Board directors must have sound knowledge of their fiduciary duties, as insufficient understanding of these duties can lead to liabilities and even inadequate board governance.
In this article, we’ll learn about a board of director’s fiduciary responsibility, why understanding and assessing it is important, and examine some real-life examples.
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What is a fiduciary responsibility?
Originating from Latin, the term fiduciary means “faith” or “trust”. Therefore, the fiduciary responsibility of a board of directors is a lawful and ethical obligation of one party to act in the best interest of another party, such as a for-profit or nonprofit organization.
In its purest form, fiduciary duty implies that board directors, with this responsibility, hold themselves to an ethical standard beyond mere legal requirements — it means doing what is morally right, regardless of the circumstances.
As this responsibility frequently involves managing finances and other resources, the board’s fiduciary duties encompass various tasks. These include formulating a strategic plan, setting both short-term and long-term objectives, assessing cash flow, overseeing expenses, and implementing protocols to prevent errors while safeguarding against fraud or misappropriation.
The obligations of fiduciaries are regulated by both federal and state laws, as well as common law. Two laws that board members act in accordance with are the Uniform Fiduciaries Act and the Uniform Trustees’ Powers Act.
Why is fulfilling fiduciary responsibility important in corporate governance?
Fiduciary responsibilities hold significant importance as they establish a rigorous standard of care for individuals and organizations.
This is especially so for a nonprofit board, where each board member bears the responsibility of safeguarding the organization’s interests. The fiduciary responsibility of nonprofit board members serves to protect the nonprofit board from any abuse of power or conflict of interest.
The importance of fiduciary responsibilities lies in their ability to ensure:
- Protection of an organization’s assets from potential misuse of power
- Prevention of conflicts of interest that may arise within the organization
- Establishment of greater transparency and corporate accountability
- Encouragement of a higher level of professionalism among the organization’s leaders
As mentioned earlier, it is essential to recognize that both for-profit and nonprofit board members are legally bound by their fiduciary responsibilities.
Nonprofit board fiduciary responsibility makes sure each executive director serves the benefit of the nonprofit organization, while for-profit fiduciary responsibility also entails using robust financial controls.
The main fiduciary duties of board members
One of the board’s primary responsibilities is to ensure the financial benefit of their operations. Serving as the board of trustees overseeing the organization’s budget, board directors must maintain a stable financial position as part of its primary fiduciary duties.
We address board member responsibilities below, such as various aspects of governance, financial management, and ethical conduct.
Duty of care
Duty of care requires acting in good faith, with reasonable care, and in the best interest of the organization. This duty involves making well-informed decisions, being prepared for meetings, and exercising sound judgment.
Directors and officers fulfill their care duty by:
- Actively participating in meetings, contributing insights and expertise to discussions.
- Working diligently to advance the organization’s mission and goals, aligning actions with its purpose.
- Engaging in the selection process of a qualified executive director, who will lead and manage the organization.
- Monitoring the budget and financial reports, ensuring fiscal responsibility and accountability, and questioning expenditures to ensure resources are used efficiently.
- Participating in strategic planning and goal setting, contributing to the long-term vision and direction of the organization.
Duty of loyalty
Duty of loyalty compels each executive director to prioritize the organization’s interests above personal or external interests. They should avoid conflicts of interest, disclose any potential conflicts, and act solely for the benefit of the organization.
A breach of the duty of loyalty by a corporate director can occur through the following actions:
- Misappropriating corporate funds or obtaining undisclosed profits that rightfully belong to the corporation.
- Engaging in competition with the corporation, thereby diverting business or resources away from the organization.
- Taking advantage of corporate opportunities for personal gain without proper disclosure or offering the opportunity to the corporation.
Duty of obedience
Duty of obedience obligates board directors to ensure the organization operates within the bounds of its mission, that it adheres to applicable laws and regulations, and fulfills its legal and contractual obligations:
Existing and new board members can fulfill their duty of obedience by:
- Reviewing and approving policies: Boards should actively participate in the development, review, and approval of organizational policies and procedures to ensure they align with legal requirements and best practices.
- Monitoring legal obligations: Boards should oversee and regularly review the organization’s legal duties, such as filing necessary reports, maintaining necessary licenses or permits, and fulfilling financial and tax requirements.
- Documenting decisions: Boards should ensure that all important decisions and actions taken by the board are properly documented, including meeting minutes, resolutions, and contractual agreements.
Duty of prudence
Under the duty of prudence, each ordinarily prudent person is expected to exercise reasonable business judgment rules in managing financial resources and investments.
For-profit and nonprofit board members, it means making informed financial decisions through the following actions:
- Conducting due diligence: Each board director should gather relevant information, consider potential risks and benefits, and seek expert advice when making important decisions.
- Exercising sound judgment: Boards should exercise sound judgment in their decision-making process, taking into account the organization’s best interests and long-term sustainability.
- Monitoring financial health and risks: Boards should regularly monitor the organization’s financial health by approving expenses, avoiding unreasonable compensation, and reviewing accounting practices.
Duty to disclose
Board directors should provide accurate and timely information to the board and stakeholders regarding any potential conflicts of interest, financial matters, or other relevant information that may impact the organization.
To fulfill their fiduciary duties effectively, board directors should consider:
- Asking specific questions to gain insights and make informed decisions, such as inquiring about the organization’s financial controls, risk management strategies, and compliance with legal duties.
- Ensuring adequate control mechanisms are in place to safeguard the organization’s assets, prevent fraud, and mitigate financial risks.
- Overseeing the organization’s legal obligations, including compliance with applicable laws, regulations, and reporting requirements.
Duty of confidentiality
Since board directors are entrusted with sensitive information about the organization, they have an obligation to maintain its confidentiality, using it solely for the benefit of the organization.
Here is how duty of confidentiality is fulfilled in practice:
- Maintaining and implementing confidentiality: Boards should treat financial data, strategic plans, personnel matters, and other proprietary information shared during board meetings with the utmost confidentiality.
- Exercising discretion: Senior executives should exercise discretion when discussing board matters outside official board settings. They should refrain from sharing confidential information with unauthorized individuals or in situations where it may compromise the organization’s interests.
- Securing Information: Boards should take appropriate measures to secure and protect confidential information, such as maintaining secure digital systems, using strong passwords, and properly disposing of physical documents containing sensitive data.
Examples of board members’ fiduciary responsibility
Real-world examples of boards fulfilling their fiduciary responsibilities include:
- Financial oversight and transparency: Board directors actively review financial documents, budgets, and policies to ensure the organization’s financial health. They implement robust financial controls, conduct audits, and monitor financial transactions to safeguard the organization’s assets and promote transparency.
- Selection and evaluation of leadership: Boards play a crucial role in selecting and evaluating the organization’s executive leadership. They participate in the hiring process, set performance expectations, and conduct regular evaluations to ensure the organization is led by qualified individuals who can effectively advance its mission.
- Ethical decision-making: Boards uphold ethical standards by acting in the best interests of the organization and avoiding conflicts of interest. They make decisions with integrity, transparency, and fairness, putting the organization’s mission and beneficiaries first.
How to improve the board’s understanding of its fiduciary duties
To improve the understanding of a board’s fiduciary responsibilities, several practices should be considered:
- Recruiting new board members, even without prior board experience, brings different perspectives to for-profit or nonprofit boards.
- Providing proper training on fiduciary responsibilities ensures that board members understand their obligations properly.
- Conducting annual evaluations provides an opportunity to assess directors’ comprehension of fiduciary duties on both for-profit and nonprofit boards.
- Engaging in regular discussions about potential liability risks related to breaching fiduciary duties increases responsibility and consciousness.
Policies and procedures to boost fiduciary capacity
For-profit and nonprofit boards elect different officers to help them develop effective procedures for fulfilling their fiduciary responsibilities. Positions include the board chairman, vice chairman, secretary, treasurer, board administrator, and other board members:
- The role of the chairman includes leading meetings, forming committees, and maintaining communication with the executive director.
- The vice chairman’s role includes assisting the chairman when needed.
- The duties of the board secretary include managing member profiles and meeting minutes and ensuring compliance.
- The treasurer’s responsibility involves managing the budget, financial statements, IRS filings, and keeping the board informed.
Seeking expert advice and establishing internal controls are essential for good decision-making and meeting legal obligations.
Additional control mechanisms include clear job descriptions and defined processes for financial matters.
What constitutes a breach of board fiduciary responsibility?
For a breach of fiduciary duty to occur, there must exist a fiduciary relationship between the trustee and the beneficiary, such as that between nonprofit board directors and nonprofit organizations.
For instance, the breach must have legally caused harm or loss to nonprofit organizations, and the damage must be a direct result of the breach.
The examples below highlight instances where boards have fallen short of their fiduciary responsibilities, jeopardizing the organization’s reputation and overall effectiveness:
- Self-dealing: A board member using their position for personal gains, such as awarding contracts to their own business(es) or engaging in transactions that benefit them personally at the expense of the organization.
- Failure to address conflicts of interest: Boards not disclosing or properly managing conflicts of interest, which can undermine the integrity of decision-making.
- Ineffective corporate governance and oversight: Boards not providing sufficient oversight of executive leadership, allowing mismanagement or unethical behavior to persist without appropriate intervention.
- Fiduciary duties refer to the legal and ethical obligations that individuals or entities have when entrusted with the responsibility to act for the benefit of another party.
- Fiduciary duties typically include the duty of care, loyalty, obedience, prudence, confidentiality, and the duty to disclose.
- To improve understanding of fiduciary responsibilities, consider recruiting new board members, including fiduciary responsibilities in the orientation program, conducting annual board evaluations, and engaging in regular discussions on liability risks.
- To enhance your fiduciary performance, consider electing officers such as the chairman, vice chairman, secretary, and treasurer.
- Self-dealing, ineffective governance, and failure to address conflicts of interest are among the most prominent examples of failure to fulfill fiduciary responsibilities.
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What is the main fiduciary duty of the board of directors?
The main fiduciary duty of the board of directors is to act in the best interests of the organization and its stakeholders, making decisions and taking actions that promote the organization’s mission and long-term success while upholding legal and ethical standards.
What are the different types of fiduciary duties?
The different types of fiduciary duties typically include the duty of care, which requires board members to make informed and diligent decisions; the duty of loyalty, which demands acting for the benefit of the organization without conflicts of interest; and the duty of obedience, which entails compliance with applicable laws and the organization’s governing documents.
What are the legal implications of failing to fulfill fiduciary responsibility?
Failing to fulfill board member fiduciary responsibility can lead to legal actions, including lawsuits and potential personal liability for damages. It may also result in consequences such as removal from the board and potential loss of nonprofit status.