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The International Journal
of Not-for-Profit Law

Volume 6, Issue 2, February 2004

A publication of the International Center for Not-for-Profit Law

Table of Contents

Letter from the Editor

The Pacific

Social Inclusion and the Indigenous People of Australia: Achieving a Better Fit Between Social Need and the Charity Law Framework
Kerry O'Halloran

Australia Crawls Closer to Reform of the Definition of Charity
Myles McGregor-Lowndes

Consultations Toward Legal Reform in Tuvalu
James Duckworth and Mose Saitala

Social Capital and Philanthropy in Maori Society
Tuwhakairiora Williams and David Robinson

The Challenges Facing American Nonprofits

Deterring Donors: Anti-Terrorist Financing Rules and American Philanthropy
Barnett F. Baron

A Needless Silence: American Nonprofits and the Right to Lobby
Jeffrey M. Berry

The Nonprofit Paradox: For-Profit Business Models in the Third Sector
Bill E. Landsberg

Articles

Survival Strategies for Civil Society Organizations in China
Julia Greenwood Bentley

An Introduction to Canadian Tax Treatment of the Third Sector
Robert Hayhoe

"Organized" Civil Society and Its Limits
Antonio Itriago and Miguel Angel Itriago

The Fiscal Framework for Corporate Philanthropy in CEE and NIS
David Moore

Defining Characteristics of Civil Society
Timothy J. Peterson and Jon Van Til

The Alchemy of Success: The Case of Corporate Responsibility
Simon Zadek

Civil Society at the Movies
Rod Smolla

Reviews

The Civil Society Reader
Edited by Virginia A. Hodgkinson and Michael W. Foley
Reviewed by Morgan Meis

The Perfect Gift: The Philanthropic Imagination in
Poetry and Prose
Edited by Amy A. Kass

Does Civil Society Matter?: Governance in Contemporary India
Edited by Rajesh Tandon and Ranjita Mohanty

The State of Civil Society in Japan
Edited by Frank J. Schwartz and Susan J. Pharr

Paved With Good Intentions: The NGO Experience in North Korea
Edited by L. Gordon Flake and Scott Snyder

The Legal and Regulatory Framework for CSO Self-Financing in Colombia;
The Legal and Regulatory Framework for CSO Self-Financing in Chile
By Nicole Etchart, Brian Milder, Maria Cecilia Jara, and Lee Davis

- - - - - - - - - -

Editorial Board

Deterring Donors: Anti-Terrorist Financing Rules and American Philanthropy

By Barnett F. Baron*

Introduction

As part of a larger effort to curtail the flow of funds to known or suspected terrorist organizations, the United States is increasing its monitoring and control of philanthropic contributions to organizations outside the United States. The policy goals of disrupting the flow of funds to terrorist organizations and “protect[ing] legitimate charities from being abused by terrorists” appear in the National Security Strategy of the United States, released in September 2002. They are being implemented through the National Security Council’s Policy Coordinating Committee on Terrorist Financing.

In the post-September 11 environment, foundations and other charitable organizations have come under particular scrutiny, because it has been alleged that terrorist organizations have used charitable foundations and non-governmental organizations as cover for their fundraising efforts. The complex routes through which the terrorist organization Al-Qaeda raises money, including its alleged use of charitable organizations, is captured in this excerpt from a report by the Council on Foreign Relations:

Al-Qaeda’s financial network is characterized by layers and redundancies. It raises money from a variety of sources and moves money in a variety of manners. It runs businesses operating under the cloak of legitimacy and criminal conspiracies ranging from the petty to the grand. The most important source of al-Qaeda’s money, however, is its continuous fund-raising efforts. Al-Qaeda’s global fund-raising network is built upon a foundation of charities, nongovernmental organizations, mosques, websites, intermediaries, facilitators, and banks and other financial institutions. Some whose donations go to al-Qaeda know full well the violent and illicit purposes their money will further. In other cases, donors believe their money will help fund legitimate humanitarian efforts, but the money is nonetheless diverted to al-Qaeda. For years, individuals and charities based in Saudi Arabia have been the most important source of funds for al-Qaeda. And for years, Saudi officials have turned a blind eye to this problem.

Al-Qaeda moves its funds through the global financial system, the Islamic banking system, and the underground hawala system, among other money transfer mechanisms. It uses its global network of businesses and charities as a cover for moving funds. And it uses such time-honored methods as bulk cash smuggling and the global trade in gold and other commodities to move and store value.

Al-Qaeda is not the only terrorist organization to make use of these mechanisms. Terrorists the world over have long used charities, for example, to help raise and move their funds— as the Irish Republican Army (IRA) did for decades in American cities such as Boston and New York.[1]

In a progress report issued exactly two years after the attacks on the World Trade Center and the Pentagon, the Department of Treasury reported that 173 nations have joined the United States in implementing orders to freeze terrorist assets, more than 100 countries have introduced new legislation to fight terrorist financing, and 84 countries have established Financial Intelligence Units to share information.[2] The report notes that during the past two years the United States and its international partners have taken action against 23 charities “involved in the funding of terror”; 315 individuals and organizations have been officially listed as terrorists; $136.7 million in assets have been frozen, including $36.6 million in the United States; and “countless millions in additional funds [have been] prevented from flowing to terrorists by disruption of terrorist financing networks, deterrence of donors,” and other international efforts. In testimony before the House Financial Services Subcommittee on Oversight and Investigations, David Aufhauser, Treasury’s General Counsel and Chairman of the National Security Council’s Policy Coordinating Committee on Terrorist Financing, eloquently asserted the underlying strategy of anti-terrorist financing as it relates to U.S. and other grant-makers:

Only a small measure of success in the campaign is counted in the dollars of frozen accounts. The larger balance is found in the wariness, caution, and apprehension of donors; in the renunciation of any immunity for fiduciaries and financial intermediaries who seek refuge in notions of benign neglect and discretion, rather than vigilance….[3]

American philanthropists with international interests are only beginning to become aware of these new measures and the post-September 11 regulatory climate in which they are being implemented. The rules and regulations through which the Internal Revenue Service regulates nonprofit organizations and their philanthropic activity are currently under review and are likely to be tightened, although precisely how remains to be seen. In the meantime, the issuance in November 2002 of the Treasury Department’s “Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities,” has raised concerns among U.S. foundations and other grant-makers about the appropriate balance between the legitimate need to prevent the diversion of charitable resources to terrorist activities and the United States’ historical commitment to private philanthropy at home and abroad.

I. Three Main Anti-Terrorist Financing Measures

The U.S. government took a series of steps after September 11, 2001, to stop the flow of funds to terrorists and terrorist organizations. Some of these steps, particularly the USA Patriot Act, are extremely broad in scope and have sparked heated debate about their potential infringement on citizens' privacy and civil liberties. Other actions directly affect international grant-making and the provision of other forms of financial and humanitarian assistance, technical assistance, and in-kind contributions by U.S. foundations and other grant-makers. The three principal measures are the following:

This article will discuss four aspects of this complicated subject: (a) the relevant sections of each of these measures, with particular emphasis on the Treasury Guidelines; (b) some of the many issues raised by these measures; (c) the responses of several prominent civil society organizations to these measures; and (d) some of the potential implications of these measures for international grant-making by U.S. foundations and others.

Executive Order 13224: Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten To Commit, or Support Terrorism.

USA Patriot Act: Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism.

U.S. Department of the Treasury Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-Based Charities.

              ► governance;

           ► dis­closure and transparency in governance and finances;

              ► financial practice/accountability; and

              ► anti-terrorist financing procedures.

This article focuses on Part IV of the Voluntary Guidelines, the anti-terrorist financing procedures.[6]

Anti-Terrorist Financing Procedures (from the Voluntary Guidelines)

The Guidelines state that grant-maker should take the following steps before any charitable funds are distributed to foreign recipient organizations.

A.      Collect the following basic information:

  1. The foreign recipient organization’s name in English, in the language of origin, and any acronym or other names used to identify the organization.
  2. The jurisdictions in which the foreign recipient organization maintains a physical presence.
  3. The jurisdiction in which the foreign recipient organization is incorporated or formed.
  4. The address and phone number of any place of business of the foreign recipient organization.
  5. The principal purpose of the foreign recipient organization, including a detailed report of the recipient’s projects and goals.
  6. The names and addresses of organizations to which the foreign recipient organization currently provides or proposes to provide funding, services, or material support, to the extent known, as applicable.
  7. The names and addresses of any subcontracting organizations utilized by the foreign recipient organization.
  8. Copies of any public filings or releases made by the foreign recipient organization, including most recent official registry documents, annual reports, and annual filings with the pertinent government, as applicable.
  9. The foreign recipient organization’s existing sources of income, such as official grants, private endowments, and commercial activities.

B.      Conduct basic vetting as follows:

  1. The grant-maker should be able to demonstrate that it conducted a reasonable search of public information, including information available via the internet, to determine whether the foreign recipient organization is or has been implicated in any questionable activity.
  2. The grant-maker should be able to demonstrate that it verified that the foreign recipient organization does not appear on any list of the U.S. government, the United Nations, or the European Union identifying it as having links to terrorism or money laundering. The grant-maker should consult the Department of the Treasury’s Office of Foreign Assets Control Specially Designated Nationals List, which will identify entities designated by the U.S. government as Foreign Terrorist Organizations or as supporters of terrorism. The grant-maker should also consult the U.S. government’s Terrorist Exclusion List maintained by the Department of Justice, the list promulgated by the United Nations pursuant to U.N. Security Council Resolutions 1267 and 1390, the list promulgated by the European Union pursuant to EU Regulation 2580, and any other official list available to the grant-maker.
  3. The grant-maker should obtain the full name in English, in the language of origin, and any acronym or other names used, as well as nationality, citizenship, current country of residence, place and date of birth for key staff at the foreign recipient organization’s principal place of business, such as board members, etc., and for senior employees at the recipient’s other locations. The grant-maker should run the names through public databases and compare them to the lists noted above.
  4. The grant-maker should require foreign recipient organizations to certify that they do not employ or deal with any entities or individuals on the lists referenced above, or with any entities or individuals known to the foreign recipient organization to support terrorism.

C.      Review the financial operations of the foreign recipient organization as follows:

  1. The grant-maker should determine the identity of the financial institutions with which the foreign recipient organization maintains accounts. The grant-maker should seek bank references and determine whether the financial institution is: (i) a shell bank; (ii) operating under an offshore license; (iii) licensed in a jurisdiction that has been determined to be uncooperative in the international fight against money laundering; (iv) licensed in a jurisdiction that has been designated by the Secretary of Treasury to be a primary money laundering concern; or (v) licensed in a jurisdiction that lacks adequate anti-money laundering controls and regulatory oversight.
  2. The grant-maker should require periodic reports from the foreign recipient organization on its operational activities and use of the disbursed funds.
  3. The grant-maker should require the foreign recipient organization to undertake reasonable steps to ensure that funds provided by the grant-maker are not ultimately distributed to terrorist organizations. Periodically, the foreign recipient organization should apprise the grant-maker of the steps it has taken to meet this goal.
  4. The grant-maker should perform routine, on-site audits of foreign recipient organizations whenever possible, consistent with the size of the disbursement and the cost of the audit.  

II.  Issues and Concerns   

In the United States, many types of organizations make international grants or provide other types of financial and humanitarian assistance abroad. International grants are made by private foundations, corporate foundations, corporate matching gift programs, and an array of public charities, including community foundations, donor-advised funds, operating organizations that provide cash grants and in-kind services, and others. In addition, many religious congregations and organizations provide cash grants for activities abroad, although their activities are not as closely monitored as those of public charities and private foundations.[7] No single set of responses can capture all the concerns of the full range of U.S.-based grant-makers.

With this important caveat, let me suggest nine broad areas of concern about the Voluntary Guidelines as they are currently written.

1.         Voluntary vs. mandatory

The Guidelines are labeled “voluntary,” but they fail to acknowledge that all U.S.-based grant-makers (except churches, temples, and mosques) are already bound by mandatory federal tax rules when making international grants. These rules, which differ depending on whether the grant-maker is a private foundation or a public charity, restrict the purposes for which grants can be made to charitable purposes and then require reporting to verify that the grant dollars are actually used for the intended purposes. Private foundations must follow detailed rules to establish the charitable equivalency of foreign grantees or exercise expenditure responsibility in implementing their grants. Public charities must exercise “control and discretion” over their foreign grants and maintain records confirming that their funds were used for the intended charitable purposes. Thus the Guidelines are misleading inasmuch as they mix currently mandatory requirements with proposed voluntary practices. In some places, the Guidelines are actually inconsistent with or contrary to existing state and federal laws governing charitable grant-making.[8]

2.         Whose best practices?

There is no consensus within the grant-making community as to what constitutes “best practice.” Practices vary according to the type and size of the grant-maker, the nature of their programs, the size and purpose of specific grants, the characteristics of the grantee, the geographical location of grants, and other grant-specific factors. The Guidelines in many instances go far beyond the current practice of most responsible and experienced international grant-makers. The implication is that these Guidelines, issued by a powerful enforcement agency of the U.S. government, are what Treasury considers acceptable and necessary--which is very troubling to grant-makers who do not or cannot follow these so-called “best practices.”

3.         The terrorist lists

Executive Order 13224 prohibits financial and humanitarian transactions with any person or organization named on any of several lists maintained by various U.S. government agencies. The Treasury Department’s Voluntary Guidelines expand the number of lists to be checked by including lists maintained by the U.S. government, the United Nations, the European Union, “and any other official list available” to the grant-maker.

Grant-makers are united in urging that the lists should be consolidated, or at least that one or more lists should be clearly designated by the IRS as authoritative for international grant-making.[9] In addition, the current lists have only limited search capabilities and several are available only as pdf files. Several larger grant-makers have found ways to download the lists, which are available on the Internet, into their internal databases so that they can be easily searched. This technical capacity is somewhat expensive, however; and many smaller grant-makers are limited to the laborious process of manually checking the lists.

Even when the technical problems of searching the lists can be overcome, the lists are of limited utility for other reasons. They contain fanciful names and aliases (e.g., several variations on “Foopie”) as well as many generic names (e.g., “Ahmed Mohammed”) which are equivalent in the American legal system to “John Doe.” In the absence of Social Security numbers or other forms of positive identification, there is a significant risk of obtaining “false positive” matches--that is, the same name may be shared by many people. How to determine whether your John Doe is the terrorist on the list? In addition, neither the Executive Order nor the Treasury Guidelines tell the grant-maker what to do if the name of a prospective grantee matches a name on one of the terrorist lists. Does the grant-maker have a legal responsibility to notify the IRS or Treasury Department? Must the prospective grant be cancelled at once?[10]

Finally, for philanthropic organizations committed to promoting the rule of law around the world, there is a disturbing lack of transparency regarding such matters as how names get on the lists and how they can be removed, if at all.

4.         Vague and sweeping language

As currently written, the Guidelines contain many undefined terms that leave grant-makers vulnerable to criminal and civil risk. We are told not to make grants to those who “deal with” or are “otherwise associated with” terrorists, or are “implicated in any questionable activity,” or appear on “any other official list available to the charity”; and we are to conduct a “reasonable search” and take “reasonable steps” to ensure that charitable grants are not diverted to terrorist organizations. None of these terms are defined, leaving grant-makers open to potential legal risk and, in turn, potentially frightening them away from international grant-making. Perhaps this is the goal, as suggested in the congressional testimony of Treasury’s General Counsel, cited earlier.

5.         One size does not fit all.

The Guidelines are silent on scalability. They appear to require the same level of due diligence for all grants, regardless of size, purpose, nature, location, and the grant-maker’s previous experience with the grantee. As written, the Guidelines would greatly increase the administrative costs of all international grant-making without providing any useful guidance on the circumstances or “risk factors” that would justify such an extraordinary level of due diligence for individual grants. Foundations and other organizations that do not have offices outside the United States and those that specialize in making small grants, for example, are particularly concerned that the cost of conducting additional due diligence along the lines recommended will make it very costly—if not impossible-- for them to operate. Corporate matching gift programs, under which corporations match the small donations that their individual employees make to local charities, are particularly at risk. Several U.S. corporations have already suspended their matching gift programs until the status of the Guidelines is clarified.

6.         The required information is not readily available in much of the “developing world.”

The Guidelines erroneously assume that comprehensive and detailed information about prospective grantees is generally available and can be readily collected in the "developing world," just as in the United States. This is not the reality one finds on the ground. In Asia, for example, no country currently has a unified, one-step process governing the incorporation and registration of all nonprofit organizations. In most countries, nonprofits have a choice of the laws or regulations under which they may register, and the different laws and regulations impose different standards of reporting and disclosure (e.g., companies acts, societies acts, trust laws, religion-based legislation, etc).

Moreover, in some countries and for some types of local community organizations, official registration and documentation may not be required, especially where privileged tax status is not available to nonprofit organizations or where the organization does not seek or receive government funding. 

In addition, few Asian countries require a nonprofit to produce a publicly available annual report with detailed information about its mission, staffing and governance, programs, and funding. Even in the few countries where public disclosure is now formally required, there is limited enforcement capacity and even less voluntary compliance with those rules. Throughout Asia, accountability in law refers primarily to an NGO’s obligations to its supervising government agency, not to public disclosure of the NGO’s governance structure, programs, and finances. Although some of the information required by the Treasury Guidelines may be available to government agencies, this information is generally treated as confidential and is not made available to the public.

In short, the Guidelines are unrealistically prescriptive as to the information a grant-maker should obtain before making international grants.

7.         Grant-makers should not be treated as police, intelligence, or law enforcement agencies.

Since many governments in Asia, Africa, and the Middle East approach the regulation of nonprofit organizations from a national security perspective rather than the goal of “enabling civil society,” the agencies that supervise and regulate nonprofits often are police, security, and intelligence agencies. Requiring American grant-makers to establish relationships with those agencies in order to collect confidential information could have a high price, including closer scrutiny and control by host governments over grants made by U.S. foundations, and a likely increase in demands for corrupt and illegal payments to ensure government concurrence. American foundations operating abroad are constantly alert to potential threats posed by host governments to our grant-making independence. We fear that the Guidelines are likely to have the unintended effect of providing a convenient rationale for increased host government scrutiny and control over both international and local nonprofit organizations.

Some of the requested information, particularly about banks and financial institutions, is simply beyond the capacity of most American foundations to obtain and assess. Treasury needs to create and maintain lists of acceptable or prohibited financial institutions in order to provide practical guidance to grant-makers. Foundations cannot be asked to become international banking regulators.

Requiring grant-makers to collect detailed information about a prospective grantee’s staff, trustees, donors, sub-contractors, and bankers, even if they are not directly involved in the program to be supported by the proposed grant, will inevitably raise questions about the role and objectives of U.S. grant-makers. In some cases, prospective grantees may view grant-makers as agents of the host government, which may be a repressive one, or as agents of the U.S. intelligence community. This could jeopardize the ability of U.S. foundations to operate effectively, and in extreme cases could even put in-country staff at physical risk.

8.         Intrusive and unnecessary due diligence requirements could destroy the trust necessary for good partnerships.  

Some of the Guidelines are very intrusive, going far beyond current due diligence practice to impose what resemble police and investigatory functions. These rules can seriously damage relationships of trust with grantees that have been developed over the years. By following these measures, as well as the requirement that prospective grantees certify in writing that they do not “deal with” known or suspected terrorist organizations, grant-makers may appear to be accusing prospective grantees—even those we have known for many years-- of being potentially “associated with” terrorists unless the grantee can prove otherwise. Especially in sensitive countries, some grant-makers are already beginning to experience hostility and suspicion from prospective grantees,[11]  particularly nonprofit organizations that advocate for political and economic reform, engage in conflict management and reconciliation efforts, and support human rights.

9.         Competing policy interests

The U.S. government has a legitimate interest in stopping the flow of funds to terrorist organizations. That goal is shared by many other governments. The Financial Action Task Force on Money Laundering, for example, is an international, inter-governmental organization established in 1989 to combat money laundering in all its forms, including the use of charitable organizations to channel funds to terrorists and other criminal organizations. The FATF issued its own recommendations on curtailing terrorist financing in October 2001 and a special report called Combating the Abuse of Nonprofit Organizations: International Best Practices in October 2002. The FATF issued revised recommendations on money laundering in June 2003, bringing it closer in line with U.S. Treasury efforts.[12] United Nations Security Council resolutions 1372 and 1390 require member states to take steps to combat terrorist financing.

In addition to curtailing the flow of funds to terrorist organizations, however, the U.S. government and the American people also have other policy objectives, including the promotion of charitable nonprofit organizations, faith-based organizations among them, at home and abroad. This policy is manifest throughout the U.S. government, most prominently at the international level in programs supported by the Agency for International Development, the Department of State, and other government agencies.

A vital element in the long-term fight against terrorism is continued support for American and foreign non-governmental organizations working to curb extremism through programs that alleviate poverty and violent conflict, increase economic opportunity, provide education and health care, enhance the roles and status of women, and encourage tolerance and secular governance. American foundations and their foreign grantees are also contributing to strengthening institutions of democratic governance, including the rule of law, free and fair elections, the protection of human and civil rights, and mechanisms for peacefully resolving conflicts.

The press release accompanying the issuance of the Voluntary Guidelines in November 2002 stated that the Guidelines “are not in any way intended to impede, corrupt, or scrutinize legitimate charitable giving,” but as we have seen, a close reading of the Guidelines leads many in the philanthropic community to fear that they will accomplish just that.

Moreover, there are circumstances in which it is unavoidable and even desirable to “deal with” organizations that may be listed as terrorist organizations or “implicated in questionable activity.” Let me cite a few examples from the current experience of some American foundations.

It is not possible to engage in conflict management or national reconciliation efforts by “dealing with” only one side of the conflict. A close reading of the Voluntary Guidelines as currently written appears to jeopardize the ability of concerned and well-informed American foundations to continue supporting critically important conflict management and reconciliation programs.

III.  Civil Society Responses to the Guidelines

Many U.S. foundations, public charities, corporations, and others have responded to the publication of the Guidelines and to a May 2003 request by the IRS for public comments on current international grant-making rules and the proposed Treasury Guidelines. Since the philanthropic universe in the United States is so large and diverse, it is not possible to summarize all these perspectives. Instead, I will focus on three sets of responses from significant membership organizations: the Council on Foundations, the American Bar Association, and a joint response submitted by InterAction and Independent Sector.

Council on Foundations

In January 2003, the Council on Foundations created a task force consisting of about three dozen legal specialists and practitioners from its member organizations to review the Voluntary Guidelines and prepare a detailed response to Treasury. The Council’s response, developed over the course of several months of conference calls among the members of the task force, was delivered to Treasury on June 20, 2003.[13] The response notes that very few international grants pose any risk of diversion to terrorist organizations, yet the Guidelines “would substantially increase the administrative costs associated with making international grants, even when there is no realistic risk of diversion. This would amount to many millions of dollars in administrative expenses that would directly reduce the funds that could otherwise be used for charitable purposes.” Moreover, the Council argued that the Guidelines are “unnecessarily detailed and restrictive,” that much of the detailed information requested is not available, and that even if grant-makers could comply with all the provisions in the Guidelines, “we seriously doubt that compliance…would be of significant value in achieving the Treasury Department’s goal of preventing the diversion of funds to terrorists.”

Instead, the Council argues, “we believe that the objective of the Guidelines can best be achieved by helping U.S. charities develop and apply a risk-based approach that (1) helps the grant-maker identify those grants that may present a greater risk for diversion, and (2) describes additional steps that the grant-maker can take to minimize the possibility of diversion for grants that have been so identified. This two-step risk-assessment process, which would replace the factors currently set forth in Section IV of the Guidelines, strikes an appropriate balance between the need to protect charitable funds from terrorist diversion and the equally important need to allow U.S. charities to continue providing humanitarian relief and helping to build free and democratic societies in chaotic nations that have been devastated by war, famine, disease and internal turmoil.” 

American Bar Association

In May 2003, the Internal Revenue Service requested public comments on how it might clarify the existing requirements that foundations and other nonprofit organizations must meet with respect to international grant-making and other international activities, and specifically invited comments on the Treasury Guidelines. Many organizations submitted replies, of which that of the American Bar Association was most detailed and may prove to be most influential.[14]

The ABA response to the IRS describes current international grant-making procedures followed by illustrative private foundations, public charities, operating agencies (such as CARE and Save the Children), religion-based relief agencies (such as Catholic Relief Services), and international charitable donations made by religious congregations in the United States (which, it notes are not as closely monitored as those of registered charitable organizations). The ABA response echoes the Council on Foundations in arguing that very few international grants “are susceptible to diversion for private benefit and even fewer for terrorist activities.” The ABA therefore argues that one size cannot fit all, and that a “risk-based approach could help minimize the burden on [grant-makers] in cases where increased oversight and due diligence is not justified from a risk-analysis perspective.”  

The ABA notes that U.S.-based financial institutions are already held to strict standards under the USA Patriot Act. That Act requires financial institutions to implement “Customer Identification Programs” that contain four elements based on the maxim “Know your Customer.”[15] The elements are as follows: 

  1. Collection of identification information;
     
  2. Verification of identification information;
     
  3. Record-keeping of all materials for five years; and
     
  4. Checking relevant U.S. government lists of known or suspected terrorists and terrorist organizations.

By applying similar logic, the ABA proposes that the IRS should issue new guidance to grant-makers based on the maxim “Know Your Grantee”: "We believe that there is a continuum of risk and that experienced grant-makers are best placed to make thoughtful and informed judgments as to where on that continuum a particular payment belongs. While all payments should be reviewed, payments above a certain threshold might merit more review than payments below that threshold. On the chart that accompanies these comments, 'Continuum of Risk Factors,' we present a non-exhaustive list of potential risk factors, clustered in four main areas: (1) the domestic organization’s familiarity with the foreign recipient ('FR'); (2) limitations on fund use through various means; (3) internal and external financial accounting mechanisms; and (4) identity verification and identification of known supporters of terrorism.” (The ABA’s “Continuum of Risk Factors” appears below as Table 1.) 

As proposed by the ABA, U.S. grant-makers would (a) perform risk assessments; (b) review the risk assessment results to determine whether a particular payment constitutes a high, medium, or low risk of diversion; (c) select and implement anti-diversion steps appropriate to the payment’s level of risk; and (d) document risk assessment and retain records for a three-year period. 

For those grants that in the view of the grant-maker constitute a higher risk of diversion, the ABA proposes the following “non-exhaustive” list of additional steps that could be taken to reduce the risk of fund diversion: 

InterAction and Independent Sector

InterAction and Independent Sector[16] jointly submitted a detailed response to the IRS on July 18, 2003, regarding existing provisions affecting international grant-making and the Treasury Guidelines.[17] By contrast to the Council on Foundations, many of whose members are private foundations or corporate grant-makers, the members of InterAction and Independent Sector are mostly public charities, only some of which make grants; others directly implement relief and development programs. Public charities engaged in international activities are affected by the proposed anti-terrorist rules, because all financial transactions, including technical assistance and humanitarian relief, are covered by Executive Order 13224, the USA Patriot Act, and the Treasury Guidelines.

Unlike the Council on Foundations and the American Bar Association, InterAction and Independent Sector argued that existing laws and regulations are sufficient to ensure that charitable funds cannot be diverted to non-charitable purposes, including terrorist activities; and that it would impossible to develop an all-purpose list of risk factors that would justify additional due diligence on the part of international grant-makers and humanitarian relief agencies. The joint response explained that “the application of fixed categories of risk[18] raises the following concerns”:

First is the problem inherent in defining the categories of risk themselves, which though intuitively appealing lack empirical support. Thus, there is no evidence to support any correlation between the size of the grantee and the risk of diversion, or that new grantees with less of a programmatic track record are riskier than long-established grantees. For every anecdote in favor of one view as to risk, there is one on the other side of the argument. For example, many well-known organizations have an established track record of legitimate charitable activities in addition to a track record of terrorism.[19] With terrorist front organizations operating throughout Western Europe and the United States, as well as in countries like Saudi Arabia or Pakistan, even differentiating by country or region is of questionable value. 

Second, those qualities identified by some as indicative of higher risk go hand in hand with those that make heightened due diligence more difficult to carry out. Thus, countries where there is active armed conflict, where significant territory is not effectively controlled by the government, or where there is a history of terrorist activity are likely those countries where banking systems function poorly or not at all (necessitating cash transfers), where the legal infrastructure for NGOs is lacking or non-existent, and where political polarization creates a major security risk for staff of NGOs that are perceived to be partisan. Thus, heightened due diligence of the kind described in the Treasury Department Guidelines may be impossible in those places where it is supposedly most needed.

Finally, those countries where the risk is posited to be the highest are also some of those countries where humanitarian crises are most acute and where the intervention of American NGOs is most critically needed. They are also frequently countries where the U.S. government interest in providing assistance through NGOs is very high (both for humanitarian reasons and for political reasons of encouraging stability and development as a bulwark against political extremism and terrorism).

          The joint response went on to offer three specific recommendations to the IRS:

First, it should be the responsibility of the U.S. government, and not that of public charities, to identify which organizations and individuals should be blocked. The U.S. government should compile and publish this information in a usable format (one list that incorporates those of other objective countries and international organizations, updated on a regular basis)…. 

Second, it is the responsibility of public charities to check these lists and ensure that their grants are not being provided to blocked entities, and to document that this is being done. 

Third, public charities should perform due diligence to ensure that their grants are not diverted by the immediate grant recipient to blocked entities. The framework for such due diligence is already contained in [existing IRS] requirements….The exact content of this due diligence will vary according to the particular circumstances of each grant relationship and will take into account many factors (including program content and means of delivery) in addition to those suggested by the commentators advocating a differentiated risk approach.

IV.  Possible Implications

          It is inevitable that more restrictions will be placed on international grant-making from the United States, although the modalities are still being developed. In the meantime, what can we say about the impact thus far of Executive Order 13224, the USA Patriot Act, and the Treasury Guidelines?

Philanthropic funding flows

OFAC Guidelines

Internal Revenue Service

 USAID

Other possible implications 

TABLE 1

CONTINUUM OF RISK FACTORS

LESS RISK

SOME RISK

MORE RISK

 

The FR has an existing relationship with the U.S. organization

The FR has an existing relationship with other U.S. organizations but not with this U.S. organization

The FR has no prior history with U.S. organizations.

 

The FR can provide references from trusted sources

The FR’s references are from sources with which the U.S. organization is unfamiliar.

The FR has no references.

 

The FR has a history of legitimate charitable accomplishments.

 

The FR is newly or recently formed but its leadership has a history of legitimate charitable accomplishments.

The FR has little or no history of legitimate charitable accomplishments.

 

The FR has specific charitable objectives and is transparent as to fund use.

The FR has general charitable purposes and is transparent as to fund use.

The FR has general purposes and is not transparent as to fund use.

The FR has strong leadership and control mechanisms, including an on-site professional staff and record-keeping systems.

The FR has strong leadership and control mechanisms and relies primarily on trained volunteers rather than professional staff.

The FR has weak leadership and control mechanisms.

 

The U.S. organization and the FR create appropriate records on the identities of recipients and timely account for the use of funds. The types of records that are appropriate will vary with the circumstances of the grant.

The FR needs technical assistance in order to develop systems capable of creating and maintaining appropriate records of recipients and the use of funds but agrees to work with the U.S. organization to improve its systems.

The domestic organization and/or the FR do not create appropriate records on the identities of recipients or timely account for use of funds.

 

The parties have a written grant agreement which states how payments are to be used.

The parties have a written grant agreement with insufficient protective provisions.

The parties do not have a written grant agreement.

 

The grant agreement prohibits fund use for non-charitable purposes, including the promotion of violence or terrorist activities.

The grant agreement prohibits noncharitable uses but does not specifically ban the promotion of violence or terrorist activities.

The grant agreement does not prohibit fund use for non-charitable purposes, including the promotion of violence or terrorist activities.

 

LESS RISK

SOME RISK

MORE RISK

The U.S. organization disburses funds in smaller increments as needed for specific projects or expenditures.

 

The U.S. organization authorizes grantee discretion within specified limits.

 

The U.S. organization disburses funds in one large payment to be invested and spent over time or for unspecified projects selected by the FR.

More formal financial systems and registered channels for transferring funds are available and used by the FR, thereby subjecting it to the safeguards of banking regulatory systems consistent with international standards.

 

Formal financial systems exist but are unreliable or corrupt and the U.S. charity and the FR agree on alternative methods that they reasonably believe to be reliable, trustworthy, and not susceptible to diversion to violent, terrorist, or other noncharitable ends.

Reliable and non-corrupt formal financial systems or registered channels for transferring funds are not available or used by the FR, thereby offering little or no safeguard of banking regulatory systems consistent with international standards.

 

The FR is located in a country that is not now, and has not recently been, identified by the U.S. government or other appropriate agency as supporting or housing known terrorist organizations and activities, or maintaining links to terrorist financing.

The U.S. government or other appropriate agency has recently determined that the country where the FR is located is no longer supporting or housing known terrorist organizations and activities or maintaining links to terrorist financing.

 

The FR is located in a country that has been identified by the U.S. government or other appropriate agency as supporting or housing known terrorist organizations and activities or maintaining links to terrorist financing.

 

The U.S. organization determines that the FR does not appear on any U.S. government agency list of known or suspected terrorists or terrorist organizations.

The U.S. organization identifies a partial match to a person or organization named on such a list and ascertains to its satisfaction that the FR or related person is not the person identified on the list.

The U.S. organization makes no effort to determine whether the FR is named on any U.S. government list.

 

Payments are not disbursed to individuals.

Payments are disbursed to individuals and records are kept.

Payments are disbursed to individuals and no records are kept.

Payments are remitted by wire transfer to a known account in a reputable financial institution.

Payments are remitted by check and deposited to a known account in a reputable financial institution.

Payments are remitted in cash.

 

Notes

* Barnett F. Baron is Executive Vice President of The Asia Foundation. This article was prepared for the Third ISTR Asia and Pacific Conference in Beijing, October 24-26, 2003.

[1] Terrorist Financing: Report of an Independent Task Force Sponsored by the Council on Foreign Relations (New York, 2002).

[2] “Progress in the War on Terrorist Financing,” September 11, 2003,

[3] Written testimony of David Aufhauser on September 24, 2003

[4] The full text of each of these measures can be accessed through the website of the U.S. International Grant-makers project of the Council on Foundations, www.usig.org. See also Timothy R. Lyman, Michael G. Considine, and Jennifer L. Sachs, “International Grant-making After September 11: Dealing with Executive Order 13224 and the USA Patriot Act,” Council on Foundations, International Dateline, Special Insert, Fall 2002.

[5] An organization’s nonprofit status, including its tax exemption and tax deductibility, is determined by the IRS, which then plays the dominant role in supervising the charitable activities of American nonprofit organizations. The Attorney General’s office at the state level also has supervisory authority over nonprofit organizations in each state. For details, see Betsy Buchalter Adler, Rules of the Road: A Guide to the Law of Charities in the United States (Washington: Council on Foundations, 1999).

[6] The full text of the Treasury Guidelines can be found at www.usig.org.

[7] Churches, temples, and mosques are not required to file Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, or to file Form 990, Return of Organization Exempt from Income Tax, the two principal documents through which the IRS and the general public monitor grant-making by charitable organizations.

[8] For details about equivalency determination and expenditure responsibility, see the United States International Grantmakers website, www.usig.org. For details about the legal issues raised by the Voluntary Guidelines, see the Council on Foundation’s response to the Treasury Guidelines, dated June 20, 2003

[9] The General Accounting Office recently recommended that the Department of Homeland Security lead an effort to consolidate the government’s various terrorist lists. The GAO report identified twelve different lists developed by nine different government agencies. United States General Accounting Office, GAO-03-322, Information Technology: Terrorist Watch Lists Should be Consolidated to Promote Better Integration and Sharing (April 2003). This has not yet happened. 

[10] Financial institutions are now required by law to call the OFAC Compliance Hotline or file Suspicious Activity Reports with the Treasury Department when they match the names of prospective customers with names on specified watch lists, but these rules currently apply only to financial institutions, not to nonprofits.

[11] See, for example, Charles Radin, “USAID Palestinian Funds Frozen,” Boston Globe, September 6, 2003.

[12] These reports and other information about the FATF are available at www.fatf-gafi.org.

[13]  The Council’s response

[14] The ABA reply is available in full at www.abanet.org/tax/groups/eo/ Follow the links to Public Policy, then the link for the paper itself, which was written in response to IRS announcement 2003-29.

[15] For a description of how these rules apply to investors seeking to open mutual fund accounts, see Ian McDonald, “Mutual funds will get nosier about investors,” Wall Street Journal, August 26, 2003. Similar rules apply or will soon apply to opening individual savings or checking accounts, obtaining credit cards, or buying stocks through brokers.

[16] InterAction is an alliance of 160 U.S.-based international development and humanitarian nongovernmental organizations. Independent Sector is a national coalition of more than 700 nonprofit organizations. Together, InterAction and Independent Sector represent some of the largest international humanitarian relief and development agencies in the world, as well as numerous smaller groups working at the grass-roots level overseas

[17] The full response is available at www.independentsector.org/programs/gr/intlactivities.html.

[18]  In fact, both the Council on Foundations and ABA responses argued against fixed categories of risk and proposed illustrative examples that individual grant-makers would apply “flexibly” and in accordance with specific circumstances.

[19] For example, the United States has declared Hamas to be a terrorist organization and prohibits financial transactions with both its political and humanitarian wings. Until September 2003, however, several European governments continued to treat Hamas’s social welfare activities as legitimate charitable activities. See Craig S. Smith, “Europe reacts coolly to Bush’s call to freeze charities’ assets,” New York Times, August 24, 2003.

[20] Cited in the Council on Foundations response to OFAC. The estimates refer only to grants made by private foundations and corporations in 2001.

[21]  Michael Anft, “Assisting terrorism’s other victims,” Chronicle of Philanthropy, September 4, 2003.

[22] Stephanie Strom, “Small charities abroad feel pinch of U.S. war on terror,” New York Times, August 5, 2003.

[23]   For example, Don van Natta, “Flow of Saudis’ cash to Hamas is scrutinized,” New York Times, September 17, 2003.

[24] In its basic form, expenditure responsibility involves five steps: pre-grant inquiries to determine the prospective grantee’s ability to comply with the terms of a grant and fulfill its objectives; a written grant agreement restricting the use of grant funds to approved purposes and prohibiting use for any non-chartable purposes; annual reports on the use of grant funds; correcting any diversion of grant funds; and special reporting on the grant in the grantmaker’s annual informational tax return, Form 990.

[25] Acquisition and Assistance Policy Directive (AAPD-02-04), effective March 25, 2002.

 
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