Occupational Fraud at Not-for-Profits: Red Flags and Preventative Steps

As we approach International Fraud Awareness Week (November 17-23, 2019), it is a great time to review the basics of occupational fraud and why fraud awareness is especially important for not-for-profits. Occupational fraud is any fraud committed against an organization by its own officers, directors, or employees. This article addresses why not-for-profits are frequently vulnerable to fraud, the financial and reputational impact of fraud, why people commit fraud, behavioral and operational red flags of fraud, and most importantly, a few simple and inexpensive steps you can take immediately to help mitigate the risk of fraud in your organization.

Why Not-for-Profits are Vulnerable to Occupational Fraud

All organizations, regardless of size, are at risk for occupational fraud. However, not-for-profits are often particularly vulnerable. This is because:

1. Not-for-profits are often strapped for resources, both financially and operationally. Any resources available are typically used for programs rather than infrastructure. Lack of available administrative resources can result in high-risk issues, such as poor separation of duties and breakdowns of internal control.
2. Not-for-profits generally exist to benefit society, and there is often an assumption that employees are there because they care about the mission of the organization and have the best interests of the organization at heart. There is often an environment of trust, which can also cause the organization to be susceptible to exploitation.
3. Not-for-profits often rely on volunteers, who may not be vetted/background-checked as extensively as an employee would be.
4. Not-for-profits often rely on and accept cash donations, especially during fundraising events. Cash theft is one of the most common occupational fraud schemes.

The Financial and Reputational Impact of Occupational Fraud on Not-for-Profits

The Association of Certified Fraud Examiner’s 2018 Report to the Nations reported that when a fraud occurs in religious, charitable, and social service organizations, the typical median loss is $90,000 per fraud. The median loss jumps to an astounding $200,000 per fraud when including all small organizations (less than 100 employees) regardless of entity type. Losses of this magnitude can create a going concern issue for many small not-for-profits and other types of small organizations.

An occurrence of fraud, or even the public perception that a fraud has occurred, can also have a huge negative impact on an organization’s reputation. The main threat is damage to the good name of the organization which can cause loss of donor funds and public trust, and the potentially large costs related to legal and public relations fees.

Financial and reputational damage can ultimately affect the organization’s ability to support its mission, or reason for existing.

Why Occupational Fraud Occurs

In 1953, American criminologist Donald Cressey developed a model to explain what ingredients need to be present for a fraud to occur. This model is called the Fraud Triangle and outlines three elements as precursors to a fraud event:

1. An employee or volunteer experiences some non-shareable pressure which might motivate them to steal from the organization. This pressure threatens to steal their standing as a successful, upstanding, and trusted person at work. Examples might include an employee with a drug or alcohol problem, gambling addiction, or various family issues, including divorce.
2. The employee or volunteer identifies an opportunity to steal. These opportunities generally arise from a lack of internal controls and/or separation of duties, a perceived low-risk of getting caught, and poor management oversight.
3. The employee or volunteer can rationalize their behavior through various methods: moral justifications (I’m only doing this for my family), denial of injury (I was only borrowing the money), denial of the victim organization (I am not paid a fair amount of money and the organization owes it to me), and diffusion of responsibility (I see my boss doing it, so why can’t I).

The opportunity to steal can be mitigated through solid internal controls and separation of duties. The organization should focus on a strong ethical tone at the top, creating a culture with a zero-tolerance policy for any unethical behavior. Employee fraud training is also important so red flags can be identified by anyone in the organization. On the other hand, internal employee pressure and their ability to rationalize are impossible for the organization to control directly but can be indirectly influenced with employee assistance programs. Rationalization can be lessened with strong HR and compensation practices.

Behavioral and Operational Red Flags of Occupational Fraud

The ACFE Report to the Nations found that in 85% of all fraud cases studied, employees committing fraud displayed at least one behavioral red flag, while 50% displayed multiple red flags. Here are some of the most common behavioral red flags:

1. The employee appears to live beyond their means.
2. The employee may appear to have an unusually close relationship with a vendor or customer.
3. The employee may refuse to take vacations or have control issues such as an unwillingness to share duties.
4. The employee may be experiencing challenging life issues.

Besides behavioral red flags, there are often operational signs that a fraud may be occurring or that the organization is at a higher risk for fraud:

1. Lack of an ethical “tone from the top.” Fraud prevention and mitigation begins with a board and executive management that communicate and demonstrate that unethical behavior will not be tolerated.
2. High employee turnover.
3. Little to no financial oversight from the board.
4. Fraud awareness training for employees is considered a luxury, not a necessity.

It is important to note that the presence of a red flag does not necessarily mean that a fraud is occurring. However, if there is a legitimate concern, then behaviors and operational issues should be documented extensively to build a potential case. Always trust but verify with your employees and volunteers.

Simple Steps to Help Mitigate the Risk of Occupational Fraud

Here are some simple steps that will go a long way in mitigating fraud risk at your organization:

1. Set-up an anonymous fraud reporting mechanism, such as a phone or email tip-line (per the ACFE study, employee tips are the most common ways that frauds are detected).
2. Hold periodic fraud awareness trainings for staff at all levels of the organization.
3. Establish and communicate a whistleblower policy, a vacation use policy (requiring mandatory use of vacation time), and an open-door policy for employees to speak freely and safely about any pressures they might be facing.
4. Ensure separation of duties if they have not already been built into your internal controls. Separation of duties means that no single employee should be responsible for more than one of the following: acquisition of assets, custody of assets, and record-keeping of assets. In cash receipts procedures, for example, the same person should not be receiving cash, maintaining custody/access to cash, and recording the receipt of cash in the accounting system.

Clark Nuber can help your organization with the fraud mitigation process. For assistance in developing or reviewing internal controls, performing risk assessments, providing fraud training to staff, or any other consulting around fraud awareness, please contact Mike Nurse.

For additional information and resources about occupational fraud, including numerous articles, a printable fraud prevention checklist, and shareable fraud videos, please click on the following link to ACFE information about International Fraud Awareness Week.

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