How I Cooked the Books and Why

A part of me cringed as I followed the Enron revelations last year. High-level executives fabricating reports. Financial statements that read like fiction. Highly motivated young staffers scrambling to cover obvious fallacies to impress gullible auditors and evaluators. What could lead well-educated and well-paid executives to such perfidy?

I know only too well.

Before I became a highly paid consultant, I worked for a nonprofit. In Houston, Texas, home of Enron. I’m not proud of what I did there, but to tell the truth, I’m not ashamed either. I did what I had to do.

I was relatively young and idealistic back then. I’d worked in other nonprofits, but never at one with furniture that matched as well as this one’s, where all the computers worked and the paychecks didn’t surprise the bank. These people had it figured out.

“But how does it really work?” I wondered, as I reported to the office the first day after the agency’s board picked me from 99 applicants to run the joint.

Managing a social service agency in Houston is no picnic, let me tell you, but I thought my 15 years’ experience in the nonprofit sector had prepared me for anything. And indeed the job seemed easy at first–just file some reports with funders, chat with the board, balance a mix of government contracts, foundation grants and participant fees.
Then I met my grant and contract managers. That’s when I learned why people called this place the living hell.

That was so many sleepless nights ago that it seems like a dream. As any executive director can tell you, this job is not for anyone who can’t take night sweats and 3 a.m. spreadsheet reviews.

So how did things get so bad?

The organization, Advancing Greater Equality: The Nonprofit Corporation for Youth  (AGENCY), had 37 sources of funding, each with a distinct goal, reporting protocol and outcome measurement methodology. Each year the proportions of the 37 changed slightly and the evaluation and performance expectations changed completely. If a program had two objectives in year one, it had five in year two. If we had to serve 70 clients with $72,000 in one year, when year two came it was strongly suggested that 120 clients would be best, though funding would drop by 3 percent.

Our staff was incredible, and connected with the community in a big way. We could tell by referrals and by our growing number of clients that AGENCY’s reputation in the community was very strong.

I understood that state government agencies were under pressure to boost “productivity” and cut expenses. They dropped friendly but persistent reminders–increase the numbers or kiss your grant goodbye. We heard the same message from our federal grant–live or die by the numbers. (I complained to some of my colleagues in the Executive Director Support Group about the pressure we were under. The response? “Oh, please! Don’t act innocent around us!”)

The United Way funding was even tougher. The volunteer allocations committee made it clear–limited funds means allocation by performance. In other words, “We report larger numbers to donors; they make larger contributions. You give us bigger outcomes by numbers; you get bigger allocations. No questions asked.”

Our front-line staff knew the numbers we were reporting were a joke, but our funding sources were dead serious: “Deliver the numbers needed, or we’ll find someone who will.”

Like other nonprofit managers–with a passion for the people and the community but not the paperwork–the numbers game wore me down. This is where I really got into trouble. Unreasonable situations can bring out a morbid survival instinct–and that’s exactly what happened during AGENCY’s agonizing last year.

Please understand, I do not relate the following “adventures in numbers gamesmanship” because I think these strategies are advisable. They obviously are not. Instead, consider the death of AGENCY as an object lesson in how one thing can tumble perilously into another, set into motion by both well-meaning and impossible conditions on grants:

January

The year starts well when our fundraising consultant helps develop our new annual fundraising strategy, and also teaches us how to improve reporting for the audit and Form 990. While the sole purpose of our mailings is to generate funds, we start including tips on parenting, heart disease and safety with machine tools (or whatever health, human services or industrial safety issue has been in the news and tests well in pre-mailings). We use middle school students doing community service to assemble the mailings, run the inserter equipment, and wheedle with the bulk mail office to accept our paperwork no matter how faulty. Allocation to fundraising: 2 percent. Allocation to program services (youth development and public education): 98 percent.

February

AGENCY has increased mailings to 2 million pieces per month. While almost all expenses are allocated as program, we’re still losing money on every piece of mail, so we hire 15 new grant writers on a contingency basis, incentivizing their performance by awarding them 45 percent of anything they raise.

March

Fifteen planned gifts mature! Our planned-giving department has been maintaining a contact-management database system that tracks 4,300 high-net-worth widows in Texas between the ages of 73 and 89. The staff regularly sends birthday cards, small newspaper clippings and personal notes, makes frequent phone calls, and organizes lunch outings twice a year. While almost none of these widows has any relationship with AGENCY, after six years of assiduous attention by our staff, more than half of them include us in their estate planning, and one-third believe they were helped by AGENCY at a critical time of their life. At any given time 25 major bequests are in probate, frequently designated for various special new programs named during cultivation dinners with the donors—generally for program ideas thought up by planned-giving officers sometime between the entrée and desert.

April

April 1: We’ve installed a long-awaited computer system–very expansive but also very expensive–tracking outcomes of social progress and pathology out to nine decimal points on the definitive measurement regimen for 13- to 15-year-old males (Delta-5 Redact™). Unfortunately, AGENCY’s county contract is based on producing successful outcomes in 73 percent of youth development cases, but our system shows improvement rates in only the mid-40s. After further reflection and some in-staff training, our intake personnel are shown the hazards of giving incoming clients too high an initial score.

April 17: Rescoring of all client intakes has quadrupled AGENCY’s performance in Delta-5 Redact™ score improvement, qualifying us for a major performance bonus and a national award!

April 23: New computer system is used for employment program analysis for the first time. Nonprofit Outcomer Pro 5.0 tracks participation and results in AGENCY’s employment training program for United Way reporting. The goal: personal income increase of 5 percent for participants, measured at the beginning and end of their time in the program. Most participants stay two years and are low-wage hospital, city and airport workers who get 2.5 percent annual cost-of-living increases. We have remarkable success reaching our wage-improvement objective.

May

AGENCY’s new grant writers turn out to be very good. Grant income explodes. Unfortunately, the program staff has no knowledge of the contents of these proposals. AGENCY lacks the staff to deliver even half of the funded activities, let alone generate the reports expected by funders.

June

June 1: United Way reports are due. We’re required to report the total number of participants in our programs each calendar year. Our after-school enrichment program runs during the school year–September through May. So, for year 2001 we served 177 kids during January to May and 181 from September to December. Our report: 358 kids served.

June 2: Cash flow is an issue. Five of AGENCY’s biggest creditors are grant writers waiting for commission payments.

July

July 15: Deadline for completing our capital campaign. Like other organizations, AGENCY’s capital campaign included naming gifts for the overall building, for each room, for the archways, for the interior court, for the lobby, and for the fresco above the lobby. Our value-added approach, which took great courage and incredible organizational skills, was that we sold the overall building naming rights four times (four sides–four large exterior surfaces with raised letters); each room two or three times (one for each entrance); each archway twice (two namable surfaces); and the lobby and its fresco both have rotating credits (familiar technology to sports fans).

July 31: We celebrate completion of capital campaign with an ethnic-themed mortgage-burning gala (in honor of our clients) with our board and major donors. The event underscores how important it is for an agency like ours to have the security and stability of owning a home facility free and clear. Very good publicity!

August

Aug. 1: Cash flow impossible. Mortgage new building to cover cost overruns on computer system.

Aug. 13: Situation deteriorating. Executive on loan from Arthur Andersen shows CFO how to reclassify 96 percent of the staff as consultants, saving on FICA, workers’ comp, unemployment, health insurance, and payroll costs. Board treasurer resigns to spend more time with family.

September

Capital desperately short. Community outreach department expands fiscal agent service for arts, education and community projects in need of a tax-exempt sponsor. (The least favorite part of my job–stringing along people whose funding was received months or even years earlier but who were still desperately waiting for us to turn it over.)

November

Nov. 14: The month we’ve been waiting for! The endowment bequests, four year grants and a big cash flow loan all come in at the same time. We quickly set up a separate foundation, two for-profit subsidiaries, a tax-exempt sub-subsidiary to one of the for-profit subsidiaries, and a foster-parent corporation for the nonprofit sub-subsidiary, and finally a completely separate bank account in the Cayman Islands in the same name as the organization but controlled by our board chair. The board is quite excited by all the incorporation papers, new boards and complex legal arrangements.

Nov. 17: Strike while the iron is hot! While the financial picture is positive, we reform our compensation system. With the incredible growth and increased complexity of our financial arrangements, the board has been concerned that AGENCY could lose its talented, dedicated and respected management staff, and so instituted a total review of compensation with an eye to making AGENCY state-of-the-art in market-competitive, incentive- and performance-based pay. (Or so they thought.) The product is a system of non-bonus bonuses, called salary “withholds”—a supposedly set-aside percentage of executives’ previous salaries that they’ll receive if they achieve defined objectives (but actually are just sums paid on top of their unchanged salaries). Board lauds increased accountability.

Nov. 26: Thanksgiving. Bad news! IRS disallows reclassification of AGENCY employees as consultants. Board members informed of their individual liability for failure to make tax withholding payments. Though AGENCY printed business cards and placed yellow pages ads to establish the authenticity of the consultants, they reported no other income. IRS balked and will require AGENCY to pay both employer and employee portions of FICA, plus various penalties. Four board members resign.

Nov. 30: AGENCY misses third payment on building mortgage. Liens filed. First negative story appears on local TV news. Two meetings with possible merger partners.

December

Dec. 3: Emergency board meeting is called and then cancelled for lack of quorum. Everyone is hiring lawyers. Youth workers are let go.

Dec. 5: Citing undue influence and fraud, the courts certify contested probate cases related to bequests to AGENCY. Planned-giving department staff defects to local university. TV news crews are camped outside portico.

Dec. 7: More media inquiries on compensation arrangements. Attorney General blasts organization on front page. Summer camp sold to land developer.

Dec. 8: AGENCY endowment completely spent. IRS attaches primary accounts. Remaining employees get food vouchers instead of pay.

Dec.15: Temporary relief. United Way check arrives and is routed to Cayman Islands account to avoid attachment. Salary withhold checks issued to management. Merger discussions get very serious.

Dec. 20: The final humiliation and media circus. Holiday party for clients interrupted by Sheriff’s seizure of AGENCY building and contents, including presents donated to poor children. Three volunteers and five parents arrested for fighting with police over gifts.

Dec. 31: The end. Merger called off. Records seized by county attorney’s office.

January

Jan. 3: Living Arts Therapeutic Retreat Center opens on Little Cayman Island with modest endowment, and no plans for grant income (or its attendant problems).