May 16, 2013 | Read Time: 5 minutes
The Hershey Trust’s settlement last week with the Pennsylvania Attorney General merits review by all nonprofit boards for what it says about charity governance and the risks of pursuing certain kinds of business activities.
While Hershey is worth nearly $9-billion, the case and its implications have broad relevance for nonprofits. It reinforces the important role of the attorney general and that the standard for breach of fiduciary duty is high. What’s more, it also shows that almost every governance structure needs improvement and that it’s always important for boards to assess whether certain big-dollar transactions, no matter how carefully considered, are worth bad publicity that can result from charges of favoritism.
The Hershey Trust runs one of the nation’s largest and most prominent residential facilities for disadvantaged youths. Over the years, the operation of its school, and the relationship between the nonprofit and for-profit boards that are part of the Hershey network, have created controversy and prompted periodic scrutiny from the attorney general.
The most recent controversy came after the school made a series of significant real-estate transactions. The most prominent of these included the purchase and development of a golf course (reportedly for $17-million), and the purchase of an adjacent fruit roadside market for $8.6 million. The reason for the purchases was reportedly to obtain “buffer property” between the student homes and the community.
The transactions attracted media attention and then the interest of the attorney general over allegations that the purchase price was too high and that some Hershey board members and their associates were benefiting. What’s more, critics called attention to the compensation paid to board members, often nearing $100,000 or more for some board members.
Things got worse when a former Trust Company board member, Robert Reese, made allegations of impropriety in a whistle-blower case in county court (which he ultimately withdrew).
The attorney general’s investigation, begun in 2011, wrapped up this month and found that the trustees had not breached their fiduciary duties. But the organization agreed to a series of governance changes at Hershey that the attorney general hoped would better support the school’s charitable mission.
Here are the key takeaways:
State attorneys general wield enormous power. Make whatever jokes you want about the political ambition of the officeholder, but don’t dismiss the authority of the office and its willingness (and obligation) to take action to protect the interest of charitable assets when there is concern that they have been placed at risk. Sure, the budgets of many state attorneys general are woefully small when it comes to charity oversight. As a result, they often lack the ability to be active enforcers of the law. But charity leadership shouldn’t underestimate the ability of the attorney general to take necessary action when significant concerns with use of charity assets arise.
Breaching fiduciary duty is a big deal—and the attorney general stuck to high standards in applying the law. In some states, the standard for proving such a breach is the failure to act prudently (known as simple negligence). In other states, the standard is tougher: that the trustee deliberately disregarded the charity’s basic interests (that’s called gross negligence).
Either way, it requires more than allegations in a newspaper article or in a whistle-blower complaint to demonstrate that trustees have acted improperly, and the Pennsylvania attorney general deserves recognition for taking the time to get things right.
After all, personal reputations and substantial financial penalties were at stake here. And after over two years’ worth of investigation, the attorney general didn’t find enough evidence to establish breach of fiduciary duty with respect to any of the allegations. It didn’t matter whether they related to the real-estate purchases, conflict-of-interest disclosure, investment practices, political fundraisers, board-member compensation, consultant contracts, or other arrangements that were under scrutiny. None.
This may be hard to accept by those who continue to criticize Hershey governance, but it bears repeating—the attorney general did not find any breach of fiduciary duty. So for those pundits and commentators, perhaps it is time to accept the rule of law. If there was something there, the state would have likely found it. They didn’t. Let it go. And maybe give the Hershey boards credit for actually doing some things right.
Now it’s clear what state regulators care about. The Hershey settlement provides nonprofits with a checklist of the types of governance issues that the state will have a strong interest in monitoring. The settlement agreement deals with the structuring of overlapping directorships in a nonprofit corporate system; sets out reasonable levels of board compensation; and outlines the process for disclosing and evaluating conflicts of interests and making major acquisitions. It also establishes a process for making sure board members are selected based on their expertise and competence in dealing with the major issues of the board.
Nonprofit boards should always pause before approving a controversial deal. Sometimes it’s worth hitting the pause button before pulling the trigger on a transaction the board knows may be controversial. That’s because it’s the board’s obligation to consider the “optics” of a deal. We don’t know whether the Hershey boards had any inkling that these real-estate transactions would raise such a commotion.
I wasn’t in the boardroom and am not aware of any facts that would suggest that they knew of any red flags. But when you think about this whole situation, the cost—in terms of dollars, damage to the reputation of both Hershey and its trustees, and the distraction away from the mission-ended up being much more than the board likely bargained for. And that’s something all nonprofit boards should keep in mind—the need to ask the question, “Will it be worth the risk?” when considering a controversial decision.
The circumstances surrounding the controversial business and governance practices of the Milton Hershey School and the Hershey Trust Company are complex. But by making clear what kind of financial and governance arrangements are acceptable, and clearing the Hershey trustees of wrongdoing, the attorney general offers valuable fiduciary lessons to all nonprofit trustees.
