Know Your Donor (KYD): Customer Due Diligence for Charities

Introduction: Charities and The KYD Approach

Charities are a vital part of civil society, helping to bridge gaps in social services and address pressing issues. They are non-profit entities dedicated to improving the well-being of individuals, communities, and the environment.

Charities tackle various social problems such as poverty, hunger, homelessness, healthcare, education, disaster relief, animal welfare, environmental conservation, and more. They work to alleviate suffering, promote social justice, and enhance the quality of life for those in need.

These organizations rely on donations to fulfill their missions and make a difference in the world. To finance their operations, charities rely on donations, grants, and fundraising. These funds support their programs and initiatives, cover administrative costs, and ensure long-term sustainability.

In the world of charitable giving, the principles of trust, integrity, and transparency are essential. People donate money to causes they believe in, and charities must ensure the money is from legitimate sources. This not only safeguards the charity’s reputation but also ensures compliance with legal and regulatory standards.

However, the rise of online transactions and fraudsters’ sophisticated tactics have made it more challenging for charities to ensure that the funds they receive are legitimate in today’s digital age. Just as financial institutions diligently adhere to Know Your Customer (KYC) regulations, charitable organizations can benefit from implementing a similar process known as “Know Your Donor” (KYD).

The Risks Charities Face: Money Laundering, Terrorist Financing, and Illicit Activities

Charities can be victims of financial crimes such as fraud, money laundering, and terrorist financing. It is common for fraudulent individuals and organizations to use charities as fronts for their illicit activities, diverting funds intended for charitable purposes to support their illegal activities.

However, those looking to engage in illegal activity may manipulate or exploit genuine charities. These individuals take advantage of some factors to use charities as a means of money laundering. Key vulnerabilities include:

1. Cash Donations: The untraceable nature of cash makes it a preferred medium for illicit transactions.
2. Complex Organizational Structures: Charities with multi-national operations and intricate frameworks are particularly hard to oversee effectively.
3. Minimal Regulatory Oversight: A lower level of scrutiny compared to other financial entities makes charities easier targets.
4. Lack of Due Diligence: Some charities may not conduct thorough background checks when accepting donations or forming partnerships.

To mitigate these risks, charities should adopt effective anti-money laundering and counter-terrorist financing (AML/CFT) measures, including Know Your Donor (KYD). An identity verification process like KYD protects charities from being abused and exploited.

What Is KYD?

KYD, which stands for Know Your Donor, is a set of policies and procedures that charities use to verify and understand their donors. It is similar to the KYC (Know Your Customer) practices businesses and financial institutions use. The main goal of KYD is to ensure that donations are coming from legitimate sources and to minimize the risk of issues such as fraud, money laundering, or financing of illegal activities.

Charities use KYD to identify potential donors and assess the risks associated with them. This is an essential part of the FATF’s (Financial Action Task Force) recommendations for non-profit organizations. It helps prevent them from being used for illegal purposes.

FATF Recommendations 

The Financial Action Task Force (FATF) is a global organization that develops and promotes policies to combat money laundering and terrorist financing. The FATF recommends that non-profit organizations implement a risk-based approach to AML/CFT measures. This means that they should assess the risks associated with their activities and donors and implement appropriate measures to lower those risks.

In this regard, KYD is a crucial tool for charities, since it allows them to verify donors’ identities and prevent fraud and money laundering. KYD can also assist charities in detecting and preventing terrorist financing. Although different countries have varying AML and CTF regulations for charitable organizations, they all strive to comply with FATF recommendations.

How Criminal Donors Exploit Charities

Although most donations are made with good intentions, charities should be cautious of certain donations and their sources. Criminals use a variety of methods to exploit charities for money laundering and other illicit activities, including:

1. Donation Layering: Criminals make multiple small donations to a charity to conceal the origin of the funds. This creates a complex and complicated paper trail that makes it difficult to trace the source of the money.
2. Shell Charities or Companies: Criminals may establish shell companies or front organizations to make donations on their behalf. These entities may have opaque ownership structures, making it difficult to ascertain the true source of the donation. They could also pose as beneficiaries using these shell organizations, misrepresenting themselves as legitimate NGOs and collecting funds that are later diverted for the wrong purposes.
3. Donor-Advised Funds: Donor-advised funds allow donors to recommend how their money is granted to charities. Criminals use these funds to legitimize the source of their illegal proceeds and get tax exemptions while directing donations to a charity of their choice, which is often an illegal one.
4. Kickbacks: Criminals provide funds to charities under the condition that a portion of the donation is returned to them or redirected to their preferred recipients. This method can be used to legitimize proceeds from illegal activities.
5. Conditional Donations with Hidden Agendas: Criminal donors attach conditions to their contributions that go against the charity’s mission or involve hidden agendas. For example, they may donate money to a charity on the condition that the charity hires certain people or organizations to handle work or projects. This could allow the criminals to gain control over the charity or to use the charity’s resources for their own purposes.

Other Types of Donations to Scrutinize Carefully

Charities should carefully scrutinize donations that fall into the following categories:

1. Large Sums of Cash: Unusually large, unsolicited donations without a clear and legitimate source of wealth or explanation should be verified to prevent potential money laundering or fraud.
2. Donations from High-Risk Countries: Contributions from countries known for high levels of corruption, money laundering, or terrorist financing should be carefully examined. Charities should be aware of international sanctions and laws governing transactions with these countries.
3. Donations with Highly Complex Structures: Charities should examine contributions made through intricate legal structures or complex financial arrangements to ensure they are legitimate and do not involve tax evasion or other illegal activities.
4. Anonymous Donations: Although anonymous donations are not inherently problematic, they should be subject to additional scrutiny. Charities should have policies in place for evaluating anonymous donations and, in some cases, may choose to decline them. Anonymous donations can be made in cash, cryptocurrencies, or through intermediaries, making it challenging to trace the source of funds.

It’s important to note that exercising caution in accepting donations does not imply suspicion of all donations falling into these categories. Genuine donations may have some of these similarities, but it is only by following due diligence that the true nature and motives for donations can be exposed.

Due Diligence Process for Charities

Donor due diligence for charities is the process of collecting and verifying information about donors to assess risks and make informed decisions about accepting their donations.

The following steps are typically involved in the due diligence process:

1. Identity verification and authentication: This involves verifying that the donor is who they say they are. Identity verification can be done with government IDs and other identity credentials.
2. Source of funds verification: This involves understanding the source of the donor’s funds. This can be done by asking donors to explain the source of their funds and by verifying their financial records.
3. Risk assessment: Not all donors or donations pose the same level of risk. Charities often use a risk-based approach, where the extent of due diligence is determined based on the perceived risk associated with the donor and the donation amount. Major donors, donors with complex financial backgrounds, or donors from high-risk countries may undergo more extensive scrutiny.
4. Background checks: This can involve checking donors against sanction lists, criminal records, and other databases to identify any potential red flags.
5. Documentation: Donor records are diligently retained for reference purposes over a specific period.
6. Ongoing monitoring: Due diligence is not a one-time process. Charities should establish mechanisms to monitor donors and their contributions to detect unusual or suspicious activities.
7. Reporting: If suspicious activity is detected, charities should report it to the relevant authorities.

Implementing KYD Practices

Charities are subject to laws in many countries and must implement a KYD framework that is fair, transparent, and consistent with their mission and values. This framework must also comply with financial transparency, anti-money laundering, and counter-terrorism financing laws. For charities with limited resources, implementing KYD processes can be a daunting task, but there are several tools available to help them do so seamlessly. Charities need to find the tools that best serve them and tailor them for their use.

Benefits of KYD

While KYD may appear intrusive, it is a necessary step to protect charities from malicious actors who may use fraudulent funds to support legal activities. Therefore, KYD can be beneficial to charities in the following ways:

1. Charities depend on the trust and support of their donors and the public, so any association with fraudulent or illicit activities can severely damage their reputation and erode public confidence. By verifying donor identities and ensuring transparency and accountability, charities can maintain their integrity and reputation.
2. With KYD, charities can contribute to global efforts to combat money laundering and terrorist financing and to promote the values of transparency, accountability, and good governance.
3. By conducting KYD, charities can assess the risk associated with each donation. This helps them make informed decisions about whether to accept or reject a donation, especially if it raises red flags.
4. The benefits of KYD go beyond fraud prevention. By verifying donors’ identities, charities can gain valuable insights into their donor base. This information can help charities better understand donors’ motivations and preferences, allowing them to tailor their fundraising efforts and improve donor retention.

Data Protection in KYD Process

In the KYD process, sensitive personal information is collected and retained. Hence, charities must adhere to data protection and privacy regulations to ensure the security and confidentiality of donor information. For some of these regulations, like the GDPR, POPIA, PIPEDA, and CPRA, the following key practices applies:

1. Charities should only gather essential information for donor verification.
2. Clearly communicate the purpose and handling of collected data to donors.
3. Obtain explicit and informed consent before collecting or using donor information.
4. Implement strong security practices like encryption, access controls, and secure storage practices to safeguard sensitive data.
5. Uphold donor rights to access, rectify, or delete their data.
6. Keep donor data only as long as necessary and ensure secure disposal.
7. Have a prompt response plan for any data breaches, including mitigation and notification steps.

Conclusion

In a sector where trust is paramount, KYD is an important process that allows charities to uphold their mission and make a positive impact on the world while maintaining the highest ethical standards. It’s a continuous commitment to verifying the legitimacy of donors and their contributions. This process is vital for protecting the reputation of charitable organizations and what they stand for.

About Identity.com

One of the procedures for ensuring that criminals are not exploiting charity organizations is following AML/CFT regulations, including an effective KYC process. The work of Identity.com, as a future-oriented company, is helping many businesses by giving their customers a hassle-free identity verification process.

Our company envisions a user-centric internet where individuals maintain control over their data. This commitment drives Identity.com to actively contribute to this future through innovative identity management systems and protocols. As members of the World Wide Web Consortium (W3C), we uphold the standards for the World Wide Web and work towards a more secure and user-friendly online experience.

Identity.com is an open-source ecosystem providing access to on-chain and secure identity verification. Our solutions improve the user experience and reduce onboarding friction through reusable and interoperable Gateway Passes. Please get in touch for more info about how we can help you with identity verification and general KYC processes.