Conflict of interest is a widely misunderstood concept. Many people label situations or relationships they don’t like or don’t understand as conflicts of interest when they aren’t. Some people employ an overly rigid or overly legalistic approach to classifying conflicts of interest that can hinder an organization’s ability to grow. Others do not see a problem with actions that most consider being glaring conflicts. Thus, in this article, we will focus on who conflict of interest laws apply to and on some of the ethical grey zones. 

Before we go any further, though, I would be remiss if I did not mention that if you are evaluating a potential conflict, you should seek the advice of an attorney. Every state has different laws regarding conflicts of interest in nonprofits. Therefore, you should always rely on the latest laws on the books in your state and, if you have any doubts, you should always seek out legal counsel.

What is the Legal Definition of a Conflict of Interest?

According to the IRS, a conflict of interest arises when a person in a position of authority over an organization, such as a director, officer, or manager, may benefit personally from a decision he or she could make. Thus, Conflict of Interest rules apply to persons who are in a position of substantial authority in an organization—including, top executives, senior management, and “disqualified persons”. 

A disqualified individual is any individual or organization that is in any of the following relationships with the organization: 

Within this context, there are times in which organizations develop relationships that fall within a grey zone of ethical practices. Examples include but are not limited to, insufficient manpower, significant cost-savings, a unique specialty or niche of a board member, or family members that banded together to start an organization. Irrespective of the origins of the conflict, the public often has little understanding of exceptions or complex situations. Conflicts can subsequently result in the loss of trust from your employees as well as from your donors and other external stakeholders. Therefore, when these types of relationships surface, they require close scrutiny, consideration, and monitoring. 

Hiring Board and Family Members: 

To the surprise of many, some practices look like a conflict of interest to the public, but they may not be legally considered conflicts of interest. Examples include but are not limited to, certain types of contracts with a board member for services, supervisors dating employees, hiring relatives under very specific situations, or taking business away or donors from other organizations. These relationships, though, are frowned upon, are considered unethical, and increase the risk that the organization assumes.

One common situation that surfaces for nonprofits and can fall in the ethical gray zone is hiring board members to do work on behalf of the organization. As a rule of thumb, board members should not receive compensation for work that they do on behalf of the organization they volunteer for. A board member should never receive compensation if the bylaws, a resolution, or the conflict-of-interest policy explicitly state that board members cannot receive compensation and there are no written exceptions for this type of relationship. If there are exceptions written into these documents, then a board member can legally be considered for compensation under certain circumstances.

It is also important to remember, though, that the IRS has very specific rules regarding board compensation and excessive executive compensation that are closely scrutinized. In fact, board members that receive compensation for their service while serving on the board, if they have not followed the organization’s Conflict of Interest disclosure requirements and are considered disqualified, can in some states lose their immunity as volunteer board members. Thus, serious consideration must be given to engaging in a contract with a board member. 

Similarly, hiring relatives, although not illegal, is frowned upon by the public. This is because of the potential for bias and preferential treatment. However, there are times in which a relative may have a niche specialty or skillset that cannot be found anywhere else and is urgently needed either in the organization or on the board. In these types of exceptional cases, there are numerous issues the board must consider before hiring a board or family member: 

• Will the organization get a significant benefit from contracting with this board or family member?
• Will there be a significantly discounted rate that the organization will receive for this work that merits not hiring another expert? 
• If this person resigns, will the board lose a talented member that cannot be easily replaced?
• Is the amount of work or the time that would be required to complete the task considered more than one person could complete without being compensated?
• Are the personal costs that the board or family member are assuming for carrying out the work without compensation excessive or unsustainable?  
• What do the most recent state and federal laws governing conflicts of interest indicate is permissible?
• Does the Conflict of Interest policy or the bylaws permit such a relationship?
• Will we be able to maintain a culture of integrity?

If the answer is yes to all of these, there may be a justification for hiring a board or family member. Ideally, the board member should consider stepping down from the board if they develop a contractual relationship with the organization. In some cases, though, that would result in a tremendous loss of talent for the board, particularly if it’s a small project or if it is a small board with limited recruitment capability. 

If after assessing all of the facts it is decided that the board or family member should receive compensation, the following must occur: 

1. There must be an immediate full disclosure, 
2. A formal deliberation process should automatically be triggered, 
3. A recusal process must be established, and
4. Deliberations should be well documented before finalizing the relationship as well as the process for managing the conflict. 

Documentation and Recusal

When a conflict is being considered, documentation is the strongest defense mechanism against wrongdoing an organization can undertake. It is also a compliance issue. During the deliberation of the matter, the board or family member(s) in question should recuse themselves from participating in the discussion or voting on the decision. This fact should be reflected in the minutes. In addition to this, the minutes should reflect a process for supervising the board member(s) on her/his/their work, ideally with another board member so as to ensure that the ED is not supervising his/her/their supervisor. Then, the role of that board member(s) should be clearly outlined in the minutes of the resolution, so that they do not overreach into conducting work in other areas of the organization that extends beyond their initial scope. With respect to hiring relatives, a separate supervision process with someone other than the ED should be established to ensure that there is no preferential or biased treatment. In the event that the relative joins the board, a process must be established where they do not approve or vote on the compensation of the ED or any other relatives. 

Conclusion

Once again, although these two scenarios are not illegal, they should be avoided to the greatest extent possible. This is because the public, upon learning of these types of relationships, even if they are not illegal, does not understand the nuanced situations that nonprofits try to manage. They just understand the headline, which will likely say something like, “Board member of organization X receives compensation” or “ED’s cousin gets paid Exorbitant Amounts of Money by X organization”. Employees, funders, regulators, and clients expect organizations to have a higher ethical standard than the private sector. Therefore, even if you’re not committing an illegal act, these types of relationships could endanger the long-term sustainability of your organization and it is best to avoid them altogether. Minimizing conflicts of interest or the appearance of a conflict is also part of the board’s responsibility in minimizing the risk that the organization assumes.

Share Your Story

Please share with us below what strategies you have used in preventing conflicts of interest. 

Please Subscribe

Please subscribe to Third Sector News, which will also provide resources and toolkits for managing real-life situations that those working in the nonprofit field experience. For example, this week, we have included a “Nonprofit Website Toolkit”. However, these resources are only available to those that subscribe.