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What’s the risk?

Allegations of negligence or intentional misconduct often motivate lawsuits against nonprofits. In certain situations, responsibility for harm may be considered automatic whether or not there’s negligence or misconduct. Nonprofits also can be held liable even when volunteers act outside the scope of prescribed duties or accepted procedures.

Still, most organizations have to manage volunteer-related risks as best they can, because operating without unpaid help would be impossible. But you can use volunteers with greater confidence by adopting certain practices. Just be sure to create policies with input from legal counsel.

How do you mitigate risk?

Your volunteer recruitment process should be almost as formal and structured as your paid employee hiring process. Before seeking volunteers, develop job descriptions for open positions that outline the nature of the work to be performed, any required skills or experience, and any possible risks the job presents.

Screen prospective volunteers according to your nonprofit’s mission, programs and likely volunteer activities. Some positions will pose few risks and your screening process can be relatively basic: Ask candidates to fill out an application and submit to an interview, and then check their work and character references. Positions that carry greater risks — such as work involving children, the elderly and other vulnerable populations, or direct access to cash donations — require a more rigorous process.

Once volunteers are on board, provide training, supervision and, if necessary, discipline. At a minimum, training should involve an orientation session to explain your nonprofit’s mission and policies. Once volunteers have begun working for you, actively supervise them.

Do you need insurance?

Adequate insurance is critical. In addition to general liability coverage, your nonprofit may want to consider supplemental policies that address specific types of exposure such as medical malpractice or sexual misconduct.

Contact us. We can help review your nonprofit’s current insurance coverage and risk mitigation policies and identify threats you may not have considered.

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Not-for-profit organizations may operate under the assumption that their missions and their board members’ good intentions protect them from litigation. Sometimes, this assumption is proven wrong with a lawsuit. To protect your leaders from financial exposure, consider directors and officers (D&O) liability insurance. This coverage allows board members to make decisions without fear that they’ll be personally responsible for any related litigation costs.

Protecting key individuals

D&O policies are designed to protect both your organization and its key individuals: directors, officers, employees and even volunteers and committee members. Normally, D&O insurance covers allegations of wrongful acts, errors, misleading statements, neglect or breaches of duty connected with a person’s performance of duties.

Such coverage typically would protect from allegations of mismanagement of funds or investments and employment issues such as harassment and discrimination. D&O insurance also usually covers claims of self-dealing, failure to provide services and failure to fulfill fiduciary duties.

If a legal complaint is filed against them, insured organizations contact their insurer to determine whether the matter is insurable and includes defense costs. Most policies reimburse the insured for reasonable defense costs, in addition to covering judgments against the insured.

Observing policy periods

D&O policyholders need to be aware of a few caveats. This type of insurance is claims-made, meaning that the insurer pays for claims filed during the policy period even if the alleged wrongful act occurred outside of the policy period. So D&O insurance provides no coverage for lawsuits filed after a policyholder cancels, even if the alleged act happened when the policy was in effect.

If you need to make a claim after your policy has been canceled or expired, you might still be covered if you have extended reporting period (ERP) coverage. It generally covers newly filed claims on actions that allegedly occurred during the regular policy period.

Considering cost constraints

Most nonprofits are cost-conscious and you may be wary of adding another insurance policy. To keep costs down, think seriously about the people and actions that should be covered and the amount of protection you need — and don’t need. If you already have general liability and workers’ compensation insurance, you probably don’t need coverage of bodily injury or property damage. And if you opt for higher deductibles, your policy will be less expensive.

Nonprofits in some states may not need D&O insurance because volunteer immunity statutes provide limited protection for negligence. Contact us for more information about the insurance you need and general risk-prevention strategies.

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Lobbying and campaign activities

There are many categories of tax exemption — each with its own rules. But certain hot-button issues apply to most tax-exempt entities — such as lobbying and campaign activities. Having a Sec. 501(c)(3) status limits the amount of lobbying a charitable organization can undertake. This doesn’t mean lobbying is totally prohibited. But according to the IRS, your organization shouldn’t devote “a substantial part of its activities” trying to influence legislation.

For nonprofits that are exempt under other categories of Sec. 501(c), there are fewer restrictions on lobbying activities. Lobbying activities these groups undertake must relate to the accomplishment of the group’s purpose. For instance, an association of teachers can lobby for education reform without risking its tax exemption.

The IRS considers lobbying to be different from campaign activities, which are completely off limits to Sec. 501(c)(3) organizations. This means they can’t participate or intervene in any political campaign for or against a candidate for public office. If you’re not a 501(c)(3) organization, campaign restrictions vary.

Excess profit and unrelated revenue

The cardinal rule about excess profits is that a nonprofit can’t be operated to benefit private interests. If your fundraising is successful and you have extra income, you must put it back into the organization through additional services or by creating a reserve or an endowment. You can’t use extra income to reward an individual or a person’s related entities.

If you’re generating income through a trade or business you conduct regularly and it’s outside the scope of your mission, you may be subject to unrelated business income tax (UBIT). Examples include a college that rents performance halls to noncollege members of its community or a charity that sells advertising in its newsletter. Almost all nonprofits are subject to this provision of the tax code, and, if you ignore it, you could risk your exempt status. That said, losing an exempt status from unrelated business income is rare.

Notice from the IRS

The best way to preserve your organization’s exempt status is to refrain from risky activities. But if you receive notice from the IRS of a violation, please contact us. We can help you respond and get your nonprofit back on track.

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In one recent cybercrime scheme, a mortgage company employee accessed his employer’s records without authorization, then used stolen customer lists to start his own mortgage business. The perpetrator hacked the protected records by sending an email containing malware to a coworker.

This particular dishonest worker was caught. But your company may not be so lucky. One of your employees’ cybercrime schemes could end in financial losses or competitive disadvantages due to corporate espionage. 

Best practices

Why would trusted employees steal from the hand that feeds them? They could be working for a competitor or seeking revenge for perceived wrongs. Sometimes coercion by a third party or the need to pay gambling or addiction-related debts comes into play.

Although there are no guarantees that you’ll be able to foil every hacking scheme, your business can minimize the risk of insider theft by implementing several best practices: 

Restrict IT use. Your IT personnel should take proactive measures to restrict or monitor employee use of email accounts, websites, peer-to-peer networking, Instant Messaging protocols and File Transfer Protocol.

Remove access. When employees leave the company, immediately remove them from all access lists and ask them to return their means of access to secure accounts. Provide them with copies of any signed confidentiality agreements as a reminder of their legal responsibilities for maintaining data confidentiality.

Don’t neglect physical assets. Some data thefts occur the old-fashioned way — with employees absconding with materials after hours or while no one is looking. Typically, a crooked employee will print or photocopy documents and remove them from the workplace hidden in a briefcase or bag. Some dishonest employees remove files from cabinets, desks or other storage locations. Controls such as locks, surveillance cameras and restrictions to access can help prevent and deter theft.

Treat workers well. Create a positive work environment and treat employees fairly and with respect. This can encourage loyalty and trust, thereby minimizing potential motives for employee theft.

Wireless risk 

In addition to the previously named threats, your office’s wireless communication networks — including Wi-Fi, Bluetooth and cellular — can increase fraud risk. Fraud perpetrators can, for example, use mobile devices to gain access to sensitive information. One way to deter such activities is to restrict Wi-Fi to employees with special passwords or biometric access.

For more tips on preventing employee-originated cybercrime, or if you suspect a fraud scheme is underway, contact us for help.

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Operations and accounting policy snapshot

One important set of footnotes is the summary of significant accounting policies. This includes two sections. The first is a brief description of your operations (featuring your chief purpose and sources of revenue). The second is a list of the significant accounting policies that have been applied in preparing your statements.

Your summary should outline specific policies such as:

• The accounting method you used,
• Classification of cash equivalents,
• Fixed asset capitalization levels,
• Depreciation methods,
• Uncertain tax positions,
• Recognition of contributions and grants as revenue, and
• Recognition of in-kind contributions.

Investment lowdown

Footnotes are also used to disclose information related to investments. This includes the types of investments held, the carrying amounts for each major type of investment you own and the current year income.

You also must disclose any related-party transactions such as those between board members, senior management and major donors. Include the nature of the relationships between the parties, the dollar amount of the transactions and any amounts owed to or from the related parties as of the date of the financial statements.

Note existing contingencies

Your footnotes should further cover any reasonably possible loss contingencies. Contingencies are existing conditions that could create an obligation in the future and that arise from past transactions or events. Disclose the nature of a contingency and provide an estimate of the loss (or state that an estimate can’t be made).

Contingencies might include:

• Pending or threatened lawsuits,
• Claims against your organization,
• Costs already incurred where reimbursement could be disallowed under a government grant, or
• IRS examinations related to tax-exempt status, unrelated business income and excise taxes.

Be sure to disclose any time that your organization hasn’t used funds in compliance with donor restrictions.

Your statements’ footnotes should also disclose information that allows users to compare the total amount of fundraising costs with related proceeds. If a ratio of fundraising expenses to funds raised is disclosed, you should cite the method used to calculate it.

Get help

As you can see, most financial statement footnotes contain technical information best prepared by an accounting professional. Let us help you with your financials.

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