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Special Report: Charity Accountability

Where does your money really go?

Contribute • November/December 2007

Created to alleviate poverty, the nonprofit Miami-Dade Empowerment Trust seemed for nearly a decade to be taking aim at South Florida’s most impoverished neighborhoods by creating new business opportunities and jobs.

As it happened, the organization also had been busy creating wealth for some of its own. The taxpayer-supported agency had lavished money on insider deals, lost money on failed loans, and spent hundreds of thousands on celebrity entertainers. Just one wasteful expense involved a tab of more than $87,000 to fly hip-hop star Sean “Diddy” Combs from New Jersey to Miami on a charted Gulfstream jet. Diddy’s antipoverty mission for the nonprofit? Hosting an MTV awards ceremony.

Suddenly, in September, it all came out in the open — on the pages of The Miami Herald, which detailed questionable practices going back years. The nonprofit couldn’t account for millions in expenses. It had exaggerated the numbers of jobs it had created. Board members and advisers benefited from insider loans. Some $175,000 had been spent on trips, including for singers Shakira and Eve, and actor Owen Wilson.

But perhaps even more telling than the abuses was the initial response to them: the nonprofit declined comment. And no wonder. It didn’t have to say anything. Nobody could make it say anything. Indeed, barring some allegation of outright illegality, those at the helm of a charity generally can persist in those trademarks of the nonprofit world: silence and denial.

By many measures, this is the golden age of the charitable-industrial complex: gifts are up. Growth is off the charts. These days, nearly everybody seems in on a benevolent act or he catalyst for one — movie stars, rock stars, former presidents, financiers, school teachers, and CEOs. From all appearances, the nonprofit sector has never been so positioned to make substantial headway against challenges such as disease, poverty, and environmental calamity.

Yet as Americans give away more money than ever before —the total amount of U.S. philanthropy is on track to top $300 billion this year — an unpleasant question lingers: how much of that money is well-spent, and how much of it is squandered? The uncomfortable truth: no one knows for sure, and even worse, few are checking.

Whether it’s wrongdoing, wasteful spending on administrative overhead, rent, or celebrity balls, or questionable proportions of benefit to causes and corporations in symbiotic cause marketing relationships, who can tell? The Internal Revenue Service lacks enough investigators to glimpse more than a minute sample of nonprofit behavior. Publicly disclosed forms often provide only a vague and incomplete picture of what’s going on. Some states are even unable to identify legitimate charities; they lack requirements for nonprofits to register. Other states lack even a single full-time attorney to investigate complaints.

“I always worry about how much money actually gets to the people that need it. There just doesn’t seem to be any oversight.”

Despite some tough talk by the feds in recent years — and initiatives in which tax authorities are said to be cracking down on nonprofit executive compensation and other abuses — the chances of an IRS audit are so remote that even shaky nonprofits can go for years without much risk of being caught. Even litigation is difficult: the Supreme Court has ruled there’s nothing inherently illegal about a charity that spends just 1 percent of donations on good deeds.

The result? Just about anything goes — an unregulated, unpoliced free-for-all in which anything might be happening to donor dollars, with anything short of blatant allegations of legal wrongdoing unlikely to be exposed, except occasionally by enterprising reporters or bloggers well after the fact. “These are times that try nonprofit souls,” says New York University Professor Paul Light. “It used to be that the nonprofit sector had the benefit of the doubt from donors. But not anymore. Donor confidence is shaky. Americans have come to believe that there is some sort of leaky bucket that no matter who they give to, some of the money will be lost through waste, inefficiency, and high executive salaries.”

Consider just a few recent headlines about what’s happening in this emerging Wild West of America’s nonprofit industry: in September, the Lucile Packard Foundation for Children’s Health in Palo Alto, Calif., reported that an employee had embezzled $350,000. Then, later that month, the director of the African Community Resource Center in Los Angeles was arrested and charged with embezzling more than $1 million. Previously, she had been named “Phenomenal Woman of the Month” by Oprah Winfrey’s O Magazine. And in October, a Goodwill employee was arrested for stealing more than $1,700 in donated goods. Finally, in late October, the Associated Press reported that the director of a Catholic charity, the North Fork Parish Outreach Center in Suffolk County, N.Y., used $700,000 in charity donations and thrift shop proceeds to finance her gambling habit, using much of that money to buy lottery tickets.

Some people tire of being so close to messy nonprofit situations. In October, Dorothy Cann Hamilton, the chairwoman of the James Beard Foundation Board, resigned five months before the end of her term, much of which was spent in damage control mode after the former president pled guilty to stealing from the foundation in 2005. “I have been put to my best and highest use,” Ms. Hamilton told The New York Times, referring to her reform efforts. “But it was never intended to be a lifetime appointment.”

At risk are more than a few sullied reputations. Nonprofits generate billions in revenue and over 8.3 percent of all wages and salaries in the United States each year, according to the National Center for Charitable Statistics in Washington. Yet despite a minimal risk of exposure, there is plenty of anxiety within the charity industry. Part of that is because the growth in charities is outpacing the growth in donations, according to Independent Sector, a nonprofit trade group that represents nonprofits in Washington. Since 2001, charitable giving has risen 12 percent while the number of charitable organizations has risen 23 percent. Adjust the numbers for inflation and the picture looks even worse. Total giving per charitable organization (in 2006 dollars) fell from approximately $382,000 in 1982 to $277,000 in 2006. Increasingly, donors would rather turn a blind eye, or walk away, rather than fight: donor churn is at an all-time high, with nearly one in two donors feeling underappreciated or ignored or simply fed up with bad management — and withdrawing their support within the first year, according to the Urban Institute.

And the trend is on the rise, says Mark Kramer, a senior fellow at Harvard University and founder of FSG Social Impact Advisers, a Boston philanthropy consultancy. Kramer, citing a survey he did for the Gates Foundation, says more donors today are becoming increasingly skeptical of the traditional nonprofit system and would rather start their own nonprofits than trust their money to an existing one. Adds Eric Kessler, principal and managing director of Arabella Philanthropic Advisors, an advisory firm based in Washington, DC: “The same people who feel like they got burned by Enron are also feeling like they got burned by some of these big nonprofits.”

And once a big scandal hits the news, many assume the worst; one bad apple tarnishes the rest. “People don’t differentiate from one charity to another. They think what they’re reading and hearing is the tip of the iceberg,” says Diana Aviv, president of Independent Sector, who opposes mandatory nonprofit regulation. “I’m very worried that the big scandals damage the image of the sector,” Aviv says.

The anxiety is more than palpable. A national survey conducted for Contribute by Harris Interactive poll puts some striking numbers on the extent of the concern and mood for change. While most of the 3,040 people surveyed between October 11 and October 15 feel strongly about the role of philanthropy, large majorities are increasingly skeptical of how nonprofits spend money — to the point of saying they believe nonprofits should be subject to more policing. As many as three-fifths of those surveyed said they agree or “agree somewhat” that there should be more regulation of nonprofit/charity organizations. More than half — 56 percent — acknowledged being more concerned about charity misuse of funds or services than they were a decade ago.

While illegality and ethical transgressions make news, nonprofit dollars can be consumed in a variety of never-intended ways, from funding excessive executive salaries to increased expenses tied to retaining existing donors and keeping new ones from walking out the door.

Sometimes, the money isn’t used at all: the 2006 tax return for the Schwarzman Charitable Foundation — the family foundation held by hedge fund mogul and Blackstone Group Chairman and CEO Stephen Schwarzman — shows five-figure assets of $63,424but only $991 of that being used for charitable purposes.

Yet for all of the instances of waste and worse that have surfaced in recent years, many politicians respond with little more than shrugs. “I see very little real interest in aggressively using resources to go after the bad guys,” says Rick Cohen, former executive director for the National Committee for Responsive Philanthropy and currently a correspondent for The Nonprofit Quarterly in Washington. Cohen is hardly exaggerating. The new head of the Senate Finance Committee was recently asked about cracking down on abusive charities. “That’s not at the top of my list. I haven’t got time,” Sen. Max Baucus, D-Mont., acknowledged in an interview published last summer in The Chronicle for Philanthropy.

Then, in October, that same publication reported that the Council on Foundations“ is changing its legislative strategy because it has gotten signals from Democratic leaders that they are more interested in efforts to promote philanthropy, especially during a time of federal budget constraints, than in regulating it.”

Some donors, meanwhile, practice what might be called give-and-forget; they don’t demand close accountability for how their money is being spent. But this, too, is starting to change. According to Blackbaud’s 2006 State of the Nonprofit Industry Survey, 31 percent of 657 organizations polled by the charity research firm said they were getting increased demands from donors asking to be updated on how their contributions were being spent, and 42 percent of organizations said they saw an increased demand from donors asking that contributions be restricted to a certain purpose — to the point that 48 percent, or nearly half of those nonprofits surveyed, reported that they’re now having trouble raising funds for general operating expenses, such as salaries or overhead to keep the lights on. In that same survey, 58 percent of charities said their biggest challenge was recruiting new donors.

Indeed, says Bill Levis of the Urban Institute’s Center for Charitable Statistics, donor retention is becoming an enormous problem for the industry at large. Blackbaud studies of nonprofit performance show that over the past five years, there’s been a gradual but steady decline in the number of nonprofit donors — particularly in the number of new ones.

Some funders are simply walking away from conventional giving channels and building their own. In 2002, a group of philanthropists frustrated with the U.S. health care system founded the Bravewell Collaborative, an operating foundation, to promote integrative medicine — and turn the traditional philanthropic model on its head. “The general feeling among philanthropists is that they’ve been burned,” says Bravewell founding member Christy Mack. “We don’t just write the check and say ‘Good luck, hope you use it the way we want.’” Instead, the collaborative oversees and runs a clinical network and a fellowship program, working closely with clinics and physicians to make sure the program on the ground matches the program on paper. New York philanthropist Lewis Cullman, who sits on the boards of New Leaders for New Schools, Chess in the Schools, and the Municipal Art Society of New York, shares Mack’s skepticism. “I always worry about how much money actually gets to the people that need it. There just doesn’t seem to be any oversight.”

That kind of crisis of donor confidence is definitely not a message that many nonprofits want to hear. Just ask Paul Light, the professor of public service at NYU’s Wagner School of Public Service. Five years ago, Light started a project monitoring the public’s confidence in charities. In 2006, he found that 71 percent of Americans say charitable organizations waste “a great deal” or “a fair amount” of money, up from 66 percent in 2005 and 60 percent in 2003. In the for-profit business world, that kind of wastewould draw plenty of scrutiny, and probably lead to firings a-plenty and intense scrutiny by investors and executives. In the nonprofit world? Light says it’s information “that nobody wants to hear.” His study ended this year for lack of funding (even though it only cost about $15,000 to run). “They just really weren’t interested in learning more,” he says of leaders in the charity sector. Whether indifferent or simply tired of hearing the obvious, says Light, “even people who have a great deal of confidence in the sector believe we don’t spend money wisely.”

Yet like any industry, the independent sector also has expended some serious time and energy on organized resistance to change. When members of Congress threatened to consider a new set of Sarbanes-Oxley–like requirements for nonprofits two years ago, the nonprofit world’s lobbyists in Washington resisted and came up with voluntary standards themselves, the better to stave off regulation. On October 18, the leading charity lobby, Independent Sector, put forth a 33-point plan outlining various ways the charity industry might better police itself, including a suggestion that it embrace a voluntary code of ethics. But even Independent Sector’s President Aviv concedes that the call for self-regulation isn’t endorsed by many charity-watchers and donors.

Doug White, an NYU instructor and a consultant for such groups as the Smithsonian Institution and Greenpeace, says: “There should be some legislation that should be scalpel oriented, but the lion’s share of the work has to be done by the charities themselves. They have to be self-motivated [to do the right thing].” After all, says White, “the question, ‘do you lie to donors?’ will never be on the Form 990…Some of the important reforms will have to be driven by the sector itself,” White told a Contribute roundtable on charity reform in Washington on Oct. 22. Trent Stamp, president of Charity Navigator, disagrees. “It’s time,” Stamp says, “to quit fooling around and go to an SEC for nonprofits.” Considering the size of the industry, its workforce, its involvement in tasks once the domain of government, its impact on the national economy, and on society overall, Stamp adds, “it’s time to regulate it for the big business that it is.” But congressional insider Dean Zerbe, a charity expert on the staff of the Senate Finance Committee, says such a measure would only pass Congress if charities supported it — an unlikely prospect.

To be sure, some even think the problem is too much regulation. In early October, mass-mailing and marketing specialists American Target Advertising sent a protest to the National Association of State Charity Officials, charging that its yearly conference“ will fail to address violations of law by the sector that

most consistently violates charitable solicitation law: state charitable solicitation officials themselves.” The long letter charged that individual regulation by states costs charities millions in wasted revenue, and claimed that many states are ignoring established Supreme Court decisions when they penalize charities.

At the state and local level, barriers to tougher scrutiny and rule-making include more than political indifference or unpopularity of going after seemingly good causes. It can be a matter of limited resources and other priorities. Jack Siegel, a consultant and former tax lawyer who writes a blog on charities, says it can be “just a practical problem — our state budget is a complete disaster, mass transit is on the verge of collapse and everybody’s screaming about the education system. To think that the Illinois attorney general is going to get ten more people in that office (to investigate charities) I think is sort of fanciful.” Regulation and policing of nonprofits is a hodgepodge across the country, at times almost nonexistent. Among the most active states is California, where Attorney General Edmond G. “Jerry” Brown, Jr., the former governor who took office this year, extracted a settlement in July from Noah’s Wish, a charity that solicited $8 million to rescue animal victims of Hurricane Katrina but spent only $1.4 million of it on them. He confiscated the $4 million remaining in Noah’s Wish coffers to redistribute to the intended beneficiaries, demanded that the charity provide governance training to its board, and barred the president from serving any charity in any capacity for five years. In June, he enjoined Sensory Integration International, a nonprofit that purported to treat autistic children, from conducting any business activities whatsoever until a trial could determine whether one of its officers was commingling charity assets with personal assets and self-dealing at the expense of the charity.

But Brown is an exception. Charities based in Florida (a state that ranks fourth in the nation in the number of nonprofit organizations registered with the IRS and14th among states in terms of the amount of money given to charities) raised $19.5 billion in 2006. Yet the state doesn’t have a single full-time auditor, investigator, or prosecuting attorney devoted solely to monitoring their books.

The situation couldn’t be more different in Pennsylvania, which lags Florida both in the number of charities based within its borders and the amount of money they raise — but has recently expanded its charity investigation staff to five investigators, four auditors, and a full-time prosecuting attorney.

As in any boom, huge sums fuel temptation — a vulnerability that nonprofit insiders have cautioned about for years but to little effect. J.J. McNab, a financial consultant and author of Tools and Techniques of Charitable Planning, put it succinctly before Congress in 2004: “Bad players have discovered that they can use small, hungry, or newly formed tax-exempt organizations to conceal everything from Ponzi and affinity scams to high-end corporate fraud and terrorism funding… (and) even good themselves sorely tempted to, if not sell their souls, at least rent them out to the highest bidder.”

But reliable, complete information about charities and nonprofits is hard to come by. Consider that the chief method of gaining a glimpse of a nonprofit’s inner workings, the IRS Form 990, deals only in broad financial categories. “For better or worse, the tax form is the nonprofit disclosure instrument,” says Peter Swords, an expert on nonprofit tax reporting and the former head of the New York Nonprofit Coordinating Committee. “It is to nonprofits what the SEC regime is to regulated companies, and it is something that ought to be taken very seriously.”

Yet hundreds of thousands — or millions —of dollars can be listed as expenses or salaries, with little sense of whether they were legitimate. Indeed, deciphering a 990 would challenge an ace detective — and probably has. Yet should a donor have to moonlight as an accountant or detective just to make sure his or her money is properly spent? “It can be easier to understand how much a Fortune 500 executive is paid than how much a charity is paying executives due to the shell games that go on,” Sen. Charles Grassley, R-Iowa, wrote to the Treasury Department, complaining about the current 990 form.

When the IRS released a proposed redesign of the form this summer, it got thousands of comments from the nonprofit sector, and backed off some of the changes. Many objected to the idea that a generic form can truly reflect whether an organization is efficient or not. “We had stars in our eyes starting out,” says Steven T. Miller, commissioner of the Tax Exempt and Government Entities Division of the IRS, the arm that oversee charities and sought to put more regulatory teeth in the form. “We thought it would be great if Joe Blow could compare organizations by looking at the 990 (and) we tried to improve the form to do that, but we have not been successful,” Miller told nonprofit leaders at the Independent Sector’s annual convention Oct. 23 in Los Angeles. “I don’t know if we’ll ever be able to get there. It’s a pity.”

So is all the stench and smoke surrounding charities a sign of doom for the sector? Is all the talk advocating reform — self-regulation or otherwise, just that — talk? Hopeless?

Hardly, says Marion Fremont-Smith, a senior research fellow at the Hauser Center for Nonprofit Organizations at Harvard University, whose experience with nonprofit organizations began in the 1960s, when she served as assistant attorney general and director of the Division of Public Charities in Massachusetts. She thinks the debate over Form 990 has been “very productive,” considering there might not have been one at all.

And while Supreme Court rulings limit the ability to challenge even seemingly excessive fundraising costs, states have other powers. “The power of the states to [oversee] charities is broader,” she says, noting that attorneys general have near exclusive standing to bring suit for abuse of the old common law concept of “charitable duties” — which include the avoidance of personal gain at the expense of a charity and gambling with a charity’s money.

Yet the most surprising force for reform is coming from an unexpected source: bloggers, activist donors, and young entrepreneurs who are willing to spend extra time monitoring charitable organizations. An example is Perla Ni, a former publisher of the Stanford Social Innovation Review, who, aiming to guide donors the way Zagat guides diners, earlier this year launched sf.greatnonprofits.org to open a few windows.  At Stanford, she realized how little was known about the nonprofits her publication regularly wrote about. Who were the good ones? Who used money wisely? Says Ni: “There’s nothing like transparency and empowering volunteers and clients to have a voice to improve accountability.” Other such efforts include London’s Intelligent Giving group and Web site. Founded in 2004 by journalist Peter Heywood, its mission is “to help you give happily and with confidence.” Heywood notes that he wants “to find a way of helping people less fortunate than me, but I’ve discovered this isn’t as easy as it sounds, largely because it’s tough to work out which charities to give money to.” Adam Rothman, a feature editor of the London-based site, recently took a British charity, the Wooden Spoon Society, to task for spending too much on overhead and not enough on the needy children it serves. “This is a truly dismal performance that lets the whole (charity) side down,” Rothman wrote in a recent posting.

To be sure, says Charity Navigator’s Stamp, today’s younger activists are mostly looking to find better ways to help society, and a partnership announced in September between the Case Foundation, the Gates Foundation, and MTV—called Think.MTV.com—“aims to be the definitive online resource and rallying point for young change makers…where everyone from sunny day volunteers to die hard activists can Get Educated, Get Connected, Get Heard, Get Active, and Get Rewarded,” noted a press release.

Stamp says that what major charities should note is that they weren’t chosen to implement the project. He says that if the charity sector keeps acting as if high-profile scandals are just business-as-usual, younger donors may be far more likely to tune out completely — as both donors to traditional nonprofits and as their employees. “For the first time in several generations,” Stamp says,“ young people have money. It’s one thing to be disenfranchised and poor. It’s something else to be all those things and have a nice fat checkbook.”

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