Consider this scenario: Two long serving members of the school board retire and the board determines that it should thank the retiring members for their service. They use board funds to purchase two watches for the retiring members worth about $5,000 each. But what's in a watch? Actually quite a lot, as the ACNC confirmed in Charity Compliance Report 2017 (Report).

Report Background and Areas for Concern

Annually, the ACNC publishes the Report to outline its enforcement priorities and its concerns for the not-for-profit (NFP) and charity sector. Most non-government schools operate as a NFP so the results of the Report prove to be interesting reading.

In 2017, key risks identified by the ACNC for NFPs included:

• fraud and financial mismanagement
• terrorism
• harm to beneficiaries, particularly when children and vulnerable adults are involved, and
• involvement in political activities through a misunderstanding of the charitable purpose.

Fraud and theft in NFPs were also discussed in our previous article and continues to be an ongoing concern for the ACNC.

The ACNC also outlined its concerns that poor governance continues to be a common theme to emerge from its investigations. The most common issues referred to the Compliance team continue to be issues related to poor financial controls, inadequate due dilligence of employees and partners and a failure by the NFP's responsible persons to act in the best interests of the charity.

NFPs are entrusted with charity funds that must be managed appropriately and part of the ACNC's role is to complete risk assessments and compliance activities on funding management within NFPs. In 2017:

• 338 risk assessments were completed
• 82 investigations were finalised with 26 charities having their registrations revoked after investigation
• 311 NFPs were issued with warning letters for failing to submit an Annual Information Statement
• 115 NFPs were issues with penalty notices (up to $4,500) for failing to submit an Annual Information Statement, and
• 780 NFPs had their registration revoked after double defaulting for two years running in not submitting an Annual Information Statement.

Registered NFPs must also meet a set of Governance Standards to be registered and remain registered with the ACNC. The Standards require NFPs to remain charitable, operate lawfully and be run in an accountable and responsible way. In particular, the Standard which caused the ACNC the greatest concern this year was Governance Standard 5: Duties of Responsible Persons, including high risks of financial mismanagement and failures to address potential harm to beneficiaries.

Which brings us back to the question of what's in a watch?

Managing not-for-profit finances: Gifts and related party transactions

All school NFP board members have a duty to act in the best interests of the charity under ACNC Governance Standard 1 and meet the duties of a responsible person under Governance Standard 5. Recent changes in both NSW and Victoria reinforce these standards as a requirement for school registration.

A significant issue for NFPs are related party transactions - where (in summary), the resources of the NFP are not used purely for the benefit of the school. Any gifts or payments to school board members that are unreasonable, unauthorised or unjustifiable may mean that the school is not complying with the Governance Standards by not demonstrating the use of school funds was for a proper charitable purpose.

Some state registration requirements have specifically addressed NFP gift giving and related party transaction issues. For example, in NSW, s 83C of the Education Act 1990 requires that schools may only enter into related party transactions that are required for the operation of the school, at no more than reasonable market value and are reasonable in the circumstances, regarding the fact that financial assistance is received by the school from the NSW Government. The NFP Guidelines for Non-Government Schools must also be met by all non-government schools in NSW for the purposes of school registration.

In practice, this means that school boards who wish to thank retiring board members with a gift, like a watch, should make sure that:

• decision making in relation to the gift is in line with the purpose and operation of the school
• charitable funds for the gift were appropriately authorised and documented (and are at reasonable market value), and
• the gifts did not go beyond a token nature, or are reasonable in the circumstances.

Managing conflicts of interest

Another issue that may be of some concern to school boards is preventing conflicts of interest when acting as a responsible person and fulfilling the duties required by Governance Standard 5. While school board members are important in the life of the NFP school, they are also people with numerous family, social and business relationships which are often important factors in the growth of the school and its community.

A conflict of interest occurs when a school board member's personal interests conflict with their responsibility to act in the best interests of the school. Recent updates to Victorian school registration requirements codified this aspect of conflicts of interest by adding a requirement to Standard 17 that "the proprietor of a registered school must have sufficient controls in place to ensure that school property and assets are not distributed or used for the profit or gain of another person or entity." The new amendments to Victorian registration include new definitions of "not-for-profit" and "prohibited agreement or arrangement" which are detailed further in our previous Briefing Paper.

A conflict of interest can result in board members:

• causing reputational risk to the school
• failing in their duty to act in the best interests of the school, and
• showing poor governance by risking accountability and transparency.

For schools, this most often occurs in situations where there is a direct or indirect financial interest or there is a conflict of loyalties.

Schools can minimise conflicts of interest occurring by:

• adopting a conflict of interests policy
• maintaining a register of interests, and
• promoting a culture of disclosure at board meetings which encourages frank discussion about how involved a conflicted member of the board can be.

What should school boards do now?

Schools should be aware of the review of the ACNC legislation which sets the framework for the charity regulator. The legislation is required to be reviewed every five years and it is now undergoing its first review since commencement. The ACNC has publicly released its submissions which contains 40 recommendations to be considered by the review panel, which may result in changes to the regulatory framework, definition of NFP and key duties of responsible persons.

The ACNC has also indicated that financial management of boards is an ongoing concern for 2018 and schools should make sure their boards are proactively identifying and assessing risks, especially those in relation to conflicts of interest and related party transactions.