Thousands of not-for-profit organizations fall victim to embezzlement schemes every year — some even losing millions of dollars. But losses go beyond actual dollar amounts. The hit to a group’s reputation may scare off donors, grantmakers and other supporters. However, with the right response, nonprofits can bounce back from fraud. Here’s how.

One best practice

A study published in the Journal of Accounting, Ethics & Public Policy makes the case that the specific steps an organization takes following a fraud incident can mitigate significant reputational damage. In its hypothetical example, the study lists several ways a nonprofit might act after discovering money has been embezzled:

• Make a formal apology,
• Undergo an external audit,
• Improve the board of directors’ oversight function,
• Pursue legal action against the guilty party,
• Improve internal controls, and
• Terminate the executive director.

The study found that improving board oversight was the only response to elicit a statistically significant positive effect on supporters’ intentions to donate. Stronger oversight also helped restore an organization’s perceived trustworthiness.

To signal improved board oversight to would-be donors, the authors suggested that an embezzled organization start requiring board members to be completely independent from management and bar employees from serving on the board. Researchers also informed study participants that a nonprofit should increase the number of voting board members and mandate that at least one member has a financial or accounting background. Participants were further told that all board members must review the financial statements at least monthly.

Comply with regulations

The study’s authors call improving board oversight “an ideal image repair strategy” because it comes at a relatively low cost. But while reputational repair is of utmost importance, it’s not the only consideration for victimized nonprofits. If your nonprofit loses funds to fraud, it must comply with federal and state reporting obligations, too.

The IRS generally requires organizations to report any “significant diversion” of assets on Form 990. A significant diversion happens when the gross amount of all diversions discovered during the tax year exceeds the lesser of 1) 5% of gross receipts for the year, 2) 5% of total assets at year end or 3) $250,000. Check with your state for other required reporting.

Act now

You may be able to save yourself a lot of heartache by preventing rogue employees from committing fraud in the first place. Tighten internal controls and board oversight now. And just in case a criminal slips through the cracks, be ready with a fraud contingency plan that can guide you in the aftermath of an incident. Contact us for help with controls or to investigate fraud.

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