Misgivings

Some foundations are pushing nonprofits to create more measures around the outcomes of their activities. For example, a homeless shelter would measure not just how many beds it provided, but also its impact on poverty in the neighborhood. Such measures emphasize not only efficiency, but effectiveness as well. The Bill and Melinda Gates Foundation and the William and Flora Hewlett Foundation have been at the forefront of pushing for these changes. Also, a movement among nonprofits to measure social return on investment as a better bottom line than efficiency is under way.

But one thing could stand in the way of getting better measures of effectiveness: it requires spending on administrative costs to conduct the research. Without a little understanding on the part of efficiency-minded donors, those research dollars could be hard to come by.

Joseph McCafferty is departments editor at CFO.

Who's Watching?

While nonprofits have plenty of incentive to show low overhead, there is little disincentive for doing so, because regulators are paying almost no attention. The federal agency that has responsibility for overseeing the Form 990s, the Internal Revenue Service's Tax-Exempt and Government Entities Division, is severely underfunded, says Elizabeth Keating, a senior research fellow at Harvard University's Hauser Center for Nonprofit Organizations. "Most of its resources go to deciding if organizations are eligible for tax-exempt status, not making sure that they are living within the [reporting] rules," she says.

For the most part, nonprofit reporting is policed at the state level, either by the attorney general or the secretary of state, and states vary greatly in their requirements. Some states, such as California, New York, and Massachusetts, demand independently audited financial statements for any nonprofit with revenues over a certain amount — $2 million in California, $500,000 in Massachusetts, and $250,000 in New York. Other states, such as Nevada, Kansas, and Kentucky, require almost no additional reporting beyond the Form 990, while some states don't even require a 990.

"There's almost no oversight. The sector is regulated as if it were a bunch of kids selling lemonade," comments Trent Stamp, president of Charity Navigator, an online watchdog group that evaluates nonprofit finances. "Is there the potential for an Enron-type situation in the nonprofit world? Absolutely."

To fill the void in oversight, private-sector watchdog groups have emerged. For instance, the Better Business Bureau's Wise Giving Alliance compiles reports on more than 500 charities; the reports include a review of the nonprofit's finances. Charity Navigator, for one, rates charities on the ratios they report, using an automated analysis of their 990 filings. Nonprofits that rate poorly on Charity Navigator's four-star scale usually spend a high proportion on administration and fund-raising. Other services, such as GuideStar, post 990s online without judgment.

However, these monitors can judge only by what gets reported in the 990, which may not be reliable. "Any nonprofit that can't manipulate the 990 to show better overhead and fund-raising just isn't trying very hard," says Paul Light, a professor at the Robert F. Wagner School of Public Service at New York University. — J.McC.

Is Supporting Distorting?

One potential source of nonprofit accounting abuse is the use of a separate entity to conduct fund-raising activities and carry the associated costs on its books. Such entities, known as supporting organizations, are common, especially for hospitals, and there is nothing illegal per se about them. But at a minimum, the setup does have the effect of making the parent organization look better in terms of efficiency and fund-raising costs.

Take Children's Memorial Hospital in Chicago, one of the top children's hospitals in the country. For the 2004 fiscal year, the latest one reported, the hospital reported direct public support of more than $37 million and government grants of more than $24 million. A glance at its accounting would show that it has a good efficiency ratio and a fantastic fund-raising ratio. Indeed, the hospital reported no fund-raising costs at all, because its fund-raising is conducted by a separate nonprofit called the Children's Memorial Foundation. The foundation raised $17 million in direct public support, but it spent almost $10 million to do it.

Trent Stamp, president of Charity Navigator, an online nonprofit monitor, says supporting organizations are sometimes used to hide fund-raising costs, enabling nonprofits to conduct lavish fund-raising events without fear of criticism. Supporting organizations also provide charities with a means of keeping huge CEO compensation out of sight, asserts Stamp, with each organization reporting only a reasonable-looking portion of the compensation.

Indeed, supporting organizations can sometimes resemble the special-purpose entities that were at the center of the financial fraud at Enron. Stamp, for one, believes that entities under the same organizational roof with the same mission and the same management should be required to report as a single entity. "If the massively complex and decentralized Red Cross can consolidate [its] operational entities into one entity with one financial-reporting mechanism," says Stamp, "can you honestly argue that the local performing-arts center needs to be six separate institutions?" — J.McC.

• « previous
• 1
• 2
• 3
• 4
• 5
• next »