Insider Deals and Other Controversial Board Practices Persist, Study Finds

At least 20 percent of nonprofit groups make insider deals with board members and more than 70 percent

have not adopted policies to insure that such deals could be easily identified as posing a conflict of interest, says a new study of 5,100 nonprofit organizations.

The study, by the Urban Institute, a Washington think tank, also found that many groups are failing to attract ethnically diverse leaders to guide their decision making. Half the boards examined in the study had only white members, none of whom were Hispanic.

Among the study’s key findings:

• 21 percent of charities have bought goods, services, or property from companies affiliated with their board members.
• 71 percent do not require their board members to disclose their financial interests in entities doing business with their organizations.
• 26 percent of boards that oversee organizations with less than $100,000 in expenses have members who are related to one another, as do 19 percent of boards of organizations with $100,000 to $500,000 in expenses.

“There is a disturbing level of insularity among nonprofit boards that is at odds with their public-service mandate,” says Francie Ostrower, a researcher at the Urban Institute who conducted the study. “Failure to be more engaged in the community may contribute to boards’ lack of sensitivity to potential public responses to their practices and decisions.”

Governance Scandals

The results come at a time when many organizations are revisiting their board structure in the wake of recent governance and management scandals involving the American Red Cross, the Smithsonian Institution, the NAACP, and other high-profile charities, and as many for-profit companies are tightening rules in response to the Sarbanes-Oxley Act.

Yet even against that backdrop, many charities have been slow to take steps to improve their internal controls.

The study, for instance, found that one-third of charities do not conduct independent audits and half of all organizations do not have a conflict-of-interest policy.

With the lack of such controls, the frequency of insider deals involving board members is probably much higher than the 21 percent of groups that reported such arrangements, the researchers said.

Insider deals are even more commonplace among larger charities, particularly those with annual expenditures of more than $10-million. Forty-one percent of such groups surveyed reported that they have bought goods or services from companies that are affiliated with members of their boards.

Regulations Might Follow

The routine nature of such deals have some experts on nonprofit accountability calling for a closer look at how charity boards conduct business.

“You look at this information and you sit straight up,” says Evelyn Brody, an expert in board governance and a professor of law at the Chicago Kent College of Law, in Chicago. Ms. Brody says the lack of oversight for these deals at many charities could prompt regulators and lawmakers to create new disclosure rules that would require extra work by charities.

“I’ve always thought the law shouldn’t tell you what you can do and can’t do,” she says. “On the other hand, that assumes and requires a board that looks out for the best interests of the charity. As some of this data shows, this isn’t what’s happening, or isn’t always what’s happening.”

Concern about such deals, however, might be overblown, says Marla Bobowick, vice president of BoardSource, a Washington nonprofit group that provides consulting services to boards of directors at charitable organizations.

Ms. Bobowick says nonprofit groups often save considerable money by buying goods and services from companies that are connected to their board members, because the board members negotiate agreements at reduced rates.

The Urban Institute study found that 51 percent of organizations that reported deals with board-affiliated companies paid below-market prices.

Another 74 percent of groups conducted at-market transactions and fewer than 2 percent reported paying above market cost. Some organizations in the study reported multiple transactions with board members.

“If the charity got the goods or services at below-market rates, good for them,” Ms. Bobowick says. “That’s a pretty standard practice. The organizations I’ve known and seen get these things so far below the market rate that it’s an in-kind contribution of sorts to the charity.”

Still, the frequency of such deals — and the fact that many charities do not have rules governing them — is cause for concern, says H. Art Taylor, president of the BBB Wise Giving Alliance, a charity watchdog group in Arlington, Va.

“What organizations must understand is that they are more vulnerable to external criticism from those that don’t approve of that kind of involvement,” Mr. Taylor says. “If you are a vendor and you’re providing services to an organization on whose board you sit, why is it so important that you provide the service? And if it is important that you provide the service, then why do you believe you are the only person who can sit in that board position? If it is all about helping the organization, then why should you want to remain on the board?”

Another controversial practice — compensating board members — is significantly less common, the study found.

Two percent of the organizations surveyed reported that they pay their board members. The percentage is higher — 10 percent — among nonprofit organizations with more than $40-million in expenditures.

Fewer than 1 percent of those surveyed, meanwhile, reported making loans to members of their boards.

Making Progress

Despite the gloomy numbers, Ms. Ostrower says, the study does show that organizations are making progress in their efforts to improve board governance and accountability.

For example, 47 percent of groups that reported having a conflict-of-interest policy say they have created it or revised it since the passage of the Sarbanes-Oxley Act in 2002.

The same is true for 46 percent of organizations that have created whistleblower policies, and 54 percent that have a separate audit committee.

Those numbers suggest that nonprofit organizations are becoming more businesslike in their governance efforts, says Ms. Bobowick.

“It’s great to see that many nonprofit boards are in compliance with regulations that are not specific to nonprofit boards,” she adds.

Besides focusing on financial accountablity, the report also studied whether boards are diverse enough to be accountable to the clients their charitable organizations serve.

The report found that nonprofit boards are considerably less diverse than the overall population — and the people served by many of the organizations.

On average, 86 percent of board members are white, 7 percent are black, and 3.5 percent are Hispanic, the study found.

And while 51 percent of organizations report having no nonwhite members, that number is much higher — 64 percent — among organizations that spend less than $100,000 annually.

Nonprofit groups that serve high percentages of minorities are significantly more likely to include board members from those minority groups.

But gaps remain.

Among organizations whose clientele is more than 50 percent black, 18 percent have no black trustees.

Among organizations whose clientele is more than 50 percent Hispanic, 32 percent have no Hispanic trustees.

“The findings about homogeneity really raise questions about the ability of these boards and the nonprofits to respond to the populations that they serve,” Ms. Ostrower says. “There needs to be some kind of initiative to help nonprofits find people for their boards.”

The Urban Institute study is available on the group’s Web site.