How Does your Nonprofit Measure Up to its Essential Fiduciary Duty?

by | Jul 27, 2021 | Announcements

Recently I overheard two gentlemen (I’ll call Harry and George) talking about their service on a local nonprofit board of directors. They voiced some basic concerns and confusion about their duties to the organization in terms of the financial reports and transactions. They were also concerned about their liability as board members.

“Sometimes I just don’t understand the financial reports they present to us at board meetings,” admitted Harry. George agreed that the reports are often confusing to him too. “What do you think we’re responsible for and how much trouble can we get into if our nonprofit makes bad spending decisions?” asked George.

They both agreed that they owed it to themselves and to the organization they love to find answers to their questions. They wanted to be good, responsible board members but didn’t even know what questions to ask.

After conducting some research and consulting with a friend in the financial industry, here’s what they discovered.

All members of a nonprofit board of directors have a fiduciary duty to the organization.

According to the Nonprofit Risk Management Center, “board members exercise overall responsibility for the fiscal affairs of the nonprofits they serve. To discharge this responsibility board members must:

  • Have a keen interest in the fiscal affairs of the nonprofit, including its overall, current financial position, the reliability of the reports the board receives, and the effectiveness of the nonprofit’s management of incoming and outgoing funds.
  • Require regular, timely and complete financial reports from internal finance staff or contract staff and expect the board to hold staff accountable for meeting the standards of timely reporting (for example, providing financial statements no later than three weeks after the close of the prior accounting period).
  • Ask critical questions about the financial reports the board receives, including budgets, periodic financial statements, the annual Form 990 and annual, sometimes audited, financial statements.

Keep in mind that a board that fails on any of the above issues is incapable of meeting its legal duty of care. A CEO who fails to empower the board to discharge its duty of care is arguably derelict as a leader.”

Pay attention to possible conflicts of interest.

Harry and George found out from the Nonprofit Quarterly that “every nonprofit organization needs to consider ways to avoid conflicts between the interests of the organization and those individuals in management, governance, and decision-making roles in the organization.

The IRS has recommended that organizations consider adopting a conflict-of-interest policy that includes provisions to which these individuals should conform when considering transactions in which they have a potential, actual, direct, or indirect financial interest.”

It’s important to watch out for self-dealing or even the perception of it.

In the same article, the authors point out that “self-dealing is invariably a consequence of a conflict of interest. If the latter were the signal of a likely opportunity, the former is the action that takes advantage of the opportunity for personal, family, or business-related gains or the gains of another manager or independent contractor (such as excessive compensation).

But it’s important to remember that self-dealing does not bar an honest, arm’s-length transaction that benefits the nonprofit and does not unduly favor the trustee or officer over others.

These types of transactions should always be approached with very careful legal and ethical scrutiny and within the scope of a carefully crafted and existing policy.”

Always be aware of board members who are not independent.

Each member of the board must be classified as independent or not, and if not, why, and how. For example, a member of the board may be classified as non-independent because his or her firm has a close relationship with the organization—such as sponsorship of its operations or services to it or being a client of the organization (or vice versa).

Knowing where board members may be coming from is important in evaluating the possible impact or perspective they might bring to specific board decisions—especially transactions with financial implications.

It is acceptable for board members to be non-independent as long as all members are informed and decisions to not unduly benefit the non-independent board member.

Nonprofit organizations also have a duty to its board members.

Trustees have the right to expect that the nonprofit organization has exactly the same duty to them as they have to the organization. They should expect obedience to their policies that are consistent with the mission of the organization.

Trustees share liability for infractions; therefore, they should expect that their directions will be obeyed. It is they, rather than the employees, who represent the public interest.

Timely and relevant information and interaction with consultants (including auditors, compensation experts, lawyers, and the chief executive of the nonprofit) are first defenses against unwitting self-dealing, conflict of interest, and general failure to perform their duties of loyalty, care, and obedience.

Trustees, therefore, have a right to know, and the organization has a duty to keep them informed.

Nonprofits have a duty to protect their board members.

There is always the possibility of a trustee’s being sued or involved in a lawsuit against the organization. How does the organization protect the trustee?

First, by timely information so that the trustee can take adequate action; second, by covering the trustee through insurance (typically through a Directors’ and Officers’ Insurance policy) and indemnification; and third, by disclosures.

In general, an officer or trustee is immune from civil suit for conducting the affairs of a nonprofit unless the action taken is willful or wanton misconduct or fraud, or is gross negligence, or if the person personally (or through a relative or associate) unduly benefited from the action taken.

Each state has its own provisions concerning the liability of board members. Harry and George learned from Legal Zoom that nonprofit directors and officers, acting in good faith, have statutory liability protections under sections 5047.5 and 5239 of California’s Corporation Code. Yet directors who breach their fiduciary duties may incur personal liability to the nonprofit.

Board members must be educated about the financial aspects of their nonprofit.

Harry and George learned through their research that it is not uncommon for some board members to feel confused about their organization’s finances. However, because it is the duty of all board members to have a certain level of financial understanding they met with the chair of the finance committee, Sarah.

Sarah agreed to conduct a regular training for all board members and to encourage questions regardless of how silly they may seem.

She described in plain English, rather than technical financial jargon, how to read the financial statements and how to understand the implications of the regular reports.

Harry and George were now feeling much better about their ability to discharge their fiduciary board duties.

In a nutshell, a board member’s fiduciary responsibilities include reviewing finance statements on a regular basis to note any concerning financial trends, making sure proper financial policies are in place and being followed, educating all board members about the regular financial reporting, and ensuring the organization’s legal and ethical integrity.

The board must make certain that all laws governing nonprofits are being followed and that high ethics are always maintained.

The board also approves the annual budget, making sure that the organization has adequate resources to accomplish its strategic plans and to fund its programs.

Of course, an essential responsibility of all board members is to engage in fundraising activities that demonstrate their sincere commitment to the nonprofit and to the community as well as to ensure the nonprofit has sufficient funds to conduct their mission.