Money changers?

JACQUELYN ALLEN-MACGREGOR loves horses-so much that her passion may land her in prison. Once prominent in Michigan equestrian society, the former finance chief of Capital Area United Way pleaded guilty to charges in connection with embezzling $1.9 million from the charity between 1996 and 2002. In February, she told a federal court that her love for expensive show horses drove her to steal the money. A federal judge is scheduled to sentence Ms. Allen-MacGregor on June 16.

Such cases have increased public concern over nonprofits' fiscal management-and increased the clout and visibility of watchdog groups like Charity Navigator and the American Institute for Philanthropy (AIP). The growing availability of data from such groups is prompting more donors to ask before they give: How much of the money a charity raises actually benefits its cause?

Sometimes, not much. Take VietNow, for example. The veterans aid group and Telemarketing Associates (TA), both based in Illinois, in the early 1990s entered into an agreement in which TA would solicit donations for the charity by phone. VietNow would receive the money, less TA's cut for doing the work. No problem there: Nonprofits hire outside fundraisers all the time. But TA told VietNow donors that up to 90 percent of their contributions would help veterans.

That was far from the truth: By contract, VietNow received just 15 cents of every dollar raised and TA kept the rest. The charity ended up receiving only $1.1 million of more than $7 million raised. The U.S. Supreme Court last month reversed a lower court's ruling that the First Amendment protected the telemarketers' pitch: The Constitution, wrote Justice Ruth Bader Ginsburg, does not protect fraud.

The Internal Revenue Service requires nonprofits to account for spending on fundraising, "general/ management," and "program services." But a May 2002 General Accounting Office (GAO) study found that increasing donor and watchdog pressure gives charities "an incentive to report their expenses in a manner that make them appear to be efficient."

To do this, some nonprofits "net" their fundraising expenses, a direct violation of IRS guidelines, the GAO reported. Here's an example: An outside telemarketer raises $250,000 for a charity but keeps $150,000 as a fee. When reporting to the IRS, though, the charity reports as a direct public contribution only the $100,000 it received, and not the $150,000 the fundraiser kept. This masks the group's fundraising expenses, creating the accounting illusion that a higher percentage of donations directly benefits the needy.

Some charities also make themselves look better on paper by puffing up program-spending numbers with useless "gifts-in-kind." In the aftermath of the Bosnian war in 1996, for instance, about 17,000 tons of unusable medicine sat in Bosnian warehouses, funneled in by relief organizations that accepted the unneeded drugs from pharmaceutical companies.

Drug companies that donate excess medicines instead of destroying them save $2,000 per ton in disposal costs-and receive a hefty tax deduction. American Institute for Philanthropy head Daniel Borochoff explained that charities sometimes accept and distribute such inappropriate gifts-in-kind because donations come in a package deal, and they must take the bad to receive the good.

Meanwhile, Paul Nelson, head of the Evangelical Council for Financial Accountability (ECFA), said spending ratios sometimes make groups appear less efficient than they really are. For example, an overseas aid group may spend more on general/management expenses because it stations auditors in foreign countries to ensure donations reach intended recipients rather than local black markets. Although the auditors' salaries may raise overhead-making the group look worse on paper than other similar charities-the charity may actually be reaching more needy people with aid because of the auditors' work.

Many nonprofits strive for fiscal transparency by joining groups like ECFA, or by adhering to charitable accountability standards such as those published by the Better Business Bureau Wise Giving Alliance. When researching charities, said Suzanne Coffman, of the Internet charity information site Guidestar.org, donors should compare charities doing the same kind of work-food banks with food banks, for example. That's because acceptable spending ratios vary for different kinds of nonprofits.

Donors should be aware that even recognized accounting standards leave room for interpretation, said Ms. Coffman, and that some charities will manipulate the system to their advantage. "But I think a vast majority of nonprofits understand that there's a trust issue that goes on here, and that being transparent and accountable is important." The bottom line, she said, is that nonprofits should be prepared to explain to donors why certain expenses are reasonable.