Legal Services Corporation: Governance and Accountability Practices Need to Be Modernized and Strengthened
Published: 2007-08-15T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Legal Services Corporation (LSC) was federally created as a private nonprofit corporation to support legal assistance for low-income people to resolve their civil matters and relies heavily on federal appropriations. Due to its unique status, its governance and accountability requirements differ from those of federal entities and nonprofits. This report responds to a congressional request that GAO review LSC board oversight of LSC's operations and whether LSC has sufficient governance and accountability. GAO's report objectives are to (1) compare LSC's framework for corporate governance and accountability to others', (2) evaluate LSC's governance practices, and (3) evaluate LSC's internal control and financial reporting practices. We reviewed the LSC Act, legislative history, relevant standards and requirements, and LSC documentation and accountability requirements and interviewed board and staff.
section_title: What GAO Found
paragraphs: Although LSC has stronger federal accountability requirements than many nonprofit corporations, it is subject to governance and accountability requirements that are weaker than those of independent federal agencies and U.S. government corporations. Congress issued LSC's federal charter over 30 years ago. Established with governance and accountability requirements as they existed at the time, LSC has not kept up with evolving reforms aimed at strengthening internal control over an organization's financial reporting process and systems. Rigorous controls are important for the heavily federally funded LSC. During fiscal year 2007, LSC is responsible for the safeguarding and stewardship of $348.6 million of taxpayer dollars. Although no single set of practices exists for both private and public entities, current accepted practices of federal agencies, government corporations, and nonprofit corporations offer models for strengthening LSC's governance and accountability, including effective board oversight of management; its performance; and its use of federal funds and resources. The board members demonstrated active involvement in LSC through their regular board meeting attendance and participation in LSC oversight. Although LSC's Board of Directors was established with provisions in law that may have supported effective operation over 30 years ago, its practices fall short of modern board practices. The LSC board generally provides each new member an informal orientation to LSC and the board, but it does not have consistent, formal orientation and ongoing training with updates on new developments in governance and accountability standards and practice. The current board has four committees, but none are specifically targeted at providing critical audit, ethics, or compensation functions, which are important governance mechanisms commonly used in corporate governance structures. Because it has not taken advantage of opportunities to incorporate such practices, LSC's Board of Directors is at risk of not being able to fulfill its role of effective governance and oversight. A properly implemented governance and accountability structure may have prevented recent incidents of compensation rates in excess of statutory caps, questionable expenditures, and potential conflicts of interest. LSC also has not kept up with current management practices. Of particular importance are key processes in risk assessment, internal control, and financial reporting. Management has not formally assessed the risks to the safeguarding of its assets and maintaining the effectiveness and efficiency of its operation, nor has it implemented internal controls or other risk mitigation policies. LSC is also at increased risk that conflicts of interest will occur and not be identified because senior management has not established comprehensive policies or procedures regarding ethical issues that are aimed at identifying potential conflicts and taking appropriate actions to prevent them. Finally, management has not performed its own assessment or analysis of accounting standards to determine the most appropriate standards for LSC to follow.

section_title: Letter
paragraphs: The Legal Services Corporation’s (LSC) mission is to make federal funding  available to support the provision of legal assistance in civil matters to  low-income people throughout the United States on everyday legal  problems. LSC pursues this mission by making grants to legal service  providers (grant recipients) who serve low-income members of the  community who would otherwise not be able to afford legal assistance  (clients). Established by a federal charter in 1974 as a federally funded,  private nonprofit corporation, LSC is highly dependent on federal  appropriations for its operations. LSC received $348.6 million in  appropriations for fiscal year 2007. For fiscal year 2006, LSC received 99  percent of its funding from federal appropriations and approximately 1  percent from grants through the Department of Veterans Affairs.
This report responds to your request that we review how LSC’s Board of  Directors has been carrying out its fiduciary duties in overseeing LSC’s  operations and use of appropriated funds and whether LSC has sufficient  governance and accountability structures and practices in place. The  specific objectives of this report are to (1) compare LSC’s statutory  framework for corporate governance and accountability to those of other  organizations; (2) evaluate the governance practices that LSC has adopted,  including the board’s operations and responsibilities; and (3) evaluate  LSC’s internal control and financial reporting practices in comparison to  current practices of other organizations.
To address these objectives, we reviewed information from a variety of  sources, including the Legal Services Corporation Act of 1974 (LSC Act)  and LSC annual appropriations acts; the LSC Act’s legislative history,  relevant legislative and regulatory standards and requirements for  financial reporting and internal control, and research and studies on  corporate governance.  We compared LSC’s governance, accountability,  and oversight requirements with those for independent federal agencies  headed by a board or commission, U.S. government corporations, and  D.C. nonprofit corporations, including the Corporation for Public  Broadcasting (CPB), which, like LSC, was established by Congress and  receives federal appropriations. To obtain information on the current  policies and practices of LSC and its Board of Directors, we interviewed  current members of LSC’s board, management, and staff, and staff in LSC’s  Office of the Inspector General (OIG) and the audit firm the OIG employs.  We also reviewed relevant documentation of the design and  implementation of LSC’s and the LSC board’s governance and  accountability practices and conducted a survey of all board members.
We conducted our work in Washington, D.C., from November 2006  through June 2007 in accordance with generally accepted government  auditing standards.
subsections: section_title: Background
paragraphs: LSC is a private, nonprofit corporation that is federally funded for the  purpose of making federal resources available to support local providers  of civil legal services for low-income people, with the goal of providing  equal access to the justice system “for individuals who seek redress of  grievances” and “who would be otherwise unable to afford adequate legal  counsel.” Since LSC was federally chartered by statute over three decades  ago in the LSC Act, Congress has been making annual appropriations to  LSC to provide grants to eligible legal service providers to carry out the  purposes of the LSC Act’s requirement “to provide the most economical  and effective delivery of legal assistance.” Since 1996, LSC has been  required to select its grant recipients through a competitive award  process. Today, LSC funds grant recipients in all 50 states, as well as the  District of Columbia and all five U.S. territories. In fiscal year 2006, LSC  reported distributing a total of $313.9 million in grants.
Local legal service providers employ staff attorneys to assist eligible  clients in resolving their civil legal problems, often through advice and  referral. According to LSC, in a typical year the largest portion of total  cases (38 percent) concern family matters, followed by housing issues (24  percent), income maintenance (13 percent), and consumer finance (12  percent). LSC reported that most cases are resolved out of court. In 2007,  LSC reported that three out of four clients were women, most of them  mothers. Most clients were at or below 125 percent of the federal poverty  threshold, currently an income of approximately $25,000 a year for a  family of four. The type of legal assistance that LSC funding supports is  subject to certain legal restrictions. By law, for example, LSC cannot  provide funds for legal services for a proceeding related to a violation of  the Military Selective Service Act or participation in litigation related to  abortion or a criminal proceeding.
In 1974, Congress enacted the LSC Act to transfer the functions of the  Legal Services Program from the Executive Office of the President into a  private corporation. Through the LSC Act, Congress chartered LSC in the  District of Columbia as a private, nonmembership, nonprofit corporation  that would not be considered a department, agency, or instrumentality of  the federal government. Under its federal charter (the LSC Act), LSC may  only pursue activities consistent with the corporate purpose of “providing  financial support for legal assistance in noncriminal proceedings or  matters to persons financially unable to afford legal assistance.”
To direct the corporation, the LSC Act provides for a bipartisan Board of  Directors consisting of 11 voting members who are appointed by the  President of the United States with the advice and consent of the U.S.  Senate. Neither the President nor the Senate has the power to remove a  director. A director can only be removed for cause, such as a persistent  neglect of duties, by a vote of at least 7 directors. Although the LSC Act  does not require board members to possess management or financial  expertise, it does include some membership requirements: no director may  be a full-time U.S. government employee, a majority of the directors must  be attorneys belonging to the bar of the highest court of a U.S. state, and at  least one director must be from the legal service client community. The  LSC Act requires the board to meet at least four times each calendar year  and prohibits board members from participating in any decision, action, or  recommendation related to a matter that directly benefits the board  member or pertains specifically to any entity with which the board  member has been associated in the past 2 years. The LSC Act prohibits  LSC personnel and grant recipients from engaging in certain prohibited  activities, such as legal assistance related to a criminal proceeding or  participation in litigation related to an abortion, and the LSC Board of  Directors, which is charged with managing the affairs of the corporation,  is responsible for ensuring compliance with these restrictions.
The LSC Act requires the Board of Directors to appoint the LSC President  and any other necessary officers, and provides that the LSC President  may appoint any employees necessary to carry out LSC’s purposes. LSC  officers and employees can be fairly easily appointed and removed,  creating essentially at-will employment relationships. In addition to the  power to appoint and remove LSC employees and to serve as an ex- officio, nonvoting member of the Board of Directors, the LSC President,  who is the only officer specifically provided for in the LSC Act, is  authorized to make grants and enter into contracts that bind LSC.
As a D.C. nonprofit corporation, LSC generally possesses all the powers  conferred on such corporations under the D.C. Nonprofit Corporation Act,  which includes a number of general corporate powers, such as the power  to sue and be sued in its corporate name, exercise a number of rights  related to real and personal property, enter into contracts, and borrow  money and issue debt obligations. Other corporate powers include  investing and lending money, appointing officers and agents and defining  their duties and fixing their compensation, making bylaws to administer  and regulate corporate affairs, and “hav and exercis all powers  necessary or convenient to effect any or all of the purposes for which the  corporation is organized.” LSC’s exercise of such corporate powers,  however, is restricted where inconsistent with the LSC Act. For example,  the LSC board’s discretion in fixing its officers’ and employees’  compensation is limited by an LSC Act provision prohibiting LSC from  compensating its personnel at rates in excess of the rate of level V of the  Executive Schedule.
Unlike most D.C. nonprofit corporations, LSC’s exercise of its corporate  powers has received additional oversight since 1988 when Congress  subjected LSC to the Inspector General Act of 1978, as amended (IG Act).
As an independent office within LSC, the LSC OIG is authorized to carry  out audits and investigations of LSC programs and operations, recommend  policies to improve program administration and operations, and keep the  LSC board and Congress fully and currently informed about problems in  program administration and operations and the need for and progress of  corrective action. Also, unlike most D.C. nonprofit corporations, LSC is  subject to congressional oversight through the annual appropriations  process as well as responding to congressional inquiries and participating  in hearings. In its annual appropriation for LSC, Congress regularly  appropriates a specific amount for the OIG. For example, Congress  appropriated about $2.54 million for the LSC OIG in fiscal years 2006 and  2007. Because in fiscal year 2007 LSC received an increase in its annual  appropriation of about $17.78 million that was not allocated for a specific  purpose, LSC officials told us that LSC, consistent with congressional  guidance, used $430,000 of this amount to increase funding for the OIG  from about $2.54 million in fiscal year 2006 to $2.97 million in fiscal year  2007. (See fig. 1.)
It has been three decades since LSC was last comprehensively reviewed  and reauthorized in the Legal Services Corporation Amendments Act of  1977, and LSC’s statutory framework has undergone only limited changes  since then. Today LSC is governed by the powers and restrictions in its  federal charter (the LSC Act) and, where not inconsistent, the D.C.  Nonprofit Corporation Act, as well as the IG Act, the federal tax law  requirements for tax-exempt status for nonprofit corporations, and LSC’s  annual appropriations acts, which since 1996 have included a number of  administrative provisions imposing additional grants management duties.
Unlike most private, nonprofit corporations, the vast majority of LSC’s  funding comes from annual federal appropriations, which originally were  authorized under the LSC Act. The LSC Act specifies that the appropriated  funds authorized under the act are available until expended and shall be  paid to LSC in one annual installment at the start of the fiscal year.  Although annual appropriations for LSC have not been authorized since  fiscal year 1980 under the LSC Act, Congress has continually enacted  annual appropriations to be paid to LSC to carry out the purposes of the  LSC Act. For fiscal year 2007, Congress appropriated almost $349 million  for LSC. The LSC Act permits LSC to receive and retain nonfederal funds,  but LSC’s recent audited financial statements show that for fiscal years  1991 through 2006, approximately 99 percent of LSC’s revenues came from  federal appropriations. In addition to direct funding through annual  appropriations, the LSC Act makes certain indirect federal support  available to LSC by providing that the President of the United States may  make support functions of the federal government available to LSC.
For both governmental and nonprofit entities, governance can be  described as the process of providing leadership, direction, and  accountability in fulfilling the organization’s mission, meeting objectives,  and providing stewardship of public resources, while establishing clear  lines of responsibility for results. Accountability represents the processes,  mechanisms, and other means—including financial reporting and internal  controls—by which an entity’s management carries out its stewardship  and responsibility for resources and performance. To provide  accountability to Congress, the LSC Act provides for Senate advice and  consent on the selection of board members, annual appropriations that  constitute virtually all of LSC’s annual revenues, and treatment of LSC as a  federal entity in limited situations either by directly subjecting LSC to  certain federal laws or indirectly by modeling provisions in the LSC Act  after provisions in laws existing in the 1970s.  For example, the LSC Act  makes LSC subject to provisions in the Freedom of Information Act  (FOIA) and the Government in the Sunshine Act, compensation limits  imposed on officers and employees at level V of the Executive Schedule,  and employer contribution requirements for participation in certain  employee benefits programs, as well as requiring LSC to engage in notice- and-comment rule making and to provide us with access to its records.
section_title: LSC Is Subject to Weaker Governance and Accountability Requirements Than Federal Entities but More Federal Oversight Than Nonprofit Corporations
paragraphs: Although LSC is subject to more statutory governance and accountability  requirements than most private, nonprofit corporations, it is subject to  governance and accountability requirements that are weaker than those of  most independent federal agencies headed by boards or commissions and  U.S. government corporations. In chartering a private, nonprofit  corporation to perform a public assistance role with federal funding,  Congress in the 1970s included certain provisions in the LSC Act to  provide for governance and accountability. The LSC Act includes  provisions providing that LSC shall be treated like a federal agency for  purposes of specified statutes that existed in the 1970s when the LSC Act  was first enacted and amended. In 1988, Congress created an OIG within  LSC. Therefore, LSC is subject to some governance and accountability  requirements that are comparable to those of federal entities, including the  presence of an OIG in the governance structure and submission of its  budget for the congressional appropriations process. Nonprofit  corporations typically are subject to limited federal requirements related  to governance and accountability; however, as discussed later, nonprofit  corporations have voluntarily chosen to incorporate many practices in  these areas.  In other respects, LSC is not subject to standard governance  and accountability requirements for federal entities including provisions  related to performance and financial reporting, internal controls, and  funds control. Additional management areas are discussed in appendix III,  and an expanded table is in appendix IV.
subsections: section_title: Governance Structures
paragraphs: Similar to most independent federal agencies and U.S. government  corporations, LSC is headed by a multiperson body (i.e., commission or  board of directors) consisting of presidentially appointed and Senate- confirmed members and has an OIG. (See table 1.)
A common form of governance for independent federal agencies and U.S.  government corporations is a multiperson body consisting of either a  board of directors (agencies and corporations) or a commission (only  agencies), both of whose members are generally appointed by the  President of the United States and confirmed by the U.S. Senate. For  example, the President appoints and the Senate confirms the members of  the boards of directors for the Federal Deposit Insurance Corporation  (FDIC) and Pension Benefit Guaranty Corporation (PBGC) (both U.S.  government corporations), the National Science Foundation (NSF) and  the Federal Housing Finance Board (both independent federal agencies),  as well as the commissioners of the Securities and Exchange Commission  (SEC) and the Nuclear Regulatory Commission (NRC) (both independent  federal agencies).
The directors of LSC may only be removed for cause by a vote of seven  other directors. This level of statutory removal protection is unique in two  ways. First, it restricts the reasons for removal to only those listed in the  statute, and second, it precludes removal by the President of the United  States or Congress. In many cases, the board or commission members of a  federal entity have less tenure protection and serve at the will of the  President of the United States, such as the PBGC directors, who are the  Secretaries of Labor, the Treasury, and Commerce. Nonprofit corporations  incorporated in the District of Columbia are required to be managed by a  board of directors, consisting of at least three directors, who serve for the  terms specified in the articles of incorporation or bylaws. A director of a  D.C. nonprofit corporation may be removed by any procedure provided in  the articles of incorporation or bylaws. If not so provided, then removal  with or without cause is permitted upon a vote that would suffice for the  election of a director for the organization.
No federal law specifically requires the board of directors of a U.S.  government corporation or a board of directors or commission of an  independent federal agency to designate audit or other committees, but  neither does any law prohibit the establishment of such committees. The  D.C. Nonprofit Corporation Act expressly authorizes, but does not require,  boards of nonprofit corporations to designate and delegate authority to  committees. In certain instances, the statutes establishing federal entities  may authorize the designation and delegation of authority to committees,  such as the statute governing NSF (an independent federal agency).
Since 1977, there has been only one governmentwide management law  that specifically included LSC as a covered entity and thus required a  change to LSC’s governance structure. In 1988, Congress amended the IG  Act to add OIGs to additional entities receiving significant federal  funding, including “designated federal entities” (DFE), which are  statutorily defined. LSC was listed as a DFE, along with such other  entities as PBGC, SEC, and Amtrak, which are, respectively, a wholly  owned U.S. government corporation, an independent federal agency, and a  federally established private, for-profit corporation that receives some  federal funding. The only other private, nonprofit corporation included as  a DFE was CPB. Like the other OIGs of DFEs that are independent federal  agencies and U.S. government corporations, the LSC OIG was created as  an “independent and objective” office to carry out audits and  investigations of LSC programs and operations, recommend policies to  improve program administration and operations, and keep the LSC board  and Congress fully and currently informed about problems in program  administration and operations and the need for and progress of corrective  action. In its annual appropriation for LSC, Congress regularly  appropriates a specific amount for the OIG. For example, Congress  appropriated about $2.54 million for the LSC OIG in fiscal years 2006 and  2007. Because in fiscal year 2007 LSC received an increase in its annual  appropriation of about $17.78 million that was not allocated for a specific  purpose, LSC officials told us that LSC, consistent with congressional  guidance, used $430,000 of this amount to increase funding for the OIG  from about $2.54 million in fiscal year 2006 to $2.97 million in fiscal year  2007.
section_title: Funds Control and Budgeting
paragraphs: Like other private, D.C. nonprofit corporations, LSC is not subject to  federal funds control laws that generally apply to independent federal  agencies and many U.S. government corporations, including the  Antideficiency Act, the Purpose Statute, and laws governing liability of  accountable officers for improper or illegal uses of funds; however, LSC is  required to submit an annual budget request to Congress. (See table 2.)
Like many independent federal agencies and wholly owned government  corporations, most of LSC’s annual revenues come from federal funds  made available through annual appropriations; however, LSC is not  required by law to control its use of those funds as are independent federal  agencies and wholly owned U.S. government corporations. The  Antideficiency Act, among other things, prohibits officers and employees  of the government from obligating or expending funds in advance of or in  excess of appropriations. This applies to the officers and employees of  independent federal agencies and wholly owned U.S. government  corporations, where personnel are officers and employees of the  government.   The Purpose Statute requires federal agencies and all U.S.  government corporations, both mixed ownership and wholly owned, to  use appropriated funds only for the purposes provided in law. Further,  for most federal agencies and some wholly owned U.S. government  corporations, such as the Tennessee Valley Authority and the Federal  Prisons Industries Incorporated, accountable officers are financially  liable for improper or illegal payments. None of these funds control  statutes apply to LSC or, in general, other nonprofit corporations that  receive federal funds. The LSC Act does contain a number of provisions  that restrict the use of LSC’s appropriated funds for certain purposes, such  as an activity that would influence the passage or defeat of any legislation  at the local, state, or federal level or that would support any political party  or campaign of any candidate for public office.
Unlike D.C. nonprofit corporations in general, and like independent  federal agencies and wholly owned U.S. government corporations, each  year LSC must prepare a new budget request as part of the annual  appropriations process. The LSC Act requires LSC to submit a budget  request to Congress, but provides no requirements related to the form and  content of the budget request. For federal agencies and wholly owned U.S.  government corporations, the Office of Management and Budget (OMB)  prescribes the form and content of budget requests, consistent with  specified statutory requirements, that are submitted through the President  to Congress. Under the LSC Act, LSC submits that budget request directly  to Congress, with OMB’s role limited to submitting comments to Congress  if it chooses to review LSC’s budget. As a federally chartered, private  nonprofit D.C. corporation, CPB also must annually prepare a budget  request as part of the annual appropriations process. Unlike LSC, however,  CPB requests and receives funding for 2 years (i.e., funding for fiscal 2008  was provided in the fiscal year 2006 appropriations act.) Once the level of  the annual appropriations act is enacted, CPB’s appropriation is paid into  the Public Broadcasting Fund, which is a fund established in the Treasury  and administered by the Secretary of the Treasury. In accordance with  CPB’s federal charter, CPB determines how to allocate amounts in the  fund.
section_title: Performance and Financial Reporting
paragraphs: Unlike D.C. nonprofit corporations in general but like CPB, the LSC Act  requires LSC to have its accounts audited annually. By contrast,  independent federal agencies and U.S. government corporations are  subject to more detailed financial and performance planning and reporting  requirements. When the LSC Act was enacted in the 1970s, audited  financial statements were not prepared for federal agencies and LSC as a  private, nonprofit corporation was not subject to the financial audit  requirements imposed on public companies and U.S. government  corporations. The LSC Act requires LSC to have its accounts audited by an  independent public accountant annually in accordance with generally  accepted auditing standards (GAAS). The LSC Act does not detail what  must be included in the report or which accounting standards to use. The  LSC Act requires LSC to file this annual audit report with us and make the  audit report available for public inspection at LSC headquarters during  normal business hours. (See table 3.)
The LSC Act requirements for financial reporting are more rigorous than  the requirements for D.C. nonprofit corporations in general but less than  those for CPB. Most D.C. nonprofit corporations are only required to keep  correct and complete books and records of account and minutes of the  proceedings of their boards of directors. This information is not required  to be published or made available for public inspection. Similar to LSC,  CPB is required to annually have its accounts audited by an independent  public accountant in accordance with GAAS. CPB’s audit report must be  included in its annual report on its operations and activities, which it must  submit to the President for transmittal to Congress. Like most D.C.  nonprofit corporations, LSC is not required to submit a similar annual  report on its operations and activities to the President or Congress.
Independent federal agencies and U.S. government corporations have  stronger financial and performance reporting requirements than LSC. The  Chief Financial Officers Act of 1990 (CFO Act), as amended by the  Government Management Reform Act of 1994 (GMRA), requires the major  24 agencies of the federal government, including some independent  federal agencies such as NSF and NRC, to submit annual audited financial  statements to OMB and Congress. These financial statements must be  prepared in accordance with generally accepted accounting principles and  audited in accordance with applicable generally accepted government  auditing standards (GAGAS). The Accountability of Tax Dollars Act of  2002 (ATDA) expanded this requirement to include most other federal  executive agencies. U.S. government corporations had been subject to  financial reporting requirements for many years under the Government  Corporation Control Act. Chapter 91 of Title 31 of the U.S. Code,  commonly known as the Government Corporation Control Act, requires  both mixed-ownership and wholly owned U.S. government corporations to  submit annual management reports to Congress (with copies to the  President, OMB, and GAO) no later than 180 days after the end of the  government corporation’s fiscal year. OMB has accelerated the submission  deadline to no later than 45 days after the end of the government  corporation’s fiscal year. Annual management reports are required to  include a    statement of financial position;     statement of operations;     statement of cash flows;    reconciliation to the budget report of the corporation, if applicable;     statement of internal accounting and administrative control systems by  the head of corporation management, consistent with the requirements  under amendments to the act made by 31 U.S.C. § 3512 (c), (d),  commonly referred to as the Federal Managers’ Financial Integrity Act  of 1982 (FMFIA);     a financial statement audit report prepared in accordance with GAGAS;    any other information necessary to inform Congress about the  operations and financial condition of the corporation.
Under OMB Circular No. A-136, Financial Reporting Requirements (rev.  July 24, 2006), annual performance and accountability reports (PAR)  issued by federal executive agencies consist of the annual performance  report required by the Government Performance and Results Act of 1993  with audited financial statements and other disclosures, such as agencies’  (1) assurances on internal control, (2) accountability reports by agency  heads, and (3) inspectors general’s assessments of the agencies’ most  serious management and performance challenges. OMB Circular No. A- 136 states that PARs are intended to provide financial and performance  information to enable the President, Congress, and the public to assess the  performance of a federal agency relative to its mission and to demonstrate  the federal agency’s accountability.
LSC follows a fiscal year starting on October 1, and for the past 5 years has  issued its financial statements in March or later, which is 6 months after its  year-end. As noted, federal agencies are required to issue their financial  statements 45 days following their year-ends, which is mid-November.
section_title: Internal Control Systems Requirements
paragraphs: LSC’s statutory requirements for internal control systems are less rigorous  than those for independent federal agencies or U.S. government  corporations; D.C. nonprofit corporations have no such statutory  requirements. (See table 4.) The LSC Act requires LSC to account for  federal funds separately from nonfederal funds, but otherwise includes no  specific requirements for the establishment of accounting and internal  control systems. The LSC Act imposes some program management duties  on the LSC directors to promote good stewardship of federal taxpayer  dollars by requiring that the directors manage LSC’s programs  economically, effectively, and efficiently. For example, the LSC Act  requires the LSC board to ensure that LSC makes grants “so as to provide  the most economical and effective delivery of legal assistance to persons  in both urban and rural areas.” The LSC Act also requires the board to  ensure that grant recipients adopt procedures for determining priorities on  how to allocate their assistance among eligible clients. Additionally, the  LSC Act imposes a program evaluation requirement on the board,  requiring it to monitor, evaluate, and provide for independent evaluations  of LSC-supported programs to ensure that the programs comply with the  LSC Act; bylaws; and implementing rules, regulations, and guidelines.
Although the LSC Act includes program management requirements, these  are much less rigorous than requirements for systems of internal control,  to which federal entities are subject. Managers of federal entities depend  on sufficient internal control to achieve desired results through effective  stewardship of organizational resources. Internal control, which supports  performance-based management, involves the methods and procedures  management uses to have reasonable assurance that objectives, such as  the following, are being met: effectiveness and efficiency of operations,  reliability of financial reporting, and compliance with applicable laws and  regulations.  Federal agencies are subject to the following legislative and  regulatory requirements that promote and support effective internal  control.
FMFIA, or 31 U.S.C. § 3512(c), (d), provides the statutory basis for  management’s responsibility for and assessment of internal control.   OMB Circular No. A-123, Management’s Responsibility for Internal  Control (rev. Dec. 21, 2004), sets out the guidance for implementing the  statute’s provisions, including agencies’ assessment of internal control  under the standards prescribed by the Comptroller General. Agencies  are required to annually provide a statement of assurance on the  effectiveness of internal control. U.S. government corporations are not  subject to FMFIA, but they are subject to similar requirements under  the Government Corporation Control Act, which incorporates by  reference the FMFIA standards in requiring U.S. government  corporations to include in their annual management reports a  statement on internal accounting and administrative control systems.
The CFO Act requires the 24 CFO Act agencies’ chief financial officers  (CFO), including the CFOs of such independent federal agencies as  NSF and NRC, to maintain an integrated accounting and financial  management system that includes financial reporting and internal  controls.
The Federal Financial Management Improvement Act of 1996, as  implemented by OMB Circular No. A-127, Financial Management  Systems (rev. Dec. 1, 2004), requires the 24 CFO Act agencies to  implement and maintain integrated financial management systems that  comply substantially with federal financial management system  requirements, applicable federal accounting standards, and the U.S.  Government Standard General Ledger at the transaction level.
Recent federal governmentwide initiatives have contributed to  improvements in financial management and placed greater emphasis on  implementing and maintaining effective internal control over financial  reporting. In December 2004, OMB issued a significant update to its  Circular No. A-123, which is the implementing guidance for FMFIA. The  update requires the 24 CFO Act agencies to include the FMFIA annual  report in their PARs, under the heading “Management Assurances.” The  FMFIA annual report must include a separate assurance on internal  control over financial reporting, along with a report on identified material  weaknesses and actions taken by management to correct those  weaknesses.
FMFIA and OMB Circular No. A-123 apply to each of the three objectives  of internal control outlined in GAO’s Standards for Internal Control in  the Federal Government: effective and efficient operations, reliable  financial reporting, and compliance with applicable laws and regulations.  OMB Circular No. A-123 calls for internal control standards to be applied  consistently toward each of the objectives. The circular’s new Appendix A,  which is a requirement only for the 24 CFO Act agencies, requires  management to document the process and methodology for applying A-123  standards when assessing internal control over financial reporting.
One important area of internal control today for both independent federal  agencies and U.S. government corporations is the development and  implementation of an entitywide information security program, as required  by the Federal Information Security Management Act of 2002 (FISMA).  As part of that program, FISMA requires entity heads to periodically         (1) perform risk assessments of the harm that could result from  information security problems, such as the unauthorized disclosure or  destruction of information; (2) test and evaluate the effectiveness of  elements of the information security program; and (3) provide security  awareness training to personnel and contractors. FISMA also requires the  federal entity to annually have its OIG or an external auditor perform an  independent evaluation of the entity’s information security programs and  practices to determine their effectiveness and to annually submit a report  on the adequacy and effectiveness of information systems to OMB, GAO,  and Congress. Because it is not a federal entity, LSC, like CPB and other  D.C. nonprofit corporations, is not subject to FISMA and has no special  information security requirements.
section_title: LSC’s Board Members Are Actively Engaged, but the Board’s Governance Practices Fall Short of Current Practices of Nonprofit Corporations
paragraphs: LSC board members are actively engaged in the board meeting process as  they consistently attend and prepare for board and committee meetings.   Board meetings are generally attended by all board members.  Board  members are provided with an agenda and related materials prior to each  board meeting. In addition, board members have interaction with both  management and the Inspector General (IG).
Nevertheless, the current board governance practices of LSC’s board fall  short of current accepted practices employed by boards of nonprofit  corporations and public companies. Although LSC has an informal  orientation program for its members, the board does not have a  comprehensive, formal orientation or an ongoing training program for  board members. Keeping up with current practice is especially important  for the LSC board because board composition changes significantly with  each new presidential administration, resulting in a board that generally  does not have the benefit of experienced members. Also, although the  board has four established committees, it has not updated its committee  structure to include an audit committee or other committees commonly  found in nonprofit corporations or public companies today. In addition,  the board’s current committees do not have charters that identify their  purposes and duties, which boards of similar organizations would typically  have. Finally, the board does not assess its own performance. Because it  has not incorporated many practices currently considered necessary for  effective governance, LSC’s Board of Directors is at risk of not fulfilling its  role in effective governance in keeping with its fiduciary duties. In fact,  recent incidents of compensation rates that exceed statutory limitations,  questionable expenditures, and potential conflicts of interest may have  been prevented by a properly implemented governance structure.
subsections: section_title: LSC’s Board Members Have Actively Engaged through Meeting Attendance and Participation
paragraphs: The current LSC board’s 10 members have attended most or all of the  board meetings in recent years. A few board members indicated that their  LSC board member role has been more time consuming than they had  expected or had experienced as board members with other organizations.  According to our survey, most board members are satisfied or very  satisfied with the frequency of the board meetings as well as the timeliness  and completeness of the information provided (in the board books) to the  board members to prepare for meetings. Board members are provided  with an agenda and a package of related materials to assist them in  preparing for each board meeting. During interviews with us, board  members indicated that they also receive information regularly through e- mails and mailings in addition to the board books—primarily from the LSC  President. Board members were generally satisfied with their interaction  with management, according to our survey, while board members  interviewed indicated a range of interaction with the IG—some members  only receive information such as the IG reports while others directly  discuss issues with the IG. The LSC board has established a conflicts-of- interest policy that requires board members to annually file financial,  ownership, and relationship disclosure reports.
LSC’s current board of directors carries out its activities primarily during  the quarterly meetings of the full board and individual committees.  Although the board has established committees with specific members,  the committee meetings are typically not held concurrently and most, if  not all, board members attend all of the committee meetings, which one  board member felt was redundant. The annual board meeting is typically  held in January in Washington, D.C., while the remaining three board  meetings take place during site visits, most recently at Little Rock,  Arkansas, in April 2007. As needed, the board and committees hold  additional meetings or teleconference calls to handle necessary business.   Semiannually, the board issues a report to Congress that discusses LSC’s  accomplishments. The board’s most recent activities have included the  finance committee reviewing financial results and discussing the budget,  the annual performance committee completing its performance appraisal  of the LSC President and IG, and the operations and regulations  committee reviewing the proposed employee handbook, approving the  handbook, and providing the handbook to the board for its review and  approval.
section_title: Board Orientation and Training Do Not Provide Key Information on Oversight and Fiduciary Responsibilities
paragraphs: The LSC board currently has an informal orientation program whereby its  members are introduced briefly to the LSC program and legal  requirements, but the orientation does not include key information on  oversight and fiduciary responsibilities.  LSC’s orientation program also  does not provide specific information on Washington, D.C. law governing  nonprofits; the Internal Revenue Service (IRS) regulatory requirements for  nonprofit organizations; interpreting LSC’s financial statements; managing  sensitive documents; FOIA requirements; or travel expenditure limitations.  New director training is a basic tool used by well-functioning boards. It  takes time for board members to learn about the responsibilities of their  positions and the workings of the organization. If board members do not  receive a comprehensive orientation about their responsibilities and the  unique requirements of the organization they are responsible for directing,  then they must learn as they serve, potentially reducing their effectiveness  in fulfilling their governance roles and responsibilities as they learn.  Current practice for public companies and nonprofit corporations is to  provide board members with a broad-based orientation that encompasses  the organization’s mission, vision, and strategic plan; its history; the  members’ obligations and performance objectives, and board policies on  meetings and attendance; and board member job descriptions, including  their performance expectations and their fiduciary obligations. The  purpose of such a program is to prepare board members for effectively  fulfilling their oversight and governance role in the organization.
Most (7 out of 10) of the current board members, in responding to our  survey, indicated that they received orientation or training on their  responsibilities as a board member. During interviews, some board  members who had attended orientation said it consisted of a day of  individual meetings, which was helpful. Our review of the orientation  materials provided to us by management indicated that topics covered  included the role of the IG and the General Counsel. During interviews,  board members who did and did not receive orientation indicated that LSC  could improve board member orientation. For instance, one board  member said that the 1-day orientation provided an understanding of what  LSC does, but did not necessarily provide general training on how to be a  board member.
The LSC board also does not have an ongoing (e.g., annual) training  program for its board members. A board needs to stay current with  information on changes in governance practices and in its regulatory  environment. Additionally, a board needs to be kept up-to-date on key  management practices and requirements in such areas as risk assessment  and mitigation, internal controls, and financial reporting so that the board  can oversee management’s key processes. As the environment that a board  operates in changes, new issues—whether regulatory, current practice, or  industry specific—emerge with the changes. For instance, although most  of the requirements of the Sarbanes-Oxley Act of 2002 do not apply to a  nonprofit corporation or its board, it has had a significant impact on the  operating environment, and many of its requirements have become current  practice for nonprofit corporations. An ongoing training program enables  a board to stay abreast of current governance practices and fiduciary  duties. When we interviewed board members, some noted that they stay  current on governance practices by reading materials provided by  professional associations, LSC management, or the IG, as well as through  seminars they may attend as part of their role on LSC or other boards.  While this individual initiative is valuable, board members’ experience and  knowledge varies, and without an ongoing training program that can equip  all members with the same knowledge, board members risk being unable  to work together as an efficient and effective body.
section_title: LSC’s Board Has Not Updated Its Committee Structure to Include Important Committees
paragraphs: A board establishes committees to aid the board’s organization and  facilitate accomplishing the board’s work. Depending upon the board’s  needs, committees may be either standing (permanent) or ad hoc (for a  particular activity). Committees handle specific issues or topics and make  policy recommendations for the full board to consider. LSC’s board has  four standing committees. However, it does not have an audit committee,  compensation committee, or ethics/compliance (ethics) committee—all of  which are commonly found in public companies and nonprofit  organizations. Table 5 lists LSC’s current board committees and the  responsibilities of each committee.
LSC’s board does not have an audit committee, which is a key element in  effective corporate governance today. According to the National Council  on Nonprofits Association, an audit committee provides independent  oversight of the organization’s accounting and financial reporting and  oversees the organization’s annual audits. An audit committee is generally  responsible for the appointment, compensation, and oversight of the  external auditor; handling board communication with the external auditor  regarding financial reporting matters; and overseeing the entity’s financial  reporting and the adequacy of internal control over financial reporting.  The audit committee also serves the important role of assuring the full  board of directors that the entity has the appropriate culture, personnel,  policies, systems, and controls in place to safeguard entity assets and to  accurately report financial information to internal and external users.  Under the Sarbanes-Oxley Act of 2002, public companies are required to  have an audit committee made up of independent directors, including at  least one financial expert, to oversee the company’s financial reporting  and audit processes.
Although LSC’s board has a finance committee, the finance committee’s  responsibilities do not include those responsibilities required of public  company audit committees or those recommended for nonprofit  organizations’ audit committees. In general, the LSC board’s finance  committee is responsible for reporting on legislation and LSC’s  appropriations as well as monitoring LSC’s budget. Given LSC’s status as a  federally funded nonprofit corporation, these are important activities that  are appropriately handled by a board-level committee. However, the  finance committee’s current functions do not include overseeing the audit  process or communicating with the auditor about financial reporting  matters, which generally are the responsibilities of the IG. The finance  committee chair indicated to us that he has had minimal interaction— primarily discussion about the annual meeting presentation—with the  independent auditor. New auditing standards reinforce the importance of  communication between the auditor and those overseeing governance of  an entity—typically the audit committee representing the board. FDIC, a  mixed-ownership U.S. government corporation, which like LSC, has an IG  who is responsible for appointing the external auditor, established an  audit committee with the responsibility of ensuring that IG  recommendations get appropriately implemented by the organization. An  audit committee at LSC could enhance the governance structure by  representing the board in communicating with the external auditor and the  IG, and ensuring that IG recommendations and any weaknesses found  during the financial audit process are appropriately addressed by LSC’s  management. In addition, an audit committee’s oversight of LSC’s financial  reporting on behalf of the board would enhance the board’s effectiveness.
subsections: section_title: Compensation Committee
paragraphs: LSC’s board does not have a compensation committee.  A compensation  committee is an accepted current practice for nonprofit corporations and  required for public companies listed on the New York Stock Exchange  (NYSE). A compensation committee of a board monitors the  compensation structure of the organization. According to the publication  Corporate Governance Best Practices, the compensation committee’s  responsibilities should include overseeing the organization’s  compensation structure, policies, and programs; establishing or  recommending to the board performance goals and objectives for  members of senior management; and establishing or recommending to the  independent directors compensation for the chief executive officer. For  LSC, this would include approving the LSC President’s contract, which  includes the length of the contract and amount of compensation, and  providing oversight for LSC’s compensation and structure. LSC currently  does have an annual performance review committee that is responsible for  annually evaluating the performance of the LSC President and IG, but it is  not responsible for the compensation structure and policies for the  organization.
For advice on complex compensation matters, board compensation  committees frequently use outside consultants. One such matter is  tracking the total cost of senior management’s compensation packages so  the board has a full understanding of the organization’s executive  compensation. For LSC, an outside consultant could assist the board in  understanding the statutes and regulations that specifically apply to LSC  officer and employee compensation. It is also a current practice that the  minutes of the compensation committee reflect and record arm’s length  negotiations with the executive and his or her attorney, including each  proposal and counter offer. Current practice also has the internal auditor  verify that compensation paid to senior management did not exceed what  the board approved.
During our work, we noted that the fiscal year 2006 salaries of all five LSC  officers, three LSC OIG personnel (including the IG), and four LSC  employees exceeded the statutory compensation limitation. Each affected  officer’s or employee’s total salary in fiscal year 2006 exceeded the annual  limitation on the rate of compensation established by the LSC Act as the  rate of level V of the Executive Schedule. Because the compensation of  LSC personnel is limited by the LSC Act to this rate, we questioned why  certain personnel received higher rates of pay. LSC officials told us that  the total salary included basic pay and a locality pay adjustment. The  locality portion of their compensation caused the compensation limitation  to be exceeded for the affected LSC personnel. After we asked LSC  officials to justify this practice, they told us that during 2007 LSC’s board  had engaged outside legal counsel to issue an opinion on whether LSC  violated the statutory compensation limitation. In May 2007, the outside  counsel issued an opinion to LSC concluding that LSC had not complied  with the statutory limitation on the rate of compensation. We agree with  outside counsel’s conclusion. Although LSC senior management did not  state whether it agrees with the outside counsel’s conclusion in its legal  opinion, LSC management told us that it is working with the LSC Board of  Directors and LSC’s appropriations and authorizing committees to take  appropriate corrective action.
We also noted that during the board’s most recent contract renewal  negotiations with LSC’s President, the Chairman of the board conducted  contract renewal negotiations, based on a delegation of this responsibility  from the full board. However, the contract renewal negotiations were  conducted before the annual performance committee had given the LSC  President her annual review in January 2007 and, thus, without the benefit  of information from the performance evaluation. Exceeding the limitations  on the annual rate of compensation for certain LSC personnel and  conducting negotiations of the president’s contract renewal without  relevant performance evaluation information could have been avoided  with properly designed and implemented procedures for overseeing LSC’s  compensation structure and policies. Without a properly designed and  implemented process for overseeing compensation, LSC remains at risk of  not complying with related laws and regulations and engaging in  imprudent management practices.
section_title: Ethics Committee
paragraphs: While operating in an ethically sensitive environment, the LSC board does  not have an ethics committee. An ethics committee is responsible for  ensuring that the corporation has systems in place to provide assurance  over employee compliance with the corporation’s code of conduct and  ethics, which LSC also does not have. Ethics is important as a component  of the control environment that helps to set the tone at the top of an  organization.  According to Standards for Internal Control in the Federal  Government, a positive control environment includes integrity and  ethical values that are provided by leadership through setting and  maintaining the organization’s ethical tone, providing guidance for proper  behavior, removing temptations for unethical behavior, and providing  discipline when appropriate. Having an ethics committee on the board is  emerging current practice for providing independent oversight over the  organization’s code of conduct and systems in place to help ensure  employee compliance with the code.
In recent years, LSC management has engaged in practices that may have  been prevented through effective implementation of strong ethics policies.   In September 2006, LSC’s OIG issued a report detailing these practices at  LSC, based on a request from Congress. The OIG found that food costs at  meetings exceeded per diem allotments by 200 percent and that LSC used  funds to pay travel expenses for its president for business related to her  positions with outside organizations. The OIG also found that LSC hired  acting special counsels from grant recipient organizations causing  potential conflicts of interest. The special counsels are responsible for  providing LSC management with advice on policy while also being  employees of organizations that receive LSC grant money. The OIG— based on a complaint from a confidential source—began investigating one  acting special counsel’s organization but reported that it had been unable  to complete the investigation because the organization had failed to  provide documentation required by federal law and LSC grant  agreements. Without the presence of a strong ethics committee providing  effective oversight in the development, implementation, updating, and  training for the code of ethics, the corporation is at increased risk of fraud  or other ethical misconduct.
section_title: The Board and Its Individual Committees Do Not Have Charters
paragraphs: The LSC board and its committees do not have charters that establish their  purpose and responsibilities. A charter is used to define the committee’s  purpose, membership, and members’ oversight duties and responsibilities.  LSC has a board resolution that provides descriptions of the committees,  but the resolution does not contain the elements of a charter and the  resolution has not been updated since it was issued in 1995 for three of the  four committees. The fourth committee was established in 2003. Current  practice is for boards and their committees to each have a written charter  that outlines responsibilities, structure, membership criteria, and  processes. Current practice also includes reevaluating the charter  periodically to see if it needs updating. A charter benefits the board by  providing a foundation and focal point for board activities. In addition, the  board’s activities can periodically be checked against the charter to ensure  that they continue to conform to the charter and, if necessary, to update  the charter. If the board and committees do not have charters with the  appropriate descriptions of their purposes and responsibilities, the board  is at increased risk that the board’s members will not be effective in  carrying out their specific oversight responsibilities.
section_title: LSC’s Board of Directors Has Not Assessed Its Performance
paragraphs: The LSC board does not assess the board or committee performance  collectively, or the individual performance of its board members. A  board’s self-assessment allows the board to periodically determine  whether it is meeting its intended goals and fulfilling its duties and  provides information needed by the board to make adjustments to its  processes and its oversight of management.  Board assessments are  common practice for nonprofit corporation boards and a NYSE listing  requirement for audit committees of public companies. An assessment can  include (1) an overall self-assessment of the entire board, (2) an  assessment of the separate board committees, (3) individual board  member assessments, or (4) all three. If a board does not assess its  performance, it is missing a key opportunity for input from its own  members for improving the board’s operations and governance policies. A  self-assessment enables the board to identify areas for improvement in the  board’s operating procedures, its committee structure, and its governance  practices. Many of the issues we explored during the course of this audit  could be evaluated through a board self-assessment. In addition, some  board members told us that documents are not provided well enough in  advance to allow a thorough review of the information prior to the  meetings or that board members are not receiving the information that  they need to fulfill their duties. Such situations could be identified and  addressed by the board in a self-assessment. Without a feedback and  assessment mechanism, the board runs the risk of not being aware of  issues that need to be addressed to improve the board’s functioning.
section_title: LSC Management Practices Have Not Kept Up with Current Practices for Key Processes in the Areas of Risk Assessment, Internal Control, and Financial Reporting
paragraphs: LSC’s management practices have not kept up with current practices in  key areas. Specifically, we found that management has neither conducted  a risk assessment nor implemented a risk management program to  mitigate identified risks, which should include a comprehensive continuity  of operations plan (COOP). Risk assessment programs identify the risks  the corporation faces and risk mitigation allows management to  implement policies that mitigate the risks. A well-designed and tested  comprehensive COOP helps mitigate risks from unexpected incidents that  can cause great damage and disruptions to operations. Also, senior  management has not conducted an assessment of the organization’s  internal controls and has not evaluated the financial reporting standards  that should be used for its financial statements. Internal control  assessment and monitoring are important because they provide reasonable  assurance that internal control failures will be prevented or promptly  detected. Financial reporting standards determine how an organization  records its financial transactions and presents the financial statements.  Without an internal control assessment and financial reporting standards,  LSC management does not have adequate assurance that the assets and  operations are protected, that funds are being used appropriately, and that  related risks are being mitigated. A key role of the board is to oversee  management practices in the areas of risk assessment and mitigation,  internal control, and financial reporting.
subsections: section_title: LSC Management Has Not Thoroughly Assessed Internal Controls or Conducted a Risk Assessment
paragraphs: Management has not completed a thorough assessment of its internal  controls or implemented risk mitigation policies in response to a  systematic or formal risk assessment. According to the Standards for  Internal Control in the Federal Government, internal control should  provide for an assessment of the risks the agency faces from both external  and internal sources. Management of public companies is required under  the Sarbanes-Oxley Act of 2002 to annually assess and report on the  effectiveness of the company’s internal controls over financial reporting.  Since fiscal year 2006, management of the 24 CFO Act agencies has also  been required by OMB guidance to assess and report on the effectiveness  of the agencies’ internal controls over financial reporting and compliance  with laws and regulations as part of an overall internal control assurance  process. As noted earlier, 31 U.S.C. § 3152(c),(d), or FMFIA, required  federal agencies to establish internal accounting and administrative  control. Assessing and reporting on the effectiveness of internal controls  over financial reporting has become an accepted practice among nonprofit  corporations.
Internal control is an integral component of an organization’s management  that provides reasonable assurance that the following objectives are being  achieved: effectiveness and efficiency of operations, reliability of financial  reporting, and compliance with applicable laws and regulations. Internal  controls serve as the first line of defense in safeguarding assets and  preventing and detecting errors and fraud.
The following are the five standards of internal control, which define  elements of internal control and provide the basis against which internal  control is to be evaluated.
Control environment. Management and employees should establish and  maintain an environment throughout the organization that sets a  positive and supporting attitude toward internal control.
Risk assessment. Internal control should provide for an assessment of  the risks the entity faces from both external and internal sources.
Control activities. Internal control activities help ensure that  management’s directives are carried out. The control activities should  be effective and efficient in accomplishing the entity’s control  objectives.  Information and communication. Information should be recorded and  communicated to management and others within the entity who need it  and in a form and within a time frame that enables them to carry out  their internal control and other responsibilities.
Monitoring. Internal control monitoring should assess the quality of  performance over time and ensure that the findings of audits and other  reviews are properly resolved.
The chief executive officer generally has primary responsibility for risk  assessment and risk management under the direction of the board of  directors. A risk assessment process includes such areas as operations,  compliance, and financial reporting, in which management  comprehensively identifies risks, and considers significant interactions  between the entity and external parties as well as internal risks at both the  entitywide and activity level. Risk assessment is also an integral part of the  Committee of Sponsoring Organizations of the Treadway Commission  internal control framework and an entity’s effective implementation of  internal controls. All entities, regardless of size, structure, nature, or  industry, encounter risks at all levels within their organizations. Through  the risk assessment process, management determines how much risk is to  be prudently accepted and strives to maintain risk within these levels.
Auditing standards that became effective on or after December 15, 2006,  cite ineffective oversight of the entity’s financial reporting and internal  control by those charged with governance, as well as an ineffective control  environment, as indicators of control deficiencies and strong indicators of  material weaknesses in internal control. The standards include the  following examples of deficiencies in the design of controls that may be  control deficiencies, significant deficiencies, or material weaknesses that  would be reported by the auditor: (1) inadequate documentation of the  components of internal control, (2) inadequate design of monitoring  controls used to assess the design and operating effectiveness of the  entity’s internal control over time, and (3) the absence of an internal  process to report deficiencies in internal control to management on a  timely basis.
According to LSC management, it relies on a cycle memorandum  prepared by LSC’s external auditor as management’s assessment of  internal controls. However, the cycle memorandum contains process  descriptions and does not identify internal controls, their objectives, or the  assertions (completeness, rights and obligations, valuation, existence, and  presentation and disclosure) that the controls are intended to ensure and  the risks that need to be addressed through controls. LSC’s  Treasurer/Controller told us that LSC management has not conducted its  own formal assessment of internal controls. The Treasurer does conduct  ongoing, informal assessments of certain financial processes on an ad hoc  basis. However, these assessments are not utilized as part of a  comprehensive internal control evaluation. Without comprehensive  internal control assessment and monitoring, LSC is at risk that it will not  prevent or promptly detect internal control failures, including  unauthorized or improper use of federal funds or violations of laws or  regulations in its operations.
section_title: Code of Conduct and Ethics
paragraphs: LSC currently does not have a code of conduct that establishes a conflict- of-interest or ethics policy for its employees. A conflict-of-interest policy is  intended to help ensure that when actual or potential conflicts of interest  arise, the organization has a process in place under which the affected  individual will recognize the potential conflict and advise management or  the governing body about the relevant facts so that potential conflicts of  interest can be resolved. Ethics provisions in the LSC Act and elaborated  on in the LSC bylaws (§ 3.05) pertain only to the outside interests of the  Board of Directors. LSC bylaws give the board authority to adopt rules and  regulations regarding the conduct of officers and employees in matters of  any adverse interest to LSC. At the time of our review, the only conflict-of- interest policy affecting employees was a prohibition against gifts, fees,  and honoraria greater than $50. LSC policy also states that officers of the  corporation must have any outside compensation approved by the board.
Federal employees are subject to various statutes and regulations that  govern ethical conduct, including public financial disclosure requirements  and outside earned income and activities limitations under the Ethics in  Government Act of 1978, as amended, and restrictions on gifts to federal  employees and acceptance of travel and related expenses from nonfederal  sources enacted by the Ethics Reform Act of 1989. The Office of  Government Ethics provides leadership for executive branch agencies and  departments to prevent conflicts of interest on the part of government  employees and to resolve conflicts that do arise.
The NYSE and the other stock exchanges have adopted corporate  governance requirements to aid their listed companies in complying with  ethics requirements contained in the Sarbanes-Oxley Act of 2002. NYSE- listed companies must adopt codes of business conduct and ethics for  directors, officers, and employees, and post the codes on their Web sites.  Under the Sarbanes-Oxley Act and the related implementation guidance,  codes of conduct and ethics should address conflicts of interest,  confidentiality, protection and proper use of an organization’s assets, and  compliance with laws and regulations, and encourage reporting of illegal  or unethical behavior. The American Bar Association (ABA) encourages  nonprofit organizations to adopt similar policies.
During the LSC operations and regulations committee meeting in April  2007, a board member suggested that a future agenda item should be  development of a compliance program that includes a code of conduct.   Without such a program that includes conflict-of-interest and ethics  policies, LSC is at risk of personnel being unaware of their responsibility  in the area of ethics and conflicts of interest, including incidents of illegal  or unethical behavior occurring and not being detected.
section_title: LSC Management Has Not Designed and Implemented a Comprehensive Continuity of Operations Plan
paragraphs: Although LSC does have a COOP, the plan is not complete or  comprehensive. It is the policy of the U.S. government for each agency to  have in place a comprehensive and effective program to ensure the  continuity of essential federal functions under all circumstances. Today’s  changing threat environment and the potential for no-notice emergencies,  including localized acts of nature, accidents, technological emergencies,  and terrorist attacks, have increased the need for COOP capabilities. In  this environment, preparing for disasters is an integral part of mitigating  risk. Federal Preparedness Circular No. 65 identifies the required  characteristics of an effective COOP program, which includes maintaining  and testing plans for responding to likely catastrophic events.
LSC’s Office of Information Technology (OIT) does perform a full, weekly  backup of data and an incremental daily backup. At the end of each  month, the most recent full weekly backup is stored off site; the most  recent 12 months are retained. According to LSC’s current COOP  description provided by LSC, OIT would need to relocate its systems to a  remote location should the LSC building not be accessible. Also, from this  description, it appears that system hardware first needs to be retrieved  from the LSC building and then transported and installed in another  location. However, there is no specific implementation plan or remote  location specified in the plan. LSC provided us with meeting agendas from  May 2006 and June 2006 regarding emergency responses, but did not  provide any additional COOP program information. Furthermore, there is  no indication that OIT conducted any simulations of disruptions to test its  established plans. An organization that does not have a tested,  comprehensive COOP is vulnerable to unexpected incidents capable of  causing great damage. Finally, because LSC does not have a  comprehensive risk assessment process, management and the board have  not assessed the risks or identified the acceptable levels of risk associated  with LSC’s current COOP.
section_title: LSC Management Has Not Assessed the Propriety of Its Financial Reporting Standards
paragraphs: LSC’s management has not conducted its own assessment or analysis to  determine which set of accounting standards—those promulgated by the  Financial Accounting Standards Board (FASB), Government Accounting  Standards Board (GASB), or Federal Accounting Standards Advisory  Board—are most applicable for LSC to use. The accounting standards that  an entity uses determine how the entity records its financial transactions  and how the entity presents the financial statements. According to LSC  management, in the mid-1990s, the former IG determined that LSC’s  financial reporting should follow the standards issued by GASB, which  establishes standards of financial accounting and reporting for state and  local governmental entities. However, management, not the OIG, is  responsible for the financial statements and for adopting the related  accounting policies and for maintaining an adequate and effective system  of accounts that will, among other things, help ensure the production of  proper financial statements.
In response to our inquiries about LSC’s selection and use of those  standards in its accounting and preparation of its financial statements,  neither LSC management nor the current IG were able to provide us with  an analysis or the primary technical reasons why LSC is currently using  GASB standards, which are normally intended for use by state and local  governments. During the April 2007 meeting of the finance committee, a  discussion was held on whether the corporation should be using GASB or  FASB standards for its accounting. The Treasurer informed the committee  members that his current opinion was that LSC should be using the FASB  standard, instead of GASB. It was agreed that further discussion would  take place between the Treasurer and OIG staff and that the committee  would receive an update at the next committee meeting in July 2007.
section_title: Conclusions
paragraphs: In recent years, governance and accountability processes have received  increased scrutiny and emphasis in the nonprofit, federal agency, and  public company sectors as a result of governance and accountability  breakdowns, most notably in the public company financial scandals that  led to the enactment of the Sarbanes-Oxley Act of 2002. Public companies  now operate under strengthened governance and accountability standards,  including requirements for ethics policies and improved internal controls.  The federal government and nonprofit sectors have followed this lead and  established new standards and requirements for improved internal control  reporting and governance and accountability. For nonprofit corporations  using funding from taxpayers and donors, effective governance,  accountability, and internal control are key to maintaining trust and  credibility. Governance and accountability breakdowns result in a lack of  trust from donors, grantors, and appropriators, which could ultimately put  funding and the organization’s credibility at risk.
Since its inception over 30 years ago, LSC’s governance and accountability  requirements, including its financial reporting and internal control, have  not changed significantly. Further, LSC’s board and management have not  kept pace with evolving governance and accountability practices. As a  result, LSC’s current practices have fallen behind those of federal  agencies, U.S. government corporations, and other nonprofit corporations.  The current accepted practices of federal agencies, U.S. government  corporations, and nonprofit corporations provide a framework for  identifying standards that can most effectively be used for strengthening  LSC’s governance and accountability. Effectively utilized, current,  accepted governance and accountability practices are necessary to  provide strong board oversight and effective day-to-day management of  LSC’s performance. In addition, NYSE listing standards and the  Conference Board provide widely accepted governance standards that can  be applied to public companies and nonprofit corporations to improve  governance structures and practices. Because LSC’s board and  management have not kept pace with the modernization of practices in  federal entities and other nonprofit corporations, many opportunities exist  to improve and modernize existing processes. By updating and  strengthening its governance and accountability structures, LSC can  increase assurance that federal funds are being properly spent and its  operations are effectively carried out to meet its mission.
section_title: Matter for Congressional Consideration
paragraphs: Since the LSC Act was enacted in 1974 and last comprehensively amended  and reauthorized in 1977, new laws governing federal agencies, U.S.  government corporations, and public companies have been enacted to  strengthen governance and accountability requirements. Therefore,  Congress should consider whether LSC could benefit from additional  legislatively mandated governance and accountability requirements, such  as financial reporting and internal control requirements, modeled after  what has worked successfully at federal agencies or U.S. government  corporations. There are different options available to Congress for such a  mandate.
Congress could maintain LSC’s current organizational structure as a  federally chartered and federally funded, private, nonmembership, and  tax-exempt D.C. nonprofit corporation and enact permanent legislation  to require LSC to implement additional governance and accountability  requirements.
Alternatively, Congress could enact legislation to convert LSC to a  federal entity (such as a U.S. government corporation subject to the  Government Corporation Control Act) or an independent federal  agency that is required to follow the same laws and regulations as  executive branch agencies. In the statute establishing LSC as a federal  entity, Congress could specifically exempt LSC from certain  requirements that would otherwise apply to that type of federal entity  in order to further special policy considerations particular to LSC.
section_title: Recommendations
paragraphs: Through our evaluation of LSC’s governance and accountability practices,  we identified opportunities for the LSC board and management to improve  their current governance and accountability practices.
subsections: section_title: Recommendations for Board Action
paragraphs: In order to improve and modernize the governance processes and  structure of LSC, we recommend that the LSC Board of Directors take the  following eight actions:    establish and implement a comprehensive orientation program for new  board members to include key topics such as fiduciary duties, IRS  requirements, and interpretation of the financial statements;    develop a plan for providing a regular training program for board  members that includes providing updates or changes in LSC’s operating  environment and relevant governance and accountability practices;    establish an audit committee function to provide oversight to LSC’s  financial reporting and audit processes either through creating a  separate audit committee or by rewriting the charter of its finance  committee;    establish a compensation committee function to oversee compensation  matters involving LSC officers and overall compensation structure  either through creating a separate compensation committee or by  rewriting the charter of its annual performance review committee;    establish charters for the Board of Directors and all existing and any  newly developed committees to clearly establish committees’ purposes,  duties, and responsibilities;    implement a periodic self-assessment of the board’s, the committees’,  and each individual member’s performance for purposes of evaluating  whether improvements can be made to the board’s structure and  processes;    develop and implement procedures to periodically evaluate key  management processes, including at a minimum, processes for risk  assessment and mitigation, internal control, and financial reporting;  and    establish a shorter time frame (e.g., 60 days) for issuing LSC’s audited  financial statements.
section_title: Recommendations for Executive Action
paragraphs: In order to improve and modernize key management processes at LSC, the  president and executive committee should take the following four actions:    conduct and document a risk assessment and implement a  corresponding risk management program as part of a comprehensive  evaluation of internal control;    with the board’s oversight, evaluate and document relevant  requirements of the Sarbanes-Oxley Act of 2002 and practices of NYSE  and ABA that are used to establish a comprehensive code of conduct,  including ethics and conflict-of-interest policies and procedures for  employees and officers of the corporation;     establish a comprehensive and effective COOP program, including  conducting a simulation to test the established program; and    conduct an evaluation to determine whether GASB should be adopted  as a financial reporting standard for LSC’s annual financial statements.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided copies of the draft report to LSC’s Board of Directors and  management for comment prior to finalizing the report. We received  written comment letters from the Chairman on behalf of LSC’s Board of  Directors and LSC’s President on behalf of LSC’s management (see apps. V  and VI). Both the Chairman and President expressed their commitment to  achieving strong governance and accountability and outlined the actions  that LSC’s board and management plan to take in response to our  recommendations. LSC management provided technical comments that  were incorporated into the report as appropriate.
The Chairman of LSC’s board expressed the board’s agreement to take  action to address each of the recommendations we made to the board.  LSC’s president on behalf of management provided a comment letter  where management fully agreed with our recommendations dealing with  financial reporting standards, COOP, and code of conduct, and expressed  commitment to further action “in the spirit of” our recommendation  dealing with conducting and documenting a risk assessment and  implementing a corresponding risk management program as part of a  comprehensive evaluation of internal control.
LSC’s President also included some clarifications to our draft report. First,  LSC management stated that “the draft report does not address the  existence of congressional oversight,” and provided additional context  regarding LSC’s congressional oversight. Our draft report included a  discussion of congressional oversight through LSC’s budget process and  the appropriations process. In our final report, we included a broader  description of LSC’s congressional oversight. Second, LSC management  points out that LSC provides certain whistleblower protection statements  in its employee handbook regarding communicating with the OIG. We  added language to our final report to reflect the existence of such  protection under the IG Act. Third, the LSC President stated that the OIG  did not find conflicts of interest related to the acting special counsel and  was troubled by the references in our report to potential conflicts of  interest. In our report, we included information about the IG’s finding that  LSC’s hiring of acting special counsels from grantee organizations  represented a potential conflict of interest. Our report also noted that the  board currently does not have an ethics committee and there is no code of  conduct for LSC employees.
Both LSC’s Chairman and President commented on the matter that we  presented for congressional consideration—that Congress should consider  whether LSC could benefit from additional legislatively mandated  governance and accountability requirements. In addition, in their  respective letters, LSC’s Chairman and President both provided their  views that LSC’s governing statutes are appropriate and have worked well  and stated that many of the governance recommendations could be  accomplished without changing the statutory framework of LSC. As we  noted, Congress chartered LSC over 30 years ago as a private corporation  for certain policy reasons with governance and accountability  requirements that existed at that time as a unique private corporation in  response to certain policy considerations. While federal agencies and  government corporations have been subject to strengthened governance  and accountability requirements over recent years, LSC has not kept up  with evolving reforms aimed at strengthening internal control over an  organization’s financial reporting process and systems, with LSC’s board’s  practices falling short of modern board practices and LSC not keeping up  with current management practices. Therefore, we presented the options  of amending LSC’s governing statutes to improve governance and  accountability requirements or converting LSC to a federal entity, which  would include compliance with related governance and accountability  requirements.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date. We will then send copies to other appropriate congressional  committees, the president of LSC, and the LSC Board of Directors. We will  also make copies available to others upon request. In addition, the report  will be available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions concerning this report, please  contact me at (202) 512-9471 or franzelj@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. GAO staff who made key contributions to this  report are listed in appendix VII.
section_title: Appendix I: Origin and Creation of the Legal Services Corporation
paragraphs: Although low-income people since the 19th century had been turning to  local legal aid societies throughout the United States for assistance with  their civil legal problems, in the 1960s President Lyndon B. Johnson  declared poverty to be a national problem and initiated a “War on Poverty”  to make federal resources available to support local antipoverty programs,  such as the legal assistance provided by legal aid societies. The first War  on Poverty legislation, the Economic Opportunity Act of 1964, established  the now-defunct Office of Economic Opportunity (OEO) within the  Executive Office of the President to administer the War on Poverty  programs, including what would become the Legal Services Program, the  predecessor to the current Legal Services Corporation (LSC).
The OEO’s Legal Services Program activities soon generated political  controversy, and by the early 1970s there was a general consensus that the  OEO’s Legal Services Program should be moved out of the Executive  Office of the President. A number of different structures were proposed.  For example, there were proposals to move the Legal Services Program  into an executive department, such as the Department of Justice, the  Department of Housing and Urban Development, or the predecessor to the  current Department of Health and Human Services. In addition to raising  concerns about political interference, critics of placing the function in an  executive department raised concerns about decreased program visibility,  reduced responsiveness to client needs, and the objectives of the program  being subordinated to the department’s mission. Another proposed  organizational home was the Judiciary, especially the Administrative  Office of the United States Courts, but critics argued that the Judiciary  was already overburdened with work and faced frequent funding  problems.
Four alternative organizational structures were suggested that took into  consideration accountability to Congress and the public while promoting  political independence, permanence, program stability, operational  flexibility, and attorney independence to represent clients consistent with  high professional standards. The four alternative organizational structures  proposed were a federal block grant program, an independent agency in  the executive branch, a U.S. government corporation, or a private  nonprofit corporation. Examples of such organizations today include,  respectively, (1) the Temporary Assistance for Needy Families Program  and the Community Development Block Grant Program, (2) the National  Science Foundation and the National Foundation on the Arts and the  Humanities, (3) the Millennium Challenge Corporation and the  Corporation for National and Community Service (Americorps), and        (4) the Corporation for Public Broadcasting (CPB).
Ultimately, consensus in the early 1970s coalesced around an entity  modeled after the CPB, which was a private, nonmembership, nonprofit  corporation in the District of Columbia with federal funding that was  federally chartered by the Public Broadcasting Act of 1967 to “facilitate  the development of public telecommunications and to afford maximum  protection from extraneous interference and control.” The CPB federal  charter created a nine-member, bipartisan board of directors that is  appointed by the President of the United States with the advice and  consent of the U.S. Senate. The board manages CPB to accomplish its  primary mission of providing federal funding via grants and contracts to  public telecommunications and production entities in order to promote  the expansion and development of public telecommunications with high- quality, diverse programming responsive to local needs and furthering  instructional, educational, and cultural purposes. CPB, which was last  reauthorized in 1992, is also funded through annual appropriations.
By transferring the Legal Services Program to a federally funded, private  nonprofit corporation modeled after CPB, supporters of this type of  organizational entity hoped to achieve the goal of greater operational  flexibility and protection from political pressure from all levels of  government while retaining accountability to Congress and the public.  Supporters also hoped to encourage private donations to LSC, so unlike  CPB’s federal charter, the Legal Services Corporation Act of 1974 (LSC  Act) provides that LSC shall be eligible to be treated as a charitable  corporation exempt from federal taxation.
Under the Internal Revenue Code, tax-exempt status basically means that  the corporation is operated and organized exclusively for charitable  purposes, does not attempt to influence legislation, does not campaign on  behalf of candidates for public office, and does not allow any of its net  inure earnings to inure to the benefit of any individual. To maintain tax- exempt status, organizations must annually file with the Internal Revenue  Service (IRS) a Form 990, Return of Organization Exempt From Income  Tax, which is available for public inspection and includes such  information as the organization’s gross income, assets and liabilities, and  compensation paid to high-level managers. A number of the provisions in  the LSC Act are consistent with IRS’s requirements for tax-exempt status.  For example, the LSC Act’s purpose of providing civil legal assistance to  low-income people qualifies as charitable, and the LSC Act prohibits LSC  from engaging in certain political activities, such as activities that would  influence the passage or defeat of any legislation at the local, state, or  federal level or from making LSC resources available to support any  political party or campaign of any candidate for public office. The LSC Act  also states that LSC has no power to issue stocks and prohibits any LSC  income or assets from inuring to the benefit of any director, officer, or  employee, except as reasonable compensation for services or  reimbursement for expenses. By making and keeping LSC a tax-exempt  organization, the LSC Act prevents federal tax dollars from being spent on  paying federal taxes and thus permits LSC to use its funds for the  charitable purpose set out in the LSC Act.
Congress enacted the LSC Act in 1974 to transfer the functions of the Legal  Services Program from the Executive Office of the President into a private,  nonmembership, nonprofit corporation with tax-exempt status that would  be federally chartered in the District of Columbia and be authorized to  receive annual federal appropriations to fund its operations supporting  civil legal assistance to low-income people in communities throughout the  United States.
section_title: Appendix II: Examples of Corporate Governance Guidelines
subsections: section_title: Corporate governance guidelines
paragraphs: In carrying out their functions, corporate directors must fulfill fiduciary duties of care, loyalty, and good  faith. Boards may delegate the day-to-day management of the company to the chief executive officer  (CEO) and other senior management, but board members retain responsibilities for oversight and  monitoring of any delegated functions.
Under state corporate law, directors owe fiduciary duties to the corporation and its shareholders:    the duty of care, which is the duty to exercise appropriate diligence and make decisions that are  informed;  the duty of loyalty, which is the duty to act without conflict and always put the interests of the  corporation before those of the individual director or other individuals or organizations the  individual director is affiliated with; and  the duty to act in good faith, which is the duty to act with honesty of purpose and in accordance  with evolving corporate governance best practices.
A strong and effective board of directors should have a clear view of its role in relationship to  management. How the board organizes itself and structures its processes will vary with the nature of  the business, business strategy, the size and maturity of the company, and the talents and  personalities of the CEO and directors. Circumstances particular to the corporate culture may also  influence the board’s role. The board focuses principally on guidance and strategic issues, the  selection of the CEO and other senior executives, risk oversight and performance assessment, and  adherence to legal requirements. Management implements the business strategy and runs the  company’s day-to-day operations with the goal of increasing shareholder value for the long term.
The board should have a set of written guidelines in place to articulate corporate governance  principles and the roles and responsibilities of the board and management. These guidelines should  be reviewed at least annually. By elaborating on directors’ basic duties, the guidelines help the board  and its individual members understand their obligations as well as the general boundaries within  which they should operate.
The effectiveness of the board ultimately depends on the quality and timeliness of information  received by directors. Each board and management should agree on the type of information the  board needs to make informed decisions and perform its oversight function. This should include  material on business and financial performance, strategic issues, and information about material risks  and other significant matter facing the company. Information for board meetings should be distributed  enough in advance of the meetings to permit directors to read, absorb, and consider it. Besides  formal processes, board and management should develop informal communication and reporting  channels.
Boards should consider the following best practices to help ensure effective decision making and  exchange of information and ideas at meetings of the full board or its committees:   Independent directors should be able to place issues on the board agenda, with time for  adequate discussion and consideration, and determine the type and quality of information flow  required for effective board action.  Last minute add-ons to the agenda, especially for weighty  issues, should be discouraged.
The lead/presiding director, if there is one, should take responsibility to surfacing issues that  impact the business and need to be presented to the board for discussion and/or action, whether  in regular or executive sessions.
Management should provide information that effectively explains the company’s operating and  financial status, as well as other significant issues facing the company and the board.  Appropriate feedback mechanisms between management and the board should be developed to  ensure that the materials are useful, timely, and of adequate depth. Meeting materials should  contain a cover letter highlighting the most important issues for directors’ consideration.
Meetings should be structured to encourage participation and dialogue among the directors.
Directors have an obligation to ensure near-perfect attendance at meetings and actively  participate in the meetings, including asking the hard questions.
The CEO should expose directors to senior management team members and operation (line)  management at meetings and field trips so that directors can, with knowledge informally acquired  from management, further delve into issues necessary to carry out their functions.
According to New York Stock Exchange (NYSE) rules, executive sessions should   1.  be held without management present;   2.  be regularly scheduled to prevent negative inferences;  3.  disclose the name of the director presiding at the executive sessions, if one is chosen, in the  annual proxy statement or the procedure by which the director presiding at meetings is selected;  and  4.  disclose mechanisms for interested parties to make their concerns known to the  nonmanagement directors as a group. NASDAQ’s rules require regularly convened executive  sessions of the independent directors.
In addition, according to best practices identified by the Conference Board Directors’ Institute,  executive sessions should   promote open dialogue among the independent members and free exchange of ideas,  perspectives, and information;  have a feedback mechanism to the CEO for important issues that may surface (the lead or  presiding director can take the lead in providing the CEO feedback);   be scheduled at regular intervals (most commonly following each full board meeting, even  though some boards may also hold a short pre-meeting executive session) to eliminate any  negative inferences from convening these sessions; and   be supplemented by additional off-line informational channels (such as dinners before board  meetings) to help build trust and relationships among the independent directors.
An independent, vigorous, and diligent board of directors is crucial to good corporate governance.  Boards must move from their traditional advisory roles to become active fiduciaries in the exercise of  their oversight responsibilities. From this standpoint, independence is essential. Although defined by  legislative and regulatory standards, a director’s independence (in thought and action) from  management influence should always be evaluated qualitatively and on a case-by-case basis.
For the past few years, issuers have been required to disclose information in Securities and  Exchange Commission filings regarding director independence and other corporate governance  matters. The commission has recently consolidated these requirements under new Item 407 of  Regulation S-K. Registrants must disclose information about director independence; nominating,  audit, and compensation committees; and shareholder communications by the following means:  Identifying each independent director of the company (and the nominees for director when the  information is being presented in a proxy or information statements) as measured by the  company’s definition of independence.
Identifying any members of the compensation, nominating, and audit committees whom the  company has not identified as independent under such definition.
Describing, by specific category or type, any related party transactions, relationships, or  arrangements not disclosed pursuant to Item 404 that were part of the board of directors’  consideration in determining that the independence standard has been met as to each  independent director or director nominee.
Providing the number of board meetings during the fiscal year and certain attendance  information, including the board’s policy on attendance at annual shareholder meetings and  attendance information with respect to the last annual meeting.
Identifying any standing audit, nominating, and compensation committees; their membership  composition; and the number of meetings, together with certain descriptive information regarding  such committees.
Disclosing information about the audit committee’s independence and expertise, and about the  process for shareholders to send communications to the registrant’s board of directors. If there is  no process, the basis for the board’s view that it is appropriate not to have such a process and, if  all shareholder communications are not sent directly to board members, a description of the  process for determining which communications will be provided to board members.
The composition and skill set of a board should be linked to the company’s particular challenges and  strategic vision. As companies develop and experience changed circumstances, the desired  composition of the board may be different and should be reviewed.
The composition of the board should be tailored to meet the needs of the company and its stage of  development. There should be a mix of director knowledge and expertise in  strategic and business planning,  industry knowledge.
As with any group working together, boardroom relationships are difficult to predict, but an effective  director  asks the hard questions,    works well with others,  is available when needed,  is alert and inquisitive,  contributes to committee work,  challenges management’s assumptions when needed and speaks out appropriately at board  meeting,    makes contributions to long-range planning, and  provides an overall contribution to the board and committees on which he or she serves.
According to the 2006 edition of the annual Directors’ Compensation and Board Practices report by  the Conference Board, the median board size, depending on the industry, ranges from 9 to 11  members. The median number for outside directors varies from 8 to 10. The 2007 edition of Board  Practices/Board Pay report noted that 72 percent of Standards & Poor’s 1,500 companies had 9- member boards in 2005, down from 12 in 2003. Boards need to be large enough to accommodate  the necessary skill sets, but still small enough to promote cohesion, flexibility, and effective  participation. “When you’ve got a 20- or 30-person corporate board,” argued one member of the  Conference Board Directors’ Institute, “it’s one way of ensuring that nothing is ever going to happen  that the CEO doesn’t want to happen. If you’ve got a small board—8 to 10 people—people do get  involved.”
The NYSE requires that a list of director qualification standards be included in the company’s  corporate governance guidelines. These standards should, at a minimum, reflect the NYSE  independence requirements. Companies may also address other substantive qualifications  requirements, including policies limiting the number of boards on which a director may sit and  specifying director tenure, retirement, and succession criteria. All directors must devote the proper  amount of time and attention to develop the broad-based and specific knowledge required to fulfill  their obligations.
In order to ensure a high level of commitment, directors should  assess carefully and guard against potential entanglements, such as service on an excessive  number of boards;  prepare for and attend all board and committee meetings and consider travel requirements for  these meetings (in particular for foreign-based directors);  participate actively and effectively at meetings;  develop and maintain a high level of knowledge about the company’s business;  keep current in the director’s own specific field of expertise; and  develop broad knowledge about the role and responsibilities of directors, including legal  responsibilities.
Boards should adopt a structure providing nonmanagement directors with the leadership necessary  for them to act independently and perform effectively. This structure could include separating the  positions of chairman and CEO; creating a lead independent director; or in case of a former  employee acting as chairman, appointing a presiding director from among the independent directors.
Any structural alternative a board wishes to adopt should   strengthen the independence and oversight role of the board,  provide the nonmanagement directors with the ultimate authority over information flow to the  board, and  improve the relationship and flow of information between the board, CEO, and senior  management.
Boards should establish committees (e.g., nominating/governance, audit, compensation)  that will  enhance the overall effectiveness of the board by ensuring focus on and oversight of matters of  particular concern. Statutory law, SEC rules, and stock exchange listing standards require that  committees must be composed solely of directors who meet specified independence standards.
An effective committee structure should require that   each committee have a charter delineating the committee’s jurisdiction, duties, and  responsibilities;  each charter include only duties that can actually be accomplished; and  each charter be reviewed at least annually.
Hiring the CEO and planning for CEO succession are two of the most important responsibilities of the  board. The board should institute a CEO succession plan and selection process overseen by one of  its independent committees or by a designated director or group of directors.
A successful succession planning process will  be driven and controlled by the board,  involve inputs from the CEO and other key employees,  be easily executed in the event of a crisis,  be tied to the corporate strategy,  be geared toward finding the right leader at the right time,  develop talent pools throughout the managerial ranks of the company, and  avoid a “horse race” mentality that may lead to the loss of key officers when the new CEO is  chosen.
section_title: Appendix III: Comparison of Other Key LSC Requirements
subsections: section_title: Grants Management
paragraphs: LSC is subject to grants management requirements that are stronger than  those of other Washington, D.C., nonprofit corporations, but somewhat  less rigorous than those governing federal entities, including requirements  related to the grantor’s audits of grant recipients, administration of grants,  and application of cost principles to grants. (See table 6.) In 1996,  Congress amended the LSC Act on a fiscal year basis through certain  administrative provisions included in the fiscal year 1996 appropriations  act for LSC (LSC 1996 Amendments). The LSC Act requires the LSC board  to ensure that each grant recipient is subject to an annual financial audit  and to maintain a copy of that audit report at its headquarters for at least 5  years. The LSC 1996 Amendments added additional requirements related  to grant recipient audits. The LSC 1996 Amendments require the grant  recipient audit to be conducted in accordance with generally accepted  government auditing standards (GAGAS) and guidance established by the  LSC Office of Inspector General (OIG). The grant recipient audit report  must state whether (1) the grant recipient’s financial statements fairly  present its financial position and results of operations in accordance with  generally accepted accounting principles (GAAP); (2) the grant recipient  has internal control systems that provide reasonable assurance that it is  managing its funds, LSC and otherwise, in compliance with federal laws  and regulations; and (3) that the grant recipient has complied with federal  laws and regulations applicable to funds received from LSC or other  sources.
The LSC 1996 Amendments include other grant management provisions.  For example, the LSC 1996 Amendments require the board to select LSC  grant recipients through the implementation of a system of competitive  awards, including such selection criteria as (1) the demonstration of an  understanding of client legal needs and capability of serving such needs;  (2) the quality, feasibility, and cost-effectiveness of the proposed plan for  delivery of legal assistance; and (3) LSC’s past experience with the  applicant, including the record of past compliance with LSC requirements.  The LSC 1996 Amendments require the board to ensure that no grant  recipient uses LSC funds for any litigation activity in providing client legal  services unless certain recordkeeping requirements are met. For all cases  or matters, the LSC 1996 Amendments require the board to obtain the  grant recipient’s agreement to maintain timekeeping records. Additionally,  the LSC 1996 Amendments require the board, before providing funding to  a grant recipient, to ensure that the grant recipient enters into a  contractual agreement to be subject to all federal laws relating to the  proper use of federal funds (i.e., not using federal funds for fraud, waste,  or abuse) and that for such purposes LSC shall be considered a federal  agency and its grant funds shall be considered federal funds. Finally, LSC  has issued regulations on its administration of grants, including provisions  establishing cost standards and procedures.
Requirements for audits of grants provided by federal agencies and U.S.  government corporations are found in the Single Audit Act, as amended,  which established uniform audit requirements for state and local  governments and nonprofit organizations that receive grants or other  forms of federal financial assistance. In addition to uniform audit  requirements, the Single Audit Act is intended to “promote sound financial  management, including effective internal controls, with respect to Federal  awards administered by non-Federal entities” and “promote the efficient  and effective use of audit resources.” The Office of Management and  Budget (OMB) has issued implementing regulations on the Single Audit  Act in OMB Circular No. A-133, Audits of States, Local Governments, and  Non-Profit Organizations (rev. June 27, 2003).
Under the Single Audit Act and implementing regulations, generally grant  recipients must annually arrange for an independent auditor to conduct an  audit in accordance with GAGAS and prepare a report on the grant  recipient’s financial statements and schedule of expenditures, internal  controls, and compliance with laws and regulations. The auditor must  report whether (1) the financial statements are presented fairly in all  material respects in conformity with GAAP and (2) the schedule of  expenditures of the grants is presented fairly in all material respects in  relation to the financial statements taken as a whole. With respect to  internal controls, the auditor must obtain an understanding of each of the  grant recipient’s major programs, assess control risk, and perform tests of  the controls. The auditor must also determine whether the grant recipient  has complied with the provisions of laws, regulations, and contracts or  grants related to the grant that have a direct and material effect on each  major program.  The Single Audit Act requires each grantor federal entity  to assess the quality of such audits and monitor the grant recipient’s use of  the federal funds received pursuant to the grant. The Single Audit Act also  requires any auditor of a grant recipient to provide access to the auditor’s  workpapers in response to a request from the grantor federal entity or the  Comptroller General as part of either’s activities in furthering their  oversight responsibilities.
In addition to providing guidance on audits of grant recipients of federal  entities, OMB uses the authority it possesses under a number of statutes to  issue guidance on uniform administrative requirements for federal grants  that each federal agency and U.S. government corporation must  implement by promulgating entity-specific regulations. OMB has issued  two different circulars for grants to different types of entities: OMB  Circular No. A-102 applies to grants to state and local governments and  OMB Circular No. A-110 applies to grants to institutions of higher  education, hospitals, and other nonprofit organizations. These circulars  provide for the use of common forms, such as applications, and common  standards, such as grant recipient financial reporting, socioeconomic  policies, and grantor monitoring and oversight responsibilities. OMB has  also issued guidance providing cost principles for federal entities to use in  administering their grants. In three separate circulars, OMB sets out  principles to determine the applicability of costs incurred by three groups  of entities to federal grants.  OMB Circular No. A-87 establishes cost  principles for state, local, and tribal governments; whereas OMB Circular  Nos. A-21 and A-122 establish such principles, respectively, for institutions  of higher education and nonprofit organizations.
section_title: Acquisition and Management of Property and Services
paragraphs: Unlike most independent federal agencies and wholly owned government  corporations, LSC is not subject to a wide range of federal laws and  regulations that govern the acquisition and management of property and  services, such as the Federal Acquisition Regulation (FAR) or the Federal  Travel Regulation (FTR). (See table 7.) As a D.C. nonprofit corporation,  LSC has few limitations on its acquisition, management, disposition, and  contract activities in relation to real and personal property and services.  Under the D.C. Nonprofit Corporation Act, it can acquire any interest in  real or personal property by purchase, gift, lease, or contract and then  “own, hold, improve, use and otherwise deal in and with” such property.   LSC can also dispose of any property interest through sale, mortgage,  lease, exchange, transfer, or any other suitable method. LSC also has the  power to acquire services through making contracts and incurring  liabilities.
In procuring property and services, most independent federal agencies and  wholly owned U.S. government corporations are subject to a number of  laws and regulations, including the Public Buildings Act of 1959, the  Federal Property and Administrative Services Act of 1949, the Office of   Federal Procurement Policy Act, the Competition in Contracting Act of  1984, the FAR, and the Federal Management Regulation (FMR). These  laws and regulations set out authorities, requirements, and standards for  most independent federal agencies and U.S. government corporations to  manage their acquisition and property systems.
Information technology and travel services are important types of property  and services that federal and nonprofit entities need to acquire. Federal  agencies and wholly owned U.S. government corporations, but not LSC,  are subject to federal governmentwide management laws in these areas.  The Clinger-Cohen Act of 1996, governs information technology  acquisitions by federal agencies and wholly owned U.S. government  corporations, requiring, among other things, the design and  implementation of a process for maximizing the value, and assessing and  managing the risks of the entity’s information technology acquisitions, as  well as the creation of a chief information officer position to help manage  this process. Federal agencies and wholly owned U.S. government  corporations, but not LSC, are also subject to statutory requirements for  travel by federal civilian employees, as well as the implementing the FTR,  promulgated by the General Services Administration, which are intended  to regulate travel “in a manner that balances the need to assure that  official travel is conducted in a responsible manner with the need to  minimize administrative costs.” For example, the FTR provides rules on  when government employees may use first-class or business-class airline  accommodations.
section_title: Human Resources Management
paragraphs: Under the D.C. Nonprofit Corporation Act, the LSC board possesses broad  powers in relation to its officers, employees, and other agents with only  limited restrictions imposed on this power by the LSC Act and other D.C.  statutes. (See table 8.) Unlike federal agencies, LSC is not subject to the  laws in the U.S. Code relating to the executive branch workforce. For  example, like directors of other private nonprofit, tax-exempt  corporations, the LSC directors have the power to determine the rates of  compensation of LSC’s officers and employees so long as the  compensation is not so high that it might constitute prohibited personal  inurement. In one of its few human resources restrictions, however, the  LSC Act specifically makes LSC subject to certain laws governing pay and  benefits for civilian employees of federal agencies and wholly owned U.S.  government corporations.  The LSC Act does so by imposing a ceiling on  compensation for any LSC officer or employee who is linked to a federal  pay schedule under federal law: level V of the Executive Schedule, which  in calendar year 2006 was $133,900. The LSC Act also treats LSC as a  federal entity for purposes of personnel participation in specified federal  employee benefits programs to which LSC is required to make  contributions at the same rates applicable to federal employers.
Unlike the employees of LSC and other Washington, D.C., nonprofit  corporations, employees of federal agencies and, to a limited extent, U.S.  government corporations, enjoy certain protections under the  Whistleblower Protection Act when they engage in “whistleblowing,”  which involves reporting evidence of illegal or improper federal employer  activities to the relevant authorities. For example, federal agency and U.S.  government corporation supervisors may not take disciplinary action  against an employee for disclosing information that the employee  reasonably believes evidences gross mismanagement, a gross waste of  funds, an abuse of authority, or a substantial and specific danger to public  health or safety. There is no equivalent statutory provision for employees  of Washington, D.C., nonprofit corporations, such as LSC or CPB. Under  Washington, D.C., law, however, if a D.C. nonprofit corporation terminates  an employee because he or she disclosed information of employer  misconduct, such as illegal activities, then the terminated employee can  sue the corporation for wrongful discharge under D.C. law’s public policy  exception to the at-will employment doctrine that at-will employees can be  terminated at any time for any reason. Furthermore, LSC employees, like  those of CPB and federal entities subject to the IG Act, enjoy additional  protections not available to employees of typical D.C. nonprofit  corporations. Under the IG Act the IG must not, without the employee’s  consent, disclose the identity of an employee who informs the IG about  the possible existence of an activity at LSC constituting a violation of law,  rules, or regulations, or mismanagement, gross waste of funds, abuse of  authority, or a substantial and specific danger to the public health and  safety. The IG Act also prohibits the LSC employee’s manager from  retaliating, or threatening to retaliate, against the employee for this  communication with the IG, unless the employee provided the information  to the IG with knowledge that it was false or with willful disregard for its  truth or falsity.
section_title: Recordkeeping and Public Access to Information
paragraphs: Large organizations such as LSC generate print and electronic records and  conduct executive meetings as part of their regular course of business.  LSC’s statutory requirements for access to information are similar to those  of federal entities, but its recordkeeping requirements are not as rigorous.  However, LSC’s requirements for access to information and recordkeeping  are stronger than those for other Washington, D.C., nonprofit  corporations. (See table 9.)
The LSC Act imposes some limited recordkeeping requirements on LSC,  such as a 3-year retention period for records that support its annual  financial audit and a requirement to keep copies of reports on grantees.  CPB is subject to a similar 3-year retention period for records supporting  its annual financial audit, but other Washington, D.C., nonprofit  corporations are subject to only minimal recordkeeping requirements,  including keeping correct and complete books and records of account and  minutes of board proceedings, which do not have to meet any particular  standard. Under the Federal Records Management laws, however, the  heads of independent federal agencies and wholly owned U.S. government  corporations have much broader recordkeeping duties: the creation of  records to document all “essential transactions” and retention of these  records for specified time periods depending on the type of transaction  documented.
For any records that LSC, federal agencies, and U.S. government  corporations retain, they must provide the public with access to these  records as required by the Freedom of Information Act (FOIA). FOIA  requires that federal entities make their records available for public  inspection and copying unless one of the listed FOIA exemptions apply,  such as the exemptions for records pertaining to medical files, internal  personnel practices, or trade secrets. This is one of the handful of  provisions in the LSC Act in which the LSC Act provides that LSC shall be  treated as a federal agency. There is no comparable public right to access  corporate records under the D.C. Nonprofit Corporation Act. While CPB is  not subject to FOIA, it does include a records access provision requiring  CPB to maintain certain records at its office and to make them available  for public inspection and copying.
LSC is also subject to the Government in Sunshine Act (Sunshine Act),  which means that all board meetings, including meetings of any executive  committee of the board, must be open to public observation. In following  the Sunshine Act, the LSC board must follow the procedural requirements  for providing adequate notice of meetings, as well as for closing all or a  portion of a meeting based on discussion of exempted subject matter, such  as personnel matters or pending litigation. In this respect, LSC is no  different from other entities subject to the Sunshine Act, which are U.S.  government corporations and federal agencies headed by a collegial body,  and very different from most D.C. nonprofit corporations that are subject  to no similar requirement. Although not subject to the Sunshine Act, the  CPB board has an open meetings requirement that resembles Sunshine Act  requirements.
While LSC is not subject to the “notice-and-comment rule making” under  the Administrative Procedures Act of 1946 (APA), LSC must provide  interested parties with “notice and a reasonable opportunity for comment”  on all proposed rules, regulations, and guidelines, and must publish these  requirements in the Federal Register at least 30 days prior to their  effective date. Federal agencies and U.S. government corporations are  subject to similar requirements in APA, whereas D.C. nonprofit  corporations have no similar rulemaking requirement for public  participation.
section_title: Appendix IV: Comparison of Key LSC Governance and Accountability Requirements
subsections: section_title: Inspector general: IG Act
paragraphs: Funds used only for  authorized purposes:  Purpose Statute (31  U.S.C. § 1301(a))
Funds used only for  authorized purposes:  Purpose Statute (31  U.S.C. § 1301(a))
Annual budget: LSC Act  (request made directly to  Congress: no content or  form requirements; OMB  comment and review  allowed)
Annual budget: 31  U.S.C. §§ 1105, 1108  (agency budget  submitted to the  President for inclusion in  the Budget of the U.S.  Government)
Annual budget: Wholly  owned U.S. government  corporations: 31 U.S.C. §  9103 (Government  Corporation Control Act)
LSC Act (report of annual  audit of LSC’s accounts)
Financial statements and  reports: Annual audited  financial statements: 31  U.S.C. §§ 9105, 9106  (Government Corporation  Control Act) (Chief Financial Officers  Act of 1990, Government  Management Reform Act  of 1994, Accountability of  Tax Dollars Act of 2002)
Strategic plans: 5 U.S.C.  § 306; Performance  plans and reports: 31  U.S.C. §§ 1115-1116  (Government  Performance and Results  Act of 1993)
Strategic plans: 5 U.S.C.  § 306; Performance  plans and reports: 31  U.S.C. §§ 1115-1116  (Government  Performance and Results  Act of 1993)
System of internal control  and Assurances: 31  U.S.C. § 3512(c), (d)  (Federal Managers’  Financial Integrity Act of  1982)
System of internal control  and Assurances: 31  U.S.C. § 9106  (Government Corporation  Control Act)
Employment: Title 5 of  the U.S. Code (Most  provisions apply to wholly  owned U.S. government  corporations, but only  some provisions apply to  mixed-ownership  government corporations)
Whistleblower protection:  Whistleblower Protection  Act (certain provisions)
Open meetings:  Government in the  Sunshine Act (if headed  by a multiperson body)
section_title: Appendix V: Comments from the Legal Services Corporation Board of Directors
section_title: Appendix VI: Comments from the Legal Services Corporation
section_title: Appendix VII: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the person named above, F. Abe Dymond; Lauren S. Fassler;  Joel I. Grossman; Maxine L. Hattery; Stephen R. Lawrence; Kimberley A.  McGatlin; and Matthew P. Zaun made key contributions to this report.