Attorney General’s Charity Chief: Fraud Is “Surprisingly Common”

James G. Sheehan is not the man you want a phone call from—if you’re a charity, that is. 

Sheehan is chief of the New York attorney general’s charities bureau. It’s his team that gathered evidence to slap a fraudulent leukemia charity with a lawsuit in late July. The organization allegedly bilked $10 million from generous New Yorkers who thought they were helping dying children—less than 1 percent of the money made it to leukemia patients.

Attorney General Eric Schneiderman denounced the group. “Nothing is more shameful than pocketing millions of dollars donated by good-hearted people who just wanted to help children afflicted with a terminal illness,”he said. “My office will continue to identify, investigate, and shutter so-called charities that use legitimate-sounding names to exploit the generosity of New Yorkers and betray the public’s trust.”

While Sheehan’s division invests significant resources to catch charities that brazenly fleece donors, most New York nonprofits are unlikely to get caught up in those schemes or unwittingly associate with them. 

”The charity that we sued…last month is an extreme outlier,”Sheehan explained. “They work with a fundraiser that takes 80 plus percent of the money that they collect.”Such operations heavily rely on aggressive telemarketing tactics that target the elderly and are unlikely to partner with legitimate charities.

"Generally, that's not a problem that most reputable charities in New York are going to face,”Sheehan said.

However, he warns that frequently there are potential problems hiding in plain sight for many charities—even at well-intentioned and otherwise ethically-run ones.

"One of the things we do tend to see a lot of is embezzlement and fraud within the organization, often by very trusted people,”Sheehan said, although his office could not provide statistics, as they said such data is difficult to track. “The classic model of an embezzler is someone who never takes a vacation. They're very good at what they do. People like them. They're relatively quiet.”

If that seemingly harmless description sounds disturbingly like one of your colleagues—or yourself—you should take comfort in your company’s internal system of checks and balances. Basically, Sheehan said, the solution is to have systems set up to dissuade any would-be fraudsters and encourage a culture of accountability.

It’s when that system is not very robust that Sheehan’s office often sees problems arise.

At the charity bureau’s office, the investigative team put together a chart compiling all the fraud cases against charities in the state. It showed that spectacular greed from embezzling executives is not limited to those organizations that intentionally set out to defraud the public.

”It's a surprisingly common problem,”Sheehan cautioned. “And it's especially common in organizations that have had the same leadership for a long period of time.”

A case in point was the Metropolitan Council on Jewish Poverty scandal.

William Rapfogel, former head of the council, was jailed for his part in a $9 million scheme that stretched over two decades and filled his pockets with a million dollars in cash, originally intended to help the half million poor or near poor Jews in New York City.

But after such scandals, Sheehan said, is when the important work of implanting those safety mechanisms begins.

For those charities that do get the dreaded call from Sheehan’s office, the conversation goes something like this: ”’Okay, charity,”Sheehan said, playacting. “‘You were defrauded. But what are you going to do to make sure it doesn't happen again?’”

Not all organizations clean up their act, Sheehan said. “We’ve seen organizations that have the same event occur two or three times because their control process is weak."

But others have managed to bounce back.

"You can look at the Metropolitan Council on Jewish Poverty,”Sheehan offered. “We have a consent agreement with them as to what they're going to do to respond to it. And they've done reasonably well.”

Of course, it’s far better to have those safeguards in the first place, he said.

When the charity bureau looks at a 501(c)(3), there are a couple telltale signs that there could be a problem. 

One red flag is long-serving board members. While keeping loyal and supportive board members on for the long haul is tempting, it’s best practice to reinvigorate the board with new blood regularly, Sheehan said.

While long-term service won’t necessarily breed full-blown fraud, in the bureau’s experience, conflicts of interest and problems with “related party transactions”can easily creep in.

"People are committed to the mission,”Sheehan said. “But sometimes the first stop is: Who's in this business that we know. And that often is a board member. So making sure you have strong conflict of interest rules and related party rules is really important to making your decision work."

He has served on three different boards himself—all of them had term limits, he said.

“I think it's a good idea,”he said of the limits. ”The research suggests that the longer people are together, as a board, the more likely this problem is to occur.”

Another red flag would be a skimpy audit.

The audit should include a look at control weaknesses in the organization, how accurate the reports are, and how complete the review is. It should also involve “fraud brainstorming,”a process to imagine how or where the charity could be exploited.

One of the things Sheehan wants nonprofits to ask in their fraud brainstorming is: What has happened to similar organizations in our field?

“So, for example, [with the Metropolitan Council on Jewish Poverty], what they were doing was paying kickbacks to the company that writes their insurance,”Sheehan said.

And while auditors are required to engage in this kind of brainstorming, one might ask: Is there a place to find that kind of information?

"That's a very good point,”Sheehan admits. “Right now, there isn't."

Sheehan hopes charity auditors will start working on it. “It's a developing area in the field,”he said. “And I think it could use a push."

But even audits are not the best way to expose fraud—whistleblowers are, according to the National Council of Nonprofits. In their 2014 report, the Association of Certified Fraud Examiners found that over 40% of all fraud is discovered as a result of a tip

“Whistleblowers typically call people internally first,”Sheehan said. “And then they call us.”Well-run charities will stay on top of any such complaints and respond to them, as required.

On a more technical note, Sheehan encourages charities to keep tabs on the regulations governing charities. A series of changes took affect in the last year. He highlighted two in particular that nonprofits should be read up on: the related party transaction requirements and the whistleblower guidance.

Additionally, Sheehan recommended new nonprofits contact the Lawyers Alliance. The organization provides low-cost services to help a new organization set up effective policies and controls from the start.

But for those daunted by the challenges of running a fraud-free nonprofit, Sheehan offered some advice.

“You don't always have to start your own nonprofit,”he said. “There are a lot of good ones."