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Monday, March 18, 2019

Nonprofit Fraud: Catching and Mitigating It


Fraud within a nonprofit environment is not only a tremendous breach of trust, but also carries steep financial and reputational costs. To the executives and board members of nonprofits, detecting and deterring fraud can feel like an insurmountable challenge — especially if you follow the news.

Here are just a few recent cases involving nonprofit victims:

  • Bill Davis, who led the now-defunct Community Action of Minneapolis for 24 years, was sentenced to four years in prison after pleading guilty to 16 counts of theft and fraud. Davis stole at least $800,000 of taxpayer money intended for low-income people and spent it on cars, lavish trips and other personal items.
  • The executive director of the North Idaho Housing Coalition was indicted on charges of wire fraud, federal program theft and fraud forfeiture. She is accused of stealing about $500,000 from the North Idaho Housing Coalition, which works with low-income families. She allegedly forged checks, opened companies to launder money, overcharged tenants and purchased personal items with an unauthorized company credit card.
  • The chief financial officer of the Capital Area United Way in Michigan was found guilty of embezzling close to $2 million by writing fraudulent checks to herself and forging signatures from supervisors. The fraud went unnoticed until the trail of missing checks was seen by the new CFO, after the former one resigned.
  • Three former officials of Second Chance, an Arkansas nonprofit that focuses on at-risk children, were sentenced to prison time and ordered to repay $310,000 after being convicted of conspiring to falsify claims for state funding.

Todd Wallack, an investigative reporter with The Boston Globe, found that more than 1,100 tax-exempt organizations nationwide have reported theft, embezzlement, or other major diversions of assets over the past seven years, according to electronic filings with the Internal Revenue Service. According to the Association of Certified Fraud Examiners (ACFE), the median financial loss for nonprofits ($75,000) was about half that experienced by private companies ($164,000), as reported in its 2018 Global Study on Occupational Fraud and Abuse. But losing even $75,000 can be devastating for a smaller organization — especially if key donors defect as a result.

Risk Factors for Nonprofits

Small and even midsize nonprofits can often be particularly vulnerable. They typically run lean, with financial duties consolidated in one position. For example, the chief operating officer might be responsible for approving vendor invoices, cutting the checks and reconciling bank statements.

Many nonprofit boards and leadership teams lack expertise in finance. As a result, thefts can go undetected for months or even years. (According to the ACFE report, the median duration of a fraud scheme for all types of organizations is 16 months.) Employees of nonprofits may rationalize their theft by thinking about the number of hours they put in and the relatively low pay.

When nonprofit leaders do discover a fraud, they may go out of their way to avoid publicizing it, fearing the reputational fallout and loss of big donors. When fraudsters escape prosecution, they are free to exploit other organizations.

Common Nonprofit Fraud Schemes

Most nonprofit employees behave ethically and genuinely want to help their constituents. However, the sad fact is that fraud can occur in any type of organization. The fraud schemes we see most often in our work with nonprofits are:

  • Skimming cash: Nonprofits often accept many donations by cash, making them susceptible to skimming and other forms of theft. Without appropriate supervision, ready access to cash can give an otherwise ethical employee the incentive to “take a little off the top.”
  • Purchasing schemes: Because purchasing schemes require more sophistication and planning, they are often executed by longtime, trusted employees. One type of purchasing scheme involves inventing a fictitious vendor and submitting invoices on behalf of that vendor; another involves collusion between an employee and an actual vendor to submit false or inflated invoices.
  • Expense reimbursement: Employees often justify falsifying a reimbursement because they think they are owed some additional compensation. For example, an employee files a fraudulent expense report claiming personal travel, nonexistent meals or other expenses that are not reimbursable.
  • Corruption: An employee misuses his or her influence in a business transaction in a way that violates duties owed to the nonprofit in order to gain a direct or indirect benefit. For example, an employee solicits or accepts a bribe or acts while under an undisclosed, impermissible conflict of interest.

Steps to Create an Anti-Fraud Environment

These common types of fraud can be challenging to prevent. However, a robust system of internal controls can deter many would-be fraudsters and mitigate the losses that do occur.

Don’t depend on trust or over-rely on a staff or board member who volunteers to “take care of all that financial stuff” without reasonable checks and balances.

The most critical step for any organization intent on preventing fraud is to set an ethical tone at the top. If executive and board leadership demonstrate that they have zero tolerance and will take action if fraud is uncovered, then employees and volunteers will be more likely to toe the line.

Anonymous hotlines and other reporting mechanisms are among the most effective ways to convey the organization’s intolerance for unethical behavior. According to the ACFE, tips are the most common initial detection method across all types of organizations, and fraud losses were 50 percent smaller at organizations with a hotline. Encourage everyone within the organization to be observant for red flags and report them. If there are sudden shifts in the lifestyle of an employee, such as purchasing a bigger home or a more expensive vehicle, or the individual appears to be struggling with drug abuse, alcoholism or gambling, those can be seen as red flags that may require further attention.

Are you demonstrating a zero-tolerance attitude toward unethical behavior? Are your internal controls adequate to reduce your fraud risks? Are you providing encouragement for those in your organization to hold each other accountable and be the “eyes and ears” to protect the organization?

Asking and addressing these questions will help you mitigate your risk. Contact your Armanino nonprofit advisor for additional ideas and support to protect your nonprofit organization against fraud.

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