You may be passionate about addressing literacy problems in your community, or perhaps the senior partner in your advertising agency or law firm has told you that you will be serving on the board of directors of a business association that sponsors an annual street festival. Then again, a friend who is chairman of an innercity hospital might have tapped you for service on the hospital’s board—or your generous contributions to the local opera company may have been noticed, causing the company’s development director to ask you to serve as a board member. There are many routes to service as a director or officer of a nonprofit. Whatever your route to service, you need guidance. This is true even if you are an attorney or accountant because like it or not, the other board members will assume you are an expert in nonprofit law, regulation, and taxation. That will be true even if you limit your practice to divorce or admiralty law, or to auditing Fortune 500 companies. This Guide is designed to help you fulfill your responsibilities by providing you some needed information. It covers a wide range of topics, including (1) how nonprofits are legally organized, (2) the roles, responsibilities, and duties of directors and officers, (3) the basic tax rules affecting nonprofits and donors to charities, (4) the laws regulating fundraising, (5) organizational risks, and (6) steps that you can take to protect yourself from liability as a volunteer director or officer. To spur discussion within your own organization, the Guide concludes with an organizational self-evaluation that summarizes the many issues it covers. The challenges facing those who run nonprofits are daunting. The primary mission of nonprofits is to educate students, treat the sick, feed the hungry, provide legal services to the disadvantaged, display art and perform music to enlighten, and serve the community in any number of other ways. Yet, nonprofit directors, officers, and employees must seek contributions and grants, comply with complicated tax laws, report to a variety of governmental agencies, protect assets, maintain records, manage multiple risks, and stand accountable to various constituencies. The only way those running nonprofits can succeed in achieving their primary missions is to act in concert with each other in developing systems and controls to successfully complete all secondary tasks. This means that the board and the executive director must be partners, exhibiting mutual respect for each other. In many instances, the organization is the brainchild of the executive director who saw a need, nurtured an idea to meet that need, found the funding to build an organization to implement the vision, and selected the directors. In other words, the executive director is often a very strong-willed person. The natural tendency will be for the board to defer to the executive director. That deference can be a fatal mistake, although few realize this until it is too late. As visionaries, executive directors tend to be mission focused, viewing much of what we will consider in this Guide as burdensome detail, red tape, and administration that interferes with the mission. One has only to reflect on the many scandals that have plagued the nonprofit sector during the last decade to realize that the headlines are rooted in failure to pay attention to secondary aspects of running an organization: risk management, control, red tape, and administration. There were no conflict-of-interest or gift-acceptance policies in place. Financial controls were inadequate. The organization operated without budgets or acceptable financial reports. There were no procedures to ensure compliance with restrictions in gifts. Investment policies and procedures were either nonexistent or poorly conceived. In almost every instance, one question, often unstated, lurks: Where was the board of directors? The law clearly assigns duties to directors. Based on the belief that only so much can be asked of what are often volunteers, the law has regrettably gone too far in relieving directors of liability for breach of those duties. This does not mean that volunteers must live up to the law’s low expectations by shirking their legal duties. As should be evident, board members should be actively engaged in the organization’s governance, asking tough questions, and demanding that controls be put in place and adhered to. That does not mean that the directors and the executive director need be locked into a never-ending battle. Quite the contrary: By ensuring that adequate controls and reporting are in place, the board is actually freeing the executive director to focus on mission.
Want to improve nonprofit governance? Lots of people do, and they prove it by making all sorts of proposals, but holding directors responsible is on absolutely nobody’s agenda. Directors can ignore the financial statements. They can miss all of the meetings. They can approve transactions evidencing blatant conflicts of interest while ignoring statutorily mandated validation procedures. They can refuse to even acknowledge internal controls. While not universally true, a likely regulatory response will be removal rather than accountability through monetary liability, and even removal is relatively rare. Why the resistance to mandating that directors act responsibly? “Everybody knows that if there is any possibility that a director will be held liable, nobody will serve as a volunteer director.” That is the gospel. Nobody is willing to question something that is so obvious. But is it so obvious? Consider the trustees of the Tampa Museum of Art. When the museum wanted to expand, it sought funding from the city of Tampa to the tune of $29.8 million.2 The museum had raised $31 million as part of a capital campaign and hoped to raise another $20 million.3 Tampa Mayor Pam Iorio was not satisfied, however, with the adequacy of the funding package. She literally asked the museum’s trustees to guarantee their decision process as a condition to financial participation by the city. Specifically, the mayor asked the trustees to personally cover operating losses through 2015 with a $9 million guarantee.4 Given the old saw about directors refusing to serve if they are held to any level of accountability, the entire board of trustees would have been expected to resign on the spot, but that did not happen. You might assume, therefore, that the trustees engaged in a lengthy debate that went on for days, if not months. That did not happen. Did they spend hours in their lawyers’ offices discussing asset protection trusts? Apparently not. Rather surprisingly, they quickly agreed to the guarantees. There will be some who argue that the museum’s directors were just a bunch of rich people who would have donated that sort of money to the museum over the next ten years. The recent fundraising experience of New York City’s Museum of Modern Art (MoMA) suggests that there is some truth in that perception.5 At the same time, it is one thing to give money to build a building. It is quite different to agree to underwrite a decision if it turns out to be a bad one in hindsight. If the operating deficits materialize, does the museum then dig a $9 million hole in the museum’s lobby and name it after the trustees? People like to fund successes. They do not like to fund disasters, but that is exactly what the museum’s trustees agreed to do should losses materialize. Would a smaller pool of volunteer directors necessarily be a bad thing? Not if it forced a consolidation of charities providing duplicative and inefficient services. Board sizes presumably would also shrink, eliminating 50-person boards that prove to be inefficient and unwieldy. So we come to our first major case. Surprisingly, the origins of this story are not in some state attorney general’s efforts to identify and correct board misdeeds but in the New York Office of Parks, Recreation, and Historic Preservation (OPRHP). Back in 1969, the Saratoga Performing Arts Center (SPAC), a Section 501(c)(3) organization that sponsored an annual performance series at an amphitheatre located in Saratoga, New York,6 entered into a 50-year rent-free lease (with a 50-year renewal option) with OPRHP. The New York City Ballet was one of the two principal resident companies participating in the series. On February 12, 2004, SPAC’s board of directors decided to terminate the ballet’s summer residency following the 2005 season. OPRHP recognized that the board’s decision was contrary to the entire rationale underlying the lease; consequently, it wanted some explanations. As regulator and funder, OPRHP sent in a team of auditors to assess the decision process. What the auditors found was a very poorly run nonprofit with major control and governance failures at virtually every level of the organization.8 Specifically, the team found that:
Corporate minutes were incomplete, lacked detail, and did not record vote tallies.
Executive compensation was too high as measured against a comprehensive benchmark study of 55 similar organizations.
Reimbursement policies were sloppy, with some of the records apparently incomplete.
The president’s wife, functioning as the development officer, was the second highest paid employee despite documented evidence of inadequate fundraising plans, efforts, and results.
SPAC fell short on building its endowment, relying too heavily on ticket sales. The auditors found no evidence of a planned giving program.
SPAC had no investment or spending policy with respect to its endowment, limited as it was.
There was no evidence of a long-term business plan despite the president’s pledge to create one after his responsibilities had been significantly reduced, leaving him additional time for developing a plan.
There may have been internal control deficiencies with respect to how large cash payments to some performers were made.
The decision to terminate the New York City Ballet was based on incomplete financial data, which, had the analysis been complete, might have actually shown that the New York City Ballet carried its weight or at least have come much closer than SPAC had suggested—it is hard to say because the audit report is unclear on the various revenue sources that the auditors apparently viewed as closing a perceived gap in funding.
Board members did not receive advance notice that the decision involving the New York City Ballet was on the agenda. Not even half of the board members attended the meeting at which the decision was made to drop the ballet.
SPAC’s decision to drop the ballet was a fundamental change in mission, yet the board and officers never sought the input of a number of SPAC’s constituencies, including its landlord (New York State).
Some fundraising events and balls lost money—although this is often characteristic of these sorts of events.
Board members provided significant services to SPAC on a fee basis, raising conflict-of-interest questions.
There was no evidence of job descriptions for SPAC employees. Something clearly was wrong with SPAC.
The report focused on the board’s lack of independence and involvement. Other boards that do not want to make the same mistakes should take the time to read the OPRHP preliminary report, asking whether their organization would receive a clean bill of health if subjected to such close scrutiny. Those boards that are feeling sheepish or even embarrassed when faced with that question might want to start with the checklist in Chapter 13, but they would be better served by first reviewing the entire Guide. By no means does this Guide provide all of the answers, particularly because personalities run organizations and interact with each other while doing so, generating competition, goodwill, conflict, humor, envy, admiration, bitterness, and a whole host of other emotions. This Guide does, however, address virtually every fault raised in that truly amazing report.
Many of the covered topics are ones that people, particularly some executive directors of nonprofit organizations, do not like to discuss. As a businessperson, lawyer, accountant, or other professional, you are probably accustomed to asking tough questions in your day-to-day professional life. If you are like many professionals, you probably view your participation as a volunteer director or officer as an opportunity to “kick back” and do some good. Don’t!! William Bowen, the president of the Andrew W. Mellon Foundation, makes a strong case in his 1994 book, Inside the Boardroom: Governance by Directors and Trustees, that the most important input from a volunteer director is his tough-mindedness.
Probably the most publicized example of nonprofit mismanagement in recent years involved United Way of America (UWA) and its executive director, William Aramony. UWA is the national umbrella organization that supports nearly 1,400 independent local United Ways across the country. According to its Web site, UWA provides these member organizations with advertising, training, corporate relations, research, networks, and government relations. The member organizations support UWA by providing voluntary funding equal to less than 1 percent of the funds the members raise.17 In 1992, stories of excessive compensation paid to Mr. Aramony began to appear in the popular press, resulting in an uproar.18 People were surprised to learn that the president of a nonprofit organization received a salary of $390,000 per year, plus $73,000 in additional compensation. The stories in the press reported trips on the Concorde, local travel in chauffeured limousines, and stays while visiting New York City in a $430,000 condominium purchased by a UWA subsidiary.19 In 1994, Mr. Aramony was indicted, charged with diverting hundreds of thousands of dollars in funds for his personal use. The jury convicted Mr. Aramony on 25 counts, and he was sent to prison. The Fourth Circuit Court of Appeals subsequently affirmed most of the convictions, although it vacated two of them.20 In an editorial, The Washington Post asked the pertinent question: “Where was [the United Way of America's] board while its staff was flying the Concorde to Europe? The board has traditionally been composed largely of leading figures from the corporate worldpeople who brought prestige to it, but put little time into it.” There are many reasons that directors check their good judgment at the boardroom door. Here are three possible explanations: First, too many directors take what might be called the “books-on-tape” approach to board membership, showing up once a month to hear the executive director tell a nice story about all of the good things the organization is doing. These meetings tend to be very relaxing with lots of carbohydrates consumed in the form of morning buns, scones, and doughnuts. If the directors are really lucky, they will receive a plate of scrambled eggs and bacon or a catered lunch of oversized sandwiches and fancy chips, but eating is not what governance is about, nor is passively watching a slick PowerPoint presentation. Second, too many board members equate governance and fundraising, assuming that they have discharged their duties if they raise enough money. While the lifeblood of many organizations is money, fundraising is not governance. Those who are good at fundraising would do everybody a favor by not demanding positions on boards unless they are willing to read financial statements, think about personnel issues, allocate resources, review budgets, and take on the other difficult decisions that come with governing an organization. Third and finally, some executive directors can be power hungry, carefully guarding their prerogatives and fiefdoms. The board may want information that is not forthcoming from the executive director. With only limited time to devote to the organization, few board members are willing to rock the boat, particularly if the executive director uses food and PowerPoint as part of the pacification process. Does this mean that the board should be at war with the executive director? Absolutely not, but there should be some institutional tension. The board does not exist to rubber-stamp every proposal that the executive director makes. No executive director is infallible. The truly good ones recognize this, causing them to seek input and advice from their boards. One nonprofit recently was reported to be in dire financial straits.23 Its former chairman functioned as the de facto executive director. Not surprisingly, one board member reported that “[he] screamed and hollered, and there were certain things he wanted done, and he was a powerful guy.”24 According to a newspaper account, “[he] drove out the treasurer, fired the development director and wound up the only person allowed to write the league’s checks.”25 This organization was the victim of a kickback scandal, resulting in the indictment of the former chairman and the attorney he had handpicked as counsel to the organization.26 The attorney subsequently pled guilty, and the former chairman pled guilty to a charge involving a similar scheme, but a different organization. The other board members had a problem that was readily apparent based on the quotes given to the newspaper. They should have either governed or resigned, but it is fairly apparent that at least some of the other members were too passive, apparently failing to provide the tension that was clearly required under the circumstances. The explanations for lackluster board performance should not be taken as excuses or justifications. Put plainly, if you are a member of a board, it is your duty to either actively involve yourself in the governance of the organization or submit your resignation. Not only are you opening yourself up to embarrassment and potential liability if you do not take your position seriously, but more importantly, you are wasting resources that others have entrusted you to protect, and you are diminishing the value of the independent sector in the eyes of the public. THE MUSEUM OF MODERN ART: A FUNDRAISING JUGGERNAUT. BUT WOULD LESS HAVE BEEN MORE?
In anticipation of the reopening of the Museum of Modern Art in November 2004, The New York Times ran a lengthy article entitled “MoMA’s Funding: A Very Modern Art, Indeed,”28 focusing on how MoMA financed the $858 million construction of its new facilities. A significant portion of the financing for this project came from a large board of trustees with members who made seven- and eight-figure pledges. Total contributions from the trustees exceeded $500 million, averaging more than $7 million per trustee. Every museum hopes that its permanent collections and curatorial staffs make it the envy of other museums throughout the world, but there is little doubt that most executive directors who read this article were even more envious of MoMA’s fundraising capacity. Like a California wildfire, the news leapt from the museum world to other nonprofits, also making MoMA the envy of social service agencies, universities, hospitals, and countless other equally worthy nonprofits. In fact, on the same day that the article appeared, Independent Sector, a nonprofit trade association, began its annual conference in Chicago. During a discussion of the ideal board size, one gentleman from the audience (a very corporate-looking lawyer: no weekendcasual dress for this prosperous fellow), took the mike, extolling MoMA’s fundraising capacity. He essentially argued that no nonprofit should limit its board size if it can find directors who can raise the sort of money described in the Times article. Word had spread. Audible gasps were heard from many of the 125-plus attendees when the tanned lawyer repeated the numbers. The undercurrent from many in the audience was, “Hear, hear. This gentleman is absolutely right. The staff of the Senate Finance Committee29 has no business telling us to limit our board size to 15 members. One size does not fit all.” Unfortunately, the dark-suited messenger failed to report the article’s subtext. The Times article included the following facts: There is now a “powerful new emphasis on net worth.” To raise the money that it did, MoMA added a number of celebrity business executives to its board who are not recognized as traditional collectors and may not fully understand MoMA’s historical context or mission. There has also been an apparent shift in power with the movement in the direction of professional managers and away from curators. There was also discussion of cost overruns. One person was quoted in the article as having said, “[The new building] ran away with the budget.” The logical question: Is fundraising capacity skewing MoMA’s mission? No one will know the answer to that question for several years, but there certainly was a lot of speculation over the size of the gift shops and restaurants. Many were questioning MoMA's jaw-dropping $20 admission price before the reopening. While MoMA was successful in tapping the pocketbooks of its trustees, it also incurred over $235 million in additional debt to finance the project, bringing its total outstanding debt to over $398 million.30 That debt and the staff needed to run a larger facility have to be funded somehow. Will this mean more blockbuster shows of big-named artists at the expense of smaller, more intimate shows highlighting the works of newer and lesser known artists? The Times article suggest the answer is “No.” In fact, the article suggests that there may be fewer blockbusters if desired attendance levels can be reached without resort them. But will there be room for many lesser-known contemporary artists, or will MOMA's collection be frozen in the Twentieth Century? Striking the proper balances is what defining, fostering, and protecting mission are about. Let’s return to our corporate lawyer and many of those at the session on governance. Governance and fundraising are not the same things. As a couple of people in the audience pointed out, large boards are unwieldy, and their members lose a sense of responsibility. Those observations are fact, not opinion. Large boards also tend to shift power to the executive director, which can actually weaken the institution by eliminating an important check on the executive director. In other words, a large board may be good for fundraising but not for governing. There are plenty of ways to reward big donors, including granting naming rights and appointing major benefactors to donor-advisory committees. Those in the room who argued against smaller boards were confusing fundraising with governance.
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