Fraud in the Nonprofit Sector

$40 Billion of Annual Nonprofit Fraud - Hauser Center, Harvard University

Posted on 2022-02-26 12:12:00

"Fraud among nonprofit entities may be on the rise." -HAUSER CENTER, HARVARD UNIVERSITY

Nonprofit Fraud

Financial Statement Fraud - Generates the largest losses for victim organizations.
Expense Misreporting - Most prevalent type of financial statement fraud.

Research into the Interaction Between Fraud and Nonprofits

“All organizations are vulnerable to fraud, but nonprofit organizations are subject to a higher risk of fraud due to their greater reliance on human decency, moral missions, and ethical values and messages” (Khadra & Delen, 2019). Nonprofits have different motivations within their organizations than compared to for-profit organizations. “Within the [nonprofit] sector, there is often the mistaken assumption that because of the nobility of their cause, employees and volunteers would not steal (Rothschild and Milofsky, 2006) from the organization. After all, who would steal money donated to grant the wishes of terminally ill children or steal funds allocated for important medical research?” (Best et al., 1993).

In research by Khadra & Delen (2019), they found some interesting insights about fraud affecting the nonprofit sector. In their research, they specifically focused on the impact of governance on nonprofit fraud reporting. “Our research provides supporting evidence that governance is an important factor in fighting fraud.” They write, “Federal audit, compliance with the law, using independent accounting to compile or review financial statements and the board of directors’ independence all affected the probability of organizations experiencing significant fraud…” (Khadra & Delen, 2019).

Research: Fraud by Gender
— Hauser Center, Harvard University

Females: "The typical (median) fraud case resulted in a loss of less than $50,000 and was committed by a female with no criminal record who earned less than $50,000 per year and had worked for the nonprofit at least three years. More than 25 percent of the reported frauds were conducted by managers and 8.6 percent of the perpetrators were executives."

Males: "The most costly frauds were those perpetrated by male manager/executives earning between $100,000 and $149,000 per year. Fraud committed by organization managers resulted in the greatest median loss to the organization ($150,000)."

In Risk Insights 2022, the Nonprofit Risk Management Center (2022) cites their research that, “According to provider tca SynerTech, up to 70% of charity networks don’t have a comprehensive vulnerability assessment to determine their cyber risks.”

Andrea M. Scheetz & Aaron B. Wilson (2018) in their research “Are not-for-profit employees more willing to be whistleblowers?” found that, “Fraud at not-for-profits, which accounts for 9 percent of reported fraud cases (ACFE, 2018), is understudied.” In their study, they found tips are the most common fraud detection method. “The authors find evidence that not-for-profit employees are more likely to report fraud [than their for-profit counterparts] and that reporting intention does not differ significantly by fraud type” (Scheetz & Wilson, 2018). They say that the typical nonprofit organization loses 5 percent of its revenues to fraud yearly.

Researchers at Griffith University wrote, “Although fraud detection rates for small organizations within the past two years are 10.60 percent, it is 19.10 percent for organizations with more than 20 employees” (Best et al., 1993). They write that nonprofits with over 20 employees use more fraud detection methods than smaller nonprofits. Citing a study by Douglas, Mills, and Owen they say several factors make nonprofit organizations vulnerable to fraud: an atmosphere of trust, the difficulty in verifying certain revenue streams, weaker internal controls, lack of business and financial expertise (Best et al., 1993). Only one in four nonprofits with less than 20 employees use one of the most effective fraud detection instruments. They conclude, “It was also found that not only do small organizations use significantly fewer fraud detection measures but they also rely on the wrong instruments. They appear to use the more common but mostly ineffective instruments such as code of conduct and internal controls review instead of fraud control policy, whistle-blower policy and fraud risk register which are more effective at discovering fraud” (Best et al., 1993).

Introduction to Fraud

Nonprofit organizations are more susceptible to fraud than you might think. Webster’s dictionary defines fraud as “... the multifarious means which human ingenuity can devise, which are resorted to by one individual, to get an advantage over another by false representations” (Best et al., 1993). The Association of Certified Fraud Examiners (ACFE) defines fraud as “... the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets” (Best et al., 1993). For nonprofit organizations, occupational fraud is likely to be the largest and more prevalent threat. Donald Cressey, a researcher in the 1950s, identified three insights into why people commit fraud. “The three key elements of fraud triangle theory are pressure (an unshareable need), rationalization (of personal ethics), and opportunity (lack of adequate controls and knowledge to commit fraud). All three must be present for a fraud to be perpetrated (Cressey, 1950)” (Best et al., 1993). Nonprofit organizations are more than often small in size and do not have the relevant expertise and resources to prevent or identify fraud.

How Can Nonprofits Change?

“Research shows that not-for-profit organizations that are forthcoming with details related to the [fraud] are punished less by donors”, says Scheetz & Wilson (2018).

One of our values at WikiCharities is transparency for this reason. Donors, volunteers, and even other nonprofit organizations usually stay away from working with or taking part in organizations that aren’t forthcoming with their financial information.

The researchers at Griffith University suggest that “[this] study also unveils the effectiveness of fraud detection instruments, in particular, fraud control policies, whistle-blower policies, and fraud risk registers, which appear to be highly effective instruments that ought to be implemented in all NFP organizations” (Best et al., 1993). They also suggest that a good fraud assessment will assist an organization in recognizing where it is vulnerable to fraud and can help foster an environment of fraud prevention.

“More companies and charities now offer nonprofits free or low-cost cybersecurity assistance… nonprofits should take advantage of those resources because some donors may not come back to the organization after a breach” (Nonprofit Risk Management Center, 2022). They also suggest increasing your nonprofit’s cyber liability insurance coverage and implementing multifactor authentication.

Conclusion

Nonprofits are at risk for fraud every day. They most likely make up a larger percentage of total fraud cases than is currently realized. The research on nonprofits and fraud is still developing constantly. It is a new field that is affecting nonprofits and hasn’t been truly realized until recently. Here at WikiCharities, we are trying to foster an environment of information and collaboration between nonprofit organizations. We are striving to be the thought provider for important topics that constantly are affecting nonprofits. By collaborating to increase the general knowledge within the nonprofit sector about key concepts, we can all take part in a better, more refined industry. In their research, the Nonprofit Risk Management Center (2022) concludes this powerful statement, “Some of your organization’s most significant opportunities exist online, and some of its biggest risks do, too.”

written by: Drew Jackson, WikiCharities Team Member

Solution: WikiCharities Validation

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