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Nonprofit Fraud

Did this Board act ethically?

Joan Harrington

Joan Harrington is the assistant director of Social Sector Ethics at the Markkula Center for Applied Ethics. Views are her own.

A nonprofit loses $900,000 over eight years due to theft by the executive director.  The executive director acted unethically.  What about the Board?

One way Boards can exhibit better governance, promote ethical behavior, and prevent fraud like this is to follow the Markkula Center’s customized Standards for Excellence® Code.  The Standards, developed by the Standards for Excellence Institute, go beyond the law and set forth best practices. Our customized version includes ethical reflections for nonprofit organizations and their boards.  One reflection we offer in the code asks: How well do Board members understand their roles and responsibilities? 

In this case, how well did the Board members understand their responsibilities?

The Board has a fiduciary duty of care, which includes a duty of inquiry or an obligation to ask questions about areas of concern.  Best practices identify specific policies and practices for which Boards are responsible.  Relevant to this situation are the following:

Review of quarterly financial statements is a Board responsibility.  These should explain any variation between actual and budgeted revenues and expenses.  If management doesn’t provide these, Board members should ask for them.  If Board members don’t know how to read such statements, they should seek training.  Armed with these financial statements and by asking questions, the Board should have discovered the over $100,000 discrepancy per year.

Proper use of an auditor is a Board responsibility. The Standards for Excellence stipulate that nonprofits with an annual revenue in excess of $500,000 should have an audit by a Certified Public Accountant, hired by the Board and overseen by an Audit Committee.  If the auditor was not sufficiently skilled or had become too comfortable with the organization and the people running it, the auditor would have missed the theft.  The Standards recommend that nonprofits change auditors every three to five years to avoid this problem.  An auditor properly hired and supervised should have found the financial discrepancy.

Ensuring there are internal financial control policies is a Board responsibility. One critical internal control policy recommended by the Standards for Excellence is that no one person should be responsible for a transaction from start to finish, not even the executive director.  The policy should assign which two roles (at least) will be involved in each transaction so there are multiple points of accountability. With another party viewing the executive director’s financial transactions, the theft would likely have been identified.

Did the Board understand their role with respect to the executive director?

The Board is ultimately responsible for the organization and is charged with hiring, firing, and reviewing the performance of the executive director. Although board members may be friends with the executive director, that friendship cannot affect the Board’s supervisory role of the executive director or create excessive deference.  Both the executive director and the Board have the responsibility of fiscal oversight of the organization.  Exercising too much deference may cause the Board to abdicate its responsibilities or create blind spots as to the executive director’s behavior.

When you agree to be a Board member for a nonprofit organization, do you have an ethical obligation to that organization? Is it part of such an obligation to fully understand your role and responsibilities and execute them to the best of your ability?  Did this Board act ethically?

Follow the Markkula Center’s Standards for Excellence Program for Ethics and Accountability to guide your nonprofit.  Learn more about the Markkula Center’s Framework for Ethical Decision Making and the Standards for Excellence Program.

May 9, 2018

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