In April of this year, the news outlets in St. Louis, Missouri turned their attention to a story about the Zoo-Museum District board that awarded a multi-million dollar contract to a design firm to build a pavilion within the St. Louis Science Center. The contract, ranging from $1.2 to $2.5 million was, unbeknownst to the board, awarded to a design firm that was owned by one of their very own directors. Once this became known to the public it sparked a heated debate in the media, and was promptly followed by the resignation of the board member.

This serves as the perfect illustration of what nonprofits must work to guard against—the real (or perceived) conflict of interest that takes place when a board member stands to gain personally from their relationship with the organization.  The story in St. Louis involves a public organization that receives taxpayer dollars and is governed by a different set of rules than the ones that govern nonprofits, but conflict of interest issues arise from the same set of circumstances. Both types of entities need strong boards, comprised of members who are knowledgeable in their fields and able to provide expert guidance and direction. In many cases, the best candidates for board positions also have a financial interest in businesses that can help advance the mission—but therein lies the danger.

The IRS offers some guidelines for nonprofits that are designed prevent board members from unethically profiting from their positions. First, the IRS requires the completion of a Form 990 in which nonprofits must disclose the compensation and potential conflicts associated with officers, directors, trustees and key employees. Second, they encourage nonprofits to establish a formal conflict of interest policy and have ongoing reviews of the policy with its staff. But the guidelines they recommend leave some wiggle room for board members to do business with the nonprofit. The IRS’s sample policy states: “A financial interest is not necessarily a conflict of interest.  Under Article III, Section 2, a person who has a financial interest may have a conflict of interest only if the appropriate governing board or committee decides that a conflict of interest exists.”

From this policy, a board member (or a company they have a financial stake in) can still ethically bid for contracts with the nonprofit, but ideally, they would be offering below-market rates of their goods and services, creating a win-win for both parties.  In the real world, things don’t always work out that way. In 2007, the Urban Institute did a survey of over 5,100 nonprofits and found that more than 41 percent of nonprofits with at least $10 million in annual expenses purchased goods and services from board members. The study also showed that only 39 percent of the larger nonprofits that did business with board members received below-market rates. The other 61 percent may not be in outright violation IRS regulations, but they are taking an enormous risk with regard to public opinion and loss of support from contributors if it becomes the public perception that a board member is taking undue advantage of their position.

Many financial consultants would advise against letting board members bid on contracts because it puts the nonprofit’s reputation at too great of a risk. Even where there is no impropriety, the mere perception of impropriety can have a damaging impact on their name, their donations, and their ability to fulfill their mission. Others might argue that the very reason board members volunteer their time and expertise is because of the financial opportunities that come from the relationship with the organization, and without these opportunities, nonprofits won’t be able to properly staff their boards.

It’s a slippery slope that each nonprofit should manage carefully according to their own code of ethics and risk tolerance. The best course for mitigating some of the risk is to create a clear conflict of interest policy, outlining precisely what behaviors and relationships are allowed, and socialize it regularly among the board and the public. If a conflict does arise, the nonprofit needs to deal with it openly and swiftly to maintain its credibility. Establishing, socializing and enforcing a strong conflict of interest policy will go a long way toward protecting your nonprofit organization from scandals like the one in St. Louis, so that when you do end up in the press, it’s for all the right reasons.

Fifty billion dollars. It’s a staggering sum of money that most people can only fantasize about, and when asked, what you would do with such an outrageous amount of money, there is  a struggle to translate into everyday terms.

To provide some perspective, here’s a fun shopping list of things you could buy if you had $50 billion:  33 Yankee Stadiums, 25 percent of the Microsoft Corporation, 520 Neverland Ranches, or 120 Airbus 380s (these are the cool double-deckers that Saudi princes buy.)

What is even more unfathomable than owning just one Yankee Stadium, is the fact that $50 billion is  the estimated amount that is lost each year to fraud in nonprofit organizations (according to the New York Times). One might assume that most fraud takes place in  large global charities with deep pockets similar to the Red Cross or UNICEF.  In reality, most embezzlement takes place in smaller organizations with fewer than 100 employees due to the fact that these organizations are less likely to have adequate internal controls in place.

When it comes to embezzlement, it is a sad irony that nonprofits are founded on the noble intention of improving the state of mankind, and unfortunately can become the easiest targets for  fraud.  Small nonprofits are even more vulnerable because their environments are very personal, more intimate, and nurture a false sense of security that “it could never happen here.” But it isn’t too hard to imagine how an employee, facing their own financial pressures and temptations, might begin to skim a little cash here or there. If you are watching the news headlines,  there have been multiple reports on   how  cash skimming  soon evolves into falsified time sheets, expense reports, and more, until the nonprofit is losing huge amounts of money – one Airbus seat cushion at a time.

What to do:  to protect the mission and the reputation of a nonprofit? Leaders can implement best practices that will go a long way toward preventing “fraud,” “embezzlement,” “larceny,” “and other charges” that are often described in the news. Conducting surprise audits, requiring regular job rotations, enforcing cross-checking and review processes for all financial transactions, and providing hotlines for anonymous whistleblowers are just a few of the precautions that can be taken. These policies are not meant to be a burden to your operations, but a way to preserve both your financial resources and the public’s trust in your good name.

If you are not sure whether or not you have enough checks and balances in place to protect against fraud, external auditors, industry experienced consultants can offer some important insight into where you may be at risk. With so much at stake, you want to ensure that the  donations that are generously made to your organization are used for their intended purpose and not for an employee’s personal gain.

Last month I gave a seminar on revenue diversification to a group of people who serve on the boards of a wide variety of nonprofit organizations. In my work, I have the pleasure of meeting dynamic leaders who are dedicated to serving others and to providing their organizations with the oversight that will help them achieve the missions for which they were created.

What I found surprising and potentially problematic was that the vast majority of my audience, though passionate about their missions, could not tell me anything about the real mission statements on which their charities were founded. The one that appears on their Form 1023 and that is submitted to the IRS to gain the service approval for a tax-exempt status. Most of my audience had never heard of, nor seen, nor read their Form 1023.

In order to gain tax exempt status under the IRS Section 501(c), nonprofits are required to complete a Form 1023, stating the intended mission of the organization such as charitable, religious, educational, or scientific purposes. They are also required to provide a detailed narrative of all past, present and planned activities that support this purpose. Gaining tax exempt status saves the organization from paying a host of taxes such as federal income tax, federal unemployment tax, state tax, and more. The danger arises when a nonprofit begins to engage in activities that fall outside the parameters of what they originally listed on their Form 1023. Then, they could be at risk of losing their tax exempt status and all of the financial benefits that come with it.

For example, if a nonprofit earns income through activities that are not related to those on the Form 1023, they could be required to pay taxes on that income. More importantly, if a nonprofit participated in political campaigns, lobbying, or engaged in activities that benefited an individual’s private interest, they could be stripped of their tax exempt status altogether. No matter how well intentioned these actives might seem, the IRS may take a completely different view.

Whenever I to talk with people who are thinking of assuming a position of leadership within a nonprofit, I strongly recommend that they first gain a clear understanding of the organization’s mission, and that includes the important information of the mission detailed in their Form 1023. One of the most important things that you can do to protect the interests of your nonprofit is to know and embrace the real mission statement and all of the rules that apply to it. And this mission, should you choose to accept it, will ensure that you, your donors, and your volunteers can continue to serve the causes that are nearest and dearest to your hearts.

This blog will self-destruct in sixty seconds.

I recently delivered a presentation at the Essex County Institute for Trustees, a full day conference for board members and executive directors of nonprofit organizations. While the subject I covered, nonprofit finance, is by no means a new subject, many organizations still struggle to optimize their operations in order to make the most impact with limited financial resources.
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In June of 2011, New York Attorney General Eric T. Schneiderman announced the formation of a Leadership Committee for Nonprofit Revitalization. The task force, composed of 29 leaders in the nonprofit sector from across the state, was charged with presenting a series of recommendations to reduce regulatory burden and costs on nonprofits while strengthening nonprofit accountability.
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