“Is Your Community Association at Risk for Fraud?” – KSN Attorney Michael Kreibich discusses potential fraud in a condominium, homeowner (HOA), and townhome community associations. He reviews financial mismanagement red flags including misuse of funds, embezzlement, bribery, conflict of interest, and more. (20 mins.)
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Episode Transcription
Bernie: You are listening to the KSN podcast, and today we are talking about community associations and the potential risk for fraud. Welcome to the KSN podcast, where you’ll hear from KSN attorneys as they share their experience and insight on legal issues surrounding community associations, collections, property tax appeals, and landlord tenant law. I’m Bernie and today we’re joined by KSN attorney Michael Kreibich. Mike practices condominium, townhome and homeowner association law. Mike, welcome to the podcast.
Michael: Hi, Bernie. Great to be here.
Bernie: All right, our topic today, a bit of an unfortunate topic, Mike, is community associations and the risk for fraud. So, let’s jump right in. Recently in the news there has been news of multiple members of homeowner associations that have been arrested for suspected theft, money laundering and other charges. Investigators have mentioned that they believe potentially millions of dollars have been stolen from a community’s budget through questionable expenses, personal purchases, diversion of association funds. Neither one of us are accountants. Neither one of us works in law enforcement, Mike, but we do work with community associations and in the end, we want to help protect associations and fraud is a potential issue, unfortunately. So how can associations protect themselves from situations like this?
Michael: Sure. Great question Bernie. So, the purpose of today’s discussion, again, as you kind of touched on, it’s not a glamorous discussion, but it’s unfortunately something we as legal counsel for our clients do see the good, the bad, the ugly. This is generally one of the more ugly topics about association finances and funds. From a big picture standpoint, associations only function based on the money that is brought in through assessments from the members of the community. That’s what makes up the money they have for their operating and their reserve funds. So their budget at the end of the day. So we see all kinds of different types of mismanagement and the purpose of, again, today’s discussion is to kind of run through some of the red flags that we see and again, we get to see them unfortunately, and then that’s when we get brought in to try to see how we can assist our clients. But the finances of the association are the lifeblood of the community and unfortunately, if there aren’t enough people paying attention, that’s where we start to run into issues.
Bernie: If you’re talking about a budget, what could you expect to find in an association’s budget?
Michael: Yeah, Bernie. So what you see in an association’s budget, generally speaking, is the maintenance and repair costs, insurance premiums, and the fees for professional services. An example of the professional services that an association should be engaging with would be management, right? Their professionally licensed managers. You have accountants and you have your legal team, which would be KSN or any other law firm that does community association law. The budget is where the money, you know, the assessments come in and that money is what is budgeted for all of the different expenses of the association.
Bernie: And that’s all meant to maintain the community property values, provide the services to the association members but again, when we’re talking about associations, the red flag’s potential fraud could come in inconsistencies in that budget. Things like unpaid bills, conflicting vendor payments, embezzlement, bribery, and other forms of financial misconduct, right?
Michael: Correct. So, let’s go through some of those different topics. Okay. So, the ones that we see that are red flags to us when this discussion comes up and again I’ll go through them, is a lack of financial oversight. So, an association, if they do not have adequate checks and balances in place to monitor the financial activities, might be more vulnerable to fraud. An example of that when you talk about checks and balances which I see frequently is that there will be one or a few board members that essentially run an association or another example is some boards will turn over most aspects of the operating of an association to their management and they basically look step back and they say, you’re our manager and therefore you are going to handle all of the financial aspects of the association. In both of those circumstances, you have a lack of checks and balances.
So talking about the first one, if you have a couple of board members or sometimes it’s just one board member, right, the board president decides that more times than not it’s somebody with a strong personality or maybe with a financial background, so everybody gets out of their way, that individual makes a lot of decisions incorrectly and in violation of what the statutes say and what the governing documents say. They make a lot of decisions on their own and one of the reasons why associations have a board of directors, more than one person running the association from an administrative standpoint, is to basically be that check and balance to make sure that the association isn’t going in just one direction. That a board member or a particular board member isn’t just picking and choosing a particular contractor, isn’t doing things basically their way and sometimes in a self-serving way. When you talk about management doing it themselves, you start talking about them making those decisions and maybe they’re steering some business in a certain direction, whether it be for personal gain or for whatever other reason. So it’s important that there be checks and balances that the board, all board members be involved and the management team be involved.
Bernie: And I think this is the case, Mike, where we work with thousands of associations because this is such a delicate balance, a lot of these decisions that board members are making, and again, volunteer board members are really always made with the best of intentions. You mentioned they might be relying on and working with a fellow association member or board member who has a background in accounting so they’re deferring to that person because they might be a subject matter expert. But again, this is where, like you mentioned, that lack of financial oversight where you’re giving too much power to one person could be a big red flag because you may do it with the best of intentions because you’re trying to maintain that fiduciary duty but I think it sounds like you go back to what you mentioned before, the team working with an accountant, with legal counsel, with your management company so that you have various eyes on it and it’s not just consolidated with one person.
Michael: Correct. So a properly functioning association is always a team-based scenario. It’s your board of directors who then surround themselves with experts or people who can assist them. Those people, again, as we’ve talked about are your accountants, your attorneys, your managers, any professional that assists the board of directors in making decisions. But again, it’s a team scenario and when things do break down and do fail, it’s because there’s not that team environment and you have one person taking on more of a role than any one person should have.
Bernie: And that’s where some of those team members could provide training cause that’s another red flag, insufficient training, right?
Michael: Correct. So the next red flag that we see, and by the way, KSN really prides itself and spends a lot of time in training our management teams that we work with and the board of directors for our client associations. Training is paramount. Again, we spend a great deal of time and effort trying to make sure that boards understand what their duties are, what their rights are, when it breaks down to what their obligations when it comes to the finances. Again, you touched on it briefly, Bernie, that you’re dealing with volunteer board members that may have absolutely no training whatsoever in the operation of these associations, which most of the time are not-for-profit corporations, in some cases have large budgets, and frankly, as you stated, it might not be nefarious intentions at all. It might just be a lack of training and that’s where we step in and we say, okay, boards or managers, here’s what you need to know, here’s how the process should be done and we spend, as I said, a great deal of time trying to make sure people are properly trained because boards turn over regularly. So, new board members have come in and we want to make sure that they understand what their obligations and their role are as a board member.
Bernie: And another red flag, Mike, because you mentioned board turnover is the misuse of funds where you might have personal expenses or investments that get involved in it. But again, because a community may have a large budget, if there are a large suburban HOA with three to 400 units, so you’re talking about different contracts, just give a few examples of the different type of vendors that you’re working with, which might help listeners understand that it’s not just assessments that they’re working with on the board side or on the management side or on the finances, there’s a lot of different financial aspects involved.
Michael: Well, sure. So, any association is going to engage different types of vendors for a lack of a better term, agents and those types of people could be landscapers, snow removal, maintenance people. Sometimes if it’s a bigger building you’re talking about door staff, janitorial, the list that goes on and on and sometimes when you talk about misuse of funds, it can be as simple as somebody saying, you know what? I’m not going to hire somebody. I’m going to go change the light bulbs, okay and I’m going to essentially do that work and I’m going to just charge back my time and I’m going to buy the different things that I need to buy. And I’ve seen this happen a number of times where a board member has the best intentions, but they decide they’re going to take on some type of a project themselves and they will go out and buy a vacuum cleaner and they will go and buy materials and they will pay themself for the work they do.
Doing so may very well, at a minimum, have the appearance of impropriety. If they are spending association funds while they think that they are doing what’s in the best interest of the association, they are doing these things kind of on their own without the authority of the board. I have seen scenarios where individual board members will use an association credit card and they will go out and buy a number of different things for the association but in looking at the receipt, they also bought themselves a couple of other things and were using association funds to do so. So that’s an example of, essentially, a misuse of funds. The likelihood is that the rest of the board or management was unaware. Again, the person probably didn’t realize they were doing something wrong, but they used association funds without following the proper channels to do so. And again, that’s just a lack of oversight and education because, again, most times they think they’re doing something in the best interest of the community, but it does fly in the face of what their governing documents are saying and in sometimes the statutes.
Bernie: KSN is committed to educating our clients and the community. As a service to our current and prospective clients, we’ve authored and compiled a number of educational resources for condo, HOA board members, property managers, landlords, and real estate professionals. If you visit ksnlaw.com/education, you’ll be able to review our educational resources, including articles, legal updates, booklets, podcasts, laws and ordinances and more. You can also sign up for the KSN newsletter where over 30,000 peers receive free industry news, legal updates and details on our upcoming events.
Associations are unique. They have different challenges, different rules and regulations, different requirements for their communities. So that suburban HOA may have that landscaper, the maintenance company that you mentioned they may be working with. You could be a downtown city high-rise that has a fitness center or an elevator, something completely unique to their community, their board members, managers, working with vendors, with agents as you mentioned and that’s sometimes where you could also see your red flag, right?
Michael: Sure. So one of the other big red flags that I come across relatively frequently is what we consider to be a conflict of interest, okay? And that would be a board member engaging, again, it can vary, but it could be a board member engaging a friend. It could be a board member actually being the person, as I kind of already discussed, doing the work themself. And it can be a direct conflict of interest or it could just be the appearance of a conflict. The bottom line is if you are engaging in what could be considered as self-dealing, right? So you award a contract to somebody who is maybe a family member or it’s your best friend and you don’t go out to bid and you give the contract to your best friend and that has not been fully disclosed cause basically most statutes and most governing documents, they don’t prohibit you from entering into a contract that could be a conflict of interest. It’s more of a conflict of interest if you failed to disclose the relationship.
So it’s paramount that you again work with the association attorney to determine whether or not who you’re engaging and how you’re engaging them is in fact a conflict of interest and that is something we deal with frequently. When you talk about conflicts that can be as innocent as, Hey, that was the best deal and I know the guy is good, I’ve used him before, but it could go as far as somebody gets hired because there’s going to be a potential kickback. And that’s something we see from time to time where somebody says, Hey, if you hire me, I’ll write you a check for $5,000 and that gets you into the concepts, kind of dirty words in the industry of potential embezzlement of funds or bribery. The bribery would be a kickback, right? If somebody says, I’ll get you this contract if you’ve given me $5,000 for an example, that is an example of a conflict of interest, but that’s bribery. Unfortunately, it does happen sometimes it’s very hard to trace and that’s why, again, it’s so important for there to be the checks and balances and to make sure people are educated so they understand that again, this is a not-for-profit corporation.
There are processes in place by which people should be engaged. There should be full discussion by the entire board when retaining somebody to avoid their being even an appearance of impropriety. That’s what you want to avoid because all of these issues, even if the money doesn’t go missing, which is what kind of this whole topic is with fraud, it’s the appearance of that that can drive a wedge in your community when people look at it and say, wait a minute, you hired who and who else did you interview for that job? And that’s what you want to avoid because the wedge that gets driven in your community can be almost as bad as the actual financial and propriety, let’s say if money were to go missing. And that kind of drive kind of puts me into the last category which is lack of transparency. The single biggest thing that I hear when I attend meetings is boards will hire somebody and spend association funds, but they don’t explain, they don’t have the discussions in meetings and they simply hire somebody and they do not explain or they do not provide information to the membership and that lack of transparency can also drive a major wedge in a community.
The single biggest thing I hear from when I sit in meetings and the owners are sitting there looking at the board and myself, they want transparency. Board members are elected to make the vast majority of decisions in a community. That does not mean that they get to hide all information from the membership and transparency is largest thing that I hear from the membership when I’m sitting in those rooms is, we didn’t know anything about this, we’re just hearing about this for the first time. And a lot of times that’s after they hired the wrong person, they overpaid that person. Only one board member made the decision as opposed to the entire board and that’s where you start to get into issues where people are going to point those finger at the board and say, Hey, that kind of seems like fraud or that kind of seems like self-dealing or any of the other things we’ve kind of talked about in this and that’s what you want to avoid as the board to avoid not only the money going away inappropriately or the association having the appearance of that happening, which can sometimes be as bad as it actually happening.
Bernie: Fraud, embezzlement, bribery, conflict of interest, Mike, they’re very charged words, they’re serious words, but they also have serious consequences. So let’s talk about some of the consequences that can come into play if potential fraud, if actually fraudulent activity is involved in an association.
Michael: Well, if there’s potential fraud, that’s certainly something that should be brought to the association’s attorney to discuss further. It has a number of different consequences. It has financial consequences and also could potentially have criminal consequences. When you talk about the concept of bribery or embezzlement, you’re starting to talk about a criminal aspect of the actions that are being taken. There are bigger picture discussions if in fact this type of conduct is taking place and unfortunately it does happen. Again, there are people, if you are on board or you are a manager, you have access to funds and sometimes it results in people doing something that could be considered or would eventually be determined to be criminal. So, it’s very important to communicate with your association’s attorney, to have the checks and balances in place, to have a paper trail as to the decisions and what’s taking place in your association because that’s going to be the evidence and the support if in fact fraud does take place.
Bernie: Legal counsel, law enforcement, checks and balances. A lot of this seems to go back to one word, Mike, from everything that you mentioned is being proactive, having those preventative measures in place to identify anything before it gets incredibly serious.
Michael: Correct. So, if you suspect that there is fraud in your association and your finances, basically the steps that you should take are that you should conduct an internal investigation. The board of directors can do that. I do believe that should be done in concert with the association’s attorney. So I believe that the association’s attorney should be involved in that discussion. But there should be an internal investigation to determine if it was either an innocent mistake, an intentional mistake, or maybe it’s just poor record keeping and no mistake took place at all. So the investigation, I think, is very important. If that investigation and working with the association’s attorney has evidence that supports that a potential fraud took place, that is when law enforcement may very well need to be brought in to discuss actually what took place to determine whether or not a crime has taken place. In concert with that, implement preventative measures and we’ve kind of discussed those already and that is the checks and balances, that is working as a team, making sure that the accountants are involved, making sure that the entire board is part of this discussion, making sure management is involved and the association’s attorney and working as a team. That is how you can ensure or limit the potential for fraud.
Bernie: That was KSN attorney Michael Kreibich. He practices condominium, townhome, and homeowner association law. KSN is an experienced legal resource ready to provide you with quality advice and exceptional service. We look forward to demonstrating how we’ve earned the trust of thousands of clients over the past 40 years. If you’d like to reach Mike or any of KSN’s experience attorneys, please call 855-537-0500. You can also visit ksnlaw.com and complete the contact form to send us a message. Thanks for listening.
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Please note the material contained on the KSN Podcast is for informational purposes only and does not constitute legal advice. No attorney-client relationship is established by your review or receipt of the information contained on the KSN Podcast. You should not act on the information discussed on the KSN Podcast without first obtaining legal advice from an attorney duly licensed to practice law in your State. While KSN has made every effort to include up-to-date information on The KSN podcast, the law can change quickly. Accordingly, please understand that information discussed on the podcast may not yet reflect the most recent legal developments. Material is not guaranteed to be correct, complete, or up to date. KSN reserves the right to revise or update the information and statements of law discussed on the podcast at any time, without notice, and disclaims any liability for your use of information or statements of law discussed on the podcast, or the performance of the podcast generally. The KSN Podcast may be considered advertising in some jurisdictions under applicable law/s and/or ethical rules/regulations. © 2023 Kovitz Shifrin Nesbit, A Professional Corporation.