April 06, 2011

Fiesta Bowl’s Lesson: Boards Must Watch for Red Flags

ZUMA Press/Newscom

As nonprofit scandals go, the Fiesta Bowl controversy is a whopper. The sheer magnitude of what went wrong is staggering.

Charitable funds have gone misspent, jobs have been lost, and the reputation of one of college football’s most prominent organizations has been sullied. The situation offers a cautionary tale for any nonprofit board.

The lessons from the revelations uncovered by an investigative report commissioned by the bowl’s board don’t lie in the details of the allegations, as juicy as they may be.

To be sure, plenty of attention will be given to the $30,000 spent on a birthday party for the chief executive, the $1,200 bill racked up at a strip club, and the dozens of employees who say they were reimbursed for making political contributions with sham bonus payments.

Rather, the Fiesta Bowl scandal offers a teaching moment about the board’s fiduciary oversight obligation. As one might suspect, the ultimate (and often unfair) question in situations like this is, Where was the board? Surely board members saw the warning signs—they seem so obvious. Were they asleep at the switch, or what? (And, trust me, those questions are being asked here).

Charity scandals provide a field day for second guessing, but they also provide a highly visible prompt to step up efforts to educate board members.

Trustees should have a clear understanding of what they are expected to do (and not do), of whom and what they can rely on, and whom and what they can’t. If they are uncertain, they will become unnecessarily concerned about their personal liability, and that in turn destabilizes the board. But it doesn’t need to be this way.

Instead, the lesson here is all about spotting and reacting to the warning signs of trouble.

The law is clear: Board members need to make their best efforts to assure that the organization has a strong plan for reporting relevant information to its leaders and that the system works to give the board an adequate “head’s up” about potential legal problems. The level of detail that makes sense for such a system is the board’s call—but its members have to think it through thoroughly.

Boards are legally expected to have their finger on the pulse of the organization’s operations. Trustees are not expected to ferret out wrongdoing or other legal risks, nor are they expected to piece together subtle indicators of trouble. Boards are not required to act until they are told about reasons to be suspicious, such as when trustees learn about actions that suggest improprieties or failures to follow the law.

At that point, the board must take aggressive steps to understand what has happened. But otherwise, the board is entitled to rely on its chief executive and other top leaders. After all, it’s management’s job to run day-to-day operations—not the board’s. The board’s basic job is to keep an eye on—and support—management.

State regulators are getting more serious about scrutinizing board members who don’t respond to clear signs of trouble, and the Fiesta Bowl case makes it even more likely that government officials will be watching nonprofit boards more closely.

In some cases, the public never hears about a regulator’s actions. The board’s leaders might “elect” to resign as part of a confidential settlement with the attorney general.

Other times the story does get out, like last fall when the Massachusetts Attorney General publicly chastised the board of Beth Israel Deaconess Medical Center, in Boston, alleging that it had damaged the organization’s reputation by failing to exercise independent oversight over the organization’s chief executive.

In the Fiesta Bowl case, the public version of the independent investigator’s report makes no judgment about whether the board breached its duty. But this incident suggests that all boards should meet with their organization’s general counsel to:

  • Determine whether the system for distributing information guarantees that potential problems get the attention of board members. Is the board’s information flow adequate? Is the board hearing directly and regularly from the organization’s compliance officer and its general counsel?
  • Establish guidelines to set out levels of authority to handle matters that require board approval, matters that require board review, and matters on which the CEO may act unilaterally.
  • Assure that appropriate policies are in place to guard against problems in areas that may be prone to mischief, such as lobbying and campaign expenditures, discretionary expenditures, gifts, and travel expenses.
  • Seek advice on the types of circumstances that may require board inquiry and possibly active investigation; i.e., to learn the warning signs that trouble is brewing.

It’s easy to talk about warning signs but harder to know what they are when you are actually serving on a nonprofit board. Some signs are hard to overlook: evidence of financial improprieties, self-dealing, or fraud, any of which could lead to a major governmental investigation.

But plenty of other signs of trouble are sometimes overlooked.

Credible whistle-blower submissions and employee complaints—anonymous or otherwise. Significant inconsistencies or “outliers” in financial statements, operational reports or governmental filings (like the Form 990, the information tax return). Investigative reports in journalistic outlets. Advice from the organization’s compliance officer or warnings from state ethics boards. Information submitted to the organization’s lawyers and others in charge of complying with federal and state laws. Written concerns submitted by outside auditors. Seemingly extraordinary amounts of executive compensation, benefits, or expense reimbursement. Significant executive employee absences. Sharp shifts in regulatory enforcement or legal requirements. Major changes in the financial markets.

Those are examples of what board members should watch for. It’s impossible to devise an all-inclusive list of indicators, but to paraphrase Supreme Court Justice Potter Stewart’s comment in his ruling on a pornography case: You’re likely to know it when you see it.

Even so, it does help to receive education as to what to look for. It’s more than something that prompts a raised eyebrow or a stroke of the chin. It’s something that prompts a “Whoa, what’s that?” moment, a “that doesn’t look right at all” situation.

And what to do about them depends on the circumstances. In the case of the Fiesta Bowl, the board members commissioned an independent investigation and fired the chief executive as soon as the report found significant evidence of wrongdoing.

And that’s the other part of the Fiesta Bowl lesson—the importance of making sure board members stay on top of their duties so they will notice signs of trouble.

Boards that take a casual approach to oversight can pretty much guarantee they will face problems at some point. Those are the boards whose members don’t read the information they are given at meetings and elsewhere; who do not dig to understand an issue or topic under discussion well enough to render a sound vote; who rely too heavily on senior managers or are too deferential to them. Other warning signs are incuriosity, poor meeting attendance, and conflicts of interest.

The Fiesta Bowl lessons are no less relevant because they arise from the ethical stew that is college sports. The Fiesta Bowl and its affiliated entities all have legal status as charities, and that means their boards are subject to the same fiduciary duties as organizations like the American Lung Association and Habitat for Humanity.

The law recognizes that no organization can put in place a foolproof plan to detect wrongdoing. Significant legal and ethical issues are bound to occur. What regulators and courts want to know is whether the board identifies and acts on problems when they start to unfold.

Football players, coaches, and fans all know how important a red flag is—that’s what signals a challenge to the referee. The real lesson in this scandal is that spotting and reacting to red flags is essential to everyone, not just those on the football field.

Michael Peregrine is a partner in the Chicago office of McDermott Will & Emery, where he advises many nonprofits.