April 27, 2011

Despite High-Profile 'Three Cups’ Controversy, Nonprofit Fraud Isn’t Widespread

Until a few weeks ago, Greg Mortenson was known­—and widely admired—as the best-selling author of Three Cups of Tea and the founder of a charity, the Central Asia Institute, that seeks to construct schools in conflict-torn areas of Afghanistan and Pakistan. But following accusations aired on the television show “60 Minutes” and by the writer (and fellow Himalayan mountain-climber) Jon Krakauer, he is now defending himself against charges that he has been using the organization for his own gain and lying about its accomplishments.

If the charges are true, Mr. Mortenson faces not only sizable personal penalties but also the prospect of the Central Asia Institute’s losing support and closing. Moreover, if this scandal affects public confidence in humanitarian groups generally, other charities may suffer, too. They may also face tighter regulation as concern about possible fraud at nonprofits spreads.

Yet, in fact, the best-available evidence indicates that fraudulent activity at nonprofits is not widespread and indeed may be far less extensive than it is in business and government.

However, an article in a prestigious academic journal and follow-up newspaper stories have created a different impression.

The article was written by Janet S. Greenlee, an associate professor of accounting at the University of Dayton, and three other scholars and appeared in late 2007 in Nonprofit and Voluntary Sector Quarterly, the journal of Arnova, the preeminent society for academic researchers interested in philanthropy and nonprofits.

It drew on a biennial survey conducted by the Association of Certified Fraud Examiners, an international group that describes itself as “the leading anti-fraud association in the world, providing knowledge and training used to reduce the occurrence of corporate fraud.”

Ms. Greenlee and her colleagues reviewed the 2004 study by the association, which covered the period since the beginning of 2003. A total of 508 cases of fraud involving $761-million in losses were reported to the examiners’ association. Of these, 12.2 percent were in nonprofit organizations. Over 70 percent were in privately held and publicly traded businesses. The rest were in government.

The association also asked its members for their estimate of how much of its revenue a typical organization in the United States lost in fraud each year. The median response was 6 percent, meaning half thought the figure was higher, while half thought it was lower. Even so, the association report concluded, the loss was “staggering,” translating into $660-billion in the 2003 economy of $11-trillion.

Although the association emphasized that 6 percent was just an “opinion” of its survey respondents, rather than “meaningful data,” Ms. Greenlee and her co-authors used it to estimate the cost of fraud to nonprofit groups.

“A survey conducted by the Association of Certified Fraud Examiners estimates that all organizations lose on average 6 percent of their revenue to fraud every year,” they wrote. “Applying this percentage to the nonprofit sector would suggest that the fraud loss would be approximately $40-billion each year,” they concluded.

However, nonprofits were not like all organizations in the association study. They accounted for a much smaller share of reported frauds. (The 2010 survey—which is international in scope—produced a still lower percentage; just 9.6 percent of the cases examined were at nonprofit groups.)

It’s hard to tell why the study found fewer fraud cases at nonprofits. Nonprofits could have been more trustworthy, or perhaps the frauds they committed were not caught as often; it is also likely a much smaller share of the fraud examiners knew much about nonprofits then. Whatever the explanation, however, applying an opinion about the median cost of fraud among all organizations to nonprofit ones produces a factoid, not a fact.

Nonetheless, despite its spuriousness, the $40-billion estimate of losses in the nonprofit world due to fraud has acquired a life of its own—and been further distorted. An article in The New York Times in 2008 about the Nonprofit and Voluntary Sector Quarterly article, for example, observes that “what is getting the attention of nonprofit leaders is the report’s estimate of the overall cost, which the authors put at $40-billion for 2006, or some 13 percent of the roughly $300-billion given to charity that year.”

Later the article notes that all sources of revenue—not just contributions—were taken into account when calculating the figure and quotes Independent Sector’s president, Diana Aviv, as suggesting that it is too high because it is “lumping” business and government together with nonprofits.

However, the article’s thrust was accurately captured by its headline—“Report Sketches Crime Costing Billions: Theft From Charities.” Exhibit number one was the $40-billion number.

The figure has appeared elsewhere (including in a Chronicle item that raises questions about where the number came from) and the Mortenson scandal is likely to keep this figure alive. Indeed, at least one article by a national news service has already included it, as well as stated that it “accounts for 13 percent of donations.”

But perhaps just as important, we don’t yet know whether Mr. Mortenson committed fraud or simply ran his organization poorly.

To be sure, the Central Asia Institute spent a great deal of money to advertise Mr. Mortenson’s books and facilitate his speaking engagements while Mr. Mortenson reaped most of the financial benefits.

But he and his defenders say that his efforts helped promote the organization’s goals as well as its ability to raise money from the public. If so, the charges being made against him may reflect the appearance of a conflict of interest more than an actual one.

As for the growing amount of evidence that important parts of Mr. Mortenson’s writings and speeches were fabricated and that the Central Asia Institute’s programs have not had as much success as claimed: If embellishment were to become a form of fraudulent activity, more than a few organizations would be in trouble.

The attorney general of Montana (where the charity is located) has already begun an investigation of the Central Asia Institute and will ultimately decide if Mr. Mortenson’s conduct went too far.

But in the meantime, those who believe that the nation’s charities need more policing would do well to take another look at their own conclusions.

Leslie Lenkowsky is professor of public affairs and philanthropic studies at Indiana University and a regular Chronicle contributor. His e-mail address is llenkows@iupui.edu.