Want To Avoid Nonprofit Fraud? Look To Your Board For Action

Want To Avoid Nonprofit Fraud? Look To Your Board For Action

Viewer Favorite: Updated & Revised
Original Publication: https://www.snpo.org/redir/articles.php?id=1752

By Eugene Fram with accounting professor Bruce Oliver

(The executive director acknowledged working with the insurance agent.) Under their scam, the council paid inflated insurance premiums and (the two) split the over-payments.
“I knowingly helped steal more than $1 million … as part of a scheme in which insurance premiums were inflated,” (The ED) told a judge in Supreme Court, the trial level court in New York State. (http://bit.ly/1QeakRt)

Here is what nonprofit board members can do to help reduce fraud in their organizations.

(1) Have a finance committee charged with these tasks:

• Review the overall results of a yearly independent audit, conducted by an outside auditor.

• Oversee executive compensation, pension benefits, and other finance activities.

(2) Have a separate dedicated audit committee containing only independent board members. (Since nonprofit board members aren’t compensated by the organization, all directors are, by definition, independent. However, some directors may have strong social, family, or political links to management personnel. It’s prudent to exclude such people from serving on the audit committee.) The board members on this committee should be reasonably financially competent, with at least one having a strong finance background who is able to overview audit issues in detail. In particular, the committee should do the following:
• Conduct a yearly review of conflict-of-interest policies.
• Make certain that all employees and board members sign a conflict-of- interest statement.
• Assure that new hires are vetted for honesty.
• Meet every four to six months.
• Be sure that a certified audit is completed at least every two years – once a year if at all possible.

Engage an external auditing firm

In the past, it was common for managers to select the external auditing firm with “rubber stamp” approval by the board. In today’s more vigilant environment, the board must be more involved. Hiring an auditing firm should be a partnership effort between management and board. The task is as serious as hiring a CEO and should be given the same amount of time and care.

The board audit committee should review the following information when hiring the auditing firm:
• the nonprofit audit experience of those who will be performing the audit
• the history and client list of the auditing firm
• the proportion of the firm’s clients that are nonprofits
• the size of the firm and whether it has the ability to serve a new client well
• the estimated costs for each audit
• the firm’s suggestion for a financial consulting firm if your organization needs such counseling.

Meet with external auditors

When your board’s audit committee meets with the external auditors, the organization’s CFO and other key financial personnel will be present. At some point in each meeting, however, board members need to meet with the auditors in executive session without the CFO, CEO, and other managers. At these private sessions, board members need to ask the auditors, “Do you have anything to tell the board without management present?” This gives auditors a chance to report any concerns that need board consideration, such as unusual travel, entertainment, or other expenses or any transactions that raise red flags. Audit committee members also have an opportunity to raise questions about the professional competence of the organization’s internal financial personnel.

Develop a conversation with external auditors

In the typical nonprofit, only one or two audit committee members will be able to formulate detailed technical questions for the external auditors. To help uncover fraud, every board member should be familiar with six audit-related topics and be able to pose questions about these six topics:

(1) Are internal controls adequate? The organization’s control system needs to be divided into operating functions. Then, each operating function must be performed by someone different so that each person checks the others’ work.

(2) Are financial records accurate? External auditors must certify that the following records are in proper form: financial statements, management contracts, sales of major assets, bonus payments, and long term lease agreements.

(3) Are activities and expenditures properly authorized? For example, have any extensive changes in plans been approved by the board? Have major expenses been properly budgeted? Have travel costs over a prescribed level been approved by a senior officer? Depending on the size of the organization, do all expenditures over a certain amount require two signatures from senior officers?

(4) Do all reported assets actually exist? This question is especially important to answer if the organization holds any physical assets at a distance from its main offices.

(5) Is the organization performing any activities that might endanger its tax-exempt status? Smaller nonprofits sometimes let licenses or even tax-exempt certificates lapse. It’s vital to certify that such documents are up to date and that taxable income and charitable donations are reported separately.

(6) Is the organization paying its payroll taxes, sales taxes, and license fees on time? Does the organization file its financial reports, like the IRS 990 report, on time? Many fraudulent cases involve failure to report and pay employee withholding taxes.

Trust but verify

Since fraud is such a pervasive cancer in the nonprofit environment, it needs intense board attention. Cases of nonprofit fraud undermine the good work of the organization and the nonprofit sector.

Every board member should know enough about finance to spot suspicious activity when it occurs. At the very least, everyone involved in the organization should be alerted to the fact that board members are giving serious attention to the fraud issue. That knowledge, in itself, may deter someone from trying to steal.

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3 comments

  1. Can a 501c3 loan money to a for-profit organization if the owner of the for-profit is an integral member of the 501c3? There is a slight argument that the mission of the 501c3 could be furthered by the loan, however, the loan seems like it would be somewhat speculative as the for-profit has not been turning a profit. There also seems to me to be a question of whether the owners involvement with the 501c3 creates a conflict of interest — or makes him a disqualified person according to IRS…Any thoughts appreciated.

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    1. A lot will depend on how the loan might enhance or detract from the organization’s mission and whether or not the interest rate being received is below market. If the latter situation, all concerned might be personally in violation of the Intermediate Sanctions Act. If this is more than a hypothetical question, I would review the details with competent legal counsel immediately, in a process of careful due diligence.

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      1. Thank you so much for your reply. I am an attorney, but do not practice in non-profit law at all. I did a cursory overview with the resources I had available to try and answer very preliminary questions about this to the individuals that asked and then did a google search and found you. I have very serious hesitations relating to the matter and didn’t think I’d be comfortable handling it anyway, but was just trying to gauge if my understanding was somewhat on base. I’ll recommend to the organization that if they wish to pursue this course, they seek counsel from someone who specializes in this area. Thanks again. Your blog is very well written and interesting to me even though I haven’t worked in or thought about this area very much before.

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