Guide For Foundation Board Members

CHARITABLE LAW SEcTION

GUIDE FOR FOUNDATION BOARD MEmbERS

TYPEs OF FOUNDATIONs Foundations may exist in various forms, but most commonly they are organized either as a nonprofit corporation or as a testamentary or inter vivos trust. A nonprofit corporation is created by filing articles of incorporation with the Ohio Secretary of State. A trust is formally created when a donor, through a trust agreement or via the donor’s will, gives legal title to property to one or more trustees to hold and manage for the benefit of another — in the case of a charitable trust, for the charitable beneficiaries. Whether a foundation is organized in corporate or trust form, and whether its managers are referred to as directors or trustees, Ohio foundation board members are required to fulfill specific duties. Although you may consider the foundation with which you are associated a private entity, it is important to remember you are administering charitable assets for the benefit of the public. Further, public benefits have been bestowed on the foundation and its donors, in the form of tax exempt status for the foundation and charitable tax deductions for its donors. Foundations rely heavily on volunteers to govern them and enable them to fulfill their charitable mission. The foundation has every right to expect its volunteers to serve in a serious and

thoughtful fashion. Foundation board members have a concomitant right to expect ready access to information and resources to ensure that they can fulfill their legal and ethical duties. Whether you are considering joining a foundation’s board or are already serving on one, you have probably not received any formal training for the job. Unlike most other jobs, it is often assumed that either no training is required or that everyone knows what is expected of them. To the contrary, there is a shared responsibility of the volunteer, the volunteer’s peers on the board and any foundation staff to request and provide the training necessary for board members to more fully understand and carry out their responsibilities. This booklet provides foundation board members with a basic understanding of their responsibilities. In addition to this booklet, Ohio Grantmakers Forum (OGF) offers training and resources for foundation boards. Please check the OGF Web site — www.ohiograntmakers.org — frequently for upcoming programs.

OHIO GRANTMAKERs FORUM GUIDINg PRINcIPLEs FOR MEMBERs Ohio Grantmakers Forum adopted the following statements in November 2004, to which all OGF members must commit as a condition of membership. 1. Adhere to the highest standards of ethical behavior in all foundation activities. 2. Operate with an active governing board that sets and regularly reviews all organizational policies, including those related to governance, conflict of interest, grantmaking and finance (including audit). 3. Have basic information readily available regarding programs, funding priorities and application requirements. 4. Maintain constructive relationships with applicants, grantees, donors and the public based on mutual respect, candor and confidentiality. 5. Strive to include the perspectives, opinions and experiences of the broadest possible cross-section of people to inform the organization’s grantmaking and contributions, governance and staff structure and business practices. 6. Support continuous learning by trustees, staff and grantees. 7. Honor donor intent through thoughtful deliberation in the context of changing social conditions. 8. Fulfill all fiduciary and legal responsibilities.

LEgAL DUTIEs Under common law and the provisions of the Ohio Charitable Trust Act, the Attorney General is empowered to investigate charitable trusts to determine whether property held for charitable purposes is being properly administered in accordance with fiduciary principles. The Attorney General may bring an action to enforce the performance or restrain the abuse of a charitable trust. In Ohio law, a charitable trust is defined as any fiduciary relationship with respect to property arising under the law of this state or of another jurisdiction as a result of a manifestation of intention to create it, and subjecting the person by whom the property is held to fiduciary duties to deal with property within this state for any charitable, religious or educational purpose. This broad definition includes nearly every person or entity that holds funds for some charitable purpose, whether formally organized as a trust or some other type of entity, such as a nonprofit corporation, association or foundation. A foundation recognized as a 501(c)(3) organization is a charitable trust under Ohio law. Individuals who have the authority to conduct the affairs of the foundation (directors, trustees or officers) are charged with certain fiduciary duties under statutory and common law. These fiduciary duties recognize and reinforce that, in taking actions for the foundation, these directors are not acting on their own behalf, but on behalf of the charitable trust, that is, the foundation and its charitable beneficiaries. The legal duties of foundation board members are separated into four categories: • The duty of care. • The duty of loyalty. • The duty to maintain accounts. • The duty of compliance.

THE DUTY OF CARE The duty of care requires that a foundation director participate actively in the foundation’s affairs, be familiar with its finances and active in its governance. In fulfilling the duty of care, directors must act in good faith, with the degree of diligence, care and skill that a prudent person would use in similar positions and under similar circumstances. For those foundations that are organized in trust form, trustees are required to conduct themselves with the level of care, skill and diligence exercised by ordinarily prudent persons in the handling of their own affairs. For foundations that are organized in corporate form, the legal standard of care is set forth in Revised Code Section 1702.30(B), as follows:

A director shall perform the duties of a director, including the duties as a member of any committee of the directors upon which the director may serve, in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would use under similar circumstances.

In order to fulfill their duty of care, a director should attend all board meetings and meetings of committees on which she serves. The director should participate actively in the discussions and decision-making process at those meetings. A director needs to prepare for each meeting by carefully reading and understanding reports and other materials distributed for the meetings, and by asking any questions that the reports raise. If a board member does not understand a particular report, he should ask for clarification or explanation until he is comfortable that he fully understands its content. Often times directors — especially those without accounting or bookkeeping training — have a fear of financial reports, perceiving the columns and pages of numbers as indecipherable. New directors may feel embarrassed if they do not completely understand a financial report. Rather than asking questions, the director may simply accept the statements of the treasurer or financial officer with respect to the report. It is extremely important that directors take the necessary steps to understand the financial documents. This does not mean directors must obtain accounting degrees. However, they can seek training and information, looking to foundation staff, peers or Ohio Grantmakers Forum for opportunities to build their financial literacy skills. Directors are also responsible for establishing organization policies with respect to the governance of the foundation, management of its finances and grantmaking activities. Boards should provide clear direction on the process for approving substantial obligations, such as compensation arrangements and professional fees. However, compliance with the duty of care is not achieved by merely establishing policies. Directors should regularly review the foundation’s policies and activities to determine whether established policies are being followed, whether the policies remain relevant in the current environment and whether policies need to be revised.

SUggEsTED POLIcIEs AND PROcEssEs • Conflict of interest policy. • Financial controls. • Background checks for staff. • Process for approval of compensation. • Process for hiring professionals. • Process for approval of major expenditures. • Document retention policy. • Spending, investment and asset allocation policies. • Eligibility for service — criteria and terms for board members. • “Whistleblower” protection policy. Directors should be involved in selecting the foundation’s key staff members, including the executive director and chief financial officer. The board should make sure that candidates have the education and skills necessary and desirable for the position. The board should also regularly review and evaluate the performance of these key staff to insure that they are performing at the expected level and their activities further the foundation’s charitable mission. Another aspect of exercising care relates to potential liability for misdeeds of the board and staff. It is important to recognize the possibility that a grantmaking foundation and its board members can be sued. The Ohio Attorney General may bring an action to enforce the performance of a charitable trust or restrain the abuse of such a charitable trust, including action for damage caused to the foundation by board members’ failures to fulfill their fiduciary responsibilities. Individual board members may themselves bring suits for alleged misdeeds of their fellow board members. Accordingly, it is advisable that boards

recognize the potential for such actions and evaluate means to address that possibility. The first line of defense is always prudent oversight of the foundation’s activities. However, the board may also discuss the necessity or desirability of indemnification language in the foundation’s bylaws or code of regulations, and appropriate limits and exclusions in any indemnification policy. The board should also discuss whether or not they should purchase directors and officers insurance, again considering appropriate limits of liability and exclusions for certain behavior, such as fraud or illegal activity. Foundation directors should establish policies and processes to insure that the conduct of board meetings provides for meaningful discussion on issues of importance without overburdening the individual directors’ schedules. Use of a consent agenda — where routine matters such as committee reports are voted on in an omnibus motion — is one practice that may be utilized so that board meetings are devoted to critical issues. Preparation for board meetings is vital to minimizing the time needed for the presentation of reports and issues and making the best use of available time for thoughtful discussion. Recent changes to Ohio’s nonprofit corporation law, Chapter 1702 of the Revised Code, allow the use of authorized communications equipment, including telephone and electronic means of communication, to give notice of meetings and to conduct meetings, when specifically authorized by the corporation’s articles, regulations or bylaws. Authorized use of telephone and electronic means of holding board meetings may be especially helpful to conduct a meeting in emergency situations when some board members would otherwise be unable to attend in person. However, conducting meetings in this manner often invites other distractions and may actually hinder discussion. Face-to-face meetings with all

board members physically present usually insure a more complete and useful exchange of ideas, discussion and resolution of issues. The duty of care also requires that directors plan for the continuity and renewal of the board itself. Policies and procedures should be implemented to establish appropriate terms for board members that allow for fresh ideas while maintaining links to the foundation’s roots. Although the needs of each foundation differ, a system of staggered terms and term limits helps to bring new trustees, while ensuring that experienced board members are available to assist in their transition. Board members should be on the alert for individuals to fill upcoming, open board seats and encourage qualified candidates to consider joining the board. Creating job descriptions and desired qualifications for board members helps to identify and recruit skilled directors needed for the successful operation of the foundation.

DUTY OF LOYALTY The duty of loyalty requires that board members hold the interest of the organization and the public first and foremost in their minds as they make decisions. They must loyally place the charity’s interest above any self-interest, acting fairly and independently to further the charitable purposes and advance the best interest of the organization. This duty can sometimes be jeopardized by conflicts of interest that arise between one’s personal interest and the organization’s interest. There are two types of such conflict situations that surface in boards of grantmaking foundations. First, a director may have a personal, financial interest in a decision. Second, a trustee may have a loyalty that could influence a decision where no personal financial interest is at stake. Board members who engage either directly or indirectly in transactions or activities between themselves as trustees/directors and themselves as individuals risk breaching this duty of loyalty. A breach can also occur when they are involved in transactions with family members or businesses in which they hold an interest. Examples of such breaches include engaging in competing enterprises to the detriment of the foundation, diverting an organization’s assets for personal gain and deriving any kind of secret profit or other advantage in dealing with or on behalf of the organization. Because board members are often involved in their communities in a variety of ways, it is not uncommon that conflicts of interest arise. These conflicts need not be disastrous, if board members and organizations establish and follow procedures for disclosing and resolving them. Adopting and implementing a written conflict of interest policy can avoid many of

the problems that arise from situations where the organization’s and individual’s interests are opposed. For grantmakers, this duty of loyalty applies particularly — but not exclusively — to awarding grants and to business activities. Accordingly, conflict of interest policies should include written disclosures made by board members of their relationships with other nonprofits and businesses that might seek to provide services for the foundation. Potential conflicts include serving on the board of a nonprofit seeking a grant from the foundation, having a relative employed by the nonprofit and owning a printing company that has submitted a bid for printing the annual report. These conflicts should be disclosed and you should not vote on the proposal. Additionally, the board may choose to prohibit you from discussing the grant award or the printing bid. Board meeting minutes should document any member’s disclosure of conflict and absence from voting and discussion. It is recommended that formal, written disclosures of possible conflicts be made by board members on an annual basis. Trustees should be sure to disclose any potential areas of conflict at each board meeting.

WAYs TO AVOID TROUBLE IN DEMONsTRATINg LOYALTY TO THE ORgANIZATION YOU sERVE

• Disclose your financial interest whenever the charity proposes entering into a business relationship with you, a family member or a business in which you hold an interest. Do not debate or vote. • Disclose your relationships with nonprofit organizations in the community you serve, whether as a board member or in another volunteer capacity. • Insist that your foundation adopt and regularly implement a conflict of interest policy that includes written disclosure and ineligibility to vote. • Educate new board members about the duty of loyalty and its importance to the ethical and legal operations of the foundation. • Regularly review the conflict of interest policy.

A cONFLIcT OF INTEREsT POLIcY • Gathers information on board members’ affiliations and those of their spouses, parents and children, and whether these affiliations are volunteer or paid positions. • Mandates that members with conflicts reveal such conflicts. • Prohibits directors with conflicts from either voting on or seeking to influence a decision. • Requires that minutes record when a board member is excluded from discussion and voting.

DUTY TO MAINTAIN AccOUNTs The duty to maintain accounts means that directors have the responsibility to properly and accurately manage not only financial matters and records, but also accounts and records related to grantmaking activities. In terms of financial matters, board members must be prudent in the investment of charitable assets. This standard requires that directors exercise the level of care a prudent person under similar circumstances would exercise. Although directors may rely on reports and information provided by other board members, board committees and professionals that the directors reasonably believe to be reliable and competent in the matters presented, each director has a responsibility to exercise his or her independent judgment in a prudent manner. That responsibility cannot be delegated. (See Ohio Revised Code Section 1702.30.) The processes and procedures for managing accounts vary in complexity based on the size and structure of the foundation as well as accounting methods that change from time to time. Whatever processes are crafted, directors should ensure that they demonstrate the wise use of funds, the fiscal soundness of the organization and that the assets are being used for their intended charitable purpose by: • Keeping accurate records of income, investments, expenses and transactions. • Developing and monitoring annual budgets that direct spending designed to achieve the organization’s programmatic plans. • Establishing internal accounting systems that provide for a system of checks and balances, so no one person has total control over finances.

• For public charities, assisting the organization in developing resources for its program, crafting fund-raising goals and policies, ensuring that appeals are presented honestly and fairly and monitoring the performance of fundraising professionals. • Maintaining accurate board minutes that contain board approval of expenditures and investments. Boards can develop and adopt certain policies to help fulfill the duty of care, including asset allocation, spending and investment policies. Directors should also be clear about the frequency of review of these policies as well as the frequency and structure for oversight of financial managers. Additionally, adoption of a formal records retention policy is advised. Similarly, the duty to maintain accounts applies to records of grantmaking activities. For funding requests, this means directors should ensure that all necessary documents — such as tax exempt letters — related to grants are procured and kept in grant files.

DUTY OF COMPLIANcE The duty of compliance requires that the board conduct the foundation’s business in a manner that obeys all legal requirements and other obligations imposed on the foundation. These requirements may be imposed by federal and state laws and regulations, the foundation’s own governing documents or agreements with and representations made to donors or others. In general, the following requirements will apply to grantmaking foundations. Under federal law and regulations, foundations recognized as 501(c)(3) organizations are subject to annual filing requirements with the Internal Revenue Service and must operate in conformance with federal regulations for 501(c)(3) organizations. Most foundations either file an annual Form 990, if a public charity, or Form 990-PF, if a private foundation. Compliance with federal law and regulations requires that these returns accurately reflect the financial activities of the foundation. In order to maintain its 501(c)(3) status, the foundation must be operated exclusively for charitable purposes and must avoid certain transactions that inure to the benefit of individuals. Private foundations are subject to additional federal regulations, including requirements to make certain minimum distributions for charitable purposes annually and to avoid self-dealing transactions. Foundations are also required to register with the Ohio Attorney General under the Charitable Trust Act and to file annual financial reports, along with any applicable fees, with the Attorney General. These reports are generally due when the federal Forms 990 are filed. Recent changes in the Attorney General’s administrative rules allow Ohio foundations to file a verification form and filing fee with the Attorney General, eliminating the need to file the complete 990 for state purposes. For more detailed information on foundation registration and annual reporting

requirements with the Ohio Attorney General, please refer to the brochure Guide for Grantmaking Foundations, available on either the Attorney General or Ohio Grantmakers Forum Web sites. If the foundation is organized as a nonprofit corporation, it is required to file a statement of continued existence with the office of the Ohio Secretary of State every five years. It is especially important for the board to update its status with the Secretary of State if it has moved, changed contact information or revised its bylaws. Certain requirements of the federally enacted American Competitiveness and Corporate Accountability Act of 2002, generally known as the Sarbanes-Oxley Act, apply to nonprofit entities. In particular, the Act makes it illegal for corporations, including charitable foundations, to retaliate against an employee who reports suspected illegal activity by the foundation. It is also illegal for the foundation to destroy or alter documents to prevent them from being used in official proceedings. The board must also ascertain that the foundation’s operations are consistent with the purposes for which it is organized. Frequent reference should be made to the foundation’s governing documents — articles of incorporation, trust document or will. The foundation has a duty to comply with the agreements and representations it has made with its donors and the public. Individual donors have a right to rely on the representations made during discussions about gifts and on specific limitations imposed on their donations. The public has a right to rely on representations the foundation has made as to the manner in which it will be operated, whether those representations were made in the course of seeking public benefits, including tax exempt status, or in seeking contributions to the foundation. As a result, the board must be careful to abide by those promises.

CONcLUsION This guide is intended as an overview of the fiduciary responsibilities of grantmaking foundation directors, providing a basic understanding of those requirements. It is not intended as an exhaustive discussion of the legal requirements, but as a point of reference to give foundation directors a sense of what is expected of them. Although the requirements may seem daunting and technical, in most cases compliance comes down to basic common sense — approaching your duties as an important responsibility and taking the necessary care in carrying out those duties. Always consult your own legal counsel for specific advice as to your particular situation.

Ohio Grantmakers Forum 37 W. Broad St., Ste. 800 Columbus, OH 43215 (614) 224-1344 www.ohiograntmakers.org

A

CHARITABLE LAW SEcTION 150 E. GAY ST., 23RD FL. COLUMBUs, OH 43215 614-466-3180 FAX: 614-466-9788