Not-for-Profits Not Immune to Fraud

May 16, 2014

Fraud has been around since the beginning of commerce and continues to plague even the largest of business organizations, from Enron to the mom and pop corner store, and America’s charitable communities are not immune to fraud.  As reported by Independent Sector, an organization that performs research and publishes not-for-profit trends and data, there were more than 1.1 million not-for-profit organizations in the United States, employing about 13.7 million individuals and generating an estimated $1.5 trillion in revenue. The Association of Certified Fraud Examiners estimates that organizations lose 5 percent of annual revenue to fraud, which means the not-for-profit sector is a victim of $77 billion in estimated annual losses due to fraud.

This lost revenue is significant to a not-for-profit organization, but the impact of fraud will also be felt in the following critical areas:

  • Damage to the organization’s reputation 
  • Negative publicity
  • Lower employee morale 
  • Cost of litigation and investigation
  • Disruption to business operations

The not-for-profit sector, which prides itself on serving the public good, is often more susceptible to fraud and abuse than many for-profit enterprises.  The reason why is simple.  Their environment of trust is unlike that found in for-profit enterprises:

  • Not-for-profits often place excessive control in their founder, executive director, or substantial contributor.
  • Not-for-profits often allocate limited resources to accounting, internal controls, and financial oversight.
  • Not-for-profits often have many volunteers working in the organization who are privy to confidential information. 
  • Not-for-profits frequently have all-volunteer boards of directors, with little or no financial oversight expertise.
  • Not-for-profits typically have nonreciprocal transactions, such as charitable contributions, that are easier to steal than other sources of revenue where there is consideration exchanged. 
  • Not-for-profits are highly susceptible to the effects of negative publicity and, therefore, are reluctant to report, or even discuss, fraud when it occurs.

To minimize the opportunity for fraud and abuse in this sector, one must understand the two broad categories of not-for-profit fraud: those committed against the not-for-profit and those committed by the not-for-profit.  Typical examples of fraud perpetrated against not-for-profit organizations include the following:

  • Skimming — Cash is stolen before the funds are recorded in the accounting records.
  • Credit card abuse — Perpetrators either use organization-issued credit cards for personal use or use donor credit card numbers. 
  • Fictitious vendor schemes — Perpetrators set up a company and submit fake invoices for payment. 
  • Conflicts of interest — Board members or executives have hidden financial interests in vendors. 
  • Payroll schemes — Continued payment of terminated employees, overstatement of hours, or fictitious expenditure reimbursement.
  • Subrecipient fraud — Abuses by a subrecipient entity include intentional charges of unallowable costs to the award, fraudulent reporting of levels of effort, and reporting inaccurate performance statistics and data.

Examples of fraud committed by a not-for-profit organization include the following:

  • Deceptive fundraising practices — Misrepresentation of the extent of a charitable contribution deduction entitled, misrepresentation of the fair market value of donated assets, and failing to comply with donor-imposed restrictions on a gift.
  • Fraudulent financial reporting — Misclassifying restricted donations to mislead donors or charity watchdogs, misclassifying fundraising and administrative expenses to mislead donors regarding funds used for programs, and fraudulent statements of compliance requirements with funding sources.

To minimize the opportunities for fraud and abuse, not-for-profits absolutely need strong board leadership and improved independent audits.  The board of directors of a not-for-profit organization has a fiduciary responsibility to the organization and its grantees and donors. In addition to its oversight responsibilities for policy making, planning, fiscal management, and public liaison, the board has fraud-related oversight responsibilities.  These duties can be fulfilled as follows:

  • Ensure that the organization has adequate fraud-prevention and risk-management policies. 
  • Ensure that the organization has taken appropriate steps to identify fraud risks and adequately protected itself against fraud through insurance and reasonable reserves. 
  • Oversee senior management’s follow-up actions in response to findings of auditors or investigators. 
  • Oversee the organization’s budgeting, financial reporting, tax reporting and financial analysis processes.

Therefore, to assure that the environment of trust is working, management and the board must be committed to a control environment complete with clearly defined policies and procedures, and rigorous systems of checks and balances.  Otherwise, the public’s trust could be lost... possibly, forever.

View the 2013 Not-For-Profit Blog: Protect Your Not-for-Profit Organization’s Credit Cards from Fraud

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