the role of nonprofit board members today -...

THE ROLE OFNONPROFIT BOARDMEMBERS TODAY:

WHAT YOU NEED TO KNOW

October 30, 2002

FIDUCIARY DUTIESOF A DIRECTOR

Fiduciary Duties of aDirector

? What is the liability?? Who can enforce director

responsibilities?? How to mitigate the liability.? Director conflicts of interest.

What is the Liability?

? Statutory Duties of Directors ofArizona Nonprofit Corporations(A.R.S. § 10-3830.A)

– Under this provision, directorsare required to discharge theirduties

? In good faith? With the care an ordinarily prudent

person in a like position wouldreasonably exercise under similarcircumstances(the “duty of care”)

? In a manner the director reasonablybelieve to be in the best interest of thecorporation (the “duty of loyalty”)


? Reliance on InformationProvided by Management,Experts, and Committees(A.R.S. § 10-3830.B)

– Includes information, opinions,reports, or statementsprepared or presented byqualified individuals

– When reliance is unwarranted


? Business Judgment Rule(A.R.S. § 10-3830.D)

– Arizona statute presumesdirector has discharged dutiesin accordance with thestatutory requirements

– Party challenging has dutyto establish by clear andconvincing evidence factsrebutting this presumption


? Liability for UnlawfulDistributions (A.R.S. § 10-3833)– A corporation may not make

any distributions, except as anthored by statue

– Authorized distributions:purchase of memberships,upon dissolution, anddistributions to non profitcorporation members


– Director who votes for or assentsto a prohibited distribution or adistribution in violation of the articlesof incorporation is personally liablefor the excess distribution amount ifthe director did not performaccording to § 10-3830.A.

? Must file a written dissent or will bepresumed to have assented

? Corporate Opportunity– Doctrine Director is obligated to

treat a business opportunity as a“corporate opportunity”

Who Can EnforceDirector

Responsibilities

? Beneficiaries or those with a“special interest”

? A “derivative” lawsuit can bebrought in the name of thecorporation ( A.R.S. § 10-3630et seq.)

? The Attorney General

? A director or a specifiedminimum number of members

? A creditor

Mitigating theLiability

? A director discharges his dutyof care by acting “with the carean ordinarily prudent person ina like position would exerciseunder similar circumstances”– Generally, in an informed and

deliberate manner– Specifically, by adhering to practical

guidelines? Careful deliberation? Review material information in advance

of meetings? Ask questions? Consider the advice of outside advisors


– Taking notes at board meetings:pros and cons

? Exculpation of Director liability(A.R.S. § 10-3202.B.1)

? Indemnification of Directors(A.R.S. § 10-3850 through 3855)

– Permitted indemnification– Mandatory indemnification– Prohibited indemnification – Advancement of Expenses


? Directors and Officers (D&O)Insurance (A.R.S. § 10-3857)

– A corporation may purchaseinsurance for director liabilities

– Insurance coverage must becarefully evaluated

Director Conflicts ofInterest

? Transaction in which a directorhas a beneficial financial interestis regulated by A.R.S. § 10-3860et seq.

? Director’s conflict of interesttransaction must be approved

? Conflict of interest transaction willwithstand challenge if it is fair tothe corporation


? The Board of Directors mustadopt a policy regardingtransactions with interestedparties, except for:

– corporations with assets less than$10 million or revenues less than $2million,

– a corporation that offers goods andservices only to members who areentitled to vote for directors,

– religious corporations that do notoffer goods and services to thepublic for remuneration,


– Corporations organized by theUnited States, Arizona, or theirpolitical subdivisions, or

– hospital, medical, dental, oroptometric service corporations

MAINTAINING TAXEXEMPT STATUS

? Charitable Organizationsenjoy a special tax status.– No income tax on earnings or

contributions received.– Donors can deduct

contributions subject to certainlimitations.


? This special status meanscharitable organizations mustobserve various rules.– The rules can be complicated.– Their purpose is clear-cut-to

ensure the charity’s assetsand energies are used only toadvance its charitablepurpose.

– There are special rules forprivate foundations.


? When a charity uses its assets orenergies for non-charitablepurposes, bad things canhappen:– Income earned from “unrelated”

business activities will be taxed.– Punitive excise taxes can be

imposed on those who exploitpositions of influence or trust toenrich themselves or others.

– Managers or Board members whopermit a charity to be exploited mayalso be taxed.


– Excessive unrelated businessactivities or incidents of privateinurement may jeopardize thecharity’s tax-exempt status.

– Engaging in politicalcampaigns or excessivelobbying will also jeopardizethe charity’s tax-exemptstatus.

EXAMPLES OF EVENTS ORTRANSACTIONS THAT CANCREATE THESE PROBLEMS.WHAT CAN BOARD MEMBERSDO TO PREVENT THEM?

? Assume a charitable organizationroutinely uses Bill Frank as itsinsurance broker. Bill is a memberof the Board and a good donor.This year another insuranceagent has offered to provideequivalent insurance coverage fora premium that is approximately15% less than that offered by theBill Frank Agency. Can the charitystill use the Bill Frank Agency?Suppose Bill leaves the room anddoes not participate in the Board’sdecision about insurance?Suppose the difference in thepremiums is only 2%?

EXAMPLES

? Maria Douglass, the executivedirector of an operating charity,has been offered a similarposition in another state. Thesalary is almost twice what she iscurrently receiving. Can theoperating charity match the otheroffer? Are there any safeguardsto be followed? Suppose Mariaoffers to stay at her currentsalary if, every January 30th, theoperating charity will also pay her5% of the amount by which itsprior year revenue increasedover the immediately precedingyear’s revenue?

EXAMPLES

? Jeff Manley is running for UnitedStates Senate. Can a charityannounce that it supports hiselection? Suppose its charitablemission is to improve theenvironment and Manley is amajor environmental activist?Putting aside any endorsement,can the charity hold a receptionfor Manley and his supporters?Suppose the charity sponsors a“Candidates Night” and invitesManley and his opponents?

EXAMPLES

? Mary’s will bequeathed 2 acres ofprime real estate to a charity.The two acres are adjacent to alarger parcel which Mary’s son,Harold, inherited from his mother.Harold wants to develop theentire parcel, including the twoacres, as a shopping center. Heproposes that he and the charityform a partnership for thispurpose. Is this permissible?

EXAMPLES

? As executive director of a charity,Carol orders a substantialamount of printing services eachyear. Carol’s brother, Pete, hasjust been hired as a sales rep fora large printing concern. He hasoffered to provide all of thecharity’s printing services for thesame price as the charity’scurrent provider. Carol brings herbrother’s proposal to the charity’sboard of directors for approval.Can the Board properly approvePete’s proposal? Are there anyprocedural safeguards thatshould be observed?

ACCOUNTINGCONCEPTS

The two primary basis ofaccounting that nonprofitorganizations use are:

? Cash basis

? Accrual basis

ACCOUNTINGCONCEPTS

? Cash Basis:Transactions are recorded

as cash is received and disbursed

? Accrual Basis:Transactions are recorded

as revenueis earned and expenses are

incurred(not tied to the receipt or

payment of cash)

ACCOUNTINGCONCEPTS

The general systemsused to recordaccounting informationare as follows:

? Computerized accountingsoftware

? Computerized spreadsheet

? Manual accounting records

REPORTS

? Balance Sheet? Statement of Activities? Statement of

Cashflows? Statement of functional

expenses

ACCOUNTINGCONCEPTS

TREATMENT OF DONOR RESTRICTIONS

? Unrestricted No outside donor

restrictions as to the time anduse of the contributions

? Designations No donor involvement,

unrestricted? Restricted - Temporarily - Permanently

ACCOUNTINGSTANDARDS

SFAS #116 - INCOMERECOGNITION

? Record contributions whenreceived (including pledges)

? Record multi-year pledges inyear pledge was received

? Contributions vs. ExchangeTransactions

? Three classes of Net Assets - Unrestricted - Temporarily restricted - Permanently restricted

SFAS #116 - INCOMERECOGNITION

? Class of Net Assetdetermined by donor

? Reporting of contributedservices

? Reporting of special events

SFAS #117 - FINANCIALSTATEMENTS

? Certain subtotals arerequired

? Formats are not dictated? Statement of cashflows is

required? Statement of functional

expense is required forVHWOs

ANALYZINGFINANCIAL

STATEMENTS

In analyzing auditedfinancial statements, thefirst step is to read the“independent auditor’sreport,” also known asthe opinion. Theauditor’s opinion shouldbe signed and dated.

INDEPENDENT AUDITORS’ REPORT

The Board of DirectorsEXAMPLE COMPANY, INC.:

We have audited the accompanying balance sheets of

EXAMPLE COMPANY, INC.

as of December 31, 200X and 200X, and the related statements of operations,stockholders’ equity (deficit), and cash flows for the years then ended. These financialstatements are the responsibility of the Example Company’s management. Ourresponsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted inthe United States of America. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An audit alsoincludes assessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation. Webelieve that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all materialrespects, the financial position of Example Company, Inc. as of December 31, 200Xand 200X, and the results of its operations and its cash flows for the years then ended inconformity with accounting principles generally accepted in the United States ofAmerica. The accompanying financial statements have been prepared assuming that theCompany will continue as a going concern. As discussed in Note X to the financialstatements, the Company has suffered recurring losses from operations and has a netcapital deficiency that raise substantial doubt about its ability to continue as a goingconcern. Management’s plans in regard to these matters are also described in Note X.The financial statements do not include any adjustments that might result from theoutcome of this uncertainty.

(signed) Date

INDEPENDENT AUDITORS’ REPORT

The Board of DirectorsEXAMPLE COMPANY, INC.:

We have audited the accompanying balance sheet of

EXAMPLE COMPANY, INC.

as of December 31, 20X1, and the related statements of earnings, retained earnings, andcash flows for he year then ended. Further, we were engaged to audit the accompanyingbalance sheet of Example Company, Inc. as of December 31, 20X2, and the relatedstatements of earnings, retained earnings, and cash flows for the year then ended. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on the 20X1 financial statements based on theresults of our audit. We conducted our audit of the 20X1 financial statements in accordance with auditingstandards generally accepted in the United States of America. Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financial statements.An audit also includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion on the 20X1financial statements. In our opinion, the balance sheet of Example Company, Inc. as of December 31, 20X1,and the related statements of earnings, retained earnings, and cash flows for the yearended December 31, 20X1, present fairly, in all material respects, the financial position ofExample Company, Inc. as of December 31, 20X1, and the results of its operations andits cash flows for the year then ended in conformity with accounting principles generallyaccepted in the United States of America. The Company did not maintain its accounting records currently during 20X2, particularlywith respect to sales, inventories, and royalties, thus requiring reconstruction of certainrecords subsequent to December 31, 20X1, and substantial adjustments to the accounts.Adequate evidential matter in support of recorded transactions was not available in allcases. There have been several changes in employees and key management personnelduring the period under audit, creating a lack of continuity in the accounting system.Further, present management is unable to furnish us with knowledgeable representationof facts and circumstances regarding certain transactions arising during 20X2. It wasimpracticable to extend our procedures sufficiently to determine the extent to which thefinancial statements as of and for the year ended December 31, 20X2, may have beenaffected by these conditions. Because of the matters discussed in the preceding paragraph, the scope of our work wasnot sufficient to enable us to express, and we do not express, an opinion on theaccompanying financial statements as of and for the year ended December 31, 20X2.

(signed)

Date

Items of concern that couldbe disclosed in the auditor’sopinion are:

? Outstanding litigation? Ability of the organization to

continue in business? Inadequate record keeping? Inadequate internal controls? Uncertainties pertaining to IRS

or State audit adjustments? Management omitting required

disclosures? Inability for the auditor to

render an opinion? An adverse (unfavorable)

opinion

In addition, as aguideline, if the auditor’sopinion Is dated laterthan five or six monthsafter the organization’sfiscal year end, inquiriesshould be made as towhy the audit was notperformed on a moretimely basis.

After reading the auditor’sopinion, the balance sheet,income statement, cash flows andnotes to the financial statementsshould be analyzed. All thesestatements contribute to aiding inthe evaluation of the organization.If the financial statements are notcomparative, the prior year’sfinancial statements should be’requested.

By analyzing two or more years offinancial data, directors can focusin on issues and warning signssuch as:

? Continuous operating losses? Fund deficits? Excessive payables and other liabilities

with minor or no cash? The eroding away of endowment and

reserves to fund operations? Excessive cash and investment that could

be used for programs and projects? Large amounts in miscellaneous expense

categories? Excessive fund-raising expenses? Excessive administrative expenses? Excessive payroll expenses? Reliance on one or two funding sources? Poor yields on investments

On the other hand, itemsthat could indicate a wellrun operations are:

? Operating profits? The building up of endowments and

reserves? Increases in pledges? Administrative expenses kept to a

minimum? Ability to add new programs and

projects? Attractive yields on investments

The final step is to perusethe notes to the financialstatement focusing in on:

? The organization’s purpose andprograms

? Litigation outstanding? Tax exempt status? Contingencies and commitments? Related party transactions

UNDERSTANDINGINTERNAL

CONTROLS

INTERNALCONTROLS

Definition:

Policies and ProceduresDesigned to Protect theAssets of theOrganization

INTERNAL CONTROLS

ASSETS=

? Physical assets? Accounting records? Reputation? Organization’s purpose? Organization’s exempt

status

INTERNAL CONTROLS

BENEFITS:REDUCES THE

POSSIBILITY OF:

? Errors? Mismanagement? Fraud

INTERNAL CONTROLS

KEY ELEMENTS:

? Segregation of Duties? Policy Manuals? Communication? Periodic Reviews

INTERNAL CONTROLS

TYPES:

? Accounting? General

INTERNAL CONTROLS

ACCOUNTING:

? Authorization oftransactions

? Recording oftransactions

? Access to assets? Asset records

INTERNAL CONTROLS

The key element ofaccountingcontrols is aproper segregationof duties

INTERNAL CONTROLS

SEGREGATION OFDUTIES =

No one individualcontrols all aspectsof processing atransaction

How do I overcome asegregation of dutiesproblem with a limitednumber or no accountingstaff?

? Design the Internal Controls toUtilize

Personnel from other areasVolunteersMembers of the Board of

Directors

INTERNAL CONTROLS

GENERAL:

? Compliance– Outside funding

agencies– Internal policies– Government agencies

? Organizationsperformance

INTERNAL CONTROLS

TO DESIGN EFFECTIVECONTROLSCONSIDER:

? The objectives? Organization structure? Management roles? Directors roles

INTERNAL CONTROLS

COST BENEFITANALYSIS:

? Costs? Quantitative? Qualitative

? Benefits? Quantitative? Qualitative

INTERNAL CONTROLS

ENFORCEMENT CANONLY BE ACHIEVED IF:

? Clear lines of authorityexist

? Clear definition ofresponsibilities exists

? Authority iscommensurate withresponsibilities

INTERNAL CONTROLS

OTHER CONSIDERATIONS:

?Controls at special events?Volunteer groups?Utilization of non-

accounting personnel?Utilization of board

members

Segregation of Duties:Examples

? Do not have the same person that opens the mail and prepares the bank deposit slip make the deposit or record the cash receipts in theaccounting system

? Do not have the same person responsible for preparing checks for payments to vendors sign the checks

Conflicts of InterestIssues


? What is a conflict?? Who can they be with?

– Members– Management– Board and officers

? What are the Penalties?– Intermediate sanctions– Revocation of exempt status


ALL ORGANIZATIONS SHOULDHAVE:

? A COMPLETE AND BOARDAPPROVED CONFLICTPOLICY

? A SIGNED CONFLICTSTATEMENT FROM ALLPOTENTIAL PARTIES


EXAMPLECONFLICT POLICY

ANDCONFLICTSTATEMENT

CONFLICTS OF INTEREST POLICY BETWEENExample Non-Profit

andthe Board of Directors

ARTICLE I.PURPOSE

The purpose of the conflicts of interest policy is to protect the Example Non-Profit’s (EXAMPLE)interest when it is contemplating entering into a transaction or arrangement that might benefit theprivate interest of an officer or director of EXAMPLE. This policy is intended to supplement but notreplace any applicable state laws governing conflicts of interest applicable to nonprofit and charitablecorporations.

ARTICLE II.DEFINITIONS

1.INTERESTED PERSON

Any director, principal officer, or member of a committee with board delegated powers who has a director indirect financial interest, as defined below, is an interested person. If a person is an interestedperson with respect to any entity in the system of which EXAMPLE is a part, he or she is an interestedperson with respect to all entities in the system.

2.FINANCIAL INTEREST

A person has a financial interest if the person has, directly or indirectly, through business, investmentor family --

(a)an ownership or investment interest in any entity with which EXAMPLE has a transaction orarrangement, or

(b)a compensation arrangement with EXAMPLE or with any entity or individual with which EXAMPLEhas a transaction or arrangement, or

(c)a potential ownership or investment interest in, or compensation arrangement with, any entity orindividual with which EXAMPLE is negotiating a transaction or arrangement.

Compensation includes direct and indirect remuneration as well as gifts or favors that are substantial innature.

ARTICLE III.PROCEDURES

1.DUTY TO DISCLOSE

In connection with any actual or possible conflicts of interest, an interested person must disclose theexistence and nature of his or her financial interest to the directors and members of committees withboard delegated powers considering the proposed transaction or arrangement.

2.DETERMINING WHETHER A CONFLICT OF INTEREST EXISTS

After disclosure of the financial interest, the interested person shall leave the board or committeemeeting while the financial interest is discussed and voted upon. The remaining board or committeemembers shall decide if a conflict of interest exists.

3.PROCEDURES FOR ADDRESSING THE CONFLICT OF INTEREST

(a)The chairperson of the board or committee shall, if appropriate, appoint a disinterested person orcommittee to investigate alternatives to the proposed transaction or arrangement.

(b)After exercising due diligence, the board or committee shall determine whether EXAMPLE canobtain a more advantageous transaction or arrangement with reasonable efforts from a person orentity that would not give rise to a conflict of interest.

(c)If a more advantageous transaction or arrangement is not reasonably attainable undercircumstances that would not give rise to a conflict of interest, the board or committee shall determineby a majority vote of the disinterested directors whether the transaction or arrangement is inEXAMPLE’s best interest and for its own benefit and whether the transaction is fair and reasonable toEXAMPLE and shall make its decision as to whether to enter into the transaction or arrangement inconformity with such determination.

4.VIOLATIONS OF THE CONFLICTS OF INTEREST POLICY

(a)If the board or committee has reasonable cause to believe that a member has failed to discloseactual or possible conflicts of interest, it shall inform the member of the basis for such belief and affordthe member an opportunity to explain the alleged failure to disclose.

(b)If, after hearing the response of the member and making such further investigation as may bewarranted in the circumstances, the board or committee determines that the member has in fact failedto disclose an actual or possible conflict of interest, it shall take appropriate disciplinary and correctiveaction.





ARTICLE IV.RECORDS OF PROCEEDINGS

The minutes of the board and all committee with board-delegated powers shall contain --

(a)the names of the persons who disclosed or otherwise were found to have a financial interest inconnection with an actual or possible conflict of interest, the nature of the financial interest, anyaction taken to determine whether a conflict of interest was present, and the board’s or committee’sdecision as to whether a conflict of interest in fact existed.

(b)the names of the persons who were present for discussions and votes relating to the transactionor arrangement, the content of the discussion, including any alternatives to the proposed transactionor arrangement, and a record of any votes taken in connection therewith.

ARTICLE V.COMPENSATION COMMITTEES

(a)A voting member of any committee whose jurisdiction includes compensation matters and whoreceives compensation, directly or indirectly, from EXAMPLE for services is precluded from votingon matters pertaining to that member’s compensation.

(b)Persons who receive compensation, directly or indirectly, from EXAMPLE, whether asemployees or independent contractors, are precluded from membership on any committee whosejurisdiction includes compensation matters.



ARTICLE VI.ANNUAL STATEMENTS

Each director, principal officer and member of a committee with board delegated powers shallannually sign a statement which affirms that such person

(a)has received a copy of the conflicts of interest policy,

(b)has read and understands the policy,

(c)has agreed to comply with the policy, and

(d)understands that EXAMPLE is a tax exempt organization and that in order to maintain its federaltax exemption it must engage primarily in activities which accomplish one or more of its tax-exemptpurposes.



ARTICLE VII.PERIODIC REVIEWS

To ensure that EXAMPLE operates in a manner consistent with its tax exempt purposes and that itdoes not engage in activities that could jeopardize its status as an organization exempt from federalincome tax, periodic reviews shall be conducted. The periodic reviews shall, at a minimum, includethe following subjects:

(a)Whether compensation arrangements and benefits are reasonable and are the result of arm’s-length bargaining.

(b)Whether acquisitions of industry segments and other provider services result in inurement orimpermissible private benefit.

(c)Whether partnership and joint venture arrangements and arrangements with management serviceorganizations conform to written policies, are properly recorded, reflect reasonable payments forgoods and services, further EXAMPLE’s tax exempt purposes and do not result in inurement orimpermissible private benefit.

(d)Whether agreements to provide services and agreements with other organizations, employees, andthird party payors further EXAMPLE’s charitable purposes and do not result in inurement orimpermissible private benefit.

ARTICLE VIII.USE OF OUTSIDE EXPERTS

In conducting the periodic reviews provided for in Article VII, EXAMPLE may, but need not, useoutside advisors. If outside experts are used their use shall not relieve the board of its responsibilityfor ensuring that periodic reviews are conducted.

PUBLICDISCLOSURE

FORM 990QuideStar.com

IRS RULES FORFORM 990

? Law for Public Inspectionof Form 990

? NPO must provide a copy of anyof the three most recent years’Form 990:– Immediately if requested in

person– In 30 days if requested in

writing– Penalties for noncompliance:

? $20 per day? Maximum of $10,000

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