Every autumn, the Council of New York Cooperatives & Condominiums holds its day-long, information-packed Cooperative Housing Conference, where more than 60 workshops and seminars present unparalleled opportunities for board members and potential board members of cooperatives and condominiums to learn and to share information on every aspect of operating their buildings. A recurring theme of Conference is the importance of vigilance and organization in ensuring the success of a board.

Summarized below is a workshop presented at the 17th annual Cooperative Housing Conference which guides boards in these areas. This and other in-depth workshops will be presented at the 18th annual Cooperative Housing Conference on Sunday, November 15, 1998. The summer issue of the CNYC Newsletter will contain the Conference brochure.

DETECTING & PREVENTING
FRAUD & KICKBACKS

According to Mindy Eisenberg, a CPA and certified fraud examiner who is a partner in the firm of Eisenberg & Krauskopf, there are two broad categories of management wrongdoing: the kind that happens on the corporation's books and records, and the kind that flows under the table. Kickbacks are an example of the latter, where you overpay for a good or service and the vendor gives the extra money to your management company or your agent or super, or even to a board member, as a "thank you" for hiring them.

In a typical example, the ABC Management Company would hire a plumber on your building's behalf. The plumber charges $2,000 for the repair, and a check for that amount is cut from the building's bank account. The plumbing company then gives $300 in cash to your managing agent. Such an act is difficult to uncover. There's a bill for $2,000, which the treasurer has seen, there's a check that's been properly signed, and the board authorized the expenditure. "No matter how many accountants and forensic specialists you engage, you will have a hard time finding it," says Ms. Eisenberg.

PREVENTION IS THE BEST DEFENSE
While most managers are honest, and those who commit these acts are certainly the exception and not the rule, says Ms. Eisenberg, it always pays to be vigilant. The best defense against kickbacks is prevention, and there are a few safeguards you can put into place:

1. Solicit sealed bids and open them before a group. Many boards allow the managing agent to get all the bids and bring a summary of the bids to a board meeting. This is asking for trouble. "You don't know that the manager didn't tell a preferred vendor what the other companies were bidding," says Ms. Eisenberg. "He could say that he has three bids at $1,500, so if his vendor comes in at $1,200 he's guaranteed to get this project. Nor do you know whether this work is worth $1,500, or even $1,200."

While it may be time-consuming, the board should gather some of the bids itself. This will not only help head off a manager-vendor tryst, but it will give the board a better sense of what the job should really cost. When you receive the bids, open them at the board meeting. Never allow the managing agent to open bids at his office and hand you a summary.

2. Hire an engineer. The bidding process is worthless unless there's a level playing field. An engineer will draw up specifications that can be sent to each bidding vendor, giving the board a reasonable standard for comparison. You may not find this necessary on a smaller job, but it should be your operating procedure on all larger expenditures. Another note of caution: Don't rely solely on your managing agent to help you choose engineers, and don't allow your engineer to gather bids from contractors.

3. Check prices. With smaller projects and purchases, legwork is the best weapon against ripoffs. A board member should call various suppliers to find out what they are charging for commonly-used items. If you suspect that supplies are disappearing or not even arriving at the building, conduct random inspections of supply orders when they arrive and periodically check in the supply room to see how fast these items are being depleted.

4. Don't grow too fond of vendors. There are persuasive reasons for establishing relationships with vendors and contractors. For example, if you use the same plumber on many jobs, it is likely that you will get better prices. But in using the same vendor or contractor year in and year out, you can lose sight of market prices. To keep vendors on their toes, review one or two vendors each year. If you find that the contractors you are using are offering bids that are in line and competitive with other bids you receive, then you will have a greater degree of comfort. In addition, "doing this sends a signal to your present contractors that if they want to stay on the property, they need to sharpen their pencils and come up with the best price for you," says Ms. Eisenberg.

Overcharging could be indicative of fraud and kickbacks. If you find overcharging, then you should begin looking into this possibility.

5. Don't rubber-stamp expenditures. When it comes to board approval of expenditures, boards err at both ends of the spectrum. Some boards approve all outlays without looking into them, while others take a magnifying glass to every bill. The former opens you up to rampant abuse, while the latter is too time-consuming and probably not necessary. The most practical approach is to consent to routine expenditures, with periodic reviews, while looking closely at larger or non-recurring expenses. This shows the agent that you're watching the store.

PREVENTING EMBEZZLEMENT
Embezzlement is an easier act to catch, since it can generally be documented through the books and records. Yet this is a common form of management wrongdoing, simply because many buildings don't have the right systems in place or they don't read their own records.

There are instances where money can be stolen right out of the building's operating account. This is particularly easy when your managing agent maintains what is called a "master vendor account". Under this method, checks that the management company collects go into your building's account. But when it comes time to pay bills, the management company writes one lump-sum check from your account to its "master vendor account", and then pays the vendors from this account. At the end of the month, you get a report from the management company showing what bills were paid and when.

The argument in favor of this method is that the management company saves time by writing one lump-sum check for all its buildings to, say, Con Ed, rather than cutting checks for each of its buildings. But the master account is also a potent lure for dishonest agents. If you have a large management company that manages 75 to 100 buildings, there could be $9 or $10 million in the master vendor account at any given time.

Furthermore, a master vendor account places a gaping hole in your own building's paper trail. If you try to follow the money, all you'll find from your account is a lump-sum withdrawal. You'll have the manager's report saying what was paid, but there will be no proof that a specific vendor was paid. This can be particularly problematic when a J--51 audit occurs and the City demands to see the canceled checks for the project, or if there is a dispute over a payment made. So, think twice before hiring a management company that uses this type of account.

The better approach -- and certainly a more common one among management firms today -- is to pay bills directly and individually from each building's account. This way, your building's monthly bank statement shows separate checks for the utility company, the management company, payroll, and so on.

GET BANK RECORDS WITH MANAGEMENT REPORT
Most buildings receive monthly management reports that show operations -- what has been collected on your behalf, what has been paid on your behalf, accounts receivable, accounts payable, and so on. What many buildings are not getting as part of that package is a copy of the monthly bank statement and a copy of the bank reconciliation -- two key elements. A reconciliation makes sure all your deposits cleared and all your checks cleared, and adds back what didn't clear.

"The reconciliation helps show that everything in the statement is on the report, and everything on the report has been accounted for vis-a-vis the statement," says Ms. Eisenberg. "Without this, you have no way of knowing that the monthly management report is accurate."

ONLY BOARD SIGNATORIES ON RESERVE FUND
Many buildings allow the management company to act as signatory on their reserve funds, and entrust the management company with investing the reserves, says Ms. Eisenberg. The argument for doing this is that if the money is needed for an emergency, management can have instant access to it. Compelling, perhaps, but also very dangerous. If a manager pays a vendor directly from the reserve fund, you lose your audit trail because reserve fund expenditures are not part of your monthly management report, and are not being accounted for.

Instead, the board should maintain the reserve account, with two board member signatures required. No one board member should be responsible for the reserve account on his or her own. Copies of all reserve fund statements should be sent to the management company and the building's accountant, so that a copy is always kept on file and available for an audit. The bank or investment bank where you keep the account should be able to send duplicate statements to the different parties.

In many cases, it's not the management company that commits fraud; it's generally an individual agent, because agents have the right to hire vendors on behalf of the buildings that they manage, says Ms. Eisenberg. Yet it is the responsibility of the firm to monitor the activities of its employees. Take a look at what your management company does to monitor its employees for fraud. Do they have a firm policy? How is it enforced?

INSURANCE PROTECTION
Insurance can provide additional comfort. As part of your management agreement, make sure the company buys a fidelity bond, covering themselves and their employees for fraud. The drawback is that you won't know if the company cancels the bond.

As a back-up, the building can purchase "employee dishonesty insurance". Although the management company is not an employee, they are acting for the building in place of an employee and so they are covered, says Ms. Eisenberg.

The key to winning any claim is to provide documentation. In one co-op where more than $200,000 was diverted from the account, the building was able to put together documentation from the banks showing that the money had been there and that it left, says Ms. Eisenberg.

The overall lesson is that boards need to be alert and conscientious.