Nonprofits Vulnerable to Fraud, But Not Powerless

Nonprofits Vulnerable to Fraud, But Not Powerless

No business is immune to fraud, but not-for-profit organizations (NPOs) may by their very nature be more vulnerable than their corporate brethren. NPOs must operate on trust, and often on a shoestring budget. Frequently, their businesses, which can involve significant cash donations, are conducted by a mix of volunteers and employees who may be dedicated to the NPO’s mission but aren’t necessarily savvy businesspeople. Their boards of directors are usually volunteers who may be dedicated and savvy but may not have the time to devote to effective oversight.

Dangers lurk

While most fraud still occurs in private companies, according to the Association of Certified Fraud Examiners’ (ACFE) 2004 Report to the Nation, NPOs still get hit hard. The median loss to NPOs is $100,000 (compared to $123,000 for private companies).

Even more damaging for organizations that live and die by public donations is the loss of reputation that accompanies fraud. The media may give only lip service to NPOs under normal circumstances, but they’re often only too happy to explore those organizations in great detail when there’s a whiff of scandal. When that happens, donors become understandably leery of making charitable contributions.

Warning signs

There usually are warning signs that the atmosphere is ripe for fraud or that fraud is occurring. In fact, NPOs may unwittingly create such an atmosphere for themselves. Shrinking government subsidies and increasingly hard-to-obtain fund-raising dollars mean that NPOs must consider budgetary cutbacks. That may mean reducing the paid workforce and relying more heavily on remaining staff and volunteers.

The increased fraud risk is twofold. Staff cuts can breed resentment that may justify fraud in the minds of some. Secondly, such cutbacks too often are accompanied by an erosion of financial controls — giving fraudsters more room to work. Similarly, tight budgets may cause board members and executives to focus on short-term fund-raising goals, allowing internal financial controls and reporting to take care of themselves.

Another danger specific to NPOs is off-site fund-raising. Without proper accounting supervision and control, benefits and other events can be open invitations to fraud. A paper trail of numbered tickets and receipts and other precautions will help curb many fraudulent impulses, but lack of oversight can make it difficult to determine whose hand was in the till — and how deep it dipped — when the event is over.

Prevention is key

Once it occurs, fraud can be difficult to spot. It is possible to stop it before it starts, though. The following steps may help:

Perform background checks. Distasteful though it may be to an organization devoted to doing good, you should perform background checks on employees and volunteers — including prospective board members and executives — who have financial responsibilities.

Require authorization. Requiring executive or board authorization for transactions over a certain amount — or, if an organization is small enough, for all transactions — will help control the money flow. Authorizing agents should also clearly understand how the transactions fit into the organization’s operations.

Segregate duties. Ensure that the same person doesn’t pay the bills, reconcile bank statements, control the safe and sign the checks. Divide duties and implement safeguards such as computer passwords to remove temptation.

Reveal and prosecute. NPOs that become victims of fraud often try to keep that news from leaking. Instead, make strong public statements, investigate fully and press charges against the perpetrators. Not only does this assure the public you’re taking steps to protect their donations, but it also lets fraudsters know that criminal activities will not be tolerated. A full investigation should also reveal how the scam was perpetrated, allowing you to take steps to ensure that it never happens again.

Don’t ignore fraud

NPOs aren’t always adept at finding fraud. The ACFE report noted that internal audits identified only 11.5 percent of fraud in NPOs, compared to 24 percent in other businesses. Such numbers, coupled with the fact that six out of 10 NPOs said they have no internal audit departments, make it important to employ external auditors to help you keep an eye on finances. While it’s tempting to defer fraud control measures in favor of more urgent programming, it’s a mistake you can’t afford to make.

Who’s minding the mint?

One of the reasons that not-for-profit organizations (NPOs) appeal to those bent on fraud is that the monitoring and regulatory procedures surrounding them are not widely known. Unlike corporations or government agencies, where monitoring is often both vocal and visible, nonprofit watchdog groups tend to maintain lower profiles.

They do exist, however. A number of private organizations, such as the National Charities Information Bureau (NCIB), monitor NPOs’ performance, either to reassure donors that their money is being used properly or to keep the public aware of the NPOs’ activities. These organizations also encourage NPOs to comply with prevailing standards.

Each state also has an office — often that of the attorney general — that is charged with watching charitable organizations. In addition to investigating fraud allegations, these offices typically maintain lists of registered NPOs and monitor compliance with their states’ fund-raising laws.

The IRS, too, takes an interest in ensuring that NPOs meet eligibility requirements for tax-exempt status. Auditors in the IRS Exempt Organizations Division review the financial records of thousands of NPOs each year.