News and analysis
June 09, 2015

Restricted Gifts Can Help Ward Off Charity Fraud, Study Finds

Nonprofits that receive support with strings attached — such as government grants or donations earmarked for a specific purpose — are less likely to be victims of fraud and embezzlement, according to an examination of Internal Revenue Service filings.

While charities may prefer to receive gifts without such stringent monitoring, the close attention paid by government or private donors of restricted money helps prevent financial wrongdoing, researchers say.

Perhaps less surprising: The study, by a trio of researchers from the College of William and Mary, Rutgers University, and the University of California at Davis, found that several "good governance practices" like financial audits and a conflict-of-interest policy, also helped reduce the incidence of fraud.

Starting in 2008, the IRS required charities to disclose any theft or unauthorized use of assets and to answer basic questions about their governance practices.

Using that information in their report, the researchers found that recipients of government grants and groups that have taken on debt in the form of municipal bonds are 38 percent less likely to fall victim to fraud. The reason, the authors say, is that lenders and government grant officers often have the legal right to monitor recipients’ progress.

The findings:

  • Recipients of restricted donations were 20 percent less likely to fall prey to fraud.
  • Nonprofits that underwent an audit and maintained administrative duties in-house rather than hiring an outsider to do them were 35 percent less likely to see their assets diverted illegally.
  • Asking board members to review tax filings and publishing a conflict-of-interest policy each lowered the chance of fraud by about 20 percent.
  • Checking a Box

    The researchers used a sample of 764 instances of theft at charities, representing an average loss of $1.5 million, culled from data compiled by The Washington Post and GuideStar, an organization that collects information on nonprofits.

    The researchers then paired those charities with other, similar nonprofits that did not suffer losses and compared the governance policies at each to determine their likely ability to deter fraud.

    The results of the study don’t suggest that every nonprofit should rush out to adopt a full slate of good governance practices, says Michelle Yetman, a professor at University of California at Davis and co-author of the study.

    "Each charity needs to consider the costs and benefits" of such policies, she says. For instance, an organization might be "super small and not want to spend the money to get an external audit."

    Ms. Yetman also warned donors to keep in mind that it’s hard to verify whether a charity has done everything it can to prevent fraud simply by looking at its governance policies. For instance, she says, a nonprofit might check a box in its Form 990 tax filing that indicates its board thoroughly reviews its finances. But there’s no way to prove it has done so, she says:

    "Just because you check the box doesn’t necessarily mean that the policy is being implemented in a meaningful way."

    Send an email to Alex Daniels.

    Send an e-mail to Alex Daniels.