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August 4, 2017
 

Nonprofit Board Members: Lessons Learned from the University of Louisville Foundation

The recent national headlines surrounding the University of Louisville and its foundation provide a concrete reminder of some of the legal, political and public relations challenges faced by nonprofit organizations and their boards. To recap, the university hired an independent consulting firm to audit operations at the University of Louisville Foundation following donor complaints and media scrutiny. The audit report disclosed issues relating to executive compensation, endowment administration, excessive spending, unbudgeted expenses, unapproved actions and attempts to avoid public records disclosure requirements.

The boards of the University of Louisville and its foundation were apparently unaware of the issues raised in the audit. Being on the board of a nonprofit organization is more than an honor or recognition of a sizable donation. Board members have meaningful responsibilities and must ensure the integrity and accountability of their organization. They have the fiduciary duty to safeguard the organization’s assets and make sure that such assets are used appropriately. While it may be difficult for a board to overcome staff attempts to conceal information, board members should consider the following steps to ensure that the organization is operated in a fiscally responsible manner:

  1. Stay engaged and informed. Board members lead busy lives, and too often every board member thinks someone else on the board is carrying out the board’s duties. Every board member has a duty to safeguard the organization’s assets through approved budgets, the maintenance of accurate financial records, and established processes to ensure that adequate financial controls are in place. If a staff member rather than a board member serves as the treasurer of the organization, a board member should have access to all accounts and financial information. While the organization’s CEO or president may be a board’s main contact, boards should communicate with multiple staff members.
  2. Carefully consider delegations of authority. Boards often delegate some form of contract or transaction authority to staff. While delegations of authority may be helpful so that contracts or transactions can move forward expeditiously between board meetings, one or more board members should supervise such delegation. This can be done by requiring notice to board members at the time of the contract or transaction and requiring board ratification at its next meeting. Such delegations of authority also may be limited to contracts or transactions below a certain dollar threshold, with those over such threshold requiring advance board approval. Board members have to prioritize their duties and access to information over objections from staff that board approvals take too long to obtain. If a board has an executive or similar committee, it may be able to approve such contracts or transactions between board meetings.
  3. Use and rotate auditing firms. Establish an audit committee of the board and staff it with accounting or other financial experts. Use reputable firms to audit the organization and document in a policy how often firms must be rotated.
  4. Diligence compensation. Often board members go through the motions of the IRS intermediate sanctions process (i.e., documenting an independent board’s approval of compensation arrangements in advance based upon comparability data). To fulfill a board member’s duty to safeguard the organization’s assets and only use them appropriately, board members must also adequately consider the staff member’s performance in relation to measurable goals as well as the financial health of the organization.
  5. Document the relationship between related entities. It is important to formally document the relationship between related tax-exempt organizations to establish that they are separate entities. If organizations are intertwined, such as having shared accounts, employees, and space, they may be deemed to be the same organization. Such relationships should still be documented to provide each organization’s purposes, expenditures, and responsibilities.
  6. Adopt and comply with policies. Establish at a minimum the following policies:
    • Record retention policy, which is essential to ensure a culture of transparency and to comply with federal and state laws.
    • Gift acceptance policy, and make sure it is updated as needed. Many organizations have a gift acceptance policy but have failed to amend it to reflect current laws and the evolution of the organization’s decision-making process. The board should be involved with the acceptance process relating to gifts for which the organization may potentially have expenses or liability (e.g., real estate or closely held business interests).  
    • Investment policy, which ensures investments and expenditures are appropriate.
    • Expense reimbursement policy, which provides for the payment of all travel, entertainment and other expenses.
    • Conflict of interest policy, which is recommended by the IRS for all nonprofit organizations and provides the disclosure and process requirements relating to conflicts of interest.
    • Whistleblower policy, which encourages individuals to come forward with credible information on illegal practices or violations of adopted policies of the organization, specifies that the organization will protect the individual from retaliation, and identifies those staff or board members or outside parties to whom such information can be reported.

Organizations may also consider whether to have a Code of Ethics that describes the behavior the organization wants to encourage and discourage.

  1. Create a culture of respect for donors' contributions. Boards and officers need to ensure every donation is used in accordance with the donor's intentions and that every expenditure funded by donations is justifiable. Smaller nonprofit organizations must ensure that restricted funds are not used for general expenses during times of challenging cash-flow. Larger nonprofits need to ensure they are spending prudently.

Conclusion
The University of Louisville and its foundation have been the front page story that every nonprofit fears, and they are now working to repair the damage under the direction of a new president and board members. The cost of the initial audit was $1.7 million and additional funds have been approved for further investigation. It remains to be seen whether any civil or criminal legal actions will be brought against former employees or board members. Donations under such circumstances typically decrease, thereby increasing the already-heightened financial pressure on the organization. Moreover, the reputational damage may be the most difficult obstacle to overcome. Be sure to create compliant processes and policies and instill a culture of compliance and donor respect in your organization.

Contact your Vorys attorney if you have questions about how to improve your organization’s legal compliance. To learn more about the Vorys tax-exempt organizations team click here.


 

Contacts

Victor J. Ferguson
614.464.6227
vjferguson@vorys.com

Suzanne R. Galyardt
614.464.5682
srgalyardt@vorys.com

Emily S. Pan
513.723.4055
espan@vorys.com


 

 

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This newsletter is for general information purposes and should not be regarded as legal advice. As always, please let us know if you want more information or have questions about how these developments apply to your situation.