In April of this year, the news outlets in St. Louis, Missouri turned their attention to a story about the Zoo-Museum District board that awarded a multi-million dollar contract to a design firm to build a pavilion within the St. Louis Science Center. The contract, ranging from $1.2 to $2.5 million was, unbeknownst to the board, awarded to a design firm that was owned by one of their very own directors. Once this became known to the public it sparked a heated debate in the media, and was promptly followed by the resignation of the board member.
This serves as the perfect illustration of what nonprofits must work to guard against—the real (or perceived) conflict of interest that takes place when a board member stands to gain personally from their relationship with the organization. The story in St. Louis involves a public organization that receives taxpayer dollars and is governed by a different set of rules than the ones that govern nonprofits, but conflict of interest issues arise from the same set of circumstances. Both types of entities need strong boards, comprised of members who are knowledgeable in their fields and able to provide expert guidance and direction. In many cases, the best candidates for board positions also have a financial interest in businesses that can help advance the mission—but therein lies the danger.
The IRS offers some guidelines for nonprofits that are designed prevent board members from unethically profiting from their positions. First, the IRS requires the completion of a Form 990 in which nonprofits must disclose the compensation and potential conflicts associated with officers, directors, trustees and key employees. Second, they encourage nonprofits to establish a formal conflict of interest policy and have ongoing reviews of the policy with its staff. But the guidelines they recommend leave some wiggle room for board members to do business with the nonprofit. The IRS’s sample policy states: “A financial interest is not necessarily a conflict of interest. Under Article III, Section 2, a person who has a financial interest may have a conflict of interest only if the appropriate governing board or committee decides that a conflict of interest exists.”
From this policy, a board member (or a company they have a financial stake in) can still ethically bid for contracts with the nonprofit, but ideally, they would be offering below-market rates of their goods and services, creating a win-win for both parties. In the real world, things don’t always work out that way. In 2007, the Urban Institute did a survey of over 5,100 nonprofits and found that more than 41 percent of nonprofits with at least $10 million in annual expenses purchased goods and services from board members. The study also showed that only 39 percent of the larger nonprofits that did business with board members received below-market rates. The other 61 percent may not be in outright violation IRS regulations, but they are taking an enormous risk with regard to public opinion and loss of support from contributors if it becomes the public perception that a board member is taking undue advantage of their position.
Many financial consultants would advise against letting board members bid on contracts because it puts the nonprofit’s reputation at too great of a risk. Even where there is no impropriety, the mere perception of impropriety can have a damaging impact on their name, their donations, and their ability to fulfill their mission. Others might argue that the very reason board members volunteer their time and expertise is because of the financial opportunities that come from the relationship with the organization, and without these opportunities, nonprofits won’t be able to properly staff their boards.
It’s a slippery slope that each nonprofit should manage carefully according to their own code of ethics and risk tolerance. The best course for mitigating some of the risk is to create a clear conflict of interest policy, outlining precisely what behaviors and relationships are allowed, and socialize it regularly among the board and the public. If a conflict does arise, the nonprofit needs to deal with it openly and swiftly to maintain its credibility. Establishing, socializing and enforcing a strong conflict of interest policy will go a long way toward protecting your nonprofit organization from scandals like the one in St. Louis, so that when you do end up in the press, it’s for all the right reasons.