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How the Board Lost Millions of Dollars…

How the Board Lost Millions of Dollars…

and maybe all their personal net worth!

This is a true story.  The details have been slightly altered to avoid revealing the identity of the association, board members, or the managing agent – but a true and chilling story nevertheless.  I do quite a bit of expert witness work, and much of that has to do with Boards acting irresponsibly.  In no case have I ever seen a Board intentionally act irresponsibly (including this one); the Boards always seem to feel they are doing right – even if it is absolutely wrong.  This case is no different.

The Board of Directors included a registered securities broker, and a licensed insurance broker.  At some point the securities broker recommended to the Board that he invest the association reserves in the stock market.  He offered to do it for half of the commission the association was paying a third party vendor (who was not using the stock market – for reasons that should be obvious to most of you).  The Board accepted that offer because they felt they could maximize their interest earnings on their reserve principal, which was somewhere near $1,000,000.

The manager gave strong advice that this was not appropriate, and asked the association’s attorney who wrote an opinion letter stating the same thing.  Basically, both advisors to the Board were telling them that the Board’s primary duty was to protect the principal, and investments in the stock market do not protect principal.  The Board proceeded with the new strategy anyway, and the broker/Board Member diversified their reserves in a variety of funds, both domestic and international.  The stock market was doing well – very well – and everyone was happy.

Also, somewhere along the way, the Board resolved to allow the insurance broker Board member to place the insurance to save the commission paid to their previous broker.

While things were going along well in the stock market, the association received a settlement from construction defect litigation.  The settlement was several million dollars – but also several million dollars short of what they would need to do the repair.  Striving to avoid a special assessment, the Board resolved to let the same broker/Board Member invest those millions in the stock market also.  He did – and the association continued to do very well.  Well enough to tout to the homeowners their success and show the membership what an excellent job the Board was doing.

Then the market turned – and the losses were staggering.  In many months, losses exceeded $300K.  In short, something in the neighborhood of $3,000,000 was lost before the bleeding stopped.  The homeowners were not happy, and the Board was more than shaken.  Now they decided to get some legal advice!  (It might have been better if they listened to the first advice.)  They discovered that there were some issues here, like investing in the stock market could be considered a breach of fiduciary duty. The good news was the broker/Board member was a licensed broker and they normally carry about $5 million in Professional Liability Insurance.  Legal action was begun against the broker/Board Member.  Guess what?  He did not have insurance!  He was licensed but he was trading online and carried no insurance.  He also fled the state and moved east, which caused other legal complications.

The next step – submit a claim on the association’s D&O Insurance (that is a Professional Liability Policy the association carried to protect the Board of Directors).  Unfortunately, the Board Member who was an insurance broker placing the association’s insurance failed to report the action against the stock broker.  That means it was a fraudulent application and as you can imagine – no coverage!  It might be questionable how much coverage there would be in any case, because the Board ignored the advice of the manager and their attorney.  When Boards fail to follow professional advice, they may lose their protections against being sued individually.  In any case, we now end up with five well-meaning Board Members being individually sued for losing $3,000,000.  It was now also pretty evident to them that playing the stock market with the reserve funds was not appropriate.

I should add that the association also sued the management company, even though they clearly did not make the decision, and advised against it so strongly they were fired.  But heck – they had insurance so why not throw management into the mix also.  Sometimes when Boards stop following management’s advice, management terminates the contract.  This is one of many reasons why they might do so – some accounts are just not worth having as clients.

I am not privy to how this case finally settled.  It settled very recently and has been ongoing for many years (since the economy collapsed).  There are some things we know for certain, however.  We know for certain that attorneys for many people were billing for many months.  I suspect the attorney fees alone for these Board Members were traumatic.  However, I suspect the fear of possibly losing most everything they had in life because of one well meaning, but foolish and improper decision caused far more sleepless nights.  I hope that economically they were not ruined completely in the settlement, but that is something we will never know.  I would suspect the association got some money back but basically they are most likely still out millions.

Why am I writing this article?  This is not the only example I could have used to make this point.  A year ago I was on a case where a Board Member hired a towing company that would tow without needing a signature (because the Board felt it was too inconvenient to have someone sign the tow chit; who cares about those pesky laws anyway!).  Then a homeowner had her leg de-gloved when the tow truck ran over her.  That should have had nothing to do with the association, except the Board hired this guy to get around the law.  Suddenly the Board is in a multi-million dollar lawsuit because they just found it inconvenient to follow the law.  There are countless other examples, many involving Boards not using reasonable care in managing the property leading to accidents and injury – this should get the attention of those of you who think your job is to forgo maintenance because it “keeps the dues down”. 

I picked this case because it had a catchy title, but I am writing on this topic because every day we see Boards that don’t think there is a down side to not following the law.  They think: “Meeting without notice is OK.”  “Discussing by email is OK.”  “Hiring unlicensed handymen is OK.”  Thinking their main job is to “reduce the dues” is OK, even when it violates the Civil Code.  They think all these laws designed to protect the membership are just plots to keep the Board from doing their job and so let’s just ignore them!  After all, it is just an HOA – let’s just use common sense and do what we think is right!

It is NOT OK.  It will eventually lead at a minimum to emotional pain and economic suffering – often for both the Board members as well as the community.  When Boards act that way, even with insurance, they can be sued individually.  Board members, do your homeowners a favor.  If you can’t follow the law - resign.  Kidding yourself that avoiding these laws is for the good of the community is NOT worth it, and could cost you personally and eventually will cost the association.

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