Avoiding Conflicts of Interest on a Board of Directors

Whether it’s a commercial entity or a non-profit organization, nearly every director that serves on a board has an outside level of interest in the organization’s business. That’s a good thing from the perspective that board members share their areas of expertise with the rest of the board. It’s a bad thing when a board member uses a position on the board to make a financial gain as a direct result of the board seat. Unresolved conflicts of interest pose the individual board member and the organization at risk of sanctions from the IRS. It’s always best to avoid conflicts of interest. The best way to do that is by having a conflict of interest policy. Boards should also make sure that board members understand the types of situations where they may be at risk of a conflict and how to respond if one exists.

Defining a Conflict of Interest

A conflict of interest is a transaction or arrangement that benefits an officer, board member, or employee on a personal level. People other than board members may also present a conflict of interest, including board members who are related to employees, immediate relatives of board members, and dual-capacity individuals (a person who is an employee that also serves on the board.)

Let’s look at a couple of examples:

Example #1: A board member works as an insurance agent outside of duties on the board. The organization places their commercial insurance policies with the insurance agency where the board member works full time. The insurance agency pays the insurance agent a commission for all new business that the agent brings into the agency. The agency paid a commission to the agent for the board bringing their insurance policies to the agency. In this situation, the insurance agent has directly profited from his relationship on the board.

Example #2: A board member serves on a board of directors for an organization that manufactures small kitchen appliances. The board member sees that this is a profitable market and uses the knowledge that gained from board experience to start up a company that manufactures the same types of products. In this situation, the board member is now in direct financial competition with the organization that he serves on the board of directors. It would be extremely difficult for him to make unbiased decisions as a board member.

Conflict of Interest Statement

An excellent example of a conflict of interest statement reads something like this:

The authors whose names are listed immediately below certify that they have NO affiliations with or involvement in any organization or entity with any financial interest (such as honoraria; educational grants; participation in speakers’ bureaus; membership, employment, consultancies, stock ownership, or other equity interest; and expert testimony or patent-licensing arrangements), or non-financial interest (such as personal or professional relationships, affiliations, knowledge or beliefs) in the subject matter or materials discussed in this manuscript.

Conflict of Interest Policy

Conflicts of interest are likely to arise, so it’s important for boards to have a plan for how to address them when they surface. Every set of bylaws should include a conflict of interest policy. The IRS Form 990 asks about whether non-profit organizations have a written conflict of interest policy. It also asks how the board determines if a conflict exists and how the board manages conflicts.

Boards should require that anyone who has, of thinks they may have, a conflict of interest to disclose the conflict publicly. Board members with conflicts of interest should abstain from voting on any matters where there is a conflict or potential conflict of interest. A sample of wording in the bylaws should include some or all of the following components:

• Purpose
• Definitions
• Procedures
• Violations
• Recording in the minutes
• Compensation
• Annual statements
• Use of outside experts

Managing Conflicts

It may be helpful to take a look at how conflicts of interest could effectively be managed in the examples stated above:

Example #1: The insurance agent could refuse to accept a commission or any other financial compensation for any insurance policies that the organization places with the board member’s employer. The board member would also disclose the conflict publicly to the board and abstain from voting on any matters related to the board’s interactions and decisions with the insurance agency or policies. If the board member abstains from a vote regarding this matter, it should be recorded as an abstention in the minutes.

Example #2: In this case, there is a direct conflict of interest which can only be resolved by the board member resigning from his position on the board or dissolving his new small appliance business.   

As part of on-going board development, it’s helpful for boards to set aside time, annually, for discussing hypothetical situations where a conflict of interest could occur. Members could role-play the situation and then discuss the situation as it pertains to their organization’s conflict of interest policy and statement. The discussion should include how the board would manage the potential conflict so that they are better equipped to handle a conflict of interest when it actually occurs.

The keys to avoiding conflicts of interest are having statements and policies for managing them and creating awareness for potential conflicts. Because of the negative consequences to the organization, each board member has a responsibility to identify and address potential conflicts.