Walker & Armstrong:
Not-for-Profit Board Governance Considerations
With sound governance especially critical in a time of
scarce resources, Walker & Armstrong offers guidelines to help not-for-profits establish
and monitor effective boards.
Not-for-profit organizations play a critical role in society by
delivering vital services that are not otherwise provided by industry or the
public sector. Sound governance is key to a not-for-profit 's effective
fulfillment of its objectives while complying with applicable laws, regulations
and contractual arrangements.
Sound governance is even more critical in this era of scarce
resources, budgetary constraints and increased regulatory oversight. The
Internal Revenue Service has emphasized the importance of strong governance
through its Form 990, which was revamped for the 2008 tax year and includes
expanded disclosures. The importance of strong governance is also recognized by
donors and grantor agencies, and the perceived strengths and weaknesses of an
organization's board can affect funding levels.
The following are certain guidelines to assist not-for-profits
in establishing and monitoring effective boards. We urge the reader to share
these guidelines with other members of management and the board of directors.
Active and Engaged Boards
Complacent board members increase the risk of noncompliance with
laws, regulations and the terms of contractual agreements. Also, the risk of
asset diversion increases when board involvement lessens. The following are
recommendations to enhance board involvement:
Increase meeting effectiveness by maintaining written
agendas for each meeting.
Hold meetings on at least a quarterly basis, and require
attendance. Nonparticipation should prompt a written notice, and habitual
unexcused absences should result in board member dismissal.
Keep the meeting time long enough to allow for meaningful
discussions and analysis, while not being excessive. Meetings that extend
beyond time that is necessary will result in less interest and involvement.
Use technology to assist in involving board members who
cannot attend board meetings in person.
Use committees to facilitate board oversight and
See Chapter 30 of Arizona Revised Statutes for specific
laws governing board meetings.
Board Size and Structure
Board size will vary depending on the size and complexity of the
not-for-profit organization and may change over time. Not-for-profit
organizations should maintain ongoing efforts to recruit new board members who
cover a sufficiently varied expertise in areas that will benefit the
organization, such as finance, law, human resources, advertising, public
The IRS reviews charitiesí board composition to determine
whether the board represents a broad public interest and to identify the
potential for insider transactions that could result in misuse of assets. The
IRS also tries to determine whether an organization has independent members,
stakeholders or other persons with the authority to elect members of the board
or approve or reject board decisions, and whether the organization has delegated
control or key management authority to a management company or other persons.
Organizations that file Form 990 will find that the form asks specific questions
about the governing body's independence.
Following are recommendations for maintaining board
At least two-thirds of the board of a public charity
should be independent.
Independent board members should not be compensated as
employees or independent contractors.
If compensated, independent board members should not have
their compensation determined by individuals who are compensated by the
Independent board members should not directly or
indirectly receive material financial benefits from the organization except
as a member of the charitable class served by the organization.
Independent board members should not be related to anyone
compensated by the organization.
IRS Form 990 requires disclosure of the number of independent
Board Education and Communication
Not-for-profit organizations should strive to educate their
board members and have a method of maintaining accountability. The following are
recommendations to assist with such education and communication:
All board members should have clear job descriptions.
Board orientations are a critical component for conveying roles
Not-for-profit organizations should have a process for
evaluating and communicating board performance.
Use annual board member self-assessments to assist in the
Have a documented process for removing non-performing board
Term limits are a matter of choice and can lead to a process of
change in governance and oversight. If term limits are not used, the
organization should consider ways to maintain active and productive board
involvement through the evaluation process and the expression of appreciation
for their service.
Executive Compensation and Excess Benefit Transactions
A charity is barred from paying more than reasonable
compensation for services rendered. While the Internal Revenue Code does not
require charities to follow a particular process in determining the amount of
board and employee compensation, the compensation of officers, directors,
trustees, key employees and others in a position to exercise substantial
influence over the affairs of the charity should be determined by persons who
are knowledgeable in compensation matters and who have no financial interest in
the determination. Note: The excess benefit transaction rules are not applicable
to 501(c)(6) organizations.
The Form 990 requires disclosure of the process used to
determine the compensation of an organizationís top management official and
other officers and key employees, including a review and approval by independent
persons, comparability data and contemporaneous substantiation of the
deliberation and decision. In addition, the Form 990 solicits compensation
information for certain officers, directors, trustees, key employees and highly
The IRS has observed significant errors or omissions in the
reporting of executive compensation on the IRS Form 990 and other information
returns, and executive compensation continues to be a focal point in their
Conflicts of Interest
Directors of not-for-profit organizations should act in the best
interest of the organization rather than in their personal interest or the
interest of some other person or organization. Specifically, directors should
avoid conflicts of interest that are detrimental to the organization.
The IRS encourages boards to adopt and regularly evaluate a
written conflict-of-interest policy that requires directors and staff to act
solely in the interests of the organization without regard for personal
interests. The policy should include (a) maintaining written procedures for
determining whether a relationship, financial interest or business affiliation
results in a conflict of interest, and (b) prescribing a course of action when a
conflict of interest is identified.
The IRS encourages organizations to require its directors,
trustees, officers and others covered by the policy to disclose, in writing and
on a periodic basis, any known financial interest that the individual, or a
member of the individualís family, has in any business entity that transacts
business with the organization. The organization should regularly and
consistently monitor and enforce compliance with the policy.
Understand Funding for the Not-for-Profit Organization
To provide sufficient oversight and support of management, board
members should learn as much about the not-for-profit organization as possible.
Board members should learn about the various programs and understand the
challenges and opportunities of each.
This understanding should also encompass the organization's
revenue and support and the related restrictions and legal requirements,
including those pertaining to endowments and Federal and state grants and
The State of Arizona has adopted the Uniform Prudent Management
of Institutional Funds Act, which places special requirements on board members
of organizations with endowments. The act generally requires the governing board
of an endowed organization to establish a spending policy and establishes a
rebuttable presumption of imprudence for spending greater than 7% of the
endowment in any given year. In addition, the board should have a general
understanding of debt compliance requirements, including guarantees, if any.
Review of Governing Documents, Missions and Goals
The board has a fiduciary responsibility to perform periodic
reviews of the organization's governing documents to determine whether
operations are consistent with its articles of organization and bylaws. Although
the Internal Revenue Code does not require not-for-profit organizations to have
governance and management policies, the IRS will review an organizationís
application for exemption and annual information returns to determine whether
the organization has implemented policies relating to executive compensation,
conflicts of interest, investments, fundraising, documenting governance
decisions, document retention and destruction, and whistleblower claims.
Governing documents should be amended in a timely manner to
reflect organizational changes. The IRS must be informed of significant changes
to governing documents, policies and programs. This can be done through the use
of an attachment to the Form 990. Care should be taken to ensure that changes do
not affect an organization's tax exempt status.
As indicated in the preceding paragraphs, board governance takes
substantial responsibility and commitment to ongoing improvement. We hope this
summary will assist not-for-profit organizations in communicating board
responsibilities and providing a method for monitoring the governance function.