Two Years After Madoff: An Argument for Foundation Audits

Two Years After Madoff: An Argument for Foundation Audits

It's been more than two years since Bernie Madoff pleaded guilty to eleven felony counts stemming from an elaborate Ponzi scheme he devised and ran for years, swindling hundreds of investors out of billions of dollars. Still, fraud continues to be endemic in the financial community. And foundations, which are rarely audited, sometimes prove to be an easy mark for embezzlers and thieves.

Just look at the headlines on any given day: Operating under the name the Hawaiiloa Foundation, five members of a native Hawaiian sovereignty group on Maui recently were indicted on various fraud and tax offenses related to a debt assistance program. Here on the mainland, a Washington, D.C., council member was accused of using grant money and charitable donations for personal golfing trips, hotel accommodations, and a new sport utility vehicle. The list goes on.

Madoff aside, fraud long has been a problem for foundations. Google "foundation fraud" and you'll get seventy million hits. And that only includes fraud that has been uncovered. Given that foundations typically are not audited, consider how many cases of fraud have yet to be discovered.

So Why Aren't Foundations Audited?

Good question. Currently, California is the only state that requires foundations to be audited. In Massachusetts, annual reports for foundations are reviewed by the office of the attorney general. Given the increase in fraud, however, it wouldn't be surprising if more states start requiring audits of foundations in the future.

The situation is exacerbated by the fact that foundations typically want to use every dollar possible for philanthropic purposes. If an audit isn't required by law, it may be viewed as an optional operating expense that can be avoided a short-sighted perspective. An objective, third-party look at a foundation's financial statements that includes gaining an understanding of its internal controls is the best way to for a foundation to provide transparency and ensure the peace of mind of its directors.

Arguments for Private Foundation Audits

Many of the private foundations that exist today were established by wealthy businessmen and philanthropists from earlier generations as a way to support a cause that had personal significance for them. These foundations were often entrusted to a custodian who was responsible for investing its assets, making the appropriate charitable contributions, and ensuring that the goals of the foundation were met. Such arrangements often remained unexamined for decades and many are still in place today.

From an accounting perspective, it is exactly the type of situation large amounts of money controlled by a single person or small group of people subject to little or no scrutiny that leads to fraud, embezzlement, and other Madoff-type activities. However, the benefits of an audit go well beyond the prevention of fraud. For example, an audit can:

  • Help a foundation avoid potential liability and tax penalties. As a tax-exempt entity, foundations are overseen by the IRS. If foundation funds are found to have been misused, the foundation's trustees can be held responsible. Because foundations benefit from preferential tax rates, it is essential that their assets are used for legitimate charitable purposes. Even the act of signing a tax return can subject a person to charges of perjury if the return does not accurately reflect the foundation's liabilities.
  • Protect the family name. A foundation often is a family's legacy, and any allegation of fraud that attaches to it is sure to tarnish the family's reputation. An objective third-party audit can help ensure that current generations of family members are preserving the legacy handed down to them.
  • Help advance the mission. As custodians of the foundation, trustees are charged with making sure its mission is carried out. An audit will reveal how the foundation's assets are being used (and invested) and provide a level of assurance that distributions are being made for designated purposes.
  • Improve efficiency. An audit can improve a foundation's operating efficiency by giving trustees a better sense of whether proper internal controls are in place, which operational areas need improvement, and what needs to be done to strengthen its controls.

The misuse of foundation funds can have serious negative consequences for everyone involved. Simply put: Would you rather have an audit conducted by an independent firm acting on your behalf as a trusted advisor or an audit conducted by the Internal Revenue Service?

William C. Jenczyk, CPA (wjenczyk@dgccpa.com) and Laura Barooshian, CPA, MST (lbarooshian@dgccpa.com) are principals at DiCicco, Gulman & Company, a CPA and business consulting firm in Woburn, Massachusetts.