Ron Mattocks

Willie Sutton is attributed with saying “I rob banks because that’s where the money is.”   If he were alive today, Willie Sutton would find it more productive to steal from nonprofit organizations than from banks.  In fact, based on several new studies, including a report from the Association of Certified Fraud Examiners, nonprofit organizations on average experience losses to embezzlement and fraud at a rate double the experience of for-profit corporations (How to Steal from a Nonprofit: Who Does It and How to Prevent It, Nonprofit Quarterly, December 21, 2007).

If you sit on a nonprofit board, the rate of theft of nonprofit assets should be cause for alarm.  The culture of “do-good”, mission driven charity and service appears to be genetically predisposed to trust and adverse to business disciplines, or the healthy skepticism that insists on accountability and integrity.  If you sit on a nonprofit board and are not dead serious about this threat, you are vulnerable, and you are not fulfilling your responsibilities as a board member.

There are many paths a nonprofit organization can travel to financial distress, ranging from economic turmoil to changing markets, to unanticipated outcomes of business plans, to loss of donor support, or even fraud and embezzlement.  And while audits are important and useful, most fraud is uncovered based on insiders, not uncovered by audits.  According to the Association of Certified Fraud Examiners, 75% of nonprofit theft involves wrongful disbursements of funds.

So what is a board to do?  First, never ever believe that your organization and your people are so good that “it could not happen here.”  The depravity of mankind can exhibit itself where you least expect it.  Board skepticism is prudent.  Trust but verify.  Second, work with your auditors or outside CPA each year to establish a variety of checkpoints designed to unearth liabilities or hidden schemes.  Finally, review all board policies and specific written delegated responsibilities to assure that the board’s directives are understood and implemented.

Kudos to Rev. Soaries of the First Baptist Church of Lincoln Garden, New Jersey for his innovative leadership helping homeowners avoid foreclosure.  (TOP ASSEMBLY LEADER: NEW JERSEY MUST MAKE IT EASIER FOR NONPROFITS TO HELP STRUGGLING FAMILIES STAY IN THEIR HOMES, Potlicker.com/NJ, October 14, 2008). Under the Soaries plan, First Baptist Church and other nonprofits in New Jersey purchase houses threatened by foreclosure and lease them back to the homeowner with a goal of selling the house back to the homeowner within seven years.  The New Jersey State Legislature is currently considering a bill that would help by eliminating the real estate transfer fees, further reducing the costs of the transactions in hopes that more foreclosures will be avoided.

Given the increasing threat of foreclosures, Rev. Soaries and the State Legislature have both exhibited innovative leadership that can make a real difference.  Communities ravaged by foreclosures, empty houses and plummeting real estate values are a tragedy to be avoided, and the nonprofit sector has a role to play along with government.

Most nonprofit organizations demonstrate a high degree of innovation at their inception, but over time these organizations are typically managed into defensive postures that leave them risk adverse and devoid of innovation.  But if we view the nonprofit sector combined, with its 1.5 million organizations controlling $3 trillion in assets as a public trust, the current economic turmoil creates a stage on which these organizations should demonstrate their value.  Special thanks to Rev. Soaries and the New Jersey Legislature for rising to the challenge.

John J. Havens, a researcher at the Boston College Center on Wealth and Philanthropy points out that that during the 1999-2003 market crash household wealth declined by 20% but charitable giving by individuals increased by 10% (Charitable Giving Might Not Melt Down, Philanthropy Scholar Predicts, Chronicle of Philanthropy, October 8, 2008).  It is an interesting observation based on the notion that household income does not necessarily decrease proportionate to household wealth during market corrections.

While this seems to offer some encouragement to nonprofit organizations dependent on charitable gifts, the current market turmoil is more global, more severe, and fundamentally different from that crash.  The speed and scale of this crash, combined with the collapse of financial institutions and the dysfunctional credit market are reason for significant concern.  Nonprofits today face reductions in net assets, loss of corporate sponsors that are filing for dissolution, and limited access to credit.  This is a potent mix for one out of three organizations that were operating on thin margins without significant reserves prior to the current market declines.

Boards and management teams of nonprofits must take speedy and prudent action to reduce expectations for charitable gifts in the short term, and to reduce reliance on credit to solve short term cash needs.  Failure to adjust quickly may jeopardize the viability of organizations that are sorely needed to help many through fiscal challenges.  This is a time for steady hands and bold action to assure long-term viability.

You need a score card to keep track of the Sioux Falls City funding commitments to local nonprofit organizations. After the mayor reduced funding to local nonprofit organizations in the city budget, the city council restored the funding. The mayor vetoed the council action, cutting the funding a second time. The council restored the funding a second time, only to be trumped by a third veto by the mayor. (Don’t Depend on Money From City, Argus Leader, October 9, 2008).

At the heart of the debate, the city council and mayor were at odds about the value of funding local nonprofit organizations. Given the current economic uncertainties, and the need for government, individuals, corporations, and foundations to tighten their belts and reconsider every expense, nonprofits must offer a credible value proposition to sustain charitable gift revenue moving forward. And funders link their support to the value proposition. In a case like Sioux Falls, city funding of a nonprofit homeless shelter may actually be a cost saving move, if the ultimate demise of the shelter would result in even greater expense to the city.

Nonprofit organizations that are so focused on survival that they cannot articulate a value proposition that resonates with funders will ultimately fail. Those organizations that survive the economic turmoil will survive, in part, because they have defined and articulated a value proposition that resonates with funders.

Nonprofit organizations are particularly challenged when managing donor-restricted funds during periods of financial distress.  Dependent on charitable gifts, nonprofits typically accept unrestricted gifts to be used for any legitimate purpose of the organization, and donor restricted gifts that can only be used for the purpose stated by the donor.  Best practice would call for the nonprofit receiving a donor-restricted gift to book the revenue as restricted, releasing funds to cover expenses as incurred for the intended purpose. The gift is booked as a funded liability, and the cash is managed in a separate fund.

 As a practical matter, too many nonprofits receive the restricted gift, book the liability, but comingle the cash with the general operating fund.  Assuming that the general operating fund exceeds the amount of the restricted gift, the liability is still funded.  However, during periods of financial distress, if the general operating fund is depleted, the organization may find that the donor-restricted gift is suddenly an unfunded liability.  This is a legal, ethical, and donor relations issue that cannot be ignored, and is all too common in today’s environment.

 Boards governing financially distressed nonprofit organizations (i.e. organizations operating in the zone of insolvency) have expanded legal responsibilities and liabilities to care for the interests of all parties to the corporation.  In this case, the donor’s interests, accounting standards, and legal requirements must be honored regardless of operating needs for cash.

 The American Red Cross demonstrated great discipline in this regard over the summer when faced with high demand for services to support hurricane victims in Texas and the Gulf Coast.  The Red Cross borrowed $200 million to manage short term cash flow needs for hurricane relief.  At the same time, management launched a campaign to pay off that $200 million loan through grants and charitable gifts, securing a $100 million government grant, raising $42 million in charitable gifts, and with ongoing efforts to secure the remainder.  Note that the Red Cross actually borrowed $200 million from the bank, and did not raid donor-restricted funds to meet the need.

Given the current dysfunctional credit market, nonprofit organizations are finding it difficult to impossible to borrow, pushing organizations into cash flow crisis.  It is times like this when the pressure mounts to raid the donor-restricted funds.  And it is times like this that board and management must demonstrate great discipline and resolve to take the high road and not cave to that temptation.