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Marquette Legal Initiative for Nonprofit Corporations (M-LINC). Ethical Issues A rising F or A ttorneys S erving on Non p rofit Boards Marquette Law School November 14, 2012. With support from the Helen Bader Foundation H. A Reminder about M-LINC.

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marquette legal initiative for nonprofit corporations m linc

Marquette Legal Initiative for Nonprofit Corporations (M-LINC)

Ethical Issues Arising For Attorneys

Serving on Nonprofit Boards

Marquette Law School

November 14, 2012

With support from the

Helen Bader FoundationH

a reminder about m linc
A Reminder about M-LINC
  • M-LINC is the Marquette Legal Initiative for Nonprofit Corporations
  • Housed at Marquette University Law School
  • Launched in September 2008
  • Karin Holmberg Werner, JD, is the director of M-LINC
  • Currently serving as a resource for Wisconsin nonprofits with legal questions
  • M-LINC coordinates FREE legal advice and educational programs on legal issues important to small and mid-sized nonprofits
what will we discuss today
What will we discuss today?
  • This program is aimed at ensuring that you:
    • Understand your responsibilities as a member of the board of directors of a 501(c)(3) organization;
    • Know the applicable federal and state law regarding service on such a board; and
    • Become aware of commonly promulgated best practices for such boards to avoid potentially unethical situations.
our roadmap for today
Our Roadmap for Today
  • The Role of a Board Member
  • Case Studies (Part I)
  • The Law: What is Required of Nonprofit Boards?
    • Wisconsin Law
    • Federal Law
    • Common Law
  • Best Practices
    • IRS Form 990
    • Miscellaneous Ethical Standards
    • Insurance
  • How to Comply With These Requirements and Best Practices
  • Case Studies (Part II) and Other Examples
the role of a board member
The Role of a Board Member
  • Direct
    • Further the organization’s mission with an appropriate level of risk tolerance. Focus on both short-term and long-term goals.
  • Oversee
    • Oversee the financial performance and overall health of the nonprofit.
    • Oversee the performance of the executive director.
  • Protect
    • Protect the charitable assets of the organization.
case studies
Case Studies
    • University of Virginia
    • Penn State University
  • Note: Neither board was prosecuted for legal violations, yet both boards evinced ethical and/or governance shortcomings.
  • Note: As public universities these are not technically 501(c)(3) organizations, yet we feel the examples are illustrative for all 501(c)(3)s.
university of virginia
University of Virginia
  • Facts:
    • In June 2012, two members of the University of Virginia’s governing body (Board of Visitors) met with then UVA President Teresa Sullivan privately and asked her to resign.
      • The head of the board had private conversations with each member of the Board of Visitors, as well as the Governor of Virginia and key UVA donors, prior to asking for Sullivan’s resignation.
      • Sullivan, along with most university faculty and administrators, was shocked by this turn of events. Many claimed they were unaware of the board’s displeasure with Sullivan prior to their request for her resignation.
      • Key: The full board never debated or voted on whether Sullivan should be asked to resign.
      • Sullivan’s resignation was accepted by a vote of the board’s executive committee at a meeting where only 3 of the 6 members were present.
    • Why was Sullivan ousted? The failure of the board to adequately explain this decision was one of their major missteps. It seems the board felt that President Sullivan’s strategy for instituting change was not decisive enough and was only causing incremental change at an institution in need of more radical change. However, their rationale was not adequately conveyed to stakeholders.
    • This decision resulted in a great public outcry.
    • Less than one month later, the board unanimously voted to reinstate President Sullivan.
university of virginia continued
University of Virginia (Continued)
  • Were the board’s actions illegal?
  • Were the board’s actions contrary to general best practices?
  • Where did the board go wrong?
    • In their general oversight of President Sullivan:
      • Did not clearly communicate their goals to her (drastic, rapid change rather than incremental, consensus-based change).
      • Did not provide her with clear expectations.
      • No evidence in press of annual reviews gauging her performance over her two years at UVA.
    • In their handling of President Sullivan’s initial dismissal:
      • Worked around Virginia’s open meetings law by having one-on-one discussions regarding Sullivan’s dismissal instead of having a full board meeting discussion.
      • Did not effectively communicate to stakeholders why Sullivan’s resignation was called for.
      • Resignation was accepted by a vote of the executive committee (when only 3 of the 6 members were present) rather than by a vote of the entire Board of Visitors.
      • Failed to take into account the opinions of the organization’s stakeholders (i.e., they should have had a better communications strategy in advance of resignation).
penn state
Penn State
  • In 1998, the mother of an eleven-year-old boy reported to the Penn State University Police Department that Jerry Sandusky showered with her child. The police investigated but did not find enough evidence of a crime to file charges.
  • University employees aware of this incident did not report it to the Board of Trustees.
  • In 2001, a Penn State football assistant witnessed Jerry Sandusky engaging in sexual behavior with a child inside the Penn State football locker room.
  • The incident was reported to head coach Joe Paterno as well as to Penn State employees, including the then president and athletic director. Those employees prepared an action plan, which involved talking to Jerry Sandusky about not bringing children to campus, as well as informing the Second Mile charity of his actions. They did not report the incident to the Department of Welfare or other authorities.
  • As in 1998, the university employees did not report the incident to the Board of Trustees.
penn state continued
Penn State (Continued)
  • In March 2011, a press report alerted certain board members to a criminal inquiry.
  • After two requests for more information, the board chair was informed of the situation (April 2011).
  • The next month, the full board was informed via a report at a board meeting. Few questions were asked.
  • At subsequent board meetings no updates were provided and no questions were asked.
  • On November 4, 2011, Sandusky was charged with sexually assaulting eight boys over a 15-year period.
  • The Penn State president was again reluctant to inform the board of the situation.
  • The Board soon thereafter decided to fire Coach Paterno, force the retirement of two employees with prior knowledge, and to remove the university’s president from his position.
penn state continued1
Penn State (Continued)
  • Were the board’s actions illegal?
  • Were the board’s actions contrary to best practices?
  • Where did the Board go wrong?
    • Did not ensure adequate reporting to it of important university information.
    • Failed to oversee the president adequately.
    • Did not ask “hard questions” or take swift action when originally made aware of Sandusky’s behavior.
    • Used any means to protect the reputation of the Penn State football program, to the detriment of others.
    • Board meetings did not often focus on difficult issues and instead were overly scripted, often highlighting only positive news.
    • A more active oversight role was required of them.
our starting point the law
Our Starting Point: The Law
  • Both federal law and Wisconsin law govern the behavior of 501(c)(3) boards of directors and the responsibilities of individuals serving on such boards
    • Wisconsin Statutes:
      • Chapter 701 – Trusts
      • Chapter 184 – Unincorporated Associations
      • Chapter 181 – Nonstock Corporations (i.e., nonprofit corporations)
    • Federal Law
      • IRC 501(c)(3)
      • IRC 4958 – Intermediate Sanctions
      • For Private Foundations Only:
          • IRC 4941 – Self Dealing
          • IRC 4943 – Excess Business Holdings
          • IRC 4944 – Jeopardizing Investments
          • IRC 4945 – Taxable Expenditures
  • Note: Beyond the Wisconsin statutes and the Internal Revenue Code, there is an overlay of the common law and best practices for good governance.
law wisconsin
Law: Wisconsin
  • Chapter 701 – Trusts
    • Defines charitable trusts (701.10)
    • Prohibits certain acts in the administration of private foundations (701.105):
      • Engaging in any self-dealing, IRC 4941(d)
      • Retaining any excess business holdings, IRC 4943(c)
      • Making any investments which would jeopardize the carrying out of any of the exempt purposes of the trust, IRC 4944
      • Making any taxable expenditures, IRC 4945(d)
  • Chapter 184 – Unincorporated Associations
      • This legal entity is separate from its members for purposes of entering into contracts and for liability generally (184.06). It also may own property in its own name and not in the name of the members (184.04)
law wisconsin continued
Law: Wisconsin (Continued)
  • Chapter 181 – Nonstock Corporations (i.e., nonprofit corporations)
    • Powers of Board (181.0801(2))
      • The board shall direct the affairs of the corporation. Namely, “all corporate powers shall be exercised by or under the authority of, and the affairs of the corporation managed under the direction of, its board.”
    • Delegation (181.0801(3))
      • The board may authorize a person to exercise some or all of the powers which would otherwise be exercised by the board.
    • Consideration of Interests (181.0853)
      • A board may take into account the interests of: members, employees… communities in which the corporation operates, and any other factors that the directors consider pertinent to determining what is in the best interests of the organization.
    • Director Conflict of Interest (181.0831)
      • Covers when contracts are void or voidable due to a conflict of interest (disclosure and approval or fair and reasonable to the corporation).
    • Loans to Directors and Officers (181.0832)
      • A corporation may not lend money to an officer or director unless the loan is approved by the members or the board determines that the loan benefits the corporation and approves the specific loan or a general plan authorizing loans.
      • NOTE: This does not apply to a reimbursement for reasonable expenses incurred (181.0874).
law wisconsin continued1
Law: Wisconsin (Continued)
  • Chapter 181 (continued)
    • Reliance by Directors or Officers (181.0850)
      • Directors and officers may rely on information prepared by other officers, employees, professionals, experts, and committees so long as there is no knowledge that makes reliance unwarranted
    • Limited Liability of Directors and Officers (181.0855)
      • Directors and officers are generally protected from liability so long as the behavior is not self-serving, willful or criminal.
    • Liability for Unlawful Distributions (181.0833)
      • Directors and officers who vote for unlawful distributions are directly liable to the corporation.
    • Insurance (181.0883)
      • A corporation may purchase and maintain liability insurance for a director or officer.
    • Indemnification (181.0871 thru 181.0881)
      • A corporation shall indemnify a director or officer to the extent that he or she has been successful on the merits or otherwise in the defense of a proceeding, for all reasonable expenses incurred in the proceeding if the director or officer was a party because he or she is a director or officer of the corporation.
law federal
Law: Federal
  • IRC 501(c)(3)
    • Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific…, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
law federal continued
Law: Federal (Continued)

IRC 4958 – Intermediate Sanctions

  • Excess benefits defined: Any transaction in which an economic benefit is provided by a nonprofit organization directly or indirectly for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration received (including the performance of services) for providing such benefit.
  • Penalty Tax: For any excess benefit, there is first imposed a tax of 25% of the excess benefit on the individual receiving the benefit and potentially also a tax of 10% of the excess benefit on the organization manager who knowingly approved the transaction.
  • If the excess benefit is not corrected within the taxable period, a tax of 200% of the excess benefit is imposed on the individual receiving the excess benefit.
law federal for private foundations only
Law: Federal(For Private Foundations Only)
  • IRC 4941 – Self Dealing
    • Penalty tax on decisions made in the best interests of the individual director and not in the best interests of the organization.
  • IRC 4943 – Excess Business Holdings
    • Penalty tax on excess business holdings. A private foundation can not hold substantial investments in any one entity. Be aware of generous periods allowed for diversifying assets.
  • IRC 4944 – Jeopardizing Investments
    • Penalty taxes on investments which jeopardize charitable purposes (i.e., too risky). Quite vague, however the Uniform Prudent Management of Institutional Funds Act in Wisconsin is more specific.
  • IRC 4945 – Taxable Expenditures
    • Taxes due for private foundations on any amount paid or incurred by a private foundation: (1) to carry out propaganda, or influence legislation; (2) to influence the outcome of public elections; (3) as a grant to an individual for travel, study, or other similar purposes unless the grant satisfies special requirements; (4) as a grant to any non 501(c)(3) public charity, unless that grant satisfies special requirements.
common law
Common Law
  • Duty of care:
    • Requires a director to act in good faith using the degree of diligence, care and skill which prudent people would use in similar positions and under similar circumstances.
      • Brian L. Anderson et al., A Guide for Wisconsin Nonprofit Organizations (3rd ed. 2010).
    • Tips to fulfill the duty of care requirement:
      • Mere rubber-stamping of staff requests may constitute a violation of the duty of care
      • Be familiar with organization's finances
      • Attend all board and committee meetings and actively participate
      • Carefully read material prepared for meetings prior to meetings
      • Allow time to meet without management present
      • Obtain minutes for any missed meetings
      • Make sure there is a clear process for approval of major commitments and decisions
      • Participate in risk assessment and strategic planning
      • Encourage diversity among board members
      • Periodically review performance of Executive Director
      • Keep informed and make reasonable inquiries when appropriate
      • Ask difficult questions when they need to be asked
common law continued
Common Law (Continued)
  • Duty of Loyalty
    • Requires directors to:
      • Put organization’s interests before their own;
      • Avoid or handle conflicts of interest between board members and the corporation pursuant to a policy;
      • Allow the corporation to take full advantage of business opportunities rather than letting directors exploit such opportunities personally; and
      • Maintain confidentiality and discretion regarding the affairs of the corporation.
      • Brian L. Anderson et al., A Guide for Wisconsin Nonprofit Organizations (3rd ed. 2010).
  • Duty of Obedience
    • Dictates that directors carry out the purposes of the corporation.
      • Purposes are expressed in the organization’s articles of incorporationand bylaws or other governing documents.
      • Brian L. Anderson et al., A Guide for Wisconsin Nonprofit Organizations (3rd ed. 2010).
    • Ensure that organization does not engage in unauthorized activities (i.e., political activity).
    • Ensure that organization complies with all applicable laws (i.e., file tax returns each year).
statutory protections for volunteers
Statutory Protections for Volunteers
  • Wisconsin Statutes (181.0855)
    • Directors and officers of nonstock corporations are specifically protected against the risk of personal liability, so long as no conflict of interest, violation of criminal law or improper personal benefit.
  • Federal Volunteer Protection Act of 1997
    • Applies to all volunteers for all nonprofits, including unincorporated associations as well as corporations. Provides broader personal liability protections than the Wisconsin Statutes, so long as no gross negligence or criminal activity.
    • Immunizes, with some exceptions, individuals who do volunteer work for nonprofit organizations from liability for acts of ordinary negligence committed in the course of their volunteer work.
  • Note: These statutes do not protect the organization itself from a claim. Organizations may still be held liable for actions of volunteer, even if volunteer merely negligent.
best practices
Best Practices
  • What are Best Practices?
    • Push for best practices in nonprofit as well as for-profit realm after the Enron debacle. Ideas for good governance. Promote transparency and internal controls. Specifically arose after congressional and IRS scrutiny of nonprofits from 2003 to 2006.
  • Governance Policies Promoted by the IRS Form 990:

Note: These policies are promoted by embarrassment through transparency.

      • Conflict of Interest Policy
      • Whistleblower Policy
      • Document Retention and Destruction Policy
      • Compensation Review and Approval (by independent persons using comparability data) for Executive Director and Key Employees
conflict of interest policy
Conflict of Interest Policy
  • What is a conflict of interest?
    • Investing nonprofit funds in a company owned by a director or where a director is a key manager
    • Signing a large contract with a company owned by a director or where a director is a key manager
    • Buying land owned by a director
    • Loaning a director money
  • Conflicts of interests do not need to be avoided completely, but often can be effectively dealt with by following a policy. Often, such transactions are quite beneficial to the organization.
  • IRSModel Conflict of Interest Policy:
      • Procedure for annual disclosure
      • Mandatory disclosure as situations arise
      • Recusal – i.e., leave the room during vote if conflict of interest
      • Resignation – appropriate in situations where continuing, pervasive, and important board function is affected by the conflict of interest
      • Meeting minutes should document disclosure and recusal
  • Note: Self-dealing rules for private foundations are more restrictive and may not allow for conflicts that are acceptable in the public charity context.
insurance as extra protection
Insurance as Extra Protection
  • Regardless of how careful a nonprofit is, lawsuits may arise. Even baseless lawsuits can sap a nonprofit’s resources. Insurance policies are an integral shield against liability costs.
  • Insurance trades possibility of heavy loss for the certain, but more moderate and manageable, cost of insurance premiums.
  • Types of Insurance to consider:
    • General liability insurance
    • Professional liability insurance
    • Directors and officers insurance
    • Special event insurance
    • Automobile insurance
insurance continued
Insurance (Continued)
  • General liability insurance
    • Coverage in the event the nonprofit’s property is damaged or the nonprofit is sued by a third party for damages.
    • Could occur if third party suffers injury due to the negligence of a nonprofit volunteer, such as a van driver injuring a client.
  • Practical point: the nonprofit should fully disclose to the insurance broker or carrier the precise nature of the programs and services it provides and whether it uses volunteers in addition to employees. The nonprofit should ask the insurance broker or carrier if volunteers can be added to their existing general liability policies as“insureds,” so that insurance will cover injuries to third parties based on the negligent acts of volunteers.
  • Professional liability insurance - Check to see if volunteers have their own professional liability insurance where appropriate.
case studies1
Case Studies
  • University of Virginia
    • The Board of Visitors fired and re-hired President Sullivan within one month.
  • Penn State
    • The Penn State Board of Trustees did not deal with the Jerry Sandusky sex scandal until the situation had become public and had gone on for many years.
case study university of virginia
Case Study: University of Virginia

How could the Board of Visitors have done a better job?

  • Clarify expectations for lead employees. Hold and document annual reviews that foster an ongoing dialogue with lead employees about board expectations.
  • Important decisions should be debated and voted on by the entire board.
    • An executive committee should not be delegated responsibilities that should be left to the full board.
  • Get out ahead of potential public relations fiascos by clearly explaining case for decision.
case study penn state
Case Study: Penn State
  • How could the board have done a better job?
    • Create a system and culture that encourages reporting of key information to the board.
    • Adequately oversee the organization’s lead employee.
    • Understand that being a member of a board entails addressing difficult issues and making difficult decisions.
    • Ask for more information when sufficient information is not provided.
    • Be more transparent with decisions and quicker to act on potentially damaging issues.
conserve school conflict of interest
Conserve SchoolConflict of Interest
  • Directors of a Wisconsin nonprofit corporation, the Conserve School Corporation, also served as trustees of an Illinois trust that was sole source of funding for the school.
  • Those same individuals were also directors of a Delaware for profit corporation, Central Steel and Wire Company, whose stock was the only asset held by the Illinois trust.
  • When the stock fell in 2008, the directors/trustees decided not to sell the stock. Selling the stock would have meant that they could have lost control of the for profit corporation but also meant that the Wisconsin nonprofit corporation could no longer support its then activities.
  • In March 2009, the Wisconsin Attorney General intervened in the case and argued that the directors’ conflict of interest rendered them incapable of exercising independent judgment as to the affairs of the Conserve School.
  • In May 2009, a Wisconsin court ruled that the nonprofit corporation’s director’s decision to change the format of the school from a four year to a semester only program was within their discretion.
  • Note that the Wisconsin court did not directly address the conflict of interest issue.
adelphi university excess comp and conflict of interest
Adelphi University Excess Comp. and Conflict of Interest
  • In 1997, the New York State Board of Regents removed 18 of 19 Adelphi University trustees for failing in their oversight duties, including allowing excessive compensation and conflicts of interest involving approving transactions with businesses related to two trustees.
  • The university’s outside auditor, Deloitte & Touche, had recommended the conflict of interest policy in 1992, 1993, 1994 and 1995, according to university documents, before the board began complying in 1996.
  • ''I can't tell you why it took as long as it did,'' said Thomas Calabrese Jr., who heads the board's audit committee.
  • A Chronicle of Higher Education survey in 1996 ranked Dr. Diamandopoulos as the nation’s second highest paid college president.
  • Key facts – board minutes never reflected board approval of the president’s compensation, despite the bylaws requiring such approval. Instead, the chairman and two other trustees reviewed and set compensation each year. They simply reported to the full board that they had done so but did not reveal details of the compensation package. Testimony also stated that the trustees stopped looking at comparable compensation information from other schools because it was “of very little value.”
    • Was review process sufficient without full board approval?
adelphi university continued
Adelphi University (Continued)
  • Board chairwoman owned an insurance company that collected more than $1.2 million in commissions from the university from 1986 to 1996.
    • Was the argument that the university benefitted from this arrangement a sufficient defense?
    • Key facts – the finance committee was told that the insurance company was providing services “free of charge” in 1986-87. Evidence of whether that representation related only to consulting services or insurance commissions was disputed.
    • Were insurance commissions concealed by deceptive statements?
    • University president unilaterally decided on insurance company. University trustees never formally voted on hiring the insurance company.
    • Board chairwoman admitted that there was much discussion at board meetings of the insurance coverage even if not so noted in the minutes and that she never stepped out of the room for such board discussions on insurance.
getty trust
Getty Trust
  • From 2003 to 2005 IRS and California Attorney General investigations.
  • Accusations included excess compensation for its then chief executive, Barry Munitz, who collected salary, benefits and perks totaling nearly $1 million annually.
  • Getty Trust had an endowment at that time of more than $5 billion.
  • Conclusions included misuse of funds for lavish travel, gifts and perks.
  • Such expenses were approved by the trust’s board and included first-class air travel, stays at five-star hotels and a leased Porsche Cayenne.
  • Also at issue was a 2002 sale of real estate owned by the trust to Eli Broad, a billionaire investor and art collector who is a close friend and traveling companion of Mr. Munitz. It was asserted that the property was sold for $700,000 less than its appraised value.
  • Misspent money was recouped when Munitz agreed to repay $250,000 and forgo more than $2 million in benefits when he was removed as chief executive. He resigned without a severance package.
getty trust continued
Getty Trust (Continued)
  • In 2006, the California Attorney General investigation revealed that Mr. Munitz misspent trust money on his wife’s travel, used employees for personal errands and made improper payments to a graduate student.
  • The California attorney general declined to take civil or criminal action against Mr. Munitz or the then board of directors as the misuse of funds did not result from fraud and the value of the settlement between the trust and Mr. Munitz exceeded the value of the losses from any improper payments.
  • Getty reforms included restricting travel expenses, prohibiting the use of employees for personal ends and forbidding gifts from the trust to its trustees.
  • Note: all payments/expenses approved by the board and no indication of false statements or submitting false bills.
  • The California Attorney General required reports every six months for two years regarding compliance with reforms.
how to comply with legal requirements and best practices i e meeting the board s duties
How to Comply with Legal Requirements and Best Practices (i.e., Meeting the Board’s Duties)
  • Develop a strategic plan
    • Frequently reflect on how current programs and activities are furthering the organization’s purpose.
  • Delegate when appropriate
    • Designate qualified people to delegate to and make sure they have the right tools and guidance from the board.
  • Hold effective meetings
    • Ask for information
    • Attend regularly and contribute actively
    • Ask difficult questions when they need to be asked
  • Keep good records (both financial and nonfinancial).
  • Comply with a conflict of interest policy.
  • Follow compensation review and approval procedures, including annual review with clear expectations for executive director and other key employees. Be sure to review and document comparability data.
  • Ensure important decisions are debated and approved by full board.
  • Promote transparency
    • Make sure that information is generally publically available. Be aware of the potential negative ramifications of not properly explaining and publicizing controversial decisions. Hire a communications expert when needed.
thank you and contact information
Thank You and Contact Information

Thank you for coming today.


Karin Holmberg Werner, JD

Director of the Marquette Legal Initiative for Nonprofit Corporations

Marquette University Law School

Office 138D

(414) 288-5536