Building Strong and Ethical Foundations: Doing It Right

1
Building Strong and Ethical Foundations Doing It
Right

• Indianapolis
• September 16, 2004

Janne Gallagher Vice President and General
Counsel
2
Setting the Stage

• Excessive Compensation
• Lavish Perks
• Costs Exceed Grants
• Board Conflicts
• Investment Practices

3
Questions Being Asked

• Who makes decisions?
• How are they made?
• Why is there no public input?

4
Agenda

• Federal and State Law
• General governance
• Conflicts of interest
• Compensation
• Investments
• Sarbanes-Oxley The Coming Storm?
• Ethical Framework

5
Legal Requirements State

• State Corporate and Trust Laws
• Duty of care Knowledge and judgment
• Duty of loyalty The foundation comes first
• Investment laws
• Uniform Management of Institutional Funds Act
• Uniform Prudent Investor Act

6
Legal Requirements Federal

• Fiduciary obligations
• Self-dealing ( 4941)
• Intermediate sanctions ( 4958)
• Investment restrictions
• Excess business holdings ( 4943)
• Jeopardy investments ( 4944)

7
Conflicts of Interest

• Two kinds
• Economic
• Non-economic (appearance of conflict)
• Two legal structures
• Charitable trusts
• Nonprofit corporations
• Two ways to resolve
• Law prohibits transaction (self-dealing)
• Disclosure and abstention

8
Conflicts of Interest (state law)

• Trust law
• Strict (but donor may vary)
• Voidable regardless of good faith or fairness
• Corporate law
• Follow procedural rules
• Not voidable if fair or proper vote
• Some states bar loans to directors and officers

9
Conflicts of Interest (state law)

• Remedies
• Restitution
• Removal
• Ban from serving on charity boards

10
Conflicts of Interest (federal law)

• Private Foundations
• Basic rule No transactions with disqualified
  persons
• Major exception compensation for personal
  services
• Disqualified persons
• Officers, directors, trustees
• Substantial contributors
• Family members of the above
• Businesses controlled by the above

11
Conflicts of Interest (federal law)

• Penalty excise tax
• Self-dealer must pay back amount
• Self-dealer pays 5 of amount
• Managers who approve pay 2.5 of amount
• Examples
• Loans prohibited
• Reasonable compensation allowed

12
Conflicts of Interest (federal law)

• Public Charities
• Excess benefit transactions
• Excessive compensation
• Other transactions rent, purchases, etc.
• Penalty
• Repayment
• Plus 25 percent of amount
• Possible manager tax 10 percent

13
Addressing Conflicts

• Adopt and follow written policy
• Disclosure
• Abstain from voting
• Leave the room

14
Compensation (state law)

• Reasonable compensation allowed
• Examples
• Bishop Estate
• King Foundation
• NYSE

15
Compensation (federal law)

• Services must be reasonable and necessary
• Compensation must not be excessive
• Service must be personal
• Foundation management
• Banking, legal, accounting, investment services
• May not include real estate management, most
  consulting

16
Reasonable Compensation

• What similar persons get paid
• For similar work
• In similar circumstances
• In the same geographic area
• A word about percentage-based compensation

17
Determining Compensation

• Data use appropriate comparability data
• Decision by disinterested governing board or
  committee (where possible)
• Discussion
• Document, document, document

18
Compensation Example

• Chief Executive Officer/
• President of Family Foundation
• Source Council on Foundations, 2004 Grantmakers
  Salary and Benefits Report

19
Investments (state law)

• Permits investments based on portfolio theory
• Permits delegation
• Standard of care
• Prudent investor (trusts)
• Ordinary business care and prudence
  (corporations)
• Diversification
• Required (trusts)
• Not required (corporations)
• Duty of Loyalty (avoid conflicts of interest)

20
Investments (federal law)

• Self-dealing (avoid conflicts)
• Limitations on business ownership
• Jeopardy investments
• Unrelated business income tax
• No requirement to diversify (if rules are met)

21
Investment Policies

• Investment objectives
• Asset allocation
• Risk tolerance
• Benchmarks
• Costs

22
Corporate Governance Reforms

• Whistleblower Protection
• A confidential, anonymous mechanism for
• reporting inappropriate financial management
• practices
• What process?
• How communicated?
• No retaliation

23
Corporate Governance Reforms

• Document destruction
• Altering
• Covering up
• Falsifying
• Destroying
• Litigation-related documents
• Involving any federal investigation.

24
Corporate Governance Reforms

• Internal Controls
• Is information accurate and does it fairly
  present financial condition of company?
• Will controls detect fraud or misappropriation?
• Is material information presented to top
  management, audit committee and outside auditor?

25
Corporate Governance Reforms

• Audit Committee
• Independent
• Financial expertise

26
Corporate Governance Reforms

• Independent Auditor
• Limits on providing other kinds of services
• Audit partner rotation

27
Corporate Governance Reforms

• Other Requirements
• Certification of financial statements
• CEO/CFO understand and verify
• Ethical codes for key finance staff
• No loans to insiders

28
Corporate Governance Reforms

• New California Regulations
• (passed by Legislature, not yet enacted)
• Applies to nonprofits with more than 2 million a
  year in revenue
• Independent audit committee
• Independent audit filed with state
• Board review and approval of executive
  compensation

29
Corporate Governance Reforms

• Key not slavish imitation
• What areas in your foundation are susceptible to
  fraud or misrepresentation?
• What controls do you need?

30
Corporate Governance Reforms

• Some areas to think about
• Transactions with insiders
• Asset valuation
• Fundraising expenses
• Donor intent
• Grant due diligence
• Should investment management be separated from
  audit?

31
Ethical Framework

• Self-imposed rules
• Creates trust by filling gaps left by the law
• Guides decisions in hard cases
• Helps ensure consistency
• Family/corporate principles
• Policies
• Conflicts of interest compensation investments
  grant-making
• Disclosure
• Explains decisions

32
Contact Information

• Janne Gallagher, Esq.
• Vice President and General Counsel
• 202/467-0288 gallj_at_cof.org
• Diane Canova, Esq.
• Interim Director, Government Relations and Public
  Policy
• 202/467-0405 canod_at_cof.org
• Andras Kosaras, Esq.
• Director, Ethical Standards and Philanthropic
  Outreach
• 202/467-0399 kosaa_at_cof.org