A substantial majority of the board of a public charity, usually meaning at least two-thirds of its members, should be independent. Independent members should not: (1) be compensated by the organization as employees or independent contractors; (2) have their compensation determined by individuals who are compensated by the organization; (3) receive, directly or indirectly, material financial benefits from the organization except as a member of the charitable class served by the organization; or (4) be related to anyone described above (as a spouse, sibling, parent or child), or reside with any person so described.
Board members who are not encumbered by having a personal financial interest in the organizations they oversee will generally find it easier to exercise their “duty of loyalty” that requires that they put the interests of the organization above their personal interests and make decisions they believe are in the best interest of the organization. Organizations are expected to make a reasonable effort to determine which of their board members are “independent” based on the IRS definition, and to report the number of such members on the annual information returns they file with the IRS. In addition, most nonprofits are required to report whether any of their officers, directors, trustees, or key employees had a family or business relationship with another individual in one of those leadership positions. The IRS does not consider board members to lack independence simply because they contribute to the organization, receive financial benefits from the organization as a member of the class served by the organization, are reimbursed for expenses associated with fulfilling their board responsibilities, or are compensated for their work as a board member. (For a more complete discussion of board compensation, see principle 20.)
The founders of a nonprofit corporation sometimes initially turn to family members and business partners to serve on its board of directors, but interlocking financial relationships can increase the difficulty of exercising the independent judgment required of all board members. It is therefore important to the long-term success and accountability of charitable organizations that a sizeable majority of the individuals on their boards be free of financial conflicts of interest. Some states laws establish a minimum number of independent members for nonprofit organizations boards.
Some charitable organizations may not find it appropriate or feasible to adopt this principle. This includes private foundations, certain medical research institutions, and certain institutions that operate under specific legal restrictions regarding self-dealing transactions, and other charitable organizations whose articles of incorporation or trust instruments include special stipulations regarding board composition. For example, an organization established under the auspices of a religious institution may be required to include clergy or other paid representatives of that institution on its board. A supporting organization may be required to have representatives of its supported organizations on its board.
When a charitable organization determines that having a majority of independent board members is not appropriate, the board and staff should evaluate their procedures and meeting formats to ensure that board members are able to fulfill their responsibilities to provide independent, objective oversight of management and organizational performance.