The emergence of money schemes like the all-too-common email fraud, combined with the prevalence of identity theft has taught us to be wary of potential scams. While we are often mindful of these items in our own lives, it is important that association managers and board members assess how their HOA could be at risk of becoming the victim of theft, too.
HOAs typically have large bank accounts and easy access to homeowner information. As a result, people sometimes target them for all types of theft, especially fraud and embezzlement.
The good news is that there are preventive measures board members can introduce to their association’s daily practices that can help prevent financial theft of any type from happening to your association.
What Is the Difference Between Theft, Fraud, and Embezzlement?
While terms like theft, fraud, and embezzlement tend to invoke strong reactions, one is not necessarily “better” or “worse” than the other two. Each state has its own statutes regarding theft, fraud, and embezzlement, but the circumstances and the amount of money involved will always determine the legal repercussions.
Understanding the difference between theft, fraud, and embezzlement will help you understand the different ways your association may be at risk.
Theft involves stealing someone’s money or property without the intent to return it. Theft also includes the stealing of services, too, like a dine and dash or going to a movie theater and sneaking past the ticket counter.
So, if a volunteer was helping the board at either a fundraiser or a social event and reached into the money box and grabbed $100 while no one was looking – that’s theft.
Fraud is a type of theft. A person commits fraud when he or she obtains something of monetary value through deception.
If a board member claims, for example, that the landscaper’s charge to fix the association’s sprinkler head was $100 when it was really $90 so they can pocket the extra $10 – that’s fraud.
Embezzlement is another type of theft. Embezzlement happens when an employee or volunteer steals or misuses money or resources placed in their trust.
So, if the treasurer figures out a way to skim part of the homeowner’s assessments off the top and cook the books to make it look normal – that’s embezzlement.
While the consequences of theft of any type can be dramatic and cause long-term problems for an association, many board members may understandably ask themselves, “Is my association even at risk for fraud and theft?”
Related: Common Scams and Crimes
How common are fraud and embezzlement?
There is currently no data on the prevalence of fraud in the HOA industry specifically. However, many board members choose to run their association like it’s a business. Additionally, most people who interact with HOAs view them more as business entities and recognize that they perform almost all the functions of a business.
So, if you’re running your association like a business… what is the statistical likelihood of fraud, embezzlement, happening to a business? Unfortunately, it’s high: on average, each business will lose 5% of its yearly revenue due to fraudulent behavior.
In fact, the smaller your business is, the more at risk you become for fraud and embezzlement.
Moreover, there are many myths about fraud and embezzlement. Many individuals believe that fraud or embezzlement is easy to spot. Many people also believe that as long as you run thorough background checks on your volunteers, you will be able to spot red flags.
The data shows us a very different story. Here are some surprising statistics about fraud:
- It generally takes about 18 months before someone discovers fraudulent behavior.
- Most people discover fraud through a good Samaritan reporting suspicious behavior. The second most common way to discover the fraudulent activity is by accident.
- More than 90% of fraud perpetrators are first-time offenders.
- It’s a myth that you will always get recompense for theft: on average, only 39% of funds are recovered.
With these facts in mind, what can boards do to protect their association?
Protecting Your Association
To prevent fraud, it’s important to put specific safeguards in place. See below for our top suggestions:
Give each board member a reviewing task (from the list below) to perform quarterly. Since many cases of embezzlement involve more than one person, having everyone on the board take part in screening the association’s finances helps ensure that you will catch instances of theft early.
Check all bank accounts and account numbers periodically using the association’s Federal Tax Identification (FTI) number. Knowing your association’s FTI will help you find all bank accounts. Specific red flags to look out for:
- If a bank account is under someone’s name (all bank accounts should be under the association’s name).
- If the FTI number doesn’t match on an account listed as the association’s account.
Move to an electronic payment system, or, failing that, use a lockbox system for checks. Using an electronic payment system or a lockbox will help prevent someone from depositing money into the wrong account.
Safeguard your association’s accounts. All accounts should have two names attached to them. One board member should never have total control over an account.
Send duplicate operating and reserve accounts statements every month to at least two separate parties. Send one statement to the management company and send the other one to a board member who cannot sign checks or withdraw funds. If you’re self-managed, send the first statement to the treasurer instead of the management company.
Regularly review invoices for discrepancies. If you were sent checks, you can review them against the invoice. If you were paid via credit cards, be sure to keep any and all receipts for review. If you’re self-managed, a board member without access to the accounts or credit cards should review the invoices regularly. If you utilize a management company, we recommend the treasurer review the invoices.
Only work with banks who can demonstrate that they have safeguards to minimize theft. Here are some specific safeguards to ask your bank to demonstrate:
- Dual signature enforcement.
- Prohibiting electronic transfers between accounts that do not have the same FTI number.
Make sure you and your management company are properly insured. We recommend having fidelity coverage that, at minimum, equals the reserve account plus 3 months of the operating account’s expenses.
Additionally, we recommend requiring the management company to carry fidelity insurance, too.
Have check signers review supporting documentation. It’s always a good idea to ask to see the bill, for example, and we recommend having a separate sheet where you note/initial the check number, date, amount, and bill it’s associated with.
Have a CPA conduct an audit. Check with your governing documents to see how often you should have you’re booked audited by a third-party professional. If your governing documents are silent on the matter, we recommend yearly audits.
Ultimately, the tips above are about creating a system with plenty of checks and balances. A system that requires financial transparency for all to see is the best way to monitor all financial transactions and prevent a theft from taking place.
Related: Credit Card Fraud
Benjamin Franklin said it best: an ounce of prevention really is worth a pound of cure. While there are steps you can take to recover your financial losses in the wake of a theft, putting the right safeguards in place first will help your association remain financially sound and prevent the drama associated with fraud recovery.
If you’re self-managed, we recommend utilizing a management company to help protect your association. Employing a management company can increase transparency and help you catch any fraudulent behavior.
Not sure you want a traditional management company? We recommend you look at our friends at JellyBird! They take a new approach to HOA management, and they specialize in small HOAs who want to remain independent from the traditional HOA management model.
If you suspect fraudulent activity is happening, it’s important to take quick action. Gather as much documentation as possible to support your claim before accusing anyone. Consider requesting copies of the following items:
- Financial documents relating to budgets, statements, audits, etc.
- Vendor contracts
- Tax returns
- Board meeting minutes
- Check registers
- Purchase orders
- Governing documents
The above documents will help you ascertain if there’s a problem, the extent of it, and what to do about it if you do uncover fraudulent activity.
We hope this article has clarified the difference between theft, fraud, and embezzlement. Further, we hope the above tips have helped you to understand how to prevent theft, fraud, and embezzlement from your association.
Want to know more about how to protect your association? We have courses designed just for you!