Watchful Eyes the Best Defense Against Fraud

Published on: April 1, 2010

Most community association boards think of fraud – if they think about it at all   — as something that happens to other communities, but not to theirs.

In fact, reports of fraud-related losses affecting New England condominiums have been rare.  It’s certainly been a long time since we’ve seen anything close to the recent New York case, in which a manager systematically stole $1.3 million from six cooperatives by pocketing the funds allocated for their property taxes, then negotiating installment payment agreements that he never mentioned to the cooperative boards and never fulfilled.

The Association of Certified Fraud examiners estimated in a 1996 report that fraud and other forms of financial abuse cost organizations of all kinds more than $400 billion annually.  Clearly, the problem is immense, and while community associations may not be the primary victims, they are by no means immune to the risk. 

Just last year, the press reported the arrest of a Maine bookkeeper who had stolen more than $30,000 from two community associations for which she had worked for more than a decade.  True, this doesn’t touch the $1.3 million stolen from the New York cooperatives, but a $30,000 loss, or even a $5,000 loss, can leave a large and potentially devastating hole in the budget of a small community association.

Understanding the Risks

Small, self-managed associations are particularly vulnerable because they are less likely to have an accountant reviewing their books on a regular basis, more likely to have financial responsibilities concentrated in very few hands, and less likely to have anyone looking over the shoulders of those managing the community’s finances.

While smaller communities may be somewhat more vulnerable to fraud, any community with an operating budget, bank accounts and checkbooks is at risk, regardless of its size. The recipe for fraud includes only two ingredients:  Opportunity, defined as access to the association’s funds; and motivation, defined as a compelling reason to steal them.  That reason may be simple greed on the part of someone lacking ethics, a conscience, or both, or a desire for revenge on the part of a manager or employee who doesn’t get an expected promotion or raise. 

But the people who steal from associations are often, if not always, motivated by financial pressures of some kind – gambling losses, a divorce, medical bills, or the like – that create a desperate need for money.  Sometimes the thefts are almost accidental – a board member or office manger “borrows” a few dollars from petty cash with every intention of repaying it.  But the debt slips their mind and when they remember it, two or three weeks later, they realize no one has noticed.  One small “loan” becomes many more that are also never repaid.   The longer this continues and the larger the sum involved, the harder it becomes to repay the funds or admit the poor judgment.  In this way, a $10.00 “loan” can become a $10,000 theft over time if no one catches it.  

Telltale Signs

Fraud is not always or even usually innocent, but it is often detectable based on the behavior of the people involved.  Sudden changes in mood, behavior, or lifestyle are among the obvious indicators that something may be amiss.  If the bookkeeper who has been driving a 10-year-old Chevy shows up in a new BMW, you might want to inquire about the source of his good fortune — and take a good long look at the association’s books.  A manager who never takes a vacation is another possible red flag.  Dedication to the job is one explanation for the reluctance to take time off, but a fear that someone may discover something in the manager’s absence is another.  There’s a reason banks require tellers and their supervisors to take two consecutive weeks of vacation every year, and it’s not primarily because banks are particularly concerned about the welfare of those employees. 

If you suspect financial mismanagement, you should have a CPA audit the association’s books.  If the audit confirms the suspicions, you should contact the association’s attorney and, with the attorney’s assistance, confront the individual or individuals involved.   Your goal is to recover the stolen funds and if you can achieve that goal quietly and without legal action.  So give the individual a short time – no more than a day or two – to admit the crime and reimburse the association. 

If that approach doesn’t work, you should contact your insurance agent and report the incident to the insurer providing the association’s fidelity coverage.   For purposes of the condominium loans they will purchase, Fannie Mae and Freddie Mac require associations to have coverage equaling three months of operating expenses; for FHA loans, the requirement is three months of expenses plus reserves.  Assuming your community has sufficient coverage (unfortunately, many do not meet even these minimum requirements), the insurer will reimburse you for the loss and decide whether and how to pursue the guilty party.  Most insurance companies will require   you to report the fraud to law enforcement officials as part of the claims process. 

To Chase or Not

If the board decides to handle the problem privately, make sure the guilty parties are both able and likely to fulfill any repayment promises they make.  In one case, a manager who had stolen association funds confessed, signed a repayment agreement, and then immediately filed for bankruptcy.  Given the slim prospects for collecting anything from that individual even if the association won a judgment against him, the board decided that the loss didn’t justify the cost of the collection effort.  Many boards confronting relatively small losses may reach the same conclusion. 

If the manager, bookkeeper or other trusted service provider you catch stealing from your association has other association clients, it is possible, and probably more likely than not, that he/she is stealing from them, too.  The understandable instinct would be to inform those communities of that risk.  But your first obligation is to protect the interests of your community.  If there is to be a line for reimbursement, you want your community to be at its head.  Once your community has been made whole, you can inform others of your experience with an individual who is working for them.  You have no legal obligation to share that information, of course, but the Golden Rule – “do unto others” — suggests a moral imperative for doing so.  Presumably, you would appreciate a warning from others that your community might be at risk. 

Be careful about what you tell others, however.  If the individual you accused of fraud has admitted it and reimbursed the community, you can share that information.  But you would risk a suit for slander if you report allegations of financial wrongdoing that you suspect but haven’t proven. 

Fraud Prevention

The best strategy for dealing with fraud-related losses, of course, is to avoid them entirely.  This does not require expensive consultants or high-technology equipment.  Common sense and watchfulness are your most effective tools; complacency – the assumption that all is well and that everyone can be trusted is your biggest risk. 

You don’t have to treat managers, bookkeepers and fellow board members as potential suspects.  But you do have to recognize that anyone with access to association funds could mismanage them.  Former President Ronald Reagan’s strategy for dealing with the Soviet Union – “trust but verify” – is good advice.  The more eyes scrutinizing the association’s finances, the harder it will be for anyone to play fast and loose with the funds and the less likely anyone will try.  Paying careful attention probably ranks first among essential anti-fraud measures for community associations, followed closely by the following:

  • Divide financial responsibilities.  Having one person send invoices, pay them, collect common area fees, make deposits and reconcile the association’s account statements is a recipe for fraud.  You want several degrees of separation – multiple checks and balances – making it difficult for one individual to perpetrate a fraud without the assistance of others.
  • Establish reasonable financial controls and have the association’s accountant review them periodically to make sure they are appropriate and effective.  In addition to the division of responsibilities described above, reasonable controls would include, among others, requiring multiple signatures on checks above a specified amount, restricting access to the association’s checkbook, and maintaining a low limit on any credit card you use for association expenses.
  • Require regular financial reports from the association manager (bookkeeper or treasurer) and review them.  Reports no one reads (a description that probably applies to many reports provided to boards in many community associations) are virtually worthless as a defense against fraud.  Insist that the reports include bank statements and reconciliations so someone can independently review the background information on which the financial summaries are based. 
  • Compare and contrast.  Match invoices (vendors and amounts) against checks written to those sources.  Match contractors’ charges against the bids they submitted.  Watch for discrepancies in recurring expenses. If the price of standard supplies doubles suddenly, or an invoice references work you don’t remember being performed, ask for an explanation.
  • Sweat the small stuff.  If you seem to be buying light bulbs or cleaning supplies more frequently, it may be because someone with access to the association’s supply closet is treating the association’s supplies as their own. 
  • Check the math.   Fraud isn’t the only explanation for financial discrepancies; sloppy accounting ¾ fees that aren’t collected, duplicate payments or funds deposited inadvertently to the wrong account — can cost the association money, too. 
  • Ask questions.  If something strikes you as odd, unusual, or suspicious, ask about it and demand a satisfactory explanation.  The only stupid questions about association finances are the questions no one bothers to ask.