May 11, 2012

Why Watching CEO Expense Accounts Matters

But some of the most embarrassing and damaging scandals erupt over what sometimes seem like small irregularities—$20,000 or $50,000 out of a multimillion- or multibillion-dollar budget. Abusive spending not only raises questions of general accountability but also damages the reputation of the nonprofit and its governing board.

The University of Texas Southwestern Medical Center is the latest to feel the sting over a top leader’s inappropriate spending. Last month it released the results of an internal investigation, concluding that one of its top administrators and fundraisers routinely mingled business and personal spending. The controversy had been the subject of unrelenting coverage from the Dallas Morning News, and on Tuesday, the university announced that Kern Wildenthal was stepping down as head of the university’s foundation as a result of the questions that had been raised.

Plenty of other institutions have faced angry donors and reporters when executives have made questionable charges on the organization’s tab. We were reminded of this last November with the death of William Aramony, the head of United Way of America who went to jail two decades ago after newspapers revealed his first-class travel and lavish spending of the nonprofit’s money on his young mistress. The Smithsonian Institution and several other big universities have all faced major debacles over the personal spending habits of their chief executives.

The Texas controversy got its start when questions were raised about spending by Dr. Wildenthal, who had led the institution for 22 years. Dr. Wildenthal has been widely credited with building the institution both as an administrator and fundraiser.

But newspaper and television journalists got tips from people in the know that suggested Dr. Wildenthal was spending the institution’s money on lavish international travel, fine wines, and other extravagances. Amid the scrutiny, he stepped down as chief executive and took over as head of the fundraising arm for the medical center until he left this week.

The detailed report on the allegations of misspending at Southwestern Medical reached a series of findings that other nonprofits will want to consider as they look at their own practices. It said:

  •  Dr. Wildenthal “exercised questionable judgment” in making discretionary-spending decisions he said were necessary as part of his leadership roles and duties. According to the report, he inappropriately meshed his business and personal travel and entertainment expenses, testing the boundaries of the organization’s policies.
  • Southwestern didn’t follow its own rules in handling Dr. Wildenthal’s expense reports. The business office routinely approved the expense reports without careful review and did not insist that he document the business purpose of each expense.
  •  The organization’s auditors failed to alert top leaders at the institutions when they found incomplete documentation.

As a result of the investigation, Dr. Wildenthal was given a choice to stay on as foundation president or retain his faculty position, and this week he made public his decision about leaving the foundation. The director of Southwestern’s internal audit division resigned his position, and the UT System’s chief audit executive retired.

The entirety of the report leaves an impression—fairly or unfairly—of a respected executive who developed a sense of “entitlement” based on a record of extraordinary accomplishment. Members of the university’s audit staff were excessively deferential when they saw questionable expenses, for fear of harming Dr. Wildenthal’s reputation and that of the entire organization.

Southwestern had a well-established set of procedures to monitor the review and approval of executive expense reports, but the system didn’t work. And that goes to the heart of the lesson here—that when it’s the CEO’s expense reports, plain-vanilla policies and procedures may not be enough.

Nobody wants to get into a situation in which boards forbid leaders from using their expense accounts to advance the cause of their organization. Nor should anybody start suggesting that CEO’s be forced to submit their expense reports for full board review and approval. The chief executive of a large and sophisticated nonprofit should not be treated like an adolescent. But setting out policies that are clear is essential.

The board chair, the chief executive, and the general counsel should sit down together to figure out the best way to ensure that the CEO has the discretionary-expense guidelines he or she needs, and the board gets the accountability it deserves.

The first task is to craft workable guidelines for distinguishing business and personal expenses and identifying the appropriate business-related expenses for the chief executive’s spouse. The guidelines should also discuss how to account for and acknowledge donations to the charity from the CEO and how those will be reported for tax purposes.

Second, the nonprofit should create a system that makes it routine and easy for the board chairman to review expense-account spending. Auditors who work for the CEO can’t be the ones to raise the questions if something goes wrong; that is a board duty, and in some cases, one for the general counsel.

Boards should take action to step up their oversight of expense accounts, not solely out of concern with the CEO’s actual practices but also because it is a smart way to protect the institution and the office of its chief executive from scandal. CEO’s deserve effective guidelines from board leaders.

William Aramony, the United Way leader, served over six years in prison for his wrongdoing. Benjamin Ladner left American University after he was accused of hiring a personal chef and social secretary, as well as taking lots of personal trips using the institution’s checkbook.

Lawrence Small resigned from the Smithsonian after the institution’s investigator general found he was charging expensive meals and housing and office renovations to the museum complex.

Karen Pletz, who was indicted in 2010 for systematically defrauding the Kansas City University of Medicine and Biosciences through a series of falsified expense reports, committed suicide last year, just a few months before her federal criminal trial was to begin.

In each instance, the venerable institutions these CEO’s represented have survived and thrived again. So, too, undoubtedly, will Southwestern Medical School. But in each case, the way back involved much pain and cost. That’s why board chairmen have no choice but to make sure they are able to raise tough questions about personal spending even when that makes things uncomfortable for an otherwise outstanding chief executive.

Michael Peregrine is a lawyer who advises nonprofits in the Chicago office of McDermott Will & Emery.