The Value of a Conflict of Interest Policy

OK. We got the message. The IRS says we should all have written conflict of interest policies even though that doesn't seem to have anything to do with tax status. But we did not fight that point. We generally agreed that the Sarbanes-Oxley-like corporate governance reforms were good, so we willingly wrote and formally adopted conflict of interest policies for our non-profit organizations.

Now what? The IRS seems satisfied if the only thing we've done is write and adopt the policies. The agency so far does not seem to care whether any conflicts actually exist or even if they are

uncovered or resolved by a policy. The mere existence of the policy satisfies the IRS, and we can establish that simply by checking "yes" on the Form 990 every year where it asks whether our non-profit has a conflict of interest policy.

Obviously, the IRS policy makers are hoping the mere existence of conflicts policies will result in fewer conflicts at the outset and quick exposure and resolution of conflicts that arise over time, but they don't have authority to do much more than ask about the policies at appropriate times. So far there are, I think, only three opportunities for the IRS to act in an official way on your conflicts policy. The first time is when you apply for tax-exempt status. The second time is each year when you file your annual information return, the famous Form 990. The third time is as part of an audit. We know the IRS is so strapped for resources that audits are very rare, and even if the number of audits is doubled, you are still not likely to get audited unless your non-profit made the mistake of getting into a major attention-getting scandal recently.

Let's assume your bosses failed to follow your wise legal counsel, and as a result your non-profit got into a terrific mess that drew a lot of press and, therefore, Congressional attention. You get the call that an IRS Exempt Organization Revenue Agent will be auditing your organization, including its governance procedures. You still don't have anything to worry about even if by that time you still hadn't quite implemented your conflicts policy. According to the Governance Check Sheet (Form 14114) that the auditors use, they are going to ask you at most four questions, the first being whether you've got a written policy. You do. The second is whether your policy includes provisions for recusals (presumably from voting by conflicted directors). It almost certainly does. The third asks whether you require annual written disclosures of conflicts from key staff and the board. Of course you do. So far, so good because every question is about what you have on paper, and paper is the one thing you have for sure.

Finally, the fourth question asks whether you've actually used the policy, and then only "during the primary year under examination." It asks only that if any conflicts were disclosed, "was the ... conflict of interest policy adhered to?" That's it. Did you follow your own policy? In other words, the IRS wisely does not attempt to impose its judgment about how any particular conflict is to be handled or even the definition of a conflict. It does not do so because it lacks the authority to regulate the governance of tax-exempt organizations. At most, it can only ask about governance. It can act only when bad governance results in a misuse of the tax exemption.

If your organization is being audited, it is either a random audit or one prompted by a red flag. If you're getting a red flag audit, something bad must have happened involving money, in which case the revenue agent will likely ignore the conflicts section of Form 14114 to focus more on the executive compensation and financial oversight sections. The point is, if you're in the middle of a red flag audit, there is a lot more to worry about than whether your conflicts policy is up and running.

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