Missing the Obvious in Nonprofit Ratings

[Note: This post is simultaneously being published as an opinion piece in the October 6, 2013 edition of the Chronicle of Philanthropy.]

Americans love ratings and rankings. We like to think that all large, complicated questions can be answered by simple numbers.

That’s given rise to the notion that nonprofits can be fairly and simply rated. And it’s not surprising that, once you scratch the surface, nonprofit rating systems prove to be nonsensical and even harmful.

The best-known and most ubiquitous of the rating systems is Charity Navigator. Charity Navigator bases much of its evaluation on certain financial ratios, such as the percentage of an organization’s budget that goes toward raising money. (The less a nonprofit spends on fundraising compared with its budget or to the dollars raised, the higher its score.)

Because Charity Navigator relies on ratios drawn from tax returns, it leaves itself open to manipulation by the charities it rates. A 2012 investigation by Scripps Howard News Service found that over 40 percent of large nonprofits report spending absolutely nothing on fundraising, suggesting that underreporting of fundraising dollars is not simply theoretical.

Many of Charity Navigator’s measures seem arbitrary, and metrics that have relevance for a large educational institution, for example, don’t have the same significance for a midsize human-service organization. Moreover, Charity Navigator does very little to investigate at anything more than the most superficial level whether a nonprofit is making the right ethical choices.

Nothing so exemplifies what’s wrong with that approach as Charity Navigator’s commendation of the American Endowment Foundation, which has received Charity Navigator’s top rating for 11 years in a row. Charity Navigator asserts that this places the foundation among the top 1 percent of all nonprofit institutions in the country and “differentiates American Endowment Foundation from its peers and demonstrates to the public that it is worthy of their trust.”

The American Endowment Foundation (AEF) is hardly a charity in the traditional sense. Essentially, it is a back-office operation whose only function is to attract and manage donor-advised funds. AEF tracks investments by donors and cuts checks to charities as its donors so authorize. This is not a nonprofit in the way we typically imagine it. AEF is not a soup kitchen or a music school or a land-conservation group.

All the while AEF benefits, as I’ll explain, from a very cozy relationship with the financial-services industry.

Yet in the report from Charity Navigator, AEF rates highly in large part because it is considered extremely efficient in its operations, allocating 96.7 percent of its annual expenditures to program expenses—however those may be defined at a donor-advised fund operation that essentially runs no programs—and 1.7 percent for fundraising.

AEF has grown fast over the past 20 years (it weighed in at over $333-million in unrestricted net assets at the end of 2012), and this expansion seems to have stemmed directly from monetary incentives provided to its donors’ financial advisers. Those financial advisers “stay involved in the investment decisions” for the charitable funds after the money has already technically been donated to AEF.

That is to say, the donors’ financial advisers pick the mutual funds in which the donor-advised funds are invested (hardly heavy lifting), and they receive either a fee from the donors or a commission from the companies in which the funds are invested, depending on how their overall fee relationship with their clients is structured. In other words, brokers get a financial cut from these charitable dollars, and they continue to do so year after year.

Along with what Charity Navigator considers sterling financial management, AEF gets a perfect score—70 points out of a possible 70—for accountability and transparency. AEF scores so well because it is diligent about such items as having a whistle-blower policy in place and making all its board minutes and tax returns available to the public. But a deeper look into how the American Endowment Foundation operates shows that it is hardly a model of nonprofit governance.

First and foremost, AEF’s founder, Philip Tobin, for many years received a six-figure compensation ($160,000, plus benefits, in the 2011 tax year) to serve as both chief executive and board chair.  Appointing the same person as paid CEO and board chair is a structure that is unusual in the nonprofit world. That’s a model—and an increasingly discredited one—from the for-profit corporate world.

But there’s more. The four top executives at the American Endowment Foundation are related. Thomas Tobin, Philip’s son, serves as president; John Tobin, another son of Philip, is executive vice president. Thomas Tobin’s wife, Gail, is the organization’s treasurer.  In AEF’s 2011 tax forms, the three Tobin men are also listed as members of the AEF board of directors, along with six unpaid board members. (AEF’s Web site now lists only Philip and Thomas as being on what is an eight-person board of directors.)

Given that salaries and benefits at AEF totaled $854,715 in 2011, and given that the combined salaries of the four family members listed in the tax return were $581,746, this means that those four family members received 68 percent of the organization’s total compensation.

I called Charity Navigator and asked how an organization could get a perfect score for accountability and transparency when a paid board chair and several family members both sit on the board and serve as paid executives (and when the organizational structure suggests that family members report to one another). Sandra Miniutti, Charity Navigator’s vice president for marketing and chief financial officer, said that AEF has at least five independent directors, and consequently these issues were not problematic.

Ms. Miniutti also said that Charity Navigator had noted the unusual family involvement in its report—but in fact, nothing is said about that point in the report now online. In other words, Charity Navigator examines a few key pieces of information it thinks collectively ensure transparency and accountability in governance, while ignoring the obvious problem that this is essentially a family-run operation.

This is not to say that American Endowment Foundation is alone in the nonprofit world in having multiple family members involved in staff and board positions. But the foundation is not a family foundation, the more natural place for such family ties. And when the only board members who are also paid are all related, when family members report to one another, and when this is a national organization with significant ambition—well, the family ties are not illegal, but they certainly would raise some questions, if only Charity Navigator were aware enough to notice.

Uncovering this information hardly requires skilled investigative work: Most of these facts are readily available in the very same public documents that Charity Navigator uses to form its all-powerful and seemingly authoritative ratings. One would think, at the very least, that before issuing a letter asserting that AEF is among the top 1 percent of all nonprofits in the nation, a document that AEF places on the home page of its Web site and shares with its donors, Charity Navigator would at least take a minute to look at how the place is actually run.

Let’s contrast this situation with a social-service organization that happened to bring in and spend less money in 2013 than in 2012 or 2011. (There are many such organizations, particularly with the consistent reductions in government funds.)

Charity Navigator would declare that such an organization was not moving in the right financial direction and would subtract points from its score. (The Charity Navigator site notes, “As do organizations in other sectors, charities must grow over time if they are to sustain their programs and services.” Exactly why this is so, Charity Navigator does not make clear.) And if that organization were to hire an additional development officer to raise more money, Charity Navigator would penalize it again, because it would then be spending too much of its budget on fundraising.

This social-service organization, which may actually provide a critical service and be run by underpaid, idealistic people doing their best, would probably get one or two stars. Meanwhile, the American Endowment Foundation is held up as a shining four-star example of nonprofit excellence.

I’m convinced that having no rating system at all would be vastly better than having one that is so deeply flawed, distorting, and damaging to the nonprofit world.

This is even more worrisome now that Charity Navigator is embarking on an effort to evaluate program impact. Given the historical challenges to evaluating nonprofit impact (a subject that requires great nuance and context), and given Charity Navigator’s attitude to date (absolute and cocksure), I have a hard time thinking that this is good news.

Copyright Alan Cantor 2013. All rights reserved. 

Update: October 27, 2013. Readers may be amused or outraged, or both, to know that in the same month of October 2013 as this post went up and was simultaneously published in the Chronicle of Philanthropy, Charity Navigator took two utterly contradictory actions. On one hand, on page ten of their 2013 Charity CEO Compensation Study, Charity Navigator singled out American Endowment Foundation for having multiple family members receiving salaries in excess of $100,000. That certainly, to my mind, implies criticism. On the other hand, in the same month Charity Navigator sent off another laudatory letter to American Endowment Foundation (which duly placed a link to the letter on its home page), praising AEF for having earned CN’s top 4-star rating for a twelfth year in a row.

Charity Navigator, not an organization that’s reluctant to praise itself, notes in the letter to AEF that it takes pride in highlighting “the fine work of efficient, ethical, and open charities.” Charity Navigator also takes pride in noting that it has influenced the donation of approximately $10 billion in charitable giving. Make of that what you will.