Conflicts of interest are more common than you think. Board members, officers, and other key employees at for-profit businesses often volunteer their time and expertise by serving in similar positions for nonprofits. As such, conflicts inevitably arise. Though not required by law, prudent nonprofits will adopt a Conflict of Interest Policy clearly laying out the procedures for navigating situations where conflicts may exist. Moreover, the IRS strongly encourages nonprofits seeking recognition of exempt status to adopt a formal system for handling transactions where interested individuals are, or may be, conflicted.
A comprehensive Conflict of Interest Policy should include procedures for disclosing potential conflicts, addressing the conflict, proper documentation, and approving conflicted transactions. The following is a list of provisions we generally advise our clients to include in their Conflict of Interest Policies.
The Conflict of Interest Policy should define certain key terms so everyone in the organization is on the same page when interpreting and applying the policy. For example, the policy should define who it applies to. Conflicts generally only arise at the highest levels in an organization, so the Conflict of Interest Policy should state that it applies to those “interested persons” such as directors, officers, and certain key employees. Typically, interested persons include anyone which may receive a direct or indirect financial interest resulting from the proposed transaction.
2. Duty to Disclose.
The Conflict of Interest Policy should impose a duty to disclose potential conflicts. The best mechanism for flagging conflicts is requiring interested persons to disclose when they may be conflicted. Normally, the interested person will disclose a potential conflict and the remaining board members (or officers) will independently decide if a conflict exists. All key employees should receive the Conflict of Interest Policy during the onboarding process and be required to sign an attestation that they will follow the policy and disclose any potential conflicts. The policy should also discuss penalties for violating the duty to disclose.
3. Addressing the Conflict.
The Conflict of Interest Policy will contain procedures for addressing the conflict of interest. Most people incorrectly assume that the conflicted party can take no part in the process of approving a conflicted transition. To the contrary, the conflicted party may be in the room when the transaction is discussed or may make a presentation to the board (or other decision-making body) regarding the transaction. However, the interested person must recuse himself or herself from the vote itself. Best practice normally includes asking the interested person to leave the room when the vote takes place, ensuring objectivity and removing pressure on the disinterested parties.
4. Records and Documentation.
One of the most crucial parts of a Conflict of Interest Policy are the provisions on documenting the conflicted transaction. As soon as a conflict is disclosed, the board and officers should act as record keepers by safeguarding all documents, meeting minutes, consents, voting records, and other materials relating to the conflicted transaction and preserving them in secure corporate files. At minimum, these documents should include:
- the names of the conflicted persons;
- the nature of the conflict;
- any action taken to determine if a conflict exists;
- the names of the persons present for discussions regarding and votes on the conflicted transaction;
- the content of such discussions (including any alternatives proposed); and
- a record of the votes taken.
Directors, officers, and other key employees must not vote on his or her own compensation. The Conflict of Interest Policy should state this proposition. In addition, the policy should mandate periodic reviews of all compensation arrangements to ensure the nonprofit does not engage in activities which may jeopardize its exempt status.
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The IRS publishes a sample Conflict of Interest Policy for exempt organizations as an appendix to its instructions for Form 1023, which can be found here.
Kyler Mejia is an attorney (bar pending) with Caritas Law Group P.C. Kyler advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide as well as donors with regard to major gifts. To schedule a consultation call (602) 456-0071 or email us through our contact form.