Fraud
FRAUD: HOW IT HAPPENS AND HOW TO PREVENT IT
By: Brad Schneider, CPA
Certified Fraud Examiner
CondoCPA, Inc.
Ph. 877-900-1040
In early 2014, a former condo manager gets a 10 year sentence in a kickback scheme.
Apparently he was able to make more than $3 million in inflating the cost of
construction projects and having the contractor pay him for the difference between
the true cost and the amount the association paid to the contractor.
In early 2014 a Board President signed a contract for a hallway redecorating project
without full Board approval. However, the contract was with a company owned by
the President’s brother.
In 2012, a chief financial officer of a management company was caught writing
checks on the accounts of 2 Association’s managed by the management company he
was working for. Over $700,000 of the associations’ money was used to pay for the
CFO’s gambling.
As you can see, there are many ways for a manager or board member to take funds
from an association. We will talk about why this happens and how it happens and
ways to prevent it from happening.
Why it happens
To explain why financial fraud occurs we have to turn to the Fraud Triangle which was
a theory developed by the famous criminologist and sociologist Donald R. Cressey.
His theory is that all three legs of the triangle must be present, simultaneous, for an
individual to engage in fraud.
www.condocpa.com
1.877.900.1040
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 their bills or a drug or gambling
addiction. (It seems like more and more are happening because of gambling
addictions.) The desire for status symbols such as a bigger home or a nicer car.
(Keeping up with the Jones’.) It can also be brought on by the need to meet
specific professional goals.
Opportunity – This is the method in 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 is when there are no segregation of duties. 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 a financial fraud. If the Association is selfmanaged, they should strongly consider outsourcing their financial accounting to a
reputable company, whether it is a management company or an accounting firm.
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 of
how frauds occur for community associations are classified in 4 basic categories:
1. Taking income that is meant for the Association. Examples are assessments,
user fees, unauthorized waiver of fees or assessments, ancillary income such
as antenna income, cable income, vending income, interest income, parking
income.
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. Usage of company credit cards for personal
purchases, are included under this category too. Increasing time reported for
payroll or ghost employees.
3. Taking of Association equipment or inventory for personal use. Included 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
will vary depending on the transaction being hidden. Below are various ways and
are categorized by the method that was used to perpetrate the fraud.
Income:
Check kiting and adjusting unit owners accounts with other unit owner checks,
adjustments to income accounts offsetting the fund balance or shown 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.
Expense:
When the internal controls are not proper, such as when the invoice authorization
and the check signing is performed by the same person, the transaction can be
easily hidden by changing the paid invoice 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:
In order for this to be hidden, controls over equipment and supplies will need to be
circumvented or non-exist.
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. It can also be by
having the manager review the records of the maintenance and other staff
members. Oversight is also performed when a supervisor approves or
oversees purchases by the managers or by reviewing the financial statements
in detail each month. It can also be by 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.
Below are some additional positive internal control steps that can help safeguard
the Associations assets.
! When bidding out a contract, require at least 3 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 should have some involvement in
the bidding process.
! Time cards of employees should at least be reviewed by the on-site manager.
(Oversight)
! 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.)
! Be wary of employees that never go on vacation.
! For larger buildings, have a perpetual inventory system used where usage is
traced to work orders. Then usage of more expensive supplies is accounted
for. Also, use an equipment inventory. You would be surprised how many
items disappear when there is no tracking system used.
! Do background checks for new employees, looking at criminal and credit
history. The 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.
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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.
Many adjustments to receivables are not normal. If there are many
adjustments downward to unit owner’s accounts investigate.
Items that are put to fund balance should be investigated. Sometimes they
are valid but it is a good place to hide fraudulent activity.
Remember a good fraud prevention program is worth it’s weight in gold…literally!