Principles in Crafting and Implementing a Conflict of Interest Policy for Your Non- Profit Board

Transcription

1 Principles in Crafting and Implementing a Conflict of Interest Policy for Your Non- Profit Board Joshua W. B. Richards Partner, Saul Ewing LLP (215) jrichards@saul.com

2 Definitions... A conflict of interest is... A personal interest that might impair or reasonably appear to impair a board member s independent, unbiased judgment in the discharge of his or her responsibilities to the organization.* 2

3 Financial conflicts tend to dominate the discussion, but others include: Political gain; Unmerited preferences in hiring; Excessive pay packages for staff/ executives; Loans to former board members; Etc. 3

4 No written policy document can define conflict of interest so exactly as to forbid all undesirable relationships and permit all desirable ones. However, a good conflict of interest policy should: Raise board members awareness of the possible existence of conflicts of interest; Educate board members on the types of relationships and situations that might give rise to conflicts of interest; Remind board members of the broader interests of the organization (for example, protection of its reputation or its assets); Establish a regular process to follow when a conflict or potential conflict arises; Make clear to regulators and the public that conflicts of interest are disclosed and managed, as well as prohibited when appropriate. Permit the Organziation to answer yes on federal tax filings related to conflicts of interests policies (e.g. Form 990) 4

5 A Brief Word on Form 990: The new Form 990 now asks (Part VI.B, Line 12) whether the organization has a written conflict of interest policy (Line 12a), whether officers, directors, and key employees1 are required to disclose annually interests that could give rise to conflicts (Line 12b), and whether the organization regularly and consistently monitors and enforces compliance with the policy (Line 12c). The IRS has stated that the absence of a conflict of interest policy will not by itself place an organization at risk for audit; however, an answer of No on any of Lines 12a, b, and c, if coincident with other evidence of insider transactions (e.g., leases between the organization and one or more of its disqualified persons) may increase an organization s audit risk. 5

6 The Why Nonprofit boards fiduciary duties to their organizations require that a board conduct periodic and thorough reviews of its conflicts of interest policy to ensure Adherence to the policy; and That the policy is keeping pace with best practices. 6

7 The What But what are best practices related to conflicts of interest? Vary by type of organization, mission, state law, and other considerations, but 7

8 There are guiding principles that make it easier to plan for, and solve for, conflicts. 8

9 So what do we talk about when we talk about conflicts of interest? 9

10 Our Structure Going to address twelve (12) principles to facilitate discussion on board decisions and policies: Board Responsibility Reasonable Observer s Standard and the Compelling Interest Recusal Broadly Defining Conflicts Disclosure (Information to Board Members from Organization) Disclosure (How Often) Disclosure (How Much) Disclosure (Family Members) Breadth of Policy (Beyond the Board) Side by Side Conflicts Board Investment Committee State Law Requirements 10

11 Particular Focus... Transactions by the Board involving an apparent or actual conflict of interest should only be approved if the Board finds that the transaction will provide a compelling benefit to the organization. We ll discuss a number of guidelines in this exercise 11

12 Principles of Governance: Conflicts of Interest 12

13 Principle 1: Board Responsibility Each board bears responsibility for the terms and administration of its conflict of interest policy. Organziational officers, staff, and legal counsel can assist in administration of the policy, but boards should be sensitive to the risk that the judgment of such persons may be impaired by their roles relative to the board s. 13

14 Principle 2: Reasonable Observer s Standard and the Case of the Compelling Benefit As a best practice, the following standard properly gauges whether a board member s actual or apparent conflict of interest should be permissible, with or without (as the situation warrants) organizational management of the conflict: (a) If reasonable observers, having knowledge of all the relevant circumstances, would conclude that the board member has an actual or apparent conflict of interest in a matter related to the organization, the board member should have no role for the organization in the matter. (b) If, however, involvement by the board member would bring such compelling benefit to the organization that the board should consider whether to approve involvement, any decision to approve involvement should be subject to carefully defined conditions that assure both propriety and the appearance of propriety. 14

15 Principle 3: Recusal When a board member is barred by actual or apparent conflict of interest from voting on a matter, ordinarily the board member should not participate in or attend board discussion of the matter, even if to do so would be legally permissible. If, however, the board determines that it would significantly serve the interests of the board to have the conflicted board member explain the issue or answer questions, the board may consider whether to invite the board member for that limited purpose. Any resulting invitation should be recorded in the minutes of the meeting. 15

16 Principle 4: Broadly Defining Conflicts A board should not confine its conflict of interest policy to financial conflicts, but should instead extend that policy to all kinds of interests that may (a) lead a board member to advance an initiative that is incompatible with the board member s fiduciary duty to the organization, or (b) entail steps by the board member to achieve personal gain, or gain to family, friends or associates, by apparent use of the board member s role at the organization. 16

17 Principle 5: Disclosure (Information to Board Members from Organization) Board members should be required to disclose promptly all situations that involve actual or apparent conflicts of interest related to the organization as the situations become known to them. To facilitate board members identification of such conflicts, organizations should take affirmative steps at least annually to inform their board members of major organizational relationships and transactions, so as to maximize awareness of possible conflicts. 17

18 Principle 6: Disclosure (How Often) Board members should be required to disclose not less often than annually interests known by them to entail potential conflict of interest. 18

19 Principle 7: Disclosure (How Much) Boards of organizations should take into account the governmental sponsorshiprelated thresholds in their area of operation, if applicable, in determining thresholds for mandatory disclosure of board member conflicts of interest. 19

20 Principle 8: Disclosure (Family Members) Interests of a board member s dependent children, and of members of a board member s immediate household, should be disclosed and regulated by the conflict of interest policy applicable to board members in the same manner as are conflicts of the board member. 20

21 Principle 9: Breadth of Policy (Beyond the Board) Organizational policy on board member conflicts of interest should extend to the activities of board committees and should apply to all committee members, including those who are not board members. 21

22 Principle 10: Side by Side Conflicts Boards should consider whether to adopt conflict of interest policies that specifically address board members parallel or side-by-side investments in which the organization has a financial interest. 22

23 Principle 11: Board Investment Committee Boards should also consider whether to adopt especially rigorous conflict of interest provisions applicable to members of the board investment committee, if any. 23

24 Principle 12: State Law Issues To the extent that the foregoing recommendations exceed but are not inconsistent with state law requirements applicable to your boards should voluntarily adopt the recommendations. Likewise, if your state imposes additional requirements with regard to conflict of interests of nonprofit board members, those laws should be incorporated into your policies. 24

25 What is a compelling benefit, and when does it justify a conflict of interest? 25

26 Remember our 2 nd Principle: (a) If reasonable observers, having knowledge of all the relevant circumstances, would conclude that the board member has an actual or apparent conflict of interest in a matter related to the organization, the board member should have no role for the organization in the matter. (b) If, however, involvement by the board member would bring such compelling benefit to the organization that the board should consider whether to approve involvement, any decision to approve involvement should be subject to carefully defined conditions that assure both propriety and the appearance of propriety. 26

27 What does this mean? The board in no event should approve a conflict of interest transaction unless the transaction (1) would bring compelling benefit to the organization, and (2) is subjected to warranted carefully defined conditions that assure propriety and the appearance of propriety. The next few slides pertain to the first condition, by addressing what we mean by compelling benefit. 27

28 Caveat: The compelling benefit standard pertains to conflicted transactions. It does not pertain to non-transactional situations involving organizational policy or personnel, and conflicted board members should have no involvement in such decisions. 28

29 Assumption: When conflicted transactions are proposed, organizations will prohibit them in the great majority of cases. The proposer of the transaction will have the burden of persuading the board that the transaction would bring the organization compelling benefit. The board will subject that assertion to searching examination. 29

30 Compelling Benefits In light of the risks and costs that conflicts of interest entail, a plausible conclusion might be that board member conflicts of interest should never be tolerated. But board members have a fiduciary duty not to dismiss out of hand transactions of great benefit to the organization. 30

31 Guidelines: When is a Benefit Compelling? A paramount concern should in all cases be integrity and reputation. The board may well conclude in a particular situation that a conflict should be prohibited even if the financial benefit to the organization would be great. 31

32 Guidelines: When is a Benefit Compelling? If there is only slight benefit to the organization, the conflict of interest should not be permitted. 32

33 Guidelines: When is a Benefit Compelling? Compelling benefit is not limited to financial benefit. 33

34 Guidelines: When is a Benefit Compelling? Whether organizational resources should be taken into account in gauging compelling benefit is not an easy question, but the definition of compelling by dollar amount alone will vary by organization. 34

35 Guidelines: When is a Benefit Compelling? A board may differently analyze the cost of losing an existing arrangement than the benefit of entering into that same arrangement. 35

36 Guidelines: When is a Benefit Compelling? A benefit replaceable without heavy burden is presumptively not compelling. On the other hand, a benefit that is unique or irreplaceable may likely be compelling. 36

37 Guidelines: When is a Benefit Compelling? Speculative benefit will rarely be compelling. 37

38 Guidelines: When is a Benefit Compelling? Compelling benefit should be subject to independent confirmation by the nonconflicted board members. A conflicted board member s assurances regarding the benefit of the transaction should be independently verified. The board should engage expert advice as needed and appropriate, but the final decision should bemade by the board. 38

39 Guidelines: When is a Benefit Compelling? In situations that do not meet the definition of conflict of interest such as a board member who votes for himself or herself for board chair neither compelling benefit nor noninvolvementof the board member is required. 39

40 Guidelines: When is a Benefit Compelling? Conflicts that arise from a board member s fiduciary or other nonremunerative relationship with an organizational affiliate or a charitable organization, such as membership on the board of an affiliated hospital, will generally meet the compelling benefit standard. 40

41 Guidelines: When is a Benefit Compelling? Compelling benefit should not take into account threats, quid pro quos, or actual or anticipated negative or inappropriate conduct by a board member. 41

42 Guidelines: When is a Benefit Compelling? A transaction involving a board member should not be considered compelling unless it is compared to alternatives. 42

43 Guidelines: When is a Benefit Compelling? The compelling benefit standard applies to organizational/foundation investments. When considering whether the board should approve a proposed investment transaction which a board member has a conflict of interest, the board should take into account such considerations as the uncertain nature of the benefit to the organization, available alternatives, and the benefit to the board member. The board should rely on independent information and, as needed, independent advice and should not rely on unconfirmed advice of a conflicted board member. 43

44 Guidelines: When is a Benefit Compelling? Professional services relationships between an organization and a board member or his or her firm present special conflict of interest concerns, related to such factors as the potential for adversity following provision of advice that leads to bad results, and the difficulty of identifying objective measures of quality and value of service. 44

45 Guidelines: When is a Benefit Compelling? For each conflicted transaction the board approves, the reasons for approval, including the compelling benefit to the organization, should be memorialized. 45

46 Quick and Dirty Final Key Questions to Ask: Has your board discussed what constitutes a conflict of interest for a member of the governing board? Is your board s process for disclosure of all pertinent conflicts clearly explained and followed? Is each board member required to disclose all pertinent conflicts before a board vote? What standard apart from any applicable legal requirement does your board use to gauge whether a board member s conflict of interest is permissible? Does your board s policy require recusal of a board member with a conflicting interest, and if so, is the recusal by absence, or by non-participation in the discussion? Should the conflict of interest policy be limited to board members, or should it include others, such as executives and staff? 46

47 Final Questions or Comments?

48 Additional questions? Contact: Joshua W. B. Richards Partner, Saul Ewing LLP (215)