PROTECTING YOUR RESERVE FUND

Two examples: One of our clients received a $2.5 million settlement intended to satisfy the building's foreseeable capital needs. But instead of investing it in treasury bills (T-Bills) or certificates of deposit (CDs), both of which are insured by the Federal Deposit Insurance Corporation (FDIC), the treasurer bought shares in a mutual fund that traded in government obligations. The directors quickly learned the difference between a T-Bill and a mutual fund that trades in T-Bills. Before stopping this practice and liquidating the mutual-fund investment, they lost 25 percent of their precious new reserves in under four months.

Another client, contemplating bankruptcy, devised a complicated workout that paid off its debts, sold unneeded assets, cut operating expenses and established a healthy reserve fund. The board had spent hundreds of hours crafting and negotiating the workout and was justifiably proud of the results. Three years later, without one capital improvement project being implemented or one emergency requiring its use, the reserve was all gone and the co-op was insolvent again.

What happened? Greed. Some of the reserve fund was used for operating expenses because the board members didn't want to raise their monthly expenses. Even worse, the board allowed the treasurer to embark on option transactions with a goal of tripling the reserve in a short period. The strategy was an utter failure, and the money vanished.

How can you avoid such a catastrophe?

Rule 1: Never Risk the Principal

Reserve funds are too important and too hard to replace. They should be treated like trust funds. Never invest or speculate with them in any manner that puts the principal at risk in any way. Invest directly in T-Bills or FDIC-insured CDs — one CD per bank, and no more in any one institution than the $100,000 limit that the FDIC guarantees in case of bank failure.

Do not invest in mutual funds. That places your money at risk. Likewise do not purchase of stocks, no matter their quality.

Some boards treat the reserve fund as though it were a day-trading account. One well-respected accountant, conducting an audit, was appalled when the treasurer at one building provided a large stack of trade confirmations. Day-trading is gambling, and can open a treasurer to personal liability. Same with options, commodity trading and "rare metal" trading. No matter how attractive the return promised, the investment is inappropriate and should be avoided.

Finally, keep track of your CDs or T-Bills, because, while rare, banks and brokerages do go out of business.

Rule 2: Segregate Reserve Funds

Keep reserves in separate accounts maintained in separate financial institutions. Do not commingle your reserves with operating funds. It is harder to keep track of commingled funds and to know when reserves are being improperly used.

Rule 3: Never Permit Wire Transfers

There is never an emergency so great that a bank check or a certified check cannot be used. The need to wire money is almost always the result of bad planning. Second, wire transfers do not create adequate paper trails. Third, transfers can be initiated by unauthorized people. One management company caused 26 of its co-ops to lose over $2.6 million because an unauthorized employee secured access to the account numbers and passwords, and proceeded to wire-transfer funds back and forth among the 26 cooperatives to cover his embezzlement.

Rule 4: No Access for the Agent

Permitting a managing agent direct access to reserve funds is never wise. Large pools of money are attractive targets of opportunity for anyone who wants to "borrow" funds — or to "lend" your reserves to another building that's short of cash. That happens a lot more often than you'd think.

Keeping the out of reach of management also insures that the agent cannot use the funds for ordinary operating expenses, which the monthly maintenance or common charges should cover.

Rule 5: Reserves Are Item No. 2

Your reserve fund is the second most important item on your monthly board agenda. Generally, financial matters should be the first item on every board's agenda — before the heated arguments about lobby redecoration, gossip about the new purchasers or a discussion about repairs.

After analyzing income and expense issues, the treasurer should present a short report on the reserve fund. Every board member should know how much is in the fund and available, and where the money is invested and how.

Rule 6: Reserve Funds Are for Emergency or Capital Use Only
Reserves are for emergencies and long-term, building-wide capital improvements. If a property is using its reserve funds for operating expenses, the board has a problem that it has not addressed.