Charity Fraud: To Give or Not to Give

Philanthropists and charities should protect themselves against fraud schemes to ensure that donated money is truly benefiting good causes. Fraudsters don't discriminate, which places the most trusted nonprofits at risk. The most benign-sounding organization could be funding a white-collar criminal's summer home - or even terrorism. Here's information that all fraud examiners need. 

 

Similar to the legitimate Make-A-Wish Foundation, Kidwish USA claimed to grant last wishes for terminally ill children by collecting money from philanthropic donors. However, Kidwish was a fraud. The phony organization used photos of children from the brochures of genuine charities for their own advertisements to wring millions of dollars out of unsuspecting donors and didn't grant a single child's wish. Michael Manzer and Richard Carbonaro, who with their cohorts organized the sham charity in New York and other states, both were convicted of mail fraud and money laundering charges and sentenced to prison for two years and fined $5,000 each. Kidwish USA is one of the few questionable charities to result in criminal charges, prosecutors said.1 

 

There's no prototypical fraudster - no common physical features or economic status. Anyone can fit the profile and those who work for charities, donate to them, and run these humanitarian organizations are no exception. Most victims are shocked to find out that the individual who committed the fraud is someone like them - someone they trusted and never suspected. Case in point: Jacquelyn Allen-MacGregor, former vice president of finance for the United Way, an employee of 20 years who was caught stealing $2 million from the organization by writing checks to herself and forging officers' names. Investigators found that she was using the money to purchase expensive quarter horses. In June 2003, the court sentenced Allen-MacGregor to four years in prison and ordered her to pay $2.08 million in restitution.2 

 

Fraudsters tend to label their fictitious charities using sympathy-rousing words such as Christian, children, homeless, and hunger. Senior citizens are often the prime prey because of their propensity for compassion and naiveté about these types of schemes. Con artists advertise their charities in a variety of places, and even solicit donations by going door to door, particularly in neighborhoods populated by the elderly. An afternoon of these fraudulent face-to-face solicitations can bring in up to several thousands of tax-free dollars. 

  

A recent study that used the results of the ACFE Report to the Nation estimated that losses in the nonprofit area might be close to $40 billion a year.3 The downturn in the economy over the past several years has deprived organizations of the resources to protect themselves from schemes, which is causing an increase in nonprofit fraud.4 Charity fraud seems to run rampant because charities are afraid to report the fraud. Some fear that reporting fraud will negatively affect the number of charitable contributions to their organizations. Most nonprofit organizations either prosecute at the local level or choose not to prosecute at all, leaving any dishonest, terminated employees free to exploit another organization. 

 

THE FRAUD TRIANGLE 

Individuals commit fraud for a variety of reasons. Three key elements compose the three sides of the renowned Fraud Triangle: a perceived pressure, a perceived opportunity, and rationalization. Perceived pressures might include living beyond one's means, debt, unexpected expenses, vices (gambling, drugs, alcohol), costly extramarital affairs, financial pressure from a spouse, occupational pressure, or dissatisfaction with one's job or employer. In some cases, perpetrators simply seek the thrill of beating the system. Perceived opportunity is the individual's belief that he or she can conceal the theft. Rationalization is a self-satisfying reasoning and justification for committing the fraud. Charities that understand the Fraud Triangle can focus on individuals for whom the three elements appear to be present and attempt to intervene before it is too late - a task easier said than done. 

 

FRAUD PREVENTION 

For humanitarian organizations, the consequences of fraud are severe, ranging from a cash flow crunch and loss of donor confidence to compromising the very existence of the charity. Given the seriousness and increased number of nonprofit frauds, it's essential that donors, and those involved and employed at charitable organizations, are aware of the importance of prevention. Copious resources are available to anyone interested in enhancing their knowledge of indicators of fraudulent activity. Being proactive won't completely eradicate deceit within these organizations, but deterrence measures can certainly reduce the number of offenses. 

 

Nonprofit organizations are typically focused on their causes and generally don't spend the necessary money to protect their financial infrastructure. Although there are a number of approaches to prevention, the difficulty and cost of implementation vary. Simply segregating duties, which is fairly inexpensive, can deter fraud. In their article, "CPAs' Role in Fighting Fraud in Nonprofit Organizations," (The CPA Journal, January 2006) Andi McNeal and Jeffrey Michaelman state, "In many cases, small nonprofits that have suffered at the hands of fraudsters would have uncovered previous financial transgressions or possible fraudulent motivations simply by conducting thorough background and reference checks on the perpetrators prior to hiring them." Larger organizations that handle greater amounts in contributions should also update their accounting systems, hire outside firms to reconcile accounts or to review financial records for indicators of fraud, and obtain crime insurance coverage. 

 

McNeal and Michaelman say organizations can address the opportunity component of the Fraud Triangle and thus reduce the likelihood of fraudulent activity by establishing adequate internal controls. Charities can never be too cautious when it comes to implementing measures of prevention. Although these require upfront costs such expenses are minimal compared to the financial risk of fraud, which is increasing at an alarming rate. 

 

In addition to the risk of fiscal loss, fraud can also damage the reputations and support bases of individual charities and of the sector as a whole. Once benefactors become aware that fraud has occurred within an organization to which they contribute, they might be hesitant to make later donations. In fact, charity officials say that they are far more concerned about how donors will react than they are about the threat of short-term money loss.5 The Federal Trade Commission (2003) provides a charity checklist that might be useful when donating to a charitable organization. Given the rise in the frequency of charity fraud, it pays to be vigilant when making contributions. 

 

A BRIEF HISTORY OF MAJOR CHARITY FRAUDS 

In the face of adversity, Americans rise to the occasion and provide support to those in need. When two airplanes crashed into the World Trade Center buildings in 2001, Americans contributed countless hours to help clean up the crash site in addition to contributing money for the families of all the victims of that terrible day. Americans again came to the rescue when a tsunami destroyed much of Thailand, donating supplies, money, and volunteer time. In 2005, hurricanes Katrina and Rita ravaged Louisiana and Mississippi, killing many and devastating New Orleans. Americans contributed billions of dollars to aid in the cleanup and provide victims with shelter and other necessities. Unfortunately, some people make their living by exploiting the generosity that comes with crises. 

 

The American Red Cross is a nonprofit organization with a mission to "provide relief to victims of disasters and help people prevent, prepare for, and respond to emergencies." After Katrina, the American Red Cross was on the scene almost immediately to provide food, money, and other supplies to victims. Unfortunately, the Red Cross was not the only organization that acted so quickly. Fraudsters began sending out charity relief scam e-mails within hours of the hurricane. Then-Attorney General Alberto Gonzales created a task force on Sept. 8, 2005 to coordinate and expedite investigations of Katrina fraud. By mid-December, the FBI estimated that 60 percent of the 4,000 Web sites claiming to offer help to Katrina victims were fraudulent.6 

 

Some fraudulent activity in the Red Cross involved its own employees. In December of 2005, approximately $400,000 was stolen from the organization. Forty-nine people were indicted for using their positions at the Red Cross call centers to steal money. They were accused of having friends and family members call in with false claims and furnishing them with pin numbers needed to collect money from the Red Cross.7 

 

The American Red Cross has taken steps to ensure that people who truly need help receive it. They are aware that bogus Red Cross Web sites exist and have established formal agreements with Web sites collecting donations that ensure that the funds be used for their intended purposes. Under Section 706 of Title 18 of the U.S. Code, "Whoever wears or displays the sign of the Red Cross or any insignia colored in imitation thereof for the fraudulent purpose of inducing the belief that he is a member or an agent for the American National Red Cross shall be fined or imprisoned." The Red Cross is working with authorities to indict and convict those committing fraud against the organization.8 In addition, when the Red Cross is defrauded, it seeks full restitution and requests that authorities prosecute to the full extent of the law. The organization participates in the Department of Justice's Hurricane Katrina Fraud Task Force.9 The Katrina Task Force has prosecuted numerous perpetrators and these prosecutions have led to ineligible recipients returning $18.2 million to the Federal Emergency Management Agency and the Red Cross.10 The Red Cross' 2007 Hurricane Task Force reported that the organization has resolved more than 9,300 allegations with more than $2.5 million in returned funds. 

 

The United Way is another organization created to help those in need, with a mission "to improve lives by mobilizing the caring power of communities." It's difficult to achieve this mission, however, when top executives in trusted positions use contributions for their personal benefit. On March 4, 2004, Oral Suer (former chief executive of 27 years for the United Way of the National Capital Area) pleaded guilty to defrauding the organization of nearly $500,000 by using organization funds to pay for personal expenses such as bowling equipment and trips to Las Vegas. He paid himself more than $300,000 for leave he had taken and took $94,000 more than his share from the United Way pension plan. 

 

Since this scandal was discovered in 2002, the United Way in the national capital area has shrunk dramatically. In that same year, the organization was only able to raise $19 million versus the $90 million it raised the year prior to the scandal. Because of this fraud, the organization laid off more than half of its workforce, closed offices, and surrendered contracts for fundraising. Officials believe that Suer stole more than the $500,000 he admitted to, according to audit findings, which show that he might have taken $1.6 million or more.11 Not only did this top executive cost the United Way the amount of money he stole, he also caused potential benefactors to lose faith in the organization as a whole. It might take years for this United Way chapter to win back its benefactors and millions of dollars in contributions. In November 2007, The Washington Post reported that the national capital area United Way collected $35.8 million in the previous fiscal year - a 1.7 percent increase from 2005 when it recorded its lowest total in at least a decade. 

 

FUNDING TERRORISTS THROUGH FRAUDULENT CHARITIES 

Some charitable organizations actually use donations to fund terrorism. In his testimony before a U.S. Senate Committee, Secretary O’Neill said, "few actions are more reprehensible than diverting money intended for charity and using it to support hatred and cruelty. Such abuse corrupts the sanctity of charitable giving, diverts funds and resources from those in need, betrays the trust and goodwill of donors, and is a danger to us all."12 

 

Terrorism is not a new or recent concept. It has existed for almost as long as civilization. One definition is "the systematic use of terror as a means of intimidation and coercion." Terrorism has become an expensive endeavor. Al Qaeda was said to spend approximately $30 million per year to sustain itself in the period prior to Sept. 11, 2001. It's even less clear what al Qaeda needs or expends today.13 Charities are an attractive target for terrorist organizations because many countries are reluctant to scrutinize rigorously their activities. 

 

With limited information, authorities are forced to discern between legitimate charity organizations and those that deliberately support terrorist groups. Often, the latter groups raise funds from both individuals purposely seeking to fund terrorism as well as from innocent contributors. Diverting money through charities to terrorist organizations differs fundamentally from that of, say, money laundering. While money laundering is concerned with converting assets of illegal origin and bringing them back into legal economic circulation, charity-based financing of terrorism is concerned with using legal assets for an illegal activity. 

 

In an effort to combat the flow of charitable funds to terrorist organizations, the U.S. government has enacted legislation. First released in November 2002, and revised in December 2005, the U.S. Department of the Treasury's "Anti-Terrorist Financing Guidelines: Voluntary Best Practices for U.S.-based Charities" is designed to assist charities that attempt to protect themselves from terrorist abuse. The guidelines address such areas as fundamental principles of good charitable practice, governance accountability and transparency, financial accountability and transparency, and programmatic verification. 

 

Additionally, The Office of Personnel Management (OPM) issued rules that require charities and nonprofits to screen all employees and others for any connections to terrorist organizations. The OPM oversees the Combined Federal Campaign (CFC), which since 1961 has allowed approved charitable organizations to solicit contributions from U.S. federal government employees. The CFC raised $271.6 million from federal workers and military personnel during 2006. More than 2,000 charities have applied to participate. However, the new screening rules aren't without controversy. A coalition of 12 nonprofits, including the American Civil Liberties Union, the Sierra Club, and Amnesty International USA, announced an effort to try to force the OPM to rescind the requirement. In protest, the ACLU quit the campaign. (In 2005, the coalition successfully challenged in court the government requirement that charities check employees and expenditures against government watch lists before accepting donations from federal personnel in the CFC.) 

 

"We are certainly against terrorism," said Chip Pitts, board chairman of Amnesty International USA, which received about $350,000 through 2003's CFC campaign. "The problem with these lists [of charitable organizations] is that they are notoriously riddled with errors [and] they are subjective."14 

 

During 2004, however, the $2 billion Charles Steward Mott Foundation began requiring the organizations it funds to certify that they don't engage in "terrorist activity." The $10 billion Ford Foundation checks the names of its 4,000 grantees against the government lists daily. Ford spokesperson Alex Wilde said the group is legally bound under the USA PATRIOT Act to check whether its grantees are on the government list of terrorists. "Beyond that," he added, "it's just the right thing to do."15 

 

In July 1996, at the Paris Ministerial Meeting on Terrorism, the G7/G8 nations agreed to adopt domestic measures to prevent terrorist financing through front organizations that have, or claim to have, charitable goals.16 At an extraordinary Plenary on the Financing of Terrorism held in Washington, D.C. in October 2001, the Financial Action Task Force (FATF) expanded its mission beyond money laundering to focus its energy on disrupting and preventing terrorist financing. A specific recommendation of the FATF requires countries "to review the adequacy of laws and regulations to prevent nonprofit organizations from being used to finance terrorism."17 

 

The U.S. Department of Treasury established Operation Green Quest in October 2001 to identify, disrupt, and dismantle terrorist financing networks by bringing together the financial expertise from the Treasury and other branches of the government. Green Quest's work, in cooperation with the Department of Justice, has led to 38 arrests, 26 indictments, and the seizure of approximately $6.8 million domestically and more than $16 million in outbound currency. 

 

U.S. Customs, U.S. Secret Service, and the Federal Bureau of Investigation are carrying out other operations. Based on the FBI's preliminary work, the Holy Land Foundation for Relief and Development, the largest U.S. Islamic charity, has been designated as a terrorist support organization because it was being used as a charitable front to raise and funnel money to Hamas.18 Examples of fraudulent charities and terrorist organizations include the Afghan Support Committee (ASC) and the Revival of Islamic Heritage Society (RIHS). The ASC falsely asserted that the funds collected were destined for widows and orphans. Instead, it turned these funds over to al Qaeda operatives. In fact, the ASC's financial chief served as the head of organized fundraising for Osama bin Laden. Terrorist financiers subverted the charitable intentions of RIHS. The Pakistan office of RIHS would defraud donors by padding the numbers of orphans it cared for by providing names of non-existent or dead orphans. Instead, the RIHS diverted donations to al Qaeda terrorists.19 

 

DUE DILIGENCE AND ACCOUNTABILITY 

Charities will always be a prime target for fraudsters. There's no single correct approach to ensuring transparency and oversight of charitable organizations. The final responsibility for investigating legitimacy rests with the donors, who should confirm that the charities they support engage in appropriate due diligence, notably those operating in high-risk areas. It's important that individuals don't let their compassion override their common sense when choosing to contribute to a charitable organization. 

 

Those working within charities can do the following to guard against fraud and misuse of assets: 

• Board members should be continuously trained in financial controls and systems plus potential areas where fraud might exist. 
• Introduce procedures and processes that protect assets, limit liabilities, and curtail abuse of personal expenditures. 
• Integrate the financial department into the entire organization. 
• Segregate duties among financial and executive personnel. 
• Develop an accounting manual. 
• Use properly trained audit committees. 
• Accountability is the key and charities can benefit from the experience and knowledge of practicing accountants. Here are some basic tips: 
• Budgets should be adopted in advance and overseen by the board. 
• The board should appoint one person as the financial/accounting officer who is ultimately responsible for the daily controls over the money. 
• An independent CPA firm should review the finances and issue yearly financial statements if total gross income of the charity exceeds $250,000 annually. 
• All funds received and disbursed should be reported according to GAAP and the IRS requirements. 
• All disbursements should be made by either check or wire transfer, never cash.  

Precautions When Making a Donation 

• Be wary of appeals that tug at your heartstrings especially pleas involving patriotism and current events. 
• Ask for the name of the charity if the telemarketer doesn't provide it promptly. 
• Ask what percentage of the donation is used to support the cause described in the solicitation and what percentage is used for administrative costs. 
• Call the charity to find out if it's aware of the solicitation and has authorized the use of its name. 
• Don't provide any credit card or bank account information until you've reviewed all information from the charity and made the decision to donate. 
• Ask for a receipt showing the amount of the contribution and stating that it's tax deductible. 
• Understand that contributions made to a "tax-exempt" organization aren't necessarily tax deductible. 
• If the telemarketer claims that the charity will support local organizations, call the local groups to verify. 
• Avoid cash gifts. They can be lost or stolen. For security and tax record purposes, it's best to pay by checks made payable to the beneficiary, not the solicitor. 

[Some source links may no longer be available. —Ed.]

Hurricane Katrina Scams: http://scambusters.org/hurricanekatrinascams.html  

 

 

1 - "In Giving to Charity, Let the Donor Beware." ABC News online. July 18, 2003. http://abcnews.go.com/Primetime/story?id=131956  

 

2 - James Prichard. "Horse-Crazy Embezzler Took $2M." CBS News online. June 17, 2003. www.cbsnews.com/stories/2003/06/17/national/main558960.shtml  

 

3 - J. Greenlee, M. Fischer, T. Gordon, & T. Keating. 2007. "An investigation of Fraud in Nonprofit Organizations: Occurrences and Deterrents." Nonprofit and Voluntary Sector Quarterly. 36: 676-694. www.hks.harvard.edu/hauser/people/researchers_staff/ekeating_fraud.pdf  

 

4 - Brad Wolverton, Brad. "Fighting Charity Fraud." The Chronicle of Philanthropy. Aug. 7, 2003. http://philanthropy.com/free/articles/v15/i20/20002901.htm  

 

5 - Ibid.  

 

6 - Hurricane Katrina Scams. http://scambusters.org/hurricanekatrinascams.html  

 

7 - T. Costello. 2005. "49 Indicted in Red Cross Scam." www.msnbc.msn.com/id/10619317/  

 

8 - News Release: "American Red Cross National Headquarters Statement on Internet Fraud." American Red Cross Web site. www.redcross.org/press/mediarel/me_pr/010913fraud.html  

 

9 - L. Simmons. Oct. 17, 2005. "Red Cross Combats Fraud with Federal Partners." www.redcrossnorthland.org/placed/story/10-072005Oct6.html  

 

10 - T. Frieden. "Task force flooded with Katrina fraud." http://cnn.usnews. Sept. 13, 2006  

 

11 - J. Salmon. March 4, 2004. "Area United Way's Ex-Chief Admits $500,000 Fraud." www.washingtonpost.com  

 

12 - "U.S., Allies Work to Stop Terrorist Abuse of Charities." 2006. Hearing before the Senate Committee on Banking, Housing, & Urban Affairs. Subcommittee of International Trade & Finance. Testimony of Kenneth W. Dam, Deputy Secretary, Department of the Treasury. The U.S. Embassy Web site. http://usembassy-australia.state.gov/hyper/2002/0801/epf410.htm  

 

13 - R. Looney. March, 2006. "The Mirage of Terrorist Financing: The Case of Islamic Charities." Strategic Insights. 5(3). www.ccc.nps.navy.mil/si/2006/Mar/looneyMar06.asp  

 

14 - J. L. Salmon. Aug. 12, 2004. "Charities to Contest U.S. Terrorism Screening Requirement." www.washingtonpost.com/ac2/wp-dyn/A613272004Aug12  

 

15 Ibid.  

 

16 "Charities in the International Context." The Canada Revenue Agency Web site www.cra-arc.gc.ca/tax/charities/international-e.html  

 

17 Ibid.  

 

18 "U.S., Allies Work to Stop Terrorist Abuse of Charities." 2006. Hearing before the Senate Committee on Banking, Housing, & Urban Affairs. Subcommittee of International Trade & Finance. Testimony of Kenneth W. Dam, Deputy Secretary, Department of the Treasury. The U.S. Embassy Web site. http://usembassy-australia.state.gov/hyper/2002/0801/epf410.htm  

 

19 Ibid.   

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