Illicit financial flows in charity

Money doesn’t stink?

Philanthropy would seem to have nothing to do with front page stories about blatant theft of public and private money, money laundering, and billions received from operations that undermine faith in humanity. However, the reality is that charities can be directly involved, whether consciously or not, in the vortex of illegal money flows. Without an active policy of absolute financial transparency, effective filtering procedures for donated funds, and a clear stance on the treatment of illicit capital, philanthropy can tarnish its image and undermine the results of its work.What are illicit financial flows?

What are illicit financial flows?

Illicit financial flows (IFF) are illicit movements of money or capital from one country to another that is illegally earned, transferred, and/or utilized. We are talking about a huge hidden economy that is built upon big crimes and big names. It is estimated that every year only the US fails to collect in taxes $1trl. The world poorest countries annual loss to IFF is $416bn. One can only guess at financial flows concealed by big multinational companies that take advantage of tax holes in countries they operate in. At the global level we are talking about IFF volumes that could be enough to cover the annual cost ($5-7trl) of reaching the UN Sustainable Development Goals by 2030.

Money laundering mechanisms

For the money to be reinvested in legal markets or simply end up in the pockets of those involved in illegal activities, it needs be legalised.  Often this is done by means of funds wired through offshore companies and shall trusts funds. Also, the money can be deposited in banks in countries that do not ask unnecessary questions about its origin. The scandals with Panama papers and HSBC money laundering schemes became a turning point in the discussion on the IFF and served as a trigger to develop measures aimed at ending these legal and financial blind spots. However, what goes almost unnoticed and consequently unresolved is that non-profits can also be used as conduits for illicit money flows.

• From time to time, financial authorities spot fake non-profits that launder dirty money by transferring illegally gained money into its account as donations. The deposited money then is transferred as contracts or grants to individuals who are part of the criminal circle. There are also cases where a non-profit organisation is set up only to pay high salaries to its founders, who may be members of the same family, for example.

• Bribery. Imagine a situation where, in order to obtain an approval for a lucrative tender in a foreign country, a businessman, instead of directly bribing an official, which is easy to trace, transfers a large sum of money to charities owned by a relative of a foreign official, or political party.

• Terrorism financing. Charities can get involved in IFF by the nature of entrusted funds use. The Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog, lists ways of how terrorist financing can occur: by terrorist organisations posing as legitimate entities, through the exploitation of legitimate entities, by the diversion of funds intended for legitimate purposes to terrorist organisations, or by undertaking fundraising activities and diverting all or some of the funds to terrorist activity.

• Tax avoidance. Not all IFF stem from illegal activity. The state itself allow individuals and companies to benefit from tax breaks. However, when a multinational company moves its head office to a place with a lower tax jurisdiction, or records the bulk of its profits in a country where the corporation tax is significantly lower, we can confidently call it immoral and harmful. Donating to philanthropic organisations further lowers the taxable base of High Net Worth donors. At the end, they pay almost nothing compared to their wealth and the amount of their charitable pledges looks like peanuts.

Fighting back

Every organisation has to decide what its position is in relation to illicit funds. The belief that it does not matter from where the money comes, as long as it benefits those in need, doesn’t stand up to scrutiny. This argument fails to acknowledge that the harm caused by unethical business practices that resource philanthropy often far outstrips any charitable dollars spent. As Theodore Roosevelt declared: “No amount of charities in spending such fortunes can compensate in any way for the misconduct in acquiring them.”

Given its tax-exempt status, which means that the public budget is decreased to the amount of allowed tax exemption, non-profits should stay vigilant and introduce the closest scrutiny and accountability to monitor their finances and operations.

Practical solutions

Any grant should be screened using objective criteria, be accurately documented through open financial reports available on the organisation’s website, and be consistent with the foundation’s anti-corruption compliance procedures. The due diligence process in place should help to check:

• If an allocated grant will be used solely for intended purposes,
• If a grant benefits any foreign government or is given to an individual that has a right of regulatory oversight over the charity,
• If an external actor recommended or endorsed the proposed grant in an improper manner,
• If a new recipient organization passed a risk-based due diligence

Due diligence for donations is all about knowing the source of money. If donated funds were derived from illegal or unethical activities, they can’t be accepted. If at the time of money depositing the information on its origin was not known and became apparent later, the funds should be returned. There is no other way. The good example was the reaction of Harvard University that returned unused funds received from Jeffrey Epstein to the social activist groups dealing with sex assaults. Tufts University’s position was quite different. It decided to keep the money while simply scrubbing the Sackler’s name off their buildings to which the family donated millions of dollars. Similarly, the Catholic University of America didn’t find it contradictory in accepting a gift from the Koch Brothers, known for their anti-government stances.

We all agree that illicit money flows weaken state institutions by fuelling corruption and violence, undermines the rule of law, and deprives the society of resources that are needed for sustainable development. Philanthropy can’t allow itself to stand aside in the struggle to eradicate these harmful practices and turn a blind eye on the use of its channels by IFF. Otherwise it’ll betray its ultimate goal of solving society’s systemic problems.