Internal frauds committed by officers, directors, managers, and other employees in a position of trust are common threats that homeowners associations must contend with. These threats are generally a product of a permissive environment or misplaced trust. If an association lacks internal controls, or if they exist but are not enforced, temptation beckons those with the opportunity to go astray. Studies have shown that the common factors that lead to the commission of this type of fraudulent conduct are:
- Motive- The person has some pressing financial need such as a family illness, excessive debt, or a gambling problem.
- Means- The person has skills that qualify him or her for a job working with cash or other employer assets.
- Opportunity- The association’s lack of internal controls or enforcement thereof, or just misplaced trust, create an environment conducive to fraud.
- Rationalization- The person has developed a belief that they are entitled to something such as higher pay or more appreciation, thus justifying committing the fraud. Or, “I’m really only borrowing it; I’ll replace it later.”
Common Types of Fraudulent Conduct Involving HOAs
The most common occupational fraud that is perpetrated on a homeowners association is some form of “misappropriation of cash” such as larceny, embezzlement, skimming, or phony disbursements Cash is generally misappropriated through one of the following means:
- check tampering
- revenue skimming
- fraudulent disbursements by fake invoicing,payroll schemes, and billing scams.
Larceny and Embezzlement
Larceny and embezzlement are cash theft schemes that are perpetrated after the cash has been recorded in the association’s books. The difference between the two crimes is that larceny is a “trespassory” taking of another’s property with the intent to steal it, while embezzlement is the taking of another’s property by a person in a position of trust who had legal access to the property, or the fraudulent appropriation of money or property lawfully in one’s possession. Common examples of larceny and/or embezzlement are the stealing of cash from a cash register or the company’s daily bank deposit, or the stealing of customer checks received to pay accounts receivable balances.
Internal controls are necessary to protect against larceny and embezzlement. Segregation and/or rotation of duties, surprise audits of cash on hand, independent reconciliation of register contents and tapes, and voucher accounting are ways to prevent embezzlement . Associations should not have one individual with the sole responsibility for receiving cash, counting it and reconciling registers, preparing and making bank deposits, doing the voucher accounting, and posting payments to open receivable accounts.
Skimming is another way to steal from an association. The fraud involves stealing unrecorded sales and is usually committed by cashiers, accounting personnel, customer service people and management. The following are typical incidences of skimming:
- A cashier rings up a “no sale” without management approval. This allows access to the cash drawer with no corresponding entry on the tape.
- Selling a product to a customer and not recording it at all.
- Accounts receivable frauds such as creating phony receivables or re-dating receivables to make them appear current to avoid detection of misappropriated payments.
- Misappropriating payments received for credit to a particular account and covering it up by replacing the stolen amount with receipts from another account.
- Under-recording sales transactions.
Ways to Protect Against Fraud
Homeowners associations are particularly vulnerable to fraud because they are typically controlled by a small number of people who act in positions that require a high level of trust with little or no oversight. Recognizing their vulnerability and the potentially disastrous impact of being a victim of insider fraud, associations should adopt policies and procedures that employ a system of checks and balances and which are designed to protect against the possibility of becoming a victim of an insider’s fraudulent schemes. Such policies and procedures should include such things as:
- Background and credit checks on employees, vendors and board members.
- Require fidelity bonds on managers, directors, and employees in positions of trust.
- Mandate full disclosure of all relationships with vendors and service providers.
- Retention of an independent accountant.
- Properly supervise employees and volunteers with access to funds and association property.
- Keeping track of the numerical sequence of all checks that are issued.
- Require multiple signatures on checks.
- Safeguard all blank checks.
- Do not allow payments by cash.
- Regularly review and reconcile bank statements.
- Have duplicate bank statements sent to different people.
- Utilize different people for depositing funds and reconciling statements.
- Periodically rotate responsibilities and tasks.
- Properly supervise all employees and managers.
- Periodically update bank signature cards and authorizations.
- Require employees to take time off work.
- Observe and respond to indications of employee/agent stress and unusual behavior.
An important part of the duties of a homeowners association’s board of directors involves the oversight of the association’s funds. Adopting and implementing policies and procedures that are designed to protect against fraud is basic, yet often overlooked. By becoming more aware of the issues and implementing policies and procedures to protect against fraud, the chances of becoming a victim of fraud will be greatly reduced.