Fraud, the economy and the not-for-profit client

1. Fraud, the economy and the not-for-profit client AGN Conference MAY 2009 Liz Gantnier Stegman & Company

2. According to a Times report by Stephanie Strom, fraud and embezzlement in the non-profit sector account for a loss of $40 billion a year, or roughly 13 percent of philanthropic giving

3. Organizations with 1-99 employees were more likely to have losses due to fraud (39%) than those with 100-999 employees (20.1%),

4. Of the 959 cases studied, 14.3 percent of those involved a not-for-profit organization, with a median loss of $109,000 per incident.

5. Internal and external fraud • Internal – committed by persons inside the organization – employees, officers, directors • External – committed by persons outside the organization – vendors, sub-recipients, grant applicants and program participants

6. Two types of fraud • Asset misappropriations • Fraudulent financial reporting

7. Methods of asset fraud found in not-for-profits in the 2006 ACFE study: • expense reimbursements, 28.6%; • billing, 28.6%; • check tampering, 24.5%; • skimming, 24.5%; • cash larceny, 17.7%; • non-cash theft, 14.3%; • payroll, 12.9%; • and fraudulent statements & wire transfers, 5.4% each.

8. Stealing • Revenue and cash receipts: • Skimming • Theft of donated merchandise • Purchasing and cash disbursements: • Credit card abuse • Fictitious vendor schemes

9. Payroll: • Ghost employees • Overstatement of hours worked • Fictitious expenditures • Other: • Theft of fixed assets • Stealing time, supplies, etc - corruption

10. Cooking • Charging fund raising costs to programs to improve expense ratios • Failing to comply with donor-imposed restrictions pertaining to the use of a gift • Failure to comply with IRS regulations • Misclassifying employees

11. Failure to disclose related party transactions • Failure to disclosure non-compliance with debt covenants • Misclassifying restricted donations • Holding the books open to increase revenues • Misclassifying expenses

12. Failure to correctly value receivables or donated assets and other • Failure to record payables in the proper time period

13. Liberal interpretation of donor agreements • Donations directed to a specified beneficiary are liabilities not revenue • SFAS 136 stipulates that unless donor explicitly grants the organization variance power – donation is liability

14. Understanding Fraud Three elements are starting to come together: • Opportunity (internal control) • Incentive (entity encourages certain behavior with reward or small punishment) • Rationalization (individual is accepting of the behavior)

15. Economy and the fraud triangle • Cutbacks in personnel/funding • Less people, less segregation of duties • Desire for maintaining results • Can provide incentive for improper behavior • Funding • No raise or poor raise can lead to rationalization of bad behaviors • Fear/uncertainty • How will bills get paid? What if someone loses a job? How will tuition payments be funded?

16. Auditor should respond to increased risk with new/different tests • Send confirms and include/clarify terms and restrictions • Review underlying documentation • What do historical trends tell you? • Review minutes to determine if restrictions were discussed

17. Slow to No pay • Review underlying documentation including correspondence related to government grants and contributions • Review minutes of the governing board • Discuss with management potential collectibility issues

18. Resources allocated to program activities, not internal control • When controls are depleted risks of fraud increase with opportunity • Watch • segregation of duties over cash since it is easily misappropriated • Controls over restricted contributions to ensure they are properly identified • Perform • Detailed tests of compliance with donor restrictions • Analyticals of data against reliable benchmarks

19. Management characteristics • Significant portion of management's compensation represented by bonuses that are contingent upon the organization achieving unduly aggressive targets for cash flow

20. Executive director possesses significant power and latitude to override controls • A major donor or fundraiser exercises substantial influence over the affairs of the organization.

21. Industry • Unusually intense competition exists for a limited pool of government grants. • The threat of significant reductions in third-party funding. • An usual focus by external financial statement users on the amounts reported as program, management and general, and fund-raising expenses.

22. Operating characteristics • Significant sub-recipient relationships, without a clear program purpose or business justification. • Diverse programs funded by multiple sources involving many complex requirements that must be complied with by the organization. • The organization has to comply with numerous federal requirements.

23. Susceptibility of assets to misappropriation • Lack of job applicant screening procedures relating to employees with access to assets susceptible to misappropriation. • The presence of volunteers working in the organization who have access to assets susceptible to misappropriation and who have not been adequately screened.

24. Lack of timely and appropriate documentation for transactions related to promises to give. • The presence of easily convertible assets such as bearer bonds and certain types of inventory.

25. Thanks for coming!