How to Prevent Fraud

Managers and board members are at it again. Keeping their hands out of the corporate cookie jar is no easy task.

By Bill Morris

Shortly before Christmas, Matthew Stoll, the treasurer of a Rockland County condo board, pleaded guilty to stealing $130,345 from the Sussex Condominium III Association. Three weeks before that, Mark Modano, owner of the Mark Modano management company, was arrested and charged with stealing more than $1.3 million from the operating accounts of six clients in New York City. Modano allegedly commingled funds from the various properties into larger master accounts, then spent the money on himself. If convicted, he faces up to 15 years in prison. Fraud, that durable chestnut, is back in the news just in time for the New Year. And these new cases served as reminders that co-op and condo boards need to be diligent not only when dealing with their property managers – historically the most common practitioners of fraud – but also when dealing with their other professionals, with contractors, and even with their fellow board members.

Easy money, it turns out, is an equal-opportunity temptress.

“Fraud’s on people’s minds right now because of a few rotten apples,” says Mindy Eisenberg-Stark, an accountant and certified fraud examiner. “Also, [convicted embezzler Bernard] Madoff made everyone freak out and made people aware of what financial fraud is. It made people re-think their financial relationships and become distrustful of people who handle their finances.”

Eisenberg-Stark, a veteran fraud examiner, says that such crimes tend to run in cycles. There was a major wave of fraud in 1994, when 82 managing agents and four firms were indicted in a kickback investigation. The indictments were followed by a period of heightened diligence by boards which, in time, gave way to backsliding. In 1999, 59 more individuals and 21 companies were indicted in various kickback and payoff schemes. Among the indicted were managing agents, management companies, supers, architects, engineers, waterproofing contractors, and even co-op board members. The arrests of Stoll and Modano, coupled with the sudden collapse of Charter Management (see “Corruption Concerns,” Habitat, October 2009), indicate that we might be entering a third wave.

“I do agree that it’s cyclical,” says Patrick Dugan, chief of the investigative division in the Manhattan district attorney’s office, and an active participant in the prosecutions during the 1990s. “But I would not conclude that there has been a 10-year hiatus in corruption. The corruption’s still there. The industry needs to be constantly on guard.”

Dugan cites the arrest of Modano. Not only is the manager charged with commingling funds from the six properties, he also allegedly failed to make tax payments, then arranged with the city’s Department of Finance to pay the back taxes on an installment plan – and then failed to pay up.

“The people in those buildings didn’t even know this [arrangement had been made] and the Department of Finance didn’t tell them,” Dugan says. “Now they have to pay fines and penalties. They trusted Modano.”

The Face of Fraud

Ken Citarella is an attorney and certified fraud examiner who has spent 28 years investigating white-collar crime in Westchester County. He’s now in private practice with Meiselman, Denlea, Packman, Carton & Eberz, and as he sees it, co-op and condo fraud comes from a fairly simple source.

“The basic problem is that most people on boards are volunteering their time,” Citarella says. “So a lot of the management chores get contracted out to the managing agent. Unless the board knows what specifically to look for, it’s easy for the manager to deceive them. When you have a large amount of money and you have to give him the authority to spend it, if that person decides to steal from you, it can be very difficult to detect.”

But there are ways for boards to increase their chances of preventing fraud.

“You want to try to create an atmosphere where fraud will not be tolerated,” Citarella says. “A board should set a policy of zero tolerance – and then be actively involved in what the managing agent and contractors are doing. It’s not a guarantee, but it has a deterrent effect. The thief is going to go where the pickings are easier.”

This is where numbers come into play. “My experience with fraud is that the more people that [need to be] involved in committing the fraud, the less likely the fraud is to occur,” Citarella says. In other words, spreading out the responsibility for your finances is a safer route to take.

Indeed, while trust and loyalty are noble things, Citarella advises that they should be tempered with a healthy dose of caution when a board is dealing with a managing agent, super, contractors, vendors, or other professionals.

“Just because someone has been reliable in the past, doesn’t mean they’ll continue to be reliable,” Citarella says. “Love your employees, send birthday presents to their kids. But on the job, don’t trust them. It’s not personal, it’s a business.”

He advises boards to be on the lookout for changes in a manager’s personal life – a death in the family, a spouse’s job loss, a sudden taste for drugs or gambling, anything that can change a person’s motivation and, eventually, his behavior. He also advises boards to be wary of a manager who never takes a vacation.

Beyond these general precautions, Citarella ticks off half a dozen of the most common types of fraud as well as ways to deal with them. They include:

• Checks payable to cash. Make sure you get copies of all checks along with your monthly bank statement.

• Invoices from nonexistent companies. Inspect a copy of every paid invoice; if you have doubts, do a Google search and call the company to make sure it exists.

• Kickbacks from legitimate vendors to the managing agent. With the help of your engineer, compare bids to invoices as they come in. Get documentation for all cost overruns.

• Phantom employees. Keep an up-to-date list of employees and call periodic employee meetings. Count noses.

• Bid-rigging. Make sure all bids are opened by a board representative, not by the managing agent, and rotate bids to different vendors. Check references. Make sure bidders exist.

“None of this is easy,” cautions Citarella. “That’s the unfortunate truth of it.”

And none of it is fail-safe. If your precautions fail to catch a thief and you discover that your co-op or condo has been defrauded, there are several steps the board should take, according to Citarella.

First, protect the evidence by collecting all bank records, computer files, checkbooks, and other relevant records. Second, have a forensic accounting conducted by a CPA who is a certified fraud examiner. At this point you might try to recoup the loss directly from the thief, but Citarella cautions that this is usually futile and can even be risky.

“It rarely works out well,” he says. “And if you decide to sue later, that can compromise your legal position. If you do make that demand (that the thief repay what was stolen), you’re better off doing it through your attorney. I would not advise doing that on your own.”

In all his years of investigating fraud, there was only one case where the thief still had his ill-gotten gain when he finally got caught. It was a financial clerk in a large corporation who embezzled more than $1 million and had it sitting in a safe-deposit box when he was arrested. “People steal money to spend it, not to save it,” Citarella says.

Your Day in Court

So, rather than hoping to recoup your money, you should probably get ready to go to court. At this point, the board must decide if it wants to pursue the matter in civil or criminal court. A lawyer with fraud experience should be able to advise you about which course is suited to your situation, but there are a few simple things to keep in mind.

In civil court, your lawyer works for you at your expense. You make the decisions, while your lawyer collects evidence and talks to the defendant. If you win, you will receive a money judgment.

In criminal court, a prosecutor works the case without charging legal fees. The investigation of claims and the gathering of evidence typically precede an arrest. You make no decisions, and the defendant may refuse to talk. If guilt is established beyond a reasonable doubt, the defendant will receive a sentence and you will probably receive a monetary judgment. Whether or not you ever receive any money is another matter.

“Remember, prosecutors have limitless work and a lot of what they do is triage – who can I help and who can’t I help?” Citarella says. “They have to decide where to spend their resources. A fraud-experienced attorney can help you present the type of evidence that’s likely to attract a prosecutor’s attention. You need a large dollar value, a sympathetic victim, a really bad guy – something that’s going to bubble up and attract a prosecutor’s attention.”

A Special Tool

There is an invaluable tool which, if properly and diligently used, can protect you and keep you out of courtrooms. It’s called the monthly management report.

“This is the most basic thing: having a good management report that someone on the board looks at on a monthly basis,” says Eisenberg-Stark, the CPA and fraud examiner. “Basically, it shows you the cash flow, but more importantly it gives you the bank statement and the bank reconciliation. That will tell you if the rest of the management report is fictitious. Someone needs to read the report and trace the elements back to the bank statement.”

She advises boards to be on the lookout for some classic red flags. They include:

• Deposits that are delayed in hitting the bank.

• Debits on the bank statement that are not in the manager’s monthly report.

• Large withdrawals with no justification. Even if the money is replaced, it usually means the manager is borrowing money short-term, which can lead to serious problems.

• Deposits not going directly into the operating account, or deposits that come from other unrelated bank accounts. This is usually a sign that the manager is commingling funds from other properties, a once-common but now discredited practice.

• A discrepancy in payees. If the management report says a check was paid to one person but the cancelled check has a different payee, it’s possible the original payee is fictitious.

• Payroll checks to fictitious employees, or large amounts of paid overtime. The monthly report should contain an up-to-date list of all employees.

Three additional precautions Eisenberg-Stark advises: make sure all employees work for the corporation and not the management company; check that at least one board member is a signatory on all of the corporation’s bank accounts; and always remember who’s boss.

“Boards need to realize that the management company works for them, they don’t work for the management company,” says Eisenberg-Stark. “Boards have to take responsibility for the money. At the end of the day, if there’s malfeasance or fraud, it’s going to come back to the board. The shareholders or unit-owners are going to ask, ‘Why weren’t you watching?’”

Ultimately, it all revolves around the monthly management report. Boards need to demand that it’s accurate and thorough and that it arrives no later than the 20th day of the following month. If there’s any balking on the part of the property manager, steps need to be taken.

“If boards are not getting that information on a timely basis, they need to demand it,” says Eisenberg-Stark. “Or speak to their lawyer. Or hire a new management company.”

Citarella agrees. “That management report is the monitoring device you must have to check their performance,” he says, adding that it is not optional. “If they object to that, then move on to a new management company.”

Of course, the source of fraud isn’t always the management company, as board members learned during the 1990s. Sometimes, the cancer spreads inside the board itself. There are ways to make sure that your fellow board members are not crossing the line.

“You should never let any one person have too much control,” Eisenberg-Stark says. “No one person should be making decisions on capital improvements, hiring contractors, or having access to the reserve fund. This usually happens in buildings where one person has been on the board a long time and everyone sits back and lets him do what he wants to do.”

She is quick to add that there’s not necessarily anything wrong with a board member putting in long years of service.

“You have to have checks and balances within the board itself,” she says. “Hold meetings, take minutes, vote on things, and always have majority board approval for major projects.”

In other words, boards need to act like boards. And that’s the best way to prevent fraud.