Understanding and mitigating the risk of fraud in not-for-profit organizations

Not-for-profit organizations can be shockingly vulnerable to the risk of fraud. As an example, because of limited accounting staff size, an organization’s accounting clerk could be responsible for both opening donations, as well as for recording and depositing those donations. Due to this lack of segregation of duties, that clerk could embezzle $250,000 in funds intended to support the organization’s mission and might only be caught by an audit prompted by a whistleblower’s allegation.

Alternately, consider a scenario where an organization’s CFO manipulates the financial statements to create a misleading picture of financial health and programmatic success, resulting in significant increases in donations and grant funding. But when the fraud is eventually uncovered due to a donor’s request for detailed financial information, donors and granting agencies may became understandably concerned and halt funding, thereby curtailing the organization’s mission. In this case, the pressure to meet fundraising targets and the lack of internal controls contributed to the occurrence of the fraud.

Another example involves a procurement director accepting bribes from vendors in exchange for awarding contracts. The director was able to award contracts of any dollar value, with no additional review from management. The fraud was discovered when a whistleblower reported suspicious activities. When confronted with the fraud, the procurement director blamed insufficient compensation as a motivating factor for his actions. In this case, the lack of oversight and ethical training contributed to the occurrence of fraud.

Think something like this can’t happen to your organization? Well, think again. Fraud in not-for-profit organizations is more common than you think and can have serious impacts.

• Financial losses: Director financial impacts that can hinder the organization's ability to fulfill its mission. Losses may include penalties, legal liabilities and costs incurred to investigate fraud.
• Reputational damage: Loss of donor trust and public confidence leading to reduce funding. Not-for-profits rely heavily on donations, grants and volunteer efforts to achieve their work, which makes protecting your reputation imperative to being able to achieve your goals.
• Operational disruption: Diverts resources from mission-critical activities to address fraud-related issues; therefore, leading to increased costs and operational inefficiencies.

Unfortunately, this reliance on external resources, combined with natural resource constraints internally and less complex organizational structures, can leave not-for-profits vulnerable to fraud.

Fraud triangle

Fraud experts often refer to the “fraud triangle,” which outlines the three elements that lead individuals to commit fraud; only one element can be present for fraud to occur:

• Financial pressure or the motive compelling someone to commit fraud.
• Opportunity or the ability to commit a fraud.
• Rationalization or the justification a fraudster uses to explain why they committed a fraud.

Fraud in not-for-profit organizations

Not-for-profit organizations face heightened risks of occupational fraud due to lean accounting teams, potential for conflicts of interest, grant and donation fraud, vendor kickbacks, false expense reimbursements and payroll fraud. They are particularly vulnerable because of fewer resources to prevent and recover from fraud loss.

The ACFE Occupational Fraud 2024: A Report to the Nations found that not- for-profit organizations reported 164 fraud cases, with a median loss of $76,000 and an average loss of $611,000. In addition, organizations that experience a fraud, may be fined or penalized, and the report further noted that not-for-profit organizations received fines most frequently, while publicly traded companies were the least likely to receive a fine.

Corruption was the most common scheme, underscoring the need for strong controls and ethical corporate culture.

• Lack of internal controls: Many not-for-profits operate with limited resources and may not have robust internal controls in place, creating opportunities for fraudsters to exploit.
• Limited oversight: Not-for-profits often rely on volunteer boards and committees for oversight. These individuals may not have the expertise or time to effectively monitor the organization's activities.
• Pressure to meet financial goals: Not-for-profits may face pressure to meet fundraising targets or financial goals. This pressure can lead to unethical behavior and fraud.