Wednesday, July 9, 2008

Two Recent Case Studies on How to Respond to Embezzlement/Excess Benefit Transactions

I have occasionally been asked how a nonprofit organization should react when it (i.e., responsible people within the organization) learns that an insider has engaged in some serious excess benefit type behavior -- ok, just plain old embezzlement or overspending.  There are, of course, two options.  One is to handle the matter in-house and quietly, no matter how mad the board and certain other key employees are at the miscreant.  The benefit to that approach is that past, present, and future donors don't find out that their money has, is being, or might be mispent in the future.  Private inurement and excess benefit scandals typically result in a serious decline in donor revenues.  And yet, punishment is often appropriate and necessary and  damn well deserved.  I once advised a nonprofit that immediately informed a private foundation that the grant the foundation made had been misspent -- the board sent the letter to the foundation before I got involved.  Even though the public charity had sufficient funds to  make up the  short-fall and  had reported the matter to local district attorney, the private foundation demanded and eventually received a refund of the grant despite our contractural right to keep the grant, in my opinion.  No good deed goes unpunished, I suppose.  Had we insisted that we were not liable for the refund of the grant we might have won the legal battle but lost the donor and volunteeer war.  Therein lies the rub.  In cases of embezzlement, (which is not private inurement but probably is excess benefit), the nonprofit is in a catch-22.  If it reports the matter, the nonprofit might die from lack of future donations.  If it does not report the matter, several negative consequences apply.  Board members and other managers risk being treated as complicit or negligent with regard to the excess benefit transaction; they too are subject to excise penalties.  In the shorter term, the nonprofit reduces its legal leverage to seek repayment by the greedy insider.

The New York Times ran a story today that describes two "case studies."  In one, the insider skimmed about a million dollars and the nonprofit decided to handle the matter in-house.  In another, the nonprofit immediately reported the matter to law enforcement even before it determined the full extent of the wrong doing.  Ironically, both cases ended up in the press anyway so perhaps the lesson to be learned is "disclose, disclose, disclose" in any event.  Still, in the case I was involved in the amount was relatively small (less than $50,000) and had I been asked, I might have said let's handle this quietly to protect our reputation in the donor  community.  Here is an excerpt from the Times article describing how one nonprofit decided to handle the matter quietly (until a whistleblower went public):

The [founder's] brother, Dale Rathke, embezzled nearly $1 million from Acorn and affiliated charitable organizations in 1999 and 2000, Acorn officials said, but a small group of executives decided to keep the information from almost all of the group’s board members and not to alert law enforcement.  Dale Rathke remained on Acorn’s payroll until a month ago, when disclosure of his theft by foundations and other donors forced the organization to dismiss him. “We thought it best at the time to protect the organization, as well as to get the funds back into the organization, to deal with it in-house,” said Maude Hurd, president of Acorn. “It was a judgment call at the time, and looking back, people can agree or disagree with it, but we did what we thought was right.” The amount Dale Rathke embezzled, $948,607.50, was carried as a loan on the books of Citizens consulting Inc., which provides bookkeeping, accounting and other financial management services to Acorn and many of its affiliated entities. Wade Rathke said the organization had signed a restitution agreement with his brother in which his family agreed to repay the amount embezzled in exchange for confidentiality.

Hmmmm.  I wonder what the accounting firm's exposure is, and to whom, from its cooperation.  Clearly the decision whether to report the matter to law enforcement is the board's so the "small group  of executives" messed up from the start.  They should and had an obligation to inform the board and let the board decide how to proceed.  This points to another consequence of insider bad behavior (at least at sub-board level).  If I had been on or advised someone on that board, I would probably consider or advise stepping down immediately and perhaps indignantly (though not necessarily loudly) with a CYA letter.  The other significant point to be made about this case is that the "embezzlement" occured eight years before it came to light, suggesting that the "disclose, disclose, disclose" rule is most prudent because bad things will eventually come out.  Here is how the second organization handled the problem.  Notice the concern voiced regarding the effect on the donor and volunteer community:

Officials at Points of Light began looking into complaints about a store the organization operated on eBay and by late June had discovered what its president and chief executive, Michelle Nunn, called “abnormalities” in the business practices of an independent contractor hired to run the store, which did a brisk business auctioning travel packages and items donated to the organization. The travel auctions were stopped immediately, Ms. Nunn said, and the store was shut down a short time later. Points of Light also posted a statement on its Web site last weekend about the problems and contacted the United States Attorney’s Office in Washington, as well as people who had bought the travel packages.  Two people who have been involved in the internal investigation at Points of Light, who spoke on the condition of anonymity because it is incomplete, said it appeared that Maria Herrmann, a former Points of Light fund-raiser who was hired as an independent contractor to manage the eBay store operation, may have been auctioning off bogus trip packages.  Ms. Herrmann did not respond to a message left at her home on Tuesday, and phone and e-mail messages to the office were answered by automated responses from the service Points of Light has hired to process reimbursement applications for the packages.  The organization is making good on trips scheduled through next Tuesday, Ms. Nunn said, and hopes to repay consumers for the rest of the packages that were sold. She said Points of Light began alerting donors last week about the problem, and some have agreed to help it repay customers who bought the packages.  Ms. Nunn also said she did not know how much the group would lose. “Our hope is that this is an isolated event, and that the actions of what we believe to be a single individual at this point doesn’t jeopardize the work of millions of volunteers,” she said.

[emphasis  added].  Lies and cover-ups have a way of making things that much worse, and then you are always waking up in the middle of the night wondering when you will get caught.  I suppose the damage to an organization's donor and volunteer support is inevitable, and  even worse when stakeholders learn that the nonprofit tried to hide the matter.  Better to come clean right away.  Still, being the human that I am, I might advise keeping things on the down low when the amount is relatively small; once it hits a certain amount, I think nonprofits are better off biting the bullet now rather than later.  Points of Light  will probably come out of this better than Acorn.  A criminal scholar of mine once opined that there are cases where you just what to "take the bastard out back and shoot him."  The emotion applies to nonprofit embezzlement, but cooler heads must prevail. 

dkj

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