Have You Done Enough To Protect Your Organization From Fraud?

In early May we set up a daily Google alert for the words “nonprofit fraud”. As of writing, we were sent no less than 20 articles outlining cases of nonprofit fraud throughout the US. From CEOs to operations managers, dozens of people were caught last year with their hands in the cookie jar. Over the past several years several high-profile cases of nonprofit fraud have been splashed across the headlines. At the end of 2022, 48 people in Minnesota were charged by the Department of Justice with a plot to take advantage of COVID-relief funds. The defendants, under the guise of providing food to underprivileged children, are accused of defrauding $250 million. This is just one of many on-going legal cases.

Nonprofit fraud not only damages the reputation of the organization involved, but also undermines public trust in our sector as a whole. It threatens the capacity of our organizations to fulfill their mission and serve their intended beneficiaries.

If you’re a nonprofit board member or member of the executive team, have you done enough to prevent fraud from happening in your own organization?

The Dangers of Nonprofit Fraud

The most harmful consequence of nonprofit fraud is the erosion of trust. Donors, volunteers, and the public at large may lose faith in the nonprofit sector, making it more difficult for even honest and effective organizations to raise funds and accomplish their goals. Depending on the severity and nature of the fraud there are also legal consequences. The individuals involved may face criminal charges, fines, and even imprisonment. The organization itself may lose its nonprofit status, resulting in loss of tax-exempt benefits. Finally, misappropriation of funds can deplete resources, making it harder for the organization to carry out its mission. In severe cases, this can even lead to the organization's dissolution.

Factors Contributing to Nonprofit Fraud

Nonprofit fraud is typically a consequence of lack of oversight, poor financial controls, and inadequate transparency. Too often, nonprofit board members rely on the goodwill and trustworthiness of their staff and volunteers without implementing robust checks and balances. This is especially true of community based or grassroots organizations, where personal relationships play a large role in appointing volunteers and employees.

Additionally, the constant drive to minimize administrative costs to appease donors can sometimes lead nonprofits to skimp on important investments in financial management and oversight, which can leave them vulnerable to fraud. Is your nonprofit investing enough resources into financial management and oversight, or is most of your overhead going into marketing and fundraising?

Preventing Nonprofit Fraud: A Multi-Pronged Approach

If you’re a board member or member of the executive team, there are several steps you need to take to minimize any chance of fraud.

1) Implement Strong Internal Controls: Establish a system of checks and balances to ensure no single individual has control over all financial transactions. This should include procedures for approval of expenses, dual signatures for checks, and regular reconciliation of bank statements.

2) Regular Financial Audits: Conducting regular, independent audits can help detect any irregularities in the financial statements and identify potentially fraudulent activities. It’s also a good practice to rotate audit firms every few years to bring a fresh set of eyes to the process. Remember, it’s the role of the board to select an audit firm.

3) Promote a Culture of Ethical Behavior: Cultivating a strong ethical culture within an organization can be a powerful deterrent to fraud. This involves setting a clear code of conduct, providing training to employees and volunteers, and establishing a confidential reporting mechanism for suspected fraudulent activities.

4) Transparent Reporting: Regularly publishing detailed financial reports can increase accountability and deter fraudulent behavior. This transparency can also help rebuild public trust if an incident of fraud has occurred. It’s a lot harder to get away with fraud when numbers are constantly being scrutinized by employees, board members, and donors. How often does your CEO or Executive Director present a detailed financial update to the team? Are your staff trained on reading nonprofit financial statements? How much time is your Treasurer and Finance Committee spending on the monthly financial statements?

5) Invest in Fraud Prevention Training: It's crucial to provide regular training to board members, employees, and volunteers about the risks of fraud and how to spot warning signs.

8 Practical Ways to Decrease Chances of Fraud

1. Hire the right people

While challenging, weeding out potential fraudsters during your hiring process is not impossible. A great deal can be learned from a candidate’s references, work history, credentials, pre-employment drug testing, and criminal background checks. How robust is your hiring process? Even if you can’t afford third party verification companies, make sure to research the candidates using Google and LinkedIn. Call their former employers to verify their work history, and do check that their education credentials are legitimate!

2. Develop a formal fraud policy and code of conduct

Put policies in writing and have all employees sign documents saying they will follow the rules. Conduct regular trainings on these policies.

3. Establish internal controls

Preventive controls might include keeping blank check stocks under lock and key, setting authorization limits, and requiring multiple signatures on checks. Detective controls include having an independent employee reconcile bank statements, surprise inventory counts, and independent reviews of accounts payable lists.

4. Require vacation and job rotation

When an employee stays in the same position for a long period, or never takes a vacation, there are ample opportunities for that person to design, commit, and conceal fraud. Mandatory vacations and job rotation make it difficult for an employee to continue concealing a crime.

5. Create a whistleblower reporting system

Most fraud cases are initially detected through tips from employees, clients, and outside vendors. Ideally your reporting system should be anonymous, managed by a third party, and available 24/7. If you don’t want to invest in a vendor (some are very cheap), who in your organization should receive these whistleblower reports and how?

6. Educate employees and volunteers

Employees and volunteers are the eyes and ears of your organization, but they can’t report fraud if they don’t know what it is. Invest in educating your people about what is and is not legal!

7. Be Mission Focused

Keep the organization’s purpose and mission at the center of everything. Lead by example. Undue pressure to meet goals can lead employees to bend the rules, falsify records, or commit other offenses to meet expectations.

8. Personnel policies and procedures should be fair and applied universally

Employees might commit fraud because they feel hardly done by. Maybe they believe they have been underpaid or are otherwise treated unfairly. Make sure that all policies are applied equally and fairly.

Nonprofit fraud is a serious issue that can undermine the essential work carried out by your organizations. However, by recognizing the risks, understanding the factors that contribute to fraud, and implementing robust preventive measures, you can protect your organizations from fraud and continue to effectively serve their missions. Board members and nonprofit executives are ultimately responsible for protecting your organization against fraud. If you’re worried your organization may not be fully protected from potential financial abuse, forward them this article!