The Overhead Debate: Low Administrative Costs Make It Harder to Fight Thefts and Scams

A Washington Post story on “the hidden world of thefts, scams, and phantom purchases at the nation’s nonprofits” offers another persuasive argument for taking a hard look at the pressure on nonprofits to keep their overhead costs low.

The Post made use of one of the many revisions to the Form 990 informational tax return that were ushered in by the Pension Protection Act of 2006—a measure precipitated by major corporate frauds, most notably the WorldCom and Enron scandals. The new form, which larger nonprofits must file annually with the Internal Revenue Service, now includes a one-page checklist of management practices and disclosures, including whether the organization became aware during the year of a significant diversion of the organization’s assets.

The Post found more than 1,000 nonprofits that checked the “diversion” box for tax years 2008 through 2011—charities, social-welfare organizations, professional associations, cooperatives, voluntary employees’ beneficiary associations, credit unions, and others.

Of course, these are just the organizations that discovered the problems and disclosed them on the Form 990 at some point during the period. We don’t know how many more simply failed to do so, were blissfully unaware that someone was ripping them off, or were too small to face the new requirement. (Those with revenues of less than $1-million or total assets of less than $2.5-million may file Form 990-EZ, which does not have a similar check-off box.)

Even so, this seems like a relatively small number, especially on an annual basis (391 in 2011), considering that in 2012 there were more than 2 million nonprofits, including more than 90,000 with revenues of $1 million or more.

However, the dollars involved run to the hundreds of millions and the damage to the organizations and the broader nonprofit world is enormous, undermining trust by the public, especially donors, that these organizations use all available resources to advance their missions.

So why does it happen? There are, of course, the usual explanations of individual greed, human frailties, and bad management. However, something else must take at least some of the blame.

Nonprofit organizations, charities in particular, are under pressure to spend as little on administrative costs as possible. Government agencies, foundations, donors, and watchdog organizations, most notably the Better Business Bureau’s Wise Giving Alliance and Charity Navigator, have championed accountability standards that ding charities for spending “too little” on program activities.

However, even those groups are now trying to dampen the low-overhead clamor, joining with GuideStar, which posts financial information about charities, in a campaign to “end the overhead myth and start supporting nonprofit investments in sustainability and success.”

I hope the Post’s reporting on fraud and malfeasance by nonprofit employees, board members, and volunteers will give this belated effort new vigor. Nonprofits need the support of grant makers, donors, and self-appointed regulators to put in place the management practices that will avoid, or at least minimize, financial losses from fraud.

But some of those management practices and efforts are costly. For example, a full audit, designed to detect such problems, is beyond the financial means of many charities.

Other practices require well-established internal controls, such as dual signatures on checks, separation of responsibilities for cash receipts from disbursements, formal approval of reimbursements, and background checks. While most such procedures are not costly to create, they require dedicated staff or board members to put them into effect and monitor. In short, they require administrative efforts, and that increases nonprofit overhead costs.

But that goes against the grain. Nonprofits underinvest. Many have few staff members serving in administrative roles, including financial management, or they rely on inexperienced people to do those jobs and spend little on training.

As noted in a 2008 report by the Bridgespan Group, board and staff members “become acclimated to working in such circumstances and then have trouble justifying investments in overhead, even when they are clearly needed.”

That opens the field for ordinary human frailties. Many board members do not understand their fiduciary responsibilities and don’t have the training or expertise to carry them out effectively. Similarly, while most nonprofit executives are highly competent and dedicated, many have come up from the ranks and may not have the management training to put appropriate safeguards in place.

Greed, or at least the unwillingness to make do with what you have, lies at the heart of fraud at nonprofits and elsewhere. We live in a society that measures people’s worth by how much money they have, spend, and accumulate. We celebrate financial success. And while we may not all endorse Gordon Gekko’s “greed is good” credo, most of us admire people who can show they have “made it.” Committing fraud or theft is one way some people get there.

Before putting all the blame on greed or incompetence, though, let’s use this Washington Post report as one more reason to debunk the “overhead myth.”