Nonprofit Organizations Need A Whistleblower Reporting Mechanism

|||Nonprofit Organizations Need A Whistleblower Reporting Mechanism

Nonprofit Organizations Need A Whistleblower Reporting Mechanism

November 2018

The IRS Form 990 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.

For the 2018 tax year (returns filed in 2019), most tax-exempt organizations with gross receipts over $200,000 or total assets over $500,000 will be required to file the Form 990. Certain tax-exempt organizations, such as political or religious organizations, remain exempt.

The IRS instructions on the Form 990 included the following:

“A whistleblower policy encourages staff and volunteers to come forward with credible information on illegal practices or violations of adopted policies of the organization, specifies that the organization will protect the individual from retaliation, and identifies those staff or board members or outside parties to whom such information can be reported.”

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.”

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” 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.”

The National Council of Nonprofits advocates implementing whistleblower and anti-relation policies for nonprofits:

“Your nonprofit is practicing sound governance and exercising prudent risk management if you have a written policy. Your organization will only be in a position to correct a situation if it becomes aware of the problem. That is why having a policy that encourages people to report their concerns without fear of retaliation is so critical to good governance.”

The DC Bar Pro Bono Center stresses the importance of using an anonymous reporting through independent third-parties for this role:

“As a simpler alternative… organizations can establish confidential and anonymous reporting procedures by designating an external advisor, such as the independent accountant or outside attorney, to whom concerns should be addressed and by instructing that external advisor to contact the board of directors if there is a report.”

DC Bar Pro Bono Center continue to describe how of anonymous reporting through a third-party intermediary can provide an “extra layer of protection” against retaliation claim.

It is unavoidable: whistleblower reporting systems are now a best practice. Formal collection mechanisms for whistleblower complaints should be adopted by all nonprofits. It would not be surprising that nonprofits with weak governance practices will be more likely to face audits. At this point, Boards of Directors who do not address this area will be criticized.

Nonprofit organizations have way-too-frequently been the victims of employee fraud. While nonprofit’s losses due to fraud may be comparatively small, typically limited resources mean that any losses are more devastating. According to 2018 statistics from the Association of Certified Fraud Examiners:

  1. Approximately 9% of all frauds occur at nonprofits.
  2. The median loss for nonprofits is $75,000.
  3. The median duration of all frauds at nonprofits is 16 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.

For additional guidance, see Best Practices for Whistleblower Reporting Systems.

Fulcrum Inquiry performs financial investigations and provides turn-key whistleblower collection services.

 

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