2006. First, the form was revised to reflect the requirement that a section 509(a)(3) supporting organization must generally file Form 990 (or Form 990-EZ, if applicable), even if its gross receipts are normally $25,000 or less. Sponsoring organizations and controlling organizations, as defined in Section 512(b)(13), cannot file Form 990-EZ; these organizations must file their return on Form 990. The definitions of disqualified persons and excess benefit transactions have been revised. New lines were added to show total contributions to, and grants made from, donor advised funds for the year. This change reflects section 6033(k) requirements for sponsoring organizations. Section 501(c)(3) organizations that filed Form 990-T after August 17, 2006 must make the Form 990-T available for public inspection.

Section 516 of the Taxpayer Increase Prevention and Reconciliation Act of 2005 also resulted in changes to the Form 990. Lines have been added to the 990 and the 990- EZ to ask if the organization was a party to any prohibited tax shelter transactions. As a result of the legislation, new section 4965 was added to the Internal Revenue Code. This section imposes an excise tax on certain tax-exempt entities that are party to prohibited tax shelter transactions, and any entity manager who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction and knows or has reason to know that the transaction is a prohibited tax shelter transaction. New section 6033 was also added to the Code and provides new disclosure requirements on any tax-exempt entity that a is a party to a prohibited tax shelter transaction. Every tax-exempt entity must file a disclosure of such entity being a party to any prohibited tax shelter transaction and the identity of any other known party to the prohibited tax shelter transaction.

The IRS also made changes to the 2006 Form 990 that did not result from any specific piece of legislation. First, an exempt organization must file electronically if it has total assets of $10 million or more at the end of the tax year. Next, the discussion of an excess benefit transaction was revised to include embezzlement. The discussion for determining whether a non-life insurance company qualifies as a tax-exempt organization under section 501(c)(15) was revised to reflect the meaning of gross receipts. Finally, several instructions have been modified to include additional reporting requirements and to provide greater clarity.

Draft Redesigned Form 990. In June 2007, the IRS released for public comment a discussion draft of a redesigned Form 990. This draft is a significant redesign of the form and the IRS anticipates using this form in the 2008 tax year. The redesign consists of a 10-page base form to be completed by each filing organization, along with 15 separate schedules requiring specific information from organizations engaged in particular activities, such as fundraising, political campaign and lobbying activities, and non-cash charitable contributions. The new draft is based on three principles: enhancing transparency, promoting tax compliance, and minimizing the burden on the filing organization. The IRS and its stakeholders will be provided with a realistic picture of the organization and its operations, along with a basis for comparing the organization to similar organizations, which will enhance transparency. To promote compliance, the form aims to provide an accurate reflection of the organization’s operations and use of assets, so the IRS may efficiently assess the risk of noncompliance. To minimize the

burden on the filing organization, questions will be asked in a manner that makes it relatively easy to fill out the form, and that do not impose unwarranted additional recordkeeping or information gathering burdens to obtain and substantiate the reported information. More specifically, the 2007 supplement offered clarification and guidance relating to: 1) the class of expenses to be reported on Line 1d (Government contributions) 2) the types of expenses to be included on Line 25, (Compensation of current officers, directors, key employees, etc.) and the appropriate method of accounting for those expenses; 3) the information sought on lines 75b and 75c (concerning the relationships between officers, directors, and highly compensated employees and the types of compensation they receive); 4) the information sought in Part V-B (Former Officers, Directors, Trustees, and Key Employees That Received Compensation or Other Benefits); 5) the types of transfers to be reported on Lines 106 and 107; and 6) the persons to be identified on Schedule A (Supplementary Information for 501(c)(3) organizations).

Internal Revenue Service Notice 2007-62, August 6, 2007. This notice announces the intent of the Treasury Department and the Internal Revenue Service to issue guidance under §457 of the Internal Revenue Code, which applies to nonqualified deferred compensation plans of state and local governments and tax-exempt entities concerning the definitions of a bona fide severance pay plan under §457(e)(11) and the definition of substantial risk of forfeiture under §457(f)(1)(B). Section 457(e)(11) states that §457 does not apply to certain types of plans, including a bona fide severance pay plan. The planned guidance will provide that an arrangement is a bona fide severance pay plan under §457(e)(11), and thus is not subject to the requirements of §457, if (1) the benefit is payable only upon involuntary severance from employment, (2) the amount payable does not exceed two times the employee’s annual rate of pay, and (3) the plan provides that the payments must be completed by the end of the employee’s second taxable year following the year in which the employee separates from service.

Section 457(f)(1) provides that compensation under a nonqualified deferred compensation plan subject to §457(f) is included in the gross income of the participant or beneficiary for the first taxable year in which there is no substantial risk of forfeiture of the rights to such compensation. Section 457(f)(3)(B) states that the rights of a person to compensation are subject to a substantial risk of forfeiture if such person’s rights to such compensation are conditioned upon the future performance of substantial services by any individual. Substantial risk of forfeiture is important under section 457(f) plans because benefits under such plans are subject to income tax when they are no longer subject to a substantial risk of forfeiture. The IRS plans to issue guidance applying the same definition of substantial risk of forfeiture under section 457(f) as was previously published under section 409A. The definition of “substantial risk of forfeiture” under section 409A generally disregards: (1) any extension of the period that a benefit is subject to a “substantial risk of forfeiture”, (2) any risk of forfeiture based on refraining from the performance of services, (3) any risk that is applied to a regular salary, and (4) any risk of forfeiture based on the employee quitting for “good reason”, unless the requirements for good reason are strong enough to be tantamount to involuntary termination. The Treasury and the IRS anticipate the guidance delivered in this Notice would be prospective. The IRS is accepting written comments until October 15, 2007.

Internal Revenue Service Release of Governance Guidelines for Exempt Organizations. The IRS posted a set of guidelines to its website designed to help exempt organizations maintain regulatory compliance and public support. Specifically, the following guidelines were suggested to promote effective governance and the successful discharge of the responsibilities unique to exempt organizations: 1) Provide a mission statement describing the reason for the charity and the goals it seeks to achieve; 2) Develop a code of ethics to convey a strong culture of legal compliance and integrity; 3) Implement policies and procedures to enable directors to discharge their duties and act in good faith; 4) Implement a conflict of interest policy that ensures that directors carry out their duty of loyalty to the organization while preventing self-dealing; 5) Institute a policy to ensure transparency in the organization by making the organization’s financial information, such as Forms 990 and financial statements, publicly available; 6) Implement policies to ensure fundraising conforms to government requirements; 7) Conduct financial audits to ensure consistency with the organization’s annual budget; 8) Develop policies that discourage director compensation and encourage reasonable officer compensation; and 9) Adopt written standards for document integrity, retention, and destruction.

Revenue Ruling 2007-41, June 18, 2007. Revenue Ruling 2007-41 came in the aftermath of an investigation that revealed three-quarters of 82 charitable organizations investigated by the IRS had engaged in some prohibited political activity during the 2004 election. This ruling included twenty-one fact patterns and how the IRS would rule on each. The following are several holdings contained within the Ruling regarding permissible political activity for 501(c)(3) organizations. First, the IRS held that organizations are not engaged in political campaign intervention when they promote voter registration without naming any particular candidate, but that an organization promoting voter participation to registered voters through a phone drive, whose callers read voters a different script depending on whether they support a particular candidate or issue, is engaged in campaign intervention. The IRS also held that while leaders of organizations are not restricted in their free speech when giving their opinion as individuals, they are prohibited from making partisan comments in official organization publications or at official functions of the organization.

The IRS issued opinions on candidate appearances in several different scenarios. First, Section 501(c)(3) organizations may invite candidates to events, but they must give each candidate the equal opportunity to participate in the same or similar events, and should not indicate their opinion on any particular candidate. Likewise, when candidates are at events, the nature of questions asked, equal opportunity to give their views and pressure to endorse the organization’s views are considered in deciding whether campaign intervention has occurred. Where an organization claims that a candidate was invited in his individual capacity, the IRS will consider the extent to which the individual is there only in a non-candidate capacity, and whether other remnants of the campaign, including mention of candidacy, campaign activity, or a partisan atmosphere, taint the event.

The IRS also ruled on the distinction between advocating an issue and advocating a candidate. While nonprofits may take positions on policy issues, including those that

divide candidates in an election, they must not do so where it would have the effect of advocating for a particular candidate. Factors that affect this assessment are the proximity in time of the statement to the election, whether the statement makes reference to voting or an election, and whether the issue in question has been raised as an issue about which candidates disagree. A nonprofit may be entitled to identify a candidate if the timing of the advocacy coincides with another non-campaign-related vent such as a vote on legislation.

Business activity may also sometimes constitute political campaign activity where an entity provides goods or services to one candidate and not another, only candidates and not the general public, or one candidate at a nonstandard rate. Finally, links to other organizations’ Web sites on a nonprofit organization’s Web site may constitute campaign intervention if the content of the link, and the manner in which it is posted, indicate that the link advocates for a particular candidate. A organization may post a voter guide including nonpartisan information about each candidate with a link to their Web site without causing campaign intervention, provided that the context in which the candidates’ sites are posted is neutral and treats all candidates equally.

Senate Finance Committee Minority Staff Report: Investigation of Jack Abramoff’s Use of Tax-Exempt Organizations. October 2006. The Senate Finance committee commenced an investigation into tax-exempt organizations that were found to be involved in the lobbying activities of Jack Abramoff in 2005. A previous investigation by the Senate Committee on Indian Affairs revealed that certain exempt organizations were taking contributions at the direction of Mr. Abramoff and using those monies to further the agendas of Mr. Abramoff’s clients. The Minority Staff investigation found that some officers of certain exempt organizations assisted Mr. Abramoff in exchange for cash payments by: 1) laundering payments to obscure the source of those payments; 2) drafting news releases favorable to Mr. Abramoff’s clients; 3) acting as a front organization for congressional trips paid for by Mr. Abramoff’s clients; and 4) providing Mr. Abramoff’s clients with introductions to government officials. The Minority Staff concluded that these activities amounted to profit-seeking and private behavior by the exempt organization, in violation of the Internal Revenue Code provisions under which these organizations are organized. Specifically, IRC section 501(c)(3) organizations must be organized and operated exclusively for tax exempt purposes and IRC section 501(c)(4) organizations must be organized primarily for the promotion of social welfare. The Minority Staff called the failure of these tax-exempt organizations to operate in a manner consistent with the dictates of IRC section 501(c)( 3) and (4) a “fraud on other taxpayers.”

United States Government Accountability Office: Testimony by Gregory D. Kutz Before the Subcommittee on Oversight, Committee on Ways and Means, House of Representatives on July 24, 2007. The GAO reviewed unpaid taxes and exempt organization data from the Internal Revenue Service and selected 25 organizations to serve as case studies for audit and investigation. The following results are the findings in this investigation. Nearly 55,000 exempt organizations had almost $1 billion in unpaid federal taxes as of September 30, 2006. Charitable organizations were responsible for more than 85 percent of the $1 billion in debt. About 1,500 of these

entities each had over $100,000 in federal tax debts, and some owed multi-million dollars in federal taxes. The majority of this debt represented payroll taxes and associated penalties and interest dating back as far back as the early 1980s. This figure is likely understated; IRS data on tax debts for current periods and disputed debts is not included because they may be routinely resolved or not represent a fully valid tax debt. Willful failure to remit payroll taxes is a felony under US tax law, however the IRS does not have the authority to revoke an organization’s exempt status because of unpaid federal taxes. The GAO investigative work included obtaining and analyzing tax, financial, criminal history, and other public records of the 25 non-representative organizations selected to serve as case studies.

The investigation showed that many organizations failed to remit to IRS payroll taxes withheld from employees, and instead the executives diverted the money for other purposes. Often these payroll taxes were diverted to fund operations or to pay hundreds of thousands of dollars in compensation to the organization’s top officials. Despite repeatedly abusing the federal tax system, all the exempt organizations in the case study continued to maintain their exempt status. Existing federal statutes do not authorize the IRS to use tax debt as a cause for revocation of an organization’s exempt status, however, the IRS is allowed to revoke exempt status when it determines the organization has ceased to operate in a manner consistent with the purpose for which it was granted the exempt status, or for other extraordinary circumstances, such as when the organization engages in more than inconsequential illegal activities.

The investigation also found that more than 1,200 of the exempt organizations with over $72 million in tax debt received over $14 billion in direct federal grants in fiscal years 2005 and 2006. Over 1,150 of these organizations are charitable organizations that owed approximately $70 million in unpaid federal taxes. Additionally, the estimate of over $14 billion in federal grants disbursed to tax delinquent organizations is likely understated because the audit did not include all federal agencies that provided grants and did not cover pass-through grants. The case study found that five of the six case studies they examined failed to disclose their federal tax debts on their Applications for Federal Assistance. This report calls for exempt organizations to comply with the federal tax law in order for the federal government to collect the funds to which it is entitled to finance critical government priorities and to improve the overall compliance with the nation’s tax laws.