Foundations Must Set the Standard for Integrity

The Charity Aid, Recovery and Empowerment (CARE) Act contains several important and worthwhile provisions to encourage more private giving for charitable purposes.

However, what is not in the bill is a provision to reduce the excise tax that private foundations pay on net investment income from a variable rate of either 1 or 2 percent to a flat rate of 1 percent. That provision was deleted from the bill passed by the Senate Finance Committee in July for two reasons: first, the loss of revenue from a tax reduction, given the current state of the federal deficit, and second, concerns over improper foundation administrative and governance practices. Regardless of whether the CARE legislation is amended to include this measure, this omission — if indeed linked to concern about foundation behavior — should be a wake-up call for philanthropy.

Estimates are that a reduction in the private-foundation excise tax could result in an additional $450-million being made available for charitable purposes. In addition, lowering the tax would simplify what has become a time-consuming and tricky calculation process that causes administrative headaches and can, over the long haul, reduce the amount of money going to charity.

Almost all observers of the foundation world, including legislators, grantees, foundation executives, and foundation critics, agree that the excise tax should be reduced to a flat 1 percent, as the House bill already does. What should have been a slam-dunk — the inclusion of that provision in the legislation (to date) — simply wasn’t.

What is more troubling are the questions about foundations that have been emerging on Capitol Hill about excessive trustee compensation and staff salaries, cases of self-dealing, and high administrative costs.

Over all, I believe foundations and charities have a good record of accomplishment, service, and management. That is not to say that abuses haven’t occurred, but they have been the exception rather than the norm. However, a few abuses can result in serious damage. Philanthropy needs to take prompt, forceful steps to deal with these situations — real or perceived — when they come to light. Let’s not wait for the regulators.

Today’s post-Enron environment creates a milieu in which the public, news media, regulators, and legislators demand that institutions of all types adhere not just to the letter, but to the spirit, of the law. We must employ ethical practices and be open and transparent in any business dealings. In other words, they rightly are demanding accountability. If organizations fail to police themselves, regulatory agencies and Congress have and will continue to step in and do the job. No part of our society — including philanthropy — should consider itself immune from these repercussions.

Foundation boards of trustees must set the highest standards of behavior and operations for their institutions and staffs. We need to take whatever steps are necessary to correct the perception that foundations are unresponsive. Even more important, we need to understand the limits of power and money, particularly when they are undisciplined by the democratic process. We need to listen to diverse voices and apply the levers of caring, humility, collaboration, and partnership in our decision making and problem solving.

American foundations are a diverse group, and that is a strength. Philanthropies support a wide range of causes, and make grants to organizations of all political and philosophical stripes. Not everyone agrees about what projects should get support or the value of philanthropic aid. And that’s fine — disagreement and dialogue are key components of democracy.

Many national associations, affinity groups, and regional associations of grant makers have developed and put in place codes of principles and practices, requiring their members to adhere to them as a condition of membership.

From time to time, these organizations have had frank conversations with member foundations that might be violating the public trust. In some cases, that has resulted in the correction of offending behaviors. The time has come when these conversations should become a regular practice.

Adopting practices and principles promulgated by national or regional membership organizations is critical; more important, each foundation must embrace ethical and responsible behavior that goes beyond such standards. That obligation starts with the board of trustees, assisted by its audit committee and other appropriate committees, and then is put in place by the responsible officers.

Following are the key issues:

• Educate trustees about their responsibility as keepers of a foundation’s ethics. Make sure the board has the necessary tools within its governing documents, including board and committee responsibility statements, and a structure to accomplish that task. Each foundation should adopt a formal conflict-of-interest policy and disclosure process. If a conflict of interest occurs, it should be handled promptly and openly. It is also important to have written codes of behavior for trustees and staff members that cover organizational effectiveness and integrity, and recognize the need to provide quality service to grantees, and to respect the value and contributions of other constituents.
• If a foundation is paying trustees, it should be benchmarking the fees against those paid at comparable foundations. Foundations are in the business of strengthening charitable activities. Furthermore, there is a tradition in parts of the nonprofit world that trusteeship is a privilege and duty and therefore should not be compensated. At times, compensation may be appropriate, but the level should reflect the traditions of service and charity.

  The same holds true for staff salaries and benefit packages. Designing compensation packages to attract and retain first-rate talent is a challenging task, and one influenced by many variables, including geographic location, the labor market, and the skill set required to do the job. Foundations should make use of benchmarks, including data from studies published by the Council on Foundations and other sources, to ensure that compensation practices are competitive without being excessive.

• Foundations need to adopt policies that support openness and transparency, as well as support efforts to increase the availability of information about foundations, other nonprofit organizations, and the nonprofit world as a whole.

  While foundations must follow basic legal requirements for providing information on their informational tax returns, we need to go beyond those requirements to help the public understand our mission and our work.

  Twenty-five years ago, publication of an annual report was the gold standard of accountability for grant makers.

  Today, foundations need to step beyond a print annual report to explain their guidelines, decision-making processes, grants financed, and project outcomes using a variety of media, including the Internet.

  We need to support efforts that increase the availability of information about nonprofit organizations. People want to know more about the finances, salaries, and administrative costs of nonprofit organizations, including foundations, as they evaluate and make decisions about what charities to support. They want assurances that their gifts to charity are being used for the purposes they intended.

  In addition, more of the revenue generated by the federal excise tax on foundations should be devoted to making timely and accurate information about nonprofit groups available to the public. In 1999 the budget of the tax-exempt division of the Internal Revenue Service was $59-million, but the excise tax produced $499-million.

• We need to be vigilant about our fiduciary responsibilities as managers of assets that are essentially a public trust.

  Such discussions inevitably turn to how much a foundation should be legally required to distribute to charity. Today, that rate is set at 5 percent, which includes grant payments, foundation-administered projects, excise tax, and administrative expenses. The latter need to be reviewed constantly to make sure they are not excessive.

  Differing opinions abound among intelligent, thoughtful people about the level of the payout rate and what it should include. But we should not forget donor intent, i.e., the fact that many philanthropists establish foundations with the desire to make their resources available for the long term and with a degree of flexibility for the unknown.

  The philanthropic table of the 21st century has room for many styles and values, whether it is the short-term spending of all of a foundation’s resources to solve a specific problem, or increasing payout rates on a short-term basis, or using payout and investment strategies to sustain a portfolio’s philanthropic potency over the long run. Pluralism and diversity are strengths of the field, and it would be unfortunate to see them disappear.

• Be prepared to go beyond the minimum requirements of the law in financial and management practices. Foundation officials should make sure they are comfortable having any aspect of their practices reported on in the national, local, or trade press.

  At the end of the day, we need to focus on the basics of our business. It behooves grant makers to set a good example of ethical conduct for nonprofit groups in both the United States and overseas. We must be sure that our everyday actions pass this litmus test, whether they benefit or detract from our reason for existence, which is to provide resources for charitable purposes.

William S. White is president of the Charles Stewart Mott Foundation. This article is adapted from his message in the foundation’s 2001 annual report, which is being released this month and is available online at http://www.mott.org.