Fiduciary Responsibility of Nonprofit Board Members
One of the primary responsibilities of any nonprofit board member is to maintain the financial integrity of the organization they serve. Board members act as trustees of the organization’s assets and must exercise due diligence and oversight to ensure that the nonprofit is well-managed and that its financial status remains sound.¹
In this article, we’re going to take a look at the best ways a board member can fulfill their fiduciary responsibilities.
Websters defines fiduciary as a trustee (noun), and as follows: involving trust, especially with regard to the relationship between a trustee and a beneficiary (adjective). In other words, it is a relationship where one party is legally accountable to the other to serve its interests before their own.
BoardSource says it this way:
Fiduciary duty requires board members to stay objective, unselfish, responsible, honest, trustworthy, and efficient. Board members, as stewards of public trust, must always act for the good of the organization, rather than for the benefit of themselves. They need to exercise reasonable care in all decision making, without placing the organization under unnecessary risk.
Being a fiduciary obviously includes the financial aspects of a nonprofit. Each board member has a responsibility to ensure, to the best of their ability, that all funds are handled and accounted for in a transparent and compliant manner. That includes a number financial fronts, which we’ll look at next.
Boards of Directors should be the ones who set the organization’s budget each year. With larger nonprofits, it’s not uncommon to see a specific committee compile the annual budget, often with the participation of staff members who directly handle funds. Whether or not the budget is put together by others and presented to the board for approval, or the board members develop the budget directly themselves, it should be the board that signs off on the annual expenditure picture for the upcoming year.
Too many times, we see nonprofits with no written budget, and no oversight by the board. That amounts to a dereliction of duty, and does nothing to relieve the board members from financial responsibility. Ignorance is a choice, not an excuse.
One of the most important responsibilities of a board of directors is establishing compensation guidelines. This can get a little confusing as to where the customary lines are drawn. We’ve seen plenty of situations where the board does all the staff hiring. That’s probably OK in a smaller charity, but once you start having significant numbers of staff members, that becomes impractical.
What’s important is for the board to set parameters for each staff position, not necessarily each staff person. Again, the legwork might be done by a committee for board approval. The key point is that the IRS limits nonprofit salaries to what it calls reasonable compensation. It’s a fairly vague standard, but salaries should be tied directly to job descriptions, be comparable to similar positions in similar organizations, and be within the financial means of the nonprofit. This is especially important for Executive compensation.
Nonprofits are required by law to account for income and expenditures with compliant bookkeeping practices, and report annually via Form 990 (federal) and possibly at the state level as well. Your organization needs to be able to produce accurate, standardized financial reports, such as an Income Statement (Profit/Loss) and a Balance Sheet (or Statement of Financial Position). If it cannot, then it is likely that your accounting practices are not up to snuff.
Again, this is the responsibility of the board to ensure proper accounting and reporting is happening at all times. It’s great to farm out the task itself, and that’s usually advisable. Foundation Group provides bookkeeping services for many, many organizations. The point is less about who does it, and more about the fact that it must be done, and done the right way.
Most smaller nonprofits aren’t too concerned with investing activity. They’re too concerned about having enough resources to keep the programs operating. But for medium-sized and larger organizations, investments are a typical part of their financial picture.
What many board members don’t know, however, is that the IRS and most states’ Charity Divisions require nonprofits to satisfy the Prudent Man Rule in investing. The Prudent Man Rule basically means that investments by a 501(c)(3) should not be excessively risky, with real balance between risk and return…preferably giving the risk side even more consideration.
We often get questions as to whether or not a nonprofit can invest in the stock market. Yes, they can. There is no prohibition on that. But, if the average charity is contemplating investing in securities, deciding between an index fund or penny stocks should yield the more conservative choice.
This one often gets overlooked until it bites someone. How money is handled within an organization is one of the most important aspects of fiduciary responsibility. I’m talking about both literal handling, and virtual handling.
Literal, or physical, handling involves who is touching the money. Virtual means accounting for it. Whether it’s cash from sales, or checks that come in from donors, it is crucial to have multiple accountability. That means at least two, independent people need to be involved in money handling and accounting…sometimes more. Having only one person who is responsible for counting, spending, and accounting for the funds is a recipe for disaster.
Many years ago in the early days of Foundation Group, I was hired by a local historic home charity to come in and reconcile their books each month and compile financial reports. Before I was brought in, all financial activity was conducted by the nonprofit’s administrative assistant. It didn’t take me long to discover significant problems. As I dug into the records, the problems got worse. Eventually, I was able to prove that the administrative assistant had been skimming cash from the gift shop for a long time…to the tune of over $60,000! But because no one else was involved in the money, she was never caught. To make matters worse, the board chose not to legally pursue the thief because they didn’t want to look bad to their major donors for shirking their fiduciary duty.
Having multiple accountability also protects your staff and volunteers. When only one person is involved, and an irregularity is discovered, they’re almost always guilty until proven innocent. That’s not fair to put someone in that position.
The cost of failing at your fiduciary duty depends on the situation, and the expected level of responsibility any one board member should have.
The IRS can hold board members personally liable for Intermediate Sanctions penalties for allowing excess private benefit to occur. This usually involves unreasonable compensation to someone who is both a board member and an employee. It could also occur if the board decides to do business with another board member’s outside company without properly allowing for competing alternatives. These situations are considered inurement and are prohibited under penalty of Intermediate Sanctions, which are fines levied directly against the director, not the charity. They can go as high as 200% of the amount of excess benefit. In fairness, they are rarely assessed. But given the choice, the prudent thing for every board is to ensure due diligence is exercised when any type of money is being paid to an insider.
The other risk is legal. People get sued all the time. If a board flagrantly allows financial mismanagement, it is possible directors could be sued by donors or by members of the organization. It happens in churches, schools, HOAs, etc. Again, the risk is very, very small if the board puts the measures in place that they are required to in the first place.
Fiduciary accountability is not something to be feared, but rather, something to be understood. I’ve met great people who would make incredible board members who won’t do it for fear of this. That’s not necessary.
The standards and guidelines are there. Understanding what’s expected, and putting forth your best good faith effort to make sure things are handled properly is simply your job as a board member, as doing that alleviates virtually all reasonable risk.
Go and serve!
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