Congressional Response To The Smithsonian Institution And Allegations Of Abuse: What Could It Mean For Other Nonprofit Organizations?

Spurred by a recent Inspector General’s audit of the Smithsonian Institution, Congress took an aggressive step to demonstrate its intolerance of perceived abuses by Smithsonian Secretary Lawrence Small. The audit found that Small engaged in excessive expenditures, including:

• over $90,000 in unauthorized expenses;

• $2 million in authorized expenses for Small’s private home and office, which include $160,000 for office renovations ($31,000 of which was for upholstery), $273,000 for housekeeping, $14,000 for three new French doors, and $12,000 for swimming pool maintenance;

• an unauthorized charge of $14,500 for the use of a chartered plane; and

• regular first-class travel and accommodations on Smithsonian business trips for Small and his wife, which included a trip to Las Vegas worth over $9,500 and a $6,000 trip to Hawaii during a Thanksgiving holiday weekend.

The Smithsonian is the world’s largest museum complex and research institute, which receives nearly 70% of its $1 billion budget from Congress. It is governed by a seventeen member Board of Regents, which consists of two nonvoting members: Chief Justice of the United States Supreme Court, who serves as the Chancellor of the Board, and the Vice President of the United States. Also on the Board are three members from the House of Representatives and three members of the Senate.

Senator Charles Grassley, ranking member of the Senate Finance Committee and the senator who brought the actions of the Smithsonian to the attention of other members of Congress, was outraged by the Smithsonian Board of Regents’ failure to carefully review these expenditures and, on occasion, approve expenditures without having sufficient information. On March 22, 2007, the Senate unanimously supported Senator Grassley’s budgetary amendment to freeze a $17 million increase for the Smithsonian Institution until it:

• Ceases to compensate any employee at a salary greater than the United States President’s annual salary (this would reduce Small’s salary from $915,000 to $400,000) or a deferred compensation plan that is more generous than the President’s plan;

• Ensures that all Smithsonian travel expenditures conform with federal government guidelines; and

• Subjects all Smithsonian employees to ethics rules similar to those widely applicable to all federal employees.

Two days after the amendment passed, Secretary Small tendered his resignation, which was thereafter approved by the Board of Regents. The Board of Regents is not offering Small a severance package. As a result of Small’s resignation, Senator Grassley has indicated that he would remove the Smithsonian amendment from the budget resolution. On April 11, 2007, the Senate Rules Committee (chaired by Senator Dianne Feinstein), which has oversight jurisdiction over the Smithsonian, will hold a hearing on the Smithsonian’s compensation and expense practices.

The Congressional response to the Smithsonian situation raises broader concerns with respect to reasonable compensation and proper board governance.

The Senate took a bold move with its amendment, which would have reduced Secretary Small’s salary by more than half and would have also reduced Small’s deferred compensation package. In sum, the Senate dictated what it thought reasonable compensation ought to be for the Smithsonian Secretary without conducting a comparability assessment. Secretary Small, after all, managed the largest Museum Institution in the world and raised over $1.1 billion in private donations during his tenure. However, the ultimate issue is whether the Senate’s action is a sign of things to come – that is, will Congress require nonprofit organizations to cap their salaries at a certain level – or was the Senate’s action solely a response to what they perceived as a particularly egregious situation, with no further implications for other nonprofit organizations. The answer is unclear.

Compensation packages in nonprofit organizations have been the subject of scrutiny as of late. Media reports of perceived excessive compensation for hospital managers, university presidents and athletic coaches, and certain museum directors prompted the IRS to launch a three-part executive compensation compliance project. To date, the IRS has indicated that only 51% of public charities attempted to satisfy all three prongs of the rebuttable presumption of reasonableness, which helps prevent the imposition of intermediate sanctions for excess benefit transactions under Internal Revenue Code section 4958. To obtain a rebuttable presumption of reasonableness, an organization must establish that:

• a compensation committee, comprised of board members who do not have a personal interest in the compensation package, reviewed comparability data;

• the comparability data consisted of an industry survey documenting the compensation of at least three similar positions in similar organizations, expert compensation studies, or other data; and

• the governing body documented the basis for its determination, which must include:

• the terms of the approved transaction and the date approved;

• the members of the decision-making body who were present during debate on the transaction that was approved and those who voted on it;

• the comparability data that was relied on by the decision-making body and how the data was obtained; and

• any actions by a member of the decision-making body having a conflict of interest.

Members of Congress expressed outrage over the fact that the Smithsonian Board of Regents approved Small’s expenses and compensation package. Even after reports revealed that $90,000 of expenses were unauthorized, the Board nevertheless stated that it found the expenses and compensation packages to be "reasonable for the leader of the world’s largest museum and research complex." Notably, the Inspector General found no evidence of fraud or abuse, but stated that some expenses could be considered extravagant or lavish. Several news commentators have remarked that the Board of Regents’ failure to adequately monitor Small’s expenditures may be due, in part, to the Board’s composition, which consists of a disproportionate number of high-ranking public officials and figureheads who may not have the time and attention necessary to effectively manage the organization. Recently, the Board of Regents set up a committee on governance, which will compare the Smithsonian’s governance with that of other institutions and present a best practices plan to the full board.

Nonprofit organizations should take this time to be proactive with respect to their governance structure and practices. Boards of directors should evaluate their composition to ensure that the board consists of the right number of directors who have the time and ability to effectively administer their responsibilities. Boards of directors should also evaluate their current practices to ensure that directors are exercising duties of care, loyalty, and obedience as they oversee the programmatic and fiscal operations of the organization. Boards should review, or have an attorney review, their governing documents to ensure that these documents provide effective guidance and reflect the requirements of the law. Examples of governing documents that should be reviewed include the mission statement, bylaws, and policies on conflict of interest, compensation and expense practices.

We will continue to monitor Congressional and IRS actions that may impact nonprofit organizations. In the interim, please contact one of the individuals in our Exempt Organizations Practice should you need counsel with respect to your board structure, governing documents, compensation practices, or any other matters.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.