Combatting Grant Fraud in Not-for-Profits

A recent study indicated that of reported frauds nearly 20% occurred at governmental and not-for-profit entities (“NFPs”).^[1] Although NFPs report relatively modest fraud-related losses in whole dollars, incidents of fraud can be devastating to organizations that have limited resources (e.g., certain religious, charitable and social-services agencies). For these NFPs, precious resources are wasted and public confidence may erode. But if grant funds are fraudulently diverted, critical sources of periodic funding may evaporate, damaging or endangering the organization’s ability to accomplish its mission.  

NFPs characteristically rely on funding from charitable organizations, private donors and/or the government in the form of grants, which are usually intended for a particular purpose and specific time period as delineated in a grant agreement. Grant agreements often require that such funds be spent for an intended purpose, within a certain timeframe and be supported by appropriate documentation—or else be subject to return to the benefactor. Grant agreements may also stipulate recordkeeping and budgeting requirements and/or limit the extent to which the monies are available for administrative and overhead purposes in order to ensure that funds are expended for intended programs; general fundraising usually is not an acceptable use. As such, NFPs must maintain detailed records and diligently track and support any spending allocations.

The U.S. Department of Justice’s Office of the Inspector General (“OIG”) warns that the consequences of grant fraud when the benefactor is a federal entity can include “debarment from receiving future funding, administrative recoveries of funds, civil lawsuits and criminal prosecution.” Government-granted funds generally are awarded for a specific public purpose, often including an explicit provision for the locality of use, intended demographic to be served, or even months in which they must be spent. Beneficiaries are expected to use the funds as agreed to prevent fraud, waste and misuse. The grantor agency typically attaches an audit and/or monitoring clause to assess both the grantee’s compliance with such mandates and the performance of the relevant program before renewing or extending a grant.

The OIG’s Grant Fraud Awareness^[2] discusses that during “the fog of fraud” fraud, waste and misuse are rarely black and white, requiring that the evaluator follow-up on such concerns to understand what is really happening. The whitepaper also establishes common grant fraud risks including conflict of interest, lying, failing to properly support, and theft. The Internal Revenue Service’s (“IRS”) concerns regarding these issues are reflected in the NFP annual information return, Form 990, which requires that the organization, among other things, certify whether it has written conflict of interest, whistleblower, and document retention and destruction policies in place.^[3]  Specifically regarding conflicts of interest, the IRS describes such policies as “recommended” as a “strategy [to] encourage … a means to establish procedures that will offer protection against charges of impropriety …” and warns that NFPs “will lose their tax-exempt status unless they operate in a manner consistent with their charitable purposes.”^[4]

NFPs live and die by their reputations and, as such, must be free of conflict of interest in both fact and appearance. As such, NFP boards should, among other things:^[5]

• Discuss conflicts of interest at every meeting.
• Review and oversee hiring and termination decisions by management and document any steps to evaluate the reasonableness of compensation paid (including benefits).
• Develop, post and enforce hiring and termination policies.
• Require that each member and director sign a conflict-of-interest policy and prohibit them from voting on matters where conflict may exist.
• Mandate that only conflict-free personnel can execute contracts and agreements.
• Evaluate shared service agreements with other entities in order to verify that such agreements are between unrelated parties and based on market rates.

Failing to properly support the use of grant funds is an additional area of risk. Not only must NFPs maintain receipts and payroll ledgers, time logs with job descriptions and contemporaneous itemized expenditure explanations are necessary to support charges against program budgets. To the extent possible, such expenses should be budgeted and board approved in advance. Further, such budgets should be reviewed against actual performance on a regular basis and verified by an independent party to benchmark performance results.

In some cases, grants are matching funds to other funding sources. In these circumstances, the NFP must maintain sufficient documentation to demonstrate that that the original matched monies were, in fact, received. If they were based on in-kind goods and services, they should have been recorded at appropriate market rates and documented in real time.

Theft, another issue that should be of great concern to NFPs, is best addressed by maintaining well-designed and sufficiently tested systems of internal controls that prevent and detect anomalies. These should include, without limitation, segregation of the duties of authorization, custody and accounting/reporting. As part of an effective control environment, the NFP should monitor access to credit cards, debit cards and gift cards; require two authorization signatures for checks; and include images of cancelled checks in the monthly reporting package prepared for the board.

NFPs with substantial operations may want to consider establishing anonymous tip lines. Federal whistleblower protection laws provide legal remedies for employees or job applicants who face retaliation for making protected disclosures of fraud, waste, abuse and mismanagement. Whistleblowers who report federal or state grant fraud may be entitled to rewards under the False Claims Act.

Given areas of significant exposure, such as those discussed herein, it is essential that NFP boards and management know their responsibilities; practice accurate and complete recordkeeping; establish solid prevention, detection and remediation practices; operate with priority on the organization’s mission; and hold all interested parties responsible for their duties and roles.

[1] Association of Certified Fraud Examiners’ 2018 Report to the Nations.

[2] See https://oig.justice.gov/hotline/docs/GrantFraudHandout.pdf.

[3] See IRS 2018 Form 990. Part VI, Section B, items 12a, 13, and 14.

[4] See IRS Form 1023.

[5] See, e,g, https://docplayer.net/4477518-Governance-and-related-topics-501-c-3-organizations.html.

FRAUD WEEK

ARTICLES

• The Why, How and When of Fraud Detection
• A Roadmap for Preventing Expense Reimbursement Fraud
• Combatting Grant Fraud in Not-for-Profits
• To Trust or Not to Trust the Trustee?
• When You’re in the Eye of the Shareholder Dispute Storm
• Breaking Up Is Hard to Do: Business Valuation in Owner Disputes

BLOGS

• National Fraud Week Focus on Occupational Fraud
• National Fraud Week Focus on Vendor Fraud
• National Fraud Week Focus on Payroll Fraud