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The Value of Good Governance Policies

As one of the most looked-at portions of the tax return, the section on Governance, Management, andDisclosure (Part VI, Core Form) can raise many questions, but also provides a way to showcase goodgovernance practices for an organization. Good governance of an organization would certainly include

particular attention to the Part VI, Section B. which deals with a variety of policies the organization mayhave.

A common question regarding Part VI of the return is whether this information is required by the IRS.While providing the information requested for Part VI on policies and procedures is generally not arequirement, the IRS does consider these policies to be a harbinger for improved tax compliance. It isimportant to note that, technically speaking, the IRS does not have the authority to enforce these policiesor procedures--like much of the return itself, these questions are more informational in nature.Organizations should consider discussing why they may not have a particular policy, as even though it isnot required, the absence of policies may cause the casual observer to question whether there areactivities or processes that are not appropriate for nonprofit organizations occurring.

Conflict of InterestThe conflict of interest policy referenced in Questions 12a-12c of Part VI-B of the return is possibly the

most complicated to deal with. Conflicts of interests can encompass more than just financial issues, bedirect or indirect, and also tend to be more situation-specific than other issues. The IRS, in the return,wants to know specifically if 1) you have a written conflict of interest policy, 2) whether board membersand key personnel are required to disclose potential conflicts of interest, and 3) whether the organizationregularly monitors compliance with the policy. In requiring key persons to disclose potential conflicts ofinterest, it is the intent of the IRS to require disclosure or updates to disclosures on at least an annualbasis, if not more frequently. Asking personnel to sign a conflict of interest policy when they startemployment, then not requiring updates to their disclosures annually would not satisfy this requirement. Ifthe organization monitors compliance with a conflict of interest policy, the organization will need todescribe in detail the process, using Schedule O. An explanation of the process ideally should include theprocedures used for monitoring both potential and ongoing transactions for conflicts, the steps to be takenin regards to potential or actual conflicts (including those discovered before and after the transaction hasoccurred), and who is covered under the policy. Additionally, if the organization has any constraints on

persons with a conflict like disallowing participation on issues with which they may have a conflict, theserestrictions should be disclosed in the explanation as well.

Whistleblower and Document Retention & DestructionThe basic premise of a whistleblower policy (Part VI, Line 13) is to encourage personnel and volunteersto feel comfortable coming forward with credible information on illegal activities or violation of organizationpolicies. The policy should clearly stipulate that the organization will provide protection against, as well asrefrain from, retaliation against individuals who come forward. Included in the policy should be informationregarding who whistleblowers should report to, whether they be inside personnel, board members, oroutside parties. The policy doesn't have to be extraordinarily complex--at its most basic, the whistleblowerpolicy just establishes a process for reporting any alleged violations of ethics or illegal activity without afear of retribution. Whistleblower policies are important to nonprofit entities, particularly those with asmaller staff, that cannot always segregate duties, and have the checks and balances in place that are

usually effective in deterring fraud. The policies can help to ensure people step forward to report abusesthat they might otherwise not, via the protection against retaliation the policies afford.

A document retention and destruction policy (Part VI, Line 14) should simply let personnel and boardmembers know what documents need to be retained (and for how long), and protects against improperdiscarding and destruction of records. Included in the policy should be timelines for holding on todocuments, processes used to preserve electronic data such as emails and voicemails, and parametersfor the disposal and destruction of data. It is also advisable to consider including a system for haltingdocument destruction, such as in the event of investigation, as well as when destruction may resumeonce halted. This policy can help to manage the inundation of paperwork and electronic records that are

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part of everyday business by codifying the processes involved. Dont forget, however, that the IRS doesrequire that you keep specific records (Form 1023, Form 990) available for public inspection, andtherefore should not dispose of these documents.

It's important to note that in regards to these two particular policies, certain federal and state laws maycome into play. For example, while generally speaking, Sarbanes-Oxley does not apply to nonprofitentities, certain portions of the legislation are applicable. For example, there is criminal liability forretatliion against whistleblowers who report federal (not state or local) transgressions, as well as for thedestruction of records with intent of impeding a federal investigation.

CompensationOrganizations should disclose and explain if they have a process for determining the compensation of theCEO, executive director, or other top management official (Part VI, Line 15a), as well as other officers orkey employees (Part VI, line 15b) of the entity. It is important to note that the process must include areview and approval by independent persons, comparability data, and contemporaneous substantiation ofthe deliberation and discussion, in order to be able to answer affirmatively. The independent persons canbe the board, if persons with a conflict of interest regarding the compensation arrangement are notinvolved, or it can be an independent third-party compensation committee. The compensation must becompared to similarly situated entities (budget size, market or sector, geographic location), and forfunctionally comparable positions. In other words, you cannot say you used comparability data if you

compared a CEO at a large urban firm and a Vice President of Membership at a small firm in a rural area.The documentation of the process for determining the compensation arrangement must be eitherconcurrent, or reasonably soon thereafter, the actual deliberations and decisions take place, in order tobe considered contemporaneous. These policies are designed to preclude or discourage inappropriatelevels of compensation. By documenting the process used to determine compensation for key personnel,the organization can protect itself by ensuring the compensation offered is both reasonable and notexcessive.

ConclusionAlthough tax-exempt organizations are not required by law to adopt certain policies and standards ofconduct, the reality is that doing so can only help your organization. Successful nonprofits make bettergovernance a priority, and in doing so improve their performance and results by providing a strongunderpinning and framework from which the organization can grow. There is no one-size-fits-all guide to

governance policies, and each organization will need to take a thorough look at their own specificcircumstances in order to craft the right set of policies to help guide their entity..