Minimizing Financial Fraud

Despite the strong ethical culture of the nonprofit sector, the EthicsResource Center (ERC) has reported that financial fraud is more prevalent in nonprofits than for-profit businesses or the government. In their article, “Minimizing financial fraud” (Nonprofit Observer, Fall 2008), San Francisco Bay Area CPA Firm Lautze & Lautzeprovides a quick guide to a multi-faceted defense of process, people, and prosecution/publicity to combat financial fraud.

First Line of Defense – The Process.  A sound accounting process can most simply be understood as an internal system of controls that allows an organization to “divide and conquer.”

  • Divide tasks: By dividing the responsibilities of handling incoming funds and expenses among many people, an organization can reduce the likelihood of cash disappearing without at least one employee’s knowledge. For example, separate individuals should be responsible for opening mailed donations, making bookkeeping entries, and depositing the checks, respectively. This is similarly applicable to expenses in which the person who authorizes a purchase should be different from the person who writes the check.
  • Divide finances into manageable parts: System controls such as using receipts with preprinted tracking numbers for outgoing money and confirming incoming invoices against the goods or services billed for is a great way to ensure the individual transactions that make up the organization’s cash flow have all been be accounted for.
  • Use experts to help conquer trouble spots: Occasional audits can help locate any gaping loopholes that exist in the current process and identify areas where further structure  is needed.

Second Line of Defense – The People
. Financial fraud prevention with employees can occur as early as the employee application process. Positions that involve access to and control over sensitive materials such as cash and donor records require diligent screening.

  • Background checks and calling references and previous employers are essential.
  • The interview itself provides another opportunity to learn how the applicant would handle certain scenarios (i.e., what the applicant would do if he or she thought records were being kept inaccurately) before the individual ever has access to or control over the organization’s sensitive materials.

Additionally, supervision and accountability should continue once the employee is hired.

Third Line of Defense – Prosecution and Publicity. An organization that has suffered financial fraud should not indulge in a concern over bad publicity at the cost of responding to the fraud “swiftly and appropriately.” Often, a fear of bad publicity will cause an organization to sweep the problem under the rug or feel reluctant to prosecute or terminate the employment of those involved in the theft. However, pursuing applicable employment consequences and criminal charges against those responsible for committing financial fraud not only sends a message to the public that the organization is working to preserve its integrity but also sends a message to current employees that reinforces the organization’s ethical culture that such behavior is not tolerated. Although a financial fraud situation carries some potential for negative publicity, taking action can actually generate a powerful and positive external and internal publicity effect.

The Lautze & Lautze Nonprofit Observer publication, Fall 2008, is available here.

– Emily Chan