How Board Members Can Respond to Investment Turmoil

It used to be that serving on the investment committee of a nonprofit group’s board was a coveted position, offering the opportunity for a committed board member to achieve tangible results for the benefit of the charitable mission. Committee membership attracted volunteers with investment sophistication. Not anymore. Volatile markets, investment-manager scandals, and increased regulatory scrutiny have combined to make such committee service more of a hardship than a reward. Even the most financially astute trustees have met their match in today’s market turmoil. Questions as to the scope of board members’ insurance-liability coverage increase as portfolio performance decreases.

Yet it is not entirely a dead-end assignment, especially if the groups’ executives and board members pay attention to the best ways the committee can perform its duties during tumultuous times and continue to meet the legal standards of fiduciary conduct. Following are some suggestions for responding to today’s challenges:

First, let us recognize the obvious: The heat is on the investment committee. The law expects that committee members will be particularly diligent during a financial crisis. That makes it wise to approach the charity’s investment advisers not only for guidance on investment strategies suitable for market turbulence, but also for an assessment of past and current economic performance.

Second, board members who are not on the investment committee will put its members under more scrutiny than ever. Full board oversight of, and regular interaction with, the investment committee is particularly crucial during periods of market turmoil. After all, everyone on the board is in this boat together.

The board is ultimately responsible for monitoring and understanding the impact of the turmoil on the charity’s investment portfolio, so an open-door policy for inquiries is vital. Indeed, it may be wise to create a special working group, consisting of members from the full board as well as representatives of the executive and investment committees, to provide special monitoring of the portfolio for at least the near term.

Third, board members should be encouraged to reach out to the general counsel and ask a couple of crucial questions that can make life easier for the committee.

For example, the committee should know if its actions are subject to the new Uniform Prudent Management of Institutional Funds Act or some other standard. That act has been adopted in multiple states. It codifies the requirement that charities invest prudently and encourages diversification of investment portfolios in a way that is more progressive than old laws that applied to charity investments. The committee should also be briefed on the scope of liability coverage for board members and officers; the information is likely to be somewhat reassuring.

Fourth, investment committees must look inward. They must recognize that despite its diligence, the members are unlikely to escape some criticism for the investment losses suffered by the organization. In that regard, the committee can anticipate the line of questions: Who are the committee members? What are their qualifications for service? How often has the committee met? Are the meetings’ minutes available?

As predictable as those questions might be, the committee would be well served by asking itself the same questions, and by reviewing its practices concerning selection and composition of members, meeting practices, investment-manager oversight, and the sufficiency of the process designed to screen out conflicts of interests among committee members.

Fifth, look externally at the same time, and anticipate the need for increased openness about the committee’s composition and practices. Openness and accountability are increasingly key themes of charity regulators. Hence the committee should prepare for an increased volume of questions about investment performance from donors, government agencies, the news media, and the public.

A charity’s staff members, as well as the full board, should be prepared to answer all questions regarding the performance of the organization’s investments and the qualifications of its investment advisers. In that regard, consistency is key, and public statements should be vetted before release by both the charity’s general counsel and the investment advisers.

Special action should be taken if the charity has suffered extraordinarily large investment losses, markedly beyond those of its peers. In such circumstances, the investment committee may wish to recommend major steps designed to preserve remaining capital and to respond to any inquiries from donors, the news media, and state regulators.

Among those steps could be a full board inquiry into the performance of investment managers and consideration of whether the nonprofit group’s allocation of assets and board and committee procedures should be overhauled to avoid additional losses. Along the same lines, constant communication should be maintained among the board, the investment committee, the finance committee, and senior managers over the impact of investment losses on other obligations; such as bond-financing covenants and pension-financing requirements.

Given the widespread news coverage of prominent investment scandals that have victimized charities, the investment committee should exercise skepticism about its investment advisers and managers — Who referred them? Any conflicts? Who are their major clients? — their performance, their liquidity, and other critical factors.

Trustees should not be hesitant about asking — they know the questions are coming, and come they must, considering the magnitude of the scandals, the sophistication of many of the organizations (and individuals) who suffered losses, the enormous size of the losses, and the trust that had previously existed between the charities and the investment advisers. Now is not a time to be discreet.

Finally, investment-committee members should be aware that charity regulators are likely to cut the average charity some slack in terms of investment-committee performance. While it is their duty to monitor charities’ investment-management practices, regulators are sensitive to the impact of the financial turmoil and to the fact that most, if not all, charities have suffered damage to their investment portfolios.

Nevertheless, those regulators carry some scar tissue from past scandals, such as the New Era scam, which entangled several prominent philanthropies.

The regulators are responsible for preserving charitable assets and are appropriately on the lookout for situations in which losses may be due more to internal charity shenanigans than to a recessionary market in securities. In some states, attorneys general have begun to review the conduct of charity trustees involved in some of the market scandals.

The IRS, too, has demonstrated its concern that charities not get involved in aggressive financial products involving inappropriate levels of risk. So it is more than just angry donors who are watching.

There is no question that service on a charity’s investment committee places trustees squarely on the hot seat. Resignation is not an effective option, especially when much of the damage has already been done. The opportunity for the investment committee to valuably serve the charity exists equally in recessionary times as in bull markets. It is just the manner of such service that is different.

Michael W. Peregrine is a lawyer at McDermott Will & Emery, in Chicago. His colleagues Neil Kawashima and Elizabeth Mills contributed to this essay.