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January 17, 2013

A Bit of Sarbanes-Oxley for Universities, Please

Thumbnail image for dartrustees.jpg

By Todd J. Zywicki

The impulse to impose Sarbanes-Oxley on universities is tempting.  Indeed, formal legal mandates on conflicts of interest and the other attributes of good governance might be even more appropriate for universities than for public corporations, as universities lack many of the safeguards of good governance, such as the ability to measure performance through profitability and engaged  shareholders with incentives to monitor performance.

It has traditionally has been assumed that universities, as ostensibly charitable organizations, would be run with an eye on the public good, thus formal restraints on self-dealing, conflicts of interest, and rules that apply to private corporations would not  be necessary.  Today, however, universities are big businesses riven with self-interest.  And there is little evidence that charitable purpose plays any role in their behavior.  University president's salaries routinely reach into the seven figures--Dartmouth's recent president, for example, earned over one million dollars a year and demanded millions of dollars of renovations to the college president's house and access to a private jet as part of his compensation package, even while laying off dozens of staff members and issuing hundreds of millions of dollars in debt (to be financed by future generations of students and parents) to close a massive budget deficit caused when the endowment cratered in the wake of the financial crisis.

Looking Under the Lamppost

And university trustees have all but abandoned any pretense of governing.  To some extent this is the nature of the job itself--board membership is treated by most trustees as little more than a hobby and a prestigious perk that provides access to top-notch football seats and guaranteed college admission for your children, not as a serious governance responsibility.  For example, when I proposed that Dartmouth's board add a standing committee on academic affairs to its existing standing committees on Finance, Governance, and Buildings and Grounds, I was instructed that the board had "no expertise" in academic matters and that such a committee would thus be inappropriate.  It apparently never occurred to him that this "looking under the lamppost model" of governance was a jaw-dropping indictment of the board.

This tendency toward lax oversight has been exacerbated in some places by conflicts of interest by board members--at Dartmouth, for example, 13.5% of its $4 billion endowment has been invested in the various hedge fund and private equity funds of investment banker trustees (generating tens of millions of dollars in management fees for the favored trustees), all with few internal safeguards and minimal external disclosure.  Boards have exploded in size to 30 or 40 members or more--far too big for effective governance--as trustee seats are viewed primarily as fund-raising tools rather than governance positions.  This combination of feel-good boosterism, self-interest, and absence of personal responsibility for governance creates a "go along to get along" culture inimical to engaged governance and probing oversight of the university's management.  From there it is but a short step to the moral corruption of Penn State's board of trustees, which evidently viewed the gruesome child abuse scandal in its football program as a PR scandal and fund-raising concern, rather than a moral abomination of the highest dimension.

A Cozy Arrangement for Trustees

So true governance is absent from most university boardrooms today.  And while application of Sarbanes-Oxley might force boards to do their jobs better, at the very least universities would do well to voluntarily adopt many of Sarbox's ideas.  One that proved especially important at Dartmouth was a contract between the board of trustees and the alumni association providing that half of the board of trustees would be elected as essentially independent trustees, elected by the alumni in true contested elections (the other half of the board was chosen by the board itself).  Indeed, alumni could nominate candidates as private "petition" candidates to challenge the hand-picked candidates proposed by the alumni council (which is how I was elected).  Because we were nominated and elected by the alumni body as a whole, we owed our allegiance only to Dartmouth and its students, not to the personal ties of other members of the board or the college president who selected us--much like the independent directors required by Sarbanes-Oxley.

Needless to say, after petition trustees won four elections in a row, the board expanded the size of the board to dilute the influence of elected trustees relative to insider trustees in general, rewrote the rules for trustee elections to advantage loyalist candidates, and purged obstreperous trustees from the board.  They explained that board seats were too valuable a fund-raising commodity to allow the alumni to fill through elections and, that as one of the board members bluntly justified the board-packing plan, "Trustee seats should be a reward for your largesse."  In short, when faced with a threat to its cozy culture the board imposed changes that moved it in a direction diametrically opposite of that recommended by Sarbanes-Oxley.

If the common sense soundness of many of Sarbanes-Oxley's governance principles seems obvious--indeed, more applicable in many ways to non-profits than public corporations--why not mandate their application to universities?  Well, for one, regulatory mandates are always blunt instruments and Sarbanes-Oxley has had many unintended consequences for corporations and could be expected to have unintended consequences for universities as well.  Second, compliance costs with Sarbanes-Oxley can be substantial, and if it is applied with equal force to financial behemoths like Harvard and smaller, shallower-pocketed colleges, the regulatory cost could further raise student costs and exacerbate the already unequal playing field between large and small colleges.  On the other hand, if boards continue to eschew responsible voluntary reforms, public regulators may have to consider whether regulation is appropriate to ensure that universities operate in a manner consistent with their charitable purpose.

Harvey Silverglate argues, however, that rather than imposing the expensive and cumbersome regulatory apparatus of Sarbox on universities, it might be more effective and less expensive to hold trustees to their traditional common law obligations of fiduciary duty, including the duty of loyalty and duty of care.  Unlike for-profit firms where shareholders have the standing and incentives to hold directors accountable for breaches of loyalty or care, however, it is not clear who would have the ability to enforce fiduciary duty obligations on university boards.

Todd J. Zywicki, a professor at George Mason Law School and a regular blogger at the Volokh Conspiracy, served as a trustee at Dartmouth from 2005 to 2009.

(Photo: Members of the Dartmouth Board of Trustees, November, 2007)



Comments (1)

PatD:

Harvey is right. I work in IT in a non-profit healthcare organization and I've watched as SOX has doubled our staff, halved our productivity and accomplished nothing.

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