Non-profit entities and charities serve an important function in the United States’ free market economy. We have agreed as a society to promote organizations that are committed to fulfilling a public benefit, and therefore grant these organizations exemptions from property and income taxes. Better still, actual charities, e.g. those with 501c3 status under IRS guidelines, can actually grant tax deductions to ordinary citizens who donate money to them. These benefits amount to an incredible advantage over for-profit companies, most times rightfully so.

In exchange for such benefits, non-profits and charities naturally must abide by certain guidelines under United States and Massachusetts law. Unfortunately, however, there is little enforcement in the non-profit sector, oversight and compliance is left to the Attorney General offices in each state, offices that already enforce a broad range of other state laws and regulations. This lack of oversight predictably results in a wide range of inappropriate and illegal behavior among non-profits. This article explains some common red flags in non-profit governance.

The Inverted Board of Directors

The structure of many organizations naturally tends towards a reliance on the executive of the entity. We see this trend in our own U.S. government as an example, where powers have increasingly collected in the office of the President. But it happens throughout organizations in the public and private sectors; city councils find convenience in deferring to the acts of mayors, select boards defer to instructions from town managers, and boards of directors often defer to presidents or chief executive officers.

While such deference is not itself a violation, any organization that leaves all of its decision-making authority to one individual is obviously at a higher risk of abuse. It should traditionally be the board, council, or legislature that is charged with setting the direction of the organization, while an executive or manager simply determines how to carry out those directions. Whenever a problem arises in a Massachusetts non-profit, it will very often be accompanied by an imbalance of these powers.

Conflicts of Interest Not Identified

A non-profit, like any company, will often favor convenience when seeking to purchase a product or service. Its members, employees and at times beneficiaries will likely be considered in this process. As a relatively benign example, a CEO might employ a relative who owns a cleaning business to service the non-profit’s offices. In a more sensitive scenario, a board member might charge the non-profit for his or her “consulting” services if she considers herself a professional of some kind.

Whether benign or not, however, any non-profit should have clearly written conflict procedures whenever such circumstances arise. The procedures for engaging in this transaction not only should be written out, they should be practiced in each and every transaction where an officer, employee or board member stands to benefit from that transaction. The policies are quite easy to follow, and merely require a vote of the disinterested directors on the board, i.e. those who do not stand to benefit from the transaction. Because these processes are so simple, there really isn’t any reason for a Massachusetts non-profit to forego them, and failing to have or honor conflict policies most certainly creates a serious risk at minimum, if not outright suspicion of wrongdoing.

Absence of Fiduciary Behavior

Fiduciary relationships are very common, and can be found in trustees, or executors (personal representative) in Massachusetts estates, and even broker dealers of stocks. In a non-profit, all of the management and board of directors owe a fiduciary duty to the corporation itself, as well as to the beneficiaries of that corporation according to its mission. A fiduciary duty is simply a legal obligation for one party to act in the best interest of another, over and above that party’s own interest. In the earlier “board member consultant” example, her status as a fiduciary means she should not have charged for her services if those services could have been obtained for free, or e.g. if the non-profit didn’t need the services at all for its mission.

An individual who enjoys this type of authority, and yet breaches her fiduciary duty, is often easy to identify in these circumstances. The reason for this is that people rarely behave out-of-character, and if they act outside of a fiduciary capacity in one instance, it is a good bet they do so quite often. In non-profits, when we discover a board member breaches her fiduciary duty in one instance, we usually discover a pattern of behavior consistent with that breach.

Transactions Inconsistent with Contract Law

This may sound obvious, but a hard rule on transactions within the company is that if it’s illegal outside of the company, it’s illegal inside the company. In other words, no transaction in Massachusetts is legal if it fails to adhere to Massachusetts contract law. Sometimes officers may want to waive certain legal requirements in favor of being expedient or ensuring smooth operations. Again using the board member consultant as an example, this board member might attempt to bill for her consulting services a decade ago, when the statute of limitations on contracts in Massachusetts is only 6 years.

Attempting to collect on a debt this old would be illegal between any two parties in Massachusetts, so that it too should not be practiced within the organization. Board members should be cognizant of this requirement, and should raise this issue of illegality if they see it anywhere within their non-profit.

Inaccurate Tax Filings

We are all aware that non-profits, especially charitable ones, require very rigid and detailed tax filings on a quarterly basis. In such filings, every service provided to that organization should be detailed and expensed in the year such service was provided. It most certainly would not make sense if a non-profit or any officer could simply siphon off its earnings with expenses that were not reported in any given year. Using our errant board member in yet another example, her attempt to charge the non-profit for services not expensed in the tax filings from a decade ago would essentially amount to tax fraud.

Board members, employees, officers or even members of the public who are suspicious of inaccurate tax filings from a non-profit can actually research what is going on from a great resource, http://foundationcenter.org/find-funding/990-finder. While some might hesitate to report this behavior for fear of hurting the mission of the non-profit, fixing the problem (or problem board member) early is a much safer strategy than allowing the problem to continue indefinitely.

Conclusion

The above examples are just a handful of potential problems that indicate a Massachusetts non-profit might be non-compliant. If you or someone you know suspects malfeasance at a non-profit or charity that is of concern, reach out to our offices today for a consultation with a business attorney.