How to Detect and Prevent Theft, Fraud, & Embezzlement in HOAs

It's a sad but true fact: Condominium associations, homeowners associations, and other residential community management organizations are frequent targets of embezzlement and fraud. A combination of factors makes them a tempting and lucrative target for embezzlers: relatively large sums of money; lax standards and enforcement; and part-time volunteer boards in charge of accounting and control. These surprising statistics establish the magnitude of the problem:

• The median embezzler manages to steal $145,000, according to the Association of Certified Fraud Examiners. 22 percent of embezzlers steal $1 million or more.
• Embezzlers can keep up the con for an average of 18 months before being caught. Alternatively, a Marquet International study estimates that this could be as long as 4.8 years.
• 28 percent of all companies with fewer than 100 employees are victims of fraud, with an average loss of $154,000.
• Smaller organizations experience bigger losses than larger firms, generally due to weaker control measures.

How to Detect Fraud & Embezzlement in HOAs

Watch out for these common warning signs of embezzlement in HOAs, which can be innocent in isolation but may indicate a larger issue over time:

• Balances exceeding budgeted amounts
• Multiple payments to a vendor that was only supposed to be a one-time transaction
• Single-source contracts
• Vendors' addresses on invoices have P.O. Boxes instead of hard street addresses
• Vendors' addresses have the same address as an employee or board member
• Property management employees refusing promotions or vacation time
• Missing or misplaced documents, letters, bills, etc.
• Copies of documents on file where one should find originals
• Delays in bank deposits
• Fees paid for 'consulting' without a full vetting by the board of directors
• Duplicate payments
• A petty cash fund that keeps disappearing
• Accounts payable and accounts receivable are out of balance
• An employee or board member always wants to work at home instead of the property management office, or is there working alone a lot
• Someone gets defensive when asked for a report from the accounting/bookkeeping software your association uses
• Drinking/drug/gambling problems
• Services paid for but not performed

One common technique is overbuying. For example, your accountant receives an invoice for 100 pool recliners, and your pool area only has 20. Someone somewhere is pocketing a lot of extra money. See who signed for what.

Another technique: Sometimes a manager, employee, or board member may go to Lowes or Walmart and buy hundreds of dollars' worth of supplies. They then go back and return them, pocketing the money. The association's bookkeeper has a copy of the receipt, but the fraudster used the original to get a refund and pocketed the cash. Now your property is out the money and the supplies.

Don't rely on background checks alone. The vast majority of embezzlers are first-time offenders; only about 7 percent of those who have been caught had been convicted previously for fraud. Some employers have had success with pre-employment tests designed to measure a predilection for theft, fraud, or other forms of dishonesty. For formal hires, you could consider testing finalists, or testing employees before granting them additional responsibilities.

How to Prevent Fraud & Embezzlement in HOAs

Be proactive: The best countermeasure is straightforward: Board members themselves must take the time to inspect records and paperwork. They need to hold staff accountable not just for records, but also for supplies and inventories. A simple culture of awareness, transparency, and accountability needs to be established. The knowledge that board members pay attention to accounting details should prevent most fraudsters from committing crimes; or at least it could limit the scale of fraudulent schemes, simply because the opportunity isn't there.

Maintain checks and balances: The same person authorized to sign the checks should not be the person in charge of gathering and verifying invoices; and a different person altogether should check invoices against supply deliveries and services received. Employees who take in cash or money orders should not be the same people responsible for reconciling bank statements. Keep the reserve account and the operating account strictly separated. Don't co-mingle these funds with each other, nor with any individual's funds.

Invest in training: Board members are volunteers; they aren't necessarily professional bookkeepers or risk management professionals themselves. They are almost never forensic accountants. Consider bringing in an outside expert to give new board members a class on accounting procedures and checks and balances to ensure that they understand their role in the process.

Name accounts properly: Always keep bank accounts in the name of the association itself, never an individual's name.

Require multiple signatures on checks: The Davis-Sterling Act, a well-known California law regulating condominium governance, requires a minimum of two signatures on all checks drawn on reserve funds. It's a good idea to require two signatures on all checks above a certain minimum amount. The person who prepares checks should not be the person authorized to sign them.

Keep bank records updated: Update signature cards on file at your bank every time there's a staff or board member change. Do it within a day so there is no chance an ousted board member can sneak some checks through before you get around to the change.

Switch bookkeepers from time to time: Rotating responsibility prevents an embezzler from monopolizing control.

Keep checks in a safe: Inventory them by number.

Investigate late vendor payments: Talk to your vendors. Are they being paid on time? Outstanding vendor payments and frequent late or missing payments beyond Net 30 could indicate someone floating checks. If the association is going to be late with a payment, the board should know about it before it happens. Staff should never take the board by surprise.

Require accounting and bookkeeping staff to take occasional vacations: Banks often require employees to take one or two consecutive weeks off each year, because embezzlers need to maintain a constant presence to prevent detection.

Take debit card and ACH bank withdrawals: Encourage automatic payment of rent and other invoices. Wherever possible, money should be automatically deposited into the association bank account, bypassing at least one or two middlemen. The fewer people walking into the property management office handing money orders to staff, the less opportunity there is for fraud or attempts to 'float' the incoming rent payments.

Use a bank 'lockbox' service: Your bank may be able to accept checks on your behalf, either in person or by mail, and deposit them into your account.

Conduct periodic audits, including some that are unannounced: Some states require a CPA audit of financial records for properties of certain sizes. In California, for example, Civil Code 5305 requires a CPA audit for any fiscal year in which gross income for the association exceeds $75,000. In addition, a copy of the financial statements must be distributed to members within 120 days after the end of the fiscal year. Other states have their own rules, of course, but you don't have to wait until the law forces you to get an audit. It's a good idea to get a prompt audit whenever there's a change in leadership, management, or bookkeeping services—and again at random intervals, so longtime staff members and other insiders know that they could be held accountable for their records at any time.

Call in fraud experts: If fraud is suspected, consider using a certified fraud examiner—a specialized discipline within the accountancy profession. The Association of Certified Fraud Examiners has published a fraud prevention check-up to get you started.

Back up records: All financial records should be backed up daily and stored offsite.

Purchase fidelity insurance: This is a specialty insurance policy that pays a benefit in the event that a person defined in the contract commits a crime such as insider theft, embezzlement, or fraud. Ideally, the association should be named as the insured, and the insured amount should be sufficient to cover the maximum funds in custody of the association or management agent at any time.