Inadequate Governance and Financial Oversight
Dan Busby, CPA, President, Evangelical Council for Financial Accountability (ECFA)
This article provided by the Engstrom Institute
Experienced leaders understand that boards set policy and maintain accountability controls, while the CEO executes those policies in running the operation. The buck appears to stop there. However, history demonstrates that when things go wrong, more often than not the cause can be traced to failure of financial accountability.
When the Evangelical Council for Financially Accountability (ECFA) was founded, "financial" was in its title—not because boards and CEOs weren't seen as the top of the organization—but because financial management is the fulcrum that keeps an organization in balance. Proper financial management requires good governance practices to maintain the proper check and balance between the board and staff in perpetuating a level of accountability.
When a nonprofit organization experiences a significant failure, the following governance and financial management controls are often lacking or abused:
- Expense reporting, including inadequate documentation, approval, lack of business purpose, and timing
- Credit card abuse, including lack of business purpose
- Inadequate separation of duties
- Financial reporting not timely or accurate
- Lack of board oversight over the audit process
- Payables never tested
- Donor-restricted contributions not monitored
- Lax oversight of bank accounts
- Lack of an investment policy
- Lax attitudes towards the board's responsibilities
- Improper compensation packages, including inadequate documentation of executive compensation
In the last three decades, there have been 12 notable examples of nonprofit failure. When asked to identify the ten examples, the names of PTL, the United Way, and the Red Cross might come to mind, and perhaps New Era. But the details of any of these 12 examples are often forgotten in the fog of time. The following summary capsulizes the key aspects of these nonprofit failures:
1. Praise the Lord Ministries (PTL). There was plenty of blame to go around with PTL. Due to a board that was AWOL and a leadership team that held a false belief that it was invincible, the problems only surfaced when the money ran out. [1]
Warning signs in neon lights were missed because fundamental financial management and controls were lacking. Bills were paid into a blind executive fund with no accountability. Income designated for construction of a hotel was ignored in favor of huge bonuses for the leaders. Totally inadequate financial controls and reporting masked the huge losses and impending disaster.
The audit firm also failed to catch and warn of the collapse that was coming. Its culpability in court findings and the resulting public disclosure eventually ruined the firm.
In Ft. Mill, South Carolina, my first sight of the once vibrant PTL campus was sad indeed. The only clues of the former theme park were a few remnants of the park entrance. The empty high-rise hotel, surrounded by chain link fence with sections of brick facing missing, was a stark reminder of the PTL collapse that was played out in living color night after night on TV newscasts in the early 1980s. To this day, PTL remains the flagship embarrassment for the Christian ministry community.
2. Foundation for New Era Philanthropy (New Era). The ramifications of inadequate financial controls may be best highlighted by the fraud perpetrated by New Era.[2][3] The foundation offered a "new approach" to fund-raising—thus the name "New Era Philanthropy"—and emphasized matching grants from anonymous benefactors.
Hundreds of individuals and charitable organizations (255 to be exact) invested funds with New Era in the early 1990s.[4] They expected their funds would be doubled in six months by guaranteed monies that New Era founder, John "Jack" Bennett, had secured from several wealthy benefactors.
There were no anonymous benefactors and New Era was operating a Ponzi[5] (or pyramid) scheme in which money from later investors was used to pay earlier investors.
While PTL caught the attention of the public at large, New Era sent greater shockwaves through the ministry and broader charity world. This scandal, more than any other incident in recent memory, demonstrated the close relationships within sub-sets of the ministry and charity community. These follow-the-leader relationships were based on the feeling: "If it's good enough for _________, then it's good enough for us."
New Era had a significant governance problem—there was no governance. The board, represented as having key respected philanthropists as members, did not exist. It was the product of a delusional leader. Not one of the investors in New Era bothered to verify the authenticity of the board.
But still, at the center of New Era was inadequate accounting control, reporting, and oversight. The CFO testified against the founder to obtain a reduced prison sentence, the auditor was also cited (now out-of-business), and even Prudential Financial (New Era's banker) was highly criticized for not "pulling the plug" on an organization that, in hindsight, was a sham. Prudential contributed sizable funds to New Era's historic settlement in order to avoid legal liability.
It is worthy to note that when the New Era fraud began, the Form 990 was not subject to the current public disclosure rules. If New Era's Form 990s had been subject to public disclosure, its activities would have been more transparent and the fraud might have been discovered much earlier.
In the end the total amount taken from the various charities totaled $354 million.[6] "Victimized charities later recovered more than 90 percent of their loss in an unprecedented bankruptcy settlement orchestrated by ECFA (and its board chair, Federal Judge Rollin Van Broekhoven) who formed the United Response to New Era." [7]
An aftermath of New Era has been the improvement of investment policies by many nonprofits.
3. Greater Ministries International (GMI). GMI was a church ministry that ran a Ponzi scheme taking at least $500 million dollars from 18,000 people. Headed by Gerald Payne in Tampa, Florida, the ministry bribed church leaders around the U. S. to keep "donations" coming in. Gerald Payne was sentenced to 27 years for his conviction on 19 counts of fraud, conspiracy, money-laundering, and related charges. His wife, Betty Payne, received 12 years and 7 months.[8]
Payne and other church elders promised the church members double their money back, citing scripture. However, nearly all the money was lost and hidden away. Church leaders received prison sentences ranging from 13 to 27 years.
Their group founded a newspaper, the "Greater Bible College" in Tampa, a line of "Greater Life" herbal remedies, cancer treatments ("We actually pull the cancer right out of your stomach", Payne claims), even a supplement called "Beta 1, 3rd Glucan" (to survive "end-times plagues") and plans for "Greater Lands," an independent country (an "Ecclesiastical Domain … similar to the Vatican") where other governments will have no jurisdiction.
4. Baptist Foundation of Arizona (BFA). BFA engaged in one of the most audacious fraud schemes on record with thousands of elderly investors losing their life savings.[9] This scandal began due to a risky investment choice—a financial decision that would have been prevented if the board had implemented sound investment policies.
BFA invested heavily in the Arizona real estate market. These investments corresponded with the acceleration in BFA's sales of IRA-type retirement investment plans to church members. There was an increase of these investments from 7.2 million in 1984 to $211 million in 1985.[10]
When the Arizona real estate bubble burst and property values declined, poor financial management kicked in. Instead of providing transparency concerning the financial situation, BFA began an elaborate cover-up involving over 90 insider-controlled entities. The leaders were determined to only show positive results on the financial statements and refused the audit team's request to turn over the related organization's financials.[11] Collectively, these entities had negative net worth that was in the hundreds of millions. The cover-up was not detected—even by BFA's auditors, Arthur Anderson & Co.
When Anderson came under fire for lax oversight in other companies, this failure quickly surfaced and contributed to the accounting firm's demise. The result: many trusting investors lost their life savings and a once reputable organization tarnished other Baptist ministries and foundations.
5. United Way. A significant scandal of the century-old, nationwide Virginia-based mega-charity, the United Way, involving the agency's improper use of funds was first revealed by the Washington Post in 1992. The revelation was followed by the resignation of William Aramony, United Way's president for 22 years.[12]
It was revealed that their long time CEO had virtually no oversight from a "blue ribbon" board. The familiar lavish living and immoral lifestyle was undetected by poor internal controls and limited accountability. Even with lax oversight, basic accounting controls should have surfaced this issue years before it was discovered.
The United Way made drastic changes in its board requirements and internal controls after these events but has paid a heavy price in damaged reputation.
Only a few years later, while the long time CEO was still in prison, United Way's high profile Washington D.C. chapter experienced another scandal, involving CEO Oral Suer who admitted stealing $500,000 over 27 years,[13] followed by another United Way scandal revealed in 2003 in the Bay Area of California involving PipeVine, a San Francisco nonprofit group that, according to a court-ordered report, processed on-the-job contributions for companies. More than $17.7 million in charitable donations never made it to the intended recipients as a result of the implosion of PipeVine.[14]
6. American Red Cross. In many respects, the American Red Cross is America's charity of choice in times of disaster relief. The venerable organization took a serious hit, however, following the 9/11 relief efforts when it actually received so much money that it set aside some of it for future relief efforts.[15]
The donor public, the media, and many watchdogs all pounced on the issue, forcing the Red Cross to eventually retreat. The episode damaged its reputation, cost CEO Bernadine Healy her job, and created some internal reorganization. The whole experience highlighted once again the reality that no charity can raise money for one project and, without donor permission, spend it on something else, no matter how noble the "something" might be.
The Red Cross faltered again following Katrina, setting off a new round of criticism, and another CEO, Marty Evans, separated from the organization.[16]
The string of problems can be traced to an almost impossible board structure. The Red Cross was formed by an act of Congress to ensure that charitable relief could be channeled through a government-sanctioned organization for the benefit of all Americans. It established a fifty seat board with a significant number of seats to be occupied by high level incumbents in whatever administration was in power at the time.
These individuals realistically did not have the time to give to the charity and therefore rarely attended meetings or became closely involved in the oversight of the CEO. This structure is a textbook formula on how a charity will struggle to meet its mission when a board is too large and disengaged.
The disengaged board left the local chapters to run free with little national oversight. The local chapters had the vested authority as they were collecting the donations, had the ability to exert influence over the weakened board, and resisted tighter controls over chapters.[17]
The structure issue is now being addressed by some members of Congress. In a letter from Senator Grassley to The American Red Cross urging them to improve governance the senator writes, "I have found again and again in my oversight work that many organizations can trace their problems to board governance. This is true whether it be non-profit or for-profit." He continues, "The [former] Commissioner of the IRS, Mark Everson, came to a similar conclusion in a March 30, 2005, letter to me:
Lax attitudes towards governance. An independent, empowered, and active board of directors is the key to insuring that a tax-exempt organization serves public purposes and does not misuse or squander the resources in its trust. Unfortunately, the nonprofit community has not been immune from recent trends toward bad corporate practices. Like their for-profit brethren, some charitable boards appear to be lax in certain areas. Many of the situations in which we have found otherwise law-abiding organizations to be off-track stem from the failure of fiduciaries to appropriately manage the organization.
Senator Grassley finishes this section by stating, "There are three areas related to governance that are of concern to me … a) lack of participation of board members; b) size of the board; and, c) independence of the board."[18]
7. American University. A reputable organization, also chartered by Congress, was led by a charismatic President, Benjamin Ladner, who was gifted at fund-raising.
It all came crashing down in a scandal of high salary, lavish expense reports, secret perks, and an employment contract between the President and the University that superseded the initial hiring contract.[19] This was known by some long-term members of the board but kept secret from the newer members.
Their auditors raised concern with extravagant expenses including fine wines, expensive meals, and personal chauffeurs who would run personal errands.[20]
It played out in the media to the embarrassment of the board, staff, faculty, alumni and students.
Normal financial reporting of this sophisticated institution failed to reveal any of the problems. It produced an inquiry and hearing by Senator Charles Grassley, which led to some reform amongst the University's trustees including improving transparency and giving students and faculty a stronger voice on governance issues.[21]
8. Smithsonian. This was another Congressional-created nonprofit organization established for the benefit of all Americans. The magnitude of the executive compensation and increased scrutiny caused Secretary Lawrence M. Small to resign from his position thus leaving the large museum without top-level leadership for over a year.
There were too many high profile board members who, realistically, didn't have time to serve.[22] Embarrassing internal control lapses resulted in wasted donor money and another Senator Grassley inquiry.
Among the many items to gather public and congressional scrutiny was the Secretary's high compensation, large housing allowance, and lavish office decorations. Senator Grassley, "It looks like the Smithsonian Castle has been turned into Mr. Small's palace."[23]
While some of the members of the board defended the high levels of compensation, Mr. Small's predecessor never had a housing allowance or made any significant redecoration changes.
9. The Nature Conservancy. After a series of investigative reports by the Washington Post, Capitol Hill called for an investigation of the practices of The Nature Conservancy, which eventually led to the restructuring the of the organization's board.
Among the various items investigated by the Senate Finance Committee was the organization "allegedly selling land to trustees, making loans to employees, and receiving money from the sale of land to federal and state governments."[24]
Senator Grassley states in a letter to The Nature Conservancy, "People who donate property and dollars to help protect the environment deserve to know The Nature Conservancy won't betray them."[25] Some of the items for which he requested documentation pertained to a $1.55 million loan at 4.59 percent from the organization to the president and CEO Mr. McCormick as well as documentation regarding executive compensation, discretionary funds, and transactions with board members.
The investigation by the Senate Finance Committee prompted governance changes by The Nature Conservancy. These included implementing controls to prevent conflicts of interest and increasing the interaction between the board of trustees and management.[26]
10. Rise and Shine Ministries. To hear Bill Bresnahan tell it, he was a hero at ground zero. When the jets piled into the World Trade Center towers, the retired Philadelphia police officer sped from Chester County to New York—more than 120 mile in 55 minutes. There, he pulled body parts from the rubble. He roped himself to firefighters in a hunt for survivors. With tales such as these Bresnahan wowed audiences across the nation. Tearful churchgoers and students opened their hearts—and wallets.[27]
Bresnahan was labeled a "con man" and an aspiring "big shot" by the Chester County Pennsylvania judge who sentenced him. He was sentenced to three to six years in prison for violating state charity laws, based on 94 counts of wrongdoing alleged by the State of Pennsylvania.[28]
Bresnahan founded Rise and Shine, a West Chester-based ministry, which accepted donated goods worth about $275,000. Although the items were designated for charity, he sold them to a liquidator and funneled the money into for-profit companies he controlled.
Rise and Shine was the victim of a serious lack of board governance.
11. J. Paul Getty Trust. This was another situation in which a lack of proper board oversight and controls allowed inappropriate use of charitable funds. In order to avoid serious repercussions during an investigation, the board changed leadership and enacted new policies and more stringent oversight to curb future abuse.
The California attorney general led a thorough investigation into the trust's activities and practices. This investigation focused on excessive executive compensation, reimbursements, and the purchase of artwork for retiring directors.[29]
The attorney general's office found that trustees improperly allowed the expenditure of trust funds for travel expenses for the president's wife; buying gifts of artwork for retiring trustees; and allowing the president to use Trust employees to run personal errands for him. The attorney general's office also found that, while not illegal, it was inappropriate and unreasonable use of trust funds to pay for luxury hotels, dining at expensive restaurants, and first-class flights especially when they were not overseas or transcontinental.[30]
The state imposed an independent monitor to oversee the trust's activities for the following two years. The state did not take additional action only because the president resigned, repaid $250,000 in improper expenses, forfeited $2 million in benefits, and the trust adopted policies to prevent reoccurrences in the future.[31]
Senator Grassley said, "It's important to note that even with the attorney general's good work, he had to take a pass in some troubling areas, like executive compensation and business relations with trustees, because current law is limited or unclear."[32]
12. Bernard Madoff. U.S. prosecutors and regulators arrested Bernard L. Madoff (pronounced Made-Off, as in Made Off with the money) in December 2008 for allegedly running a Ponzi scheme through the family investment firm and defrauding investors out of $50 billion. A few days later, Thierry Magon de La Villehuchet, co-founder of an investment advisory firm that lost $1.5 billion in the Madoff scandal was found dead in an apparent suicide in his Manhattan office.
Some charities were direct investors in Mr. Madoff's funds. At least four foundations closed as a result of being almost entirely invested in Madoff funds. But a far greater number of charities received support from foundations and individuals that have seen their wealth wiped out or greatly reduced by investing with Mr. Madoff.[33]
Mr. Madoff was at the epicenter of Jewish philanthropic life in New York and Palm Beach. Early reports indicate that major Jewish foundations have lost 50% to 100% of their assets.
How did Mr. Madoff operate a Ponzi scheme over four decades, basically undetected? He always stayed just under the radar. He was an ingenious marketer, built on exclusivity—investors had to be invited to join.[34]
The lesson for charities from the Madoff scandal? Nonprofit boards must exercise adequate due diligence over the organization's investments. Fundamental to this process is the development of conservative investment policies and the election of an investment committee composed of qualified individuals to oversee the execution of the investment policies.
The Madoff scandal demonstrates how little financial scams change over time. There was the "reputation ruse"—Madoff was very trusted on Wall Street. There was the "affinity quagmire"—Madoff moved in upper-crust Jewish society. Investors fell "for a free lunch"—investment returns were consistently 10% to 12% annually in good markets and bad. Many of Madoff's clients put all of their "eggs in one basket"—trusting an unregulated investment firm with virtually their entire portfolio. There was the "magic black box"—Madoff told clients he produced steady returns with a "split-strike conversion" options strategy, a secret he said was "proprietary." Finally, it was the "fox guarding the henhouse"—Madoff used close affiliates to lure money and was audited by an "unknown three-person accounting firm."[35]
Summary. In summary, all of the above examples of highly publicized nonprofit organization failures unmistakably link financial collapse to boards that missed basic best practice fundamentals of good governance and financial oversight.
As Senator Grassley said to the American Red Cross, "I have found again and again in my oversight work that many organizations can trace their problems to board governance."[36] This trend has been noticed by the IRS as evidenced by the new Form 990's additional governance questions.
Policies and procedures need to be put into action similar to the Apostle Paul's charge to the believers in Philippi when he said, "Whatever you have learned … put into practice." (Phil. 4:9)
The author wishes to thank John C. Van Drunen, C.P.A. and Attorney, Director of Compliance, for his contribution to this article.
[1] Forgiven, Charles E. Shepard, 1989, Atlantic Monthly Press
[2] Bird, Wendell R. 1996. "The Foundation for New Era Philanthropy Debacle: New Era Philandering," 8 Journal of Taxation of Exempt Organizations 69.
[3] Securities and Exchange Commission. 2001. "Prudential Securities Incorporated Stuart P. Bianchi, and John C. Burch, Respondents." Ruling 33-7945; File No. 3-10413, January 29.
[4] Investors included financiers such as Laurence Rockefeller, a Goldman Sachs partner, and former Treasury Secretary William Simon, and institutions such as the University of Pennsylvania, the American Red Cross, and the Nature Conservancy. Bennett transferred most of his assets to the bankruptcy estate. Most individuals and nonprofits returned their gain to the bankruptcy court. Overall, the nonprofits received over 90 percent of their initial contributions, while the individual investors lost their entire funds. The leadership of the Evangelical Council for Financial Accountability was the key factor in the high recovery of funds for the charities which invested funds with New Era.
[5] Based on a niche in the world's postal network, Charles Ponzi promised 50% investment returns in 45 days, tempting about 40,000 people to invest. Mr. Ponzi was arrested in 1920 and convicted. The investor losses would be about $156 million in today's dollars.
[6] Jeff Jones, Non Profit Times, June 1, 2005
[7] Ibid
[8] "Greater Ministry Leaders Get Lengthy Prison Terms," Christianity Today, October 1, 2001
[9] Lawrence C. Mohrweis, The CPA Journal, New York Society of CPA's, July 2003
[10] Ibid
[11] Lawrence C. Mohrweis, The CPA Journal, New York Society of CPA's, July 2003
[12] The United Way Scandal: An Insider's Account of What Went Wrong and Why, John S. Glaser, 1993, John Wylie & Sons
[13] The Chronicle of Philanthropy, May 17, 2004
[14] The Chronicle of Philanthropy, March 4, 2004
[15] The Chronicle of Philanthropy, November 1, 2001
[16] The Chronicle of Philanthropy, November 10, 2005
[17] Sharyl Attkisson, Disaster Strikes in Red Cross Backyard, CBS News, July 29, 2002
[18] US Senate Committee on Finance, Senator Chuck Grassley to the Chairman of the American Red Cross, February 27, 2006
[19] The Chronicle of Philanthropy, October 13, 2005
[20] Associated Press, Diverse Issues in Higher Education, November 3, 2005
[21] US Senate Committee on Finance, Senator Chuck Grassley to the President of American University, May 17, 2006
[22] The Chronicle of Philanthropy, June 28, 20074
[23] Washington Post, March 19, 2007
[24] Brad Wolverton, Chronicle of Philanthropy, March 18, 2004
[25] US Senate Committee on Finance, Senator Chuck Grassley to President and CEO of the Nature Conservancy, July 16, 2003
[26] Brad Wolverton, Chronicle of Philanthropy, March 18, 2004
[27] Monica Yant Kinney and Peter Nicholas, Philadelphia Inquirer, "Wanna-be Hero of 9/11 Exploits Tragedy," May 19, 2002
[28] Kathleen Brady Shea, Philadelphia Inquirer, "Former Charity Head Sentenced to Prison for Fraud," March 1, 2002
[29] Report on the Office Of The Attorney General's Investigation of the J. Paul Getty Trust, California, October 2006
[30] Ibid
[31] Harvy Lipman, The Chronicle of Philanthropy, October 12, 2006
[32] Ibid
[33] Ben Gose,The Chronicle of Philanthropy, December 16, 2008
[34] The Wall Street Journal, Madoff Created Air of Mystery, December 20-21, 2008
[35] William P. Barrett, Forbes, New Dog, Old Tricks, January 12, 2009
[36] US Senate Committee on Finance, Senator Chuck Grassley to the Chairman of the American Red Cross, February 27, 2006
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