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January 2009 |
Advisors and Oversight: A Matter of Trust Bernard L. Madoff is a name that is already inscribed in world history with respect to investing, finance and especially Ponzi schemes. Stories continually occupy print and on-air media detailing new allegations, court claims and losses. Charities are prominent among the many victims of Madoff's Ponzi scheme. For charities, unique problems and issues are presented, which should be considered not only by the victims, but by all individuals who work with charities, whether as a volunteer or for compensation. All charities are managed by a board of directors (sometimes referred to as a board of trustees). Although the management is vested in the board as a whole, each individual director is nevertheless subject to certain duties and standards imposed by state law. In most states, board members must discharge their duties in good faith and with the degree of diligence, care and skill that ordinarily prudent persons would be expected to exercise in similar circumstances. With respect to investing a charity's funds, this means that a board member must consider several factors, including the long and short-term needs of the charity in carrying out its purposes, the charity's present and anticipated financial requirements, the expected total return on the charity's investments, price level trends, and general economic conditions. Since most individuals lack the specific knowledge and expertise to evaluate proposed investments in light of these factors, board members often delegate their investment duties to others who are more qualified to make investment decisions. Generally, most states permit a board to delegate investment authority to its committees, officers, employees or agents (including independent investment managers). Similarly, a board may contract with independent investment advisors, investment counsel or managers, banks, or trust companies to perform these services. Despite the ability to delegate these responsibilities, state law nevertheless requires board members to take affirmative steps to ensure that individuals or entities to whom power is delegated are qualified to exercise such power. In other words, in order to delegate power to someone else, you must first establish that the person to whom you are delegating is an appropriate recipient of the delegation. Furthermore, once the delegation is made, the law requires that the board member take certain steps to oversee the delegatee in order to ensure that the delegatee is acting properly and should continue to exercise the delegated power. Thus, in the case of the Madoff Ponzi scheme, charities could be required to substantiate their decision to select Bernard Madoff as their investment advisor. Many difficult questions may be asked of board members regarding why he and his firm were selected, and, once selected, retained. Failure to provide sufficient evidence of care and oversight in response to these questions could, in certain cases, subject a board member to substantial liability even if the board member is serving in a volunteer capacity. When the board delegates all or part of its investment authority, board members must remember that the board retains ultimate responsibility for the organization's investments. When delegation is properly executed, the law will relieve the board and its members of liability, to a greater or lesser extent, with respect to investments, as long as the board can show that it made the initial selection with appropriate care and has maintained an appropriate oversight and monitoring program with respect to the investments and the persons to whom investment authority has been delegated. The Madoff Ponzi scheme is a harsh reminder of the importance of adhering to the fiduciary duties imposed by state laws. Organizations, particularly those that have found themselves with losses from the Madoff Ponzi scheme, may be well advised to consider a careful review of their current policies and procedures to determine their adequacy. To the extent such policies and procedures can be improved, boards may be well advised to consider doing so. This is yet another important example of why operating a nonprofit can be a tricky business. The laws impacting nonprofit organizations (including family foundations) are complicated. If you are involved with a nonprofit or are thinking of becoming involved with one, make sure you seek experienced skilled professionals to work with you and your organization. The consequences of missteps in administering the organization can extend far beyond the organization. RECENT PUBLICATIONS
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