Interesting reading for the next VMOA Treasure . . .
Benevolence, trust and compassion traditionally form the cornerstone of not-for-profit organizations and are attributes which facilitate their success. But, when fraud prevails, these same characteristics can contribute to the vulnerability of a charitable organization.
Perhaps it is the inherent culture of trust and compassion prevalent in nonprofits that cause them to be susceptible to exploitation by perpetrators of fraud. It is difficult for benevolent leaders to imagine trusted colleagues perpetrating any sort of fraud. Therefore, not-for-profit organizations frequently do not have the basic, formal controls in place that prevent, detect and deter fraud.
Kind leaders may view formal prevention methods such as Codes of Conduct, whistleblower programs, awareness sessions, investigation and discipline guidelines as evidence of distrust and misgivings. Internal controls, robust audit programs and monitoring systems may be seen as indicators of suspicion or doubt. However, it is this lack of anti-fraud controls that may put the organization?s precious assets at risk.
The former treasurer of the Episcopal Church embezzled $2.2 million in church money over five years, spending it on real estate, jewelry, clothing, trips abroad and limousine service. According to the church?s bishop, the diversions went undetected for years because the treasurer had "absolute control" over auditing at the headquarters and prevented others from checking the books.1
Schemes Orchestrated Against Not-For-Profit Organizations
Embezzlement and other fraud schemes executed on not-for-profit organizations are as bountiful and resourceful as the charities themselves. Common schemes include skimming of donations, unauthorized fraudulent disbursements, as well as the payment of personal expenses with charity funds. Other examples of frauds involving non-profits include the use of the tax exempt status of the organization to generate fictitious deductions, kickbacks from vendors, use of international initiates to lauder ill-gotten funds, exploitation of established networks to fund terrorist activities and fraudulent financial reporting.
Charities are particularly vulnerable to skimming schemes (cash and check). Fund-raising events often include cash intensive events (gambling, raffles, etc.), which can be easily stolen. Charities also are susceptible to skimming receipts in the form of checks because they often operate under the acronyms of their initials. Checks payable to the organization?s initials can be easily altered and deposited to a personal account. For instance, CFA can be easily altered to reflect C. F. Anderson.
Other embezzlement schemes perpetrated by employees of not-for-profit organizations involve the creation of fictitious vendors and fraudulent invoices that resulted in disbursements to the fictitious vendors. Employees with access to the organization?s checks may issue checks to pay their personal expenses, make checks payable to themselves or counterfeit checks to be used for their personal gains. The organization?s credit cards may also be used to purchase personal goods or the credit card numbers of donors may be used by perpetrators for personal use.
Ten days after the chief financial officer of the Capital Area United Way took office she noticed during an internal review that dozens of checks were missing from the organization's records. When the bank faxed her the checks, a fraud scheme unfolded. Each check was made out to the organization?s former vice-president of finance who had forged the names of two officers to make hundreds of payments to herself totaling $2 million.2
Vendor kickback schemes normally result in an award or benefit to a person or company who has paid a bribe to receive preferential treatment by the organization. Bribes paid to employees or managers of non-profit organizations can impact the organization financially or qualitatively and damage its relationships with donors or grantors.
A former consultant for the central purchasing agent of the Archdiocese of New York pleaded guilty in August of 2006, to eight fraud, tax and obstruction of justice charges stemming from a scheme he orchestrated to receive kickbacks from vendors who wished to do business with the Catholic Church. The indictment alleged that several individuals used their positions as employees and consultants at Institutional Commodity Services Inc. (ICS), the purchasing arm of the archdiocese, to defraud the archdiocese of more than $2 million from 1996 until 2004.3
Not-for-profit organizations are often used by tax cheats in an attempt to substantiate fictitious deductions on their tax returns. Some fraudsters will go so far as to send a donation check to a charity and subsequently request a refund of the donation. The fraudster uses the original check to document the refund. There have also been instances of collusions between tax cheats and trusted individuals within the tax exempt organization who refund 90 percent of the original contributions.
The former head of fund-raising for the American Cancer Society's New York City branch was indicted several years back for masterminding a scheme that enabled contributors to take nearly $4 million in illegal tax deductions. Federal officials said contributors made out checks to the Cancer Society and then received cash kickbacks for 90 percent of the amount of the checks. The contributors could deduct the full amounts on their income-tax returns, using the canceled checks to back their claims.4
Since September 11, 2007, increased government scrutiny has uncovered not-for-profit organizations specifically set up to fund terrorist activities. In addition, legitimate charities have been found to be used to channel money to terror organizations.
A federal grand jury indicted a now-defunct Islamic charity and five men for illegally transferring funds to Iraq and stealing U.S. government grant money. A 33-count indictment charged the Islamic American Relief Agency, or IARA, headquartered in Columbia, Mo., and charity officers and associates with a range of crimes related to money transfers to Iraq.5
Other fraudulent practices perpetrated by representatives of not-for-profit organizations include failure to comply with Internal Revenue Service requirements related to political campaign contributions, housing allowances, or compensation reporting.
It may be difficult to understand how fraudulent financial reporting could occur in organizations that, by definition, do not show a profit. However, unscrupulous managers of not-for-profit organizations have manipulated expense ratios and other performance indicators to impress donors, grantors and evaluators of charities.
Protecting Not-for-Profit Organizations from Uncharitable Acts of theft or abuse
What can charities and not-for-profit organizations do to determine their risk management needs? Establish entity level controls that deter fraud by creating an environment that has a zero tolerance for fraud, including:
Clear Code of Conduct in Concert with Awareness Programs
One of the most important elements of fraud prevention is the establishment, communication and monitoring of the organization?s Code of Conduct. The organization?s commitment to ethical behavior should be clearly and concisely communicated to management, employees and related third parties. Commitment to the code should be affirmed by all employees on a periodic and ongoing basis, and the institution may choose to reinforce the importance of the code and business principles through training. All violations of the code should be subject to disciplinary action that is consistent with the level of infraction in order to create a positive impact on the ethical atmosphere of the workplace.
Training about an entity?s values and its code of conduct should be provided to new employees at time of hiring and include an element of ?fraud awareness.? Employees should also receive refresher training thereafter, specific to their level within the organization, geographic location and assigned responsibilities.
Employee Screening Procedures
Screening procedures should be incorporated within the organization?s hiring process as a precaution. Background checks should be vigorous and include credit reports. Education and prior employment should be verified; reputation should be established through references, and resume gaps should be explored. Employees and managers should be properly trained to recognize symptoms of fraud.
Screening procedures should be incorporated within the organization?s hiring process as a precaution. Background checks should be vigorous and include credit reports. Education and prior employment should be verified; reputation should be established through references, and resume gaps should be explored. Employees and managers should be properly trained to recognize symptoms of fraud. Regarding the aforementioned scheme perpetrated by the Treasurer of the Episcopal Church, other Church officials said they did not really know the treasurer. Her resume said she graduated from a prominent university in 1969 with a degree in economics. But the university officials say they have no record of her attending the university.6
Perhaps a background check would have prevented this fraud and embezzlement from occurring.
Whistleblower Procedures
Procedures for the receipt, retention and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters should be established by not-for-profit organizations.
Tone at the Top - Set a good example
The Association of Certified Fraud Examiners (ACFE) reports that having an ethical ?tone at the top? can be the most effective means of avoiding fraud. Leadership should avoid giving people the rationalization to defraud. A positive tone at the top can be earned by treating people fairly and ensuring that management at all levels of the organization follow the rules.
Audit and Monitoring Procedures
Frequent audits should be conducted focusing on areas which could be vulnerable to fraud. Consideration should be given to using an outside auditor or an audit committee to ensure independence.
Many of the fraud schemes cited in this article would have been uncovered through an effective audit program. Fraudulent schemes historically have been identified by internal audit at twice the rate of external audits through clear fraud risk-related audit steps. Vigorous monitoring activities should also be utilized to assure that the system of internal control is designed and operating effectively to help prevent, deter and detect fraud.
Enhanced Segregation of Duties
Duties within a function of a not-for-profit organization should be separated so that one person does not perform processing from the beginning to the end of a process.
?If the United Way of East Lansing had segregated responsibilities in its finance department, the former vice president might have been caught sooner,? officials there say. ?She had sole control over the chapter's internal accounting system, which tracks pledges, and a computer program that accounts for donations that the organization receives. She had no authority to write checks, but she alone reconciled the checking account.? 7
Why Fraud Prevention and Detection is Important to Charitable Organizations
Not-for-profit organizations have a responsibility to their donors and grantors to ensure that the funds to which they are entrusted are used for their intended purpose. Even if an organization has adequate employee-theft insurance, damage to a charitable organization?s reputation can be far-reaching and lasting. Charity officials say that they are far more concerned about how donors will react than they are about the short-term money they lost.
Charitable organizations thrive on their good reputation. A good reputation ensures donor confidence and induces continued contributions. On the contrary, a reputation tarnished by instances of fraud can foster a loss of confidence and cause a decline in contributions.
Shortly after the fraud was uncovered, a spokesperson for the Episcopal Church stated, "The church has lost a lot of integrity, the church has lost trust. People are disillusioned and we'll pay for that in a thousand ways." 8
It is important that not-for-profit organizations add good governance and an anti-fraud environment to their many attributes to ensure their continued success. These enhancements can build public trust and confidence in Charities and encourage continue support by donors and grantors.
Benevolence, trust and compassion traditionally form the cornerstone of not-for-profit organizations and are attributes which facilitate their success. But, when fraud prevails, these same characteristics can contribute to the vulnerability of a charitable organization.
Perhaps it is the inherent culture of trust and compassion prevalent in nonprofits that cause them to be susceptible to exploitation by perpetrators of fraud. It is difficult for benevolent leaders to imagine trusted colleagues perpetrating any sort of fraud. Therefore, not-for-profit organizations frequently do not have the basic, formal controls in place that prevent, detect and deter fraud.
Kind leaders may view formal prevention methods such as Codes of Conduct, whistleblower programs, awareness sessions, investigation and discipline guidelines as evidence of distrust and misgivings. Internal controls, robust audit programs and monitoring systems may be seen as indicators of suspicion or doubt. However, it is this lack of anti-fraud controls that may put the organization?s precious assets at risk.
The former treasurer of the Episcopal Church embezzled $2.2 million in church money over five years, spending it on real estate, jewelry, clothing, trips abroad and limousine service. According to the church?s bishop, the diversions went undetected for years because the treasurer had "absolute control" over auditing at the headquarters and prevented others from checking the books.1
Schemes Orchestrated Against Not-For-Profit Organizations
Embezzlement and other fraud schemes executed on not-for-profit organizations are as bountiful and resourceful as the charities themselves. Common schemes include skimming of donations, unauthorized fraudulent disbursements, as well as the payment of personal expenses with charity funds. Other examples of frauds involving non-profits include the use of the tax exempt status of the organization to generate fictitious deductions, kickbacks from vendors, use of international initiates to lauder ill-gotten funds, exploitation of established networks to fund terrorist activities and fraudulent financial reporting.
Charities are particularly vulnerable to skimming schemes (cash and check). Fund-raising events often include cash intensive events (gambling, raffles, etc.), which can be easily stolen. Charities also are susceptible to skimming receipts in the form of checks because they often operate under the acronyms of their initials. Checks payable to the organization?s initials can be easily altered and deposited to a personal account. For instance, CFA can be easily altered to reflect C. F. Anderson.
Other embezzlement schemes perpetrated by employees of not-for-profit organizations involve the creation of fictitious vendors and fraudulent invoices that resulted in disbursements to the fictitious vendors. Employees with access to the organization?s checks may issue checks to pay their personal expenses, make checks payable to themselves or counterfeit checks to be used for their personal gains. The organization?s credit cards may also be used to purchase personal goods or the credit card numbers of donors may be used by perpetrators for personal use.
Ten days after the chief financial officer of the Capital Area United Way took office she noticed during an internal review that dozens of checks were missing from the organization's records. When the bank faxed her the checks, a fraud scheme unfolded. Each check was made out to the organization?s former vice-president of finance who had forged the names of two officers to make hundreds of payments to herself totaling $2 million.2
Vendor kickback schemes normally result in an award or benefit to a person or company who has paid a bribe to receive preferential treatment by the organization. Bribes paid to employees or managers of non-profit organizations can impact the organization financially or qualitatively and damage its relationships with donors or grantors.
A former consultant for the central purchasing agent of the Archdiocese of New York pleaded guilty in August of 2006, to eight fraud, tax and obstruction of justice charges stemming from a scheme he orchestrated to receive kickbacks from vendors who wished to do business with the Catholic Church. The indictment alleged that several individuals used their positions as employees and consultants at Institutional Commodity Services Inc. (ICS), the purchasing arm of the archdiocese, to defraud the archdiocese of more than $2 million from 1996 until 2004.3
Not-for-profit organizations are often used by tax cheats in an attempt to substantiate fictitious deductions on their tax returns. Some fraudsters will go so far as to send a donation check to a charity and subsequently request a refund of the donation. The fraudster uses the original check to document the refund. There have also been instances of collusions between tax cheats and trusted individuals within the tax exempt organization who refund 90 percent of the original contributions.
The former head of fund-raising for the American Cancer Society's New York City branch was indicted several years back for masterminding a scheme that enabled contributors to take nearly $4 million in illegal tax deductions. Federal officials said contributors made out checks to the Cancer Society and then received cash kickbacks for 90 percent of the amount of the checks. The contributors could deduct the full amounts on their income-tax returns, using the canceled checks to back their claims.4
Since September 11, 2007, increased government scrutiny has uncovered not-for-profit organizations specifically set up to fund terrorist activities. In addition, legitimate charities have been found to be used to channel money to terror organizations.
A federal grand jury indicted a now-defunct Islamic charity and five men for illegally transferring funds to Iraq and stealing U.S. government grant money. A 33-count indictment charged the Islamic American Relief Agency, or IARA, headquartered in Columbia, Mo., and charity officers and associates with a range of crimes related to money transfers to Iraq.5
Other fraudulent practices perpetrated by representatives of not-for-profit organizations include failure to comply with Internal Revenue Service requirements related to political campaign contributions, housing allowances, or compensation reporting.
It may be difficult to understand how fraudulent financial reporting could occur in organizations that, by definition, do not show a profit. However, unscrupulous managers of not-for-profit organizations have manipulated expense ratios and other performance indicators to impress donors, grantors and evaluators of charities.
Protecting Not-for-Profit Organizations from Uncharitable Acts of theft or abuse
What can charities and not-for-profit organizations do to determine their risk management needs? Establish entity level controls that deter fraud by creating an environment that has a zero tolerance for fraud, including:
Clear Code of Conduct in Concert with Awareness Programs
One of the most important elements of fraud prevention is the establishment, communication and monitoring of the organization?s Code of Conduct. The organization?s commitment to ethical behavior should be clearly and concisely communicated to management, employees and related third parties. Commitment to the code should be affirmed by all employees on a periodic and ongoing basis, and the institution may choose to reinforce the importance of the code and business principles through training. All violations of the code should be subject to disciplinary action that is consistent with the level of infraction in order to create a positive impact on the ethical atmosphere of the workplace.
Training about an entity?s values and its code of conduct should be provided to new employees at time of hiring and include an element of ?fraud awareness.? Employees should also receive refresher training thereafter, specific to their level within the organization, geographic location and assigned responsibilities.
Employee Screening Procedures
Screening procedures should be incorporated within the organization?s hiring process as a precaution. Background checks should be vigorous and include credit reports. Education and prior employment should be verified; reputation should be established through references, and resume gaps should be explored. Employees and managers should be properly trained to recognize symptoms of fraud.
Screening procedures should be incorporated within the organization?s hiring process as a precaution. Background checks should be vigorous and include credit reports. Education and prior employment should be verified; reputation should be established through references, and resume gaps should be explored. Employees and managers should be properly trained to recognize symptoms of fraud. Regarding the aforementioned scheme perpetrated by the Treasurer of the Episcopal Church, other Church officials said they did not really know the treasurer. Her resume said she graduated from a prominent university in 1969 with a degree in economics. But the university officials say they have no record of her attending the university.6
Perhaps a background check would have prevented this fraud and embezzlement from occurring.
Whistleblower Procedures
Procedures for the receipt, retention and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters should be established by not-for-profit organizations.
Tone at the Top - Set a good example
The Association of Certified Fraud Examiners (ACFE) reports that having an ethical ?tone at the top? can be the most effective means of avoiding fraud. Leadership should avoid giving people the rationalization to defraud. A positive tone at the top can be earned by treating people fairly and ensuring that management at all levels of the organization follow the rules.
Audit and Monitoring Procedures
Frequent audits should be conducted focusing on areas which could be vulnerable to fraud. Consideration should be given to using an outside auditor or an audit committee to ensure independence.
Many of the fraud schemes cited in this article would have been uncovered through an effective audit program. Fraudulent schemes historically have been identified by internal audit at twice the rate of external audits through clear fraud risk-related audit steps. Vigorous monitoring activities should also be utilized to assure that the system of internal control is designed and operating effectively to help prevent, deter and detect fraud.
Enhanced Segregation of Duties
Duties within a function of a not-for-profit organization should be separated so that one person does not perform processing from the beginning to the end of a process.
?If the United Way of East Lansing had segregated responsibilities in its finance department, the former vice president might have been caught sooner,? officials there say. ?She had sole control over the chapter's internal accounting system, which tracks pledges, and a computer program that accounts for donations that the organization receives. She had no authority to write checks, but she alone reconciled the checking account.? 7
Why Fraud Prevention and Detection is Important to Charitable Organizations
Not-for-profit organizations have a responsibility to their donors and grantors to ensure that the funds to which they are entrusted are used for their intended purpose. Even if an organization has adequate employee-theft insurance, damage to a charitable organization?s reputation can be far-reaching and lasting. Charity officials say that they are far more concerned about how donors will react than they are about the short-term money they lost.
Charitable organizations thrive on their good reputation. A good reputation ensures donor confidence and induces continued contributions. On the contrary, a reputation tarnished by instances of fraud can foster a loss of confidence and cause a decline in contributions.
Shortly after the fraud was uncovered, a spokesperson for the Episcopal Church stated, "The church has lost a lot of integrity, the church has lost trust. People are disillusioned and we'll pay for that in a thousand ways." 8
It is important that not-for-profit organizations add good governance and an anti-fraud environment to their many attributes to ensure their continued success. These enhancements can build public trust and confidence in Charities and encourage continue support by donors and grantors.
