The core problem

Earlier this week, The New York Times and the New York Post published reports about CORE Services, one of the biggest homeless shelter operators in New York City, and the self-dealing of its chief executive Jack A. Brown III. 

These allegations serve as a reminder of how nonprofits can be used to commit outright fraud or at least take advantage of legal gray areas to enrich themselves. This is because nonprofits are easy to set up, there’s a lot of them and they generally face limited scrutiny from outsiders. 

Nonprofits can easily be established, somewhat opaque and like any corporate entity they can provide a shield against personal liability.

There are over 1.5 million registered nonprofits across the country, which leaves the various federal, state and city agencies with oversight responsibility, such as the Internal Revenue Service and state attorney generals, stretched thin. Of course there are also a lot of for-profits but regulators focus more of their attention on certain types of for-profit companies over others, including the systemically important companies, the publicly traded companies and companies with higher perceived risk. This approach is verboten in the nonprofit sector, where for legal and cultural reasons, all organizations are treated equally.

Nonprofits are non-stock corporations, so nonprofit leaders have no shareholders to answer to. While they are governed by their boards of directors only in rare cases, like with membership organizations or Federally Qualified Health Clinics, does any outside group have the right to appoint any of these directors. This allows leaders who wish to avoid scrutiny the option of filling the board with patsies or friends. 

Few outsiders have an economic incentive to examine even the largest nonprofits closely in the way that rating agencies or investors scrutinize the largest for-profits. The lack of detail in the publicly available data, which is often only found on an organization’s Form 990, also makes it difficult for even the most intrepid analyst to really understand an organization’s spending, program impact, related-party transactions and compensation. There isn’t an equivalent, even for the largest nonprofits, to comprehensive disclosure requirements that large, publicly traded companies satisfy through their annual 10K filings.

The government agencies that often contract with nonprofits are also surprisingly unable to spot problems. Their procurement, contracting and reporting processes typically focus on contracts without any real understanding of the values, governance and financial position of a nonprofit organization as a whole. For example, while Children’s Community Services raised obvious organizational red flags, its contract-level paperwork may well have been impeccable and it likely offered the lowest price for the particular contacts it received. In a similar vein, when FEGS Health and Human Services, then the largest social services nonprofit in the city, collapsed in 2015, nobody in the government saw its downfall coming despite the voluminous disclosure that the agencies received through the New York state’s Consolidated Fiscal Reporting System as well as other mechanisms. 

Nonprofit clients are often marginalized and find it difficult to agitate for better services, switch to another organization or blow the whistle on potential wrong-doing.

It is also worth highlighting that some nonprofits can wield considerable power. They can be major employers, real estate owners, important customers to for-profit vendors and politically powerful in their local communities. Unscrupulous leaders can often use this power to avoid scrutiny no matter how substandard they may be. 

Despite all of this, the city could easily eliminate the type of large scale nonprofit scandals that New York has seen in recent years by doing three simple things:

• Designate the 50 nonprofits with the greatest volume of city contracts as “systemically important nonprofit partners” and appoint an ex officio observer on the board or finance committee of every one of these organizations. This is not a novel idea, as the federal government already designates some Systemically Important Financial Institutions and the New York City Department of Cultural Affairs appoints ex officio observers to boards of certain institutions, such as the Bronx Museum of the Arts. 
• Prohibit nonprofits that are contracted by the city from employing related for-profit companies. The market for the things that nonprofits usually buy from related parties, including security, food and real estate, are commoditized and competitive. The notion that a nonprofit cannot secure these services from unrelated third-parties is preposterous and an obvious opportunity for self-dealing.
• Rebid contracts that fail to attract any credible organizations. In response to the allegations levied against CORE Services, Mayor Bill de Blasio said, “There are only so many organizations that provide the services.” While there are certainly times when new and less experienced organizations should be awarded contracts, if the city offers a large contract and not a single experienced nonprofit responds then the city should redesign that contract. If the current procurement rules prevent this then they should be changed.

Fixing the endemic problems with procurement, contract terms and payment delays will take a concerted long-term effort by the next mayor, the city’s comptroller, various city agencies and possibly philanthropists. Still, the task of avoiding large-scale scandals has easy, short-term solutions.

These scandals not only waste taxpayer money but they also erode trust in the nonprofit sector and denigrate all the people who work in it. In my experience, the vast majority of nonprofit leaders are honest, well-meaning, mission-driven people who work hard under very difficult circumstances. Yet trust in nonprofits has declined and these well-publicized scandals are part of the reason. Most importantly reducing fraud and self-dealing would deliver more and better services to those who need and deserve them most.