Fraud: How It Happens and How to Prevent It

By Brad Schneider / Published August 2016

• In 2012, a chief financial officer of a management company was caught writing checks on the accounts of two associations managed by the management company he was working for.  More than $700,000 of the associations’ money was used to pay for the CFO’s gambling.
• In early 2014, a former condominium manager received a 10-year sentence in a kickback scheme. Apparently he was able to make more than $3 million by inflating the cost of construction projects and having the contractor pay him the difference between the true cost and the amount the association paid to the contractor.
• Also in early 2014, a board president signed a contract for a hallway redecorating project without full board approval. However, it was revealed that the contract was with a company owned by the president’s brother.
• In March 2016, El Nuevo Herald and Univision 23 performed an investigation that revealed the frequent instances of fraud facing condominiums in Miami-Dade County.
• In April 2016, more than 250 South Florida condominium residents marched through the streets of Doral to demand that the authorities take steps to stop a wave of fraud hitting condominiums in their area.

As you can see, fraud is a big issue that affects many communities in Florida. There are many ways for a manager or board member to take funds from an association. We will talk about why and how this happens and ways to prevent it from happening.

Why It Happens

To explain why financial fraud occurs, it is important to turn to the fraud triangle, which was a theory developed by the famous criminologist and sociologist Donald R. Cressey (www.acfc.com/fraud-triangle.aspx). His theory is that all three legs of the triangle must be present simultaneously for an individual to engage in fraud.

Pressure—The fraud begins with pressure, usually financial pressures. For example, there is financial pressure when the spouse of the fraudster loses his or her job. The economic pressures brought on by the recession can have a big effect. Some other reasons are the inability for the fraudster to pay his bills, a drug or gambling addiction, or the desire for status symbols, such as a bigger home or a nicer car (keeping up with the Joneses.) It can also be brought on by the need to meet specific professional goals.

Opportunity—This is the method by which the crime can be committed. The key elements are too much power and keeping the crime a secret. Some ways a person can commit the crime are when there is no segregation of duties or when there are poor internal controls. Self-managed associations, beware. When the treasurer or on-site manager is authorizing the invoice, signing the check, and producing the financial reports with little or no oversight, look out. Keeping the crime a secret is a key element in the opportunity phase. If the other board members are actively overseeing the treasurer or manager in these situations, the fraud could be avoided. Having a management company is no guarantee that all fraud will be avoided, but most management companies with an accounting department will have developed a much stronger internal control system to help avoid financial fraud. If the association is self-managed, they should strongly consider outsourcing their financial accounting to a reputable company, whether it is a management company or an accounting firm.

Rationalization—The final leg of the fraud triangle is rationalization. If the fraudster has financial pressure and opportunity, the rationalization will help them move to commit the fraud. Rationalization is the way the person justifies the act.

Some common rationalizations are:

1. “I was only borrowing the money.”
2. “I was entitled to the money.”
3. “I had to steal to provide for my family.”
4. “I was underpaid; my employer deserved it.”
5. “My company does bad things, and I got them back for it.”

How It Happens

We have discussed why it happens and partly how it happens. Some of the ways fraud occurs for community associations are classified in four basic categories:

1. Taking income that is meant for the association. Examples are assessments; user fees; unauthorized waiver of fees or assessments; or ancillary income such as antenna income, cable income, vending income, interest income, parking income, work order income, and pool passes.
2. Unauthorized or inflated purchase of materials or services from association funds. Examples are purchasing items for personal use or gain with association funds. Other examples are kickbacks on contracts signed on behalf of the association. Use of company credit cards for personal purchases is included under this category too, as is increasing time reported for payroll or ghost employees.
3. Taking association equipment or inventory for personal use. An example in this category is when a maintenance person installs items in a unit for personal gain while paying for the parts with association funds.
4. Use of association assets for personal gain. Included in this category is using association investments as collateral on a personal loan or placing association accounts into a person’s name to gain investment income from the association’s investment.

How It Is Hidden

Without the ability to hide the transaction, the economic benefit received by the fraudster would be short lived. There are so many ways to hide the transaction, and the method employed will vary depending on the transaction being hidden. Below are various ways that are categorized by the method that was used to perpetrate the fraud.

Income can be hidden by lapping and adjusting unit owners’ accounts with other unit owner’s checks, or making adjustments to income accounts by offsetting the fund balance or making it appear as a deposit in transit. Income that is taken before it is recorded on the books as income can be difficult to trace. If there is no budget for an item, such as antenna income, or the budget is very low, then the extra income can be siphoned off with no one noticing.

Expenses can be disguised when the internal controls are not proper, such as when the invoice authorization and the check signing are performed by the same person.  The transaction can be easily hidden by changing the paid invoice (note: pdf copies can be manipulated), combined with modifying the accounting records. If proper contract bidding is not done, then kickbacks are very difficult to uncover.

Using and taking of association equipment or inventory for personal gain can be hidden if controls over equipment and supplies do not exist or can be circumvented.

Ways to Avoid Fraud

     Good internal controls go a long way in making it more difficult to be successful in defrauding the association. The list is very lengthy, but I will review some of the important ones:

1. According to the Association of Certified Fraud Examiners, the best way to avoid fraud is by oversight. Oversight is done at various levels. It can be performed by having an outside auditor audit the books. In Florida, associations are required to have an audit if their assessments exceed $500,000. How many associations opt out of the audit for three years and then have their audit in the fourth year as required? When you announce an audit every fourth year, does that mean the perpetrator can avoid being caught if he/she steals for only three out of every four years? If you do not have an audit, are you saving more than the over-sight is worth? In my experience, the audits do not cost very much and have been a useful oversight tool. Oversight can also occur by having the manager review the records of the maintenance and other staff members. Oversight is performed when a supervisor approves or oversees purchases by the manager or reviews the financial statements in detail each month. Oversight can be having board members more involved in looking over invoices and understanding financial statements. The more oversight performed by looking over the records and checking the work of others, the more difficult it will be for the fraudster to be successful in hiding a fraudulent transaction. If there is a good chance the transaction will be uncovered by someone, most people will be very hesitant to commit a fraudulent act.
2. Advocate for stronger oversight by local police and the Florida Department of Business and Professional Regulation.
3. Protest and lobby your local representatives for stronger legislation from Tallahassee to require that the Condominium Trust Fund money (paid by each owner through their association) be used exclusively to protect association owners and retain funds left over each year for only that purpose, and to require better internal controls and transparency by boards.

Below are some additional internal control steps that can help safeguard the association’s assets.

• When bidding out a contract, require at least three proposals. Bidding out smaller contracts often can lead to issues with continuity. Bidding out all contracts every year can be a huge waste of time. Large contracts should always be bid out, and the bid specifications should be reviewed so that all proposals are on the same basis. The board or board committee should have some involvement in the bidding process.

• Time cards of employees should at least be reviewed by the on-site manager.
• Avoid having cash taken in by the management office or garage.
• Use lockbox services whenever possible. (A lockbox is a post office box used by a bank so that the owner’s assessments go directly to the bank.)
• Consider using a vendor payables lockbox system. You can add more levels of approval and scrutiny by management and the board.
• Be wary of employees who never go on vacation.
• For larger buildings, have a perpetual inventory system used where usage is traced to work orders, then usage of more expensivesupplies is accounted for. Also, use an equipment inventory. You would be surprised how many items disappear when there is no tracking system used.
• Run background checks for new employees, looking at their criminal and credit history. Online companies now charge very reasonable fees for these services.
• When reviewing bank reconciliations, look for items that do not clear. Items that tend to be left on the bank reconciliation for many months can turn out to be improperly recorded or a possible suspicious item.
• Do not sign checks unless all of the evidence of the purchase is attached. For instance, if you have a credit card bill and a large item does not have a receipt, wait for the receipt before signing. Duplicate receipts are usually available.
• Frequent adjustments to receivables are not normal. If there are many adjustments downward to unit owners’ accounts, then you need to investigate. Require board approval of any unit owner balances that are written off.
• Items that are put to the fund balance (or retained earnings account) should be investigated. Sometimes they are valid, but it is a good place to hide fraudulent activity.
• When waiving audits for some years, change it up and do not be predictable. Perhaps have the audit the first year and then again in the third year or when there are capital projects.

Remember, a good fraud prevention program is worth its weight in gold…literally!

Brad Schneider, CPA

President and Founder of CondoCPA, Inc.

Brad Schneider, CPA, is the president and founder of CondoCPA, Inc. a CPA firm that specializes in community associations. Schneider is a CPA, licensed in Florida, Illinois, and California, a certified fraud examiner, and has an MBA in Finance and Marketing. He has been working with community associations for more than 30 years. The firm has offices in Sarasota, Tampa, and Orlando, Chicago, and Felton, California. CondoCPA is a founding member of the Alliance of Community Association CPA’s, (cacpasalliance.com). For more information, call (877) 900-1040 or visit condocpa.com.