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Fraud traps await unwary associations

A lack of safeguards and financial acumen can leave homeowner groups vulnerable.

April 06, 2008|Frank Nelson | Special to The Times

Homeowner associations are rocked by a triple whammy when they discover they are victims of fraud.

First, there's the financial loss, which may be substantial. Next, the association members have to deal with the betrayal of trust. And third comes the nagging realization that this might have been prevented.

Fraud at nonprofits and small businesses -- both categories that include homeowner associations -- mostly involves conflict of interest, bribery and illegal gifts, false reimbursement of expenses, billing issues, check tampering and cash theft, according to the Assn. of Certified Fraud Examiners, based in Austin, Texas.

Perpetrators may be board officers or members, managers or other staff, association homeowners or outside parties such as vendors or tradespeople doing business with the association, said Ronald S. Stone, professor of accounting and information systems at Cal State Northridge and a certified fraud examiner.

Homeowner associations, as nonprofits handling large sums of money -- in reserve and replacement funds, and daily operating accounts -- are especially at risk, Stone said, because they lack the checks and balances, and financial acumen, of most commercial businesses.

But at the same time they are expected to exercise prudent judgment and maintain detailed financial records.

"They have a fiduciary responsibility to all the owners to exercise good business judgment," Stone said, adding that they must also keep adequate books, records and files, including copies of major contracts, paid bills, bank statements and detailed collection records.

Red flags can include missing bank statements and other documents, photocopies instead of originals, unexplained cash shortages, duplicate payments to vendors and payments for unspecified services.

Stone recalls a case in the early '90s in which a Calabasas community manager used phony invoices and false bank statements to steal more than $1.5 million of association funds. He was eventually sentenced to six years in prison for check forgery and grand theft.

Many warning signs went unheeded in that case as the manager of the 268-unit association set up a system involving duplicate checkbooks, hidden bank accounts, bogus and real vendors, photocopies of documents and a set of false financial statements, Stone said.

Boards often are composed of well-intentioned volunteers, unit owners who typically are elected; however, they undergo no screening or background checks, Stone said, and may lack financial training or experience.

State legislation mandating three hours of board member education failed last year; the latest version of that bill, rather than make the education compulsory, would require members only to disclose whether they have taken such a course.

Yet another bill seeks to usher in education and training under the umbrella of a state bureau of common-interest developments that would be funded, at least in part, by a charge on community association homeowners.

Too much trust -- in fellow board members, board officers, vendors, the manager or management company -- and too little oversight, mixed with complacency and a reluctance to confront people and ask hard questions, can be a recipe for disaster.

Sometimes homeowner apathy is so widespread that the normal oversight flowing from the involvement of interested and caring residents is missing; this lack of participation may be extreme -- and leave associations especially vulnerable to criminal abuse -- in associations with high numbers of absentee owners.

David Harvey, treasurer of the association at Diamond Head, just west of Valencia, for seven years and now the association president, believes an obsession with the minutiae of association politics among many board members blinds them from seeing the bigger picture.

"Nobody watches the money," he said. "Most of them are not businesspeople; they're busybodies. They're only interested in trying to control their neighbors."

Meanwhile, property managers, who may have half a dozen properties, could be doing kickback deals with vendors, landscapers, painters and other suppliers, he said. "That's what you need willing volunteers to watch out for."

Pasadena attorney Kelly Richardson, co-founder and managing partner of Richardson & Harman, a law firm specializing in real estate and community association issues, recommends that to minimize fraud risk -- and even questionable actions that can appear illegal -- boards need to know what they're doing, keep accurate records and operate as transparently as possible.

Looking back over some of the cases he's been involved with, Richardson blames bad judgment, poor management and lack of documentation rather than dishonesty or intent to defraud.

Richardson said that even when accusations are unfair and unfounded, boards too often react by refusing to disclose information. "They make themselves look defensive and crooked when they aren't."

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