A quick Google search for the phrase “nonprofit embezzlement” turns up thousands of news stories about thefts, ranging from relatively small amounts to millions of dollars. Regardless of the size of the misappropriation, the way a victimized organization responds can make or break its reputation, fundraising results and, in turn, ability to pursue its mission.
Of course, half the battle with some nonprofits is getting past the idea that they don’t really need to worry about embezzlement. In reality, nonprofits often are particularly vulnerable to theft from within the ranks.
One reason is that they generally foster cultures of trust and rapport more than for-profit businesses do. This comfort level may lead to a disregard for internal controls (“we don’t need them”) and make it tough for colleagues to ask the difficult questions when red flags pop up. In addition, an organization’s power frequently lies in the hands of a small group of people who can bypass or override any controls. High rates of turnover, a reliance on volunteers and limited resources also can make nonprofits susceptible to embezzlement and other kinds of fraud.
Moreover, the economic effects of the coronavirus (COVID-19) pandemic might lead an otherwise reliable employee, now financially injured, to resort to fraud.
Best course of action
So what should you do if you can confirm an embezzlement incident? A recent study published in the Journal of Accounting, Ethics & Public Policy looked at several options for repairing reputation and mitigating adverse financial effects after a major misappropriation. They include:
- Making a formal apology,
- Undergoing an external audit,
- Improving the board of directors’ oversight function,
- Pursuing legal action against the guilty party,
- Improving internal controls, and
- Terminating the executive director.
It turns out that improving board oversight had the highest and only statistically significant positive effect on supporters’ intentions to donate, planned donation amounts and an organization’s perceived trustworthiness. The researchers call this measure “an ideal image repair strategy” because it comes at a relatively low cost. Termination of the executive director, by contrast, was judged inferior to many of the other strategies.
The study took several steps to signal improved board oversight to would-be donors. Donors were told, for example, that the organization is now requiring board members to be completely independent from management, so no employees can serve on the board.
Researchers also informed the study participants that the nonprofit increased the number of voting board members and mandated that at least one member has a financial or accounting background. Participants were further told that all board members must review the financial statements at least monthly.
Note: These steps elicited positive reactions from donors only because they knew of them. In other words, it’s not enough to make such changes — you also must publicize them.
While prevention tactics and reputation repair are of utmost importance, they’re not the only critical considerations. You must comply with federal and state reporting obligations, too.
Nonprofits are subject to several regulatory reporting requirements when misappropriation takes place. The IRS, for example, generally requires organizations to report any “significant diversion” of assets on Form 990. A significant diversion happens when the gross amount of all diversions discovered during the tax year exceeds the lesser of 1) 5% of gross receipts for the year, 2) 5% of total assets at year end or 3) $250,000.
Save your organization a lot of pain by thinking ahead about how you’d handle an embezzlement episode, rather than risking rash, heat-of-the-moment decisions. Better yet, help preempt such schemes altogether by tightening your internal controls and board oversight before something goes wrong.