A review of the Aboriginal Children's Service, which has headquarters in Sydney's Redfern, found the children in its care were living in overcrowded homes across NSW, with foster parents that were neither registered nor trained.
One girl had fled her foster home to live with a boyfriend, who killed her.
The elders who manage the corporation say the decision to cut the funding is racist.
They are mostly members of the Coe and Weldon families, some of the best-known Aboriginal people in NSW.
The clan includes Paul Coe, a barrister who was paid $1.2 million for work with the Aboriginal Legal Service in Redfern and who was later stripped of a $100,000-a-year position at the Metropolitan Land Council, after being accused of misappropriating funds.
His sister Isabelle Coe was
a founder of the Redfern tent embassy.
Other clan members Bev and Betsie Coe managed the Aboriginal Children's Service at different times. Bev Coe also served on the board.
The Coes say they are fighting to have the funding reinstated because otherwise another generation of Aboriginal children will end up in white foster homes.
But NSW Children's Guardian Kerryn Boland told The Australian yesterday that the Coes had not responded to a registered letter, dated September 8, that sought to clarify their intentions.
"We haven't been able to talk to them about the future. In fact, the other day we were thinking we might just go over and talk to them, and see whether they want to continue or not," she said.
It may be they have looked elsewhere for business opportunities. Documents lodged with the Australian Securities and Investments Commission show that two of the group -- Val Weldon and her son-in-law, Hewitt Whyman, have formed a new company, Gannambarra.
It received $1.29 million in funding last year and $450,000 this year to help "alleviate poverty". The bulk of the money went on wages.
In a statement to The Australian, the NSW Department of Community Services said the Aboriginal Children's Service had lost its funding because it had failed in almost every aspect of its operation, despite receiving more than $1.1 million a year since the early 1990s.
A review of the service was conducted in 2006. The corporation has since gradually wound down, receiving its final cheque, worth $92,688, in the 2007-08 financial year; this year, the group got nothing.
Ann Weldon, who remains on the board, said the children's service had its problems that could have been solved by more money, not less.
She has been backed by an anthropologist from Sydney University, Gaynor Macdonald, who said yesterday that DOCS had shown no understanding of the way Aboriginal kinship relationships work.
"They got accused of nepotism but of course they are all related," she said. "Aboriginal culture is a kinship culture. They are required to work together and support each other."
The company admitted that its foster children were living in homes with too few bedrooms, and in poor condition, but so too did many Aboriginal people.
"The review is not an accurate reflection of (our) operation," it said. "We have the common goal of making things better for Aboriginal children.
"We were shocked by the lack of acknowledgment in the review of the skills, knowledge and expertise which our board and workers have to offer."