May 01, 2008

Donors’ Role in Non-Profit Fraud

by Tim Ogden

A study on fraud in American non-profit organizations published in the December issue of the Nonprofit Quarterly contains some surprising findings. Most significantly, the authors estimate that $40 billion is lost annually to fraud, a figure that accounts for more than 10 percent of private funds given to charity in the US each year. A follow-up on the study from the New York Times provides a good summary and some of the underlying context, pointing out that donor confidence in non-profits is low and sinking, and that the extent of the problem may become clearer as charities are required to disclose incidences of fraud on their Forms 990 beginning next year.

What neither the study nor the article discuss, however, is the culpability of donors themselves in non-profit fraud. This is not to say that those committing fraud are not at fault, of course. But donor behavior plays a key enabling role in fraud.

We know from various studies of corporate fraud that a significant percentage of those who acknowledge stealing from their employers justify doing so because they believe they deserve the money. Their argument is that they are making up for the difference between their wages and their actual value to the company. It doesn’t take a large leap to suspect that a good portion of non-profit fraud can be accounted for in the same way, given that most non-profit jobs pay significantly less than the average wage at a for-profit company. In fact, the study finds that the “typical ... case was committed by a female [who] earned less than $50,000 a year and had worked for the nonprofit for at least three years” and stole less than $40,000. In addition, the most common type of fraud in non-profits, according to the study, is fraudulent disbursement—paying phantom bills or employees, expense-report or time-card-padding, etc. This type of fraud is easiest to commit in organizations which lack sophisticated finance systems (processes and software).

What do donors have to do with this? It is common donor practice today to demand that non-profits maintain ridiculously low overhead costs, and that donations be used only to deliver services. These donor practices are intended to forestall mismanagement or, indeed, fraud. Yet they do the opposite: they make the motivations for fraud more acute by effectively preventing nonprofits from paying market rates for their talent. They are largely responsible for both low salaries that are far below employees real value and for the lack of non-profit investment in the kinds of financial systems and processes required to prevent and detect fraud.

For those donors who are most concerned about fraud, their first priority shouldn’t be to demand proof that their funds are only being used for program expenses. Instead, they should demand that their funds be used to invest in quality financial systems and well-paid finance professionals.