Earlier this year, Massachusetts Attorney General Martha Coakley sought to ban financial compensation of nonprofit board members without state approval. Although the bill failed, both Coakley and her legislative allies promise that the fight is not over. What can nonprofit health care organizations learn from this?

It really should not have been a surprise, given recent history.

In September 2009, Massachusetts Attorney General Martha Coakley wrote to four nonprofit health insurers in her state — Blue Cross and Blue Shield, Fallon Community Health Plan, Harvard Pilgrim Health Care, and Tufts Health Plan — raising questions about financial compensation of members of their boards. In November of that year, her office "restated the basis of our concern and formally requested review of this practice," asking for documents from the insurers by March of this year.

About the time the information was due, Blue Cross and Blue Shield and Fallon voted to suspend board compensation indefinitely, whereas Harvard Pilgrim and Tufts decided to continue to pay their trustees. Coakley responded to the latter action by saying that her office "was disappointed in their decisions and believe they are ill-advised."

In April 2011, Coakley announced that she was pursuing legislation banning financial compensation of trustees of nonprofit organizations without state government approval. The bill gained momentum when state Sen. Mark Montigny (D-New Bedford) attached it to budget legislation that was passed by the Massachusetts Senate in June. The House and Senate budget bills then had to be reconciled and, in the process, the board compensation provision was eliminated. But Coakley has made it clear that she will not let this issue go, and Montigny plans to submit a stand-alone version of the bill in the fall.

An Unfortunate History

The debate over nonprofit board compensation has gone on for decades. And there are reasons for that. Paramount among them is a series of board scandals (sometimes accompanied by executive compensation scandals) involving very high-profile charitable organizations.

Perhaps the most egregious were the questionable doings at the Nature Conservancy — the wealthiest environmental charity in the world — that were revealed by a series of Washington Post exposés in 2004. The conservancy, among other things, sold land that donors had assumed was protected to board members at reduced prices, then allowed highly dubious construction on that land (a swimming pool was classified as a pond, and a residence as a maintenance shack). The board members then made donations back to the conservancy based on the full price of the land — which should not have been sold to them in the first place — and wrote it all off their taxes.

I had been a member of the conservancy for decades. I terminated my membership and have not renewed it.

No one involved in this mess has ever been punished in any significant way.

There have been other scandals involving directors of nonprofits, although most had to do with their role in excessive executive (not board) compensation, trustees who just weren't paying attention and odd board composition.

The American Red Cross, for example, has a 50-member board (established by its Congressional charter), many of whom are required to be political officeholders. As Dan Busby, president of the Evangelical Council for Financial Accountability, wrote in the Christian Leadership Alliance newsletter earlier this year, "These individuals realistically did not have the time to give to the charity and therefore rarely attended meetings or became closely involved in the oversight of the CEO. This structure is a textbook formula on how a charity will struggle to meet its mission when a board is too large and disengaged."

The Red Cross's controversial redirection of some funds that had been donated specifically to aid victims of the 9/11 attacks and Hurricane Katrina could be attributed, in part, to its "large and disengaged" board.

As most health care folk know, Sen. Charles Grassley (R-Iowa) has an acute interest in how nonprofits behave, and he took the Red Cross to task, citing a letter he had received from former IRS commissioner Mark Everson in 2005, which read, in part:

"An independent, empowered, and active board of directors is the key to insuring [sic] that a tax-exempt organization serves public purposes and does not misuse or squander the resources in its trust. Unfortunately, the nonprofit community has not been immune from recent trends toward bad corporate practices. Like their for-profit brethren, some charitable boards appear to be lax in certain areas. Many of the situations in which we have found otherwise law-abiding organizations to be off-track stem from the failure of fiduciaries to appropriately manage the organization."

(Ironically, in 2007, Everson was appointed president and CEO of the American Red Cross, only to be dismissed six months later after it was learned that he had engaged in an improper personal relationship with a subordinate.)

Then there was the Smithsonian Institution — 70 percent of whose budget is funded by taxpayers — whose CEO, Lawrence Small, ran up incredible expenses, squandered a small fortune on dubious activities, and generally violated most of the organization's rules for executive behavior while the board smiled benignly and ignored what he was doing. He resigned in 2007 without any penalty.

As Pablo Eisenberg of Georgetown University wrote in The Chronicle of Philanthropy in April of that year, "The audit committee of the Smithsonian's board … was willing to overlook Mr. Small's unauthorized expenditures and then write new rules to legitimize them. Roger W. Sant, the committee's chair … seemed to excuse these infractions by saying that, after all, Mr. Small was a terrific fundraiser. Now, there's a rationale for unethical behavior."

There have been many other disappointing situations, often featuring rubber-stamp boards allowing (or enabling) CEOs to garner huge salaries and pile up massive expenses, including the proverbial first-class airfares and expensive resort stays. Sometimes executives also got cut-rate loans from the charities.

These are, generally speaking, not the types of activities for which supporters of charitable entities expect their donations to be used.

So it should not surprise anyone that the nonprofit sector is under scrutiny by Congress, state governments, the IRS, watchdog groups and others. In 2005, at the time of the Nature Conservancy scandal, John H. Graham IV, president and CEO of the American Society of Association Executives, said, "You have a general erosion of trust in institutions that 40 years ago people trusted without question."

Showdown in Massachusetts

Although the Massachusetts bill, had it passed, would have applied to the majority of the state's hospitals (which are among 22,000 nonprofits based there), that was not its focus; insurers were.

There were two separate issues. One was the $11 million payout to departing Blue Cross and Blue Shield CEO Cleve Killingsworth, who had presided over fiscal losses and complaints about the plan's management, and who at one point or another sat on 14 corporate boards, several of which provided him with financial compensation. Coakley launched an investigation of the payout, citing recent significant plan premium increases and the appropriateness of its spending money in this manner. In July, the plan announced that it would refund $4.2 million — the equivalent of the severance part of Killingsworth's goodbye package — to policyholders. According to Robert Weisman in the Boston Globe on July 7, "The rebate works out to less than $1.50 per member."

Coakley also had been questioning the plan's compensation of its board members for years, noting that each trustee was paid between $56,200 and $84,463 annually. At least two members of the board defended the arrangement. One is Robert J. Haynes, president of the state AFL-CIO, who, ironically, long has criticized what he sees as exorbitant corporate executive compensation. "The cost of health insurance is not affected very much," he told the Globe. "It's about $1 million that board members get paid. On $13 billion in revenue, it's like pennies a year." (One might be tempted to say that's not the point, but let's not go there.)

Paul Guzzi, president of the Greater Boston Chamber of Commerce and another plan trustee, who was being paid $84,463 per year, argued that "because it's a $13 billion company, there's a lot of responsibility for directors." He added that board members attended over two dozen meetings in 2010.

But insurers do not pay the highest nonprofit compensation in the state. That honor apparently goes to the George I. Alden Trust of Worcester, which pays its four trustees $130,000 each annually. However, the trust, which makes small grants to private schools and YMCA branches, apparently has no staff, so the directors actually run the organization. Some other foundations, which do have staff, still provide lavish compensation to their board members.

Massachusetts Hospital Association (MHA) president and CEO Lynn Nicholas reports that her organization strongly opposed the Coakley-Montigny legislation, on the grounds that it would have represented state intrusion into local board decisions. Also, the MHA's position was that new IRS rules require greater transparency in terms of executive compensation and thus meet the goals of the measure.

She also says that "the time-honored practice of [nonprofit hospitals and health systems] not paying trustees will prevail. They want to serve, even if it's a lot of work. It's an honor. But in the current situation, even if hospitals aren't the issue, it would be a shame if they got caught up in it." She adds that "insurers are different—they are not community assets in the same way that hospitals and health systems are—and they may well need to pay trustees."

Nicholas adds that potential conflicts of interest on the state Blue Cross and Blue Shield board are more of a concern than compensation. Labor and powerful employers are well represented, but providers and patients are not.

How Widespread Is the Practice?

There are many examples, in Massachusetts and elsewhere, of nonprofit board members being handsomely compensated but, according to Guidestar USA which monitors nonprofits nationwide, only 3 percent of charities across the country pay some or all board members.

According to a recent American Hospital Association (AHA) survey of 1,000 CEOs and 461 board chairs, 88 percent reported that no board members received compensation; 10 percent paid trustees per meeting attended; and 3 percent paid them an annual fee. It was more common to compensate trustees of health systems than those of individual hospitals. Nicholas says that's only logical: "As systems get larger and larger and cross state lines, given the board members they want to attract and the time and travel requirements involved, can they continue not to compensate trustees?"

The AHA does not have a formal position on the issue.

The Governance Institute's 2009 Biennial Survey of hospitals and health systems (the 2011 edition is still in the field) found that 9.6 percent of respondents compensated the board chair. Only 4.7 percent of independent hospitals did so, whereas 12.7 percent of systems and 19.1 percent of government-sponsored hospitals did. In addition, 9.1 percent of respondents said that they compensated all board members; 1.1 percent paid some of them, such as officers or committee chairmen; and 89.8 percent did not pay any of them.

On the other hand, a 2004 survey of nonprofit health insurers in the Northeast conducted by Mercer Human Resources Consulting found that 89 percent paid an annual retainer to the board chairman, 89 percent also paid fees to chairs for attending meetings, 25 percent paid for committee membership and 88 percent paid for meeting attendance. The median annual board retainer was $25,000 for the chairman and $11,250 for other board members.

Clearly, the practice is far more common among insurers than among providers.

Government Involvement

Although the Massachusetts situation has been the highest-profile instance to date, it is not unique. Sen. Grassley continues to question nonprofits' policies and practices, and there have been rumblings in both New Jersey and Oregon about board compensation and other trusteeship issues.

And although — in part because of pressure from Grassley — the IRS revamped its Form 990 to beef up reporting by nonprofits, its guidance on this particular issue remains rather vague. IRS advice reads, "A charity may not pay more than reasonable compensation for services rendered … . Although the Internal Revenue Code does not require charities to follow a particular process in determining the amount of compensation to pay, the compensation of officers, directors, trustees, key employees, and others in a position to exercise substantial influence over the affairs of the charity should be determined by persons who are knowledgeable in compensation matters and who have no financial interest in the determination."

The guidance goes on to point out that Form 990 requires information about how compensation decisions were reached, and whether that included "a review and approval by independent persons, comparability data, and contemporaneous substantiation of the deliberation and decision." Compensation data for "certain officers, directors, trustees, key employees, and highest compensated employees" also are required.

It's not exactly chapter-and-verse instruction, but it should give pause to any boards that are voting compensation for themselves without outside oversight.

And, of course, there is the American Competitiveness and Corporate Accountability Act of 2002 (where do they come up with these titles?), universally known as Sarbanes-Oxley, which puts some strictures on board compensation, as well as encouraging transparency.

So Is It Justified?

The arguments for and against nonprofit board compensation are many and varied. Those who support the practice say that in order to attract the best directors, they must pay for their time. Of course, the vast majority of trustees, who serve voluntarily, might be tempted to respond, "And what am I? Chopped liver?" It would be fascinating to conduct a study of financial health, patient satisfaction and clinical outcomes comparing hospitals and health systems that pay trustees and those that don't. I suspect that, although differences would inevitably be found, they would have nothing to do with whether board members were being compensated.

Also, the argument often is put forth that at least some board members bring specific expertise to the organization, and their special skills should be rewarded. Most certainly, service on the audit committee or in quality or ethics oversight is highly demanding, time-consuming and sometimes exhausting, especially if the Joint Commission is about to drop by or outcomes data are going to be posted on the Internet by the state. Critics counter by saying that if such specific expertise is required, those who possess it should be serving as consultants, not as holders of fiduciary responsibility for the organization.

There is also a conflict of interest that is rarely mentioned. Serving on multiple boards at, say, $80,000 to $100,000 a year each would provide a generous income — generous enough that one might be inclined not to rock the boat, in order to keep the money flowing. Is a compensated trustee less likely to blow the whistle on excessive executive salaries, sexual harassment in the C-suite or financial misdeeds? Maybe; maybe not. But the temptation is obviously present.

The issue can become more vexing when board membership diversity comes into play. One way to ensure that the question of compensation won't come up in the first place is to appoint only millionaires to be directors. Bill Gates really wouldn't need another $80,000, after all.

The problem is, in an age of greater public scrutiny of nonprofits overall and health care providers in particular, such a policy likely will result in an all-white, largely all-male, privileged-class board. With many provider organizations struggling mightily to create more diverse leadership teams, including the one in the board room, the question becomes whether a hands-on, small-business owner or a single, female, freelance financial consultant who has two small kids can afford to take time off work to serve. Yes, meeting hours can be adjusted, child care can be provided and other actions can be taken, but if board service actually costs a middle-class trustee money, should she not be compensated?

In a white paper discussing the issue, the Knowledge Center of the American Society of Association Executives offered many pros and cons. The pros in favor of compensating trustees included:

  • promotion of board diversity by making it possible for some people to serve who could not afford to do so otherwise;
  • promotion of professionalism rather than amateurism;
  • attraction of the most qualified and able individuals;
  • awarding "in a tangible way" valuable personal time and contributions;
  • promotion of more risk taking;
  • better attendance at meetings;
  • board members who are more accountable for their performance.

The arguments against compensation included:

  • nonprofit trustees are thought of as volunteers;
  • donors and members expect their money to be used for the cause, not paying directors;
  • if others are willing to give their time to the mission, trustees should do the same;
  • there are no stakeholders;
  • nonprofits are supposed to be pursuing a mission;
  • compensation could discourage volunteering;
  • compensation could discourage charitable giving;
  • boards hold fiduciary responsibility for the organization's funds, and compensation thus presents a potential conflict of interest;
  • paid board members might as well be staff;
  • boards will not want to risk losing the status provided by the Volunteer Protection Act of 1997, which affords some protection against lawsuits to volunteers who serve charities.

Paul Neumann, general counsel at Trinity Health, in Novi, Mich., told Crain's Detroit Business last year that there is also an issue of courage: "I really do see that straight boards that are not compensated think of themselves as volunteers and are really less likely to take on a CEO or a difficult problem." Of course, the reverse could be true as well, as in the don't-rock-the-boat argument. Trinity Health compensates its board members.

Rick de Filippi, a trustee of the Cambridge (Mass.) Health Alliance, told Hospitals & Health Networks in 2006 that there is a very practical reason not to compensate trustees: "I think if I went into my congressman's office, and I knew him pretty well, and he knew I was making $25,000 per year as a trustee, he would see me more as a hired gun, not as an advocate for the community. If you are drastically underpaid, you can carry the torch pretty well."

People on both sides of the issue often feel very strongly about it. So do government interests and watchdogs. And another scandal or two might provoke other states to follow Massachusetts' lead. One of the saddest things about how policy is made in the United States is that often it is the worst offenders who define the debate. On the other hand, shining light on questionable practices is never out of order. As Pablo Eisenberg wrote in the Chronicle of Philanthropy in 2007 about the excesses at the Smithsonian, "Let's hope [this] episode spells the beginning of an effort to bring transparency to all nonprofits and more integrity to the way they are managed."

10 Questions

So here are 10 questions that nonprofit health care board members — whether they are compensated or not — might ask themselves and each other:

  • Should our board members be compensated?
  • If so, should all of them be compensated, or only some? In that case, will the members who are not paid resent it?
  • What would be the proper approach — an annual fee, per meeting or some other way?
  • What would be appropriate compensation, and who should determine that?
  • Are our policies for nondirect compensation (reimbursement of travel expenses, payment of the costs of attending trustee education conferences, maybe a golf outing) reasonable?
  • Do we have effective conflict-of-interest policies in place for our board, and are they enforced? Do these policies cover professional services, contractual relationships with vendors or others, and potential sale or conversion of our organization?
  • If trustees are compensated, how can the board prevent a situation in which some members are afraid to raise difficult questions that might lead to their being forced to leave the board and lose the income?
  • If we decide that compensation is inappropriate, should we allow exemptions for potential board members who are lower-income or self-employed, or otherwise would experience financial hardship if they agreed to serve?
  • Are our board compensation policies sufficiently transparent? Is all compensation included in the annual report, on our website and in communications with the community? Are we in accordance with federal and state law in this regard?
  • Would our compensation practices pass the sniff test? How would they play on the evening news, in the papers or on investigative websites? Can we defend what we are doing?

Most boards can answer most or all of these questions satisfactorily. But those that cannot should take pause and understand the stakes, because people — many people — are watching.

*Compensatory justice is an ethical principle that supports making up for previous wrongs by giving priority to those whose predecessors suffered discrimination or other injustice. Affirmative action programs are an example of this principle. I just couldn't resist using it as a pun for the title of this piece.

Copyright © 2011 by Emily Friedman. All rights reserved.

Emily Friedman is an independent writer, speaker and health policy and ethics analyst based in Chicago. She is also a regular contributor to H&HN Daily and a member of Speakers Express.

The opinions expressed by authors do not necessarily reflect the policy of Health Forum Inc. or the American Hospital Association.