Good Nonprofit Governance and the Legal Responsibilities of the Nonprofit Director Incorporated Research Institutions for Seismology May 31, 2012 Jacqueline A. Henson, Esq.John N. Rodock, Esq. Ober Kaler Grimes & Shriver, P.C.

TOPICS  WHAT DOES THE LAW REQUIRE OF NONPROFIT DIRECTORS?  WHAT IS GOOD GOVERNANCE PRACTICE FOR 501(c)(3) SCIENTIFIC ORGANIZATIONS?

FEDERAL AND STATE LAW  HISTORICALLY, CORPORATE GOVERNANCE AND THE AUTHORITY, RESPONSIBILITY AND ACCOUNTABILITY OF DIRECTORS AND OFFICERS ARE MATTERS OF STATE LAW. IRIS IS A DELAWARE NONSTOCK (NONPROFIT) CORPORATION FORMED IN IRIS’ INTERNAL CORPORATE AFFAIRS ARE GOVERNED BY DELAWARE LAW.  CURRENTLY, THE FEDERAL GOVERNMENT, PARTICULARLY THE IRS, HAS ASSUMED AN INSTRUMENTAL ROLE IN DEFINING GOOD GOVERNANCE PRACTICES AND THE ROLES, RESPONSIBILITIES AND ACCOUNTABILITY OF DIRECTORS AND OFFICERS.

DUTIES OF A DIRECTOR/OFFICER (STATE LAW) DIRECTORS MUST KNOW THE SCIENTIFIC ORGANIZATION’S PURPOSE AND THE CONSTITUENCIES OR INTERESTS IT SERVES. MISSION ORIENTATION

A DIRECTOR ’ S RESPONSIBILITIES (DELAWARE) In carrying out their functions for the scientific organization, directors are subject to two primary, fiduciary obligations: a duty of care and a duty of loyalty.

THE DUTY OF CARE = THE DUTY TO BE INFORMED AND ACT ACCORDINGLY (Delaware)  A director’s duty of care requires the director to act in a reasonable and informed way in the Board decision-making process and also in the Board’s oversight of the scientific organization’s management.  A director must discharge his or her duties in good faith, with the care that an ordinarily prudent person in a like position would reasonably believe appropriate under the circumstances.

ELEMENTS OF THE DUTY OF CARE  Attend meetings  Come prepared to, and participate in, meetings  Exercise independent judgment on behalf of the whole, not a segment of the whole  Vote (each director is treated as an equal, enjoys an equal vote in the corporation’s direction)

BUSINESS JUDGMENT RULE The business judgment rule provides that a court will not re-examine the actions of a director in authorizing or permitting a corporate action, provided such director’s action was undertaken in good faith, in a manner reasonably believed to be in the best interests of the corporation, and based on the director’s independent and informed judgment. The business judgment rule does not apply in basic breaches of duty by the director (criminal activity, fraud, bad faith, willful and wanton misconduct).

THE DUTY OF LOYALTY The duty of loyalty requires directors to exercise their powers in good faith and in the best interests of the corporation, rather than in their own interests or the interests of another entity, constituency, group or person. A director may not use a corporate position for individual personal advantage.

CONFLICTS OF INTEREST Directors of charitable corporations often have interests that conflict with those of the charity. The duty of loyalty requires that a director be aware of the potential for such conflicts and act with candor and care in dealing with such situations. It is the manner in which the director and the board deal with a disclosed or hidden conflict that determines the propriety of the transaction.

CONFLICT OF INTEREST cont ’ d A conflict of interest is present whenever a director has a personal interest in a proposed contract or transaction to which the scientific organization may be a party.

HOW TO HANDLE A CONFLICT OF INTEREST 1. Disclose the conflict to the proper persons. 2. Refrain from participating in the decision- making process (Recusal). 3. Document the Disclosure, Recusal and Voting Process and Decision.

DUTY OF LOYALTY: CONFIDENTIALITY  A director should not, in the regular course of business, disclose information about the scientific organization’s activities unless they are already known by the public or are of public record.  In the normal course of business, a director should treat as confidential all matters involving the scientific organization unless there has been general public disclosure or unless the information is a matter of public record or common knowledge.

DUTY OF LOYALTY: CONFIDENTIALITY cont ’ d The individual director is not a spokesperson for the scientific organization. Disclosure to the public of corporate activity should be made only through the scientific organization’s designated or authorized spokesperson.

RIGHTS OF DIRECTORS  Books and Records. A director has the right to inspect, for reasonable purposes and at a reasonable interval, the scientific organization’s books and records and receive requested data derived therefrom (subject to federal and state laws regarding privacy and confidentiality).  Management Access. Directors have the right to contact the chief executive or similar staff person to obtain information needed to fulfill the Board’s duties.  Notice. All directors must be given ample advance notice of all board and committee meetings that the directors are expected to attend.

RIGHTS OF DIRECTORS cont ’ d  Right to dissent and to have dissent recorded. Any director may dissent from holding a board meeting for which the proper notice has not been given or other procedural requirements have not been satisfied. A director has the right to vote against any matter subject to a vote at a board meeting, and also to have the minutes of the meeting record that the director dissented from the action approved by other directors.  Minutes. A director has the right to demand minutes of meetings of the board and any committee exercising board powers.

THE ROLE OF THE BOARD OF DIRECTORS The Board has the ultimate responsibility and accountability for the management of the scientific organization. All authority resides with the Board and is delegated by the Board.

THE ROLE OF THE BOARD The Board has five fundamental responsibilities : 1.The Mission: The Board defines the organization’s mission as well as its vision. This is the product of periodic strategic planning. (What does it mean for the scientific organization to be successful?)

THE ROLE OF THE BOARD cont ’ d 2.The Chief Executive Function: The Boards selects, compensates, evaluates, and if necessary, dismisses the president or the chief executive.

THE ROLE OF THE BOARD cont ’ d 3.Finances: The Board must strive to ensure the integrity and reliability of the organization’s finances--approving and overseeing adherence to the budget, contracting for an independent audit, controlling the investment of capital funds, conserving major financial assets and employing spending policies for income derived from such assets. 4.Program Oversight and Support: The Board oversees (but does not manage), the programs, staff and administration of the organization. 5.Compliance with Law. The Board must strive to ensure the scientific organization’s compliance with applicable law.

ROLE OF A DIRECTOR  A director acts as a part of a board.  A director does not perform the scientific organization’s activities (unless so directed by the Board or by virtue of a dual officer position).

THE ROLE OF THE CHIEF EXECUTIVE Responsible for the fulfillment of the Board’s vision or plan Responsible for the day-to-day management of the corporation The “Board’s employee”

The Different Roles BoardDirectorExecutive Responsible For:  Defining the Mission  Choosing and Evaluating the Chief Executive/Administrator  Ensuring Finances  Overseeing Management  Ensuring Compliance with Law THE ULTIMATE AUTHORITY FOR THE CORPORATION Responsible For: Duty of Care:  Attending meetings  Being informed  Voting Duty of Loyalty  Respecting and Recognizing Conflicts of Interest  Confidentiality NO INDIVIDUAL AUTHORITY OVER THE CORPORATION Responsible For:  Implementing the Board’s vision of the Mission  Managing Staff  Utilizing Organization Assets in Implementing the Mission AUTHORITY DELEGATED BY BOARD

Setting the Stage for the IRS  Overseeing the responsibilities of directors and officers of scientific organizations traditionally fell to the state attorney generals  Charitable organization governance scandals: United Way, Red Cross, American University, the Smithsonian, Good Will, etc.  State budget constraints/lack of enforcement

The Expanding Role of the IRS IRS recognized as the “hall monitor” for nonprofit governance.  A well-governed organization is more likely to be compliant with the federal tax law.  Poor governance can easily lead to all kinds of trouble.  Good governance also allows organizations to self-identify and self-resolve problems.  Let the sun shine on nonprofit governance practices. Let the public see how an organization is run – what standard of conduct it desires and aspires to.

Attributes of Good Governance — The IRS View  Mission Orientation  Engaged, Informed and Independent Board  Effective Policies and Procedures to Safeguard Assets (Internal Controls)  Transparency

IRS Requirements for 501(c)(3) scientific organizations  Activities: Primary activities must be scientific, conducted in the public interest. Unrelated activity may be taxable as unrelated business income. Too much unrelated business income could threaten Section 501(c)(3) status.  Lobbying: Lobbying (attempting to influence legislation) permitted only to an “insubstantial” extent. May make an election to spend up to roughly 20% of program budget (limit of $1,000,000) on lobbying.

IRS Requirements for 501(c)(3) Scientific Organizations (continued)  Political Activity: NONE  Deductibility: Contributions deductible as charitable contributions.  Inurement: Inurement Restrictions Apply. Assets are dedicated to a charitable purpose; they do not belong to any single individual or entity.  Dissolution: Assets must be transferred to another 501(c)(3) upon dissolution