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In a counter-point to a Washington Post expose, John Langan says nonprofits should not be penalized for directing donor money toward the governance infrastructure the public expects in order to reduce the risk of fraud.

Nonprofits Need Funding, Not More Regulation, to Prevent Fraud

  • 12/2/2013

Let’s be clear: The Washington Post’s recent investigation of fraud in the nonprofit sector has done a clear public service. But rather than congressional involvement and more regulation, we need to advocate for more money and support for nonprofits to build finance and governance infrastructure that can help them meet the public’s expectations.

There is no excuse for abuse of the public trust through the direct or indirect theft of taxpayer dollars. This is particularly true with respect to social service agencies trying to make a difference on a shoe string. But as someone who has worked with nonprofit organizations for more than 30 years, I feel the indignation of politicians, regulators, and others to the The Post’s reporting — as highlighted in a follow-up article in The Post — is naïve and somewhat hypocritical. Members of Congress immediately called for multiple investigations. Senator Charles Grassley, the ranking member of the Judiciary Committee, said this “should be a wake-up call for every tax-exempt organization.”

A closer examination of the numbers further illustrates this overreaction. According to a study by the Association of Certified Fraud Examiners, typical organizations (for-profit and nonprofits) lose 5 percent of revenues to fraud and theft a year; $3.5 trillion a year on a global basis. While unfortunate, disappointing, and sometimes heartbreaking, the fact that 1,000 nonprofits over the past four years (out of more than 1 million required to file Form 990 annually) have reported being victim of more than $250,000 in fraud is no greater incidence than occurs in the for-profit world. No excuse, just reality.

Having audited nonprofits for many years I can report that the vast majority of nonprofit managers and boards do not need “a wake-up call.” They are keenly aware of the threat of financial and reputational loss resulting from fraud. The paid and volunteer leaders I interact with on a daily basis work tirelessly to ensure that the financial support they receive is applied to their tax-exempt purpose, and to protect the reputation they have worked so hard to build. These efforts are supported by numerous organizations serving the sector with free resources to help nonprofits improve their financial controls and governance oversight.

Unfortunately, the public expectation and view that the best organizations spend the smallest percentage of their total revenue on “overhead” can be a catch-22 for nonprofits. They should spend more of their funding to ensure sound financial controls, but risk their funding by doing so.

It is no secret why fraud occurs — motive, means, and opportunity. Human behavior in the nonprofit sector is no different than in the for-profit world and the incidence of fraud is no greater. What is unique is the expectation that an underpaid sector with volunteer oversight should be bulletproof in protecting donor dollars. Transparency is a very good thing and nonprofits now have even more reason to improve their compliance with return disclosures so the nature and amounts of any significant diversions of assets is made clear to the public.

Let’s hope that the recent investigation leads to more support for the sector in promoting sound financial controls and improved governance, rather than knee-jerk “reforms” that only increase administrative burdens and make politicians and regulators feel better until the next headline-grabbing story.

For more on fraud prevention in nonprofits: