Consider this scenario: Maria is a volunteer at a nonprofit organization providing educational support to underprivileged children in her community. She has been helping out for years and is a trusted member of the volunteer team—so trusted, in fact, that she is routinely asked to collect cash donations at the nonprofit’s fundraising events.
Like many nonprofits, the organization Maria assists has few formal procedures in place for handling cash, and little in the way of accounting oversight. Maria is not even required to offer donors a receipt when she collects cash. Without tangible evidence of transactions, the nonprofit has no way of tracking the flow of funds or to detect potential discrepancies.
And that is how Maria, the trusted, longtime volunteer, gets away with siphoning a substantial portion of the nonprofit’s cash donations into her own pocket. Once her fraud is finally uncovered, the nonprofit discovers that it has not only lost large sums of money— but it also has undermined the trust and goodwill it has painstakingly built within the community.
Maria the fraudster may sound like a worst-case scenario. Unfortunately, financial fraud committed against nonprofits is all-too common and is often fed by the informal structures of many mission-driven organizations. Recent data collected by the Association of Certified Fraud Examiners (ACFE) finds that nonprofits lose an average of $76,000 a year to fraud—a potentially devastating figure considering that 88 percent of nonprofits in the United States operate with less than $500,000 per year.
LOCKING THE DOORS AND WINDOWS
The absence of proper accounting controls and oversight at many nonprofits creates an environment ripe for exploitation and highlights the critical need for proactive measures to mitigate financial fraud risks. Think of it this way: A nonprofit organization is a house with many doors and windows. Each door or window represents a different source of funding. Some of these doors and windows are well-monitored and secure; others are less frequently checked.
On occasion, a large gust of money may blow in unexpectedly through one of the less-monitored entrances. This windfall might be a blessing for the organization, but it creates risk as well. Just as a burglar might see an open window as an easy opportunity to break into a house, a dishonest individual within the nonprofit might see this unexpected and insecure donation as an easy target for embezzlement.
In a house, you can lock your doors or windows. In a nonprofit, the way to keep out embezzlers is to make sure funds are subject to robust internal controls and oversight.
ANTI-FRAUD CHALLENGES FOR NONPROFITS
For many nonprofits, the task of creating, implementing and managing anti-fraud controls can be a challenge. Among the reasons:
• Limited Funds. Nonprofits often operate on shoestring budgets, with limited funds allocated for administrative expenses, including financial oversight and controls.
• Limited Staff. Many nonprofits rely on a small team of dedicated staff members who juggle multiple roles and responsibilities, leaving little bandwidth for comprehensive financial management.
• Complex Funding Sources. Nonprofits often receive funding from diverse sources, including grants, donations, and government contracts, each with its own set of reporting requirements and compliance obligations.
• Limited Experience. With volunteer boards and part-time staff, many nonprofits may lack the expertise needed to provide robust oversight of financial activities, which increases the risk of fraud and mismanagement.
FIGHTING FRAUD: STEPS NONPROFITS CAN TAKE
Knowing that financial resources and staff are limited, what steps can nonprofit organizations take to fortify their defenses against fraud?
1. Employee Training: Equip employees with knowledge on prevalent types of fraud, including phishing scams, identity theft, and invoice fraud. Training can be conducted in-house or via online resources, empowering staff to identify and report suspicious activities. Take advantage of free monthly meetings offered by organizations like local chapters of the Association of Certified Fraud Examiners. Training employees to spot fraudulent behavior sets the tone of the organization and reinforces a zero-tolerance policy towards such actions.
2. Establish Policies and Procedures: Develop and enforce clear policies and procedures for handling sensitive information, conducting transactions, and authorizing payments.
3. Regular Audits and Reviews: Conduct regular audits of financial records, accounts, and transactions to identify anomalies or discrepancies. This can help detect fraud early on and prevent it from escalating. Providing board members with financial literacy training and engaging them in regular discussions on financial performance and risk can enhance accountability and transparency within the organization.
4. Implement Internal Controls: Implement internal controls such as requiring dual authorization for financial transactions, regularly reconciling accounts, and conducting background checks on employees handling sensitive information. Introducing segregation of duties ensures that no single employee can execute a process without oversight or approval from another individual, thus minimizing the potential for internal fraud.
In cases where staffing resources are constrained, implementing compensating controls are advisable. For instance, consider directing bank statements to an alternate address for a designated recipient to review. This should be someone without signature authority or cash handling responsibilities, such as the chairman of the board or the executive director.
5. Leverage Technology: Utilize fraud detection software and tools that can identify unusual patterns or behaviors in financial transactions. Many affordable or even free solutions are available, including open-source software and basic versions of commercial fraud detection tools.
6. Stay Informed: Keep abreast of the latest fraud trends, techniques, and prevention strategies through industry publications, online resources, and networking with other professionals in your field.
7. Encourage Reporting: Create a culture where employees feel comfortable reporting suspicions of fraud without fear of retaliation. Implementing anonymous reporting mechanisms can help facilitate this.
INTEGRITY AND TRANSPARENCY
While their organizations are designed to pursue noble causes, nonprofit boards and executives should not overlook the inherent risks of fraud that accompany financial operations. Doing so can damage the long-term fiscal health and reputation of their organizations. They can also lead to fines and penalties. According to ACFE data, nonprofits are fined more frequently for financial fraud issues by their oversight agencies and authorities than public or private companies or governmental organizations.
By implementing proactive measures, however, nonprofits can fortify their defenses against fraud and uphold their commitment to serving their communities with integrity and transparency. Remember, the fight against fraud requires vigilance, diligence, and collective effort from all stakeholders involved.
To learn more about how nonprofits can fight back against financial fraud, contact us for a consultation or visit our Forensic Investigations practice page for additional information about our approach to financial fraud investigations.