Editor's note: 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.

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In September 2009, Massachusetts Attorney General Martha Coakley wrote to four nonprofit health insurers in her state — Blue Cross Blue Shield, Fallon Community Health Plan, Harvard Pilgrim Health Care, and Tufts Health Plan — raising questions about financial compensation of board members. She later asked for more detailed information.

Earlier this year, Blue Cross Blue Shield and Fallon voted to suspend board compensation; Harvard Pilgrim and Tufts decided to continue to pay their trustees. Coakley responded that her office "was disappointed."

In April 2011, Coakley announced that she was pursuing legislation banning financial compensation of nonprofits' trustees without state approval. The legislation passed the state senate, but ultimately failed. Coakley continues to pursue the issue, and the bill will be resubmitted.

An Unfortunate History

This debate has its roots in, among other things, a series of board scandals involving high-profile charities.

One egregious example is the Nature Conservancy, which sold supposedly protected land to board members at reduced prices, then allowed highly dubious construction (a swimming pool was classified as a pond, and a residence as a maintenance building). The trustees then made donations to the conservancy based on the full price of the land and wrote it all off their taxes. This was revealed in a 2004 Washington Post exposé.

Other situations have involved overly large, too complex or inattentive boards. The American Red Cross, for example, has a 50-member board, many of whom are political officeholders. As Dan Busby, president of the Evangelical Council for Financial Accountability, wrote in the Christian Leadership Alliance newsletter, "These individuals realistically did not have the time to give to the charity. This structure is a textbook formula on how a charity will struggle 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.

Sen. Charles Grassley (R-Iowa), who has an acute interest in nonprofits, took the Red Cross to task, citing former IRS commissioner Mark Everson: "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. 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."

At the Smithsonian Institution, CEO Lawrence Small ran up huge and questionable expenses and violated many of the organization's rules for executive behavior; the board looked the other way. He resigned in 2007. As Pablo Eisenberg wrote in The Chronicle of Philanthropy, "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 Mr. Small was a terrific fundraiser. Now, there's a rationale for unethical behavior."

Small wonder that the nonprofit sector is under scrutiny. John H. Graham IV, president and CEO of the American Society of Association Executives, has 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 would have applied to most of the state's hospitals, that was not its focus; insurers were.

There were two issues. One was the $11 million payout to departing Blue Cross Blue Shield CEO Cleve Killingsworth, who had presided over fiscal losses and had sat on 14 corporate boards, several of which paid him. Coakley is investigating the payout. In July, the plan announced that it would refund $4.2 million — the equivalent of the severance part of Killingsworth's package — to policyholders.

Coakley's other question is why each Blue Cross trustee was paid between $56,200 and $84,463. Trustee Robert J. Haynes, president of the state AFL-CIO, who, ironically, has often criticized exorbitant executive compensation, told the Boston Globe, "The cost of health insurance is not affected very much. On $13 billion in revenue, it's like pennies a year."

Trustee Paul Guzzi, president of the Greater Boston Chamber of Commerce, who was being paid $84,463, argued that "there's a lot of responsibility for directors." He said board members attended more than two dozen meetings in 2010.

Massachusetts Hospital Association President and CEO Lynn Nicholas says her organization strongly opposed the proposed state oversight legislation because it represented state intrusion into local board decisions, and also because new IRS rules require much greater transparency and thus accomplish many of Coakley's aims.

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."

How Widespread Is the Practice?

According to Guidestar USA, which monitors nonprofits, only 3 percent of charities across the country pay some or all board members.

A recent American Hospital Association survey of 1,000 CEOs and 461 board chairs found that 88 percent reported that no board members received compensation; 10 percent paid trustees per meeting attended; and 3 percent paid them an annual fee.

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

The Governance Institute's 2009 biennial survey of hospitals and health systems found that 9.6 percent of respondents compensated the board chair; 9.1 percent compensated all directors; 1.1 percent paid some of them, such as officers or committee chairmen; and 89.8 percent did not pay any of them.

Government Involvement

Although the Massachusetts situation has been the highest-profile instance to date, it is not unique; there have been rumblings in both New Jersey and Oregon about nonprofit trusteeship issues.

And although the IRS did beef up reporting by nonprofits, its guidance on this issue remains vague: "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 the new 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."

This should give pause to any boards that are voting compensation for themselves without outside oversight.

So Is It Justified?

Those who support the practice say that in order to attract the best directors, they must pay for their time. But the vast majority of trustees, who serve voluntarily, might be tempted to respond, "And what am I? Chopped liver?"

The argument is also often put forth that some board members bring specific expertise to the organization, and their skills should be rewarded. Critics respond that if such expertise is required, those who possess it should serve 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.

And board diversity also comes into play. With many providers struggling to create more diverse leadership teams, the question is 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. If board service actually costs a trustee money, should she not be compensated?

In a white paper on the issue, the American Society of Association Executives offers many pros and cons. The "pros" include promoting board diversity by making it easier for people of lesser means to serve, encouraging better attendance at meetings, and reinforcing accountability. The "cons" include donors' belief that their money should be used for the mission, not to pay trustees; that if others volunteer for the cause, so should board members; and that compensation could discourage both volunteerism and donations.

Paul Neumann, general counsel at Trinity Health, in Novi, Mich., told Crain's Detroit Business last year, "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.

But Rick de Filippi, at the time a trustee of the Cambridge (Mass.) Health Alliance, who was not compensated, told Hospitals & Health Networks in 2006, "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."

Ten Questions

So here are 10 questions that nonprofit health care board members — compensated or not — might ask:

  • 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 indirect 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.

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.