5 Specific Risks and 5 Actions to Help Prevent Nonprofit Fraud

Americans gave almost $500 billion to charities in 2022. In return, the giving public holds nonprofits accountable for the stewardship and proper use of those donated resources. Since most nonprofits are dependent on public and private contributions, achieving and maintaining public confidence is extremely important. A news story disclosing a defalcation or the improper use of donations can be disastrous for a nonprofit. This underscores the importance of sound internal controls and proper training for staff or volunteers. 

Some nonprofits are so focused on their charitable mission that they overlook the significance of administrative functions, such as a strong accounting department. Additionally, volunteers with little training or experience may fill some important positions. This is especially true at smaller or early-stage organizations, and can lead to an increased risk of fraud. 

While the accounting department is not solely responsible for fraud detection and prevention, it is an organization’s primary line of defense against improper use of funds. To ensure compliance and proper controls are in place, nonprofits should also properly staff and invest in other areas, such as program managers and human resources. Underinvestment in any of these areas can result in increased opportunity for fraud to occur, opportunity being one of the three components of the fraud triangle, along with incentive/pressure and rationalization — where, when present, fraud is more likely to occur.  

5 Risks Specific to Nonprofits 

Here are five potential risks that all nonprofits should know. 

1. Tone at the Top

Some nonprofit leaders may take a less critical approach toward fraud risks due to a false belief that all employees/volunteers are honest and ethical. While an organization may have a positive mission, it does not mean all who work there always behave in ethical ways. A healthy amount of skepticism is needed.

2. Lean Business

Many nonprofits face staff shortages and, as a result, have volunteers in key roles without adequate skills, experience or training. While the volunteers may be donating their time with the best intentions, they should still be qualified for the role they are in. Further, among all types of organizations, nonprofits have the lowest implementation rate of fraud awareness training, according to “Occupational Fraud 2024: A Report to the Nations” from the Association of Certified Fraud Examiners (ACFE)  

3. Non-reciprocal Transactions

When someone donates cash or goods to an organization, they do not receive a good or service in return. This makes it easier for an employee or volunteer to steal the donation without the donor being aware.

4. Improper Spending of Donor-Restricted Funds

Nonprofits generally present two categories of net assets: those with donor restrictions and those without donor restrictions. As the name indicates, those net assets with donor restrictions have constraints that have been placed on them by donors for either a specific purpose or time period. 

It is the nonprofit’s fiduciary responsibility to ensure that the funds are being spent in the manner the donor prescribed. However, sometimes nonprofits improperly spend donor-restricted funds. This can create a host of issues for the nonprofit in that they can be subject to ramifications from the donor as well as the state attorney general or charities bureau.

5. Cash and Credit Card Transactions

While most nonprofits try to avoid having cash on hand, there are times when it is unavoidable. For example, there are some nonprofits that run senior centers, where suggested cash donations are collected at the door. Other nonprofits need to maintain petty cash on hand as they may need cash to be readily available. Credit card transactions can also present potential challenges to nonprofits. Once a nonprofit accepts credit card donations, the opportunity exists for potential theft of a donor’s gift to occur or even identity theft if steps are not implemented to ensure there is a safe and secure electronic platform.  

5 Actions for Nonprofits to Help Prevent Fraud

Now that you’re aware of the risks, here are the actions your organization can take to help prevent fraud. 

1. Risk Assessment 

Every organization is unique in its organizational structure, number of employees and funding levels. The first step to manage fraud risk is to perform a fraud risk assessment of your organization. Keep in mind that what was deemed adequate for your organization in the past may no longer be appropriate as threats/operations change.

2. Cash/Credit Card Payment Controls

Minimize the number of cash donations and/or transactions your organization accepts or performs. If cash transactions are unavoidable, ensure compensating controls are put in place to prevent potential employee theft. For donations via credit card, ensure the website used has proper security in place and that employees are trained on how to secure any documents that contain donors’ credit card information.

3. Segregation of Duties

With proper planning, smaller organizations can still find ways to segregate responsibilities to create a system of checks and balances across sensitive job functions. Even if there is only one employee in the accounting department, ensure that someone else in management reviews monthly bank reconciliations, journal entries and other accounting transactions. In addition, ensure employees take vacations so that someone else can perform their duties, potentially uncovering errors or defalcations.  

4. Fraud Awareness 

Provide fraud awareness training to all employees at least annually. Nonprofits that do so uncovered fraud more than 2.5 times faster than those organizations that did not, according to the ACFE report. 

Don’t forget to train volunteers and board members, too. Even if they aren’t being paid, they may be an important part of your internal controls. Having all involved in the organization sign a code of ethics can help demonstrate the seriousness of the organization’s stance toward fraud and professional ethics.

5. Reporting Program 

Most fraud is exposed by tips from whistleblowers. Establish reporting system protocols and ensure that both employees and volunteers are made aware of them. Remember, anonymity is the key to encouraging people to come forward with tips.

For many nonprofits, the biggest consequence of committed — or even suspected — fraud is the public perception of not being good stewards of public donations. If that trust is lost, future contributions could dry up. Media organizations are quick to report on improprieties at nonprofits due to the implied public trust in the organization. Further, nonprofits may be required to disclose information about the diversion of assets (including, but not limited to, embezzlement or theft) on their IRS Form 990, a document that is filed on the IRS’s website for the public to see. 

On a positive note, nonprofits were the most likely type of organization to modify their anti-fraud controls following an incident of fraud, according to the ACFE report. While this is great news, nonprofits would be better served if they assessed their anti-fraud controls prior to an incident of fraud rather than afterward.

The preceding post was provided by an individual unaffiliated with NonProfit PRO. The views expressed within do not directly reflect the thoughts or opinions of NonProfit PRO.