HOA Fraud Prevention: Red Flags Roadmap
Don't Miss the Signs!
Most homeowners' association (HOA) board members are hardworking volunteers who want to make their communities better places to live. They are homeowners, too, after all.
Each HOA board member is a fiduciary - they are responsible for managing funds on behalf of the association. They have their fellow homeowners' best interests in mind when making financial decisions, approving the budget, and enforcing policies.
As with any organization, there is a level of risk involved. Just as residents must follow the HOA rules, the HOA members themselves must also adhere to their own rules.
What is HOA Fraud?
While it's a rare occurrence, HOA fraud can happen when at least one of the following fiduciary duties is breached:
Duty of loyalty - Also known as the "duty of good faith," this fiduciary responsibility means board members decide based on the organization's best interests, not to further personal interests.
Duty of care - This means board members stay updated on the association's governing documents to make informed decisions on homeowner matters.
Duty to act within the scope of authority – Board members educate themselves on the limitations of their authority, never superseding local, state, and federal laws, and always comply with the Fair Housing Act.
According to the Texas Property Code, "each officer or member of the board is liable as a fiduciary of the unit owners for the officer's or member's acts or omissions." Unless modified by an association's governing documents, an HOA owes a fiduciary duty to all community residents.
Why Does HOA Fraud Happen?
Fraud has no address: Although HOA boards are comprised of volunteers who want to help their communities, the reality is, fraud can happen anywhere. Any group of volunteers who handle finances is particularly susceptible to fraud and mismanagement.
Lack of checks and balances: Each HOA board member plays a role in handling daily tasks of the association, but the management of finances should be a shared responsibility. One person should write the checks, while another should deposit and record them. When checks and balances are not practiced, this gap in the process is prone to exploitation.
Crime of opportunity: Volunteer organizations tend to function with less oversight and more dependence on goodwill. Therefore, managed associations must establish and enforce strict rules and regulations. HOA fraud cannot happen when the board members ensure the opportunity isn't there.
Types of HOA Fraud
Working together to protect an association is easier if all board members know the different types of fraud. Although most associations have parameters in place to prevent these from happening, here are the three most common examples of HOA fraud:
Embezzlement – When funds are covertly stolen in small amounts over an extended period.
Bribery and Kickbacks – When monetary gifts or favors are exchanged for using a specific vendor's services.
Cooking the Books – When accounting documents are altered or fabricated to hide suspicious activity.
Red Flags of HOA Fraud
Board members should be familiar with signs of questionable activity so they know how to recognize them if they ever occur. Here are the top five areas to look for possible red flags:
- Bookkeeping - Mistakes happen. We're all human. However, if you see the same errors happening consistently, it's time to investigate further.
- Bookkeepers - Volunteers in any organization have personal lives. When life gets hectic, we sometimes take it to "the office" with us. However, if you notice a drastic change in a member's behavior, this could be an area of concern.
- Revenue - A drop in revenue can happen to any association. However, if it's an unexpected drop, board members should immediately look for discrepancies in their financial records.
- Checks, statements, and receipts - Make sure any association checks are only written to authorized companies and that they are deposited promptly. Ensure bank statements match HOA financial statements, accompanied by the original receipts.
- Vendor payments - Ensure all vendor payments are made in full and on time. Double-check for any duplicate payments.
What to Do If You See HOA Fraud
While vigilance is always a best practice, think carefully before immediately jumping to conclusions. HOA fraud is a serious accusation and cannot be taken lightly. Again, most board members are volunteers who are eager to serve their communities. However, if you still suspect HOA fraud, here's what to do:
Gather proof. Collect all the documentation you can to support your claim. According to Tex. Prop. Code § 209.005(c), "Owners have the right to review the books and records of your association, including financial records, and to obtain copies of information in the records."
Request an external audit. This brings in a third-party accounting firm to review the board's financial records.
Call for a meeting. Schedule a special board meeting to review documentation, audit results, etc., to prove or disprove HOA fraud.
Prevent Fraud Before It Happens
The best way to protect your association from HOA fraud is prevention. While no association is 100% immune, there are ways your board can drastically reduce the risk of fraud. A reliable management company can help - it already has the security measures in place to protect your association. A company with the right security measures should be able to:
Segregate duties, so the people who have access to the money don't also have access to the transaction records
Require formal invoice approval protocols
Use multifactor authentication on all electronic systems
Automate bank reconciliations to mitigate the risk of human error
Offer fraud detection and check verification services
Maintain the right types of insurance
Most of all, a good management company will ensure your board members won't have to worry if HOA fraud ever happens in your community. All board members and homeowners must work together to prevent fraud. Still, it's easier when you have a management company by your side, ready with the knowledge and resources to keep your association safe.
Want to learn more about keeping your association safe? We're happy to help navigate you in the right direction! Contact FirstService Residential Texas today.