Nonprofit Financial Controls

Is your nonprofit at risk for fraudulent financial activity?  Nonprofit organizations tend to be more trusting of their employees, have less resources devoted to administrative costs, and have less stringent financial controls than for-profit organizations.  They are more likely to be victims of such fraud. 

According to a 2013 Washington Post report, more than 1,000 nonprofit organizations disclosed hundreds of millions in losses attributed to theft, fraud, embezzlement, and other unauthorized uses of funds and organizational assets, from 2008 to 2012.  Nonprofits were second only to the financial services industry, experiencing one-sixth of all major embezzlements.  In one recent example, a California CPA reportedly stole $4 million while managing a church’s books for nearly seven years.  He is now headed to prison.

How can nonprofits reduce their risk of fraud?  A key answer is internal financial controls, and other options can provide valuable safeguards too.

Is There a Risk? Volunteer Directors' Standard of Misconduct

Nonprofit directors often ask if they can be held personally liable for their board actions.  The somewhat unsettling answer is probably not, but maybe.  In other words, state statutory immunity and indemnification protections generally apply to a volunteer director’s misconduct, but subject to certain exceptions for misconduct.  More specifically, a director may have heard that he or she may be personally liable for “gross negligence” or “intentional or reckless misconduct.”[1]  What do these terms mean?  The following guidance addresses how nonprofit laws define the type of misconduct that triggers personal liability for volunteer directors and discuss additional safeguards such as indemnification and directors’ and officers’ insurance. 

Willful or Wanton Conduct – Explained.

Most states’ statutes provide a limited level of immunity for volunteer directors serving on nonprofit boards.  By way of background, directors and officers owe fiduciary duties of care, loyalty, and obedience to the corporate mission.  Under these statutory provisions, a director will not be personally liable for damages resulting from their actions carried out in furtherance of such fiduciary duties, so long as these actions do not rise to a certain level of misconduct.  This level is often described as “gross negligence” or “reckless misconduct.”  The Illinois General Not-for-Profit Corporation Act (the “Act”) uses the classic legal phrase “willful or wanton conduct.”  The federal Volunteer Protection Act (“VPA”), which protects volunteer directors at the federal level, uses similar language.  (Notably, a lower legal standard of “ordinary negligence” typically applies to paid directors and officers, so payments of stipends or other modest compensation may likely be inadvisable.)

So, what exactly does “willful or wanton conduct” mean?   Willful or wanton conduct means a course of action which either “shows an actual or deliberate intention to cause harm” or which, “if not intentional, shows an utter indifference to or conscious disregard for the safety of others or their party.”  

Great Board Expectations

Serving on a nonprofit board presents great opportunities for meaningfully contributing to a worthy cause.  But board service also involves significant responsibilities that may feel burdensome at times.  How can current board leaders effectively equip newly-recruited board members for successful board service?  In a nutshell, it’s all about a good fit, clear expectations, and safeguards.

A. Who is the right person for the job?

Nonprofit boards need leadership from individuals who share a passion for the organization’s mission.  To help potential leaders understand this mission, make sure that the nonprofit’s corporate purpose statement clearly and accurately articulates the organization’s mission.  Ask prospective board members to read the corporate purpose statement.  Then ask them to consider the following question.  Is this mission something that I believe in, and is it worth committing my best efforts?

B. What will be expected of board members?

Board leaders often speak in terms of “time, treasure, talents” or “wealth, wisdom, work” parameters.  These phrases may be helpful to show that board members should expect to contribute some of their time, some of their money, and some of their skills or expertise.  But better yet:  develop a one or two-page “Board Expectations” document that helps new board members to understand more clearly how they are to contribute meaningfully.  Also consider assigning seasoned board members to mentor new board members in their new responsibilities.

A “Board Expectations” document could include the following elements to inform new board members about their roles.