Fraud Detection and Prevention
In a challenging economy
Although the US economy appears to have been in a steady decline for some time, it would seem that financial fraud and abuse are, unfortunately, "growth sectors."
In 1996, the Association of Certified Fraud Examiners (ACFE) published its Report to the Nation (available on the ACFE Web site, www.cfenet.com/ home.asp), believed to be the most comprehensive research and analysis ever conducted on the subject of fraud and abuse. The report estimates that fraud and abuse cost organizations over $400 billion annually. The same study estimated that organizations lose an average of six percent of their total revenues to fraud and abuse. During any phase of the economic cycle, that six percent represents a serious problem for an organization, but in the current environment, vigilant fraud and abuse prevention is even more imperative. The issues for people not specifically trained as professional fraud investigators are straightforward: Why should you care about fraud and abuse? As a lay person, what practical steps can you take to detect and prevent fraud in your building?"
The answer is that many of us have multiple roles in our lives. As both industry professionals and board members, many of us share an interest in ensuring the safety of our Common Interest Realty Associations (CIRAs), giving this topic broad applicability. As industry professionals, we can apply this information to help safeguard other organizations in which we volunteer, and as board members, we can use this information to benefit our homes and neighbors.
Where Fraud Breeds
Fraud and abuse are crimes, and they occur because someone has a financial needor incentiveto perpetrate them. Organizations that provide an environment "friendly" to a sufficiently motivated or needful person often find themselves victimized. There are three main categories that, separately or in combination, enable fraud and abuse:
Complacency: You may believe that fraud and abuse cant or wont happen in your organization, but fraud is an equal-opportunity crime. It happens in organizations of all sizes, whether they are for profit or non-profit entities, and is committed by people of every social and educational strata at every level of the management hierarchy. In fact, according to the Report to the Nation, fraud-related losses caused by perpetrators with post-graduate degrees were more than five times greater than those caused by high-school graduates. Whats more, losses caused by managers and executives were 16 times greater than those caused by non-managerial employees. Turning a blind eye to irregularities and ignoring suspicious activity will cost you in the long run.
Inadequate supervision of employees and volunteers: This is a by-product of the complacency problem. Monitoring your building staff doesnt mean that you need to become Big Brother, but it does mean that you may have opportunities to enhance your management practices while keeping better tabs on the people working in your building.
Lack of internal controls: Who has the keys? Who has the access? Does your board president know what the head of the finance committee is doing? Any organization, regardless of size, needs a system of internal checks-and-balances to protect board members and volunteers, and to insure against fraud and abuse. To quote an old adage; the left hand must know what the right is doing.
How Could We Let This Happen?
Opportunities for fraud and abuse are as boundless as the imaginations of their perpetrators, of course, but some painfully similar stories show up again and again: Theres the vengeful employee who believes hes been wrongly terminated and decides to "punish" his employer by misappropriating resources; the purchasing manager who receives kickbacks from vendors or suppliers; or the experienced manager who realizes she has no further room for career advancement and decides to divert funds to "supplement" his or her retirement savings.
Sometimes, fraud isnt quite so easy to spot. Residential associations regularly suffer when orders placed by the association for supplies or services are diverted to "subsidize" another facility or organizationor for personal use by the purchaser. Equally destructive are circumstances in which funds escrowed for capital improvements or replacements are misappropriated by committee members or their advisors, or when finance professionals misappropriate checks or transfer funds, then "disguise" the transactions as bad debt, or some other nebulous expense. Still other examples include board members or association professionals establishing a "wholly-owned company"which the association then utilizes for various "services," or association employees and board members making unauthorized transfers and "sanitizing" financial records to hide the transactions.
Of course, this is only a tiny glimpse of possible scenarios. There will always be unscrupulous or desperate people who will seek to defraud an organization. Because of the damage that this relatively small group of people can cause, it is necessary to have an adequate and appropriate system for preventing and detecting fraud and abuse. By the same token, however, its important to realize that the overwhelming majority of industry professionals and volunteers are honest and trustworthy people; its the few rotten apples that spoil the bunch.
Yes, But How Do You Stop It?
Return for a moment to the three "environmental factors" mentioned earlier. That provides a place to start discussing the ways in which fraud and abuse can be detected and prevented.
Complacency: The initial priorityand challengefor the board and associations management company is to create a work climate that balances trust and respect for the individual with the need to protect the associations financial resources. Periodic reviews of contracts, financial documents, and accounting policies and practice can help catch irregularities and deter potential defrauders. Often, simply paying attention will save your building from paying a far higher price down the road.
Supervision of Employees and Volunteers: It may seem obvious, but the risk to a building is too great to be lax when it comes to the issue of supervision. The goal is not to make employees or volunteers paranoid, but it is absolutely within reason to create and communicateas well as periodically reviewexplicit expectations for professionals and volunteer conduct. This assumes complete integrity and full disclosure of all financial transactions in which the building has, or might have, an interest. A board and its management company must jointly develop and enforce policies to ensure compliance with all building procedures and policies.
Supervision also implies conducting thorough background checks on potential employees. It means communicating job responsibilities and financial/operating procedures to employees and volunteers clearly and directly; creating appropriate levels of accountability for tasks performed; regularly reviewing employee activities, job performance, and professional development opportunities; and creating and disseminating written documentation outlining job responsibilities, performance reviews, and complaints.
If this seems like a lot of work, remember that disgruntled employees dont just emergethey are bred over time. Managers and board members have a major role to play in ensuring that their staff is adequately trained and satisfied in their jobs. Disgruntled and disaffected staff can become vengeful staffand fraud and abuse can become their tools of revenge. Good management practices dictate that a content staff will be more productive, which benefits everyone involved.
Lack of Internal Controls: Fraud and abuse are often "crimes of opportunity." It is crucial for the fiscal well-being of an organizationas well as for its efficient and effective managementthat it develop, maintain, and monitor an appropriate set of internal checks and balances.
The first level of control is segregation of staff duties for financial transactions; does the person making a transaction report to a second party, who is then responsible for recording the transaction? Your board should also require dual signatures on checks and fund transfers, and should pay all bills based on written invoices approved by the board. Statements from financial institutions should be distributed to multiple board members, and written guidelines for investment and funds transfer policies should be established and periodically reviewed to insure that policy is being followed.
Any board should also conduct regular meetings with their managing agent and outside professionals to jointly review the buildings fiscal matters and financial statements. Meeting materials should include a balance sheet, bank reconciliation, statement of revenues and expenses, and statements from financial institutions. If it is impractical for the entire board to conduct these reviews, they should be done by a finance committee accountable to the board.
Boards should also establish a schedule of contracts and associated payments to be made to vendors/suppliers, and periodically reconcile the schedule to financial statements to make sure everything adds up. Lastly, its not a bad idea to retain an independent CPA to conduct annual audits and provide guidance regarding other situation-specific measures that might be appropriate for your building. If you feel you may be a fraud/abuse victim, or just "at-risk," consult a Certified Fraud Examiner for guidance.
Dont Get Taken
The bottom line is that fraud and abuse can happen to your organization; you need to understand how it can occur, and then take practical steps to detect and prevent it. Fraud is an increasing threat to organizations of every size, type and mission. The good news is that appropriate measures of prudence and common sense, combined with sound financial and management practices can dramatically reduce the likelihood that your building will be victimized.
Mr. Rosen is a shareholder of Wilkin & Guttenplan, PC, an accounting firm in East Brunswick, New Jersey.