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Lessons for nonprofits from Smithsonian audit

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By Michael I. Sanders

Though it remains unclear whether the Senate’s swift actions in response to the recent Inspector General’s audit of the Smithsonian Institution are a sign of things to come, there is no doubt that nonprofit compensation packages and governance structures have been subject to scrutiny of late.

And Congressional outrage over excesses at the Smithsonian offer several lessons for the rest of the nonprofit community.

When it comes to compensation, recent figures from the IRS show that only 51 percent of public charities attempt to satisfy its procedural test for “reasonableness.”

In light of the Smithsonian situation, it is now even more important that nonprofits ensure that:

* Compensation committees are composed of board members who have no personal stake in the compensation being determined.

* Comparability data used in assessing the compensation package should include at least three similar positions in similar organizations, expert compensation studies, or other relevant data.

* Documentation supporting the governing body’s decision should be maintained, including the term of the approved transaction; the date approved, the members of the decision-making body present during the debate and who voted on it; the comparability data that was used and how it was obtained; and any actions by members of the decision-making body having a conflict of interest

Several commentators have also raised questions about the Smithsonian’s board of governors, stemming from the fact that it approved former Director Small’s expenses and compensation package.  They point to the board’s composition as a factor in this, noting its high-profile members may not have had the time necessary to effectively manage the organization.

In this regard, boards should consist of directors who have both the time and the ability to effectively administer their responsibilities.

Boards of directors should also evaluate their current practices to ensure that directors are appropriately exercising their duties of care, loyalty, and obedience as they oversee the programmatic and fiscal operations of the organization.

It is also advisable to conduct a review of governing documents to ensure they provide effective guidance and reflect the requirements of state law.

These governing documents include the articles of incorporation, bylaws, mission statement, and policies on conflict of interest, compensation and expense practices.

There is no doubt that nonprofits today face an environment of heightened compliance scrutiny.

High-profile cases, such as the Smithsonian Institution’s case, should serve as a warning to others about the pitfalls that lie ahead for those that do not take steps now to review compensation and governance procedures, at a minimum.

Michael I. Sanders chairs the Tax Practice Group at Powell Goldstein LLP in Washington.  He can be reached at msanders@pogolaw.com or 202.624.7308.

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