Photo: Dodger Harrison. Source: Morguefile
“Pay to Play” is a pernicious system where nonprofits use their business needs to generate donations. Periodically, a nonprofit will ask vendors to submit business proposals – say, for snowplowing services, or investment management. When the proposals are evaluated, the nonprofit also examines the record of charitable contributions they may have received. Unless a business is on the list of the organization’s donors (they “pay”), they don’t have a chance of being hired (they won’t “play”).
It’s pernicious because it uses a business contract to extract donations. Investment management or other services should be conducted by the firm best suited for the job. An investment manager needs to tailor an endowment to fit within the overall financial picture. In the case of a very large endowment, the best sub-managers should work within each allocated sector. But with “pay to play,” performance is secondary to other considerations, like donations.
A few years ago, Dartmouth College was accused of taking “pay to play” to an extreme level. Ten current or former Trustees either managed or directed the management of over $1 billion of Dartmouth’s $5 billion endowment. Many of those Trustees had also been generous benefactors, donating millions and getting their names on buildings. But they also earned millions in management fees from the endowment. Quite regularly, over 10% of the College endowment is in the hands of Trustees or members of the Investment Committee.
Public Domain. Source: Wikimedia
In a subsequent examination, the New Hampshire Attorney General found that the Trustees involved had followed all the laws that apply to nonprofits when it comes to awarding business contracts. Specifically, they recused themselves from any decision in which their firms were directly involved. But following rules that apply to Town Trust Funds and the local thrift shop as well as multi-billion-dollar institutions isn’t the point. It’s easy to hire your friends. We all suffer from familiarity bias. When interviewers evaluate job candidates, they tend favor folks who look like them. But if a financial advisor doesn’t do well, it’s a lot harder to fire your buddy.
Large institutions of higher learning should follow a higher standard. Any Trustee who stands to benefit personally from their business should resign from being a Trustee. There are plenty of well-qualified people willing to serve. Either that, or they should manage the investments pro-bono.
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”