Insider Deals Are Common Among Nonprofit Boards, Study Finds

Almost half of large nonprofit groups make insider deals with board members, and one-third of those deals occur without the prior approval of other board members, according to a new study by the Urban Institute.

The study, which is described in a report released on Monday, “Nonprofit Governance in the United States: Findings on Performance and Accountability From the First National Representative Study,” also found that many groups fail to attract ethnically diverse leaders. Half the boards that participated in the study had only white members, none of whom were Hispanic.

The findings are based on a 2005 survey of 5,115 nonprofit organizations, of which 23 percent were educational institutions. The organizations varied in size, type, and location.

Among the study’s key findings:

Forty-five percent of organizations with annual budgets of $40-million or more reported having bought goods, services, or property from companies affiliated with their board members during the previous two years.

Thirty-three percent of those insider transactions were not reviewed or approved by other board members.

Eighty-six percent of the board members were white, 7 percent were black, and 3.5 percent were Hispanic.

“The findings about homogeneity really raise questions about the ability of these boards and the nonprofits to respond to the populations that they serve,” said Francie Ostrower, a researcher at the Urban Institute who conducted the study. “There needs to be some kind of initiative to help nonprofits find people for their boards.”

Ms. Ostrower said the insider deals typically come at fair prices, particularly among the big-budget group that includes colleges and universities. About 85 percent of the nonprofit organizations that obtained goods or services from board members in the previous two years said they had done so at market rates, and 24 percent said they had done at least some of those transactions at below-market rates.

However, Ms. Ostrower said the frequency of insider deals suggests that the practice should be given more scrutiny. “This really is something that we should know more about,” she said.

The Association of Governing Boards of Universities and Colleges does not recommend a ban on business deals between colleges and trustees, but it encourages boards to have conflict-of-interest policies.

“Boards need to be very careful with this,” said Richard D. Legon, the association’s president, adding that conflict rules should be refreshed regularly.

Scandal and Conflict

The study comes at a time when many institutions are revisiting their board structures in the wake of recent governance scandals in both the corporate and nonprofit sectors.

But while the boards of some universities and charitable organizations have followed Wall Street’s lead and tightened rules in response to the Sarbanes-Oxley Act of 2002, which requires stricter governance of public companies, many nonprofit organizations have been slow to take steps to improve their internal controls.

The study, for instance, found that one-third of the participating charities did not conduct independent audits, and that half did not have a conflict-of-interest policy.

With the lack of such controls, the frequency of insider deals involving board members is probably much higher than what survey participants reported, the researchers said.

The routine nature of such deals has some experts on nonprofit accountability calling for a closer look at how charity boards conduct business.

“You look at this information and you sit straight up,” said Evelyn Brody, an expert in board governance and a professor of law at the Illinois Institute of Technology’s Chicago-Kent College of Law. The lack of oversight of such deals at many charities could prompt regulators and lawmakers to create new disclosure rules that would require extra work by charities, Ms. Brody said.

“I’ve always thought the law shouldn’t tell you what you can do and can’t do,” she said. “On the other hand, that assumes and requires a board that looks out for the best interests of the charity. As some of this data shows, this isn’t what’s happening, or isn’t always what’s happening.”

Concern about such deals, however, might be overblown, said Marla J. Bobowick, vice president of BoardSource, a Washington nonprofit group that provides consulting services to boards of directors at charitable organizations.

Ms. Bobowick said nonprofit groups often save considerable money by buying goods and services from companies that are connected to their board members because the board members negotiate agreements at reduced rates.

“If the charity got the goods or services at below-market rates, good for them,” Ms. Bobowick said. “That’s a pretty standard practice. The organizations I’ve known and seen get these things so far below the market rate that it’s an in-kind contribution of sorts to the charity.”

Still, the frequency of such deals–and the fact that many charities do not have rules governing them–is cause for concern, said H. Art Taylor, president of the BBB Wise Giving Alliance, a charity watchdog group in Arlington, Va.

“What organizations must understand is that they are more vulnerable to external criticism from those that don’t approve of that kind of involvement,” Mr. Taylor said.

Effect of CEO’s Role

Having an organization’s CEO as a voting member on the board seems to have a chilling effect on board oversight, according to the study, with the board playing a decreased role in financial stewardship, policy making, and community relations.

Anne D. Neal, president of the American Council of Trustees and Alumni, said 60 percent of presidents at private colleges serve on boards as voting members. That practice confuses the governance relationship, she said.

“Presidents, after all, work for the board and frequently bring proposals to the board,” Ms. Neal said in an e-mail message. “Permitting the president to vote poses a real conflict of interest.”

Despite some troubling findings, the study shows that organizations are making progress in their efforts to improve board governance and accountability, Ms. Ostrower said.

For example, 47 percent of groups that reported having a conflict-of-interest policy said they had created it or revised it since the passage of the Sarbanes-Oxley Act in 2002. The same was true for 46 percent of organizations that have created whistle-blower policies, and 54 percent that have a separate audit committee.

Those numbers suggest that nonprofit organizations are becoming more businesslike in their governance efforts, says Ms. Bobowick. “It’s great to see that many nonprofit boards are in compliance with regulations that are not specific to nonprofit boards.”