"Every organization shall avoid conflicts of interest. Transactions with related parties may be undertaken only if all of the following are observed: 1) a material transaction is fully disclosed in the financial statements of the organization; 2) the related party is excluded from the discussion and approval of such transaction; 3) a competitive bid or comparable valuation exists; and 4) the organization’s board has acted upon and demonstrated that the transaction is in the best interest of the organization."
While certain ECFA standards require external evidence of financial accountability, such as distributing financial statements, Standard 6 deals primarily with internal behavior and decision-making, which are related to personal and usually private intent and integrity.
This standard provides additional assurance to donors and other supporters of the accredited organization that financial transactions are conducted fairly and are in the best interest of the organization and its ministry. As with other standards, compliance with the related-party transaction standard does not guarantee that all activities are in the best interest of the organization. It does provide for a more impartial environment, supporting fairness in decision-making. Another goal of this standard is to provide to accredited organizations some good business principles, helping them to achieve the best long-term results while bringing honor to the Lord.
Anyone who has been involved in the leadership of a nonprofit enterprise or church has most likely experienced a situation in which a donor, board member, or other influential person has tried to conduct business with the organization in such a way as to gain some personal benefit. This can include such things as trying to “pass through” gifts restricted for individuals while obtaining a charitable gift acknowledgement, or promising future gifts only if the organization conducts business with a particular individual or company. Experienced leaders can agree with the maxim that mixing business with charity or other pursuits does not work. Compliance with this standard assists leaders in withstanding such efforts by helping them make the right decision for the organization and themselves.
There is an example from Scripture that should guide us as we seek to work within the spirit of this standard. In 1 Samuel 12, Samuel is near the end of his service as high priest of Israel. He is about to admonish Israel for their disobedience, but before he does he reminds them of his integrity in all his dealings with them.
Samuel said to all Israel, “I have listened to everything you said to me and have set a king over you. Now you have a king as your leader. As for me, I am old and gray, and my sons are here with you. I have been your leader from my youth until this day. Here I stand. Testify against me in the presence of the LORD and his anointed. Whose ox have I taken? Whose donkey have I taken? Whom have I cheated? Whom have I oppressed? From whose hand have I accepted a bribe to make me shut my eyes? If I have done any of these things, I will make it right.” “You have not cheated or oppressed us,” they replied. “You have not taken anything from anyone’s hand.” Samuel said to them, “The LORD is witness against you, and also his anointed is witness this day, that you have not found anything in my hand.” “He is witness,” they said. 1 Samuel 12:1-5
It is on this solid record of faithful, honest service that Samuel has the place of integrity to speak into the lives of his people. Organizations should seek to conduct their work and avoid all conflicts of interest that they may always be able to speak from a similar place of integrity as they lead their organizations.
Related-party transactions and conflicts of interest. While in one sense all related-party transactions could be conflicts of interest, a useful contrast between related-party transactions and conflicts of interest can be helpful to good decision-making. In other words, a conflict of interest is a subset (only a part) of all the possible related-party transactions. While ECFA accredited organizations are to avoid conflicts of interest in their financial transactions, related-party transactions are permissible if they are in the best interest of the organization.
Conflicts of interest areare situations in which a person has a responsibility for promoting one interest, but has a competing interest at the same time. When
one exercises a competing interest over a fiduciary interest, the conflict is realized. Examples of a realized conflict of interest include the following:
An organization’s purchasing manager owns an interest in a travel agency. That manager purchases airplane tickets and lodging reservations for the organization from the agency without obtaining competitive pricing.
An organization’s board member also acts as legal counsel for the organization, recommending legal courses of action that will generate fees to the personal benefit of the board member’s firm without the challenge of a competitive bid or second opinion. To mitigate this somewhat, the organization could prohibit the board member from voting on or approving such engagements and manage the attorneys’ time charges, ensuring only fees for work that is necessary. (This example can apply to other professionals such as accountants, insurance agents, and architects.)
An executive decides on her own frequency of travel and selects the airline through which she personally accrues frequent flier miles. The conflict of interest is not in personally accruing frequent flier miles, but in acting without review or higher approval on both the need for travel and on airline selection—especially if other carrier schedules and fares are more advantageous to the organization.
An employee, especially at a managerial level, pursues extracurricular activities—such as membership on boards and committees or other leadership roles in industry-related associations—so that substantial amounts of time, energy, or resources are diverted from the primary organization in which he or she is employed. In this situation, excessive amounts of extracurricular involvement are driven more by personal ambition than by benefit to the employing organization. While a conflict of interest is not always readily perceived, this type of situation can have serious implications for the employing organization; i.e., lost resources and dissemination of confidential information as a result of frequent contact with peers from other organizations
These examples demonstrate that conflicts of interest are both obvious and subtle. The determining factor in each situation is the potentially inappropriate use of an organization’s resources to benefit some competing interest. ECFA expects that accredited organizations will avoid conflicts of interest in their financial transac.
Related-party transactions are transactions that occur between two or more parties (individuals, businesses, organizations, etc.) with inter-linking relationships. Sometimes these relationships can be benign: an organization buys a computer from a company that employs the wife of a staff member—a staff member with no decision-making ability regarding the purchase. A more significant related-party transaction might occur if an organization purchased insurance coverage through a brokerage firm controlled by one of its board members. Additionally, this example would also constitute a conflict of interest if the purchase was not disclosed, was not approved appropriately, was not made at the best possible price, or was not made in the best interests of the organization.
If an organization’s board member or employee speaks at a function related to the organization—or speaks on its behalf and receives an honorarium—this is a related-party transaction. While the precise facts and circumstances may help determine whether a conflict of interest has also occurred, it may be useful for the organization to adopt a policy regarding the ownership of honoraria.
When determining if a transaction is in the best interest of the accredited organization, all aspects of the transaction should be carefully examined to ensure that no conflict of interest exists, even in subtle forms. The organization should also ensure that the financial transaction makes economic or sound business senseense.
Indeed, some related-party transactions are clearly advantageous to the economic benefit of an organization. Using the previously cited example of purchasing insurance coverage through a brokerage firm controlled by a board member, contracting with the firm may financially benefit the organization. If the coverage provisions are independently or competitively determined, and if the brokerage firm controlled by the board member elects to eliminate or significantly reduce its commission well below competitors’ bids, then it would be in the organization’s best interest to contract with the related party.
ECFA believes that related-party transactions may be in the best interest of the organization in certain circumstances, if they meet certain tests to ensure objectivity and are carefully evaluated to avoid conflicts of interest.
Criteria for allowing related-party transactions. Before undertaking a related-party transaction, an ECFA accredited organization shall meet all of the following criteria for material transactions (those transactions that would be considered consequential to an objective third party) to assure the avoidance of conflicts of interest:
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Related-party transactions must be disclosed to decision makers and resource providers. The financial statements are the primary vehicle for disclosing related-party transactions to external constituents and resource providers. In fact, disclosure of related-party transactions is also required by accounting principles generally accepted in the United States (GAAP). One of the benefits of disclosure through the financial statements (at least to external readers of the financial statements) is that they have to be reviewed and verified by an independent accountant for completeness and veracity.
Related-party transactions should be disclosed to executive staff and the governing board. An essential part of this internal disclosure process is a conflict of interest policy written and distributed within the organization. Often a conflict of interest policy is part of the corporate bylaws and/or a board policy manual.
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To help ensure that the decision to approve a related-party transaction is made in an objective and fair manner, the party that has a related interest should not participate in the discussion or approval of the transaction. The other members of the board or staff involved in the decision should have the freedom to discuss and act on the transaction without any degree of pressure or reticence generated by the related party’s involvement in the entire process. For instance, ECFA expects board decisions involving a related party who is also a board member or executive staff member of the organization to be adequately and appropriately discussed without the related party present or participating.
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A related-party transaction can only be undertaken if there is evidence that the goods or services being procured are the best that can be obtained for the resource commitment (e.g., cost to the institution). While competitive bids are the most common form of determining cost-and-benefit relationships, they are not always available or appropriate. For example, consider the situation of a chief executive officer (CEO) asked to serve on an important board in a distant city. This might thrust the CEO into the national spotlight, could be personally rewarding to the CEO, and could require a substantial investment of time and travel cost to the organization. While competitive bidding has no meaning in this situation, the governing board still needs to make a cost-and-benefit evaluation to determine whether this situation is ultimately in the best interest of the organization.
The primary point of this criterion is to ensure that the organization performs the necessary evaluation and documents its decision to support the reasonableness of the related-party transaction. A formal internal procedure and record may be appropriate to show that a thorough cost-and-benefit evaluation was conducted. This may include the governing board’s review of the information before making a decision.
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Although more subjective in nature, the final criterion is just as important as the previous three. After the governing board has disclosed all relationships, discussed the transaction openly and without bias, and conducted cost/benefit evaluations, it should look at the transaction as a whole and determine the overall wisdom of entering into it, asking questions such as: Will the transaction, when disclosed, raise more questions with external (and internal) constituents or regulatory groups than we can adequately answer? Will we set a precedent, making it difficult to respond negatively to future situations? Does this decision ultimately have the best long-term interests of the organization at heart, or will it give short-term gains only? Since the governing board will be held responsible for the outcome of the transaction, it must exercise the utmost prudence in its evaluation and decision.
Summary. The proper handling of related-party transactions shows integrity in handling some of the most sensitive transactions in the life of an organization. Ensuring that these transactions are always in the best interest of the organization is a fundamental principle.