Good Nonprofit Governance Starts with the Board

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1 Good Nonprofit Governance Starts with the Board Views from our Endowment and Foundation Practice Leadership Group Effective governance is essential to fortifying the long-term effectiveness and sustainability of any enterprise, and nonprofits are certainly no exception. The stakes are high: In today s challenging environment, strong and engaged board leadership can make the difference between success and failure. In this paper we cover the functions and responsibilities of nonprofit directors and how boards can take advantage of best practices to implement good governance policies and processes. Nonprofit Boards Play a Vital Role While each organization has its unique characteristics, nonprofit boards usually have decision-making responsibility on strategy, direction, policy and governance. A board s scope normally includes: Defining the organization s mission and goals and making decisions on strategy. Monitoring organizational performance to confirm that the organization is being managed capably and that there is accountability for the organization s operations and results. Providing effective stewardship of the organization s resources. Overseeing the stability of the organization in critical areas, including financial statement integrity and internal risk systems and controls. Recruiting, selecting, supporting and assessing the organization s chief executive. Evaluating and strengthening the board s effectiveness. Enhancing the organization s public image and generating support for its activities. Importantly, good board governance does not involve handling day-to-day matters or operational details. Instead, the role of the board is to provide direction and guidance to the organization s management and to monitor progress the board should not try to manage the nonprofit or interfere with the organization s management. Board Members and Their Fiduciary Responsibilities Directors of a nonprofit organization have fiduciary duties and thus have the responsibility to protect and preserve the organization s resources for the public benefit or charitable purposes for which the organization was established. This means that the directors accept the role of stewardship of the nonprofit s assets to confirm that resources are utilized

2 in a reasonable and appropriate way. As persons of trust, board members have the authority and obligation to act prudently, honestly and in good faith on behalf of their nonprofit. In general, the exercise of fiduciary responsibilities involves fulfilling the duties of care, loyalty and obedience: Duty of Care: Exercise prudent judgment in decision-making and provide oversight for all activities that advance the nonprofit s effectiveness and sustainability. Duty of Loyalty: Act solely in the best interests of the nonprofit rather than pursuing courses of action that further a board member s self-interest. Duty of Obedience: Confirm that the nonprofit obeys its stated mission and purpose and that it acts in accordance with applicable laws and ethical practices. An extension of the duty of obedience is the duty of transparency, which is the obligation of the board to make certain that the nonprofit is open in its operations. This duty of transparency includes confirming that all tax filings have been made and are available to the public. 5 Basic Good Governance Practices Maintain minutes of all board meetings and committee meetings for committees that are authorized to act on behalf of the board, such as an executive committee. Annually review a written policy and complete a questionnaire about conflicts of interest (See IRS Form 990, Part VI) and document in the minutes of board meetings when the policy is invoked. Approve the executive director/ceo s compensation and benefits, and document how the board determined that the compensation is appropriate and not excessive. Require the board to review a copy of the IRS Form 990 before it is filed. For smaller nonprofits that only file Form 990-N, make sure the board knows about the annual filing requirement. Disclose to the public the nonprofit s three most recently filed annual returns with the IRS, as well as its application for tax-exemption and related correspondence and attachments. And 4 More for Good Measure There are four additional governance policies that IRS Form 990 asks whether a charitable nonprofit has adopted: Written whistleblower protection policy. Written document retention/destruction policy. Written gift acceptance policy to govern the receipt of non-cash gifts, such as gifts-in-kind, and unusual gifts (e.g., land, vehicles, art). Joint ventures: If the organization has participated in a joint venture, IRS Form 990 asks whether the nonprofit took steps to avoid prohibited private benefit. Source: The National Center for Nonprofit Boards 2 Good Nonprofit Governance Starts with the Board

3 Critical Board Fiduciary Functions Board members are expected to be active participants in meetings, do their homework and be knowledgeable about the work of the nonprofit. In satisfying its fiduciary obligations, the board must establish and maintain a policy and administrative framework within which the nonprofit operates, which generally includes: Establishing a budget typically on an annual basis that dedicates resources to the programs and initiatives created to help the organization accomplish its mission and goals. Designing and implementing a system to regularly monitor, evaluate and report on the nonprofit s financial condition and performance. Installing a performance tracking system and holding the organization s chief executive and staff accountable for results and adherence to policies. Adopting policies to govern major transactions, including the acquisition of assets. Creating a compliance system to confirm that all IRS tax filings and reporting are satisfactorily completed on a timely basis and that regulatory and disclosure requirements are met. Implementing an independent external audit on a regular basis usually on an annual basis to assess the organization s financial condition and viability, including the effectiveness of risk management and control systems. Developing a written conflicts of interest policy to confirm that board members are familiar with the types of activities or transactions that may impact their ability to serve as a board member or participate in certain decisions. Creating and implementing policies and guidelines for investments and spending, and providing oversight on how investments are managed and what is spent. Fiduciary Investment and Spending Responsibilities of Boards As mentioned, the board takes on the role of stewardship of the nonprofit s assets to confirm that these resources are utilized in a reasonable and appropriate way. Since its adoption in 1972 by the National Conference of Commissioners on Uniform State Laws (NCCUSL), the Uniform Management of Institutional Funds Act (UMIFA) has provided guidance to organizations on the management, investment and spending of funds held by nonprofits. In 2006, the Uniform Prudent Management of Institutional Funds Act (UPMIFA) was adopted by NCCUSL to address shortcomings in UMIFA and is designed to: Update the prudent investment standard for nonprofit funds. Provide clearer rules and guidance on spending from institutional funds and enable nonprofits to more easily deal with market fluctuations in the value of funds. Simplify rules on the release and modification of restrictions on charitable funds to permit more efficient management. In one form or another, UPMIFA guidelines have been implemented in all states except Pennsylvania, which will be addressed in a following section. 3 Good Nonprofit Governance Starts with the Board

4 UPMIFA Accumulation and Spending The most significant change in UPMIFA from earlier guidelines is the elimination of the historic dollar value (HDV) limitation on spending from institutional funds. Under UMIFA, net appreciation of an endowment fund could be spent although the HDV had to be preserved. For example, assume that a nonprofit received an original endowment of $1 million, which represents the HDV of the donation. If the market subsequently declines and the fair market value of the fund fell to $980,000, the nonprofit would not have been permitted to touch the money for expenditures under the old rules. Subject to the donor s intent, UPMIFA now permits an institution to accumulate or spend as much of an endowment fund as the nonprofit deems prudent for the uses, benefits, purposes and duration for which the endowment fund is established. There are exceptions to the more expansive rule under UPMIFA. When a donor expresses intent clearly in a written gift instrument, UPMIFA requires that the charity follow the donor s instructions. In addition, UPMIFA does not apply to private foundations held by individual trustees or commercial trustees, such as banks or trust companies, even if the sole beneficiary is a charity. Such trusts are instead governed by the instruments establishing them and applicable state trust law. The UPMIFA prudence guideline is consistent with standards already applied throughout business, legal and investment communities: A board member must act in good faith and with the care an ordinarily prudent person in a like position would exercise in similar circumstances. In making a determination to accumulate or spend endowment fund assets, a nonprofit s board is to apply the prudent person standard and consider, if relevant: The duration and preservation of the endowment fund. The purposes of the institution and the endowment fund. General economic conditions. The possible effect of inflation or deflation. The expected total return from income and the appreciation of investments. Other resources of the institution. The investment policy of the institution. UPMIFA Investing Standards UPMIFA allows board members the freedom to implement an investment policy that meets the intent of the endowment fund and to use their business judgment in managing fund assets. In making decisions on managing and investing an institutional fund, subject to the intent of a donor, the board must consider: The charitable purposes of the institution and the purposes of the institutional fund. General economic conditions. The possible effect of inflation or deflation. The expected tax consequences, if any, of investment decisions or strategies. The role that each investment plays within the overall investment portfolio of the fund. The expected total return from income and the appreciation of investments. Other resources of the institution. The needs of the institution and the fund to make distributions and to preserve capital. An asset s special relation or special value to the charitable purposes of the institution. 4 Good Nonprofit Governance Starts with the Board

5 UPMIFA prudent investing standards require a board to fulfill its duty of care and to manage costs. Investment decisions must be considered as part of the overall investment strategy and within the context of the institutional fund s investment portfolio. UPMIFA requires diversification of assets, absent special circumstances, and the strategy must be based on risk-return objectives that are suitable for the nonprofit and the fund. The board may delegate management and investment of the fund to external agents as long as it acts prudently and in good faith in selecting the agent and establishing the scope and terms of the delegation. The board must also periodically review the agent and its performance. Release and Modification of Restrictions Over time, changing circumstances may necessitate adjustments to an endowment to permit more efficient management of its funds. To lessen the burden on nonprofits, UPMIFA provides rules for modifying donor restrictions on these funds, which generally require court approval. Pennsylvania Act 141 As mentioned, Pennsylvania is the only state that has not adopted UPMIFA in some form. Instead, Pennsylvania operates under a state statute named Act 141. In effect since 1998, Act 141 permits nonprofit boards to determine annually the amount of income available for spending from an endowment fund. In making this determination, organizations may follow a total return policy, where total return is composed of interest, dividends and net capital appreciation, which includes both realized and unrealized gains. On funds for which it has investment management authority, the board may elect to spend between 2% to 7% of the fair market value of the fund for purposes that benefit the organization. The value of the assets under Act 141 is the average fair market value of the assets over a three-year period (or the average fair market value of the assets over any shorter period in the case of assets held by the nonprofit for less than three years). The total return policy approach provides the board with significantly greater flexibility than the option of a principal and income policy where the nonprofit may only spend interest and dividends from the fund. Recommendations Regarding Nonprofit Governance Investments and Spending The prudent person concept in today s legal and operating environment doesn t mandate success with every outcome no one could meet that standard. Rather, it focuses on how boards make decisions. Boards will have met their fiduciary responsibilities if their actions are based upon well-informed judgments and if they adhere to a disciplined decision-making process. Often called procedural prudence, there are steps boards may take to strengthen nonprofit management, including: Developing sound, well-thought-out policies and processes for plan management. Documenting compliance with these policies and procedures. Building audit files that can be readily accessed if needed. With this in mind, many nonprofit boards are implementing standard practices to confirm that their organizations are meeting the requirements of UPMIFA and their fiduciary duties with regard to investing and spending. These include: 5 Good Nonprofit Governance Starts with the Board

6 Representative Investing and Spending Practices for Nonprofits Fiduciary Duties of Board Know standards, laws and any trust provisions Preparation of Investment Policy Statement, Spending Policy and Gift Acceptance Policy Diversify assets to specific risk-return profile of nonprofit Confirm compliance with investment and spending guidelines and policies Use of prudent professionals and documentation of due diligence Control and oversight of investment fees Monitor activities of prudent professionals Avoid conflicts of interest and prohibited transactions Confirm compliance with donor intent Board Action Directors are well versed in issues pertaining to the nonprofit. The board has approved a written Investment Policy Statement, Spending Policy and Gift Acceptance Policy, which are reviewed annually and modified as needed. Asset allocation guidelines and rebalancing parameters are approved by the board. Recommendations and decisions made for investments and spending are documented and maintained on file. All prudent professionals (money managers, custodian, consultants, legal) are approved by the board and decisions are recorded and maintained. All fees related to investments and custody are reviewed as part of an annual fee analysis, which includes competitive benchmarks. Quarterly investment review meetings are conducted and considerations and decisions are documented. Directors are required to verify and attest to any potential conflicts of interest. Gift agreements are reviewed to clarify donor intent where necessary; the use of release or modification provisions is considered to address problem donor funds. Trends to Watch The rise of Millennials: Baby Boomers are rapidly giving way to Millennials, also known as Generation Y (adults who came of age in 2000 and after). According to The Brookings Institute, Millennials will make up 75% of the workforce by Nonprofit leadership will increasingly be composed of Millennials, who will have skill sets and an approach to leading organizations that will differ from earlier generations. This age group is also a class of donors that is growing in significance. As Millennials enter the workforce and have money to give, organizations will need to put strategies in place to best engage them. Social media awareness: Social media is growing in importance as a way to communicate about the work and needs of a nonprofit. Donors can learn about and become engaged in a nonprofit s work in many different ways, which will help drive nonprofits to segment their messages and strategize communications across multiple channels and devices. Being current with the latest technology is essential for a nonprofit to be effective and achieve sustainability. Nonprofit privacy: Security breaches in both the private and public sectors have exposed confidential information of many Americans. The nonprofit world will have to pay increasing attention to the kind of data-privacy questions that are surfacing at an alarmingly fast pace. Increased demand for visible outcomes: Major donors see their gifts as investments that are intended to produce some tangible outcome. They want to see how an organization s programs and their contributions directly create a positive impact. It s not about effort it s about achievement. Access to Big Data: Big data is becoming ubiquitous and easier to manage and understand. As noted by the Stanford Social Innovation Review, more and more organizations are successfully leveraging external wealth-screening data to evaluate a donor s capacity to give. The Rise of Short-Term Nonprofits: Transitional organizations focused on solving problems and then disbanding will increasingly challenge established nonprofits. In the future, the nonprofit landscape will likely include significantly more nonprofits formed for 3-to-5-year periods, as forecast by the Stanford Social Innovation Review. 6 Good Nonprofit Governance Starts with the Board

7 Good Nonprofit Governance Starts with the Board Conclusion Effective governance plays a critical role in the success and viability of a nonprofit in today s challenging world. While the technical requirements for boards may seem complex, there are some straightforward steps that all boards can take to confirm that directors are meeting their fiduciary obligations and helping the nonprofit achieve its goals. It takes some work, but nonprofits and boards need clear policies and disciplined processes to confirm operations run smoothly anyway. In the end, establishing a sound governance framework is really just part of good management. For more information, contact your PNC Relationship Manager or Steve Strayer, Endowment and Foundation Practice Leadership Group Lead, at or stephen.strayer@pnc.com. The material presented herein is of a general nature and does not constitute the provision by PNC of investment, legal, tax, or accounting advice to any person, or a recommendation to buy or sell any security or adopt any investment strategy. The information was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy. The opinions of PNC professionals expressed herein are subject to change without notice. The opinions expressed by persons who are not PNC professionals are their own opinions and not the opinions of PNC. You should seek the advice of an investment professional to tailor a financial plan to your particular needs. For more information, please contact PNC at The PNC Financial Services Group, Inc. ( PNC ) uses the marketing name PNC Institutional Asset Management SM for the various discretionary and non-discretionary institutional investment activities conducted by PNC Bank, National Association ( PNC Bank ), which is a Member FDIC, and investment management activities conducted by PNC Capital Advisors, LLC, a registered investment adviser ( PNC Capital Advisors ). PNC Bank uses the marketing names PNC Retirement Solutions SM and Vested Interest to provide non-discretionary defined contribution plan services and PNC Institutional Advisory Solutions SM to provide discretionary investment management, trustee, and other related services. Standalone custody, escrow, and directed trustee services; FDIC-insured banking products and services; and lending of funds are also provided through PNC Bank. Securities products, brokerage services, and managed account advisory services are offered by PNC Investments LLC, a registered broker-dealer and a registered investment adviser and member of FINRA and SIPC. PNC does not provide legal, tax, or accounting advice unless, with respect to tax advice, PNC Bank has entered into a written tax services agreement. PNC does not provide services in any jurisdiction in which it is not authorized to conduct business. PNC does not provide investment advice to PNC Retirement Solutions and Vested Interest plan sponsors or participants. PNC Bank is not registered as a municipal advisor under the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Act ). Investment management and related products and services provided to a municipal entity or obligated person regarding proceeds of municipal securities (as such terms are defined in the Act) will be provided by PNC Capital Advisors. Vested Interest is a registered trademark and PNC Institutional Asset Management, PNC Retirement Solutions, and PNC Institutional Advisory Solutions are service marks of The PNC Financial Services Group, Inc. Investments: Not FDIC Insured. No Bank Guarantee. May Lose Value The PNC Financial Services Group Inc. All rights reserved.