Conflicts of Interest: Manageable…Unless They’re Not

No one wants to experience a certain panicky sinking feeling sensation, followed closely by crystal-clear hindsight that they could have completely and easily avoided getting their organization into a terrible fix, or a damaged reputation, or a loss of funding.

All nonprofits—whether foundation or charity—have conflicts of interest from time to time; all nonprofits should be able to recognize and manage them, thereby avoiding the scenario above.

CONFLICTS OF INTEREST

Hence, the value of the Conflicts of Interest Policy: a strategy to manage these pesky conflicts preemptively, or at least as they arise, to protect your organization. Most conflicts of interest (CoI) policies are comprised of two distinct sections. First, the actual board-approved policy, and second, a document that board members, staff, and sometimes volunteers, sign annually. My own preference is that the CoI policy also include an explanation of the different types of conflicts are that might arise, in order to refresh the reader and help get everyone in the organization on the same page.

If you click over to my contact form or send me an email, I can send you my favorite sample CoI policies. There are many other excellent articles on CoI; these from the Nonprofit Risk Management Center, the National Council of Nonprofits, and Blue Avocado are among the best.

NOT CONFLICTS OF INTEREST

I also want to take a look at two common ways that a 501(c)(3) nonprofit can veer from manageable CoI into areas that are actually illegal, simply by not recognizing them. And there’s a third way private foundations can get into similar hot water.

These illegal and usually inadvertent practices are:
1. Private benefit,
2. Private inurement, and
3. Self-dealing (of concern to private foundations only).

The overview below is not all you need to know, but these quick descriptions can help you recognize them:

1. Private benefitPrivate benefit is when when any individual, regardless of any relationship (or not) to the organization, gets some sort of benefit (could be financial, preferential treatment, etc.) from the organization that is not consistent with its tax-exempt charitable purpose. There is a concept of de minimis that comes into play–if the private benefit is insubstantial and incidental, both qualitatively and quantitatively, it may be fine.

2. Private inurementPrivate inurement is when an insider gets more benefit out of a transaction with the organization than he or she should. (Remember, transactions are not just financial ones.) Therefore, every transaction between the organization and an insider needs to be evaluated to ensure that no insider is receiving any excessive benefit.

I’ve noticed three key differences between private benefit and private inurement in even these very basic descriptions:
• First, private benefit can involve anyone at all, while private inurement only applies to insiders;
• Second, if the amount of private benefit that occurs is determined to be insubstantial, it may be fine–but with private inurement, there is no de minimisleeway; and
• Third, private benefit looks at benefits that are inconsistent with charitable purpose, whereas private inurement is related to insiders getting more than they ought to out of the relationship with the organization.

3. Self-DealingSelf-dealing applies only to private foundations and is a sweeping list of prohibited transactions between a private foundation and a disqualified person, with a number of exceptions to each type of prohibition. These rules are tricky at best—and it’s no exaggeration to say that they are not rational. The intricacies are well beyond the scope of this blog post.  The best publication that I know of on self-dealing is this one, published by Exponent Philanthropy.

KNOWING WHICH IS WHICH

If the board of directors and any staff with decision-making authority are well-informed about conflicts of interest, private benefit, private inurement, and, when applicable, self-dealing, then they’ll be able to catch risky transactions before they happen and be able to make an informed assessment about next steps.

These three practices all have serious penalties attached to them, in some cases including revocation of tax-exempt status; this is nothing to mess with. If you ever have any concern that your organization is at risk in any of these areas, do please call your attorney. If you are a nonprofit or foundation and you don’t have an attorney but think you may be at risk, you can give me a call and I can help you track down a good one.