January 15, 2012 | Read Time: 5 minutes
It’s a fair bet that 2012 will be a momentous year in terms of nonprofit governance.
The rise in wrongdoing, both high-profile scandals and little-noticed embezzlements, plus pressure on government spending and growing attention to the accountability of board members, will all increase the challenges for top nonprofit executives and board members.
Among the key trends to follow:
Scandal spillover. The standards for fiduciary conduct could become much clearer in the wake of prominent scandals that arose in 2011—including the Fiesta Bowl, Penn State, and the Hershey Trust.
Each of those scandals, and others like them, raised questions about the quality of board oversight, the independence of the governing board, unresolved conflicts of interest, self dealing, and financial judgment.
Given the lack of judicial decisions or formal guidance from regulators on fiduciary standards for nonprofit boards, what happens next in all of these cases could have an outsized impact on charity trustees. Indeed, the potential exists that Louis Freeh, the former FBI director who is investigating Penn State (and other scandals) may exert more influence on nonprofit governance than any court or regulator.
Discussions of accountability will also be spurred by the 10-year anniversary of both Enron and the Sarbanes-Oxley law, which it and other corporate scandals prompted. This will surely lead to widespread coverage in the news media and discussion among policy makers about the ways boardrooms now operate, both for-profit and nonprofit.
Such a public discussion of board responsibility will not only serve to refocus attention on the proper role of the trustees but will also provide an important opportunity to reconsider what governance procedures every board should follow.
Dealing with the deficit. Legislative efforts to curb enormous state and federal deficits will have major implications for the bottom line of many nonprofits as well as the manner in which boards provide strategic guidance to senior managers.
While it’s impossible to predict where legislatures will make the inevitable cuts, it is clear that subjects such as entitlements—as tax-exempt status may fairly be described—and the charitable deduction are fair game for policy makers to reconsider.
Efforts at the state level to strip nonprofits of local property-tax exemptions provide a clear warning of what may be to come.
Under such circumstances, the board has several key fiduciary responsibilities. The first is to make a concerted effort to articulate exactly what government gets in exchange for offering tax breaks.
Second, board members need to monitor government deficit-reduction plans and do some “doomsday” calculations: Just what would be the impact on the organization’s finances if it lost tax-exempt status or if the charitable deduction was eliminated? What would the organization do as a fallback plan? How would it replace the lost revenue? How would it retool its financial orientation?
The board should pay attention to those risks and work with the organization’s top leaders to get the necessary answers.
Businesses and sophisticated nonprofit boards regularly identify risks that could do significant harm. Now it’s time for all nonprofits to recognize that deficit reduction is the kind of threat that needs the board’s attention.
Reining in rip-offs. Embezzlement, self-dealing, and other financial wrongdoing have grown so rampant, the Internal Revenue Service now asks whether organizations have done any of these things on the informational tax returns they must file ever year.
Lawyers at nonprofits send phony invoices payable to secret bank accounts, construction managers skim funds from contractors, senior executives inflate expense reports, employees forge approvals for bonus payments or mischaracterize vacation travel as seminar attendance, scientific researchers appropriate intellectual property for their own use, and board members surreptitiously direct nonprofit business to their own companies.
Board members need to recognize how serious this problem has become. They must understand what internal controls the organization has and whether they make a difference.
And they need to understand what board members are supposed to do when they see potential wrongdoing. What questions should they ask? How can individual board members effectively raise their concerns, particularly in situations involving senior, previously trusted executives or others?
Effective whistle-blower policies and strong auditing procedures can help charities avoid trouble.
Preventing fraud and other illegal activity gets to the heart of a board’s obligation to be stewards of the organization’s assets. Failure by board members to understand this very real risk can expose them to substantial criticism and potential liability.
Managing break-ups. Two recent court rulings are placing unexpected and counterproductive governance pressures on nonprofits that operate through local chapters or divisions controlled through a central charity headquarters.
One ruling involves the Girl Scouts of the USA, which tried to consolidate some of its affiliates and was told it could not under Wisconsin’s franchise law.
Another involved Lifespan, a health system that was involved in a merger that went wrong and was forced to pay millions in damages by a court that said the system had breached its fiduciary duties to its subsidiary hospital.
These rulings deal with the nature of the relationship between the headquarters organization and individual divisions. What are the fiduciary duties of each organization and how can they be breached?
While those cases raise critical issues, they came about from unusual circumstances.
Unfortunately, the rulings have been misinterpreted and misapplied by those at nonprofit affiliates who seek to do mischief to the charitable network they operate within. This has destabilized some national systems, a result totally inconsistent with public policy.
Boards now need to focus on what it means to be part of a larger organization, dedicated to a single charitable purpose, and what trouble can happen when affiliates seek to freelance and substitute their parochial judgment for that of the system as a whole.
Not every organization needs to worry about all these matters, but it’s up to chief executives and the people who chair America’s nonprofit boards to understand how much change is in the air.
Strong board leadership and an effective partnership with senior management are the right ingredients for a nonprofit to respond to the challenges of a new year.
