The Fraud Triangle and Why it is Important

Many people have probably heard horror stories about fraud and money being stolen from condominium and homeowners associations.  While the majority of people are honest, there are a few that have stolen from association bank accounts.

Many theories state that those who commit fraud must have three factors to be able to commit the fraud and embezzle money from the Association.  This is usually referred to as the “Fraud Triangle”.


Three Factors in the Fraud Triangle

Pressure:  Financial pressure is prevalent these days, especially in a weak economy.  Think about the person who just got divorced, lost their job, or can’t pay the employees that work for their small business, or their house is about to go into foreclosure, or they can’t afford groceries.  Perhaps someone has a substance abuse problem or gambling addiction which they can no longer fund.  Good people can commit irrational and illegal acts when they are under pressure.

Opportunity:  The person who is ultimately pressured into an act like stealing money must also have the opportunity.  What checks and balances does your Association have in place?  Do you have segregation of duties among your accounting staff?  Do you allow money transfers online without written approval each time?  Who (if anyone) reviews the bank statements monthly?  Does the Association have a regular audit?   The Association’s assets must be protected.

Rationalization.:  Often, an individual will take money for the first time, with the intention of only borrowing the money with the plan to return it shortly.  Then it gets to the point where they can’t replace it any more.  At that point,  they may either transfer funds from other accounts or falsify documents to cover their trail.  They may also feel that the Association has wronged them in some way.

How can you detect if fraud is going on in your Association?  The initial step would be to have a CPA conduct an audit of your Association.   Provide original documents to the auditor.  Also, cross-check any vendors who were paid for services with actual invoices.  Fraud can go undetected for a period of time when checks are made out to “ghost vendors”.    Another practice is writing off an account as a bad debt when it has actually been paid.   Someone may finally come current after being delinquent, and their payment is recorded in the accounting records.  It’s just pocketed.

Studies show that the typical fraud lasts about two years.  After two years, many perpetrators can no longer hide the large sums of money they have taken and are discovered.    Moral of the Story:  Put good controls in place and beware of anything unusual .