The Case for Effective “Policing” of Nonprofit Funds

April 23, 2014

By Edward J. Loya, Jr.

Charitable giving in the United States is big business. From 2008-2012, nonprofits received more than $1.5 trillion in donation from charity-minded Americans.[1] The nation’s 965,000 nonprofits[2] range from one-person operations to huge, multinational organizations and represent a diverse spectrum of viewpoints, causes and approaches. What they all have in common is the trust of the public that their donations will be spent responsibly. To protect that trust, donors, nonprofit boards, and nonprofit management all have a part to play in preventing fraud, embezzlement and misuse of charitable funds.

In March 2014, Public Counsel invited me to co-author a client alert setting forth guidelines for handling nonprofit internal investigations involving employee fraud and theft. As a former federal prosecutor, I was able to bring my experience dealing with these issues to this important project.

From 2008-2013, I served in the Public Integrity Section of the Criminal Division of the U.S. Department of Justice, investigating and prosecuting government officials at all levels (local, state, and federal). Given the overlap between government and philanthropic and community-based programs, many of our cases dealt with fraud and embezzlement in the nonprofit sector.

Some representative cases include our successful prosecution of the executive director of a local commission who stole more than $325,000 intended to fund community-based programs and the successful prosecution of a former acting executive director, grant administrator, and nonprofit legal assistant who stole more than $150,000 from a now-defunct nonprofit organization that provided free legal services to the poor. Today, as a lawyer in the L.A. office of Venable LLP, I devote part of my white-collar investigations practice to assisting nonprofits with internal investigations.

According to the Washington Post, more than 1,000 nonprofits reported hundreds of millions of dollars in losses from 2008-2012. These numbers suggest that nonprofit funds intended to serve the public are at serious risk of being diverted and/or stolen if proper safeguards are not put in place.

Individuals and organizations involved in donating or awarding funds to nonprofit organizations—and nonprofit organizations receiving these funds—should ensure that recipient organizations take necessary precautions to protect the funds, specifically:

Require checks to be signed by two signatories
Segregate duties regarding payment requests, payment authorizations and record keeping
Require annual fixed asset inventories
Use automated controls, including electronic notification of bank account activity
Require background and credit checks for new hires
Implement a sound whistleblower reporting program;
Implement a strong compliance program, including a detailed code of ethics
Require annual audits
Ensure that the organization has proper insurance coverage, including a policy that protects against employee dishonesty and covers costs associated with hiring outside counsel to conduct internal investigations.

Prospective donors who are contemplating a substantial donation might consider asking about the nonprofit recipient’s internal control policies.

Equally, if not more important, is the sensitive task of handling allegations of employee fraud and/or embezzlement. Donors, nonprofit boards, and nonprofit management have a shared interest in protecting and/or recovering the organization’s stolen funds or assets; identifying wrongdoers (and clearing innocent employees); ensuring that the organization’s stakeholders are properly informed about these matters; protecting the nonprofit organization’s reputation; and, where appropriate, reporting these matters to authorities, including law enforcement officials. Given the importance of these matters, nonprofit organizations often retain experienced outside counsel to assist them.

One cannot help but wonder how much of a better place the country would be if the hundreds of millions of dollars that was reportedly stolen from 2008-2012 had actually been used to fund the community services and programs for which the money was given. As the nonprofit sector continues to grow, donors and nonprofit organizations will need to develop intelligent ways to deal with the threat of employee fraud and embezzlement. In addition to making sure that funds are made available to deserving nonprofit organizations, individuals working in the nonprofit sector must take steps to ensure that the funds are properly protected.

* * *

Mr. Loya is a trial lawyer in the Los Angeles office of Venable LLP, a DC-based law firm with substantial experience representing nonprofit organizations on the East Coast and the West Coast. He can be reached at eloya@venable.com.

[1] http://www.givingusareports.org/

[2] http://www.usatoday.com/story/news/nation/2013/02/02/nonprofits-grow-in-numbers/1886317/

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