You need to be very certain of financial irregularities before you start any litigation.

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Question:

A financial report for our co-op building does not add up. How can I request an audit?

Answer:

“Before you get involved in requesting an audit you should have an accountant or someone with a strong accounting background to review the building’s financial statement to see whether there are in fact discrepancies or if it is simply a misinterpretation of the numbers,” says Steven Wagner, a partner at the Manhattan law firm Wagner, Berkow & Brandt who represents co-op and condo boards and owners. 

Wagner says in some cases, members of a newly elected board will have stories or suspicions about funds that have gone missing in prior years but if you are considering requesting an audit or indeed following up with litigation, you need more than that. “You need proof and that's where you need an accountant,” Wagner says. 

In some cases there may be significant red flags: The reserve funds may be going down without any commensurate capital investments or there may be dramatic increases in operating costs when typically staffing costs in union buildings are very stable. Another red flag may be that there is a large amount of work being done by a company affiliated to the managing agent. “This may not be a sure sign of irregularity—it may be that the affiliated company offers very good deals—but if that’s not the case, it may be worth asking questions,” Wagner says.

Your rights as a shareholder or owner

The governing documents of most condos and co-ops allow owners or shareholders to review the books and records of accounts, Wagner says.

Although this term—books and records of account—is not legally defined, it is generally considered to include relevant documents regarding the building's financial operations. “Not only that, but there is plenty of case law to support your rights as a shareholder to look at a building’s documents if you have a good faith belief that there is possible misconduct,” Wagner says. 

This allows you to ask the board or the managing agent for information or to look at the general ledger and supporting schedules.  Wagner says the general ledger will give you an idea of where money has been spent. Supporting schedules and work papers will contain more detail about payments and invoices. 

“You might want to get even more granular and ask to see the contracts with certain companies,” Wagner says. 

Reading the financial statements

A building’s financial statements will generally be certified by an accountant employed by the managing agent. “This is the very highest level of scrutiny that accountants offer and it results from a complete examination of the building’s books and records,” Wagner says. This certification is important because the accountants can be liable if someone purchases an apartment relying on the financial statements they produce.

If your building doesn’t use an accounting firm or you still have concerns, you’ll need to bring in an independent expert. 

“In any action or proceeding, you’d need an expert, typically an accountant, in order to identify where money may be missing or if it has been taken, so it’s to your advantage to promptly get an expert involved to confirm your suspicions,” Wagner says. 

Requesting an audit

Raising your concerns about financial discrepancies with the board is an important first step. However, Wagner says if the board is taking kickbacks, or participating in fraud or defalcation they are going to resist your requests for information. 

If you meet significant resistance from the board in obtaining documents, you will need legal representation and the help of a specialist in forensic auditing in order to challenge their accounting. An attorney will help you get all the records and make a full determination of the money that is missing.

When considering the specialist you should employ for this work, Wagner suggests choosing someone who is comfortable doing fraud audits and testifying in court and who has had special training in uncovering fraud and the theft of funds. 

“Depending on what the concern is, the accountant will make a recommendation and will send you an engagement letter for this special project. If they start discovering irregularities, the audit may go in a different direction too,” Wagner says. 

You may also have to begin a lawsuit demanding further financial information. “A good faith allegation that something is amiss and the demand for records will usually be met by a positive response from the courts,” Wagner says. 

If your concerns lie with the managing agent rather than the board, you may need to begin litigation to get access to all the information in the managing agent’s possession.  In one case, Wagner represented a co-op board where it was discovered that the managing agent had been stealing money by putting maintenance fees in a shadow account. 

“Residents were paying their maintenance and instead of having it shown as a payment, credits were being issued—and in this way money was syphoned off into a separate account controlled by the managing agent,” Wagner says. Ultimately Wagner was able to quickly terminate the services of the managing agent, have the building’s operating and reserve accounts turned over to the co-op board, and get all his clients’ stolen funds returned. 

New York City real estate attorney Steven Wagner is a founding partner of Wagner, Berkow, & Brandt, with more than 30 years of experience representing co-ops, condos, as well as individual owners and shareholders. To submit a question for this column, click here. To arrange a free 15-minute telephone consultation, send Steve an email, or call 646-780-7272.

 

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