Homeowners rely on their board of directors to govern responsibly and honestly, entrusting them with overseeing financial operations to promote the community's best interests. While most associations operate transparently and ethically, fraud, embezzlement, and mismanagement can and do occur.

Association fraud is a serious problem that cannot be ignored. Fraudulent activities can result in significant financial losses for the association and its members and potentially lead to legal consequences for those involved.

Why some people commit fraud

Most association stakeholders are trustworthy, hardworking contributors who want to make their communities better places to live. Unfortunately, some selfish individuals engage in fraudulent activities for personal financial gain. Other factors can contribute to fraud, including:

Financial Pressures: An association stakeholder may feel desperate for solutions when facing personal financial difficulties. Fraudulent practices could be tempting under such circumstances.

Opportunity (from a lack of oversight): To conceal deceptive accounting practices, individuals may exploit loopholes or manipulate records.

By being vigilant about potential fraud, your association can avoid financial losses, legal issues, and reputational damage.

Association fraud has become increasingly common in recent years. In 2023, several board members of a large HOA in Florida were accused of stealing from their association. In response to years of complaints, four ex-board members were investigated and ultimately arrested for allegedly siphoning $2 million of the association’s funds.

“One of the most effective ways to safeguard your association is by educating community leaders on identifying potential risks,” said Danny Ellis, president at FirstService Residential. "Empowering individuals to identify and address signs of suspicious activity is fundamental to maintaining responsible governance within an association."

Red Flags

Awareness is the first step in preventing fraud. Here are some common red flags to watch out for:

  • Lack of controls, such as when accounting tasks are concentrated in the hands of one individual, can set the stage for fraudulent activity. It's crucial to establish systems of checks and balances to safeguard against mistakes and uphold accountability.

  • Unexpected or inconsistent drops in revenue can indicate fraud.

  • Vendor price increases can also indicate potential fraud. Individuals may manipulate pricing or create fake vendors to embezzle funds.

  • Checks made out to “cash” should raise serious concerns about fraud and should warrant investigation.

  • Missing petty cash and a lack of proper documentation and transaction reconciliation raise concerns about financial transparency.

  • Copies of receipts or invoices rather than the original documents may indicate an attempt to conceal alterations or fabrications.

  • Payment for non-existent items or services can be a tactic to create fictitious transactions, inflate expenses, and divert funds to unauthorized parties. 

Financial strength involves a proper annual budget, sound financial planning, and a strategic approach to your reserve fund. Download our checklist to get your budget on track.

Types of Association Fraud

Various forms of fraud can be committed within an association. These include embezzlement, financial manipulation, fund misappropriation, and other unethical practices. The following are some common types of association fraud:
Kickback schemes – Accepting money or other incentives in exchange for directing the association to a specific vendor.   

Creating fictitious vendors - Fraud of this type involves creating fake invoices and payments to nonexistent vendors.

Borrowing funds - Borrowing for personal reasons diverts these funds away from their intended purpose, constituting a misuse of resources.
Embezzlement - Diverting funds for personal gain rather than used for their intended purposes.
Bribery – Offering money or other incentives to a board member or employee in exchange for them taking a specific action. This fraud can manipulate decision-making and lead to other questionable practices.

Cooking the Books – Misreporting expenses or inflating revenue to create a false picture of a community's finances. This can seriously affect the association and lead to financial and legal penalties.

If you suspect fraudulent activity in your association, gathering as many documents as possible to support your suspicions is essential. Contact your association’s attorney and the local police if a crime has been committed.

Preventing Fraud

Clear rules and processes are essential to safeguarding your association's financial integrity. The following 6 tips will help you get started.

Tip #1.  Immediately reconcile transactions. Reconciling your transactions – comparing financial records, such as bank statements and accounting records, to your balance sheet, credit card statements and invoices to receipts– is one of the simplest yet most effective ways to prevent fraud. Reconciling helps pinpoint disparities or irregularities, serving as a crucial mechanism for early fraud detection.

Tip #2. Require board approval for new vendors. Requiring board approval adds oversight to vendor selection. Board members, collectively representing the community's interests, can thoroughly evaluate potential vendors, ensuring their legitimacy and appropriateness for the association.

Tip #3. Implement regular audits and financial reviews. It's not a good idea to leave all financial responsibilities to one person. At least two board members should independently review financial documents each month. This practice adds an extra layer of protection, making it harder to manipulate bank statements, exaggerate budgets, or duplicate payments or reimbursements.

Tip #4. Hire a professional management company. Professional management companies have the expertise and resources to handle association finances properly. A solid property management company will implement proactive measures, such as strong internal controls and established safeguards, thorough financial reviews, regular audits, and secure systems, to prevent fraud.

Uncertain about whether your association needs a management partner? Read: When Does Our Self-Managed Association Need a Management Partner? 6 Questions Your Board Should Ask

Tip #5. Educate yourself. Given that most board members are volunteers who may have limited expertise in finance or accounting, it's advisable to explore training opportunities such as industry seminars, online courses, or workshops designed to enhance their financial management knowledge and skills. A good management company will offer training that can help your board members better understand financial management.

Tip #6. Avoid using cash when possible. Unrestricted access to cash without adequate controls or oversight can create problems. One way to alleviate this issue is through a credit card program. FirstService administers a credit card program that allows employees to make purchases on behalf of associations. The program includes transaction monitoring features, making it easier to detect unauthorized or fraudulent charges.

For expert guidance on fraud prevention best practices, contact FirstService Residential.

Monday March 04, 2024