2017 Nonprofit Industry Update Seminar Recap Part 1 of 3: Preventing, Detecting and Remediating Nonprofit Financial FraudBy Michael McNee | January 8, 2018
Back in 1994, the worst nightmare of any nonprofit came true when United Way CEO William Aramony – who built United Way of America into one of the nation’s premier charities, was forced out as head of the organization and went to prison for six years after embezzling $1.2 million in funds to support a lavish lifestyle.
Michael McNee, Co-Partner-in-Charge of our Nonprofit, Government & Healthcare Group drew attention to this near-legendary tale of nonprofit fraud during his presentation on combating nonprofit fraud at our 2017 Nonprofit Industry Update Seminar in New York City.
McNee was joined by Yael Fuchs – Co-Section Chief of the Enforcement Section of the Charities Bureau in the Office of New York Attorney General Eric Schneiderman. Ms. Fuchs characterized her job as both, “seeking to shut down corrupt nonprofit practices, as well as supporting New York State’s (NYS) nonprofit community by helping them remain in compliance and identify systemic failures, where preventative systems and controls can help prevent fraud.”
US Tax Code 4958
Congress has long been concerned about financial abuses between exempt organizations and those who control them. Until the 1996 enactment of the intermediate sanction rules of Section 4958, the IRS had no way to curtail such abuses short of revocation of tax-exempt status.
Section 4958 imposes penalties in the form of excise taxes that are the result of an excess benefit received by certain organization insiders, termed “disqualified persons.” A disqualified person is anyone that can exercise substantial influence over the affairs of the organization, such as an officer, director, key employee, family member of such a person, and certain related entities.
Ways to Preempt Nonprofit Fraud
Yael Fuchs at Marks Paneth’s 2017 Nonprofit Industry Update Seminar
Ms. Fuchs challenged the audience to put in place effective internal controls, and to think through problem scenarios: “Do you know what to do when a conflict of interest arises? Do you have a whistleblower policy? Ask your auditors, ‘What do we do if this happens?’ Don’t get caught being unprepared.”
She urged attendees to review lessons learned from past whistleblower complaints to ensure that the organization has in place effective ways of addressing them in real time. She noted that, in the event a fraud is discovered, her office will ask nonprofits whether there were past complaints and how they were handled. Another point of fraud defense she cited was, “To prevent fraud – know who your vendors are. Clearly understand your business model. How is money coming into, and leaving, your organization? How is it accounted for?” She stressed that a board that really understands its nonprofit’s money flow will be less likely to overlook fraudulent payments to bogus consultants or the like.
New York State’s Commitment to Nonprofit Fraud Prevention
New York Attorney General Eric Schneiderman has put some real teeth behind the State’s efforts to prevent and prosecute fraudulent activities in the nonprofit sector. Ms. Fuchs helps oversee this more aggressive posture as Co-Section Chief Charities Bureau Enforcement Section. Specifically, she oversees and conducts investigations and civil litigation of fraud, misappropriation, and breaches of fiduciary duty in charitable organizations. Yael also works directly with nonprofits to remediate gaps in compliance and internal controls.
These enhanced regulatory efforts by NYS have additionally been underscored with the creation of charitiesnys.com – a portal for information, statutes and regulations, regulatory reporting and educational programs around nonprofit sector regulation.
The NYS Charities Bureau is responsible for supervising charitable organizations to protect donors and beneficiaries of those charities from unscrupulous practices in the solicitation and management of charitable assets. The Charities Bureau also supervises the activity of foundations and other charities to ensure that their funds and other property devoted to charitable purposes are properly used, and protects the public interest in charitable gifts and bequests contained in wills and trust agreements.
Ms. Fuchs appealed to the audience for help: “We need the help of the nonprofit boards and auditors when it comes to preventing fraud in nonprofits.” Enhanced awareness of what, where and when to look for potentially fraudulent activities would seem like a great place to start in this effort.
Ten Indicators that Your Nonprofit May be the Victim of Fraud:
Michael McNee presents at 2017 Nonprofit Industry Update Seminar.
Mr. McNee shared the following warning signs of potential fraud:
- You have very little or no segregation of duties, and approvals of adjusting entries and other oversight is sporadic at best.
- Internal controls are not periodically reviewed as to their viability in a changing world.
- Bank reconciliations are not performed in a timely or proper manner, or they have continual reconciling items – like old outstanding checks that suddenly clear. They are also not reviewed.
- Someone in your accounting department is having their wages garnished, or other obvious financial difficulties.
- Vendor invoices are on plain paper or don’t look like real company letterhead.
- Transaction amounts below an approved level are not considered important enough to periodically review, and internal financial statements are not scrutinized in a timely way by “Line Managers” with an emphasis on budget to actual variances.
- Duplicate payments are made to vendors.
- Computer access controls are poor.
- Your nonprofit doesn’t have anti-fraud policies in place and has let some previous transgressions “slide.”
- Documents are missing or are copied.
McNee went on to make several additional observations about fraud prevention:
“Did you know that the most frequent employee theft is committed by the one person trusted to manage all of the nonprofit’s finances?”
The most common misperceptions about fraud include:
- That sweet little bookkeeper could not have intentionally done such a thing.
- We have adequate controls.
- My CPA will find it while auditing the books.
- Our employees are trained to detect financial irregularities
- The bank will detect forged signatures or altered checks.
- The bank will notify us if a wire transfer is made that is not in accordance with our policies.
Other topics covered throughout this session included:
- Steps to prevent “trusted” staffers from committing fraud
- How to stop incoming receipts from being fraudulently diverted
- Equipment theft
- Kickbacks or false vendors
- Payroll theft
- How to keep close tabs on overall financial indicators
- Formal fraud prevention policies and training
- Appropriate responses to/policies concerning employee theft
For more information on our nonprofit capabilities, please contact:
Partner-in-Charge, Attest Services
Co-Partner-in-Charge, Nonprofit, Government and Healthcare Group
212.503.8954 | firstname.lastname@example.org
This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.
About Michael McNee
Michael McNee, CPA, is the Partner-in-Charge of Attest Services and Co-Partner-in-Charge the Nonprofit, Government & Healthcare Group at Marks Paneth LLP. He is also a member of the firm’s Executive and Management Committees. In these roles, Mr. McNee is responsible for overseeing the execution of the firm’s audit and attest services and directing the operations of the Nonprofit, Government & Healthcare Group. He develops strategy, sets policy and acquires and develops talent. In addition to his managerial... READ MORE +
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