Fraud in the private and nonprofit sector

Moderated by Rick Badie

As we learned last week, nonprofit organizations aren’t immune from employee fraud. Employee misconduct at the Woodruff Arts Center is reported to have resulted in the cultural organization being defrauded of $1.438 million over the last five years; a former administrator is accused of submitting invoices for phony services. Today’s topic: fraud in the nonprofit and for-profit sector. A CPA says small businesses are always vulnerable to embezzlement, but especially so in tough economies. A watchdog group director writes about the pervasiveness of nonprofit fraud.

Workers cheat charities

By Gary Snyder

Nonprofit fraud is pervasive.

The latest estimate is that it is a $51 billion business. It affects medium, large and small charities. With $2.7 trillion in assets, the charitable sector is ripe for abuse. Few care. One study says charity fraud happens at almost twice the rate as for-profit fraud.

Nonprofit Imperative has documented abuses in such nonprofits as breast cancer charities, veterans’ organizations, disaster relief efforts, colleges, universities and religious organizations. We have just completed a study where we found elected officials took almost $300 million from charities.

There are few incentives to not take advantage of the public’s trust. Philanthropic leadership accepts the failed notion that self-regulation (like self-deportation) is the answer. Leaders have been recently quoted as saying there is no interest (in fraud detection) on their part because no one is going to listen.

The judicial system has coddled criminals using the ruses that there is no jail space and that restitution (which is virtually never discharged) is more important. The IRS has recently awakened to the malfeasance problem. State enforcement agencies are unable to perform their charge because of a lack of economic and political support. Watchdog agencies are moving in the right direction, but budget constraints preclude them from monitoring charities in the same manner that the SEC oversees for-profits. Lawmakers have had ample opportunity to stiffen charity behavior but have walked away.

While most charities are honorable, internal controls are, nevertheless, a must as well as a significant deterrent. The charitable sector is made up of approximately 77 percent small and medium agencies. Their budgets have been challenged for the better part of a decade. Charity fraud is simply not a priority unless the agency has been struck by such untoward conduct.

Denial has been the watchword of anyone in a position to tackle the problem. Very few professional nonprofit conferences address fraud as a threat. Educational institutions seldom engage in the topic. Only on rare occasions do funders use malfeasance prevention, including effective governance, as a criterion for backing.

Aside from significant intervention from those that have the wherewithal to affect this scourge, here are a few steps to at least mitigate the problem. Donors should monitor governance and decision-making. Use GuideStar/Charity Navigator, an independent charity evaluator, before contributing; information on smaller agencies may not be available. Expense ratios do not necessarily tell the whole story. Use the charity’s website. If there are no financials, call the agency. If unavailable, consider a different agency. Is the agency being audited? Make sure all money is spent in supporting the mission of the agency. No funds should be spent on any programs that are inconsistent with the mission of the agency. Ask if internal controls are in place. Ask if staff leadership salaries are being monitored by the board and are in sync with comparable agencies in the same geographic region.

Agencies, meanwhile, should strengthen governance and decision-making. Remember that, as a charity, you are in the public domain. Behave as such. Understand that the public uses expense ratios as a proxy measure for the value of their contribution. Be as transparent as possible. The discipline in doing so will result in open accountability. Have an audit or compilation. No funds should be spent on any programs that are inconsistent with the agency’s mission. Make sure there are internal controls and that they are continuously being monitored. Engage in a salary survey. Be open with the board. Nonprofits should not be expected to pay less than government or for-profits.

Gary R. Snyder is the managing director of Nonprofit Imperative, a West Bloomfield, Mich.-based watchdog group.

Fraud challenges small firms

By Michael Thompson

While all companies are vulnerable to fraud, small business owners are particularly susceptible when it comes to fraud committed by employees. Smaller companies generally don’t have the time or resources to implement strong financial controls. As a result, employees have the ability to exploit the lack of controls and create schemes to defraud their employers. In addition to having a unique capacity to commit such acts, employees of small businesses who commit fraudulent acts generally increase their activity during tough economic times.

Recent years have shown a rise in the volume of occupational frauds. Often these activities go undetected, and companies may even be forced to dissolve without knowing that the reason for poor profits was an employee’s dishonesty, not a declining economy.

In the “2012 Report to the Nations on Occupational Fraud and Abuse,” the American Institute of Certified Fraud Examiners found that 87 percent of frauds involved embezzlement of assets that are generally cash or inventory related. Examples:

• Billing Schemes: In this scheme, a manager at a company would create a second company with an accompanying bank account. Fake invoices would be created stating that the second company had provided goods or services and purchased materials. The same manager who created the secondary company approves the invoice to be paid and forwards it to the accounting department. As a result, the company proceeds to process and mail checks to the fake corporation. The manager pockets the money.

• Check Tampering: An office manager sends a false invoice to a company from a legitimate vendor. The accounts payable clerk processes the invoices and records the transaction. The office manager uses his access to the checking account to write the check to a friend rather than the vendor. Because banks no longer return check copies to companies, the employee performing the bank reconciliation assumes the proper vendor cashed the check. The manager and his friend split the cash from the fraudulent check.

• Skimming Sales: This scheme occurs when a cashier who sells a product or service never records transactions. The cashier is frequently able to take money from the customers and simply keep it because he never completed the sale at the register.

Many frauds are not sophisticated and can easily be accomplished by employees at various levels within small businesses. Fraudsters are not always obvious and often are employees trusted by their employers. More than 85 percent of the people engaged in frauds have no prior record. Therefore, screening protection is oftentimes an ineffectual form of protection. Furthermore, the average fraud continues for a period of approximately 18 months before a problem is ever detected. To make matters worse, nearly half of all victims were unable to recover losses.

How can companies protect themselves?

While nothing can eliminate small businesses from all fraud risk, certain steps can be taken to limit exposure. Setting up proper internal controls through a system of checks and balances within the company is one of the best preventative measures. Unfortunately, it also remains one of the biggest challenges for small business.

The general rule of segregation of duties is that no one person should be in charge of more than one of the following: authorization of transactions, recording of transactions, and handling of assets. Having strong segregation of duties, in conjunction with a whistle-blower policy, can be some of the most effective means of deterring employee fraud.

Michael Thompson is managing director of Atlanta-based Thompson & Associates CPAs. 

2 comments Add your comment


December 5th, 2012
11:17 am

The IRS offers a class to teach you how to comply with tax forms for non-profits. At the class I took the IRS representative says that the IRS never, ever checks on non-profits unless they make the news in a big way. Hundreds of people where there taking the class.
The government actually helps folks not pay taxes for any stupid idea they can think of claiming it helps society. To those who pay taxes……………..your being duped by millions cheating the system under a lie that non-profits actually help society.
Ex: A friend worked for a large “lets cure cancer” non-profit. Her job was to host doctors at lavish resorts while they talked about curing cancer. She stated “why would they find a cure, there is too much money in not finding a cure and besides we would be out of work”. Non-profits actually work against the good of society. Another government program run failure. And this is what will happen to our new health care in America. Government will incentivize people not to cure/heal you.


December 4th, 2012
5:41 pm

What is more troubling is to see what percentage of the contributions made to some organizations go to “administrative” functions instead of the core mission of the non-profit.