Embezzlement: the fraudulent taking of assets (money or property) of another
by a person in a position of trust or responsibility over those assets.
Embezzlement is a form of fraud, a white-collar crime where a person misappropriates money or property entrusted to him/her. The theft is by someone in a position of trust or responsibility over the asset, i.e., a board member, an association employee, or a management company.
Elements of Fraud. The elements of fraud are (i) misrepresentation or concealment of information, (ii) reliance by the association on the misrepresentations resulting in (iii) a loss. In each case, the person has been entrusted with the asset but uses it for their benefit. The fraudulent appropriation is a violation of the person's fiduciary duties against self-dealing.
Statistics. According to a report on embezzlement by Marquet International:
- Embezzlers generally begin in their early 40s. The average time period for embezzlement is 4.7 years.
- Women are 2/3s more likely to embezzle than men, but men embezzle larger amounts than women.
- Gambling is often a motivating factor.
Schemes. Their research found that the most common types of embezzlement involve the following schemes in order of frequency:
- Forging checks payable to cash, themselves or personal vendors;
- Pocketing cash receipts meant for deposit into HOA accounts;
- Issuing extra paychecks and/or bonus checks through payroll to themselves;
- Submitting fraudulent expense reports for reimbursement;
- Submitting fraudulent invoices from phony or legitimate HOA vendors;
- Using association credit or debit cards for personal use.
Warning Signs. There are warning signs that your manager/bookkeeper may be stealing funds from your association. Following are red flags when the person handling funds:
- Refuses to take time off (someone temporarily taking over their duties could discover the thefts).
- Takes work home or works weekends (so books can be altered without someone looking over their shoulder).
- Creates financial reports that are confusing and often late (so they can cover their trail).
- Becomes defensive when board members ask about the association's finances.
- Has a lifestyle that exceeds their income (clothing, cars, home).
- Takes frequent trips to gambling establishments.
- Shows signs of drinking or drug use.
- Has a sudden costly change in their life, such as a divorce or other family financial problems.
Discovering Fraud. Most fraud is not discovered by CPAs. According to a 2012 study by the Association of Certified Fraud Examiners (ACFE), fraud is most often discovered from tips from employees, customers, vendors, and others. Employee tips led to detection of fraud 43% of the time–-three times more than the next detection method. Following are the rankings of fraud detection:
- Tips, 43%
- Management reviews, 14.6%
- Internal audit, 14.4%
- By accident, 7%
- Account reconciliation, 4.8%
- Document examination, 4.1%
- External audit, 3.3%
- Notified by police, 3%
- Surveillance/monitoring, 1.9%
- Confession, 1.5%
- IT controls, 1.1%
Suspected Embezzlement. If the board has a good faith belief that embezzlement has occurred, they should immediately take the following steps:
- Legal Counsel. Notify the association's legal counsel. Depending on the amounts stolen and the association's insurance coverage, a lawsuit may need to be filed.
- Notify Insurance. All of the association's insurance (fidelity bond, D&O, etc.) need to be put on notice. Failure to give timely notice can result in denial of any subsequent claims. Many policies require the association to put the carrier on notice of a claim within 60 days of discovery of the loss. To be safe, HOAs should put the carrier on notice as soon as they suspect a loss has occurred. Fidelity policies generally contain language similar to the following:
Discovery of loss occurs when you first become aware of facts which would cause a reasonable person to assume that a loss covered by this Policy has been, or may be incurred even though the exact amount or the details of the loss may not then be known.
- Insulate Accounts. Insulate the association's funds by (i) putting the person on paid leave or suspending their control of books and records, (ii) instructing the bank to call a designated person for approval before processing any more checks, and (iii) changing bank signature cards, if needed.
- Investigate. Boards have a duty to conduct a reasonable investigation. The board does not need to spend $50,000 on a forensic auditor and legal expenses chasing a few hundred dollars. If the investigation discloses sloppy bookkeeping, the association's financial statement can be restated if the corrections are large enough to warrant it.
- District Attorney. If the investigation reveals significant embezzlement, the county District Attorney should be notified. The DA will not assist with any civil action against the person but may file a criminal case.
Recommendation: To minimize the risk of embezzlement, boards should (i) maintain separate bank accounts for operating and reserve accounts, (ii) require the signatures of two directors on any check from the association's reserve account, (iii) not give authority to the management company to transfer funds from the association’s reserve account, (iv) establish internal controls over the association's assets, (v) personally review financial records, (vi) adopt a conflict of interest policy, (vii) hire an independent CPA to review or audit the association's annual financial statement and (viii) carry a fidelity bond.
ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter.