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Charities, Donors, and the First Amendment

A Case for Reform

Charity Navigator

Author: Kyle Waide, Deputy Director

March 22, 2003


An upcoming Supreme Court case is the talk of the town among charities, their fundraisers, and the regulators and watchdogs responsible for monitoring their activity. The talk, mostly among insiders, is polite and the problem debated all-too-familiar. What do we do about charities that spend "too much" of our money on fundraising?

Charities and the companies they hire to raise money are, of course, lining up on one side of the debate, while state attorneys general, charity watchdogs, and some consumer advocates are lining up just as dutifully on the other. Dividing them is that blurry line between a charity's First Amendment rights and the rights and responsibilities of the state to regulate charities and to protect its citizens from fraud.

(Charity Navigator, by the way, has not taken a position and we've decided to exercise our right not to get in line.)

One would hope that this debate, and the case precipitating it, would result in an agreement or set of solutions that would bring order to the largely chaotic world of charitable fundraising. At the end of the day, all the amicus briefs filed, coalitions formed and e-mails exchanged ought to help us figure out, once and for all, how to protect donors from inefficient charities and greedy fundraisers, while preserving the rights of charities to continue their very important work. In other words, the debate should lead to the kind of reform that will enhance the efficiency and effectiveness of charities.

Well, friends, don't get your hopes up. This case and the rather muted hullabaloo surrounding it is much ado about nothing, little more than a rehashed and relatively benign debate among charity insiders that will not result in any real reform.

Once again, charities and regulators are missing the boat. The key to reform is not finding constitutionally acceptable ways to restrict charities. The key is to empower donors. Until we shift this debate, real reform will not take place.

In the case at hand, Ryan v. Telemarketing Associates, the Attorney General of Illinois accuses a for-profit fundraiser, Telemarketing Associates, of fraud for pocketing 85% of the money it raised on behalf of the veterans' organization that hired them, VietNow National Headquarters.

That wasn't a misprint. VietNow hired Telemarketing Associates to conduct fundraising activities on their behalf. As compensation, VietNow agreed that Telemarketing Associates could keep around 85% of all the money it raised through the campaign. That means that if you made a donation to VietNow through Telemarketing Associates, only $0.15 of every dollar you contributed actually went to VietNow.

That's an appalling statistic. Based on that record alone, we laypersons would assume that Telemarketing Associates had to have done something illegal or fraudulent. I mean, when your child has chocolate on his face, you don't have to find a candy bar wrapper to know it's out there somewhere.

Despite these appearances, the courts have not sided with the Attorney General. His complaint was dismissed by three consecutive lower courts, including the Supreme Court of Illinois. The basic problem is that despite the state's interest in protecting citizens from fraud, it cannot pursue that interest by acting in ways that are inconsistent with the First Amendment. Based on a series of U.S. Supreme Court decisions in the 1980's, states' attempts to prohibit charities from spending "too much" on fundraising are inevitably inconsistent with the First Amendment. Here in a nutshell is why.

Charitable solicitations are protected as speech under the First Amendment because a significant component of the speech involved in these appeals is persuasive, informative or political in nature. When VietNow or its fundraiser calls to ask for money, they're also raising awareness and seeking support for the various economic, political and social issues affecting veterans. If they couldn't solicit—i.e., ask you for money—they wouldn't call you or contact you and the flow of their information would likely cease.

Because charitable solicitations are protected as speech under the first amendment, the state cannot act to limit this speech in ways that are inconsistent with the First Amendment. And the courts have held, thus far, that the Attorney General's claim is such an improper limitation of speech. Why?

In charging Telemarketing Associates with fraud because they retained an "excessive" amount of the proceeds, the Illinois Attorney General has asserted that a charity or a professional fundraiser commits fraud any time its fundraising costs are "excessive." In this case, the Attorney General's claim is based on the notion that a fundraising fee of 85% of the proceeds is an excessive amount. On three separate occasions, the U.S. Supreme Court has held that percentage-based restrictions on charitable solicitations—i.e., 85% is excessive and therefore fraudulent—limit speech in ways that offend the First Amendment. The problem is there's no "nexus" between fundraising costs and fraud. In other words, it's impossible to identify a percentage above which fundraising costs are always excessive and fraudulent. It's a classic problem of where do you draw the line.

Think about it. As already stated, a significant component of a charitable solicitation is persuasive and informative, and as a result there's no way to quantify the value of simply making the phone call and telling people that the charity exists. While I personally believe that 85% is a ridiculously high price to pay to let the people of Illinois know about VietNow, I respect the fact that someone out there may disagree and wants to know about VietNow, regardless of the cost.

Second, a new charity, or a charity promoting a highly unpopular cause, will very likely incur much higher fundraising costs to raise the same amount of money than will a more established charity promoting a more popular cause. So 85% may be excessive for one group, but may be an enormous achievement for someone else. If states are allowed to set limits on fundraising costs, then they will in effect be able to choose who gets to speak and what causes get promoted.

While we have to find a way to reign in greedy fundraisers, we (probably) don't want the state to decide what charities and causes are acceptable. Imagine how unpopular a charity promoting racial integration might have been in the 1950's, or a charity benefiting victims of AIDS in the mid-1980's. Certainly those causes were less efficiently supported in those times than were less politically divisive causes then, or than those same causes now. If it were acceptable for the state to limit a charity's speech based on its fundraising costs, then those causes might not have been promoted as vigorously as they were, and our society might not look the same today. So even though Telemarketing Associates weren't promoting a particularly divisive issue, state restrictions on a charity's fundraising costs limit speech in ways that (probably) violate the First Amendment.

Given their past rulings, it's highly likely the Supreme Court will affirm the rulings of the lower courts in Ryan v. Telemarketing Associates, and will assert once again that charitable solicitations are fully protected speech that cannot be limited according to their associated fundraising costs.

Or, maybe the Supremes will decide in favor of the Attorney General, and give states some latitude to restrict what charities can spend on fundraising.

Neither ruling, however, will solve the larger issue raised by this case. Nor will the current debate among charities, fundraisers and regulators lead to meaningful reforms that root out the bad apples. If the Court preserves the status quo, groups like Telemarketing Associates will continue to hide behind the First Amendment and take advantage of the charitable intentions of thousands of individuals. But even if the Attorney General could say that 85%, or 75%, or 65%, is fraud, those same groups would find ways to sneak under percentage limitations on their fundraising costs without changing their activity in any meaningful way. Such a top-down attempt at reform will not change behavior.

Donors will continue to lose if we don't change the debate. We need reform from the inside out, not from the top-down through a magic-bullet limitation on the behavior of charities and their fundraisers. We must reform the culture.   

To do so, we should stop focusing on the First Amendment, and instead debate and agree upon ways to create a marketplace that informs donors. By empowering consumers to make better decisions, fewer of them will be deceived, fewer inefficient or dishonest charities will be able to survive, and fewer fundraisers will be able to get rich off the naiveté of uninformed donors and complacent charities.

We can create this marketplace. The responsibility for doing so rests fully on the shoulders of state and federal regulators, consumers and charity watchdogs, and the "independent" sector itself. Each of these groups has a tremendous amount of leverage at its disposal to create a more effective marketplace. How can we put that leverage to work?

To begin with, let's find ways to help regulators empower donors by enforcing the laws and regulations already in place.

Despite appearances, charities and for-profit fundraisers face numerous regulations. Both groups are required to register with states before fundraising in those states. Both are required to report to the states where they operate on their activity, as well as to report to federal authorities, in particular to the IRS. Indeed, the annual informational tax returns of charities are a matter of public record, such that anyone can access and review them. In addition, stiff penalties can be imposed if these groups fail to register or report as required by federal and state authorities, or if they engage in such inappropriate and illegal activity as making fraudulent fundraising appeals, engaging in self-dealing, or awarding excessive compensation to officers and directors. Indeed, recent settlements and decisions involving Hale House and affiliates of the United Way , Easter Seals, and the Red Cross illustrate the point that the state is not helpless when it comes to regulating charities.

As such, the challenge confronting states is finding the capability to redouble their efforts to enforce laws already on the books. The IRS and state charity officials are understaffed and underfunded. Faced with a sector growing out of control, and faced with their own shrinking budgets and staffs, they spend most of their time reviewing applications for tax-exempt status from new charities rather than performing audits, enforcing reporting requirements, and monitoring fundraising appeals. As we argued here last fall, this is a recipe for disaster and will result in a non-profit version of Enron, WorldCom, and Global Crossing.

Given the limitations to their resources, regulators must focus on remedies and actions that shift some of their regulatory burdens to consumers and watchdogs. The best step they can take in this regard is to strictly enforce the reporting requirements for charities. Charities are required to provide their informational tax returns to anyone who requests them. If charities refuse to provide these returns, they face stiff penalties. Yet our experience soliciting returns from more than 2,000 organizations, only 50% of whom complied after our first request, suggests those penalties are rarely imposed to the extent that they could be. That must change.

In addition, regulators should require charities to report with greater timeliness. Currently, charities must file their informational returns with the IRS 4 ½ months after the end of the year. They are also allowed an automatic 3 month extension that comes with no penalty, as well as another 3 month extension which they can request and which is rarely denied, again with no penalty. That means that many charities regularly file 10 ½ months after the end of their fiscal year. (By comparison, you and I have 3 ½ months to file, and if we owe taxes, we pay a penalty if we do not pay on time.) Again, by allowing charities so much time to file their financial returns, we prevent donors from accessing accurate and reliable information about the activity of charities.

If we want to change the culture, regulators need the resources that enable them simply to enforce the regulations already in place. They must ensure that donors can access information about charities that is reliable and up to date. When charities obstruct that process, they must face stiff penalties. None of these steps violate the First Amendment, and each of them will help create a more informed public that is better equipped to protect itself.

Next, let's find ways to help donors and charity watchdogs access and disseminate the best information available about the activity of charities and about giving in general. 

The most powerful way to protect donors from fraudulent fundraising practices is to equip them with the information and resources they need to make more informed giving decisions. In providing information, we have made tremendous progress over recent years, as donors have more substantial and immediate access to the financial data of charities than ever before.

That said, many donors continue to lack the resources to make effective use of all this information. If the average stock market investor were asked to make investment decisions based only on the information in each company's SEC filings and on his or her unaided ability to understand that information, then our financial markets would lose their viability. Similarly, we cannot simply post IRS filings and expect that to satisfy the donor community's need for information and advice. 

Despite the protestations of some charities, donors need more ratings and reviews of charities provided by charity watchdogs. The availability of more ratings, not less, will at the very least help a greater number of donors identify and avoid the most egregious examples of fundraising inefficiency, such as the one presented by VietNow and Telemarketing Associates. In addition, more donors will think about charities and giving differently. They'll view charities as sophisticated organizations that require ongoing investments, not one-time gifts. As a result, they'll become more proactive in their giving and become less vulnerable to the high-pressure fundraising tactics of highly inefficient charities. Meanwhile, by evaluating more charities over time, watchdogs will inevitably improve and expand their rating methodologies, which will ultimately help regulators and donors alike monitor the performance and activity of charities.  

So instead of debating ways for the government to protect uninformed donors, let's debate ways to encourage the efforts to educate and empower donors that have already begun. In doing so, we will decrease the likelihood that an inefficient charity can take advantage of the charitable intentions of donors. We'll build the confidence of donors in charities and enhance their involvement in giving. These outcomes will each improve the philanthropic marketplace without violating the First Amendment.

Then, let's share ideas for how charities and the broader non-profit community can become more transparent, accountable, and less vulnerable to the unjustifiably high fees charged by some fundraisers.

A great place to start is to ask why a charity would ever sign a contract surrendering 85% of the money raised on its behalf to a telemarketer. That is the most vexing question raised by Ryan v. Telemarketing Associates.  It's in no one's interest to allow the state to prevent a charity from signing such a contract. Excluding telemarketers, it's in everyone's interest to send the message loud and clear that VietNow made a horrendous business decision in agreeing to the terms of their contract with Telemarketing Associates.

Fundraising is big business. Individuals donated more than $150 billion to charities in the year 2001. While most of that revenue was generated by the charities themselves, for-profit fundraisers did generate a significant portion of that total. When they keep unjustifiably high percentages of that total as fees for themselves, then the amount that can be used for charitable purposes is diminished. Given the potential impact of their fees on our charitable resources, the independent sector must view their fundraising partners with the same neutrality as businesses in any sector view their vendors. They must negotiate for better terms with fundraisers, or they must find more competitive alternatives that do not cripple their productivity. The fees charged by fundraisers vary too dramatically to believe that charities are working as hard as they can to get the most bang for their buck. Charities must work together to identify fundraising cost structures that are acceptable, and then they must negotiate better contracts with fundraisers. Not doing so severely limits their resources. By simply making better business decisions, charities will go a long way toward increasing their effectiveness.

Secondly, the independent sector must lead the way in empowering donors to make better decisions. The carrot in this game is to reduce their fundraising costs. By participating in efforts to encourage donors to become more involved in and knowledgeable of their activities, charities will lessen the burdens of cultivating and retaining donors. Charities and their allies must work to encourage the flow of information, not restrict it. This means cooperating with watchdogs, initiating efforts to improve the methodologies of watchdogs, reporting financial data with greater attentiveness and timeliness, and making it available whenever requested. Foundations should help support research initiatives that identify ways to improve the information available to donors. Finally, other giving intermediaries, such as online giving portals, donor-advised funds, and philanthropic advisors, should aggressively promote and disseminate ratings and reviews of charities, so that the transactions they enable become more effective. 

By creating a more competitive environment, the independent sector will institutionalize its own improvement. The charities that naively pay outrageous fundraising fees will slowly go out of business. The companies charging those fees will follow. Those charities that demonstrate their efficiency and effectiveness to the greater number of donors will develop a greater capacity to pursue their missions. Less transparent charities will either change their practices or lose support. Ineffective organizations will be subsumed by more effective ones, inspiring a wave of consolidation in the sector that is sorely needed. And donors will have access to increasingly powerful tools for managing their giving, tools that will simultaneously reduce fundraising costs for charities. Again, these measures will benefit donors, regulators and charities, and the First Amendment will not be offended.

On March 3, the Supreme Court will hear arguments in Riley v. Telemarketing. Months later, they'll issue their decision. Neither of those occurrences will improve the non-profit marketplace.

The debate that awaits us does not concern the First Amendment. The debate concerns reform, and the components of reform that empower donors to become more informed. Let's have that debate. Let's achieve reform. Millions of donors, in Illinois and beyond, are waiting for us to act. Their good will is at stake. We must not offend them any more.

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