05/18/10: Investing Association Moneys

Housing Counsel

By Benny L. Kass

Q. The treasurer on our condominium board of directors is a stockbroker. He has convinced our board to allow him to invest our association funds with his own company. Is this legal?

The Board does vote to approve this, and the Treasurer recuses himself from this vote. Am I correct that however little research board members do, or whether they just “go along” with the rest of the board, every board member is personally responsible for illegal (or just plain wrong) decisions that the board makes?

Unfortunately, it appears that this stockbroker/treasurer has a powerful impact over the rest of the board.

I have attempted to research conflicts of interest, but have not been able to find this particular issue.

A: Ethical considerations may not be relevant depending on where he is investing the money. In a community association, there are two categories of funds: operating and reserve. The operating funds are used for the routine, everyday expenses of the association – such as insurance, utility bills, payroll or taxes.

Reserve funds, on the other hand, are use to pay for emergencies or for future contingencies, such as replacing a boiler or an elevator. These funds are “reserved” and accumulated yearly. Unit owners always prefer to pay a few dollars into a reserve account each and every month, rather than be hit with a large assessment when the time comes to spend the money. These reserve accounts may have hundreds of thousands of dollars. In some cases, they may even be over a million dollars.

Board members have a fiduciary duty owed to the owners who elected them. Typical language found in most association Bylaws state: “The Directors shall exercise their powers and duties in good faith and with a view to the interests of the Association and consistent with the purposes set forth in the Declaration.” This means that directors of an association have to act in the best interests of the entire association. In dealing with association funds, this also means that they have to be invested in a safe and secure place – and that usually means in government backed and insured investments. This means either certificates of deposits (CDs) that are FDIC insured or federally backed bonds.

Several years ago, such investments carried interest rates ranging from 5-7 percent a year. Today, however, one is lucky if they can get even 1 or 2 percent interest. Indeed, sometimes the bank charges cancel out any possible growth of these funds.

What can the board do when interest rates are so low? The first thing is to consult with an independent financial advisor, to get some suggestions. Usually, the association’s property manager makes the initial contacts and suggests how the funds should be investments, but “the buck stops with the Board”. Where association funds can be invested is a decision that only the board can make, after a thorough investigation. Nevertheless, the funds must be protected by the federal government and should not – and must not – lose money.

Can the Board invest its funds in stocks? I often get questions like this: “the stock market appears to be on the rise. Why can’t we invest in some good “blue chip” companies, so that we can get a better return for our money?”

The answer is simple: you can invest your own money where you want. You can even go to Las Vegas to try to make a financial killing. But these are not your funds. Unless 100 percent of the owners authorize you to invest in the stock market, you cannot do that.

I do not like the idea that the stockbroker/treasurer of your association is in charge of your funds. No matter how honest he may be, there will always be the perception that he has a selfish – pecuniary – interest by investing funds through his own company. He is not the “independent” financial advisor I recommended earlier that should be consulted by the association.

But it is not necessarily a conflict of interest. Most association bylaws contain language dealing with “interested directors”. Contracts or investments made by associations in companies associated with a particular director are valid, if the following conditions exist:

– the Board knows of the director’s involvement with the company, this fact is reflected in the Board minutes of the meeting, and the Board votes affirmatively to approve the transaction;

– the transaction is commercially reasonable at the time it is authorized by the Board.

So the specific answer to your question is that there may not be a conflict of interest, since the Board knows that the Treasurer is a stockbroker. The real question goes to where he is investing the funds. If they are in secured government insured securities, that would be considered commercially reasonable. But if he is investing in the stock market, hoping for a large gain for the association (and himself) that is wrong and the Board should immediately remove him from the office of Treasurer, and move the association funds immediately to a safe investment.

Board members are elected by the owners, and only the owners can remove a director. But officers – such as President or Treasurer – are usually elected by the Board and thus the Board can remove any officer by majority vote.