When I meet with a new 501(c)(3) organization client, one of the things I usually ask about is whether the organization has a conflict of interest policy. Usually, one of two things happens:
- “Yes, we do have a policy in place.”
- “A conflict of interest policy? What is that? Do we need one?”
No matter which answer I get, it’s okay. Conflict of interest policies are important, but it’s not hard to get one and adopt it. Let’s answer the questions in #2 up there to explain why this is a big deal.
What is a conflict of interest policy?
A conflict of interest policy does a few important things:
- Defines just what a “conflict of interest” is;
- Creates a procedure for detecting conflicts;
- Creates a procedure for addressing conflicts; and
- Allows for corrective action to be taken if the policy is disobeyed.
If you want to see the IRS’s sample policy, take a look at the Instructions for Form 1023, and you’ll find the sample policy (which may not work for every organization, although I generally like it) on pp. 25-26. The sample policy requires interested persons–someone who exercises control over the organization (a director or officer, for instance) who also has a financial interest in a transaction involving the organization–to disclose the interest to the board.
If a leader thinks that there is some possibility that he or she has an interest in a transaction being considered by the board, a good policy should encourage disclosure. The leader should disclose all the facts about whether the leader has a financial interest, and the board should decide if they believe a conflict exists. This how the sample policy is written, and it’s probably best for the organization if the leader discloses and lets the board decide–without the vote of the member with the possible conflict, of course.
The other feature in the sample policy that I like is the requirement that the policy be reviewed every year and that board members be polled every year to make sure that they have a chance to review the policy and disclose potential conflicts. I think the best time to do this is after new board members are elected, because you might find a conflict with a transaction that’s already in progress or has been under consideration. The annual checkup is a great idea, and even if you don’t use the IRS sample policy, your policy should include the annual checkup.
Why do you need a conflict of interest policy?
In short, to avoid a situation where “inurement” or “private benefit” to a leader occurs. That can happen if a leader unfairly benefits from a transaction with the organization at the organization’s expense. These types of transactions can be hit with taxes, and if not reversed, can threaten the organization’s 501(c)(3) exemption. It’s important, is what I’m saying.
Board members have a few duties to the organizations they serve. Among those duties is the duty of loyalty. That duty requires that board members put the interest of the organization ahead of their own interests. So, if an organization is thinking about doing a transaction with a board member’s company, for instance, the board member is on both sides of the transaction: their company is involved, and they help lead the organization. Some people might choose to use their influence to strike a deal that’s better for their private interests than the interests of the 501(c)(3) organization. That’s when inurement and private benefit show up.
The purpose of the conflict of interest policy is keep the organization from winding up in that situation. By keeping an interested party from sitting on both sides of the negotiating table, the organization’s interests are protected and the inurement problem is avoided.
And how could all of this go horribly wrong?
Your organization could adopt the most well-written, thoughtful conflict of interest policy, and it would be completely useless if you don’t follow it. It’s easy to forget the duty to disclose, and it’s easy to skip over annual reviews. Make a point of scheduling an annual policy and disclosure review at least once a year. Avoiding bad deals and inurement is critical to your organization, and the conflict of interest policy is a valuable tool to prevent that, but only if you use it.