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HOA Fraud

How to Recognize HOA Embezzlement

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.

What is HOA embezzlement?

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.

Basics of Internal Control

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:

  • Authorization – Ability to approve and expense or a check.
  • Custody of an Asset – Access to the bank account or other association assets.
  • Recording – Recording of accounting information.
  • Monitoring – Review of transactions and financial results.

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. 

hoa fraudThe biggest control weakness in embezzlement cases occurs when either one person, usually a president or treasurer, controls all four duties. 

Having control over all four duties allows for embezzlement to happen and not be discovered timely.

Structure of most HOAs

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:

      • Limited Oversight – The HOA usually has a volunteer board of directors. These volunteers may or may not have a business background and many have regular jobs that take up their time. Sitting in the board meetings tends to be a low priority. Additionally, few of the residents of the association will come to board meetings. Because of this, there is usually limited oversight of the HOA outside of the president, treasurer, and other officers.
      • Control Over All Aspects – HOA finances are usually centered around a few individuals. These individuals will tend to have more control over various function of the association. This is usually due to the limited oversight discussed earlier.
      • Authority – The HOA president, treasurer and or management company tend to have total authority over the expenditure of funds and yearly dues. While there may be loose guidelines in place, the lack of oversight enhances these individual’s authority.

Common HOA Embezzlement

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:

HOA President Embezzlementhoa president embezzlement

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:

    • Cash intentionally diverted to personal accounts
    • Vendors used for personal jobs and paid for by the HOA
    • Kickback from vendors or personal conflicts not disclosed.

HOA Management Company

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:

      • Theft of dues payments
      • Overcharging for services or charging for services not performed
      • Charging the association for owner’s rep fees when such situation wasn’t needed

How to Recognize HOA Embezzlement

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:

    • Financial information either not provided or limited. When an individual commits embezzlement the first thing they want to do is cover up or hide the theft. The accounting records and financial statements will be a great indicator as to something is wrong.

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.forensic accounting

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.

    • Excuses for the ‘complicated’ general ledger. The embezzler will indicate homeowner’s can’t have access to the general ledger because the accounting is complicated. This type of organization is really a simple cash in, cash out type business. There are rarely any transactions that are complicated. If this excuse comes up, either the individual is not qualified to do the accounting or possible theft is occurring.
    • No access to original bank statements. When an individual commits embezzlement they want to steal cash. The bank statement is the one document that is out of their control to manipulate. So the embezzler will come up with excuses to not allow access.
    • Budgets seem disproportionate. The longer an embezzlement has gone on the harder it is for the embezzler to cover for the theft of funds. This becomes evident when maintenance work doesn’t appear to be happening yet the dues have increased. To compensate for the theft and still pay vendors, the embezzler will have to increase budgeted dues disproportionally to the services received.

Mitigationfraud risk mitigation

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:

    • Require that all bank statements be reconciled monthly and reviewed by someone independent of the preparer.
    • All checks written during a month should be presented to the board for review and approval monthly.
    • Expense fluctuations between budget and actual should be reviewed by the board and any significant discrepancies reviewed.
    • Monthly balance sheets and income statements should be available to all homeowners, such as posted on the website.
    • All vendor contracts over set dollar amount should be reviewed and approved by the board.

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 Suspect HOA Embezzlement

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.

Forensic Accounting Next, contact the Association’s legal counsel. While embezzlement might be happening, there are certain legal steps that need to be taken to prevent future litigation issues.

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.

Conclusion

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:

Post Author: Steve