The WOLF in sheep's clothing

How to protect your association's finances

Bruce Middleton, former treasurer and president of the Mayde Creek Community Association in Houston, was arrested in January 1996 on charges of embezzling close to $50,000. Middleton allegedly siphoned money during his three-year term by writing checks to a company he owned and forging the second signature.

On April 10, 1996, Robert Nehilla pleaded "no contest" to charges he embezzled $11,000 over three years as treasurer of the Camelot Homeowners Association in Mojave, California. Nehilla, who filed for bankruptcy in 1992, wrote 32 association checks to himself.

Milt Hanson, a California real estate agent, confessed in October 1996 to stealing $70,000 from eight Orange County community associations over an 11-year period. Hanson forged checks to himself and sent false financial reports to his boards of directors.

In December 1996, an attorney was arrested on charges of stealing a $1.4 million construction defect settlement from his client, the Woodside Commons Homeowners Association in Santa Cruz, California.

No association is safe from the wolf.

ACCESS TO FUNDS

Limiting the risk of embezzlement means limiting the number of people who control funds. Only the president, treasurer, and the management company or on-site manager should handle association accounts or disbursements. Anyone who handles funds--more specifically, anyone who signs checks--should be bonded or otherwise insured.

No manager or board member should have sole authority for writing checks. The key is to separate duties. When writing checks, each step should be handled by a different person. One person should make out the check, someone else should obtain the signatures, and a third person should do the monthly reconciliation. If one person is responsible for every step, embezzlement is easy. Kevin Davis, vice president of Ian H. Graham insurance in Encino, California, worked with an association that learned this the hard way. An association employee wrote an $18,000 check to a defunct insurance company. After getting the check signed by the president and treasurer, she initialled the check with a "G" (her name was Gina). Thanks to that simple initial, she was able to deposit the check in her own account. She also was responsible for reconciling cashed checks, so when the check returned, she simply approved it. That easily, the association was $18,000 poorer.

One way to prevent this easy access to funds is through electronic fund transfers. With electronic fund transfers, funds are moved by computer from one account to another. Since the money is transferred electronically--from an association to its vendor, for example--a director or manager would not be able to write false checks.

Electronic fund transfers might have prevented a 1996 white-collar crime in Nevada. On April 12, 1996, community association manager Janice Dalske was sentenced to five years probation and 90 days house arrest for embezzling $7,070 from the Huffaker Hills Homeowners Association in Reno. Dalske collected assessments from nine absentee owners and never deposited the money into the association's accounts. If homeowners' assessments were automatically deposited in the association's account, Dalske wouldn't have been involved in the collection. (For more information on electronic fund transfers, contact the National Automated Clearing House Association or see the May/June 1996 Common Ground article "In No Time Flat.")

Automation does not necessarily equal protection, however. Hackers can penetrate even the most sophisticated computer system. The greater threat is association employees and volunteers with access to codes. Computer codes and access codes should be as secure as cash, and as confidential as a vault combination.

DUAL SIGNATURES

Robert Nehilla, an association treasurer in Mojave, California, wrote 32 association checks to himself totalling $11,000. In this case, dual signatures--requiring two board members to sign a check--may have prevented the loss of the funds. A cosigner surely wouldn't have signed 32 checks written to the same director. Although many managers and boards find dual signatures to be a burden--and many banks honor checks even if they lack the second signature--it provides one more hurdle for an embezzler to overcome. A single signature makes embezzlement simple; dual signatures may reduce temptation.

Dual signatures are far from foolproof, however. Bruce Middleton, as mentioned on page 34, successfully wrote checks worth $50,000 to a company he owned by forging the second signature. While it is nearly impossible to prevent forgeries, associations can detect them by periodically checking invoices against payments. The board also should receive copies of all cancelled checks and review them at least monthly.

The association also may want to require that the board approve and sign all checks over $500 or $5,000 at a regularly scheduled meeting. The size of the limit depends on the association. The manager of a large planned community with a multimillion dollar budget would be severely restricted by a $500 limit. Consider the number of checks the association writes each month and the size of its budget. Don't make it impossible for the manager to function.

PHANTOM COMPANIES AND SERVICES

In January 1996, police in Colorado announced plans to file a felony theft charge against an association board president who funnelled $44,000 to two companies he owned. The association received 16 invoices from the president's companies; no one with the association knew for certain if the companies had ever performed any work. Eleven months later, a Florida manager turned himself in to Sunrise police after writing three checks worth $12,080 to an insurance company that didn't do business with the association. He allegedly cashed the checks at a nearby convenience store.

Embezzlers use a number of tricks to cover their tracks. They create false invoices. They change the date on old invoices and resubmit them. They submit the same invoice twice. The way to detect this is through oversight. Review invoice numbers. Check current invoices against previous invoices. Examine work orders--was the work actually performed? Or was this something we did last year? Also be aware of conflicts of interest. Ask vendors to disclose personal or professional relationships with board members. Be particularly wary of directors who want the association to contract with their own companies.

When reviewing invoices and work orders, look for patterns. Look for similar disbursement amounts, the same vendor with different addresses, or invoice account numbers that aren't in sequence. More importantly, ask questions. Board members tend to sign off on checks and invoices without questioning them. Directors should carefully review checks, invoices, and financial statements for discrepancies. Keep careful records. If the board votes on payments to its landscape company at its monthly meetings, make a notation in the minutes. That way the board has a record of who is getting paid and why.

Always question the outflow of cash. Match invoices with outgoing checks and verify that work that has been performed. If someone is falsifying records and stealing money, scrutinizing checks and invoices will help uncover the abuse.

REVIEWING FINANCIAL INFORMATION

A Maryland condominium association lost $98,000 in 1993 when its property manager stole funds and covered his tracks by falsifying records.

Audits by an independent, certified public accountant are extremely helpful in identifying falsified records. Every association should conduct an annual audit. The auditor examines invoices, verifies balance sheets, and analyzes accounts receivables. He or she determines whether the association's financial statements meet generally accepted accounting principles.

Board members should not rely solely on their accountants, however. At least two directors and the manager should receive and review monthly financial statements. They should look for discrepancies between what the manager shows on the general ledger report and the numbers on the financial institution's monthly statement. If the association receives the statement directly from the financial institution, a potential embezzler may think twice about altering the statements included in the board package.

Boards also should consider checks and balances. Ask the finance committee to review the financial statements as well. Make no mistake--it will create an additional layer of bureaucracy. It will impede an association's ability to efficiently function. But for an association that wants to protect itself, it could be a small price to pay. In 1994, four board members of a Florida association were charged with using $7,000 in association funds for personal salaries and expenses. They reportedly bought lawn equipment, TVs, cellular phones, and other items. If a finance committee were monitoring its activities, the board members may never have bought their first TV.

Boards cannot take a casual attitude toward association finances. If they do, a volunteer or employee could embezzle funds for years. Boards and association professional must take the time to question and verify each and every item of substance. Only then will the likelihood of embezzlement be reduced. It may be inconvenient, but convenience is a small sacrifice to ensure that your accounts aren't $50,000 short.

The responsibility ultimately rests squarely on the shoulders of the board. As a board member, you are empowered by your homeowners to protect, maintain, and enhance their hard-earned assets. It is your responsibility to check, double-check, and sometimes triple-check to ensure their money--and yours--is spent wisely and appropriately. It is your duty to spot the wolf in sheep's clothing.

tips for PROTECTING funds

* Keep only small amounts of money in the operating fund

* Don't let one person have too much control--have one person make out the check and another obtain the signatures

* Allow only bonded or insured managers or directors to handle funds

* Require co-signatures on large transactions

* Confirm expenses in board meetings

* Pay vendors and collect assessments through electronic fund transfers

* Constantly scrutinize checks and invoices--don't sign off without questioning them

* Match invoices with outgoing checks to help detect forgeries and phony invoices

* Verify that work is performed--don't blindly approve invoices

* Conduct an annual audit

* Ask at least two board members to review monthly financial statements

* Consider checks and balances--ask the finance committee to review financial statements as well

* Protect checks and computer codes

INSURANCE & embezzlement

Anyone who handles association funds should be bonded or insured--and in many states, bonds and insurance are required by law.

Fidelity bonds protect associations against fraudulent or dishonest acts by the individuals named in the policy. Typically, it protects the association from theft by its own employees, not independent contractors. Board members are protected only if they are specifically named in the policy. Examine bonds carefully--a management company's bond may not protect the association. In terms of size, the industry standard--according to Kevin Davis, vice president of Ian H. Graham insurance in Encino, California--is three months assessments plus reserves.

Boards also need to obtain adequate directors and officers (D&O) insurance. D&O insurance will not replace stolen funds. If the board is found to be liable, however, the D&O coverage would protect it from any subsequent lawsuits.

The best insurance, said Davis, is establishing internal controls to prevent embezzlement, such as separation of duties, annual audits, and dual signatures on checks. "If an association doesn't have these controls, we won't write the policies," said Davis.