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Minding Your Money Boards Must Be Alert for Financial Shenanigans

In the increasingly-paperless world of modern banking, there are fewer hands writing checks and processing transactions. With no need to physically deal with cash and checks, this should mean fewer mistakes — and better security. Does this also mean fewer opportunities for fraud and embezzlement? Not necessarily, since determined thieves will always try to find a way into a system, whether it’s the cash in Grampa’s mattress or accounts in CitiBank’s computers. Plus, not everyone trusts wire transfers and direct deposits, and not every association or unit owner is banking-by-computer quite yet.

Regardless of trends in electronic banking, the occurrence of fraud and embezzlement within community associations, experts report, is thankfully rare. And while financial transactions have gone high-tech and electronic, the situations where managers, trustees or contractors have scammed or stolen from association accounts seem decidedly low-tech and old-fashioned. Most embezzlers are hiding in plain sight.

“I have been on ethics panels and been privy to situations where someone caught in the act, was being disciplined and have had cases where associations were ripped off,” notes Attorney Henry Goodman, a principal at the Dedham, Massachusetts and Lincoln, Rhode Island law firm of Goodman, Shapiro & Lombardi, LLC. “People who commit fraud often do so in a way that’s both open and yet disguised. Further, it is not confined to any one group. It could be a contractor, a manager or a board member. You can have a trustee or manager who’s well-liked and respected… presenting paperwork at board meetings that appears valid, but when the board eventually checks the bank accounts, they find that they’re empty.”

In one case, Goodman states, “An association’s treasurer in a self-managed community had fired the accountant, but took the accountant’s letterhead from an old report, and created phony financial documents on altered photocopies. He also took old insurance policies and changed the dates and policy numbers to make it look like new policies, while diverting funds in the budget intended for insurance payments. The result was… the association had no insurance for several years. Fortunately there were no insurance claims. This individual was finally caught when a contractor contacted the board president because he was waiting for his bills that had not been paid. This case, because the fraud went on so long, it cost the board a lot of money — into six figures.”

Spreading the Scam

Often, however, the perpetrators find ways to skim that don’t involve huge sums for any one association, essentially spreading the theft around. Goodman describes a management company in which a manager bought a large order of (several cases) of supplies, enough for one association, installed some in each of several associations and then charged every association that the company managed for the same full order of supplies. “And the other associations got charged for the installation as well, he says.” In a similar example, he adds, “What happens when you have a contractor doing all your fencing or siding, or whatever… and the board opens a charge account at the local Home Depot? The guy may be buying tools and supplies the condo doesn’t use. All of a sudden, someone on the board notices a charge for red paint, and there is nothing painted red on the property. Board members have to be diligent [in checking charges].

“I had a case where a landscaper was ordering big piles of mulch at a townhouse community. After it was spread, management walked through and checked the job, observing that the new mulch seemed to be spread awfully thin. Eventually, one of the landscaper’s employees was fired, and blew the whistle on his boss, who had been spreading a single load of mulch at three different properties, charging each for the same load… and he’d been doing this for years.”

For boards that discover these kinds of crimes, satisfaction is often hard to come by. “When culprits are found responsible for a crime [such as theft],” Goodman continues, “they may offer to pay the missing funds, as restitution, and cut a deal… so they won’t get prosecuted. It is not right to use the criminal courts to collect the debt, but this often is the result as a practical matter. Needless to say, once a criminal act has been discovered, the board will terminate the contract.”

“We saw a case recently when a site manager and former board president were indicted for grand larceny. In this case, the board had proper insurance, but insurers do not make payments unless the claim is proven to their satisfaction. Here, directors had to prove everything. The insurance company tried to make their payment contingent on a criminal conviction, and they eventually paid some months later, because there was one conviction,” he relates, adding that a criminal conviction for associations victimized by a treasurer’s embezzlement or a contractor’s scam is rare, because often associations and insurers are more interested in restitution.

Manipulating Data

Goodman points out that “things like this can happen when checks and balances lapse. You cannot ignore the basic safeguards, like double signatures on checks. Maybe electronic banking and bill paying can be helpful—if all the figures and transactions are correct on a spreadsheet.” He emphasizes that often the basis for fraud is altered documents, “The question is, can someone manipulate the spreadsheet? Having the proper controls in place simply comes down to double-checking—and doing it consistently.” He advises that consultation with a CPA as to proper controls and following that advice, as well as having a board member double-checking, is the safest approach.

David Barrett is director of operations at Crowninshield Management Corp. in Peabody, Massachusetts, and is incoming president of the Boston Chapter of the Institute of Real Estate Management. “This organization has been teaching ethics in our industry since 1930,” he notes. Over the years, Barrett says, “I have heard of some less-than-ethical dealings in our industry [although] most management companies and boards are reputable and these encounters are rare.”

In one instance, he notes, “An association was victimized by a trustee along with the on-site manager—the two were working with certain vendors and asking them to overcharge for services… committing fraud and sharing the extra income. In another community, the management company was a small, family-run operation. At one point, a broadband company had offered marketing incentives to be paid to the association, but the manager had other ideas. Upon investigation, it was found that the manager had also hand-written a number of checks to himself from the association accounts. A civil case resulted in a judgment of over $50,000, but there was no restitution for the board, since the management firm had no recorded assets.”

Barrett advises boards to use due diligence when hiring anyone, especially a management firm, since the lack of assets could serve as one warning about a company’s legitimacy. “I also advise clients to have enough fidelity insurance,” he says, adding, “Most banks require coverage in the amount of three months’ income plus enough to cover all the funds in the reserve and operating account at a given time.

“All our associations have an annual financial review and it is recommended that an audit is conducted every few years,” he says, “even though, under Massachusetts condo law, annual reviews are not required for properties with 50 or fewer units.”

Oftentimes, due diligence serves to ultimately qualify a contractor’s or manager’s honesty. Barrett continues, “Prior to joining Crowninshield I was involved with some associations who complained that the former management was stealing, and I found that’s not usually the case, that something else was going on. At one garden-style community with over 200 units in the Boston area, the original developer was the majority owner—of well over half the units—and rented the units that he owned. He was providing maintenance and the services of a management company, but he didn’t believe he had to divulge his books and finances.

“The minority unit owners were suspicious about where their fees were going, and sued to gain management control—that’s when our firm was hired to take over management,” continues Barrett. “Under court order, we were able to review his records and discovered he had handwritten ledgers and receipts and could account for every transaction. As it turns out, he had been subsidizing the association with his services in return for not paying his fees, and the value of the services were tipped in favor of the association.” So this was a case where the “suspect” was not only innocent, but generous.

When Suspicions Arise

The incidence of board members or unit owners becoming suspicious is not unusual, and can even stem from something as simple as a manager’s loyalty to a particular vendor or contractor. “I’ve seen instances where people suspect there’s something going on but most of the time they’re legitimate expenses,” reports Heather Cozby, CPA, who is managing partner in Cozby & Company of Plymouth, Massachusetts. When trustees or unit owners feel they’re not getting enough information about the finances, suspicions arise. “Most of the time… it’s a matter of perception, so we always encourage transparency. When communication changes, or stops, suspicions arise,” says Cozby. “Within associations, fraud usually involves collusion,” she adds. “Sometimes, just changing [management] companies will make the trustees’ anxiety go down.”

She warns that boards should not necessarily call for an audit when they have a suspicion or concern about financial management. “An audit is not designed to uncover fraud… that’s not the goal. You should rather ask, ‘What is it you’re trying to find out? You may only need an ‘agreed-upon procedure,’ which is when you engage a CPA for a specific problem or complaint… to address a very specific concern. This can be done in a couple of hours and will cost a lot less [than an audit] and will result in a finding, telling you what actions did or didn’t conform to your particular financial practices. Then the board can take the next step, if they choose.”     

Marie N. Auger is a Massachusetts freelance writer and a frequent contributor to New England Condominium.

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