Enron's Downfall Offers Many Lessons for Charities
By Henry Goldstein
Reprinted with permission from The Chronicle of Philanthropy, February 2002
What can American charities learn from the Enron debacle? Charity leaders might look at the collapse of Enron and think that it is simply a business story, perhaps one that reminds them why they don't work in the corporate world. But the situation also offers several important lessons for the nation's nonprofit organizations.
The most important one is that governance counts. Enron's board was supposed to represent the interests of all Enron shareholders. Charity boards are entrusted with the task of acting, first, in the public interest, as the stewards of funds and other assets. The board not only sets the ethical tone, but also has an obligation to make sure the charity it serves lives up to the highest ethical standards.
Boards also have an obligation to avoid conflicts of interest. Not only should directors of nonprofit organizations serve without pay, they also must step well away from even a perceived conflict. And that's where many boards risk trouble.
It is not enough for board members to recuse themselves from voting on matters in which they have a real or potential financial interest. That is a wink-and-a-nod approach that happens all too often. Clearly and simply, board members, their employers, their relatives, and any others to whom they have close ties should not benefit financially from board service.
Lawyers serving on boards should not be paid, nor should partners in their law firms; that is not arm's length. Brokers and other financial advisers, insurance agents, contractors, anyone offering goods or services should not be permitted to benefit directly or indirectly from being a board member.
The conventional wisdom is that a nonprofit board's chief task is to hire and oversee the chief executive. True enough. But as the Enron meltdown shows, the role of the outside auditor is critical, and almost as important as selection of the chief executive officer. In the charity boardroom, selection of the outside auditor is often left to the chief executive and rubber-stamped by the board. Though even a rubber stamp leaves an impression, the board should not be quick to cede that decision to staff members because many nonprofit organizations are not on top of their finances. Timely reporting, proper accounting, and intelligible numbers seem to elude many charities.
Boards rightly grumble because the financial information they need to make good decisions is not available sufficiently in advance of board meetings; and even sophisticated business people have trouble reconciling the general accounting principles they understand with arcane “fund accounting,” the bedrock of nonprofit bookkeeping. Though that is slowly giving way to modern practices, many charities have not yet made a full transition. Furthermore, accounting practices at higher-education and health-care institutions are still murky and frustrating to many trustees, because clarity, comparability, and transparency are often lacking.
Tardy financial reporting blindsides trustees, and often results in nasty surprises. A good accountant will attach a letter to the audit effectively telling the nonprofit organization to clean up its act. All of that assumes that the charity's board is paying attention and understands the information it does receive.
Since that doesn't happen as often as it should, donors and others have come to expect government and professional associations to step in.
Despite the existence of the Securities and Exchange Commission, the Financial Accounting Standards Board, other federal and private overseers, state regulators, trade association ethics committees, and so on, Enron went its way unchecked.
Monitoring of corporate behavior has been shown to be weak, but oversight of charities is even less rigorous. State registration is little more than a nuisance and a minor expense of doing business. Except in the most egregious instances, governments do little to enforce the laws that do exist. Even at the federal level, only a small number of charity informational tax returns are audited. Some experts have long called for a charity version of the SEC to rectify the problem, but that idea is about as popular as the metric system. Of course, one could argue that, given the scandals at Enron and other corporations, an SEC clone may not be much of a solution.
The public corporation, beholden to stockholders — whether the board of directors serves them properly or not — is something of a check on the most outrageous behavior. Plenty was known about Enron before it collapsed. But charities are not publicly held, don't offer stock, and lack sufficient accountability to donors, employees, clients, and other stakeholders.
Like Enron's books, the annual financial reports of some charities easily conceal as much as they reveal — excessive compensation, unreasonable expenses, higher fund-raising costs than shown, and conflict of interest among board members, to name the more common sins.
The admonition to give wisely is a bit misleading, because so little hard information is available to the consumer except through direct personal knowledge. Thus, the role of the charity board is even more critical, because it is the public's only real protection. Most boards, in my experience, are made up of people who want to do the right thing, and most nonprofit chief executives and staff members are honorable and ethical. But unhappily, some are corner-cutters, moral misfits, and, in a few cases, outright crooks.
A nonprofit board must ensure legal and ethical behavior without taking over the charity it governs. The most difficult conflict of all is the exquisite tension — some of it healthy, some not — that arises between board and chief executive over who's in charge.
Karen Brooks Hopkins, chief executive officer of the Brooklyn Academy of Music, puts it rather well: “We are staff-led, and board-advised.” And so it should be.
In these hard times, every charity should re-examine its behavior for potential ethical breaches, and ensure that it is meeting its obligations to the public and acting in ways that reflect the ideals that created it in the first place.
Henry Goldstein, president of the Oram Group, a fund-raising consulting company in New York, is a regular contributor to these pages. Click here to send an email.