Court Ruling Underscores Need to Disclose Conflicts of Interest

There are 8.3 million new reasons why charity executives should be more attentive to conflicts of interest, not just those of their board members but also their own.

That’s roughly the dollar size of the damages awarded by a federal-district court judge in an important case involving conflicts of interest at nonprofit organizations. For nonprofit executives, the case should be an eye opener. To be sure, the $8.3-million award highlights the potential financial risks that can occur when an organization’s top leaders don’t disclose actual or potential conflicts of interest. But it’s the nature of the conflict—based on friendship, not dollars—that should provoke a good deal of self-examination at nonprofits across the country.

The case involved a series of long-running business disputes that had arisen during the course of a brief and unsuccessful alliance between Lifespan, a large New England nonprofit health-care system, and the New England Medical Center (now called the Tufts New England Medical Center). The hospital system was mad because the medical center had failed to make required payments after their relationship fell apart. The medical center admitted it had not made the payments but said it was because Lifespan had breached its fiduciary duties during their relationship. The Massachusetts attorney general intervened in the case on behalf of the New England Medical Center.

The conflict of interest issue was at the heart of one of the principal rulings by the District Court of Rhode Island, which reviewed the lawsuit. Specifically, the judge ruled that the health system—which had supervisory authority over the financial affairs of the medical center—breached its duty of loyalty by failing to disclose that Lifespan’s chief financial officer had a conflict of interest in connection with a complex financial transaction it was directing the medical center to pursue (to its ultimate loss). The court found that the CFO had a “close, longstanding, personal relationship” with the investment banker.

Nevertheless, and contrary to health-system policy, the CFO failed to disclose the relationship and recuse himself from the process of considering the financial investment. With highly descriptive words, the court concluded that this relationship resulted in the CFO providing “preferential access” for the investment banker in connection with the proposed transaction and influenced the CFO’s decision to pursue the transaction over the medical center’s objections. Notable was the court’s conclusion that the CFO was particularly motivated by a desire to “please” his friend in hopes of joining a wine partnership in which the investment banker held an interest. In other words, the court ruled that the CFO had pulled out all the stops to make the deal happen for his friend—all for the purpose of advancing his own self-interest.

The court’s discussion of the conflict of interest is harsh, and its legal analysis fairly aggressive, but it reflects real life. (Ever see the movie, Diary of a Mad Housewife? Think the Richard Benjamin character.) You find yourself saying, “I can kind of see how this kind of thing could happen.” That is, until you think about the $8-million penalty and the losses that New England Medical Center sustained.

To be fair, this is far from the first case of a nonprofit’s conflict of interest arising from a personal relationship. Hadassah, one of the nation’s largest nonprofits, faced that problem when its chief financial officer disclosed her affair with Bernard Madoff—conducted while the organization was investing with him (and before it lost millions of dollars in his Ponzi scheme). The organization’s investment committee was very upset by the conflict, but others wrote that one off, attributing it to love and to Mr. Madoff.

This new case is a bit different. A bit more like what happens all the time at nonprofits. A nonprofit executive develops a friendship over time with an outside consultant, maybe puts the consultant on a bit of a pedestal, then gives the consultant what the court perceived to be preferential treatment in a deal. Maybe the officer truly thought doing it this way, with “his guy,” was the right way to go. Problem was, the court didn’t. The deal didn’t work out as planned. New England Medical Center took an expensive financial hit.

These things happen. Executives do develop personal relationships. Sometimes they lead the organization into business arrangements with people they know, like, and respect—and think have benefit to offer the organization. And all that’s fine and can work out for the best. But only if the executive raises his or her hand, to the board leadership or conflicts committee and says, “Hey—before we go down this path, I want you to know something.”

Just disclose—get it out in the open. The presence of a conflict of interest does not, in and of itself, preclude the nonprofit from pursuing a particular arrangement. The law does provide for ways in which the conflicts of interest can be managed, assuming the overall deal is fair and in the nonprofit’s best interests. But you can’t get to that place if the executive doesn’t make the disclosure.

The lesson is simple. When in doubt, disclose. The Lifespan court ruling serves as a rather rough reminder for nonprofit executives that conflicts of interest aren’t limited to the boardroom. They can arise among other senior leaders as well. They also aren’t all about money; they can arise from personal relationships.

The law is concerned with protecting the nonprofit’s decision-making process from bias—and bias can arise from any number of sources, both traditional and nontraditional. The law knows that. For nonprofit executives, the message is not “Don’t befriend your consultant,” or “Don’t send business to people who are really nice to you,” or even “Don’t do business with your friends.” Rather, the message is that nonprofit executives must keep their conflicts radar working all the time. When something could be a problem, it must be disclosed. Not doing so can cost a nonprofit millions and millions of dollars.