Details on FTC enforcement action against four cancer charities – 9

Federal Trade Commission Building in Washington, DC. - Picture courtesy of DollarPhotoClub.com

Federal Trade Commission Building in Washington, DC. – Picture courtesy of DollarPhotoClub.com

This is the ninth in a series of posts diving deep into the detail mentioned in the complaint by FTC and all Attorneys General against four named cancer charities.

The complaint can be found here. My posts in this series are visible using the FTC tag.

This is the first post in a series discussing allegations in the complaint asserting that the financial statements of the charities were misstated. Paragraphs 127 through 130 provide a condensed summary of the massive concerns the FTC has over the accounting for GIK shipments. There are severe accusations embedded in these four paragraphs.

To give you a hint where the FTC is going with this section, my paraphrase of the last sentence of paragraph 130 is the FTC alleges that the charities’ audited financial statements and 990s as provided to the IRS, state regulators, and the general public were “false and misleading.”

Deceptive Impact of Reporting GIK Transactions

  1. The increased contributed revenue and program spending Corporate Defendants reported – collectively over $223 million – had the effect of diminishing the reported percentage of revenue they spent on fundraising and administrative costs and increasing the proportion of reported expenses they spent on program services, making Corporate Defendants appear more efficient to donors than they actually were. Thus, the reported international GIK revenue for the five years from 2008 through 2012 resulted in CFA’s reported fundraising expenses being 25.4% of total contributions. In reality, 67.4% of consumers’ donations (including revenue from CSS), or 82.9% without counting CSS’s “contributions” to CFA, were spent on fundraising. For the same period, CCFOA used its international GIK revenue to report fundraising expenses of 47% of total contributions. In reality, 81.5% of consumers’ donations were spent on fundraising. Similarly, BCS reported fundraising expenses of 29% of total contributions, while in reality 84.6% of consumers’ donations were spent on fundraising. Corporate Defendants also used the inflated contributed revenue amounts when choosing purported “comparable organizations” for setting their executives’ pay, thus improperly increasing the Individual Defendants’ salaries.

You might wonder what’s the big deal if a charity records a GIK shipment when it should not, as alleged by the complaint. Revenue is increased by the valuation of the shipment and expenses are increased by the same amount. Impact on the bottom line, or change in net assets, is zero.

Why does it matter?

From an accounting perspective, which directly affects a donor’s perception, the increased cost counts as program expenses. Since most people look at some sort of ratio in assessing an organization’s “efficiency”, increasing the program amount makes the organization look better.

Let me give you a simple example. Consider an organization that had $100 revenue, of which $30 was spent on program services and $70 was spent on supporting services which consists of general & administrative plus fundraising.

That means 30% of the organization’s expenses were for program costs and 70% went to supporting services. Most people would consider that to be a highly unfavorable spending pattern.

Putting those numbers into a statement of activity (that’s an income statement for charities) and calculating those percentages gives this picture:

 

contributions 100
program exp 30
supporting services 70
total expense 100
change in net assets 0
program/total exp 30%
supporting/total exp 70%

 

Now let’s assume the charity received $75 of GIK. That increases contributions and program expense. When combined with the cost structure just mentioned, that increases program expenses which means any sort of ratio calculation will shift.

Look at the following illustration, which takes the previous numbers and adds $75 of GIK:

contributions 100 75 175
program exp 30 75 105
supporting services 70 70
total expense 100 75 175
change in net assets 0 0 0
program/total exp 30% 60%
supporting/total exp 70% 40%

 

What that shows is that by adding the $75 into program expenses increases the program costs as a percentage of total expenses from 30% to 60%. The supporting services as a percentage of total expenses drops from 70% to 40%.

That is a big change.

Now let me revise that illustration by putting the numbers somewhat in proportion to what the FTC alleges is the combined picture of the four charities.

The following illustration has a charity with $100 in cash contributions of which $20 goes to program expenses. This charity picks up $120 of international GIK shipments, all of which goes to program. The result is $140 in the program category and $80 for supporting services. The statement of activity looks like this:

contributions 100 120 220
0
program exp 20 120 140
supporting services 80 80
total expense 100 120 220
change in net assets 0 0 0
program/total exp 20% 64%
supporting/total exp 80% 36%

 

You can see the result is program services as a percent of total expenses rise from 20% to 64%. Supporting services dropped from 80% to 36% of total expenses.

If that $120 of GIK is inappropriately recognized as revenue, as is alleged by the FTC and 50 AGs, then the charity has dramatically overstated their total revenue, program expenses, and ratio of program expenses as a percentage of total expenses.

That is why the FTC’s allegations are a big deal.

Impact of the GIK transactions

Paragraph 127 of the complaint states the four cancer charities recorded a combined $223M of GIK over five years that increased program services. The alleged impact is to make them look more efficient.

The alleged impact on CFA’s financial statements was to reduce fundraising costs to 25% of total contributions from what would otherwise have been 67%. If the inter-organization contributions were removed, the fundraising percent allegedly would be 83%.

The FTC alleges that CCFOA reduced their ratio of fundraising expenses / total contributions to 47% from 81%.

For BCS, the FTC alleges the impact of GIK transactions reduced the racial fundraising to contributions ratio to 29% from 85%.

An additional impact alleged in the complaint is the charities used the “inflated” contribution number as the basis for determining what were comparable charities in order to support an alleged increase in compensation for senior staff. I had not previously thought about that ripple effect.

If you want to think about more ripple effects, follow the FTC’s allegations through to the IRS’ concern over excess benefits.

Again, all of that is as alleged in the complaint. If all of the comments in preceding paragraphs are correct, then this paragraph summarizes some of the impact.

Next: part 10.

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