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In the first installment of this pocket primer, I discussed the fiduciary duties that may be owed by the nonprofit's Board that you advise. These fiduciary duties are culled primarily from established corporate fiduciary law. Although this fiduciary law is instructive, nonprofits face unique challenges that the corporate sector may not face. Therefore, this paper analyzes some unique problems faced by nonprofit Boards that will likely arise as you advise a nonprofit Board and offers a number of best-practice suggestions for how to deal with some of these problems. However, if confronted with a specific legal issue, you should review relevant federal and state law regarding your issue.
I. Inadequate Financial Monitoring
In the wake of the well-publicized scandals of Enron and WorldCom, the federal government signed into law what is commonly known as the Sarbanes-Oxley Act ("SOX") in 2002. Among SOX's provisions include financial oversight, reporting, and monitoring requirements. For the most part, Congress only applied SOX to publicly traded American companies. However, increasingly, both nonprofit Boards and state legislatures are applying much of the concepts included in SOX to nonprofit organizations. For example, the state of California requires audited financial statements and the maintenance of an independent audit committee for organizations that raise over $2 million of funds in the state of California. See Cal. Gov. Code § 12586. Other states, such as New Hampshire, Connecticut, Kansas, and Maine, passed similar laws.
You should therefore advise the Board to at least gain an understanding of the nonprofit organization's finances and implement monitoring and review protocols for these finances. In some cases, you should inform the Board that (a) seating an independent director with financial expertise on the Board, (b) hiring an outsider auditor, or (c) creating a standing independent audit committee to monitor and review the organization's finances may decrease the likelihood of future problems the Board may face with disgruntled donors, state and federal regulators, and the public.
II. Lack of a Definitive and Consistent Mission
Although some corporate shareholders hold very divergent philanthropic interests, all shareholders likely share a common profit motive to a greater or lesser degree. This is not the case with nonprofits. Nonprofit stakeholders include a diverse group of donors, beneficiaries, and the larger public. Their interests for the organization are likely to be as divergent as each person's individual interests. Therefore, before the Board can fulfill its fiduciary duties, it must be aware of what the organization is trying to achieve. As the advising attorney, you should recommend that the Board work with stakeholders and staff to clearly define the nonprofit organization's mission, and then execute programs that consistently carry out this organizational mission.
III. Long-Term Values Versus Short-Term Gain
Although the Red Cross has annual revenue of about $7 billion a year, a million volunteers, and 60,000 employees, typical nonprofits are small and have limited resources. Powerful donors and skilled management offer nonprofit organizations much-needed cash infusions and leadership experience. However, these persons' contributions may be offered with "strings attached" that endanger the long-term values of the nonprofit organization. As the advising attorney, you should inform the Board of its duty to exercise independent judgment in the achievement of the organization's long-term values, even if these decisions defy a powerful stakeholder's short-term interests.
IV. Performance Metrics
Most for-profit corporate Boards monitor and evaluate organizational and management performance via sophisticated metrics. In many cases, corporate performance is based on the corporation's revenue, profits, and stock price. But how does a nonprofit evaluate organizational and individual performance? Would it be a failure if more homeless persons were fed in year five than year one if the organization's mission is to end homelessness? Although no one formula can apply to every nonprofit, you should advise the Board that it should at least consider how to evaluate the organization's and management's performance. The Board should also consider how these performance evaluations translate into appropriate compensation for the organization's management.
V. Inadequate Board Oversight
Many nonprofit organizations thrive because of volunteers and philanthropically-minded donors. Community support is a valuable asset, but it can become a liability if the Board ignores its duties or the duties of its staff because of their "do-gooder" nature. The Board cannot turn a blind eye to the actions of its staff, even if they are made up of volunteers. You should advise the Board that it needs to conduct appropriate oversight regardless of the good intentions of the organization's staff or management.
VI. Fully Informed Board Members
Finally, many nonprofit Boards are made up of volunteers of various backgrounds but with one common characteristic: they each have time-consuming and demanding careers and personal lives. Also, some directors may be less sophisticated on certain subjects or lack certain skills. Therefore, you should advise each director to become familiar with at least documents dealing with the five following subjects:
You are in a great position to experience the evolution of governance law in the nonprofit sector. Increasingly nonprofit Board's are faced with unique challenges that do not have sufficient counterparts in the corporate sector. As the advising attorney, you can prepare the Board for these challenges by understanding the fiduciary lessons offered by corporate law while continuously thinking innovatively about the unique problems faced by nonprofit organizations.
About the Author
Ben Kimberley is an associate in Winston & Strawn LLP’s San Francisco office. His practice involves fiduciary and business tort issues, including fiduciary duty disputes (which involve directors, officers, trustees, and other agents), managing related corporate investigations, and litigating complex commercial cases. He is also an active member of the ABA and the Northern California District Representative for the ABA’s Young Lawyers Division. Mr. Kimberley received a B.A., with Honors, from Northwestern University and a J.D. from the University of California, Berkeley School of Law.