Franck Boston / Shutterstock.com

There are big themes in the Washington Post’s series on nonprofit “asset diversions” that merit attention and action, but they aren’t necessarily the ones you might think. The unfortunate result of much of the reporting done on the basis of this data is the general perception that nonprofits tend as a class toward bad managers or crooks or both. The reality is far more nuanced, and likely not dissimilar from that of the business sector. The truth is that there are many predators out there with a lot of new scams and tools who victimize the nonprofit sector as they do individuals.

In short, nonprofits should be bulking up their protections against in-house and out-of-house thieves and embezzlers, and they should be working with governmental authorities to take action against anyone and everyone who would purloin resources from tax-exempt organizations. But they must also take action against categories of miscreants and malefactors in ways that produce change; not just for nonprofits, but for standards of ethics and accountability in the U.S. economy.

There is a small set of actions that should be taken, and NPQ, having examined the many types of situations covered in the diversion data, would like to urge that the sector get behind them. Here’s how and why.

There is a big scandal in the nonprofit sector lurking among investment advisors and investment firms using nonprofit assets.

Nonprofits are under constant pressure to invest their assets as though they were wizards of the market. Finance committees expect nonprofit CEOs to know what they’re doing when dealing with legitimate (and, unfortunately, illegitimate) advisors and brokers. Even the largest nonprofits—universities and foundations—get scammed and ripped off in the market. Witness the successes of Bernie Madoff, father of the largest investment scam in U.S. history, and so many others. In the case of Madoff, some of his largest nonprofit clients seem to have had feeders on the inside bringing investors into Madoff’s web. Perhaps this was the case with Yeshiva University’s loss of $95 million, among other Jewish charities, but with others, it was often a matter of falling prey to a too-good investment lure or otherwise turning over the thought processes to a investment firm that seemed legitimate.

The perpetrators of these investment frauds were hardly all Bernie Madoffs. We previously noted others in the Post series who fell victim to the likes of Joel David Salinas and Brian Bork at the J. David Group, responsible for a loss of $2.2 million invested by the Houston Athletic Association, and Paul Greenwood at both WG Trading and Westridge Capital Management, who misused the investment funds of pension funds for retired 3M employees and the endowments of the University of Pittsburgh and Carnegie Mellon. (A regional office of the SEC actually frustrated and deterred investigations into Greenwood’s activities at Westridge.)

Washington Post Diversions Piece: What it Really Means

There were plenty of opportunities for catching on to Madoff, but not only were the regulators less than on the ball in his case, major institutions knew about Madoff but failed to reveal what they knew—other than when trying to protect their own interests. Madoff had maintained his business accounts with JPMorgan Chase for 22 years. According to a press summary of the trustee’s suit to recover funds lost in the fraud, “JPMorgan knew that Madoff was engaged in an investment advisory business for a broad array of customers, but the Madoff bank account that JPMorgan Chase oversaw never showed a payment going to clear or process a stock trade.”

The bank notified British authorities, not U.S. authorities, which summarizes the Madoff scheme to a tee. But knowing that Madoff’s investments were fraudulent, JPMorgan Chase tried to get back the $250 million it had invested with Madoff two months before Madoff’s collapse left investors, including nonprofits, defrauded and broke but able to check the diversions box on their 990s. As the Minneapolis Foundation and other Minnesota charities learned when they sued Wells Fargo for investing their funds in dubious financial instruments, and as all charities should now know with the information that JPMorgan Chase looked out only for its own investments in Bernie Madoff’s firm, the banking sector can’t be relied upon to self-police to protect the investments of nonprofits from investment malpractice.

The Securities and Exchange Commission has lately been one of the least effective regulatory agencies in the federal government. A more attentive, better-resourced SEC might have caught Madoff and other investment-fraud perpetrators like R. Allen Stanford and others; it should have. The relationships between SEC “investigators” and firms that merit prompt investigation and prosecution have been ridden with conflicts of interest. Whistleblowers in the SEC certainly haven’t done very well. Perhaps President Obama’s appointee at the SEC, Mary Jo White, will be able to turn the situation around regarding oversight of investment firms and advisors. Although White comes with a reasonably good reputation, the drumbeat in Congress is for loosening regulatory oversight over the investment industry, including in areas like crowdfunding, which some in the SEC have been concerned about, and the overall implementation of Dodd-Frank oversight and enforcement mechanisms. (Take, for example, Congress’s failure to appropriate funds at anything like the levels called for in the legislation, or the excruciatingly slow implementation of the “investor advisory committee” called for in Dodd-Frank.)

Consider the Washington Post diversion series to be an important step toward awakening the nonprofit sector about the abuses perpetrated by investment advisors. If nonprofits think they can sit on the sidelines as Congress and the White House, supported by Wall Street investment banks and commercial banks, push back on Sarbanes-Oxley and Dodd-Frank financial oversight, they are sadly mistaken.

There is a big need to distinguish between nonprofits that abuse the public’s trust, regardless of their purported mission and motives, and those whose trust is abused by the people they employ.

Like any other sector of the economy, nonprofits get ripped off by trusted insiders. To imagine otherwise, that the sector is somehow protected by the angel wings of nonprofit self-regulation, is delusional. In many of the instances reported by the Washington Post, the asset diversions were perpetrated by people for whom such acts would have been seen as inconceivable by the members of these organizations. One can imagine the near-disbelief that their trusted friends could have done anything like the pilfering, fraud, and embezzlement that were revealed. If you think that isn’t possible, think again. For those of us who have worked in organizations in which funds were embezzled, the culprit was often a longtime colleague: trusted, forthcoming—the last person one might have suspected but for the person’s knowledge of, and access to, the means to do the dirty deed.

At a minimum, what is heartening about many of the cases in the Washington Post database is that those nonprofits seem quite willing to turn the perpetrators of fraud over to the authorities for judicial action and even efforts of restitution. People who don’t do that have every possible excuse in the world for failing to act—the perpetrator was a longtime friend; he or she faced difficult circumstances; it was a bad time in their lives, and so forth. Most of these nonprofits checking the diversions box on their Form 990 weren’t willing to play that game. Good for them.

It’s long overdue, but the time for bulking up federal and state oversight of nonprofits is now.

When a nonprofit checks off the diversions box, what happens at the IRS Tax Exempt unit? What happens at the offices of state attorneys general? Or, within those offices, with charity oversight officials? With the latter, the answer is all too clear; most states’ charity oversight offices are so desperately underfunded it’s amazing that they even do what they do. Some states, unfortunately, do even less, for reasons that are inexplicable.

Shouldn’t the checking of a box that suggests the authorized diversion of nonprofit assets be a signal for the IRS and state agencies to leap into action? It should be one of the red flags that spur questions by state and federal oversight personnel. Had that been done, wouldn’t those nonprofits that mistakenly said they suffered diversions (and meant “disbursements,” or even nothing at all) have corrected their errors? Our experience is that in many instances, oversight of the nonprofit sector comes from the press, which then spurs governmental action—though in fairness that often applies to the corporate sector, too. Witness Enron, where it took front-page articles in the Wall Street Journal to spur SEC action. If the nonprofit regulatory bodies were funded as they should be, action would be quicker, simply because there would be the capacity to act.

With the IRS, the history of underfunding has been longstanding. For years, some nonprofit leadership organizations simply said, “enforce the laws on the books,” but were unwilling to explicitly call for the targeting of resources to the IRS’s exempt organizations unit. Some advocates—such as this author—over the past decade have called for dedicating the private foundation excise tax to nonprofit (and foundation) oversight and enforcement, which was the one of the original purposes of the resource in the first place. Over time, other nonprofit leaders slowly gravitated toward that position as well, but with such lethargy that Congress would have been hard-pressed to sense significant nonprofit sector enthusiasm for boosting the resources for IRS oversight. Now, in the wake of the implosion of the Exempt Organizations unit at the IRS, the task is doubly difficult. The unit is staggering from its 501(c)(4) oversight scandal and faces the additional task of implementing the nonprofit hospital part of the Affordable Care Act.

This is the time to revive the notion of dedicating the private foundation excise tax—a tax paid by nonprofit foundations, not by other taxpayers, estimated by the IRS to amount to more than $500 million annually—to rebuilding the capacity and competence of the IRS’s Exempt Organizations unit to make the government’s oversight of nonprofits more robust, and maybe find ways of devoting some of the money to state charity offices, too.

An overwhelming proportion of the nonprofits suffering unauthorized asset diversions were small, with revenues less than $1 million, or even less than $100,000. They need help.

They read like a list of local small businesses run by your neighbors and friends. They had no idea that the bookkeeper was clipping money, writing phony checks, making payments to fraudulent vendors, or dipping into the petty cash. For what was purported to be a list of somewhat-larger nonprofits that had suffered—or engaged in—asset diversions, the list is populated by a number of really tiny organizations. These are often the scandals that get reported in your local newspaper, if they get reported at all.

There are examples in the database—and outside it—that read like the small town stories of Theodore Dreiser, William Faulkner, or Sherwood Anderson. In Bethlehem, Pennsylvania, the husband of the former treasurer of the local Little League was caught taking $36,000, perhaps with his wife’s knowledge (she was read her Miranda rights), to support his drug habit. In Lyndhurst, New Jersey, a PTA president was arrested for stealing $10,000 from the organization. In Bartlett, Illinois, a member of the town’s Fourth of July committee has been charged with stealing $4,475 by using the group’s debit cards. These are all human tragedies of daily life, comparable to the kind of small nonprofit pilfering recounted in the Washington Post stories.

How small-town tragic? Take the case of the Bartlett Fourth of July committee. According to the newspaper report, the family of the alleged perpetrator “is well-regarded in Bartlett for its extensive community service…[His] father…who died in 2011, was a founder of the Bartlett Little League, past president of the Bartlett Lions Club, a longtime park board member and member of many village commissions and committees, including the 4th of July Committee. He was named Bartlett’s ‘Living Legend’ in 1999.” Nonetheless, according to the news reports, “the group immediately contacted Bartlett police when the theft was discovered in late September.”

That seems to be the standard for many of the reports in the Washington Post database and in the press: Unlike private businesses, which often look at pilferage and embezzlement as a cost of doing business better hushed up than revealed and prosecuted, these small nonprofits seem prepared to turn their in-house miscreants over to the authorities, sometimes with a sense of grievance that feels personal, as though they and their cause had been violated.

Let’s applaud those nonprofits that, cheated and aggrieved by friends and colleagues, took immediate action to bring the malefactors to justice—in contrast to those who might have shown a bit less alacrity in going after miscreants in their own organizations.

The focus on nonprofit embezzlement—a smaller challenge in the nonprofit sector than in business—misses the point about what should be rectified about the nonprofit sector: abuses and shortcomings that are all too legal.

In a way, some of this is galling. When the Washington Postused the American Legacy Foundation as an example of an organization that had suffered major embezzlement (an estimated $3-4 million loss) and then gave new definition to lethargy in its reporting of the asset diversion and going after (or not) the perpetrator, what struck many was that the president and CEO of the foundation, according to its latest Form 990 filing from 2012, received annual compensation of $561,903, plus compensation from related organizations of another $170,945. Unlike those who worked at the tiny nonprofits that took action within months or even weeks of finding out about theft and embezzlement, the other executives at the Legacy Foundation were also quite well paid: the executive VP at $430,133 plus $146,722; the general counsel and corporate secretary, $320,374 plus $102,044; the chief operating officer, $314,273 plus $102,774. That’s just to name a few, and all for 38-hour workweeks. One of the external board memberships of the foundation president and CEO is Phoenix House, a nationwide network of heroin and other addiction detoxification and treatment centers. This year, an audit by the state comptroller of New York, not an internal review by the board, revealed $223,000 in state funds misused by the New York network of Phoenix Houses for “perks for…bosses, including cars and improper bonuses.”

Certainly, the highly-paid staff members of the American Legacy Foundation believe that they earn every penny of their salaries, even though they admit that they didn’t handle the substantial asset diversion perpetrated by one of their colleagues very well. Defenders of high salaries in nonprofits will stand up for six- and even seven-figure salaries, and there’s nothing illegal about that kind of compensation, despite the feeling of some that it’s on the excessive side, and in some cases in the Washington Post asset diversions database, their high pay didn’t make them any more effective or assiduous in going after thieves and embezzlers than the much lower paid or even volunteer leaders of small nonprofits. While getting rid of crooks in our midst is necessary—if not for the money they’ve purloined, then simply for their chipping away at the credibility of the nonprofit sector—realize that the nonprofit sector, including the largest nonprofits, like foundations, universities, and hospitals, needs sharp scrutiny over what they do legally, because society can and should expect more and better from the nonprofit sector. The list is long—as it should be for any sector of our society.

For example:

What are private foundations actually delivering for their tax-exempt status? How are they using their tax-exempt assets—in addition to the five percent they make available as grants—to invest in socially responsible, mission-related activities?
While many foundations outfit themselves with more than sufficient offices and administrative staff, why are so many foundations so reluctant to provide nonprofits with the flexible operating support they need to develop the internal systems that would help them spot or ward off asset diversions like those identified in the Washington Post database?
Why are so many nonprofit hospitals acting like their for-profit counterparts when it comes to providing in-depth healthcare support to populations that are likely to lack health insurance now and unfortunately in the future?
Why are universities sitting on such large endowments, often spending less than even the five percent minimum mandated for private foundations, while charging ever-larger tuitions?
How is it that after every natural disaster, there are disappointing reports of the slow responses and sometimes no-responses of some disaster relief agencies, as revealed most recently in the lack of spending by several agencies in the wake of Superstorm Sandy?
Why is it that nonprofits and religious organizations that have harbored and protected long-suspected and sometimes widely known pedophiles in their midst—the currently jailed Jerry Sandusky comes to mind as one—don’t suffer strict consequences, such the loss of their charitable status, or more?

There are plenty of real challenges that can be laid at the doorstep of nonprofits to answer around the notion of what they are actually doing with their tax-exempt assets to fulfill the mandate of their 501(c) status. Where the nonprofit sector falls short of fulfilling its mandate of service to the nation, particularly to people in need, that is worth the kind of investigative scrutiny that the press rarely gets near.

There are subsectors of the nonprofit sector that are subject to more widespread fraud than others, and that needs to be addressed and solved.

Embedded in the database were a couple of examples of people who created and used their nonprofit entities as instruments for theft and deception. Some organizations claimed to support military veterans; others were involved in disaster relief where the intent of the founders and operators was little more than self-enrichment, trusting the American donor to respond without much scrutiny. Consider, too, the cancer charities associated with one Greg Anderson in The Woodlands, Texas, recently investigated by local press for raising millions, employing family members, and delivering precious little to the ostensible beneficiaries of the charity, women suffering from breast cancer. Or look at the people behind the Kids Wish Network, identified in a Center for Investigative Reporting/Tampa Bay Times story as the “worst charity” in the nation, and subsequently excoriated in a report on Anderson Cooper’s CNN show. Truly corrupt charities, as some believe these to be, don’t check the asset diversion box on their 990s because they would be self-reporting on the founders and CEO.

The problem of trying to make hard and fast generalizations about 1.484 million 501(c) tax-exempt organizations regarding fraud and embezzlement is that the nonprofit sector is quite diverse. In the Washington Post database are 501(c)(3)s that range from Columbia University, with $4.7 billion in revenues in 2011, to the Community Coalition on Family Violence, a Knoxville-based (c)(3) with 2011 revenues of $8,063. Frequently, difference of size in the nonprofit sector is difference of kind, but there are other differences among the groups in the diversions database that should provide clues as to swaths of nonprofits that seem to be particularly attractive to embezzlers and thieves. Our guess is that, too often, some of these subgroups escape the attention of regulators—and perhaps journalists, too—because of the tendency to lump all tax exempts under the nomenclature of “nonprofit” and the public’s instinctive translation of “nonprofit” as charity, or 501(c)(3) public charity. The Washington Post database had much more than 501(c)(3) charities listed; some of these other categories, as well as specific types of public charities, warranted deeper looks.

501(c)(7) social and recreational clubs: Who even thinks of 501(c)(7)s as a special category of tax-exempt entities? Accounting for only 3.8 percent of 501(c) entities overall, there were several 501(c)(7)s in the database: reasonably large country clubs and private clubs, plus smaller community-oriented groups such as the Princeton Ski Club, the Fu Qi American Association, the Harrisburg Bridge Club, and the Pequea Valley Sportsman Association. With the latter, one wonders whether they were really reporting “significant” diversions. The Sportsman Association, a hunting and fishing club, cited as the diversion its purchase of land and its use of a bank loan as a down payment, which seems to be a misinterpretation of what the IRS form intended to uncover. A couple of the (c)(7) 990s were filled out in pen and ink. Nonetheless, even the (c)(7)s seemed quick to terminate thieves in their midst and refer them to the authorities for criminal action, including the Boeing Employees Tennis Club, which filed charges against its bookkeeper as soon as its leadership discovered the diversion of assets, and the Omega Psi Phi Fraternity, which says it filed multiple police reports after discovering an officer’s misappropriation of cash from the fraternity’s bank accounts.

501(c)(19) veterans’ organizations: There were 31 posts or organizations of war veterans in the Washington Post database, as well as five additional organizations that sounded quite close to being a veterans’ organization. The implication from this overrepresentation of veterans groups in the database is that veterans’ organizations—or veterans and donors to veterans—are a reasonably frequent stop for people motivated to find ways of stealing from nonprofits. Although there are almost 41,500 nonprofits listed by their NTEE classification as veterans’ organizations, the number of these groups filling 990s is much smaller—only about 10,000, according to the Urban Institute’s National Center for Charitable Statistics. There have been repeated stories and occasional congressional feints toward investigative hearings about people who have used veterans’ groups as instruments for theft and self-enrichment, but the focus has tended to be narrow and aiming at particularly odious individuals, like the repeated inquiries into Roger Chapin of Help Hospitalized Veterans, spanning from 2008 to this past year, and Bobby Thompson, the mysterious guy claiming to be a CIA agent, but sitting in jail awaiting trial for his alleged abuse and misuse of the U.S. Navy Association.

While Chapin or Thompson (lately, “Mr. X”) may be good headline fodder for a hearing here or there, a much more serious and widespread problem is the creation of veterans’ charities, by people of good will or ill, that deliver next to nothing to the millions of returning Iraq and Afghanistan veterans. Because the intended beneficiaries are veterans, donors give generously even if the 41,000 or more veterans’ organizations do little or nothing of substance for members of the military returning from overseas deployments. It may be an issue for congressional investigation—a real issue to look into, as opposed to the partisan political nonsense that occupies many congressional committees—as well as the responsibility not just of the IRS, but also for the Department of Veterans’ Affairs or even the Joint Chiefs of Staff. If predators, and perhaps some well-meaning people, too, are generating a cacophony of problems for donors trying to help returning veterans, the solution requires something more systematic than either focusing on the likes of Mr. X or assuming that there is a big “fix” for the entire nonprofit sector that will help veterans’ organizations and all others in one fell swoop.

Beneficiary associations: There are at least three kinds of 501(c) entities—(c)(9), (c)(10), and (c)(12)—that provide life, healthcare, or accident insurance (among other services). A 501(c)(12) in the list is the High Line Canal Company, which provides irrigation water to shareholders in Colorado. They suffered a diversion of assets attributed to a secretary of the company, filed civil charges against the person, and noted in its 990 that criminal charges were being investigated. Another (c)(12), the Great Lakes Energy Cooperative, caught a supervisor colluding with an outside vendor to submit fraudulent invoices for tree-trimming services along its 13,000 miles of electricity distribution lines. The cooperative conducted an internal investigation, then cooperated with the Michigan state police in a criminal investigation, got both the employee and the contractor successfully prosecuted, and then retrained all staff in “fraud awareness.” Among the 501(c)(9)s on the list are the IBEW Local 1249 Insurance Fund, the Upstate Union Health and Welfare Fund, and the Plumbers & Steamfitters Local 267 Insurance Fund—all in the Syracuse, New York area, and all of which lost money they had invested with Bernie Madoff.

At least two dozen of the groups in the list were beneficiary or insurance associations of some sort, but another two dozen were 501(c)(8) fraternal associations of Shriners, Masons, Elks, Odd Fellows, Eagles, and Moose. These, too, provide benefits of various sorts to their members. Insular in their operations and focused on a limited number of predetermined beneficiaries, these organizations in many ways operate on the fringe of the nonprofit sector, little engaged in broader nonprofit activities and sometimes removed from both the best practices of the sector and the attention of state and federal regulators. Add to that the news that these fraternal associations have been declining in membership for some years now as younger people show much less interest than their parents and grandparents in joining Eagles’ aeries and Masonic lodges. The result is that these unusual tax exempt entities may need a different kind of oversight and different kind of support.

It makes a great deal of sense to dig into subgroups of nonprofits to explore specific kinds of vulnerabilities and tailored responses. No one should imagine that ferreting out perpetrators of fraud and thievery is a snap. But it will take a robust commitment on the part of oversight agencies—not just the state AGs and the IRS, but other agencies (for example, the VA concerning veterans organizations)—and a commitment from nonprofit associations and leadership groups to call out miscreants for investigation and prosecution. Inside and outside of nonprofits, the time for omerta has passed—even if the calls for silence come from well-meaning but wrong-headed accountants and fundraisers who think that suppressing bad news is smart business strategy.

Nonprofit leadership has to step up to the plate, not with talking points or references to self-regulatory best practices, but with action in concert with state attorneys general to strengthen the nonprofit sector against predatory actors engaged in fraud and embezzlement.

A decade ago, Senator Charles Grassley held hearings on charitable accountability, focused on larger institutions whose policies had allowed for behaviors that, while not necessarily illegal, were not in the public interest. Some nonprofit leadership groups of that era lunged for seats at the Senate Finance Committee table in an all-but-transparent attempt to ward off new regulatory oversight. Their position was that the abuses of groups like the Nature Conservancy, the Red Cross, Type III Supporting Organizations, and some donor-advised fund managers would have been solved had the laws on the books simply been enforced. Of course, that wasn’t true, as the abuses were often legal, outside of the coverage of existing statutes, and the oversight agencies’ abilities to even jawbone nonprofits for changes were limited by minuscule appropriations. New laws and regulations were needed, a few changes in DAFs and supporting organizations were eventually enacted, and more were probably needed then and now.

In the Washington Post database, one of the organizations citing an asset diversion was a state nonprofit association. The Pennsylvania Association of Nonprofit Organizations didn’t suffer from a fraudulent director or accountant who might have scarfed up hundreds of thousands. Rather, its payroll serving firm failed to turn over its tax payments to the IRS, and subsequently the firm went bankrupt. Upon learning of the payroll firm’s default, PANO repaid the tax funds at a cost to the organization of $8,100.

Other state nonprofit associations, such as Oregon’s and Utah’s have posted brief comments about the Washington Post series that criticize the newspaper’s sensational language in describing the nonprofit versions and offer talking points for nonprofits on the issue, but the next step is for the state associations to do exactly what we’ve done here—pull apart the database, identify the nonprofits in their states on the list, figure out what kinds of patterns exist in their states, and join with state AGs and charity officers to work on state-specific strategies to track and counter fraud and embezzlement within the nonprofit sector.