A charitable organization should adopt and implement policies and procedures to ensure that all conflicts of interest, or the appearance thereof, within the organization and the board are appropriately managed through disclosure, recusal, or other means.
A conflict of interest arises when a board member or staff person’s duty of loyalty to the charitable organization comes into conflict with a competing financial or personal interest that he or she (or a relative) may have in a proposed transaction. Some such transactions are illegal, some are unethical, but others may be in the best interest of the organization as long as certain clear procedures are followed.
Establishing and enforcing a conflict-of-interest policy is an important part of protecting charitable organizations from unethical or illegal practices. The policy need not be complex, but it must be consistent with the laws of the state in which the nonprofit is organized and should be tailored to specific organizational needs and characteristics. The policy should require full disclosure of all potential conflicts of interest within the organization. It should apply to every person who has the ability to influence decisions of the organization, including board and staff members and parties related to them. Some organizations may extend the policy to substantial contributors as well.
Board members and staff should be encouraged to disclose any interest they have in a transaction or matter that is before the organization where that interest could be reasonably viewed by others as affecting the objectivity or independence of the decision maker, even if the interest is not the result of the staff or board member having a formal affiliation with some other party. The practice of full disclosure should be fostered particularly at board meetings, and the fact of any conflict and the action taken in response, including abstention, should be recorded in the minutes. Conflict-of-interest policies should distinguish between situations that give the appearance of a conflict and those that involve a material conflict where a board or staff member has a direct or indirect financial interest in transactions with the organization. It is important that there be in place a transparent process, in which board members engage, to understand the nature of the conflict and whether it can be appropriately managed. For example, some foundations and grantmaking public charities prohibit grants to organizations for which one of the funder’s board or staff members serves as an uncompensated director or trustee. Others require disclosure of this relationship and recusal from the decision-making process. Still others encourage board or staff members to be engaged actively with other charitable organizations, including the charities they may fund, as a way of learning about those organizations and the fields in which they work.
Once a conflict-of-interest policy is developed, all board and senior staff members should be required to sign it and to disclose any material conflicts of interest, both at the time they join the organization and at the beginning of each new board year. Many organizations use an annual questionnaire or disclosure statement for this purpose and commonly provide information about board members’ conflicts to auditors or others reviewing
the organization’s financial transactions. When senior employees, board members or their family members have a material conflict of interest in a matter being considered by the board or the staff, they should refrain from attempting to influence other decision-makers regarding the matter. Board members with a material conflict of interest are required by law to recuse themselves from board discussions and votes regarding those matters, other than to respond to information requests.
While there is no federal requirement that an organization have a conflict of interest policy,
board members and organization managers are subject to penalties if they are found to have
approved transactions that result in an excessive financial benefit to anyone in a position to exercise substantial influence over the organization’s affairs. (For a more complete discussion of excess benefit transactions, see the Legal Background to principle #13.)
The Internal Revenue Service requires public charities to disclose on their annual information
returns (Forms 990) if any officers, directors, trustees, key employees, highest compensated
employees, or highest compensated profession or other independent contractors are related through family or business relationships1 and whether the organization has a conflict of interest policy.2 The IRS Form 1023, which an organization must file to obtain a determination of federal tax-exemption under section 501(c)(3) of the Internal Revenue Code, asks the organization to indicate whether it has adopted a conflict of interest policy and, if not, how it will handle conflicts of interest.
All states mandate that directors and officers owe a duty of loyalty to the organization, and improperly benefiting from a transaction involving a conflict of interest, if improper, more than likely violates that duty. Some state statutes specifically penalize participation in transactions involving conflicts of interests unless the organization follows certain prescribed procedures.
1 IRS 2006 Form 990, Part V-A, line 75b. Family relationships include “an individual’s spouse, ancestors, children, grandchildren, great-grandchildren, siblings (whether by whole or half blood), and the spouses of children, grandchildren, great-grandchildren, and siblings. Business relationships are defined as “employment and contractual relationships, and common ownership of a business where any officers, directors, or trustees, individually or together, possess more than a 35% ownership interest in common.”
2 2006 Form 990, Part IV-A, line 75d.
These questions – from the Principles Workbook (PDF) – are intended to prompt discussion about the principle, assess the polices and practices of your organization, and encourage your organization to take steps to identify where improvements should be made.