The Need To Focus On The Intermediate Sanctions Act And Conflicts Of Interest

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The Need To Focus On The Intermediate Sanctions Act And Conflicts Of Interest

Recently NAIS released a joint statement from its in house counsel and an independent auditing firm about exercising due diligence with respect to the formation and decisions of the compensation committee of the board which should be charged with setting the annual compensation for the head of school.

Given heightened attention on not for profit CEO compensation, NAIS, law firms, auditors and Littleford and Associates, as a consultant to independent schools worldwide, are publishing frequent updates and summaries in lay person’s terms designed to help boards navigate boards through these waters.

Boards need to focus not only on how much the head is paid but equally upon several components of the process that resulted in that compensation decision. One key element in this process is the assurance of no conflict of interest on the part of any individual who is a member of the compensation committee.

Despite efforts to educate non profit boards, there are many boards where conflicts of interest exist at two levels:

  1. Individuals on the board who derive special benefits as vendors or friends of the school. These include vendors/trustees paid to do architectural, construction or landscaping work, or provide auditing, consulting, legal or search services or any other kind of activities for a fee. This relates to the vendor AND to the firm of which the vendor may be a member or employee.
  2. Individuals without financial conflicts of interest but whose personal relationship with the head as close friends, relatives or employees.

On the compensation committee of the board, there should be no one who has a business interest with the School, no one whose firm is receiving income, no employees, and no one whose objectivity might be called into question because of the nature of the relationship with the head. While the CFO or business manager completes the 990 form and does not participate in the compensation decision (because he or she is a paid employee whose salary the head determines), the CFO or business manager does and SHOULD receive all pertinent information AFTER the decision. The board chair and head of school should be familiar with how the head’s compensation is reported on the 990, as schools vary widely on their reporting methods.

The compensation committee should be “squeaky clean” in order to comply with IRS requirements AND to avoid being a target for disgruntled constituents. The participation of person(s) with a real or perceived conflict of interest in the determination of the head’s compensation package could represent serious ammunition for parents, alumni or faculty seeking to air grievances.

In one school, the compensation committee of three individuals consisted of two who were current vendors deriving a good sized portion of their business income from work with the school. As members of the committee, these individuals have felt a strong need to pay their head fairly and especially to provide a substantial annual payment for life to adjust for a history of modest retirement contributions and a relatively low salary. The sentiment is worthy. The approach may be risky.

The group was contemplating using undesignated monies to fund such a retirement annuity. The settlement would be sizeable over time. It was really not a question of rewarding fairly the head’s long record of service, sacrifice and dedication to the School. It was a question of doing so without risk to the present head and board and to future boards that might bear the burden of potential legal action or financial penalties should conflict of interest issues be raised at a later time.

Compensation committees should have a charter of their purpose or resolution. This can be short but should state clearly the authority that the board has devolved upon this committee to act on its behalf and to employ an independent compensation consultant if desired and deemed necessary. Acknowledging the increased emphasis upon transparency with respect to CEO/head compensation packages, there is always the risk of politicizing the process by making it TOO public and a political football at a board meeting. Some boards may be plagued by a lack of confidentiality, and information may find itself in the hands of employees, parents and alumni.

While head compensation (but not all components of it) of non religiously associated non profits will be published on the 990 forms (albeit two years later on Guidestar.org) inappropriate board approaches can make the topic even more politically sensitive. Hence professional counsel, while not legally required, is often advisable.

 

John Littleford
Senior Partner