THE STEVENS SETTLEMENT: GOOD FOR STEVENS, BAD FOR NONPROFIT GOVERNANCE

DATELINE: January 17, 2009, Chicago

As we noted this past Friday, the New Jersey Attorney General settled her lawsuit against the trustees of Stevens Institute of Technology, Harold J. Raveche, and Lawrence Babbio.  Although we have some disagreements with the specific terms of the settlement, overall it is in the best interests Stevens, its students, and the defendants.  Once again, however, an attorney general has squandered an opportunity...

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to plant a firm signpost for other nonprofit boards and their advisors.  Stevens and its students won’t pay the price for this failure, but other institutions and their students may.  That’s what we find most troubling about the settlement.

Overall Assessment.  The process and the resulting settlement follow the typical pattern in regulator lawsuits charging breach of duties on the part of nonprofit directors and officers.  First and foremost, the matter was resolved through settlement rather than through trial.  The lighting rod, Harold J. Raveche, will end his tenure as the university president, although this is happening outside of the settlement.  He will have a limited role as a consultant.  Finally, the institution has religion shoved down its throat in the form of massive governance reforms required as a condition to settlement. 

Settlement Terms:   The defendants admitted no wrongdoing or liability as part of the settlement terms.  With the exception of a requirement that Dr. Raveche repay outstanding mortgage liabilities owed to Stevens, there are no requirements that the defendants incur monetary liability (more about that shortly).  Although Dr. Raveche announced his resignation on the same day that the settlement was announced, that resignation was not required by the terms of the settlement agreement.

By and large, the settlement focuses on governance reforms.  The following are among the more notable reforms:

A.  Full Board Vested with Exclusive Powers.  The board of trustees will now have exclusive power over the university president’s compensation and contract, together with the power and responsibility to approve the salaries of the five other highest compensated Stevens employees.  The board now is required to review financial results at each board meeting and to approve the annual budget, changes in the endowment spending rate, and amendments to the investment policy.  The board also will be required to meet annually with the external auditor and review the management letter from the auditors.  Executive sessions will be held at each meeting where no Stevens employees or officers will be present.

B.  Separation of Oversight from Management.  The university's president will no longer be a voting member of the board, although the president can still participate in a non-voting capacity.

C.  Committee Structure will be Strengthened.  The settlement greatly strengthens and formalizes board committees, recognizing that providing effective oversight is a time-consuming task that requires board work outside of regular board meetings.  Each board committee will be comprised of at least four trustees and two faculty members, which should make members of the faculty happy.  The committees will include audit, human resources and compensation, investment, and a nominating and governance committees.  Each is required to perform the tasks that we would normally expect.  And each is required to adopt a charter, engage in self-evaluations every two years, and maintain minutes.

D.  In-House Counsel.  Stevens is required to hire an in-house counsel, which we would have assumed an organization of Stevens’ size already had.  This is an important aspect of the settlement.  We'd be interested in knowing whether New Jersey's Code of Professional Responsibility applicable to lawyers has a rule that requires counsel to an organization to report out (to a regulator) if the lawyer knows of violations of the law that the lawyer is unable to resolve internally.

 E.  Term Limits.  The agreement imposes term limits on the trustees and committee members.  As regular readers of this column know, we generally oppose term limits of any kind.  If the proper governance structure is in place, there is no need for such limits.  We do acknowledge that such limits are far more justifiable if the governing board is self-appointing, as is apparently the case at Stevens. 

We find the limits imposed by the settlement agreement either peculiar or ambiguous.  The agreement provides that a trustee “having served 12 years on the Board and having reached age 72” cannot stand for re-election.  Does this mean 12 years or having reached 72?  That would make sense, but the conjunctive  “and” suggests that someone who is elected a trustee at age 30 could serve until they reach 72, which is more than 12 years.  We suspect the requirement is disjunctive, but the language leaves much to be desired.

There also is a 15-year limit on the board chair and vice-chair.  Once again, the language leaves much to be desired.  How can there be a 15-year limit on the board chair if there is a 12-year limit trustee terms?  Is the 15-year period in addition to the 12-year period?  We don’t know, but offer two observations.  First, 12- and 15- year limits probably won’t have all that much practical impact.  Second, if the 12-year and age-72 requirements are conjunctive, this provision most likely was written to remove an existing trustee without embarrassing the individual by requiring his or her removal.  

All of this may appear hyper-technical, but there was recent litigation over the interpretation of similar term limits in Maryland.  See Tackney v. United States Naval Academy Alumni Association (May 14, 2009).  Jack Siegel has written a Lexis/Nexis Expert Commentary on the case and the drafting implications, which is available online through Lexis/Nexis.

We also are troubled by the 4-year term limit on committee memberships.  Why, if 12- and 15-year limits are appropriate for trustees, are committee members limited to much shorter periods of time?  This effectively shifts the balance of power in favor the the board chair.

F.  Executive Committee.  The settlement agreement defangs the executive committee, making it impotent.  It is not clear why there even is an executive committee given the limited and advisory role assigned to it by the settlement agreement.  Some may be surprised, but we think executive committees can serve an important function by permitting action to be taken between board meetings.  The trick is to limit the scope of the executive committee's powers.  

G.  Requirement for a Limited Accounting.  The settlement agreement directs that the board will undertake a limited accounting for certain restricted assets.  It is not clear from the settlement agreement what the end product or consequences of that accounting will be.  The agreement does leave open certain claims pertaining to the Taylor Trust, which the parties hope to resolve within five days of the date that the settlement is entered with the court.  Yet, Part D of the agreement provides for a mutual release of claims under the nonprofit corporation act, UPMIFA, UMIFA, and the common law.  So what happens if the accounting determines that there was wrongdoing on someone’s part?

H.  Transparency.  Stevens will be required to post its financial statements, credit rating agency reports, annual budget, Form 990, endowment and investment performance, and key governance documents on its website.  This will permit all stakeholders to keep an eye on Stevens if they decide to take the time.

I.  Adoption of a Gift-Acceptance Policy.  The agreement requires Stevens to adopt a donors’ bills of rights and a gift-acceptance policy.  It is surprising that Stevens didn’t have the latter in place.  The requirement for a donors' bill of rights presumably is being mandated to address allegations that donor-imposed restrictions were ignored.  One question:  By adopting a donors' bill of rights, is Stevens deemed to have conferred standing to bring a lawsuit on donors who believe their interests have been ignored?

J.  Employment of Special Counsel.  James R. Zazzali will serve as special counsel to Stevens for at least 24 months in order to assure compliance with the settlement agreement.

K.  Retention of Governance Consultant.  Stevens is required to retain a nationally recognized board governance consultant to recommend other changes and board training is required for all new board members.

Its What You Don’t Do That Counts.  In view of the allegations in the complaint, we are surprised that the New Jersey Attorney General did not require that the entire board be replaced.  The board was portrayed in the complaint and in some media accounts as being under the influence President Raveche.  We were given the impression that trustees either followed President Raveche’s program or eventually left the board.  If that was the case, we would have cleaned house had we been the attorney general.  It is possible that the term limits were designed to achieve that result without embarrassing people, but we would need to better understand those limits. 

If this matter continues to follow form, a number of directors will voluntarily resign after the dust has settled. This sort of dispute wears on trustees, causing many to reconsider the time they want to devote to the institution.  As we have pointed out in the past, resignations in the wake of controversy can be disastrous from the standpoint of fundraising if board members were selected for "the pot of gold at the end of the rainbow."  Concerns over fundraising may be one reason the New Jersey Attorney General left the board intact.

No Finding of Facts, No Precedent.  The New Jersey Attorney General made very serious and specific allocations involving breaches of duty.  As a result of the settlement, there will never be a final determination of whether the allegations were true. We always are surprised when defendants who have argued that they are innocent agree to settlements that don't make factual findings refuting the allegations, with the result that questions will remain whether there was wrongdoing on their part.

What we find most troubling about the settlement is the failure to find facts.  For that reason, we would have much preferred to see a trial or a settlement agreement that addressed the factual allegations point by point.  

As the law stands throughout the country, there is little precedential guidance clearly illuminating what constitutes a breach by a board or officers of their duties of care and loyalty to nonprofits.  That stems from the fact that attorneys general throughout the country are concerned about the damage that prolonged litigation can do to the nonprofit’s mission.  As a consequence, attorneys general are quick to settle and in many cases will reach a deal with a nonprofit without the public ever knowing that was an issue.

In our view, this practice is misguided.  The regulator resolves the current problem facing the particular nonprofit, but this approach does nothing to prevent other nonprofits from running into trouble.  We have spoken with lawyers who represent nonprofits.  They will advise against conflicts of interest and other actions that can lead to trouble, but their efforts at providing sound counsel often are thwarted when someone on the board asks:  "Can you show me a case where a board has been held monetarily liable for this action?"  When counsel is unable to do so—which is often the case—the board or officers proceed to do what they wanted to do. 

Settlements, particularly when not public, weaken the hands of lawyers and other nonprofit advisors in their efforts to provide wise legal and business counsel.  To see why, assume the allegations in the complaint regarding efforts to influence how the Towers Perrin (now Towers Watson) constructed its comparability study were true.  Had that been litigated and the allegations were demonstrated to be true, compensation consultants would have had precedent that they could have cited to thwart efforts by management to bias their studies. 

To a certain extent, we understand the problem facing state attorneys general.  The bar for holding a board or officer liable is so high that settlement often will be the practical course of action given litigation risks.  Yet, this constant refusal to litigate undercuts the efforts of others who know that a transaction involving a conflict or other action is not in the best interests of the organization.

While we can’t say whether the allegations in Stevens were true, we do note that they were quite specific and the complaint supported the allegations with what struck us as concrete evidence.  For example, at one point in the complaint, the attorney general referred to a provision in an employment contract.  Well, the provision either exists or it doesn't. 

In our view, if the New Jersey Attorney believed the factual allegations set out in her complaint to be true, she had an excellent opportunity to set some important precedent by taking the defendants to the mat.  Instead, she has missed an opportunity to send a clear message to the boards of other nonprofits, whether located in New Jersey or elsewhere.  In short, what was good for Stevens is not necessarily good for the sector as a whole.  

Having said that, we should note that the New Jersey Attorney General has extracted important governance reforms and should be commended for bringing the action.  Many of the reforms would serve other nonprofits well.  In that sense, this litigation is important and no one should ignore the outcome. 

Finally, we should note that the New Jersey Attorney General's apparent reluctance to take the defendants to the mat may be due to concerns that her soon-to-be successor might not pursue the matter with the same vigor.

What Role Did the IRS Play?  While the settlement with the New Jersey Attorney General is public, any action by the IRS is unknown because of strict prohibitions on the IRS regarding disclosure of taxpayer information.  Many of the allegations involved matters that could cause the IRS to invoke the intermediate sanctions under Section 4958.  While the settlement agreement did not impose monetary sanctions on any trustees or officers, we simply don't know whether the IRS hadn't already taken action that resulted in amounts being returned to Stevens.  We will be taking a close look at Questions 25a and 25b of Part III of the Stevens 2008 and 2009 Form 990s to obtain a better sense of the IRS's involvement.

As Senator Grassley continues to grapple with the governance of tax-exempt organizations, he might think about legislation that requires disclosure by the IRS of the results of tax-exempt organization audits when they take place in tandem with state enforcement action.  That way everyone will see the full picture.  Failing such an effort by Senator Grassley, state regulators should require the nonprofit and defendants in such actions to disclose this information as a condition to settlement.

Attorneys Fees.  Looking at the settlement agreement’s signature page, it is obvious that the parties to the suit lawyered up.  The settlement doesn’t mention who will bear what must be the considerable legal fees.  We don’t know, but we suspect that the fees most likely will be borne by the insurance company that wrote the D & O policy, if any, and Stevens rather than the individual defendants.  While we would be the first to recommend to any director or officer that service be contingent on insurance and indemnities, the presence of deep pockets to finance litigation can result in wasteful and prolonged litigation.  Moreover, it may encourage regulators to settle out of fear that additional charitable assets will be wasted if the nonprofit is the deep pocket as a result of indemnities.

Did the Stute’s Silence Cost the Student Body?  We previously have written about the student newspaper’s abysmal coverage of the New Jersey Attorney General’s lawsuit.  That is another lost opportunity.  Had the student newspaper, which certainly had the standing to pursue the matter, demanded answers to hard questions, it might have had some positive influence on the outcome and given voice to the concerns of important stakeholders in this dispute.  The editors of the Stute, however, decided to remain largely silent once they reported the initial story.  Should it therefore come as a surprise that the settlement agreement provides the student body with no new role in governance despite the fact that student dollars provide significant funding?   The lesson: If you ignore the process, it will ignore you.

And so there you have it.  Stevens was last year's nonprofit case of the year.  We can only wonder which institution will receive that honor this year.

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