• August 1, 2014

Divided Loyalties

One-fourth of private colleges do business with trustees' companies. Whose interests come first?

Divided Loyalties Boardroom

Image Source, Punchstock

Trustees are a university's ultimate decision makers. Whether approving a building project or directing endowment money, they profoundly affect everyone on the campus. In making those choices, trustees are supposed to be concerned only with what is best for the institution.

But what happens when a trustee also has a business relationship with the university?

A Chronicle investigation of 618 private colleges found that one in four have financial ties with trustee-affiliated companies. These relationships are common at both small liberal-arts colleges and large research universities. The connections, ranging from a few thousand dollars' worth of business to multimillion-dollar contracts, involve banks, law firms, construction companies, and insurance conglomerates.

In Pennsylvania, for example, six universities have contracts with PNC Financial Services Group even though bank officials serve on their boards. At Bowdoin College, three trustees are partners at investment firms that manage portions of the college's endowment.

About 90 percent of college governing boards have conflict-of-interest policies, many of which forbid members to vote on matters in which they have personal stakes. The Internal Revenue Service requires colleges to disclose potential conflicts on their tax returns, a stipulation designed to promote transparency and discourage abuses. But how those conflict-of-interest polices are written varies widely, as does the level of disclosure in tax forms. Some colleges name names and give dollar values for those relationships, while others provide only boilerplate statements.

Carson-Newman College's disclosure on its tax filing is fairly typical: Trustees "manage or have financial interest in entities which engage in certain business transactions with the college." But the college doesn't name the trustees or explain which entities, and it doesn't list the transactions. Instead, it offers this: "It is of the opinion of management, that these transactions are immaterial and the terms of the transactions and/or agreements with these entities are no more or less favorable to the college than could have been obtained from unrelated entities." In other words, trust us.

Carson-Newman rarely does business with trustees, says James P. Guenther, a lawyer representing the Tennessee college. When it does, he says, the terms of those arrangements come with "very significant savings."

Such discounts are one of the reasons college leaders argue that these relationships can be beneficial. A trustee who owns, say, a construction company may cut the college a sweet deal on a new building. Board members bring good intentions to the table when doing business with a college, they say, and having financial or legal expertise in the room when important decisions are being made can be useful. It's win-win, many campus officials contend.

Yet conflicts involving boards have caused hand-wringing in some higher-education circles for decades, particularly when a scandal flares. Where to draw the line remains murky. What happens if the college decides to fire a trustee's company? How does the board publicly disclose the financial relationship? Should the trustee be recused from board meetings at which the company's contract is discussed? Is the company's fee fair, and can the board properly vet the amount? Is the trustee's primary loyalty to the college or his or her own business interest?

'Manageable Risk'

Some experts draw a bright line. Richard P. Chait, a professor at Harvard University's Graduate School of Education who studies college governance, says colleges should almost always avoid doing business with trustees' companies. If a company offers a deal that a college simply can't pass up, then the trustee involved should probably be asked to leave the board.

Taking a casual view of trustee conflicts "is exceedingly ill-advised," Mr. Chait says. "It doesn't set the right ethical tones."

One hazard of allowing trustees to do business with a college is that it leaves the institution open to charges of favoritism. That is even more likely when a college has multiple trustees with financial connections.

Vanderbilt University, for example, lists several members of its Board of Trust in a 2008 "self-dealing statement" filed with the Internal Revenue Service. The university holds investments with a hedge fund and a real-estate investment trust in which trustees serve as top executives. In addition, Vanderbilt spent $17-million over two years with a Nashville company, Hardaway Construction, whose chairman and majority owner, L.H. Hardaway Jr., was a longtime university trustee.

Mr. Hardaway, a Vanderbilt alumnus, stepped down as a voting member of the board last year. He says he doesn't believe that his membership helped his construction company win any contracts. If anything, he says, he thinks the university is perhaps overly wary of doing business with trustees. "There's no favoritism," he says.

Still, there's no denying that Vanderbilt has been a profitable client for his construction company. Hardaway's Web site lists four major projects the company has completed for the university, including an addition and renovation to the engineering building worth more than $23-million.

While the university declined to discuss specifics, David Williams II, vice chancellor for university affairs and general counsel and secretary of the university, said in a written statement that Vanderbilt's approach is to "determine if the conflict is manageable and if so, to manage it in an above-the-board way and to eliminate those conflicts when that isn't possible."

'There Is an Optics Problem'

Managing potential conflicts has been an issue at National University as well. According to tax records, the San Diego-based institution paid trustee-affiliated companies more than $3.7-million from 2005 to 2007. Those companies provided services that included debt collection, architecture, consulting, public relations, and real estate.

In most cases, says Michael W. Prairie, the university's general counsel, those trustees had business relationships with the university before being asked to join the board. After joining, he says, they were pressed to give the university the best possible price on those services—and also to make donations. "Once they're on the board, the chancellor squeezes them for money," Mr. Prairie says. He also points out that, according to National's conflict-of-interest policy, no more than six members of the 25-member board can have business dealings with the university at any one time.

Jacqueline Townsend Konstanturos had been doing outside public-relations work for the university for about a year before she was invited to become a trustee. She says she asked about a possible conflict of interest at the time and was told that all contracts were reviewed regularly and that "everything is kept transparent and aboveboard." After she joined, she says, she stopped charging the university for the time she spent on public-relations work, although her company continued to collect fees. Between 2005 and 2007, Ms. Konstanturos's company, which she has since sold, was paid more than a half-million dollars by the university.

A longtime member and former chairman of National's board, Gerald M. Czarnecki, says he is confident that the university has received bargains on services provided by trustees, and that the board has been vigilant in handling potential conflicts. Even so, he acknowledges that it doesn't look good: "I'm aware that there is an optics problem, with people saying 'Hey, they're feeding at the trough.' My bias would be that in a perfect world, no trustee would do any work for the board."

But the precautions the university has taken are sufficient, he says, and the board has worked to reduce the number of trustees with conflicts on the board. Right now, according to Mr. Czarnecki, there are three.

Among the most common conflicts of interest for colleges is having a member of the board whose company does construction work for the institution. At St. Olaf College, the Boldt Company has completed or is working on $125-million worth of campus building projects. In 2007-8 alone, the company was paid nearly $40-million by the college.

The CEO of the company, Thomas J. Boldt, a St. Olaf alumnus, served on its Board of Trustees for 12 years before stepping down last year (board members can serve up to two six-year terms). Both Mr. Boldt and college officials say there was no competitive-bidding process for the projects his company managed, although Paula Carlson, a vice president at St. Olaf and liaison to the board, says there is "always a review of the cost" of a project, to make sure it is reasonable.

Asked if the college might have been charged a lower price if others had been allowed to bid on projects, Mr. Boldt calls that a "hard question to answer" because of the complexity of the design-and-construction process. He says his company works closely with clients to make sure buildings fit their needs. St. Olaf, he adds, has been happy with the work that Boldt has done.

As for whether board members should be allowed to have such significant business relationships with the university, Mr. Boldt says the issue has received more scrutiny in recent years, perhaps as a response to the Sarbanes-Oxley Act, a federal law that was enacted in 2002 in the wake of accounting scandals involving companies like Enron and WorldCom. Still, he believes, his membership on the board did not unduly influence his fellow board members.

"These are all adults," he says. "They understand the role they have as regents, and I think those kinds of things are discussed in a very mature way."

Hedge-Fund Connections

Colleges have long courted wealthy financiers as board members, for good reason.

Investment bankers often donate big money, and they can offer free financial advice and access to the invitation-only world of high-end investments. But dozens of colleges go further, according to tax documents, investing with firms that have ties to trustees.

In the economy's boom years, many colleges clamored to cash in on the strong returns of hedge funds and other alternative investments, and trustees with connections helped pave the way.

But such funds were hit hard in the recession, and colleges' relationships with trustees who are investment bankers now look more dubious.

Another problem stems from how secretive private investment firms can be about their business. Hedge funds in particular are subject to less regulation than conventional investments are, and generally don't have to account for where their money goes or how they perform. In addition, hedge funds are typically not liquid, meaning that colleges cannot easily gain access to their assets. That lack of flexibility can compromise a board's ability to make investment decisions.

Boards should proceed with "great care and consideration" when weighing whether to invest with a trustee-affiliated firm, says Richard D. Legon, president of the Association of Governing Boards of Universities and Colleges. The group singled out investments for extra attention in guidelines issued last year on trustee conflicts.

Where possible, Mr. Legon says, boards should avoid trustees' firms when looking for investment opportunities. "There are ways to access that talent" beyond the board, he says.

Wilmington University, in Delaware, looked for outside money managers after it received a large gift years ago, says Thomas B. Cupples, an assistant vice president. Wilmington sought out a local firm, Marvin & Palmer Associates Inc., which now handles all of its endowment, about $19-million in investments, according to tax forms.

Years later, the university recruited David F. Marvin, the investment company's chairman, as a trustee, turning that outsider into an insider.

Mr. Marvin continues to manage the university's endowment, and university officials say transactions with his firm are conducted at fair market value and at arm's length, a legal principle that generally means the services were purchased without improper influences.

Wealthy institutions are likely to have investment ties to several board members. Brown University recently held assets with three trustee-related firms, most notably one linked to Steven Rattner, an alumnus and member of the Board of Fellows of the Corporation of Brown University, the governing board. He is a founder of Quadrangle Group, a private-equity fund in which the university invests. Early last year, while Mr. Rattner was still a managing principal of the firm, he served briefly as acting chairman of the board's investment committee.

That connection now looks less advantageous for Brown. Mr. Rattner, who was President Obama's first "car czar," left that post and Quadrangle last year after news emerged that New York's attorney general was investigating how the firm had landed investments from the state's pension fund. Then, last month, Michael R. Bloomberg, New York City's mayor, removed about $5-billion in personal holdings from Quadrangle, essentially gutting the company.

The university prohibits investing with funds managed by members of the board's investment committee, says Marisa A. Quinn, vice president for public affairs and university relations. All board members are required to disclose any possible conflicts of interest, which are reviewed by the board's governance office and Brown's general counsel.

As for Mr. Rattner, Ms. Quinn says he filled in for several months as acting chair of the investment committee after the previous chair's death.

"Investments the university has with Quadrangle Group LLC were made nearly a decade prior to Mr. Rattner's service in this interim role," Ms. Quinn says in a written statement. "There were no decisions or actions made with respect to this investment during his limited time as chair."

Tax Forms Do the Talking

Colleges and board members alike are generally unwilling to make public many details about their financial relationships with trustees' companies. In most cases they let tax forms do the talking. And the forms don't say much. The brief statements in those documents describe common methods of minimizing conflicts, such as prohibiting given trustees from participating in meetings where the investments in question are discussed.

Some colleges say trustees waive fees for investments with their firms.

Mr. Marvin's company does charge fees to Wilmington University, but at discounted rates, says Mr. Cupples. The board monitors the work, he says, adding that the relationship has paid big dividends for the university. "I don't see any reason why anyone would want to stop it."

Many boards share his viewpoint, according to the latest endowment study from the National Association of College and University Business Officers and the Commonfund Institute. The number of surveyed institutions that allow business relationships with trustees is on the rise, hitting 58 percent compared with 46 percent two years ago.

The report's authors say they were surprised by the trend. Among private colleges, 64 percent allow such business deals, and only 38 percent require recusal and disclosure by the trustees involved.

Most trustees with investment companies believe they are doing the right thing by steering college money to their funds, which can yield much bigger returns than conventional investments.

But it isn't worth the risk, says Richard E. Anderson, a consultant with Hammond Associates, a company based in St. Louis that provides investing advice to more than 70 college endowments. For one thing, it may be difficult for colleges to pull their money out of an underperforming fund if a trustee is at the wheel.

"These people are of good will, and they believe in their investment vehicle," which is why it helps to have in place policies that prohibit such arrangements, he says. "Then no feelings are hurt."

Increased Scrutiny

Governance experts say colleges often have trouble recruiting trustees, which can make some boards more willing to appoint members with potential conflicts. But those arrangements are drawing new attention from regulators.

The Internal Revenue Service's newly revised Form 990 asks more questions about trustee conflicts than it did before. As a result, many colleges and universities have recently upgraded their conflict-of-interest policies and disclosure requirements. Scrutiny from the IRS is part of the federal government's deepening interest in college governance. Trustees are feeling some of the heat as lawmakers criticize colleges about rising tuition. And bad publicity from financial misdeeds at colleges and other nonprofit organizations has helped fuel the fire.

"People are looking at inappropriate uses of resources," says Kent John Chabotar, president of Guilford College and an expert on university finance. "You want to make sure that you're above suspicion."

Many observers say the national conversation about trustee conflicts is welcome, and long overdue.

"The industry on the whole has not addressed the magnitude of it," says Jan Greenwood, an executive-search consultant focused on higher education.

One institution ahead of the curve is Washington and Lee University. New trustees there receive detailed training, including a 56-page primer with case studies describing their legal responsibilities. Trustees are regularly reminded to avoid conflicts of interest and to disclose any business and financial relationships with the university or its affiliates. They must sign a conflict-of-interest statement each year.

Leanne M. Shank, the university's general counsel, says her office and the board's trusteeship committee review every possible conflict, "even if there's a perception of a potential conflict of loyalty."

Washington and Lee has not engaged in any transactions with trustee-affiliated companies, at least recently. Making the case for such an arrangement is conceivable, Ms. Shank says, but would require a rare set of circumstances. The deal's price would have to be well below market value, and nobody related to the trustee could benefit from the business.

Ties That Bind

Colleges often argue that ties with trustees' businesses are harmless. In many cases, they are. But what begins as a benign entanglement can turn into a public embarrassment.

That's what happened at Gannon University, where Joseph T. Messina had been on the Board of Trustees for 30 years. An alumnus and well-connected lawyer in Erie, Pa., he has long been a generous donor to his alma mater, a 4,200-student Roman Catholic university in Erie.

And for decades, his law firm has been Gannon's outside counsel, earning as much as $173,000 in one recent year. The potential conflict was disclosed in annual forms.

Then last April, the local newspaper revealed that Mr. Messina was in serious financial straits. He had declared bankruptcy, citing gambling debts of at least $300,000. And it turns out Mr. Messina had another potential conflict with Gannon—the university was his landlord and he owed it $24,000 in unpaid rent for the university-owned apartment he'd been living in.

Gannon says Erie is a small town and many local lawyers serve on boards for nonprofits that also hire their firms. Mr. Messina declined an interview request, saying in a written statement that "all board members must understand and implement their governance responsibilities and fiduciary obligations free of any conflicts of interest."

Mr. Messina remains on the board, at least until his term ends, in May. His law firm still works for the university.

Many colleges continue to hire companies with ties to sitting trustees. While most of those deals may be legal, they're not a good idea, concludes Jack B. Siegel, a nonprofit-governance expert and lawyer in Chicago.

"Professionals in the field know this is not a good practice," he says. "It just looks bad."

Jill Laster contributed to this article.

Comments

1. krn1951 - March 15, 2010 at 09:08 am

Public university trustees have the same potentially deleterious conflicts of interest as private college trustees, perhaps subtle and indirect but just as big.

2. iduhpres - March 15, 2010 at 10:51 am

The entire system of college governance is due a review. We work under a traditional approach that is simply not really in tune with today's world of higher Money...uhh education. The concept of having a group of outsiders come in once a month to set policy for an institution that needs day to day big and little policy decisions made is not really workable. How many trustees would let the college president or anyone else come into their business once a month or quarter, promise to just be barely briefed on what is going on yet set policy for the business? Even better, micro-manage the business once a month or quarter and then go home?

3. herlan - March 16, 2010 at 12:25 pm

I found the conflict-of-interest situation appalling. I think the extent of the problem is in part a reflection of a lowering of ethical standards by current academic administrators. As a retired faculty member, I worry about the future of higher learning in this amoral climate.

4. hodedo - March 18, 2010 at 09:17 pm

Try this tidbit of a three part series from the Anderson Valley Advertiser: http://theava.com/archives/4678

5. 11296383 - March 19, 2010 at 02:02 pm

I was struck by the absence in this article of discussion with chief business and financial officers who are most often caught in the middle of these conflicts of interest. I've been in that position at several institutions/organizations for over 35 years and have talked to many other CFOs in private about this issue. The article focuses on concerns about appearances, but in reality it is about more about good accountability. I know CFOs who lost jobs because they tried to change business arrangements with trustee firms. I know many who hand wring about their inability to really demand top service and performance from companies run by trustees (alumni & major donors).

While some trustees may be willing to give colleges a special deal (lower cost, donate profit, etc.) I think, based on my long observation on this issue, that the related party transactions should be prohibitied outright. If their (the trustees) intent is to really help the institution then do so by dropping off the board and give the institution a big discount or donation if they win the bid.

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