Nonprofit Embezzlement – What to Do When Lightning Strikes

nonprofit embezzlement

A nonprofit embezzlement incident is emotionally devastating, causing nonprofit leaders to question their own judgment and management ability. It erodes the public’s trust, jeopardizes grants and funding contracts, scares off new donors, can attract scrutiny from regulators, and in the worst cases, can bring down a nonprofit.

A 2013 investigation by the Washington Post drew attention to the problem of nonprofit embezzlement by examining significant diversions of assets reported on Form 990.

Nonprofit embezzlement can involve anyone: officers, directors, employees, volunteers, contractors, vendors, etc. In our experience, it is often someone that is trusted implicitly such that their reports are never questioned. This post offers a run-down of the steps nonprofit leaders can take to deal with the aftermath of an embezzlement incident.

What Action to Take in Nonprofit Embezzlement

Secure the nonprofit’s assets

Upon learning of the embezzlement, the first step the nonprofit leadership must take is to secure the nonprofit’s assets to prevent further losses. If the perpetrator was a signer on any bank accounts or had online access to accounts, revoke their access immediately. In case they had company credit cards, cancel them. If the loss involved other types of assets, take whatever steps are necessary to secure them.

Preserve evidence

Preserve evidence of the nonprofit embezzlement by revoking access to the suspect’s computer as well as company accounts including company email, cloud-based software platforms, and corporate social media accounts.

Sideline the suspect pending an investigation

If the nonprofit organization has either proof or strong suspicion of who the perpetrator was, the nonprofit will need to sideline the suspect while it conducts a thorough investigation. In case the suspect is an employee, place that employee on administrative leave. If they are a volunteer, suspend their clearance to serve as a volunteer.

Obtain keys and key cards

Secure the suspect’s keys and key cards if any. If there is a concern a copy was made or if the keys can’t be recovered, re-key the locks and change access codes.

Secure confidential information

Demand the employee to turn over any corporate confidential information in his or her possession. This can include hard-copy and digital files.

Conduct a thorough investigation

It may be necessary to bring in an outside investigator. Ideally, a forensic accountant will uncover exactly how much was taken and how it was taken.

Terminate suspect

Once the nonprofit organization has clear evidence that the suspect is responsible for the loss and that it was in fact nonprofit embezzlement, terminate the relationship with the individual. If the individual was an employee or a vendor with a contract, it is a good idea to consult with legal counsel.

File a police report

Ideally, the nonprofit organization should file a police report. The police report should strictly recite provable facts uncovered during the investigation. The nonprofit organization does not want to be sued for defamation.

Report the loss to the insurance carrier

Organizations’ general liability insurance may have coverage for theft. Those with employment practices coverage may have coverage for employee theft. However, to access it, the insurer typically requires a copy of the police report. Do not delay in reporting the event to the insurer as a delay could jeopardize coverage.

Attempt to recover funds from the perpetrator

It may be helpful to consult an attorney regarding options to recover stolen funds. If the funds were spent, the items that were purchased with the stolen proceeds may be able to be recovered and sold.

Report to the IRS

Significant Diversion of Assets

The IRS requires tax-exempt organizations to report a significant diversion of assets on Form 990. A diversion of assets includes theft, embezzlement, or any unauthorized use of the organization’s assets. The diversion is significant if the gross value of all diversions (not counting restitution, insurance, or similar recoveries) discovered during the tax-exempt organization’s tax year exceeds the lesser of 5% of its gross receipts for the year, 5% of its total assets at the end of the year, or $250,000.

A diversion that occurred in a prior year should be reported in the tax year it is discovered. The organization must explain on Schedule O the nature of the diversion, the dollar amounts involved, as well as any steps the organization took to correct the diversion. The organization should not identify the perpetrator by name.

Excess Benefit Transactions

If the perpetrator is a person who has substantial influence over the organization, the diversion could amount to an excess benefit transaction. An excess benefit transaction could result in penalty taxes on the perpetrator. It also jeopardizes the organization’s tax-exempt status.

Shore up Policies and Procedures

When an embezzlement, theft, or fraud event has occurred, it is critical that the nonprofit be honest about what happened and have a good story to tell. A good story should focus on the good news: it was caught, appropriately reported to the Police and the IRS, steps were taken to recover funds (perhaps they were even recovered), and the organization’s processes and procedures were overhauled to ensure it will never happen again. Depending upon the severity of the event and the level of public interest, consider engaging a crisis communications expert.

Deal Honestly with Stakeholders

If the nonprofit’s leadership isn’t honest and transparent with its stakeholders, they will sense something is off. Their assumptions will often be worse than the actual facts. Without naming names, the better approach is to be transparent about what happened and focus on the steps that the organization is taking to prevent it from happening again.

In particular, reach out to major funders as soon as possible. Funders have seen it all before and know that these things happen even under the best of circumstances. An open line of communication will go far to shore up confidence.

If lightning strikes your nonprofit organization in the form of nonprofit embezzlement, following the above steps will give it the best chance to recover. For ideas on how to avoid nonprofit embezzlement in the first place, check out our Top 10 Tips for Preventing Theft and Embezzlement.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.

Share this post

1 thought on “Nonprofit Embezzlement – What to Do When Lightning Strikes”

  1. I’ve been involved in a nonprofit organization for 34 year’s, I noticed in the last 3 years bylaws and constitution were not being followed, I asked the President for a financial report, and she immediately resigned, I approached the board gave them my findings, the board was to take a audit, they didn’t, this board has not been voted in to there position, I ask several members when was the last time they have been given a financial report, answer was 3 yrs, they have denied me to look closer to records, low and behold we had a 22 thousand dollar profit in one month, this President was in her position for 6 years, the June financial report shows many irregularities, that does not abide by bylaws and constitution pls help me with this situation

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top

How to Start a Non-Profit Organization

Download our free guide to learn about the many elements needed to run a successful nonprofit organization, as well as how to avoid common pitfalls and mistakes.