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Expect=20 Increased Scrutiny of Executive
Compensation at = Tax-Exempt=20 Organizations

In = the wake=20 of corporate scandals like Enron and Tyco, excessive = executive=20 compensation became a lightening rod issue. Constant bad = press has=20 dogged those corporations that failed to withstand the = scrutiny of=20 Congress, the IRS, the SEC, and the public. Corporate=20 America=92s = self=20 indulgence, lack of discipline, and poor judgment was on = display for=20 everyone to see.

The harsh spotlight on fiscal excess = is now=20 illuminating the non-profit world. Colleges and = universities, in=20 particular, have come under pressure to account for their = pay=20 scales. Where, despite tuition hikes, presidents, provosts, = and=20 coaches can command high six =96 sometimes seven =96 figure = salaries and=20 enjoy a range of perks on the school=92s tab, the backlash = has been=20 palpable.

Executive Privileges and Compensation = Continue=20 To Rise

In the fall of 2005, American University = President Benjamin Ladner was = forced out=20 of office after an anonymous tip revealed Ladner received $800,000 for travel = and personal=20 expenses in 2004 alone, in addition to his $886,750 base = salary. The=20 university also supplied him with other personalized = services during=20 his tenure. American University, however, = was not=20 the only higher education institution that was allowing for=20 extravagant executive privileges. The President of Mercer = Community=20 College was fired from his post in Trenton, New=20 Jersey after serving $60-per-pound Kobe beef at=20 school dinners at the same time the school was raising = tuition=20 rates. In Tennessee, an internal = audit=20 revealed the President of the University, John W. Shumaker, = was=20 using the university=92s aircraft for personal travel. He = eventually=20 repaid the university $25,000 in travel reimbursement=20 fees.

All around the country, compensation for = college and=20 university presidents is beginning to approach the = million-dollar=20 mark according to an annual survey by The Chronicle of Higher=20 Education. In 2003-2004, Boston University, = Vanderbilt=20 University, Middlebury College, Wilmington College in = Delaware, and=20 Lynn University in Boca Raton, Florida were among the = schools=20 offering administrators =91million-plus=92 compensation = packages.=20 According to the Chronicle, the year President Ladner was fired from American=20 University, his=20 salary ranked only 8^th highest among similarly = situated=20 colleagues in the field¹=20 .

The IRS Has Increased Oversight and=20 Enforcement

Many schools are adding layers of = oversight=20 to their executive compensation systems. The IRS is helping = to drive=20 these reforms with its =93Tax Exempt Compensation = Enforcement=20 Project,=94 launched in August 2004. As part of its = initiative, the=20 IRS sent out approximately 2,000 =91compliance check = letters=92 (IRS=20 Letter 3878) to non-profit institutions, and conducted more = than 600=20 inquiries into non-profit compensation schemes. The stated = goals for=20 the project are to:

address = the=20 compensation of specific individuals and identify = questionable=20 compensation practices;=20 increase = awareness=20 of tax issues to better prepare institutions to set = compensation=20 levels in the future; and to learn = more about=20 the compensation practices of non-profits and to make sure = these=20 practices are reported to the IRS and the public on annual = Form=20 990 returns.

Neither the = Internal=20 Revenue Code (IRC) nor Treasury regulations define = =93excessive=94=20 compensation. The IRC prohibits =93excess benefit = transactions,=94=20 however, which include any transaction in which the = institution=20 provides an economic benefit to a =93disqualified person=94 = (defined as=20 any person in a position to exercise substantial influence = over the=20 affairs of the organization), where the value of the benefit = exceeds=20 the value of the consideration for the person=92s services. = IRC=20 =A74958(a)(1). Specific punitive = excise taxes=20 can be levied against the =93disqualified person=94 and any = officer,=20 director, trustee, or manager who participated in the = transaction=20 willfully and without reasonable cause.

In June 2004, = the=20 Senate Finance Committee held a hearing on fraud and = mismanagement=20 in America=92s = nonprofits. At=20 the close of the hearing, Committee Chairman Charles = Grassley stated=20 the hearing was =93sobering,=94 and it was =93sad that in a = hearing about=20 charities we have to hear about million-dollar insider = contracts;=20 middlemen who purposely cheat charities to make an extra = buck; and=20 the fact that over half of all new tax shelters used a = tax-exempt=20 party.=94

Here Are Some Suggested Best=20 Practices

Out of the ashes of these scandals, = certain=20 best practices have emerged. A number of commentators = recommend that=20 a non-profit board should:

ensure = compensation=20 decisions are made only by disinterested board members;=20 maintain = oversight=20 of executive compensation committees, even where these = committees=20 represent a subset of the board of = directors;=20 approve = the=20 compensation arrangement in advance by an authorized=20 body;=20 base the=20 compensation decision upon appropriate comparable data = from=20 similarly situated institutions; document the = basis for the=20 decision, including meeting minutes and other available=20 data.

Inquiries = into=20 executive compensation continue in earnest. The New York = City Public=20 Library is the latest non-profit to come under scrutiny. = Despite=20 financial problems that necessitated an emergency $18 = million=20 fundraising campaign, the library increased the = president=92s salary=20 from $579,000 to $800,000 and hired three new officers at=20 substantially increased salaries.

Where compensation=20 decisions are well reasoned and well documented, schools = should have=20 no problem attracting and retaining top talent in the = industry=20 without constant auditing. But where deals, at the minimum, = appear=20 to be improper or excessive there will be more scandal and = punitive=20 consequences.

Robert B. = Smith and=20 Dana L. Fleming are members of the College & University = Practice=20 Group at Nelson, Kinder, Mosseau & Saturley, P.C. in = Boston, MA and=20 Manchester,=20 NH. Comments = welcome to=20 rsmith@nkms.com.=20

¹Fain, Paul. = =93High Pay=20 Makes Headlines.=94 The Chornicle of=20 Higher Education Volume 53, Issue 14, (2006) Page B6=20

This communication may be = considered=20 an advertisement or solicitation under federal law.