February 19, 2015

A Primer on Detecting, Preventing, and Investigating Nonprofit Fraud, Embezzlement, and Charitable Diversion

3 min

Increasing Scrutiny of Nonprofit Fraud, Embezzlement, and Charitable Diversion

Media Coverage and Recent Examples

On October 26, 2013, The Washington Post reported that from 2008 through 2012, more than 1,000 nonprofit organizations disclosed hundreds of millions of dollars in losses attributed to theft, fraud, embezzlement, and other unauthorized uses of organizational funds and assets. According to a study cited by the Post, nonprofits and religious organizations suffer one-sixth of all major embezzlements—second only to the financial services industry.

While the numbers are shocking, the underlying reasons for nonprofit susceptibility to fraud and embezzlement are easy to understand. Many nonprofits begin as under-resourced organizations with a focus on mission rather than strong administrative practices. As organizations established for public benefit, nonprofits assume the people who work for them, especially senior management, are trustworthy. Often these factors result in less stringent financial controls than implemented by their for-profit counterparts.

Of course, nonprofit employees are not immune to the vulnerabilities of economic distress, including financial difficulties, overspending, and even gambling. Further, high-level employees and their close associates have significant access to organizational funds and financial records, causing them to believe they can successfully commit the fraud and embezzlement and conceal their conduct from outside scrutiny. Employees may rationalize their unlawful conduct as just compensation for lower salaries or unfair treatment, or as legitimate financial arrangements whereby the employee is simply "borrowing" money from the organization.

Recent examples of nonprofits that have fallen victim to these crimes include:

  • In 2012, the Global Fund to Fight Aids, Tuberculosis, and Malaria reported to the federal government a misuse of funds or unsubstantiated spending of $43 million.
  • In 2011, the Vassar Brothers Medical Center in Poughkeepsie, New York, reported a loss of $8.6 million through the theft" of certain medical devices.
  • From 1999 to 2007, the American Legacy Foundation, a nonprofit dedicated to educating the public about the dangers of smoking, suffered an estimated $3.4 million loss as a result of alleged embezzlement by a former employee.

In light of the disturbing numbers reported by the Washington Post, Congress and numerous state attorneys general have pledged to launch investigations, and reportedly, some have. This will likely lead to even greater scrutiny by government regulators. External audits are necessary to ensure that effective financial controls and fraud prevention measures are being followed, but a standard audit is not the method by which nonprofit organizations should expect to detect fraud. The Association of Certified Fraud Examiners (ACFE) reports that less than 4% of frauds are discovered through an audit of external financial statements by an independent accounting firm.

Nonprofits may no longer elect to handle instances of fraud or embezzlement quietly to avoid unwanted attention and embarrassment. As of 2008, a larger nonprofit must publicly disclose any embezzlement or theft exceeding $250,000, 5% of the organization's gross receipts, or 5% of its total assets. A tax-exempt organization whose gross receipts are greater than or equal to $200,000—or whose assets are greater than or equal to $500,000—is subject to additional public disclosure requirements on its IRS Form 990 concerning the embezzlement or theft.

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