Posted May 1st, 2007

Are Your Trustees On Board

Last month, I shared my first experience as a board member of a local foundation. I discussed in some detail the question of whether the board was properly fulfilling its fiduciary responsibilities in connection with its management of the foundation’s investments. Making certain that the funds held by a charitable organization are properly allocated and invested is an important function of a director or trustee, but this is just one of many important responsibilities.

In the 1980s, the law firm where I worked was involved in investigating failed banks and thrifts. The cavalier attitude that many of the officers and directors of these institutions displayed toward their fiduciary responsibilities was amazing. Like most nonprofit board members, many of these bank directors were distinguished citizens and successful business leaders. However, they failed to apply the same business experience and fiduciary acumen to the bank board as they did to their own businesses.

As a result, in many cases government regulators took the position that, because the bank took public funds which were insured by the government, the board had violated its fiduciary responsibilities not only to the stockholders, but also to the depositors and, ultimately, the federal agency that insured the deposits. State regulators have taken a very similar position when nonprofit boards fail to fulfill their duties to a charitable organization that derives its funds from donors who give because they care about an organization’s mission.

The New York attorney general’s office has published a brochure that sets out in detail what due diligence a person should perform prior to accepting a position on a nonprofit board.¹

While these requirements are excellent ideas, and in the future I would use these as a guide prior to accepting any other positions myself, I don’t believe the decision to serve on a board is usually this well thought out. Most people accept nonprofit board positions because they are asked by a friend, they are interested in the mission of the organization, or they deem membership as prestigious or a way to network with other distinguished community leaders. Although it is perhaps unrealistic to expect most prospective board members to do this much due diligence prior to accepting a board position, the requirements set out by the state of New York are very instructive and could give all prospective board members a much better understanding of the duties and responsibilities of a nonprofit board member. (See the article listed below for the specific requirements for board members in New York.)

In addition to the New York State requirements, there have been numerous other articles and studies published recently about the responsibilities of not-for-profit directors. If you take the time to review these materials, you will discover that the recurrent theme stressed through these publications is that of responsibility.²

Here is a summary of the general responsibilities of a director/trustee as provided in the referenced material.

1. Adopt a code of ethics. The board, with the assistance of the staff, should draft and adopt a code of ethics which meshes with the mission of a specific organization. A copy of the code of ethics should be given to the board at least once a year. The code of ethics should be explained at board orientation meetings, and any new board members should receive a copy of the code prior to their first meeting.

Under the terms of the code of ethics, board members should complete a conflict of interest form once a year. The forms should outline any conflicts of interest and explain them in detail. The conflicts of interest should be reviewed by the board’s audit committee to make certain they are not problematic. Keep in mind an Internal Revenue Service draft entitled Good Governance Practices for 501(c)(3) Organizations warns, “The duty of loyalty requires a director to act in the interest of the charity rather than in the personal interest of the other person or organization.”

2. Establish an audit committee. The board should create a separate audit committee, of which at least one member is a financial expert. This audit committee should select an outside firm that will be responsible for annual financial audits. The auditors need to provide the nonprofit with an engagement letter outlining the scope of the work to be performed and the fee to be charged.

Once an audit firm is chosen and the terms of its engagement are approved by the audit committee or full board, if bylaws require, it is good practice to rotate the managing partner in charge of the audit or change audit firms every five years. Even if you retain a firm and simply rotate the partner in charge of the audit, I would recommend moving to a new firm after a 10-year period with the same auditors. I have seen organizations that have used the same auditor for over 25 years. In today’s environment, that is not advisable. In most of the notable past failures of large public companies, accounting firms with long-term relationships with the companies were part of the problem, not part of the solution. Even if you have had a satisfactory experience with your auditors, selecting a new firm at least every 10 years wards off the problems too much familiarity can breed.

3. The board should approve various items on an annual basis. Here is a list of some, but not all, of the items that should be approved:

  • Assess and adopt a strategy for the organization (e.g. the one-year plan, the five-year plan, and how the plan is to be funded).
  • Approve the budget.
  • Receive a report from the appropriate committee or the board chairman outlining the performance and compensation of the CEO. If you are a board member, make certain you ask questions before you approve the recommendations presented to you. CEO compensation has become a hot-button issue. For example, take the recent publicity surrounding the compensation for the Smithsonian Institution’s CEO, who received a compensation package totaling $1.28 million during the 2004-2005 fiscal year. When Congress, which funds a large portion of the Smithsonian’s budget, discovered this practice, it threatened to cut off funding to the Institution. In my experience, excessive compensation is generally the exception to the rule. Most nonprofit CEOs work for salaries that are less than they could earn in the public sector.
  • Oversee the management of endowment and reserve funds.

Final thoughts

In order for nonprofit organizations to raise funds, manage those funds, and carry out their missions of service, now more than ever they must be governed by conscientious, honest, dedicated board members. Due to increasing government oversight and public scrutiny of nonprofits, potential board members who are accustomed to more stringent requirements in the for-profit sector may become more wary of serving the charitable sector in a board capacity.

This will make attracting and securing competent board members even more critical. As prospective board members consider the charitable interests to which they would like to devote their time, talents, and financial gifts, make sure your organization stands out as one that not only inspires them, but also gives them no reservations concerning your organization’s overall leadership or financial dealings.

You may find that the prospective board members you most want to attract will respect and be impressed by the extent to which you go to ensure that they understand and are willing to comply with high standards of service. As “birds of a feather,” they may be more comfortable serving with others who have agreed to serve only in compliance with well-conceived and communicated governance policies.

“Right from the Start Responsibilities of Directors and Officers of Not-For-Profit Corporations,” Attorney General State of New York. See the following documents: “Panel on the Nonprofit Sector Invites Second Round of Comments on Revised Draft Principles for Effective Practice,” at www.independentsector.org; “IRS Prepares Draft of Good Governance Practices for 501(c)(3) Organizations” by Tax Analysts; “Governance is Governance,” by Kenneth Dayton for Independent Sector; NACUBO Study, “Taking the Right Path,” by Price Waterhouse Coopers; “AGB Statement on Board of Accountability,” adopted by the AGB Board of Directors, January 17, 2007.

Rules in the State of New York

In the state of New York, the attorney general’s office holds a nonprofit director responsible for having done the following due diligence. Though these requirements may not exist in all

states, such requirements could become a pattern for other states and are a good guideline for those considering conditions for nonprofit board leadership. Tom Dyer’s notes are in italics.

1. Read the organization’s certificate of incorporation, application of federal income tax exemption, by-laws, and board and committee minutes for at least the last year to learn about its stated purposes, activities, and concerns.

2. Obtain a current list of board and committee members and find out from the board chair and the organization’s chief executive and financial officers what is expected of board members. This will give a prospective board member an understanding of the governance of the organization. They may also wish to talk to existing and prior board members to get a sense of how the organization has been managed in the past. My personal suggestion is that one make certain that all board members are also contributors to the organization—preferably giving more than nominal amounts. There could be exceptions to this requirement, for example a trustee who is very influential in the community but may not have the financial wherewithal to make a significant financial gift.

3. Review the organization’s Internal Revenue Service Form 990 or 990 PF and audited financial statements for at least the last two (2) years as well as its current internal financial reports to see how the organization uses its assets and to evaluate its financial health. All organizations are not required to file 990s, therefore all of this material will not always be available. But determining the status of the organization’s standing with the IRS is very important, since the loss of the designation as a qualified charity could have a dramatic impact on the ability of the charitable organization to obtain funds. If the charity is a college or university, check the status of the organization’s position with the regulatory body governing institutions of higher education (e.g. Southern Association of Colleges and Schools, New England Association of Schools and Colleges, etc.).

4. Find out if the organization is required to register with the Attorney General’s Charities Bureau and, if so, whether it has registered and filed all required reports. States may require different registrations with different government agencies, therefore checking with the attorney general may not be sufficient.

5. Obtain an understanding of the internal control structure of the organization and the process in place to monitor it.

6. Understand the organization’s mission, learn about its programs, read its publications, visit its program sites, look at its website, and talk to key staff and major donors.

7. Review the organizational chart and understand the accountability structure of the organization.

8. Make sure there is a conflict of interests and code of ethics policy in place and that it is updated annually.

9. Find out what committees the board has established and decide which (if any) to join.

10. Obtain the name of the organization’s auditors and determine their reputation.

11. Find out if materials to be considered by the board or its committees are distributed in advance of meetings and whether they provide sufficient information necessary to be part of the stewardship process.

12. Obtain the current year’s budget and cash flow projections.

13. Find out whether the insurance coverage appears to be appropriate, including Directors and Officer’s liability and employee fidelity insurance.

14. Be sure to be able to devote the time expected of a board member.

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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