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Nonprofit Organizations Need A Whistleblower Reporting Mechanism

By: David Nolte
Tel: (213) 787-4100
Email Mr. Nolte

The IRS adopted a substantially revised Form 990 that calls for significantly expanded corporate governance disclosures. A charity's Form 990 is publicly available, including most importantly to potential donors and regulators outside of the IRS.

Because the new Form 990 disclosures apply to 2008 fiscal year activities for the largest nonprofits, time is of the essence. For the 2008 tax year (returns filed in 2009), organizations with gross receipts over $1.0 million or total assets over $2.5 million will be required to file the Form 990. For the 2009 tax year (returns filed in 2010), organizations with gross receipts over $500,000 or total assets over $1.25 million will be required to file the Form 990. The filing thresholds will be set permanently at $200,000 gross receipts and $500,000 total assets beginning with the 2010 tax year.

The IRS commentary on the Form 990 reporting included the following:

"The Internal Revenue Service believes that a well-governed charity is more likely to obey the tax laws, safeguard charitable assets, and serve charitable interests than one with poor or lax governance. A charity that has clearly articulated purposes that describe its mission, a knowledgeable and committed governing body and management team, and sound management practices is more likely to operate effectively and consistent with tax law requirements...

The Internal Revenue Service encourages the board of directors to adopt an effective policy for handling employee complaints and to establish procedures for employees to report in confidence any suspected financial impropriety or misuse of the charity's resources. Such policies are sometimes referred to as whistleblower policies. The Internal Revenue Service will review an organization to determine whether insiders or others associated with the organization have materially diverted organizational assets. Organizations that file Form 990 will find that Part VI, Section B, Lines 5 and 13 ask whether the organization became aware during the year of a material diversion of its assets, and whether an organization has a written whistleblower policy."

It would not be surprising that nonprofits with a Form 990 showing weak governance practices will be more likely to face audits. Whistleblower reporting systems are now a best practice.

Formal collection mechanisms for whistleblower complaints should be adopted by all nonprofits. At this point, Boards of Directors who do not address this area will be criticized.

At the encouragement of the U.S. Senate Finance Committee, the Panel on the Nonprofit Sector was formed to prepare recommendations to improve the oversight and governance of charitable organizations. One of their reports, "Principles for Good Governance and Ethical Practice: A Guide for Charities and Foundations", dated October 2007, included the following recommendation:

"A charitable organization should establish and implement policies and procedures that enable individuals to come forward with information on illegal practices or violations of organizational policies. This "whistleblower" policy should specify that the organization will not retaliate against, and will protect the confidentiality of, individuals who make good-faith reports."

Nonprofit organizations have way-too-frequently been the victims of employee fraud. According to 2008 statistics from the Association of Certified Fraud Examiners:

  1. Approximately 14% of all frauds occur at nonprofits.
  2. The median loss for nonprofits is $109,000.
  3. The median duration of all frauds at nonprofits is 24 months.

Reasons why nonprofits face a disproportionate level of employee fraud include:

  1. Constrained staffing levels at most nonprofits make segregation of duties more difficult to accomplish.
  2. Because of the emphasis on altruistic program activities, employees who appear to have these shared values are trusted more than what occurs in private enterprises.
  3. The Board of Directors often consists of volunteers who (i) are not involved with day-to-day activities, and (ii) view their positions as not involving supervision of areas where fraud can most easily occur.

For a nonprofit that has been victimized, the damage involves not just the stolen money, but the harm to reputation and future fund-raising activities. Whistleblower reporting mechanisms are a means of both (i) improving the internal control environment that discourages inappropriate conduct, and (ii) reducing the loss exposure if a problem occurs.

David Nolte is a principal at Fulcrum Financial Inquiry LLP with over 30 years experience performing forensic accounting, auditing, business appraisals, and related financial consulting. He regularly serves as an expert witness.

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