The risk of HOA fraud
Last year, members of the Board of Directors of Florida’s largest Homeowner’s Association (HOA) were arrested and charged with the embezzlement of millions of dollars. The story sounds like it comes straight from a gangster film. Aggrieved members of the HOA said that the board ran their HOA “like the mafia” by ignoring maintenance requests and skyrocketing homeowner fees year after year.
While this is an extreme example, fraud and theft by HOA boards are real risks. HOA board members are unpaid volunteers. In addition, HOA boards very often have relatively little oversight—especially self-managed associations. Unchecked power and unfettered access to HOA funds are a recipe for potential disaster. These thefts are often crimes of opportunity.
But by implementing some commonsense measures and seeking a quality insurance policy, HOA members can mitigate the risk of fraud and theft. This post will review the most common types of fraud, red flags to watch out for, and checks and balances you can implement.
Common issues in HOA management
Most fraudulent behavior is less brazen than the example from Florida. However, fraud and theft in HOA environments are common. Most incidents can be avoided by using simple checks and balances. Boards and unit owners must not be lulled into a false sense of security. Examples include:
- Embezzlement: Embezzlement occurs when HOA funds allocated for specific purposes are misappropriated (usually for the personal use of the embezzling board member). Embezzlement can be stolen checks, unapproved money transfers or wire fraud, money laundering, or vendor kickbacks.
- Election rigging: HOA board members may manipulate votes or voters to remain in power or elect an ally privy to their schemes, creating an environment conducive to theft schemes.
- Kickbacks: Vendor kickbacks are bribes that vendors pay to HOA board members in exchange for hiring the vendor for repairs or other services.
- Falsified bookkeeping: HOAs are governed under corporate law, meaning they must maintain accurate books. Deliberately altering accounting to hide theft or mask fraud is a common tactic.
Learn more: How to keep your community association board from getting sued
Potential HOA fraud and theft red flags
HOA fraud leaves behind telltale signs, including:
- Errors in accounting—often resulting from allowing a single individual handling all bookkeeping duties
- Sudden, unexplained increases in member dues
- Drops in HOA revenue
- Financial statements that don’t match
- Checks written to board members instead of the HOA
- Checks written to fishy companies or non-existent vendors
- Checks written to “CASH”
- A lack of oversight in HOA board operations
- A surge in vendor pricing
Training all HOA board members to avoid simple accounting gaffes will make spotting actual fraud red flags easier. The Community Association Institute (www.caionline.org) has great videos and best practice publications.
Employ checks and balances to prevent mismanagement
An HOA board can significantly reduce the risk of fraud and theft by implementing simple rules and processes. The board’s financial functions typically involve the following:
- Authorizing expenses and payments to vendors
- Access to bank funds or other HOA assets
- Keeping accounting records
- Overseeing all financial transactions
The potential for fraud and theft grows when these responsibilities lay with one or two individuals on the HOA board, employees or other volunteers. But, with a few tweaks to these basic operations, HOA boards can quickly fill the cracks through which theft might occur.
Checks
- Require two signatures for all checks.
- All checks must be made to the HOA (not individual board members).
- Refrain from allowing management companies to sign their checks. Property managers should submit “original” invoices and expense reports for board approval.
- All board members should review all checks and payments every month, or make sure there are multiple eyes reviewing checks.
Oversight
- At least two HOA board members should review all financial documents—not just the treasurer.
- Diversify financial responsibilities. For example, one person handles deposits while another member reconciles bank statements.
- Financial statements should be available to homeowners in public forums like the HOA’s website.
- Work with a third-party accountant or bookkeeper. Have an audit of your finances at least every two years.
- Create an election fairness committee composed of homeowners.
- Regularly review insurance coverage.
Vendors
- Require board approval of all new vendors.
- Every board member who brings a vendor to the board must disclose conflicts of interest.
- All vendor contracts over a certain threshold should be brought before the board and the association’s attorney for review.
Learn more: Four Habits for More Effective HOA Boards
Protect your HOA with insurance
There currently is no data on the prevalence of fraud and theft among HOAs. However, any time money and power are involved, the potential for abuse is present. As we’ve discussed, there are many red flags to watch out for. In addition, there are several policies you can adopt to minimize risk.
However, no plan is foolproof. Some embezzlement schemes are very sophisticated and can defy detection for years. That’s why HOAs need to seek proper insurance coverage. To supplement a basic HOA umbrella plan, consider crime and fidelity coverage and fraud protection. Additionally, D&O insurance protects board members from liability in the case of theft by employees or management companies.
McGowan Program Administrators (MPA) is a leading community association and HOA insurance provider. Whether you reside in a single-family HOA or a large community association, MPA has the experience and insurance portfolio to protect your HOA and guide your board through the dangers of fraud and theft.
