Nonprofit fraud: What are the key indicators?

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Although it's generally unsubstantiated, we probably hear or read about fraudulent activity, on average, at least weekly. The headlines confirm that fraud - lying, cheating and stealing for financial gain - does occur in NPOs and, in some instances, may have a significant impact on their continued viability, thanks not only to the monetary losses but also to the reduction in public support that generally results from any allegations of impropriety.

The rate of incidence of fraud against businesses is alarming, and the resulting losses are immense. In a recent research study the Association of Certified Fraud Examiners, estimated that fraud costs American organizations more than US $400 billion annually. Further, while it is commonly believed that fraud only occurs in large, multinational organizations, the ACFE study found that the most costly abuses occurred in organizations with less than 100 employees. These American results are likely representative of the Canadian experience as well, although on a smaller scale.

Unfortunately, while fraud is clearly having a significant impact on both our organizations and our society, it is practically impossible to gauge its true economic impact. So many incidents go unreported, undetected or fall into the grey zone of unethical behavior that the numbers fail to tell the whole story.

What are the typical indications of fraud?

Fraudsters are hard to spot. They generally look and act like any other typical employee, often turning out to have been seen as dedicated hardworking individuals who have received high praise from their supervisors and colleagues.

According to one school of thought, only 20% of the population walks the moral high ground and is always [a big word] honest. Another 20%, the inherently dishonest, are always on the lookout for ways to beat the system, and the remaining 60% fall somewhere in between these two extremes. White-collar criminals generally tend to emerge from the last group and are driven to step over the line by the right combination of motive and opportunity.

Watch for these 'red flag' indicators

The GONE theory holds that Greed, Opportunity, Need and the Expectation of not being caught are what lay the groundwork for fraud. Greed and/or need provides the motive. The fraud may be further driven by:

  • Financial problems, possible due to marriage breakdown or heavy debt load
  • Delusions of grandeur
  • An inflated ego
  • A craving for success
  • A compulsion, such as gambling or substance abuse problems.

More specific indicators of fraud include:

  • Reluctance to take vacations,
  • Living beyond one's means
  • Sudden mood swings or personality changes,
  • Inability to keep up with regular work responsibilities

These factors are frequently characterized as the typical 'red flags' that may indicate the potential for fraud. If in addition, your organization has lax or non-existent internal controls, fails to segregate duties and has a willingness to put its trust in the wrong hands, you have the explosive combination that spells opportunity.

Rationalization: They're not really stealing

Fraudsters do not expect to be caught, since they generally do not view themselves as criminals. They often rationalize their behaviour by reassuring themselves that because they have every intention of paying back their ill-gotten gains, they are not really stealing. In some instances they convince themselves that they deserve, and are in fact justified in taking, whatever they can get their hands on. An unrealized promotion, a salary level below current market rates or expectations, or feelings of being unappreciated may create a fertile environment for this sort of reasoning.

Unfortunately, fraud can take place just as easily in an NPO as in a for-profit enterprise. Indeed, some would say that it can occur more easily in NPOs for some of the following reasons:

Atmosphere of trust. The mandate of NPOs is generally based on providing services to those in need. Management, employees, and the volunteers involved in the operations of an NPO have a strong belief in the services their organization provides and are often compassionate, caring individuals. This atmosphere, positive as it is, may result in the placement of a higher level of trust in colleagues, suppliers, and other individuals with whom the organization does business, than will typically occur in a for-profit enterprise.

Certain revenue sources, such as donations from the public, are difficult to control. Volunteers often carry the lion's share of the load when it comes to canvassing or other donation activities. Generally background checks, if any, done before enlisting the help of anyone willing to volunteer their time are inadequate. The problem is compounded by the fact that receipts are not always requested for cash donations.

Financial restraints. NPOs are often funded through public donations, and in some instances by government subsidies, which in recent years have been heavily cut back. As a result, fundraising has become increasingly competitive, and funding restrictions often make it more difficult to hire the most appropriate number and mix of staff. In addition, not only can it be very difficult to adequately segregate incompatible financial functions, such as purchasing and payments, but also supervision and monitoring activities are often limited.

Lack of business/financial experience. Funding restrictions often result in management and employee salaries being less than market rates, making it difficult for NPOs to attract and retain individuals with a strong financial background. In many cases, the external auditors are relied upon to ensure that the year-end financial statements are accurate, but unfortunately, an audit is based on sample testing and is not designed to detect fraud.

Volunteer boards. The board of directors of an NPO generally consists of volunteers that want to donate a portion of their personal time to a worthwhile organization. The directors often have full-time jobs, families and other personal commitments and are therefore only able to donate a certain amount of time to the NPO's activities. Further, while they may bring a significant amount of valuable experience to the organization, they often have limited financial backgrounds. This results in reliance on the executive director, controller or accounting supervisor to make the board aware of any financial concerns.

Stuart Douglas is the national partner and Kim Mills is a Toronto-based senior manager of Deloitte & Touche's Investigative and Forensic Accounting Group in Canada. The Investigative and Forensic Accounting Group focuses on economic damages, financial investigations and forensic accounting matters in the civil, criminal and corporate areas. For more information call either of them at 416-601-6150.

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