Two Years After Madoff: An Argument for Foundation Audits
By: William C. Jenczyk, CPA, and Laura Barooshian, CPA, MST
It's been two years since Bernie Madoff pleaded guilty to 11 federal felonies for his elaborate Ponzi scheme that swindled investors out of billions of dollars. Still, fraud continues to be rampant. And foundations, which are rarely audited, sometimes prove to be an easy mark for embezzlers and thieves.
Just look at the news headlines on any given day: Operating under the name Hawaiiloa Foundation, five members of a native Hawaiian sovereignty group on Maui were recently indicted on various fraud and tax offenses related to a debt assistance program. A Washington D.C. council member has been accused of using grant money and charitable donations for personal golfing trips, hotel stays and a new sport utility vehicle. The list goes on.
Madoff aside, fraud has been a problem for foundations ranging from small, local family foundations to the $21.7 billion Gates Foundation. Google "foundation fraud" and you'll get 70 million hits. And that covers just the fraud that has been detected. Given that foundations typically are not audited, consider how many cases of fraud may exist that have yet to be detected.
So Why Aren't Foundations Audited? Good question.
Currently, California is the only state that requires foundations to be audited. In Massachusetts, annual reports for foundations are reviewed by the Attorney General. Given the rise in fraud, however, it wouldn't be surprising if more states start requiring audits of foundations in the future.
Also, foundations typically want to use every dollar possible for philanthropic purposes. If an audit is not required by law, it may be viewed as an optional operating expense that can be avoided. But that approach is short-sighted. An objective, third-party look at the foundation's financial statements, which includes gaining an understanding of internal controls, provides transparency, peace of mind and validation for a well-run foundation.
Arguments for Private Foundation Audits
Most of the private foundations that exist today were established by prior generations as a way of supporting a cause that had personal significance to them. These foundations were often entrusted to a custodian who was responsible for reporting assets, making the appropriate contributions, and ensuring that the goals of the foundation were being met. This arrangement may have been going on for years without strict oversight--and could still be in place to this day.
From an accounting perspective, this is exactly the type of situation that easily leads to fraud, embezzlement and other Madoff-type activities, when large amounts of money are controlled by one person or even a small group of people. However, the benefits of an audit go well beyond the prevention and detection of fraud to include:
• Avoid potential liability and tax penalties. As a tax-exempt entity, foundations are under scrutiny by the IRS. If funds are being misused, trustees can be held responsible. Foundations receive preferential tax rates, so it is essential that assets are being used for legitimate charitable purposes. Even the act of signing a tax return can subject a person to charges of perjury if the return does not accurately reflect the foundation's tax liability.
• Protect the family name. A foundation is often a family's legacy and if an incidence of fraud takes place, the family's reputation can be tarnished. In such cases, an audit can help ensure that the current generation is preserving its heritage.
• Carry out the mission. As custodians of the foundation, one of the trustees' roles is to carry out the foundation's mission. An audit will follow the money to provide a level of assurance that grants are provided to appropriate parties and that assets are being used for their designated purposes.
• Improve efficiency. An audit can improve a foundation's efficiency by helping trustees gain a better knowledge of their financial systems. It can help trustees understand whether proper internal controls are in place, identify key areas that need improvement and make recommendations that will strengthen the foundation's controls.
Our point is that the misuse of foundation funds can have serious negative consequences for everyone involved. How can you be sure that your foundation hasn't already been affected by fraud?
Simply put: would you rather have an audit conducted by an independent firm acting on your behalf as a trusted advisor or an audit conducted by the Internal Revenue Service?
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