Auditing Nonprofit

Organizations

(NPOs)

Framework in the Middle East

The paper examines the related risks and monitoring mechanisms of

nonprofit organizations and charities, and highlights the key

considerations that should be taken into account by auditors to

provide the best recommendations to mitigate risks.

2018

Ra’ad Al Louzi

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Table of Contents

Introduction ......................................................................................... 2

Definition of Nonprofit Organization .......................................................................... 3

The Circumstances Surrounding the Neighboring Countries of Jordan and the

Refugee Crisis .......................................................................................................... 3

Terrorist Groups That Threaten the Security of Jordan ................................................. 3

The Most Prominent and Latest Acts of Terrorism Committed in Jordan ................... 4

Statistical Data for Charities and NPOs in Jordan .......................................................... 5

Differences Between an NPO and a Charity ...................................................................... 6

Non-Governmental Organizations (NGOs) ....................................................................... 10

Charities Registration in Jordan and the Middle East .................................................. 10

Emerging Risks of Charities and NPOs ..................................................................... 12

Fundraising Models of Terrorist Financing ............................................................. 13

AML/CFT Standard for Nonprofit Organizations ................................................... 14

FATF Recommendation 8 ................................................................................................... 14

Audit Advices ........................................................................................................ 16

Charity Identifications ........................................................................................................ 16

Charity Founder ................................................................................................................... 16

Funding ................................................................................................................................. 16

Staff and Training ................................................................................................................ 17

Enhanced Due Diligence .................................................................................................... 17

Charity Activities and Audited Reports ............................................................................ 18

Special Conditions ............................................................................................................... 18

Conclusion ........................................................................................................ 19

Bibliography ........................................................................................................ 20

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Introduction

This paper describes nonprofit organizations (NPO) and their activities, and the differences between NPOs and charities. It also highlights the risks of such organizations and helps the AML1 auditor better understand the risks of their activities, programs, and monitoring tools in financial institutions and even in the government agencies that license and monitor such organizations. It discusses the key points that should be considered by auditors while working on these types of activities and related functions. The paper starts with a brief section of key definitions and the role of these entities in society, and discusses the methods of misusing NPOs and charities, or how they could fall under the control of people related to terrorist financing, money laundering, or any other illegal activities. The paper describes the risk surrounding Jordan and the Middle East that results from security instability in some countries, especially Syria and Iraq, as well as the growing risk of the continued influx of refugees from these countries, where such circumstances require more and more NPOs and charities. In addition, controls of these activities, de-risking2 activities, and risk mitigation processes will be addressed. This paper also describes fundraising models of terrorist financing and directs the auditor to the best standards and recommendations when dealing with NPOs and charities. Finally, the paper provides a number of auditing advices when reviewing or dealing with such organizations. Illegal activities, such as money laundering, terrorist financing, or any other activity, negatively impact world peace, which is a very significant risk for nonprofit organizations and charities. Due to the sensitive nature and the fact that there are active transactions and donations on a daily basis, continuous monitoring is required. This is especially important because banks and governmental entities cannot risk conducting payment or granting license intended for “bad people,” especially terrorists. Bad people (e.g., those identified as terrorists) could use other people with clean legal histories, which poses a new challenge for governmental entities and financial

institutions to identify the controlling person of the questionable entity. Such conduct

would result in prohibitively costly penalties and negative effects on banks and on a country's reputation, security, and stability. This topic was chosen due to its high relevance to today’s increasingly complex and demanding risk mitigation considerations. This paper is relevant to readers looking for a deeper understanding of the controls related to nonprofit organization risks, and has been designed specifically for the professionals in the auditing field or in the

governmental entities who control such activities and whose contributions to financial institutions/governmental controls merit a deeper understanding of this topic.

1 Anti-money laundering 2 “De-risking refers to the phenomenon of financial institutions terminating or restricting business relationships with clients or categories of clients to avoid, rather than manage, risk.” [Source: World Bank (World Bank, 2017)]

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Definition of Nonprofit Organization

The Financial Action Task Force (FATF)3 definition of a nonprofit organization: A legal person, arrangement or organization that primarily engages in raising or disbursing funds for purposes such as charitable, religious, cultural, educational, social, or fraternal, or for carrying out other types of “good works.” (FATF-GAFI, n.d.)

NPO activities include providing emergency medical care and emotional care to the survivors of disasters and empowering the public with education and training, as well as improving education, medical care, food, and infrastructure support.

The Circumstances Surrounding the Neighboring Countries of Jordan and

the Refugee Crisis

Since the Syrian civil war officially began on March 15, 2011, the number of refugees in Jordan has continued to increase; there is a direct threat to Jordan from terrorists in southern Syria, in addition to other threats related to the critical security situation in some areas of Iraq, Yemen, Lebanon, etc.

Accordingly, Jordanian authorities and financial institutions are facing stiff challenges to manage these threats, where there are many demands to provide support and charitable activities to refugees.

Terrorist Groups That Threaten the Security of Jordan

Due to the geographic location of Jordan, some terrorist groups are more active compared to others. The following are names of terrorist groups and their countries of origin that have an active influence on extremists.

Organization Name Acronym Origin Country/Principal Area of of Operations

Islamic State of Iraq and Levant / Islamic State of Iraq and Syria, ISIS / ISIL Iraq and Syria

ISIS / ISIL Iraq and Syria

Jabhat al Nusra JN

Syria

JN Syria

Al Qaeda AQ Afghanistan, transnational

Hizbullah Lebanon with transnational nenetworks, especially in Syria

3 Financial Action Task Force

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The Most Prominent and Latest Acts of Terrorism Committed in Jordan

Terror attacks are rare in Jordan, as the country is designated as safe and is ranked 58th out of 130 in the 2016 Global Terrorism Index (GTI).4 2005 Amman Bombings

The 2005 Amman bombings were a series of coordinated bomb attacks on three hotel lobbies in Amman, Jordan, on Nov. 9, 2005. The attacks killed 60 people and injured 115 others. The explosions at the Grand Hyatt Hotel, the Radisson SAS Hotel, and the Days Inn started about 20:50 local time (18:50 UTC) at the Grand Hyatt. The three hotels are frequented by foreign diplomats. The bomb at the Radisson SAS exploded in the Philadelphia Ballroom, where a Jordanian wedding hosting hundreds of guests was

taking place. Al Qaeda in Iraq immediately claimed responsibility for the attack. After the incident, the Jordanian government pledged to take new anti-terror measures to ensure that such an attack would not happen again. The bombings have been the major terrorist attack in Jordan.

2016 Al-Karak Attack

On Dec. 18, 2016, a series of shootings took place in the city of Al-Karak in southern Jordan. The attack started in the vicinity of Al-Karak where a group of unidentified militants ambushed emergency responders and then moved into the city attacking police patrols and the local police station, and finally seeking shelter in the historic Crusader-era Karak Castle, a popular tourist attraction.

Heavy fog at noon hampered police operations. After an attempt by the Jordanian Gendarmerie to besiege the castle, the five attackers were killed following the arrival of the elite Jordanian 71st Special Battalion. Although tourists were present, Jordanian authorities stated that there was no hostage situation; tourists were in a different part of the castle and were just unable to leave.

August 2018 Terrorist Attacks in Salt and Fuheis

In a huge security operation, Jordanian forces laid siege to a building in a residential part of Salt in search of those responsible for a bomb attack on a police van in Fuheis a day earlier.

4 The Global Terrorism Index (GTI) is a report published annually by the Institute for Economics and Peace (IEP), and was

developed by IT entrepreneur and IEPs

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The police van was part of security near a music festival in the majority Christian town of Fuheis, near the capital of Amman and 15 kilometers (about 10 miles) away from Salt.

Four security personnel were killed during the operation after the suspected militants sought sanctuary in the multistory building in Salt, a hillside city. The side of the building partially collapsed, possibly because of a blast from a suicide bomber inside. The shootout also injured at least 20 people, including women and children living in the area. They were taken overnight to a hospital in the capital, according to a medical source. Security forces seized automatic weapons during a search of what was left of the building.

No group has claimed responsibility for the Fuheis attack, in which one police officer was killed and six others were injured.

Statistical Data for Charities and NPOs in Jordan

Below are statistics regarding the established charities in Jordan at the city level:

Total charities through 2011 numbered 2,456, and that grew to 6,014 by the end of 2018, which means that the number of charities increased significantly after the Syrian crisis.

Number of charities per related city, 2011–2017:

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Total number of established charities 2011–2017, per the related ministry:

Differences Between an NPO and a Charity

Topic Registered Charity Nonprofit Organization

Licensing

authority Ministry of Social Development5

Ministry of Industry and Trade

Related law Charities law 51/2008

Nonprofit Organization Law 34/2017

Definition and number of founders

Any legal person composed of a group of persons no less than seven to provide services or carry out activities on a voluntary basis without the aim of profit-making and sharing or achieving any benefit to any of

A company registered in accordance with the provisions of the Jordanian Companies Law, which does not aim to make any profit and to achieve any returns, as they may not be distributed to any of the partners or shareholders.

The objectives of the company in the sectors of health, education, microfinance, and training aimed at the development of the community or any

5 A competent Ministry shall be appointed to supervise the charity activities and follow up on its affairs

2245667

356

2688 131 81 13

273

7 Ministry of Social Development

Ministry of Interior

Ministry of Culture

The Ministry of Tourism andAntiquities

The Ministry of Environment

Ministry of Political andParliamentary Affairs

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its members or to any specific person or achieve any political objectives within the scope of the activities.

purpose related to these sectors shall be approved by the controller.

For example, a limited liability company shall consist of two or more persons, and the company’s financial liability shall be independent of the financial liability of each partner. The company is responsible for its assets, funds, debts, and liabilities; and the partner is not responsible for such debts, liabilities, and losses, which shall only be by the amount of shares owned by the company. The controller

may exceptionally approve the registration of a limited liability company consisting of one person or becoming owned by one person.

Any net profits made by the company shall be deemed to be a saving for them and shall not be used except for the implementation of the purposes and objectives for which they were established and for the expansion of their activities.

The company’s title and trade name, if any, plus the term “nonprofit” shall be included in all the papers and publications it uses in its business in accordance with the contracts concluded with others. The company shall not in any way distribute any of its revenues directly or indirectly to any of the partners or shareholders

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Founder / members/owners

Must be Jordanians6 (individuals)

Could be Jordanians or non-Jordanians (whether they are individuals or entities)

Finance resource

Donation, activity and revenues—charitable events

Members’ contributions, donations (activity revenues to cover expenses)

Types “Special Assembly” means an association whose

membership is limited to a group of persons no less than three and no more than 20. The term "closed association" means an association whose membership is limited to one or more persons. Its financial resources are limited to those provided by any founding member for the purpose of enabling it to achieve its objectives.

It can be under any company types, which include:

1. Partnership company 2. Limited partnership company 3. Limited liability company 4. Shareholding company 5. Private shareholding company 6. Public shareholding company

Tax identification number

No tax registration is required (tax exempt).

Tax exempt but should have a tax number.

6 The approval of the Presidency of the Council of Ministers shall be obtained in the case if there is a non-Jordanian

founding member. There is certain arrangements for branches of foreign charities

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Annual requirements

It must provide the related ministry with an annual business plan, annual report,7 budget audited by a chartered accountant.

Not required, unless it is a public shareholding.

Capital Not required. Must be determined.

Banking and secrecy

The charity shall deposit all its funds with banks

operating in the Kingdom. Its accounts shall not have bank secrecy against any inquiry submitted by the competent minister or the registrar.

Not mentioned in the law.

Closure/dissolution /death

All assets of the dissolved charity shall be transferred to the body determined by its articles of association, provided that such entity shall be either the Ministry of Social Development or another association with the same purposes and objectives.

The amount of their shares actually paid in the company’s capital at the time of incorporation shall be refunded to the partners and shareholders. If the company’s funds and assets are less than the paid-up share capital, they will be paid according to the percentage of their participation in the capital.

Change to profitable institution

They cannot be converted into a profitable company under any circumstances.

The company may become a profitable company in accordance with the procedures stipulated in the law upon registration.

7The charity must announce in its annual report any donation or funding received , The name of the donor, the funder, the amount

and the purpose to be spent and any special conditions

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The capital of the company after conversion is the capital itself before the conversion and may not be increased from the company’s nonprofit financial surplus.

Non-Governmental Organizations (NGOs)

NGOs may be divided into two categories:

1. Those that are associated with or supported by governments, sometimes through international bodies such as the U.N.8 or OECD.9

2. Those that are nonprofit entities and not officially supported by or connected to a government.

The two types of NGOs often engage in similar work and partner with each other; however, NGOs connected to national or international bodies are more active in creating and promoting anti-corruption policies and standards.

Charities Registration in Jordan and the Middle East

As per the Jordanian Charity Law, a charity is a legal person composed of a group of persons no less than seven and registered in accordance with the provisions of the Law to provide services or carry out activities on a voluntary basis. It shall have no aim of taking profit and sharing or achieving any benefit to any of its members or to any specific person. Furthermore, a charity may not achieve any political objectives within the scope of activities of political parties in accordance with the provisions of the legislation in force. (Jordan Charity Law, 2008). In Jordan and in Middle Eastern countries, there is private charity, in which membership is limited to a group of persons no fewer than three and no more than 20. Also, there is closed charity, where membership of which shall be limited to one or more persons. Its financial resources shall be limited to those provided by any founding member for the purpose of enabling it to achieve its objectives.

In Jordan and some of the Middle Eastern countries, especially the Arab countries, a register shall be established in the Ministry of Social Development called the Council of Charities to be administered and supervised by a board called the Board of Directors of the Council, under the chairmanship of the minister and the membership of:

8 United Nations

9 Organization for Economic Co-operation and Development

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• A representative of the Ministry of Interior

• A representative of the Ministry of Culture

• A representative of the Ministry of Tourism and Antiquities

• A representative of the Ministry of Environment

• A representative of the Ministry of Political Development

• Four persons with experience in the field of charitable or voluntary work to be appointed by the Council of Ministers upon a submission made by the minister for a period of two renewable years, and any of them may be removed and replaced in the same manner.

The Council shall have the following functions and powers:

• To approve the registration of the charity and determine the competent ministry

• To evaluate the performance of the charity and its activities

• To issue the necessary plans and programs to improve the conditions of the charity and help it achieve its goals and objectives

• To manage and supervise the funds, and to follow up all its affairs

• To form one or more committees for conciliation in case of conflict between charities

• To issue the necessary instructions to regulate the work of the charity

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Emerging Risks of Charities and NPOs

Charities and other nonprofit organizations can also serve as money laundering vehicles. They have access to significant funding sources, often have a presence worldwide, and, in some jurisdictions, are subject to little regulation. Moreover, “donors” can often make contributions to charities anonymously, providing a convenient vehicle to launder funds or move money across borders.

In recent years, charities and nonprofit organizations have emerged as a significant risk for money laundering and terrorist financing, or even corruption. Terrorist organizations will also use charitable operations as covert fundraising operations to gather funds from supporters overseas. Here are some of the red flags:

Charities and nonprofit organizations that conduct wire transfers to countries where

they have no operations.

Charities and nonprofit organizations that operate in high-risk countries.

Charities and nonprofit organizations with a vague description of their purpose and

services.

Charities and nonprofit organizations that have no obvious physical presence or operate from a post office box.

Nonprofit organizations and donations to charities represent popular corruption vehicles. A corrupt official may ask for a payment to be made to a nonprofit entity, which he or she controls, or from which he or she benefits.

It is no surprise, then, that studies by the FATF have found that nonprofit organizations providing services within areas known to have active terrorist organizations are most vulnerable to misuse by terrorist financers. Nonprofit organizations involved in humanitarian services in conflict regions are also at higher risk. Charities or nonprofit organizations have the following characteristics that are particularly vulnerable to misuse for terrorist financing:

Enjoy the public trust.

Have access to considerable sources of funds.

Are cash-intensive.

Frequently have a global presence, often in or next to areas exposed to terrorist activity.

Often are subject to little or no regulation and/or have few obstacles to their creation. (CAMS, 6th edition, n.d.)

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Fundraising Models of Terrorist Financing

Traditionally, terrorist financing relied on raising funds from various backers, moving the money through legitimate and underground financial networks, and ultimately dispersing it to terrorist organizations or cells. This fundraising was, and still is, often conducted in other countries to be funneled to terrorist groups operating overseas, especially in conflict regions around Jordan.

Fundraising could come from a variety of sources:

Individual contributors: Ranging from small amounts from low-level backers on a one-off basis to larger and more consistent funding streams from wealthy individuals.

Other nonprofit organizations: Charities and foundations, ranging from radical religious organizations and their followers to charitable groups that act as fronts for terrorist funding. In some cases, nonprofit organizations may have some legitimate operations and unwitting donors, while skimming funds for terrorist organizations. In other instances, nonprofit services may be misused to support terrorist groups, helping them with recruitment, supplies, or other forms of assistance.

Political groups and systems: In some cases, the fundraising of terrorist groups could come from countries or political groups and systems, whether such groups believe in terrorists’ ideologies or are just attempting to achieve their economic and military aims to control or sabotage some areas. Usually, this type of fundraising uses informal and hidden channels to transfer money.

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AML/CFT Standard for Nonprofit Organizations

The FATF recognizes the vital importance of the NPO community in providing charitable services around the world, as well as the difficulty of providing assistance to those in need, often in remote regions. It applauds the efforts of the NPO community to meet such needs, and provides some practices to facilitate such efforts and protect the integrity of the NPO sector by providing examples of additional ways in which the governments and NPOs can work to protect the global NPO sector from terrorist abuse. These good practices are not mandatory elements of the FATF standards, and are included as examples only. (FATF-GAFI, n.d.)

FATF Recommendation 8

To help legitimate NPOs avoid ties to terrorist-related entities and to help them regain public trust, FATF issued guidelines in 2002 on best practices for charities in combating

the abuse of nonprofit organizations. The best practices guidance was updated in 2015 for the purpose of assisting countries implement Recommendation 8 on NPOs in line with the risk-based approach to assist NPOs mitigate terrorist-financing threats and assisting financial institutions in the proper implementation of the risk-based approach when providing financial services to NPOs.

The objective of Recommendation 8 is to ensure that NPOs are not abused by:

• Terrorist organizations posing as legitimate entities.

• Exploiting legitimate entities as conduits for terrorist financing.

• Concealing or obscuring the clandestine diversion of funds intended for legitimate purposes to terrorist organizations. (CAMS, 6th edition, n.d.)

The best practices cover identification and mitigation of risk by countries and NPOs alike; self-regulation by NPOs; and their access to financial services. FATF recommends that NPOs:

Maintain and be able to present full program budgets that account for all expenses.

Conduct independent internal audits and external field audits, and the latter are to ensure funds are being used for their intended purposes. (CAMS, 6th edition, n.d.)

FATF recommends that charities use formal bank accounts to keep and transfer funds so that they are subject to the bank’s regulations and controls. In turn, the banks with which the accounts are opened can treat NPOs like other customers by applying their know-your-customer (KYC) rules and reporting suspicious activities.

Countries should review the adequacy of laws and regulations related to nonprofit organizations that have been identified by a country as vulnerable to terrorist financing abuse.

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They should also apply focused and proportionate measures in line with the risk-based approach to such nonprofit organizations to protect them from terrorist financing abuse. Such risks include (a) terrorist organizations posing as legitimate entities; (b) exploiting legitimate entities as conduits for terrorist financing, including for the purpose of escaping asset-freezing measures; and (c) concealing or obscuring the clandestine diversion of funds intended for legitimate purposes to terrorist organizations. (FATF Recommendations 8, n.d.).

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Audit Advices

Charity Identifications

Make sure all needed information for identification is available as follows:

1. Certificate of registration from the related ministry.

2. Memorandum and articles of association authenticated by the Ministry of Social Development.

3. For the banking sector, an official letter from the charity soliciting to open an account and mentioning the names of the authorized signatories.

4. A letter listing the names of the administrative body of the charity members.

5. A copy of the authorized signatory’s ID card (original seen).

6. A document proving the address of the association (a site visit report, a utility

bill, or a lease contract, etc.).

7. The latest annual report and audited budget.

Make sure the articles of association of the charity contain the following:

Name of association.

Its headquarters and geographic zone of work.

The goals and objectives of its establishment in specific and clear statements.

Membership fees and the amount of annual contributions.

Number of members of the board of directors.

Sources of funding for the charity and how to manage, monitor, and audit its

financial affairs.

Rules of good governance and transparency.

How to dissolve the association.

Charity Founder

Check the information of the charity founder. He must be a Jordanian citizen who is 18 years of age and is fully qualified, and never convicted of any crime or a misdemeanor that violates honor and public morals.

Funding

The charity must have the required approval according to the Charities Law, and enhanced due diligence must be in place, especially in the case of foreign funding. In Jordan, for example, the following steps must be made to obtain the governmental approval of foreign funding:

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The charity should submit a written request to the Ministry of Social Development.

The Ministry of Social Development will send the request to the Ministry of Interior, the Ministry of Planning and International Cooperation, and any other related ministry, if any, within two days requesting that feedback be sent within a maximum of five days.

After it receives the feedback, the Ministry of Social Development will seek the approval of the Council of Ministers, which should also receive feedback within five days of the request date. (Ministry of Social Development circular , 2015)

In case there is a donation to any charity or nonprofit organization related to Syrian refugees in the country, the approval of the Ministry of Planning and

International Cooperation must be obtained.

Any charity should have a bank account so its financial transactions can be

monitored.

Note: The Ministry of Social Development of Jordan closed two associations in 2015, six in 2016, and four in 2017 for failure to comply with the related regulations of receiving foreign funds.

Staff and Training

It is recommended to establish a team at the Ministry of Social Development, and any related ministry, to combat money laundering and terrorist financing. This team should be responsible for charity monitoring and compliance with related laws and regulation and for assigning an MLRO10 to report suspicious activities to the related entity, e.g., the Financial Intelligence Unit (FIU).

At banks and financial institutions, there should be a specialized department (AML/CTF Department) to accept the onboarding of the charity (account opening) and to review the charity’s behavior and transactions, as well.

Suitable and continuous training should be in place for this team to identify the red flags for charity activities and how to conduct enhanced due diligence, and to implement an accurate risk-rating and risk-based approach for the duties.

Enhanced Due Diligence

Conduct enhanced due diligence on the entity, including:

Screen the charity’s name and the names of members/founders against the official sanctions list (e.g., U.N.,11 EU,12 and OFAC13).

10 Money laundering reporting officer

11 United Nations

12 European Union

13 Office of Foreign Assets Control

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Consider the account as a high-risk account in terms of AML/CTF risks.

Monitor the account’s transactions for both debit and credit side.

Consider any large cash withdrawal or transfer to any third party with unclear purpose as a terrorist financing threat, which requires a suspicious activity report to be submitted to the Financial Intelligence Unit (FIU) (which in Jordan is called an AML Unit). In such a case, most banks do not allow a cash withdrawal, and will inform a charity at the onboarding stage that cash withdrawals are not allowed on such accounts, per internal policies that require charities to use wire transfers or checks in order to be able to trace the money and know its final destination.

In some cases, a charity could ask to send money to other charitable associations in the region, e.g., Iraq or the West Bank, in order to pay a monthly salary to orphans and the poor. The challenge, however, is that it could be a real charitable donation and could also be used for terrorist financing. The rejection of this type

of donation could be considered a de-risking,14 but the approval of such type of donations could be considered a financial minefield.

Charity Activities and Audited Reports

You should also review the following:

An annual report that includes the achievements of the charity and its activities in the previous year and sources of revenues and expenses, in addition to any data required by the regulations and instructions issued under the provisions of the Charities Law.

An annual budget audited by a legal accountant elected by the general assembly

of the charity must be provided.

Oversight and supervision through proactive monitoring of the sector in the areas identified as being at a higher risk.

Special Conditions

Pay special attention and enhanced due diligence in any of the following cases:

• If one of the founding members of an association is a legal person or a non-national person.

• If the charity type is a closed or a private charity.

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Conclusion

The NPO sector is growing quickly because it serves the public and provides a wide range of services, especially with technology and because of the surrounding economic and political issues.

Auditing the nonprofit organizations (NPOs) AML/CTF framework will assist the financial institutions, governmental agencies, and others to fight money laundering and terrorist financing through a combination of robust KYC, risk mitigation, and ongoing monitoring processes.

A sound AML/CTF audit program will enhance the detection of suspicious activities through the NPOs, and will protect society from the misuse of such organizations.

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