When it comes to financial fraud, too many condo corporations are of the opinion “that won’t happen to us.”
Perhaps this is because condo boards, primarily volunteers, tend to be too trusting. There is a presumption of good faith that the people entrusted to enter and work in one’s home have good intentions. Condo boards can be overly trusting of those they employ to manage the corporation and fail to exert sufficient due diligence over the financial controls of the corporation.
Experience suggests that volunteer condo boards prefer to work with people they know and this, combined with weak financial controls, creates opportunity for fraud. Poor record keeping, failure to adequately track receivables and not always charging tenants for in-suite work are symptoms of weak financial controls.
In financial terms, this is failing to protect the value of the asset – the condo corporation – which is a primary responsibility of condo directors.
For fraud to exist there needs to be Pressure, Opportunity and Rationalization
Pressure is external forces upon the fraudster such as a difficult financial situation, gambling or insolvency.
Opportunity comes from the recognition that many condo corporations have weak financial controls that make it relatively easy to steal money.
Rationalization is how perpetrators of condo fraud justify the acceptability of theft from the condo corporation.
What condo corporations can and should do is minimize the opportunity for theft by implementing effective financial controls.
The Auditor’s Role
Some condo owners and directors mistakenly believe that having an auditor protects against financial fraud.
The auditor does not provide assurances that a condo corporation is operating properly or efficiently. Their role is to review financial controls, ensure fair presentation and acceptable accounting practices, and to prevent material misstatements.
An auditor may evaluate and rely on internal controls related to financial controls. They would not evaluate all internal controls. They do not review all transactions. They do not review the accuracy, precision or correctness of transactions.
Types of Financial Fraud
Cash fraud occurs when cash transactions are diverted. The most common sources of diverted cash are condo fees, guest suite rental fees and resident fines or penalties.
Theft of property has numerous forms including the purchase of goods for personal use or providing select individuals with preferred rates for use of condo property. It can occur when vendor sourcing or contracting results in related party transactions. Related party transactions are when friends or associates are employed to provide products or services to the corporation. Related party transactions may be improper depending on the bylaws of the corporation. Some bylaws prohibit non-arm’s length dealings. While there can be advantages to related party transactions, a failure to fully disclose or document such transactions in the minutes can create an opportunity for fraud.
The Condo Board can Reduce the Opportunity for Fraud
The statute of limitations on detecting condo fraud is two years from when a condo corporation should have become aware of the fraud. Any fraud that has not been detected in this time frame is a successful crime that usually cannot be successfully prosecuted.
Condo corporations can reduce the likelihood of financial fraud and increase the likelihood of detecting this fraud, when it occurs, by thorough implementation of best practices for management of finances.
Actual Fraud Situation #1
One condo corporation employed a resident as engineer for a project. Other residents were employed as contractors. These individuals subsequently were elected to the board which decided to offer the cleaning contract to a friend. Directors obtained free repairs and cleaning for their suites. The reserve fund balance decreased by $500,000. Banks stopped providing mortgages for suite sales in the building. The resale value of suites decreased and one sold for about $40,000.
Actual Fraud Situation #2
A condo manager sought to avoid disclosing how much certain vendors were receiving for services. This was achieved by having the vendors submit large numbers of invoices for small amounts. The purpose of obfuscating the vendor payments was to hide the total payments being made to certain vendors which were related to the manager. Some of the invoices were inflated or improper.
The large number of invoices submitted, and the disorganized manner in which they were provided by the manager for approval, made it difficult to determine how much each vendor received from the condo corporation.
Suggestions for reducing the opportunity for financial fraud:
- Separate custody of assets from record keeping. Allowing a single individual to retain control of assets while being responsible for the record keeping creates an opportunity to defraud and hide the information necessary to identify the defraud.
- Allowing an absentee owner, one who rents their property to others for income, to serve as a director creates a direct conflict of interest. Such an individual has a financial incentive to support reduced monthly fees to the detriment of condo owners who use their condo as a principal residence.
- Prevent collusion between insider and vendor. The hiring of friends or negotiating commissions should be fully disclosed in the minutes. When approving any contract or proposal, the condominium manager should be asked if it is an “arm’s length” transaction. The question and response should be noted in the minutes. This can serve as documentation that directors have done their due diligence. In the event of future problems, this documentation should prevent fraudsters from arguing that what they did was acceptable or proper. When dealings are not “arm’s length” transactions, such as payments to a director or compensation to a resident or family member, this should be disclosed in the minutes.
- Regardless of comfort level with any particular vendor, a bidding process should be undertaken every few years for major contracts, recurring services and high value projects. Requiring sealed bids is best. At least one of the bidders should be a random bidder invited by the board outside of management’s recommendation. Bids should be critically evaluated and not seen as simply a way to show owners that the board is honest. A preference for certain vendors can result in a failure to subject vendors or bids to sufficient scrutiny or due diligence. This can result in excessive costs or poor practices to the detriment of the condo corporation.
- Periodically review total compensation by vendor. Where contracts exist, match amounts to contractual amount.
- Transparency of operations is crucial. Open board meetings, providing complete access to records and the public posting of minutes all serve to ensure accountability. As transparency increases there is a reduced likelihood of fraud.
- Owners need to show up for meetings. Poor attendance at meetings is a signal of complacency that increases the likelihood of fraud.
- Incorporate non-financial reporting, such as the number of repairs per suite, to identify patterns that may not be evident through strictly financial reporting.
Preventing Condo Fraud, by Reagan Ruslim of Dunsmore Wearing LLP and Alan Mak of Ferguson & Mak LLP, was a presentation to the Yonge Corridor Condominium Association (YCCA). This article is a summary of that presentation.