Dartmouth Endowment Controversy Spotlights Business Ties, Conflict-of-Interest Concerns
Oftentimes, the board of an endowment or charitable organization will ask prominent alumni and/or large donors to serve on its board. When these members are also high-level money managers, or principals in an investment firm or hedge fund, their experience and knowledge of the investment industry and potential access to alternative investment opportunities can prove very beneficial the board or its investment committee when determining how to invest the assets of the organization or endowment.
Nevertheless, a recent article about the Dartmouth University Endowment in Pensions & Investments raises the issue of potential conflicts of interest that arise when the organization hires external money managers affiliated with board and investment committee members. Concerns arise around the independence of the decision to hire the affiliated firm, and how fully the conflict of interest is disclosed to all pertinent parties before the decision is finalized.
The CFA Institute Investment Management Code of Conduct for Endowments, Foundations, and Charitable Organizations provides boards and investment committees with a set of best practices that addresses, among other things, the use of external investment managers.
According to the Code, the governing body of an endowment may meet the requirement to act with skill, competence, prudence, and reasonable care by employing external advisers to implement the organization’s investment strategy. However, the selection of the manager must be conducted with independence and objectivity. What’s more, the financial incentives provided to the manager should align with the best interests of the organization.
Consider Prohibiting Affiliated Firms
When one of the managers competing to earn the business of the organization employs, or is even owned by, a member of the board or investment committee, there is an obvious conflict of interest. The simplest way to avoid this conflict is for the endowment to adopt a policy that prohibits doing business with firms affiliated with board and committee members. The establishment of such a policy ensures that all appointed individuals are working solely in the best interest of the organization.
Support for this policy can be found in the provision of the Code that requires board members to act with loyalty and proper purpose, and “avoid conflicts of interest pertaining to the implementation of the organization’s investment strategy whenever possible.” Code guidance recommends that board members not personally profit at the expense of the organization and not have affiliated firms provide services to the organization.
Steps for Allowing Affiliated Transactions
While the governing body members should try to avoid such conflicts of interest, that is not always in the best interests of the organization. When an organization desires to hire money managers with board connections, the Code recommends adopting strict policies relating to disclosures and recusal from the decision-making process when the board member’s firm is involved.
Disclosures must go beyond the investment committee and board, as the beneficiaries of the organization should be informed of the potential conflict of interest. According to the P&I article, New Hampshire regulations governing the Dartmouth Endowment require transactions with affiliated companies to “be disclosed to [the Charitable Trusts unit of the Office of the Attorney General] and published in a local newspaper.”
Moreover, the Code requires that if board or investment committee members are employed by a soliciting manager, they must exclude themselves from any deliberations or votes regarding the hiring and future retention of the investment manager. Again, New Hampshire regulations require individuals to “recuse themselves from the vote and the organization’s board approves the transaction by a two-thirds vote.”
Disclosures and dissociation will only go so far to dispel concerns that decisions were made fairly and equitably. Avoiding conflicts of interest in the first place with specific organizational policies is always the best approach. When other actions are allowed, a board or investment committee ultimately must be able to document how the decision to hire a member’s firm was in the best interest of the organization in meeting the approved investment mandate, and how subsequent conflicts of interests will be addressed.
