10 Corruption Risks Keeping NFPs Awake at Night

Working for a Not for Profit that sends funds overseas? Getting enough sleep at night?  If you’ve answered yes to both these questions, then you should be asking yourself how much you really know about corruption risks within the Not for Profit sector, writes anti-corruption expert, Jeremy Sandbrook.

While charities are the most trusted institutions in the world… given the sector’s underlying need to maintain donor “trust”, I’m always surprised when talking with people working in charities and Not for Profits, at how little they know about the inherent corruption risks within their industry.

While ranking as the most trusted institutions’ globally (topping the Edelman Trust Barometer for the last seven years in a row), charities and Not for Profits face a number of inherent vulnerabilities that significantly raises their overall corruption risk ranking. Having knowledge of these are essential if the sector, and the actors working in it, are to ensure that appropriate risk mitigation strategies are put in place.

While not exhaustive, I have outlined below, what I believe to be the 10 key fraud and corruption risks inherent to the charity and Not for Profit sectors:

1. A tendency to be “mission-driven”. While the last decade has seen a growing professionalisation of the sector, it continues to be characterised by a relatively high level of  “missionary” zeal. In such an environment, governance becomes secondary to the organisation’s mission, with adherence to the “cause” used to justify placing the action of the organisation – and its staff – above the law (a simple example of this is bribing a public official to release a container of humanitarian aid, the rationalisation being that helping those in need outweighs paying the bribe).

The extent of governance issues is highlighted by a recent compliance report issued by the Australian Charities and Not-for-profits Commission (ACNC), which showed that 72 per cent of complaints substantiated by them in the last two years directly related to breaches of governance standards.

2. The presumption of “moral authority”. A recent consultation paper by the NSW’s Independent Commission Against Corruption, called Funding NGO Delivery of Human Services in NSW stated that, “While the vast majority of NGOs and staff are dedicated to helping others, there are those that see government money as an opportunity for self-interested behaviour.”

While many of us believe that those working for charities and Not for Profits are naturally good, the most prevalent form of fraud in this sector is the embezzlement and mismanagement of funds by employees and volunteers. As a charity’s employees are perceived to work for more than just financial gain, salaries tend to be kept low, making both honest and dishonest employees more susceptible to the temptation of padding out a relatively small pay cheque, especially when oversight is less than rigorous.

This risk is heightened further for those with operations in the developing world, where jobs in the formal sector are few and far between, meaning many staff work for the organisation – not out of a deep seated belief in its “cause” – but out of simple economic necessity.

3. A high level of volunteerism. A culture of mutual trust, and the presumption that people volunteer for an agreed common good, are (in part) what makes Not for Profits and charities so effective. Use of volunteers also ensures that costs are kept to a minimum.  Despite this, a qualitative empirical study by Nichole Georgeou, in his book Neoliberalism, Development, and Aid Volunteering, found that volunteers working in the development sector expressed a sense of entitlement to receiving privileges, even though agreeing they were undeserved; the same sense of entitlement used by fraudsters to justify or rationalise their behaviour. This risk is exacerbated when operating in an environment where “volunteerism”, a relatively Western concept, as those involved may well have a preconceived expectation of being “rewarded” for their efforts.

4. The propensity to be closed to external forces. Unlike other sectors, charities and Not for Profits tend not to be embedded into broader external processes, resulting in a narrow frame of reference and a natural predisposition to be inwardly focused and closed to change. This insularity can easily make an organisation – and those in it – myopic to the broader environment, and the risks associated with it.

5. A low level of accountability. Accountability within charities and Not for Profits, is primarily enforced through a mix of self-regulatory mechanisms and internal rules and procedures. Unlike other development players, most of whom are subject to rigorous integrity regimes (for example internal and external oversight bodies), a charity’s integrity predominantly relies on the effectiveness of its governance system, and the robustness of its internal control framework.

Add to this the tendency to focus only on donor (or “upward”) accountability, precludes charities from implementing more effective anti-corruption accountability mechanisms. For more on this see ‘Trouble in Paradise: NGO Accountability & Corruption’.

6. Weak regulatory framework’s. Charities and Not for Profits tend to fall through a regulatory crack, as many of them are neither corporate entity’s, nor do they form part of government.  This grey area is characterised by minimal regulation and a lack of robust external oversight.  Even in cases where an industry regulator may be present, resource constraints tend to make effective oversight challenging. This is evidenced by the rise of the BINGO (or briefcase NGOs) whose sole purpose is to tap into development funds for the benefit of its owners.

7. Exposure to highly corruption-prone countries. The average charity’s footprint often includes exposure to programs operating in some of the most corruption-prone areas on the globe. Despite this, specific controls needed to address the increased local corruption risks are often over-looked, with most head-office staff having little real exposure to (or understanding of) the realities on the ground. In the case of one large well-established global charity, only minimal financial controls had been implemented worldwide. This was despite 80 per cent of its annual funds being channelled to highly corrupt jurisdictions, the bulk of which were classified as being, or at risk of becoming, a failed state.

8. The use of local delivery partners. Many small and medium sized charities and Not for Profits rely on local or in-country delivery partners.  While there are a number of obvious advantages to this, it brings with it an additional layer of risk.  In many cases formal due-diligence processes – common in the commercial world – are yet to be adopted as standard practice within the Not for Profit sector. In addition, key oversight mechanisms used, tend to be restricted to the provision of ongoing program reports, annual financial audits, and a program visit. While each is an essential control, they are unreliable indicators of the presence of fraud or corruption.

9. An over-reliance on external audits. Despite the external audit process not being designed to detect fraud or corruption, charities and Not for Profits continue to rely on it as primary confirmation of a ‘clean bill of health’.  In a survey of Australasian charities, while 90 per cent of respondents felt that fraud was a “problem” for their sector, 83 per cent believed their own charity to have a low fraud risk.

The main reason for this: The external audit process.  The Association of Certified Fraud Examiners annual global fraud survey however, have shown this trust to be misplaced, as external financial audits detect just 3 per cent of frauds.  Over twice that number (6.7 per cent) are uncovered by accident, making it a more effective fraud detection mechanism.  That being said, audits still act as a valuable deterrence to potential fraudsters.

10. The difficulty of beneficiary verification. One of the largest on-going challenges faced by charities and Not for Profits in the developing world, is beneficiary verification.  The issue is made more problematic when operating in countries (for example Malawi), where birth certificates are not mandatory. In one investigation I was involved in, 56 per cent of the charity’s registered program beneficiaries were found to be non-existent.  Despite being “ghosts”, they had received 48 per cent of all of the aid distributed!  While various technologies have been used to make the process more transparent, no cost-effective solution has yet been identified.

What are the ramifications of all of this?

The consequence of these vulnerabilities is that charities and Not for Profits have tended to be viewed as an easy target – not only by fraudsters – but by organised crime and terrorists groups, who have traditionally used them as conduits for money laundering and terrorism funding.

While creation of the ACNC has ensured that questionable activities by charities and Not for Profits are less likely to go undetected, its overall effectiveness will be hampered by both limited resource, and its mandate as a “light touch regulator”.

So what is the solution?

While a number of generic steps can be taken to reduce the risk of corruption taking place, the first, and most effective is for a charity or Not for Profit to fully understand its unique corruption-risk profile.

Based around analysing and assessing the risk of corruption across a number of interrelated perspectives, if done properly, it should help identify the crucial building blocks needed to mitigate the organisation’s key risks.   Until charities and Not for Profits start proactively dealing with this, many will continue to leave themselves exposed to unnecessarily high levels of preventable corruption.

About the author: Jeremy Sandbrook is the Founder and Chief Executive of Integritas360, a global social enterprise that helps charities and Not for Profits corruption-proof themselves.  A Chartered Accountant with over 20 years experience, he has spent the last decade working in the international development sector, predominantly in Africa and Europe.  An internationally accredited anti-corruption expert, Sandbrook also lectures on the topic at the University of Sydney’s Centre for Continuing Education.