The Importance of a Conflict of Interest Policy

by Paul Sehmer, CPA

Conflict of interest policies have been around a long time in the nonprofit world, but until recently, these policies seemed only necessary for large national nonprofit organizations. With the changes made in recent years to the Federal form 990, board governance has become a major emphasis for all nonprofit organizations. One of the most important factors of board governance is the establishment of a conflict of interest policy.

What is the purpose of a conflict of interest policy?

The purpose of this policy is to protect the organization's interests when it is contemplating entering into an arrangement that might benefit the private interests of an officer, director or member of the organization's top management (herein after referred to as "Interested Persons"). Without a conflict of interest policy, the organization runs the risk of losing its exempt status if the IRS would rule that payments made to an interested person, directly or indirectly, is private inurement.

There are basically 5 procedures involved in implementing a conflict of interest policy:

1.  Duty to Disclose. An interested person must disclose any financial interest and material facts in relation to any dealings with the organization to the board of directors or its executive committee. Many organizations develop an annual conflict of interest statement that is completed and signed by every interested person and reviewed by the board's executive committee. 

2.  Recusal of Self. Any director may recues himself or herself at any time from involvement in any decision or discussion in which the director believes he or she has a conflict of interest, without going through the process for determining whether a conflict of interest exists as explained in the next step. 

3. Determining Whether a Conflict of Interest Exists. After disclosure of the financial interest and all material facts, and after any discussion with the interested person, he/she shall leave the board or executive committee meeting while the determination of a conflict of interest is discussed and voted upon. The remaining board or executive committee members shall decide if a conflict of interest exists.

4. Procedures for Addressing the Conflict of Interest.

1. An interested person can make a presentation regarding the matter at the meeting, but after this presentation, he/she should leave the meeting.
2. The chairperson of the board should appoint a disinterested member(s) to investigate alternatives, if considered appropriate.
3. After exercising due diligence, the board or executive committee shall determine whether the organization can obtain with reasonable efforts a more advantageous arrangement from a person or entity that would not give rise to a conflict of interest.
4. If the board or executive committee concludes that the more advantageous arrangement is with the interested person due to it being in the best interests of the organization and that the arrangement is fair and reasonable, it shall make its decision and document its conclusions reached.

5.  Violations of the Conflict of Interest Policy. If the board or executive committee has reasonable cause to believe that an interested person has not disclosed a conflict of interest, it shall inform this interested person and obtain his or her response. If it is determined that the conflict did exist and it was not disclosed, appropriate disciplinary and corrective action should take place.

In conclusion, the adoption of a formal conflict of interest policy is in the best interests of any nonprofit organization. While there are many examples of these policies available on the web, it is always good practice to have your legal counsel review it before it's adopted and approved by the board of directors.