Homeowners associations (HOAs) act as a self-regulating entity. An association enforces rules for the properties and their residences. Many provide services for the common area, such as irrigation, mowing, snow removal, security, and more.
To provide these services the association will require the homeowner to pay HOA dues. These dues are paid either monthly, quarterly, or annually. The amount of dues collected can be substantial.
The management of these funds is done by either elected board members or through a management company. Internal controls for these types of entities tend to be weak or non-existent.
With all this cash, and the lack of internal controls, HOA embezzlement happens more often than most realize.
In this post we’ll define HOA embezzlement, common embezzlement, how to recognize HOA embezzlement, and steps that can be done to mitigate the possibility of fraud.
HOA embezzlement occurs when homeowner dues or assets have been diverted for the benefit of individuals. The diversion can take the form of cash or for products or services not directly related to the association—such as using a maintenance crew to perform personal maintenance, or for overcharging for services from a personally owned company.
To understand how embezzlement happens we first need to understand internal controls. The concept of segregation of duties is important when discussing internal controls. Segregation of duties is broken down between:
In an ideal world each of these duties would be performed by a separate individual in an organization. This is what is meant by segregation of duties.
However, outside of larger corporations, segregating each of these duties to a separate individual is not economically feasible. Therefore, most organizations including HOAs, will have some form of mitigation.
The mitigation will segregate the controls between at least two individuals. There is a breakdown in internal controls when one individual has access to all four duties or when one individual fails to perform their duties.
Having control over all four duties allows for embezzlement to happen and not be discovered timely.
Throughout the USA there are thousands of homeowner’s associations. Geographical and political locations tend to dictate when, where, and how the HOA is structured. Regardless of the purpose of the HOA, most generally have the following in their structure:
When there is a substantial amount of cash entering the organization on a recurring basis, and limited oversight, the conditions for embezzlement increase. Some of the more common embezzlement for an HOA is:
The president of an HOA has tremendous power over the direction and assets of the association. The president will have signing authority over the bank account, the ability to enter into contracts, and will negotiate with outside vendors.
Because of this ability and lack of oversight, when a HOA president commits embezzlement is primarily done by:
To eliminate the day to day oversight needed, some associations hire a management company. Management companies can and have committed embezzlement. Some of the more common embezzlement from a management company are:
The lack of oversight and monitoring of the individuals in charge of an association tends to lead to fraud. Some of the more common clues that may indicate embezzlement are:
Because of that, it is not uncommon for the individual or company to only provide limited or modified financial information. For example, one-way embezzlement can happen is dues are stolen when the funds come in. The embezzler will give out the income statement but not the balance sheet. The reason is the cash collections only show up on the balance sheet.
Sometimes the embezzler will give out ‘modified’ financial statements. This usually takes the form of an excel schedule. Because the accounting software will print out all items affecting the FS, the embezzler will import this information into excel and then eliminate the red flag accounts.
The strongest way to mitigate fraud and embezzlement in any organization is to have strong internal controls. Even with an association there are ways to strengthen internal control. Ways to mitigate are:
If there is doubt about which controls to implement or if members do not want to add more to their plate, then consider hiring a virtual bookkeeping company to perform the accounting aspect. This will add a level of control plus take the burden of bookkeeping off the treasurer.
In addition to strengthen internal controls, the association should consider fraud insurance. Some insurance carriers offer this coverage as an add on to their umbrella policy.
If you are in a situation where you suspect there is embezzlement, there are certain steps that must be considered. The first is to secure all or obtain access to source documents.
Contact a forensic accountant. While the internal investigation may have turned up the embezzlement, the attorney will need an independent report to further the litigation.
Additionally, should the association choose to criminally prosecute, the local law enforcement agency will lean heavily on the forensic accountant’s report.
With the lack of oversight on an association’s financial records, the odds of embezzlement are high. Mitigate the risk by requiring monitoring of all financial transactions and hire a forensic accountant like Hovland Forensic to review the association’s finances.
For additional information, please see the following posts: