Nonprofit Governance: Why Donate to a Fraudster?

The Sarbanes-Oxley Act (SOX) of 2002 imposed many new corporate governance provisions for public companies.

By Catherine Lofland, CPA 

The Sarbanes-Oxley Act (SOX) of 2002 imposed many new corporate governance provisions for public companies. When we think about scandals at companies like Enron, Tyco, and WorldCom, which were the impetus for SOX, it makes sense that corporate governance is so important: We must protect shareholders and encourage investment to promote economic growth. Although its importance is not as intuitive as that of the for-profit sector, the nonprofit sector plays a significant and wide-reaching role in our society. According to the National Center for Charitable Statistics, there are currently more than 1.5 million nonprofit organizations, which account for 9.2 percent of all wages and salaries paid in the United States.

In 2002, the former chief executive of the United Way of the National Capital Area (NCA), Oral Suer, was charged with defrauding the charity of as much as $1.5 million during the 27 years he worked there. Other executives were accused of stealing hundreds of thousands of dollars as well. Internal auditors uncovered questionable spending by top leaders and inflated overhead costs. Publicity of this scandal caused donations to decline dramatically. In 2001, the charity received more than $90 million; in 2011, only $35 million was donated to the still-tarnished organization. Could this scandal have been prevented if the United Way of the NCA had a more robust system of corporate governance?

In nonprofit organizations, corporate governance is all too often a low priority. First of all, mismanaged nonprofits have little incentive to reform in an effort to protect their reputations because donors are unlikely to be aware of corporate governance weaknesses. Internal controls and governance structures can be very expensive to implement. Furthermore, a smaller staff in a more intimate environment (as you find in many nonprofits) might foster an artificial impression of trust since coworkers work closely together and know each other on a personal level. Nonprofit organizations, particularly charitable ones, are especially vulnerable to weaknesses in a corporate governance structure due to the altruistic nature of their business. It’s hard to imagine that someone who devotes their career to a philanthropic organization would perpetrate fraud there.

When reforming a corporate governance system at a nonprofit, management and the board should focus on the importance of reputation. As evidenced by the United Way of the NCA scandal, a damaged reputation can be devastating. Nonprofits depend on their reputations as efficient, trustworthy and effective entities to raise funds and continue operations. Current regulation, however, makes little effort to harness the regulatory effects of a nonprofit’s efforts to protect its own reputation. Therefore, it is up to nonprofits to take the initiative in implementing corporate governance reforms to prevent scandal and succeed in their missions.

The board of directors is the cornerstone of the corporate governance function. In a nonprofit organization, the board’s role is to oversee the management of the organization and ensure that the organization fulfills its mission. To succeed in this role, a board of directors must perform the following functions:

Hire an ethical CEO or president.

Oversee the hiring process for other top executives.

Set the agenda for board meetings.

Communicate independently with the organization’s external auditors.

Monitor resource management by ensuring that funds are being used judiciously.

Ensure the organization operates to fulfill its stated mission.

Notice that the last bullet point says that the board must ensure the organization operates to fulfill its stated mission. This is what differentiates governance of a nonprofit from that of a public company: a nonprofit works toward a specific mission rather than to increase shareholder value. Resource mismanagement is especially problematic in nonprofits because employees may not be accountable to anyone with a direct stake in the success of the organization. Since the purpose and function of nonprofits is so distinct from for-profit companies, nonprofit governance reforms must be distinct as well.

Before donating to a nonprofit, you or your company needs to perform due diligence to ensure the charity is effectively governed, transparent, accountable and fiscally responsible. Consider performing the following vetting procedures for any charities under consideration:

Review the annual report.

Read the minutes from board meetings, if available.

Talk to board members to assess their level of oversight and commitment to donor stewardship.

Examine the financial statements and inspect the organization’s expense allocations.

Review the organization’s investment policy and inquire about whether there is a conflict of interest policy in place.

Assess whether the programs and services the organization provides are aligned with the organization’s mission, and determine if they have the capacity to successfully deliver these programs and services.

Without strong internal controls or an effective corporate governance system in place, nonprofit employees might find it easy to misappropriate or mismanage funds. Too often, nonprofits wait until fraud actually takes place to start thinking seriously about these fraud prevention mechanisms. Nonprofits will be more proactive in establishing an effective governance system if donors start taking the vetting process seriously. Only then can we feel confident that our donations are being used responsibly and ethically to fulfill the charity’s mission. You don’t want your generously donated funds going into the pocket of a fraudster.