Strategy Gone Awry

The Low-Down

The story involved a fairly typical scenario in which a co-op refinanced its underlying mortgage and borrowed extra money, which it planned to invest. The manager hooked them up with an investment adviser, who said, “I can invest your money. I can grow your money.” The board was happy. The problem was that no one paid attention. The adviser invested in junk bonds, and no one checked the monthly statements. While the board thought it had $330,000 sitting in this investment account, it in fact had $38,000. The co-op held its annual meeting. The accountant reported that the co-op was in excellent financial shape. Five days after the meeting, the accountant wrote to the board president saying that there was a problem with the co-op’s investments. The president called me up, and my response was, “Oh, my God.” I had a vague idea what had happened, so I called an emergency board meeting.

The Weigh-In

Before we met, the statements were delivered to my office. I reviewed them and pieced together what had happened. The bonds had been losing value, at the rate of about $5,000 to $7,000 a month, for over two and half years. I got the application the board had filled out when the account was opened, which stated that the most important goals were asset preservation and income. The investment adviser, however, invested as he saw fit.

The Outcome

We decided we had to tell the shareholders immediately – but we wanted to be able to get our story out. I thought that the best way to do this was to have a meeting with the shareholders and explain what had happened. If we tried to report it in a letter, people might misunderstand. I crafted a note to the shareholders, advising them that there were some financial issues that came to our attention after the annual meeting that we needed to discuss immediately. I instructed the board members not to tell anyone what the meeting was about. We met with the shareholders and explained what had happened and the board members took a lot of heat from everyone. (The managing agent had been invited but, on the advice of counsel, declined to appear. Probably a wise decision because the shareholders were so angry I’m convinced that they would have reenacted the last scene from the movie Frankenstein, and marched to his house with torches and burned the place down.)

The Take-Away

One of the lessons is the importance of having professionals in place with the skills to manage any crisis. Communication is a key skill. People want to hear from the board what’s going on, and regular updates are important. The other lesson is corporate transparency. If the board members had gone into a turtle shell during this crisis, they would have been besieged. Finally, the board shouldn’t accept information on face value. Had the board members asked for these statements, they would have seen the discrepancy between the managing agent’s records and those statements.