All Bark and No Bite: What it means to govern after the “Three Cups of Tea” scandal

Barking dog
When the scandal broke regarding Greg Mortenson and Central Asia Institute (CAI), many assumed “governance” was a rarely uttered word, let alone practiced concept, inside the walls or boardroom of CAI. However, when the Montana Attorney General Steve Bullock (“AG”) released his 31-page Investigative Report of Mortenson and CAI in April after a one-year investigation (“AG Report”), it detailed certain accounts that in many ways resembled an organization striving for good governance right up to the day the scandal hit the front page: by 2011, it had various written agreements with Mortenson regarding reimbursements for items such as travel expenses and royalties from his books; it had just conducted audits in fiscal years 2009 and 2010; and it had a retained an attorney in 2008 to assist with developing comprehensive policies for the organization. Such revelations certainly make the story only that much more perplexing as one must wonder how an organization that appeared to take these governance steps could find itself the subject of a scathing 60 Minutes exposé and widespread criticism, the focus of a yearlong AG investigation and, most recently, the party to a Settlement Agreement and Assurance of Voluntary Compliance with the AG (“Settlement”) that requires significant changes to CAI's organizational and financial controls as well as payments to CAI by its co-founder, Mortenson, for amounts totaling upwards of $1 million because of his alleged wrongdoings.

Part of the answer lies in the fact that good governance requires more than going through the motions. It requires a deeper commitment by directors to walk the walk, especially when the circumstances are complicated and the decisions are difficult. Although the CAI Board regularly discussed the financial benefits to Mortenson, used auditors, and hired outside legal counsel, the AG Report also revealed, among the many problems plaguing CAI, that the Board made little to no effort to enforce its agreements with Mortenson for recouping assets, ignored the problems identified by the auditors, and failed to implement the policies drafted by outside legal counsel. Given such accounts, it is not surprising that the AG Report concluded that the CAI Board failed to fulfill certain key management and oversight responsibilities and that Mortenson also failed in his responsibilities as Executive Director and a member of the Board.

Gene and I had an opportunity to discuss some of the lessons learned from the unfolding of events in our article for The Chronicle of Philanthropy, “'Three Cups of Tea' Scandal Offers Lessons for Charities and Trustees.” The recently released AG Report continues to offer insight on common governance missteps, some of which I’ve highlighted below.

Written Agreements

One troubling theme from the AG Report was the lack of agreements between Mortenson and the organization until recent years despite the long history of personal benefits flowing from CAI to Mortenson. For example, CAI spent approximately $367,000 for production costs, $4.93 million in advertising costs, and another $3.96 million for copies of “Three Cups of Tea” after it was released in 2006 even though Mortenson owned the copyright to the book and CAI had no written agreements with Mortenson regarding royalties or other return benefit to CAI until 2008 when it drafted a board resolution that required Mortenson to pay CAI amounts equal to the royalty income received from the books purchased by CAI. To make matters worse, Mortenson never provided the Board with copies of any contracts relating to “Three Cups of Tea,” the other directors never asked for those contracts, and no steps had been taken by the Board as of April 2011 to demand the payments required by the 2008 board resolution.

The Settlement makes efforts to help CAI establish agreement terms for future costs and requires CAI to maintain appropriate documentation to engage in certain transactions with Mortenson. For example, for any books purchased in the future by CAI, CAI must keep itemized receipts to account for the cost and calculate the royalties Mortenson receives on each purchase; Mortenson must provide to the Board a copy of any relevant contract for determining the amount of royalties Mortenson receives per book; and Mortenson must make a contribution to CAI equal to the amount of royalty income received for the books purchased by CAI.

Such corrective actions are an important reminder for nonprofits, that with any arrangement, boards should consider when a written agreement would be appropriate and in the organization’s best interests. Founders desiring intellectual property rights for work created that also benefits the organization are not uncommon, but these arrangements must be managed carefully; rarely are these appropriate situations to rely on informal understandings, handshake deals, or another’s good faith. Among the benefits of a well-drafted agreement include setting clear expectations about responsibilities and obligations, establishing rights of the parties, addressing terms for exiting or otherwise terminating an agreement, and providing procedures for resolving conflicts related to the contract. At the same time, even the best written agreements can have little value to an organization that is not willing to enforce it. A board must thoroughly understand any agreement before entering into it and be prepared to take necessary steps to ensure the other party is also holding up his or her end of the bargain. Additionally, boards should take heed of any applicable rules or procedural requirements under state or federal tax law prior to entering into an agreement, such as evaluating fair market value for goods or services, especially when the transactions also involve conflicts of interests with directors and officers.

Experts and Other Professionals

Another disturbing theme from the AG Report was the extent to which the CAI Board obtained but essentially disregarded the assistance of financial and legal experts. For example, the AG Report noted that CAI stopped auditing its finances after the 2003 fiscal year audit revealed material weaknesses in financial and internal controls. When CAI restarted audits for fiscal years 2009 and 2010, the latter audits revealed the same problems from 2003. Additionally, although an attorney developed policies for CAI in 2008 such as an Employee Travel Reimbursement Policy, Code of Ethics Policy, Conflict of Interest Policy, and Personnel Policy Manual, and Board Policy Manual, the AG concluded the policies were not effectively enforced and had been violated not only by Mortenson but also other employees and even nonemployees such as family members of CAI employees. The consequences to CAI for noncompliance were costly, for example, as shown by a later audit that estimated $75,000 in personal expenses were charged by Mortenson to CAI in a single fiscal year in violation of such policies.

Now, pursuant to the Settlement, CAI will use the assistance of outside parties to improve its governance including a new independent auditor retained by CAI to review financial statements and produce an audit report, an independent certified public accountant to review past credit card and travel expenses, and the AG to monitor CAI over the next three years. The Settlement furthermore references specific reformed policies that should help avoid similar issues in the future including those related to use of corporate credit cards and travel reimbursement.

The Settlement’s emphasis on outside parties to evaluate and assist CAI highlights the utility and benefit that can be gained from an objective set of eyes which often come in the form of third-party experts or professionals who bring a wealth of expertise and are more open to seeing and acknowledging problem areas. Nonprofits should remember that checks and balances are critical for proper governance particularly with financial management to prevent issues such as fraud, embezzlement, and misuse of charitable assets. Most states, for example, require larger nonprofits to conduct yearly independent audits and/or establish audit and finance committees for the purpose of strengthening financial oversight. All organizations, regardless of size, should regularly assess what frequency of audits or other review and degree of internal controls are needed for their specific circumstances.

An organization may also benefit from retaining experts or professionals in other areas besides financial. For example, using professional assistance to revise Bylaws and other governing documents, review contracts and update policies, provide skilled-based trainings, or facilitate team building or conflict resolutions can directly impact an organization’s practices, culture, and morale.

Board Oversight

The AG Report also details CAI’s unexpected growth and the serious troubles an organization can face when little attention is placed on acquiring directors with the appropriate skills, experiences, and backgrounds needed to meet the organization’s operational and practical demands under new circumstances.

CAI today runs a large-scale operation, reporting an impressive $22 million in donations for fiscal year 2009. But it had relatively modest beginnings in 1996, founded with a $1 million donation to build schools in central Asia and experiencing its first notable surge in donations only as far back as 2003. The AG Report states that Mortenson, Executive Director since CAI started, insisted on maintaining substantial control over CAI until his resignation in summer 2011 despite an inability to effectively manage an organization of CAI’s size and complexities given both his lack of management experience (specifically in financial and personnel management by Mortenson’s own admission) and his hectic travel schedule.The AG additionally observed the Board's composition, though compliant with applicable state laws, was stagnant and consisted of the same four individuals, including Mortenson, from 2003 to 2009. After a director resigned in 2009, the CAI Board thereafter stayed at three which included Mortenson and two other board members who felt great admiration for Mortenson, which the AG described as interferring with their ability to exercise independent oversight and management over CAI.

As required by the Settlement, CAI will overhaul the current composition of its governaning body in the coming years. Changes include expanding the Board to at least seven voting members, limiting Mortenson’s involvement on the Board to a nonvoting capactity, upcoming resignations by the other two current directors within one year, and using an independent professional consultant to help search for a new executive director. These changes should remind nonprofits that the working relationship between an executive director and board can have direct effects on the strength or weakness with which they govern. This already nuanced relationship becomes all the more complicated when combined with complications such as an executive director who also serves as a board member, a small board that may be susceptible to groupthink, or misguided understandings about a board’s owed loyalty to a founder.

Boards should also remember that conflicts of interests practically appear in many forms, not just through financial interests. Personal relationships can also seriously hinder or otherwise contaminate a board member’s independent decision-making with respect to evaluating the performance of the Executive Director, one of the board’s most important responsibilities. When a board’s ability to govern effectively is threatened, directors have a responsibility to address and mitigate those problems.

Although not a happy ending for CAI, the Settlement may be the best ending that CAI could have realistically hoped for. CAI now has a rare opportunity for a second bite at the apple: to actually implement, and not just create the appearance of, proper governance in compliance with the law; to restore the public trust it once had; and to ultimately refocus its energy, attention, and resources to the charitable purposes for which CAI was started and supported in the first place.

*It should be noted that the AG Report provides limited guidance in certain respects. First, the AG conclusions are based on Montana state law (CAI is a Delaware corporation with its principal office in Bozeman, MT) and there are differences among states’ laws. Additionally, the AG Report does not attempt to address the federal tax laws regulating 501(c)(3) tax-exempt organizations which are within the jurisdiction of the Internal Revenue Service. Second, certain confidential information which may have supported the AG's conclusions cannot be disclosed in the AG Report. Therefore, one can only speculate at best whether a similar occurrence would result in the same consequences. Finally, the allegations investigated by the AG have ultimately been resolved through the Settlement. Thus, no formal findings have been made by a court of law and CAI and Mortensen make no admissions of liability or wrongdoing. The Settlement instead represents a voluntarily agreement by all parties about the claims which remain in dispute.