Reserve Investments

I am an owner in a 260 condominium unit association in California. I've been on the Board in the past, but am not now. It has recently come to my attention that one Board member is single-handedly handling all of our HOA reserve investments. She works with a stock broker, but we have no official portfolio manager. He claims to have no fiduciary responsibility for our funds whatsoever. He just does what she tells him to do. She has no training, no certifications and no insurance, were she to make mistakes. She has for years been going for the highest rate of return, but has totally ignored the risk. I'm working on obtaining records to see if we have lost any money in the past, but it is my belief that she has made around $100,000 per year in interest. Not only is she putting money into long term investments, not leaving it fluid for badly needed repairs, but the majority of the portfolio is invested in C-rated or unrated bonds. Less than 3% was invested in CDs. As homeowners we are now bringing this to the attention of a very ignorant Board, who only looks at the return.

I've checked the Davis-Sterling site, but am wondering if anyone knows a specific Civil or Corporate Code that addresses the legality of this. This is not mentioned in our CC&Rs or ByLaws. We currently do not have an investment policy and I'm going to ask the Board to implement this, but unless it is illegal, I doubt they'll do anything to change it.

I've spoken to an attorney about this, but he's going to want a retainer before he gives me any more advice.

Any suggestions or comments would be much appreciated.

It is up to the board to request these funds.

It is all liquid, right?

Explain

2.75% is invested in CDs
31.76% is invested in Corporate
65.49%% is invested in CMO/MBS

The current duration of the investments is:
4.83% <1 year
27.94% 1-2 years
22.11% 2-3 years
24.45% 3-5 years
9.92% 5-7 years
1% >7 years

The quality of the investments is:
2.75% CD
< 1% Aa/AA
2.99% A/A
16.20% Baa/BBB
29.94% Ba/BBB
17.22% B/B
6.29% Caa/CCC
7.73% Ca/CC
5.88% C/C or D
10.25% not rated

You know what the answer here is going to be, get back on the board

But I'm not so sure that they are unavailable

I have found CA civil code that says the funds must be only invested in cash or cash equivalents

Civil Code §5565. Summary of Association Reserves.
[Old:Civ. Code §1365(a)(2)(A)-(D)]

The summary of the association’s reserves required by paragraph (2) of subdivision (b) of Section 5300 shall be based on the most recent review or study conducted pursuant to Section 5550, shall be based only on assets held in cash or cash equivalents, shall be printed in boldface type, and shall include all of the following: ... you can google the rest, but it is not about how the funds are invested.

Per Wikipedia...
Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper. Cash equivalents are distinguished from other investments through their short-term existence; they mature within 3 months whereas short-term investments are 12 months or less, and long-term investments are any investments that mature in excess of 12 months. Another important condition a cash equivalent needs to satisfy is that the investment should have insignificant risk of change in value; thus, common stock cannot be considered a cash equivalent, but preferred stock acquired shortly before its redemption date can be. These highly liquid financial instruments that are so near their maturity and that there is no significant risk of change in value due to fluctuation of interest rates are known as cash equivalents. Although cash equivalents are not cash, they are generally presented on the statement of financial position together with cash using the title "Cash and Cash Equivalents"

So I suspect our Board has already acted illegally because they were paying higher commissions to a stock broker for investments they should not have been buying and selling in the first place.

Why would you get sued? That's a new one.

There would only be a lawsuit if there was a catastrophic loss

Not true, Mark. I live in California. People can sue for breach of fiduciary duty. Owners might also sue for the commissions paid to the broker for the illegal investments. There does not have to be a loss. I don't want to be on the Board if or when that happens.

I would also argue that all your investments are in fact liquid and are not illegal.

And even though we have Civil Code that says otherwise?

No it doesn't

Well, thank you Mark for calling me cowardly and lazy. Without giving you a five year history of making incredibly changes for our HOA in a positive direction, I'll just leave it to say that you are clueless.

Beth

Like it or not, what the BOD is doing seems legal. It also seems you are willing to shoot arrows at them from a distance. You are also begrudging people making money as they make you money.

All that said, I do agree with you that one should not take risks with an associations money. I disagree with what your BOD is doing from a potential risk point of view.

I am VP and Treasurer of our HOA and like the Hippocratic Oath of which the first oath is do no harm, we will only invest in CD's. Not something I would do with my personal money but, I have to answer to a higher authority. My fellow owners.

I am unaware of any statutes or common law that would support that. Could you provide some citations to authorities to support your theory that board members breach their fiduciary duty by failing to follow advice from their association's attorney? Or maybe the corollary theory that a board member is immune from lawsuit if he follows advice of the association's counsel?

Check out Arizona nonprofit act 10-3842. Paraphrased, it says an officer can rely on statements of legal counsel, unless the officer has knowledge that makes the statements unwarranted. There are many other standards here, such as acting in good faith. The officer is not liable if in compliance with the section. I'm not sure how to interpret it, just passing it along for your interest. California has a similar law for directors.

Our D&O policy does not cover separate counsel when a Board member or group of members goes rogue. Not those words exactly, but our Board has discussed this extensively with our attorney in the past. Our ByLaws and CC&Rs are very old and do not address any of this at all.

We are asking our current Board to have our attorney draft an investment policy for the association that hopefully they will adapt.

Ignorance is bliss!

If you WERE on the Board, Beth, and went on record as opposed to the Board's investment strategy, you would not be sued. But you may be right in this case that being off the Board gives your more freedom to gather others for support, etc. Your HOA attorney drafting an investment policy sound good. But how is it that you have access to this attorney?? Or is s/he not your HOA attorney? Except for being prudent, the CA attorneys at Davis-stirling.com do not ciste any restrictions. But they do spell out what in their opinion is a "prudent" investment strategy.

Have you attended open board meetings and complained at open forum about your risky investments??

Took a quick look at davis-stirling.com and found this, Beth:

"INVESTING RESERVE FUNDS
The board shall exercise prudent fiscal management in maintaining the integrity of the reserve account. (Civ. Code §5515)

Investment Strategy. Prudent investments of reserve monies should focus on the following parameters in their order of importance:

Safety. A board's primary goal should be the preservation of the association's reserves against loss. Accordingly, investing in mutual funds, money market funds, and municipal bonds is considered by many to be too risky.

Certificates of Deposit, Treasury Bills and Ginnie Mae securities are generally considered safe because they are direct obligations of the U.S. government. Simple bank savings accounts, while secure, may be too conservative because of their low rates of return. Sometimes an association's governing documents require that funds be kept in FDIC insured accounts.

Liquidity. . . . If reserves are tied up on long-term investments, they will not be available in the event the association needs to (i) use funds for emergency repairs, (ii) borrow for short-term operating expenses or (iii) repair or replace large common area components that reach the end of their useful life earlier than expected. Accordingly, investing all of an association's reserves into a jumbo 3-year CD would not be prudent. A more prudent strategy is to invest in smaller CDs and stagger them to mature every six months.

Yield. . . .Boards should seek a reasonable return on the association's reserve accounts but should never adopt a strategy that emphasizes return over preservation of capital ..."

Read more: Investing Reserve Funds http://www.davis-stirling.com/tabid/1503/Default.aspx#ixzz3YdUyWpxm
from Davis-Stirling.com by Adams Kessler PLC.

Very interesting discussion. Sure have enjoyed reading everybody's comments.

Our investment policy is such that we can only invest in FDIC insured CD's.

Do others of you have an investment policy? If so, can u share it? Thanks!

The problem is that FDIC insured investments have terrible interest.

Gov and muni bond and bond funds are very safe

oops ... thought the OP is on the board, not previously

USG bonds are as safe as the FDIC. Given that some CDs are giving 0.10% interest, you could argue that the cash should just be put into a vault also.