Protecting Your Nonprofit From Fraud

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<ul><li><p>Speakers retain the copyright for all of the following materials. Any replication without written consent is unlawful.</p><p>Comments and opinions expressed by the speaker do not necessarily reflect the positions, opinions or beliefs of the AICPA and should not be construed or interpreted as such. </p><p>The materials contained in this presentation should not be considered to be in the public domain. Speeches and presentation materials contained here are proprietary works protected by copyright to AICPA and/or to the individual or entity who presented the materials at the conference. All rights are reserved. The authorized use of materials on this page is limited to download for personal reference by authorized users of the conference materials download area. Reproduction, redistribution, reuse, reposting or resale by any party in any form, format or media without express permission is strictly prohibited. Permissions requests may be directed to copyright@aicpa.org or to Thomas Robinson, Manager, Rights and Permissions at 919-402-4031.</p><p>Fraud In Non Profit Entities Dana Basney</p><p>Not-for-Profit Financial Executive Forum </p><p>Session 20</p></li><li><p>Protecting Your Nonprofit Organization </p><p>From FraudDana Basney</p><p>MSBA, CPA, ABV, CVA, CIRA, CFF, CFE</p><p>Managing Director ofCBIZ MHM, LLC and </p><p>Shareholder of Mayer Hoffman McCann P.C. </p><p>1</p><p>Dana Basney is a Managing Director of CBIZ MHM, LLC and a Shareholder of Mayer Hoffman McCann P.C. He has practiced public accounting for more than 37 years. He is in charge of CBIZ MHM San Diegos litigation support, due diligence, and valuation departments.</p><p>Dana holds a Bachelor's Degree in Liberal Arts from Bates College in Lewiston, Maine and received a Master's Degree in Business Administration and Accounting from San Diego State University. </p><p>Dana is a licensed CPA and a Certified Reorganization and Insolvency Accountant, as well as a Certified Valuation Analyst. He is a member of The American Institute of Certified Public Accountants, The California Society of Certified Public Accountants, The Institute of Managerial Accountants, The Association of Insolvency Accountants, The Institute of Business Appraisers, Inc., and the Bankruptcy Forum. He has served on the Family Law Bar's Business Valuation Subcommittee and has previously chaired the San Diego Chapter of the CPA Societys Ethic2s Committee and the San Diego Litigation Support Interest Group of the CPA Society. </p><p>Dana has extensive litigation experience and has served as an expert witness in financial and valuation matters on numerous occasions as well as a court appointed mediator and special master. Dana is also an instructor with the UCSD Extension Program teaching Advanced Accounting Topics and CPA Society approved course on Professional Conduct &amp; Ethics for Accountants.</p><p>Dana may be reached at: dbasney@cbiz.com or 858.795.2018</p><p>Dana Basney, MSBA, CPA, ABV, CIRA, CVA, CFF, CFE </p><p>2</p><p>20 - 1</p></li><li><p>Nonprofits Are A Major Economic Sector</p><p>At 10.7 million workers as of 2010, nonprofit organizations employ the third largest workforce among U.S. industries, behind only retail trade and manufacturing.</p><p>3</p><p>The above data was taken from, Holding the Fort: Nonprofit Employment during a Decade of Turmoil, a publication of Johns Hopkins Center for Civil Society Studies.</p><p>The Center is part of the Johns Hopkins Institute for Policy Studies.</p><p>Nonprofits Are a Significant Part of Our Economy</p><p>The U.S. nonprofit sector employs 15 times more workers than the nations mining industry, nearly 10 times more workers than the agriculture industry, and about twice as many workers as the construction industry. </p><p>4</p><p>The above data was taken from, Holding the Fort: Nonprofit Employment during a Decade of Turmoil, a publication of Johns Hopkins Center for Civil Society Studies.</p><p>The Center is part of the Johns Hopkins Institute for Policy Studies.</p><p>20 - 2</p></li><li><p>Nonprofits Are a Significant Part of Our Economy</p><p>The vast majority of nonprofit jobs are in three service fields - health care (57 percent), education (15 percent), and social assistance (13 percent). </p><p>5</p><p>The above data was taken from, Holding the Fort: Nonprofit Employment during a Decade of Turmoil, a publication of Johns Hopkins Center for Civil Society Studies.</p><p>The Center is part of the Johns Hopkins Institute for Policy Studies.</p><p>Nonprofits Are a Growing Part of Our Economy</p><p>During the 2007-2009 recession, nonprofit employment grew in 45 of the 46 states on which state-specific data were available, while for-profit employment declined in 45. Nonprofit employment also grew in all regions of the country from 2000 to 2010, with an average annual growth rate that ranged from 1.5 percent in the East South Central region to 3.4 percent in the Mountain region. During this same time span, for-profit employment registered annual average declines in all but two of the regions, and the growth rate in these two was no more than one-seventh as robust as the nonprofit one. </p><p>6</p><p>The above data was taken from, Holding the Fort: Nonprofit Employment during a Decade of Turmoil, a publication of Johns Hopkins Center for Civil Society Studies.</p><p>The Center is part of the Johns Hopkins Institute for Policy Studies.</p><p>20 - 3</p></li><li><p>Nonprofits Are a Significant Part of Our Economy</p><p>The nonprofit sector has been growing steadily, both in size and financial impact, for more than a decade. Between 1999 and 2011, the number of nonprofits has increased almost 31 percent; from 1,202,573 million to 1,574,674 million today. The growth rate of the nonprofit sector has surpassed the rate of both the business and government sectors.In 2010, nonprofits contributed products and services that added $779 billion to the nations gross domestic product; 5.4 percent of GDP. Nonprofits are also a major employer, accounting for 9 percent of the economys wages, and over 10 percent of jobs in 2009.</p><p>7</p><p>Source: The Urban Institutes Center on Nonprofits and Philanthropy</p><p>Wherever there is </p><p>money, there is fraud.</p><p>8</p><p>20 - 4</p></li><li><p>5% to 7% of the Economy is Being Stolen!</p><p>9</p><p>Estimates for fraud losses range from </p><p>5% to 7% of the U.S. economy.</p><p>5% to 7% of the Economy is Being Stolen!</p><p>Fraud appears to be a growth industry!</p><p>Fraud losses were estimated to have been approximately $994 billion in 2008.</p><p>Fraud losses were estimated to have been approximately $652 billion in 2006. </p><p>Estimates range from 600 billion to almost a trillion dollars.</p><p>10</p><p>20 - 5</p></li><li><p>The Extent of Fraud in Nonprofits</p><p>The extent of frauds in nonprofits is subject to debate and not well documented.There is some evidence that fraud is more prevalent in nonprofits then in for profits</p><p>11</p><p>A New York Times Report by Stephanie Strom, stated that fraud and embezzlement in the nonprofit sector account for a loss of $40 billion a year, or roughly 13 percent of philanthropic giving. The article is based on a report recently published in the Nonprofit and Voluntary Sector Quarterly in 2008.</p><p>12</p><p>The Extent of Fraud in Nonprofits</p><p>20 - 6</p></li><li><p>Financial Fraud is Higher in Nonprofit Organizations Than it is in Business or </p><p>GovernmentA National Nonprofit Ethics Survey taken in 2007 found that:</p><p>Conduct that violates the law or an organizations standards is on the rise, and in 2007 nonprofit violations have reached levels comparable to business and government organizations.Financial fraud is higher in nonprofit organizations than it is in business or government.</p><p>13</p><p>Taken From the Ethics Resource Centers National Non-Profit Ethics Survey of 2007Ethics Resource Center</p><p>2345 Crystal Drive, Suite 201Arlington, VA 22202</p><p>Fraud by Nonprofits</p><p>Nonprofit organizations can and do commit frauds. Fundraising is a particularly sensitive area that can be ripe for fraud. Fraudulent fundraising practices include:</p><p>Charging fundraising costs to programs to improve expense ratios scrutinized by donors, potential donors and charity watchdogs.Misrepresenting the portion of donations that will be used in charitable programs.Misrepresenting the extent of a charitable contribution deduction to which a contributor is entitled, such as in some car donation programs.Failing to comply with donor-imposed restrictions pertaining to the use of a gift.</p><p>14</p><p>20 - 7</p></li><li><p>Other fraudulent practices by nonprofit organizations include:</p><p>Knowingly failing to comply with Internal Revenue Service requirements related to housing.Allowances compensation reporting, knowingly misclassifying employees or using them as volunteers to avoid paying overtime.Using or selling donor data collected under false pretenses.</p><p>15</p><p>Fraud by Nonprofits</p><p>Fraudulent Financial Reporting</p><p>Fraudulent financial reporting is intentionally making false assertions relating to financial statements. Examples include:</p><p>False statements regarding compliance with specific requirements of funding sources.Charging of unallowable costs to grants and other false statements to government agencies.</p><p>Fraudulent financial reporting is most often committed by management and includes such misrepresentations as:</p><p>Failing to disclose significant related party transactions.Failing to disclose noncompliance with debt requirements or lack of waiver of noncompliance from lender.Misclassifying restricted donations to mislead donors or charity watchdogs.Holding records open beyond the period end in order to inflate revenues.Misclassifying expenses to mislead donors and others regarding the funds used for programs.</p><p>16</p><p>20 - 8</p></li><li><p>Unique Concerns for Nonprofits</p><p>If an organization is to qualify for tax exempt status, the organizations charter as well the organization must have a legal, charitable purpose, i.e. the organization must be created to support educational, religious, or charitable activities. A nonprofit corporation must specify that no part of its assets </p><p>shall benefit any of persons who are members, directors, officers or agents (its principals).</p><p>These elements do not mean that the organization cannot pay employees or contractors for work or services they render to the organization. This limitation means that as long as the organization operates within its exempt purposes and it maintains an endowment or uses any excess revenue to further develop its activities it will not be taxed by the Internal Revenue Service.</p><p>17</p><p>Unique Concerns for Nonprofits</p><p>A surplus - that is, whatever part of its income is left after its operating expenses are paid, which might be considered similar to "profit" - must be spent on the charitable or public purposes for which it was organized, not paid as a dividend or benefit to anyone associated with running or organizing it.The IRS has enacted intermediate sanctions should the members of the organization engage in practices that may excessively benefit any of the organizations members (or officers, directors, etc.) rather than revoking the organization's exempt status the I.R.S. may now levy a penalty on the organization for engaging in a transaction that resulted in a private inurement or private benefit.</p><p>18</p><p>20 - 9</p></li><li><p>Unique Concerns for Nonprofits</p><p>Not only must the organization meet the requirements of the state where it organizes sets for nonprofits, but it must also meet complex I.R.S. regulations. These regulations are used not only to determine if the </p><p>organization is exempt from tax under the organization's activities as a nonprofit organization.</p><p> If the organization purpose is one of those described in 501(c)(3) of the Internal Revenue Code, it may apply for a ruling that donations to it are tax deductible to the persons or business entities who make them. </p><p> The organization itself will be exempt from taxation as long as it does not engage in unrelated business activities.</p><p>19</p><p>Issues for Nonprofits</p><p>Nonprofits are far less likely to be able to recover from frauds due to: limited capital lack of employee theft insurance</p><p>Nonprofits depend on trusted individuals rather than systems of internal controls.Small organizations tend to have disproportionately large losses from asset misappropriation.</p><p>20</p><p>20 - 10</p></li><li><p>Frauds of Misappropriating Assets</p><p>Nonprofits often deal in cash, which is the most likely asset to be misappropriated.</p><p>Bank confirmations and reconciliations do not sufficiently cover the high risk area of cash assets.</p><p>Balance Sheet Audits do not effectively test cash transactions.</p><p>21</p><p>The person responsible for collecting and disbursing funds is also the individual who provides the financial reports.Many small organizations raise much of their funds in cash. Cash is more easily misappropriated than checks.Small nonprofits are run by trusting and committed individuals. Sadly these individuals tend to be too trusting.</p><p>22</p><p>Small Nonprofits Have Major Control Problems</p><p>20 - 11</p></li><li><p>Common Nonprofit Frauds</p><p>Skimming donationsUnauthorized fraudulent disbursementsPayment of personal expenses with the organizations fundsCreating fraudulent tax losses through refunding donationsOverstating program expensesOverstating Gifts in kind</p><p>23</p><p>Examples of Unrealistic Gifts in Kind</p><p>In 2010 the Canadian Revenue Agency revoked the charitable registration of The Orion Foundation, a bogus AIDS charity purporting to help Africans. It bought medicine for 30 cents per unit and valued it at $11.50 per unit, making enough purchases to issue $91 million dollars in donor receipts. The auditors could not tell if the medicine was actually received, used, or distributed in Africa. MAP International in 2009 reported that it was distributing donated drugs from Operation Blessing to the African nation of Ivory Coast. The GIK consisted of two shipments each of 7.5 million deworming pills worth nearly $80 million each. In other words they were claiming that a pill that can readily be bought from multiple sources for as little as 2 cents is worth $10.66. This valuation is absurd on its face because, according to WHO (World Health Organization), it would represent over 60% of total Ivory Coast government spending on health in 2009. AmeriCares in its 2009 audit counts as program services expense $42 million dollars worth of GIK that it never distributed. Accounting rules allow charities to write-off expired or unusable GIK and count it as a program expense.</p><p>24</p><p>The above material was published in the August 2011 issue of the Charity Rating Guide &amp; Watchdog Report</p><p>20 - 12</p></li><li><p>AWP = Aint What's Paid</p><p>Charities have been using pharmaceutical pricing guides that determine average wholesale prices (AWP) based on an honor system of unconfirmed reports on prevailing prices. People in the field joke that AWP really stands for "ain't what's paid." Some pharmaceutical companies have been sued for fraud for reporting AWP prices to the government to obtain inflated Medicare and Medicaid reimbursements for pharmacies and doctors. A partner at a major accounting firm told 2010 AICPA conference attendees that the drug pricing guide nicknamed the "red book," which has been frequently used by charities, valued deworming pills at $12 to $16 each even though she could go online and buy the same pills for ten cents. She said that some prices in the red book may be fine but that it is the responsibility of the charity's accountant to det...</p></li></ul>

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