The risk of fraud is a serious concern for all types of enterprises, but fraud can be particularly damaging to a Not for Profit organisation, for which a damaged reputation can have devastating consequences.
According to the most recent global fraud study by the Association of Certified Fraud Examiners (ACFE), the typical organisation loses an estimated 5 percent of its annual revenue to fraud. While fraud in Not-for-Profit organisations resulted, on average, in a smaller net loss than fraud in commercial enterprises, the Not for Profits in the study reported a median loss of $100,000—an 11 percent increase from the previous study and a significant loss to any charitable organisation.
Beyond the immediate financial loss, however, an even greater potential cost of fraud to Not for Profit organisations is the reputational damage that can occur. Because most Not for Profits depend on support from donors, grantors, or other public sources, their reputations are among their most valued assets. In addition, fraud in Not-for-Profit settings often garners unrelenting negative media attention.
Not for Profits can be particularly attractive targets for fraudsters. Executives who are passionate about their agencies and their missions are naturally trusting of others who share their interest- or who pretend to. Moreover, board members and executives who are dedicated and talented in their particular fields may not be well versed in financial issues and internal controls.
In addition, Not for Profits of all sizes may have only limited resources available to address internal controls. This makes them vulnerable to an employee who could recognize this lack of controls and use it as an opportunity to commit fraud.
As the Center for Audit Quality has noted, “fraud cannot occur unless an opportunity is present. Opportunity has two aspects: the inherent susceptibility of the [organisation’s] accounting to manipulation, and the conditions within the [organisation] that may allow a fraud to occur.” In addition, the opportunity for fraud is also affected by an organisation’s culture, a factor that is often overlooked.
The very nature of some Not for Profits also makes them tempting targets. Many Not for Profits distribute grants, scholarships, awards, or other types of financial aid to outside agencies or individual recipients. This opens yet another door for potential abuse or misappropriation and requires even more oversight to make sure funds are not being misappropriated. In addition, Not for Profits tend to have large amounts of cash and checks coming in from various sources, making them vulnerable to skimming (when an employee accepts payment from an outside party but does not record the sale and instead pockets the money) or cash larceny (when an employee steals cash and checks from daily receipts before they are deposited in the bank).
Struggling agencies also frequently experience relatively high staff turnover, making training and adequate segregation of duties more difficult. Finally, many Not for Profits depend heavily on volunteers and other community members, which can further complicate efforts to establish or maintain internal controls. It is important to remember that internal controls provide only reasonable—not absolute—assurance that the objectives of an organisation will be met. As a result, no organisation, even one with the strongest internal controls, is immune to fraud.
While Not for Profit organisations present particular temptations to fraudsters, the actual fraud schemes they might face are common to all types of organisations. Fraud schemes in Not for Profits can include check fraud, embezzlement, ghost employees, expense fraud, misappropriation of funds for personal use, fictitious vendor schemes, kickbacks from unscrupulous vendors, and outright theft of cash or assets—to name a few.
One area in which Not for Profit organisations seem particularly vulnerable is billing schemes, in which an employee fraudulently submits invoices to obtain payments he or she is not entitled to receive. According to the most recent ACFE survey, billing schemes were among the most common fraud methods in the cases studied for the 2012 report.
Billing schemes often involve the creation of a shell company. In such a fraud, a dishonest employee sets up a fake identity that bills for good or services the organisation does not receive. In some instances, goods or services may be delivered but are marked up excessively, with the proceeds diverted to the employee.
Other scams include pay-and-return schemes that cause overpayments to legitimate vendors. When an overpayment is returned, it is embezzled by the employee. Another favourite is simply ordering personal merchandise that is inappropriately charged to the organisation.
Common warning signals or red flags of potential billing fraud include but are not limited to:
These warnings or red flags can be organised into four general categories:
It is also worth noting that fraud is not about obstruction; rather, it is about deception, deflection, and persuasion. When fraudsters or white-collar criminals are profiled, they often are found to be anxious, secretive, moody, hot-tempered, friendly, outgoing, and passionate. They often are good salespeople and will say what people want to hear in order to build rapport and gain trust. Moreover, often there are other warning signs or red flags hidden in plain sight…such as living beyond one’s means, having financial difficulties, maintaining an unusually close association with vendors, or exhibiting excessive control issues, which generally will not be identified by traditional internal controls. It is important to maintain a healthy level of scepticism and always remember that trust is a professional hazard; if you do not verify information, you could become a victim.
As with all risk issues, the ultimate responsibility for identifying gaps and developing fraud controls rests with management. To meet this responsibility, management should avoid complacency and not assume that if fraud occurs “the auditors will catch it.” Although having an annual audit is a good anti-fraud control, by the time an audit uncovers a fraud scheme, it is usually too late to prevent the financial and reputational damage that will follow.
Most board members and executives of Not for Profits do not think as fraudsters do, which is a good thing. Unfortunately, this can make it difficult for them to develop controls that help reduce their organisations’ exposure to fraud risk. A critical step in the process of developing an effective fraud risk management program is assessing the board’s own skills and capabilities and deciding where professional help is most needed. The board is ultimately responsible for oversight of the organisation’s risk management efforts, which senior management is then charged with carrying out.
Here are some important principles to keep in mind as you work to refine the anti-fraud control policies at your Not-for-Profit:
As important as it is to respond quickly to fraud, avoiding the situation in the first place is the best plan of all. Although it is unrealistic to expect to completely eliminate the risk of fraud, the governing board and executives in a Not-for-Profit organisation can take effective steps to minimize the risk.
By establishing an environment in which ethical behaviour is expected, closing gaps in internal controls, and developing a proactive fraud identification and response program, Not for Profits can significantly reduce the financial and reputational risks associated with fraud.
This article was excerpted from an article published by Crowe Horwath.
Jonathan Marks is a partner and leader of Fraud, Ethics, and Anti-Corruption Services with Crowe Horwath LLP in the New York office.