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Bequest Management

Nonprofit Conflict of Interest: Not Necessarily Evil

January 11, 2021
Nonprofit Conflict of Interest: Not Necessarily Evil

Some nonprofit executives shudder when the phrase “conflict of interest” is uttered.  There is no need for fear.   A conflict of interest (COI) is somewhat like a weird family member – sometimes underappreciated and frequently misunderstood.

For charities, the timely discovery of a conflict of interest is more a cause to celebrate than to despair.  Such conflicts are almost inevitable.  They become problematic only when they are overlooked, ignored or not addressed in a prompt and effective way.  In themselves, conflicts of interest are neither good nor evil.  Charities that can handle them merit kudos for good governance.

What, Exactly, Is a Conflict of Interest?

There is no one-size-fits-all definition.  The notion of conflict of interest is rooted in the thoroughly human fact that people have conflicting loyalties and must sometimes choose between competing desires.  Recognition of this conundrum is as old as civilization itself and reflected in the biblical maxim that no person can serve two masters (or at least not at the same time!).

In the nonprofit world, conflicts of interest are most frequently discussed in the context of an “insider” in a charity (board member, executive, major donor) having the opportunity to induce organizational action that will benefit him.  For instance, suppose a board member (Jane) steers a charity’s printing business to a firm in which she has a controlling but unpublicized interest.  In that instance, Jane is using her “clout” to enrich herself.  That is bad enough, but it’s even worse if the selected printer charges more than other companies.  This sort of “insider” dealing is a classic conflict of interest and is known as “private inurement” in IRS parlance.  It is punishable by revocation of the organization’s exemption, the equivalent of the death penalty in the charitable world.

Is Conflict of Interest the Same as the “Intermediate Sanctions” That We Always Read About?

Not quite, but it’s in the same ballpark.    The intermediate sanctions rules were instituted to provide an alternative penalty for cases of private inurement, especially cases involving unreasonable compensation.  The alternative penalty is a set of severe monetary sanctions, which are levied against those who benefit from the misconduct and those who failed to prevent it.

There are two important things to remember about “intermediate sanctions”: (1) imposition of the financial penalties does not preclude revocation of exemption; and (2) the regulations greatly clarify and expand the definition of “insiders” who can find themselves in private inurement problems.

How to Protect from Conflict of Interest

Well, as a starting point, we would recommend three steps:

Sensitization Through Education

It will be impossible to deal effectively with conflict of interest situations unless the key actors recognize conflicts and potential conflicts.  This is not as easy as it sounds.  Some potential booby-traps are quite subtle.  Others, while obvious, are so ingrained in an organization’s culture that they have become part of the “background noise” that is always there, but rarely noticed.  The alertness required to perceive potential conflicts can be taught, but only when a charity makes a concerted effort to do so.  We have found that “off the shelf” training is of limited value.  Instruction is best when conducted by insiders, or by outside professionals who are given sufficient information to acquire a sense of the organization’s culture.

Procedures and Record-Keeping

Once conflicts are identified, an organization needs established procedures detailing how the conflicts are to be addressed.  This includes a clear statement of the method in which the conflict is to be reported by the affected parties, with multiple intake points for the reports.  This is quite important, as disclosure of a conflict can be a difficult or squeamish moment for some and the goal of any procedure should be to encourage the prompt and accurate reporting of troublesome situations.

Procedures must also include as much detail as possible about how conflict of interest situations are going to be resolved WITHOUT the participation of the affected “insiders.”  Finally, and perhaps obviously, the charity should keep meticulous records about the disclosure of the conflict and exactly how it was resolved, and why the charity reached a particular resolution.

Let’s go back to the example of Jane and the printing company.   The procedures should detail how and to whom Jane (or someone else) must report the conflict of interest.  There should also be a clear mandate and method for excluding Jane from the discussion and decision on the award of the contract.  Compliance with these procedures should be carefully documented and retained, as should a record of the decision-making process on the final award.  It is possible that the Board might decide that Jane’s company is the best vendor.  If so, it is incumbent on the charity to retain the data (such as competing bids) that were reviewed to reach that decision.

Adoption of a Conflict of Interest Policy

There is no wide-ranging legal obligation for a charitable organization to adopt a formal conflict of interest policy.  A few states require them as a condition of receiving a fundraising permit and IRS Form 990 now asks a “yes” or “no” question as to whether or not a policy exists.  (Many people in the nonprofit world view the question as a de facto mandate.)  Aside from that, having a policy remains optional.

We believe that the adoption of a policy is a good idea, but only if certain conditions are met:

  • First, although all such policies must contain certain basic elements (scope of policy, persons covered, reporting procedures, resolution methods and record-keeping), it is just as important that the policy be organization-specific.  In other words, a template policy found on a website will probably be of little use.  The policy must be crafted to reflect the actual structure and operation of the particular organization.
  • Second, the policy should be periodically distributed to covered persons, ideally in a situation that promotes explanation, discussion and the opportunity for questions.
  • Third, management must, by its attitudes and actions, consistently demonstrate the organization’s commitment to the identification and resolution of situations that may present a conflict of interest.