 I'm Richard Emory, your host today for Kondo Insider. As many of you know, Kondo Insider is what you show about living in an association, both Kondo and Homeowner Association, talking about the many issues we face in trying to be good government stewards in our association industry. I would remind you that the legislature has concluded, and we do have two upcoming seminars, one by Community Association Institute on July 14th on an update of all the legislation that was passed this year. I can tell you this, that all of them were signed into law by the governor, none were vetoed, so all of them have been issued an act number and have been signed. And then coming on August, August 18th, White Council Community Associations is doing a special 90-minute seminar on the new effect of the law on reserve obligations in the state of Hawaii. And because of that collapse of that condominium in Florida, the legislators all over the country, including Hawaii, have decided to ramp up enforcement requirements, inspections for condominiums in their state. So this is gonna be in-depth discussion and actually our guest today is one of our guests on that show as well, but we're going to try to give you an opportunity to learn more about what the obligations are. I would tell you it's a very important matter because they're really tightening up the obligations and that exposes board members and associations to a potential liability, depending on the circumstances. But on that note, today we're here to talk about fraud and embezzlement. And we have as a guest, David Levy, who was not only a retired certified public accountant, but he moved to Hawaii. Well, he lived to kind of part time for a while, but he moved, I guess, permanently to Hawaii a year or so ago, but welcome to the show, David. Well, thank you very much, Richard. Appreciate you inviting me to be here. Can you just expand on my little brief introduction on who you are and to me, I've known you a long time. So you told me you're a CPA. I knew that meant certified pain in the a coli to me, but the reality is I know you have a very prominent background in condo management. So why don't you share with us a little bit about your background? Sure. Well, I was born in St. Louis, Missouri a long time ago and my father moved our family to California in the early 1960s. And after I graduated college, I went to work for a couple of different CPA firms for about 10 years and then started my own practice, specializing in homeowners associations. And a lot of times people ask me, well, how did you get into this industry? Well, when I bought my second condominium, one of the longtime residents of the association, 42 units in the Bay Area knocked on my door and invited me to join the board of directors. And this person was actually the developer of the project. And that's how I got my start in the industry. I learned at the first annual meeting of the association when I was treasurer and proposed a special assessment to boost the reserves. One of the former directors in the audience stood up and said, well, at our association, when we think we need a special assessment, we'll let you know. And so that pushback told me that this wasn't gonna be an easy industry to be involved in. Subsequent to that, I spent a total of 45 years in public accounting in Northern California just doing work in homeowners associations. And when I left our CPA firm at 4,000 homeowners associations as clients, that's 4,000 out of the statewide total of 55,000. Hawaii, of course, is a lot smaller than California in terms of community associations. Do you enjoy the kind of association business? What do you think the biggest challenges they face? Well, I mean, being an accountant, obviously I'm a little more focused on the financial end of our industry. And it's separate and apart from fraud and embezzlement, the largest financial issue, most people would agree for homeowners associations is setting money aside for reserves. There's just a built-in reticence for people to fund future major repairs and replacements. A lot of people that have bought into condominiums started out maybe in an apartment building. And when you pay rent in an apartment building, you're not thinking about replacing the roof of the apartment building or painting it. But if you live in your own home in a condominium, money needs to be subsided for that purpose because in many, many locations, including Hawaii, California, as people get older and may live off of limited incomes, if there's special assessments to pay for reserves, some people might not be able to pay it. And if they don't pay it, many people may not realize that you can be foreclosed out of your home. So in my opinion, it's good practice, with public policy, to set aside money for reserves. It's kind of an aside from our topic for today. I brought with me today a number of examples of fraud and investment, as well as some ideas for how to avoid some of it. Okay, before we begin, let me just, let me just again affirm that your view about the reluctance of boards to fund the reserves, thinking they're doing their members a benefit, by not raising maintenance fees, thus leaving them in the future with potential special assessments and problems with delinquencies and insufficient money to properly maintain the building is one of the most serious problems. And that's why I would encourage all of our listeners to go to either the CAI or the HCCA seminar where we'll discuss this in much more detail and maybe cause you some lost sleep when you hear some of the things coming down the road. But we're here today for fraud and investment. Don't ruin my day and tell me there's fraud and investment and kind of associations. Yeah, I hate to tell you there is. And even my exposure to it in Northern California over 45 years, I'm sure it was only the tip of the iceberg. The first major case I was involved in had to do with the owner of a management company in California who was taking money quietly from most of his roughly 40 homeowners associations. And how was he doing it? Well, he would essentially borrow the money from the association. And if he didn't get caught, he would keep it. And this is known in many ways as a kind of a kiting scheme. He would steal money from one association. If that association figured out that he had stolen the money, he'd borrow it from another association to pay it back. So the money was moving from one association to the other but all along the way, he would keep some of the money. And it was a result actually of a CAI Community Associations Institute annual seminar in Hawaii, I forget what year, that I actually met up with an FBI agent in white collar crime who was moving to San Francisco. And so after the seminar, I went up and talked to this agent and described what the problem was. And he agreed to meet with me when he transferred to San Francisco. And in fact, he did. And then I learned that the FBI does, at least when it comes to white collar crime, they do not necessarily have the authority to take on a case. They take a potential case to the US Attorney's Office and the US Attorney will say yes or no. And even though we believe that a lot of money was being stolen from homeowners associations, we didn't know exactly how much, but ultimately we were able to convince the US Attorney that this theft of funds by this one individual affected the lives of a lot of people. And so the US Attorney agreed and the FBI agent and I worked together on this case for about three years. Ultimately, the person was arrested and brought to trial. However, he committed suicide before actually being sentenced. This particular person was a management company, a portfolio manager? No, he was the owner of a company that did portfolio management for about 40 associations. And how did he get his hands on the money? Well, the way he did it was when the board turned over, he would bring bank signature cards to the board meeting. And the new board members would sign the signature card but the very last signature before it went to the bank, it was his. So the bank was not a homeowner association bank. It was a large national bank, I won't mention the name and they didn't understand homeowner associations. They get a bank signature card, the management company owner's name is on the card. So he was able to move funds around from one association to the other. When the FBI got involved, the agent met with the internal audit staff and they had already figured out what the problem was. I mean, they made it pretty easy for the FBI in this particular case. So the main problem in this case was that the board of directors allowed the property manager to add his name to the bank's signature card without their knowledge. What's interesting in Hawaii, it's a little different. First of all, if you're 20 units or more, you're required to do an audit. I don't mean a review or a compilation. I'm talking about a true audit annually for the members. But there's also a second provision in Hawaii law that each year, this auditor must do a surprise cash verification where he goes into the management company's office and then does a immediate check of what the book balances say and what the banks say the book balances are. And the idea behind that is to prevent this kiting or I wouldn't know the right word where you're moving money between entities to keep them getting caught, which is what the surprise cash verification is supposed to do. How do you feel about that, to help? Yeah, I think it's a good idea. California doesn't have any similar laws. There's no question that when it comes to fraud and investment and internal controls, the main asset that the board members need to pay attention to is cash. And that's pretty much all we'll be talking about today. In this case, the property manager was able to move cash around. And while the financial statements were generally accurate, in some cases, believe it or not, the balance sheet would even show what the property manager would do from the property manager. And apparently, board members didn't even question that. Well, it's interesting, because I've been in this for about 30 years here in Hawaii condo management. And I've seen very rare exposed cases of fraud. And I mean, by that, there was a manager, portfolio manager company on Hawaii and suddenly the owner closed all his clients' checking accounts, took the money and just disappeared to the mainland. And he was caught in the jail. The other thing, as we see often done, management companies create artificial vendors and they're taking $2,550, $100 a week to pay some vendor that because amounts are so small, if you manage 50 condos, you're taking $100 a week. That's $5,000 a week. You know, that the people, we've seen that. But before we go further, I know we're talking about the portfolio manager, we're at the midway point, so we're going to take a one-minute break. Aloha, welcome back to Condo Insider with David Levy, retired CPA, talking about potential fraud or embezzlement in a condo association. And we just finished talking about the type of fraud that can occur with your management company. And certainly I would advise any board member that to me, the easiest way to discover fraud is make sure you get a check register every month of the money. And then number two, make sure you have a bank reconciliation, you know, and that will help quite a bit. But David, have you had an experience where the board itself, like board members and or volunteers have created an embezzlement? Yeah, well, one case had to do with a board member who was a materials designer. The board told this board member that that person couldn't redecorate the clubhouse, which she did. But of course, she was also the board member who was the treasurer. So she paid herself and she paid herself more than what she should have. She was caught by the bookkeeping firm and she was prosecuted and she actually did go to jail. In one other case, there was collusion between the treasurer of the association and the accountant for the management company. But it was the new accountant for a new management company. The association had changed from one management company to the other. The bookkeeper and the new management company discovered that the treasurer was stealing money. And instead of turning the treasurer in, the bookkeeper said, why don't you cut me in? So the two of them colluded to steal money over a period of time. And the bookkeeper was a Mexican-American and he fled to Mexico when they were caught. The treasurer who was an older fellow, he went to jail. What was the problem? They were not producing financial statements for some time within the management company, management company owner, nor the board even asked questions about it. There was poor internal controls. I think because the show goes so quickly here, we should talk about some of the ways in which the boards can protect themselves. And Richard, you pointed out two really very good things. One, looking at the check register. Only a few years ago, California law was modified to require that board members review check registers as well as reviewing bankrupt conciliations. I wanna speak for a moment about bankrupt conciliations. Over the years, we've had a number of cases where the bankrupt conciliations were not correct. And even in some cases where money was stolen and the board member would give me a document say, well, here, it's bankrupt conciliation. I'd say, yeah, it's a bankrupt conciliation but the balance on the bankrupt conciliation didn't match what was on the bank statement. So it's important if you're gonna review the bankrupt conciliation, you need to get a copy of the bank statement as well and make sure it ties to the bank statement. That would be the bank balance on the bankrupt. The book balance on the bankrupt should tie to what's on the balance sheet. If those two numbers don't tie together then the bankrupt conciliation may be faulty and it's not going to do you any good. Maybe we can speak to differences between California law and Hawaii law when it comes to disbursements. In California, people, board members have to have two board signatures on reserve checks, not just one. And it is okay in California as in Hawaii for the manager to sign operating account checks. But both in California and Hawaii, many associations are self-managed. So if you happen to be self-managed, a smaller association, you might want to consider the possibility of two signatures on a check. Most people say, well, that's a lot of extra work. We don't really want to do it but it would be an internal control that's helpful. So looking at bankrupt conciliations, looking at check registers, another document from your accounting system is the year-to-date general ledger. So when you write a check, that gets punched into the accounting software and the amount of money, the payee and what account it goes to goes into the general ledger. And the general ledger will show you all the detail. So for instance, if you said, well, from January to June, let's say we're at June 30th, you know, what went into office expense, you print out a year-to-date general ledger and it'll show you all of the expenditures that were charged to office expense. By looking at the year-to-date general ledger, you can see where the money went. You can also see where occasionally there might be a coding error and maybe a landscape expense shows up in office expense and it can be moved over. Also looking at budget to actual on your expenses. If there's a major variance, well, why is it? Was there unusual expense? Or is somebody taking the money? So... I was just to add a little bit about Hawaii. Sure. Yes, we, the management company for the major management companies anyway, set up a trust account because all the funds for a association has to be in that association's name in a separate account. You can't commingle two associations funds together must be separate. That being said, all disbursements regardless of reserves or regular operating expenses must be made from the operating account. So if you have money in reserves, you have to then transfer the money to reserves to the operating account. That being said, the state law here is that must be in writing between the board and the management company. They cannot move funds between the reserves and the operating account without written approval of the board itself. It's very unusual to have in the larger scheme of things to have the board sign the checks of any kind. It's always been the management company. And it's probably because we're bonded and assured we're covered by the real estate education fund or the fraud fund, whatever they call it where we put money in every, not we the condo associations put money into this account to cover potential fraud and investment. But to collect that money from the real estate commission is very difficult. You have to have proved that you've had a fraud and you've pursued the person who committed a fraud to the end of the earth and the end of time before you can get reimbursed. But it has been done. It has happened. So we do have some protections built in but to me it goes back to why do you want to deal with all this hassle? Why don't you just review the financial statements direct and back reconciliation and the check registered like a normal course of business? Right. Well, it's important. I mean, many times board members feel awkward about asking questions but you shouldn't feel awkward. You should ask questions if something doesn't make sense. Also, it's important to have good board minutes. This helps out your CPA who's doing a review or audit to understand what did the board approve? One of the problems I've seen over the years is the association approves money for a contract but then they don't say anything about the change orders that come through. Did the board approve the change orders or didn't they approve the change orders? So documenting what the board approves it's also helpful at controlling expenditures. And because we're getting near the end of the show I just want to put this little piece of information out. It's not exactly related but where I've seen a lot of embezzlement for lack of a better word fraud has been because of this electronic banking. And what happens is somebody has access to your electronic banking information and it may be some person in Nigeria didn't pick on Nigeria but with some third party that somehow has finagled your passwords and you don't have much protection and then they go get the information and move the money without you knowing it or the management company knowing it. And on top of that, you get into situations where they may get from your database owners for the sure paying automatic payment they may get your owners checking account information and go and steal your owner's checking account. So there's an insurance policy that can be an add on to your existing crime policy for what I'm going to call internet fraud like that. And that's only a couple of hundred bucks a year. So I think the world is going to more of this electronic fraud. And you should everybody out there should be aware of that problem. Absolutely. Also on a personal basis and they were almost out of time but I almost paid a credit card bill late with one of the major banks. And so I thought I'd call the bank and talk to somebody about making a payment. Turns out, no, you don't talk to anybody. The computerized voice asked you for two numbers. Your routing number and your account number. So those two numbers are on everybody's blank check and same for a homeowner's associations check. The bad guys, if they get hold of your routing number and their account number, they may be able to access your funds. So that's another reason for keeping your checks locked up. We're down to two minutes. Give one recommendation, it's the solid recommendation that all boards should do. Yeah, I would say read and understand your financial statements, especially variances between budget and actual and ask questions. And if your income and expense statement doesn't mesh with your balance sheet correctly, you should ask questions and talk to your manager, your CPA. Don't be afraid to ask questions. That's one of the most important things. Well, I wanna thank you for being on the show today. It was very informative. I enjoy the times we have many times talking about our industry together. I wanna remind everybody again that we have these two seminars on the recent laws and the reserve study coming up. And as David pointed out earlier, this whole reserve study issue is gonna be the new frontier for condo association. So I encourage you to go to those. And I thank everybody for viewing today. Thank you, David, for coming. Thank you. And thank you for watching Condo Insider. Thank you so much for watching Think Tech Hawaii. If you like what we do, please like us and click the subscribe button on YouTube and the follow button on Vimeo. You can also follow us on Facebook, Instagram, Twitter and LinkedIn and donate to us at thinktechhawaii.com. Mahalo.