Donor Due Diligence: A Necessary Evil

by John F. Young

Charitable organizations have a responsibility to vet donors to ensure that the gifts nonprofits accept do not cause unwanted consequences in the future.

When a nonprofit receives a large contribution from an unexpected source, the natural reaction is one of elation and pride in a job well done.

Unfortunately, charities recently have been subjected to legal action seeking to “claw back” donations allegedly connected with unlawful activities.

These claw-backs almost always result in negative publicity and can impact future fundraising activities.

In today’s environment, it is more important than ever for charities to understand the motivation behind a donor’s gift.

It is crucial to conduct due diligence of the donor, the source of funds and the effect a gift could have on the overall mission of the charity.

The board of directors is responsible for creating an environment that enforces a charity’s mission and forms the basis of the organization’s internal control structure.

At the direction of the board, management can develop a protocol to be executed each and every time a significant donation or pledge is secured. Of course, the definition of “significant” is different for every organization.

A solid “control-environment protocol” consists of procedures that identify red flags present in donor transactions of a specific size or other parameter. These flags will signal the need for enhanced investigative procedures.

A typical protocol could consist of the following:

  • An initial screening of a potential donor based on publicly available information and third-party sources. Conduct searches of the Internet and social-media websites such as Facebook and LinkedIn.
  • Further due diligence should be focused on a potential donor’s financial profile. This would include principal sources of income, investment portfolios, closely held companies and principal residences. Questions about the source of, and motivation for, the donation could uncover clues.
  • The charity also should spend time learning about the potential donor. The goal of this deeper due diligence is to uncover any criminal prosecutions or investigations, and to assess the donor’s reputation for integrity in the business and philanthropic community at large.

Comprehensive searches and inquiries can help ensure that no one affiliated with the donor, or any related entities, are linked to closed or ongoing criminal proceedings.

  • Administrators and fundraising staff also should consider tapping their network of peers in the local community. In Florida, Philadelphia and other states, for example, individuals running Ponzi schemes began making large donations to a broad array of charitable organizations. Typically, those donors had an affinity for a particular type of service and focused on children, healthcare, the arts or some other specific population.

Throwing money all over town, with no personal connection to the organizations funded, could have raised red flags if people had been talking to each other. These charities were subject to claw-backs, some going back several years. In addition to losing critical funds, the ongoing negative media coverage has been a distraction for staff and donors.

Investigating the background of a donor and the source of contributed funds is often looked upon as a necessary evil in the nonprofit world.

Fundraising staffs work very hard in locating and convincing potential contributors of the social worth, accountability and transparency of their organizations.

Following this phase of the fundraising activity by asking difficult questions concerning the sources of one’s income and wealth, and soliciting personal information for background investigations, is uncomfortable but absolutely necessary in today’s environment.

John F. Young is director-in-charge of the audit and attest practice of the accounting and consulting firm Berkowitz Dick Pollack & Brant.

Reprinted with permission of Philanthropy Journal.

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