Strategies for preventing fraud in nonprofit organizations

Nonprofit organizations are the lifeblood of providing goods and services to needy people and communities in this county.?The individuals who form a nonprofit organization and/or work for one genuinely have a passion for helping the people or community their organization serves.?The rest of the Country recognizes the importance of nonprofit organizations.?According to an ABC News report, $485 billion was contributed to nonprofit organizations in 2021.?All of these donations and contributions do not come without some risk.?

There are a lot of “bad guys” out there who target nonprofit as a source of easy money.?A fraud within a nonprofit organization can have devastating consequences.?In addition to the financial loss, a fraud in a nonprofit organization can damage the reputation of the organization, leading to the possibility that potential donors may decide to contribute to other nonprofit organizations which have the perception of being more financially sound.??A University of Dayton research study found that 25 percent of nonprofit organizations studied ceased operations within three years of a publicized fraud occurrence.?The Association of Certified Fraud Examiners 2022 report stated that 9 percent of fraud victims were nonprofit organizations, with a median loss of $60,000.

Fraud risk factors in nonprofit organizations

Before we review ways to mitigate fraud risks, let’s review some common fraud risk factors at nonprofit organizations.

-?????????It is common for nonprofits to have high turnover of staff and Board members.??High turnover leads to a lack of experience and institutional knowledge of how the organization operates, which leads to an increased risk that an illegitimate transaction will not be caught.

-?????????Staff & Board members often lack experience with business, accounting and/or internal controls. ?And in many organizations, the Board does not have at least one financial specialist.?Most are well-intentioned people who want to help the organization.?But a lack of financial knowledge is an increased fraud risk.

-?????????Nonprofit organizations typically run on lean budgets, which results in staff being stretched thin and pulled in multiple directions.?Staff not being allowed to fully focus on their primary job duties creates a higher risk of fraud occurring.

-?????????Lack of training and awareness of fraud risk issues and identification among staff and Board members.?Most staff at nonprofit organizations do not receive formal fraud risk training, therefore staff are unaware of what fraud risks to be aware of.

-?????????Nonprofit organizations tend to have a relaxed and/or informal culture, which tends to lead to a relaxed enforcement of organizational policies and controls.?A nonprofit organization may have sound internal controls, procedures and policies documented in an employee handbook or operations manual.?However if no one at the organization is making sure staff are following the policies and controls, the risk of a fraud occurring is increased.

-?????????Reliance on volunteers to perform key tasks, many of which are provided minimal training for their tasks and responsibilities.?Volunteers are key to a nonprofit providing it’s services.?However, without proper training and supervision of volunteers, fraudulent activity may go undetected.

-?????????Board not reviewing Executive management expense reporting.?This has been the issue related to a few publicized nonprofit frauds recently.?The lack of review of the Executive Director’s expenses by the Board is a significant fraud risk.

Prevention strategies

Now that we have discussed some common fraud risk factors at nonprofit organizations, let’s review some fraud prevention strategies.?Keep in mind nothing is guaranteed to prevent or detect all fraud, however the following will increase the chances of preventing and/or detecting fraud.

-?????????Start with a risk assessment of your organization.?First…what are the activities of your organization where is risk of fraud is more likely to occur??How are receipts of cash and non-cash donations handled??How is financial information analyzed and studied??Second… what is the potential financial impact of a fraud in the various activities??If you identify an activity that is both high-risk for fraud, and would have a significant financial impact on the organization, then that particular activity needs to be further analyzed for risk mitigation.

-?????????An organization which is built on a foundation of ethics and integrity is key to fraud prevention.?In order for an organization to have this culture, the message must come from the top-down… from the Board and Executive Management, and clearly and consistently communicated to the staff and volunteers.?The message should be clear… our organization has a zero-tolerance policy for fraud and unethical activities.?The organization should also let staff know that if they see or hear something suspicious, they need to speak up and let a member of the Board know of their concerns.

-?????????Learn the red-flags of employee fraud risk behavior.?All members of the organization… Board members, Executive Management, and staff should be aware of employees demonstrating the following:

o??An employee is living beyond their means.

o??Employee is having known financial difficulties.

o??Employee refuses to take vacation or time off.

o??Employee refuses to share job duties.

o??Employee has close relationships with vendors.

An employee who is demonstrating one or more of these traits is not necessarily committing fraud.?However, the identification of an employee with one or more of these traits requires further investigation.

-?????????Internal controls – your organization must have a good system of policies, procedures and controls related to your organization’s financial reporting.

o??Key is having documented reviews and approvals on documents.?Remember…if a review or approval is not documented…then it didn’t happen!

o??Their needs to be communication from top-down on the importance of following approved policies and controls.?A proper control environment needs to be part of the culture of the organization and needs to be demonstrated by those in supervisory positions.

-?????????Whistle-blower policy.?Make sure your organization’s employees know who they can speak to if they have concerns.?Your employees should know they can freely speak to a member of your Board if they have any concerns or suspicions about fraud or unethical activities.?An anonymous fraud tip hotline is one of the best ways to allow your employees to do this.

-?????????Two signatures required on checks over a certain dollar amount.?Make sure that for expenditures over a certain threshold, a second signature is required on the check.?Typically the second signature will be by a member of the Board.

Closing thoughts

Nothing is guaranteed to completely keep fraud out of your organization.?But you can take steps to keep your organization as safe as possible.?

Want to hear a story about how a real-life fraud took place??Go on Amazon Prime or Netflix and look up “All the Queen’s Horses” for a great fraud documentary.?It’s about a real-life fraud in the City of Dixon, Illinois.?After you watch how it happened it will make you take a close look at your nonprofit’s policies and controls.??