When it comes to co-ops and condos and their cash, Charles Zucker knows all the tricks - and then some. He should. As a principal in Zucker & Shernicoff, he has been auditing cooperatives and condominiums for more than 25 years. Like other long-time auditors, he has an instinctive sense of when there are problems in a co-op.
That's what led Zucker to uncover a scam. When a co-op board switched accountants, the newly hired Zucker requested that the former CPA furnish the year-end trial balance. The document showed the corporation had received $19,000 in the month of December from the sponsor but that it hadn't been deposited in the bank.
Further digging revealed that the money was earmarked as a "deposit in transit" on the bank reconciliation, but there was no indication that the money had actually been put into the co-op's account. "I found it deposited at the end of January." Essentially, the building's former accountant had floated the sponsor an interest-free loan for nearly two months, without the knowledge of the board, explains Zucker. "You see something like that and your hair stands up and you wonder, what else did this guy do?"
Indeed, and the crimes can get even more serious and ingenious. In the case of one 125-unit West Side co-op, two signatures, that of the board treasurer and the property manager, were required to write checks on the building's operating accountant. But only one signature, of the property manager, was required on the payroll account. So the manager was able to wire money from the operating expense account to the payroll account, with no board oversight.
The auditor. That professionally conservative skeptic. The one professional who can have a significant impact on the building. Yet, says Paul Herman, a manager with Rose Associates, "that's the one professional that the board spends the least amount of time with."
Typically, the board and the shareholders of a cooperative think of the audit as an end-of-the-year summary of their building's financial health. They shouldn't. It is a crucial, year-long process that provides checks and balances for the fiscal well-being of the building. At the end of the year, the audit must assure the shareholders that all the money is where it is supposed to be, that all the checks have been endorsed properly, and that the building is in good financial shape.
For that to be successful, says Mitchel Levine, treasurer of his co-op at 11 Riverside Drive, board members need to understand that the accountant is a "critical component" of the team that runs the building. Conversely, he offers, the accountant "has to have a good relationship with the board of directors and with the managing agent and has to know what the board's capabilities are in understanding the audit process."
While worrying about the co-op's annual audit and who is conducting it may be the last thing a board of directors may want to think about come February, the more a board knows about how its building is being audited, the fewer chances for error and plain, old malfeasance
THE PROCESS: A CHOICE
It is important for boards to familiarize themselves with the process an auditor practices. "Even if it's only the basic stuff, it would be very worthwhile to know," says Walter Lowery, who has been the treasurer of his building at 303 West 66th Street for the past six years. Over the years, his accountants "have flagged things we should look at, discounts we could get or one or two things that have been mischaracterized," says Jaan Vaino, president of his condo on West 110th Street.
So what does an accountant as auditor do? It depends on what you request. There are three levels of service a CPA can perform: the compilation, the review, and the certified audit. The one you choose depends on the level of assurance you want.
The compilation. For about $3,000, depending on the size of the property, an auditor will come in once a year and put a co-op's financial statements into a format known as a compilation. In that, the building's financials are collected, classified, and presented in a readable form that can be distributed at the annual shareholder meeting. "In a compilation, an accountant does not express any assurance that the financial report is an accurate reflection of the building's fiscal health," explains CPA Norman Prisand, a principal in Zeidman, Lackowitz, Prisand & Co.
The review. The next higher level of scrutiny is a review, in which an auditor expresses a "limited assurance" that there are no material modifications that should be made to the building's financial statements. In a review, say auditors, an accountant will look more closely at a building's financial records, i.e. bank reconciliations, invoices, and bills paid, but the level of scrutiny is not as intense as that of the next highest level, the certification. "It's close enough to a certification that you might as well pay for a certification," says one auditor.
The certified audit. The certification, or certified audit, can cost between $4,000 and $13,000, depending on the size and complexity of the property. It is more expensive because "there are more procedures, including outside confirmations and more testing and you are taking greater responsibility for the results," explains Prisand, who adds: "In [a certified audit], you could say it's a reasonable assurance that the financial statements are fairly presented according to generally accepted accounting principles."
THE CERTIFIED AUDIT
While all buildings vary in the level of their financial complexity, the most thorough auditors have an established routine. For instance, Matthew DiPasquale, an accountant with Lederer, Levine & Associates, wants to see the monthly income and expenses and paid bills before the year-end audit. And then he wants to see the board minutes for the approved work. "That is one of the biggest recommendations I provide to boards, that they maintain better minutes," he says.
To control the number of problems that may confront him during a certified audit, Charles Zucker has an established routine. Each month, he gets a copy of the management report, which includes the check register (checks written), rent roll (maintenance and other income), and summary of the operating income and expenses, as well as copies of all the paid bills. The data is collected and logged into a computerized general ledger Zucker maintains for each building he audits in his offices at 53rd Street and Broadway.
Then, at the end of the year, just before heading out to the management firm to look at original bills, bank statements, and invoices, Zucker sends out confirmation letters to the mortgage-holder, the building's attorney(s), and the insurance broker, asking a series of questions. Are there any insurance claims pending against the building? How much money is owed on the mortgage? Is the building involved in any litigation? If the building has contracted for repairs or improvements, a letter is also sent to the contractor. "We have the paperwork, but we want to hear what he has to say," explains Zucker.
Zucker's techniques are typical of a thorough CPA. Since the bulk of the paperwork has been done before the annual audit, it takes about a day to go through the co-op's financials at a managing agent's office, estimates Mike Esposito, a CPA with Kleiman & Weinshank, depending on the number and size of buildings a management company runs, and the financial particularities each co-op has. In a building of up to 100 units, it can take an experienced auditor a day-and-a-half to go through the records. In a building with as many as 1,700 units, it can take three auditors up to ten days to go through all the records
Once the auditor puts the numbers together, says Esposito, a draft financial statement is sent to the managing agent "who will usually disperse it to the board and they will review it and come back to us with comments."
Sometimes a board will want something changed in a statement. "It's usually a style issue," says Esposito. As long as the request coincides with "generally approved accounting practices," Esposito will agree to the changes. But if a board makes a request to drop a line item, such as a depreciation in the value of the boiler, in order to show its accounts are in the black, Esposito will refuse.
HOLDING THE ACCOUNTANT ACCOUNTABLE
Auditors acknowledge that there is an inherent conflict of interest in their relationship to boards and managing agents. "The whole relationship is odd," admits one auditor. "You have to work for a client but be independent from them." And one of the most common mistakes boards make is in believing that a CPA will serve as the watchdog for the building. Continues the same accountant: "People think an auditor goes through everything." But if board members and shareholders read their financial statement at the end of the year, "it only says that the numbers are 'fairly presented,' not perfect, and that's not by accident."
Insisting on anonymity, another auditor spoke even more frankly. "Our auditing standards don't require us to look at every transaction that an entity has. We can look at certain items and not others. It depends on how far you are going to make the effort."
One former board member, who has seen the problems such a conflict can cause, says board members and shareholders would do well to remember the natural conflict of interest faced by auditors hired to review building financials: "I don't think there is any difference between a co-op in Manhattan or a large industrial corporation. Auditors are hired by a board of directors and their primary interface is between a managing agent and a member of the board of directors, either the president or the treasurer. Somebody on the board other than the president or the treasurer should be reviewing the transactions between the accountants, the agent, the president and the treasurer. Anybody else, in fact. It doesn't have to be a board member."
So what happens when an auditor comes across problems in an audit? "If we do an audit and come across unusual items, we send a management letter to the board treasurer. We let the management company see the letter and respond to it, because there's no purpose served by banging the heads of a managing agent, because you get business from managing agents," Zucker points out.
Mindy Eisenberg Stark, a CPA in private practice, points out that there are times when boards don't want to hear bad news, because they don't want to disrupt their relationship with the managing agent. In the case of a forensic audit, "basically what we do is we would issue a management letter and talk about the problems that we found with the managing agent, problems with system of procedures and controls, and then it's a board's decision once they've been put on notice what to do. In case of criminal liability, all we can do is point it to the board's attention. I can't force them to change. I can't force them to prosecute."
DIFFERENT LEVELS OF CRIME
There are different levels of crime that an auditor looks for, and most experts stress the difference between intentional crime and mistakes. "Very often what people constitute as fraud is a lack of information, or a reluctance on the management's part to give the boards what they are asking for, which leads the board to be suspicious," says Stark. "Most of the time when we go in we find a lack of communication and documentation as opposed to fraud and criminal intent."
"We have found a couple of instances over the years where there was a lapse in insurance coverage and a building was unprotected for a period of time. That's poor management practice and it requires disclosure in a footnote [in the final report]," says Prisand. "It's not fraud, it's poor practice."
Most times, a CPA's suspicions start with the state of a management firm's books. "If you can't find things, if bills are missing, if invoices have been misplaced," this doesn't necessarily mean there is fraud, Zucker notes, "it just means that the agent is disorganized, and it's not a good sign."
Sometimes the crime is intended to be temporary. Stark says she has seen management companies, sponsors, and even building accountants falsify bank reconciliations: the documents confirm the balance in the bank on a specific date, "but it doesn't confirm the transactions within the account. So, for example, if someone took $20,000 out of the account and put it back a week later, the accountant would still reconcile at the end of the month, but someone obviously borrowed money for two weeks without authorization."
A thorough certified audit should find and flag big and small inconsistencies that can be cleared up, say auditors, who emphasize that many times what looks like a big problem can be poor record-keeping or a lack of willingness by a sponsor or managing agent to open up their books out of reluctance to share decision-making in the building
Then there is the full-blown, intentional criminal act, which falls into two types: off-the-books and on-the-books fraud. "Off-the-books fraud has been bribes and kickbacks and you are not necessarily going to find that, either by certified audit or fraud audit of books and records because it's just not there," says Stark. "It's on-the-books fraud that you are going to find as a result of a forensic audit."
A forensic audit is an exhaustive search of all the building's paperwork. It is an expensive, time-consuming process that only boards of directors who have a deep suspicion of malfeasance should be willing to undergo. In a sponsor-run building, a forensic audit may uncover that the sponsor has been paying for improvements to his own apartments with co-op funds, says Stark. It may uncover that the management company has been ordering supplies with one building's account and shipping the supplies to another building. It can turn up fictitious vendors, or reveal that goods and services that have been paid for have never been delivered.
"We have found instances of fake bills being created by people at a management agency and being paid," says Prisand. "In two recent examples, there were fake bills and other defalcations. And we analyzed it and made sure there was a financial settlement that made the building whole, and the matter was disclosed in a footnote, discussing what had happened and the settlement."
PREVENTION: A WAY TO CURE
Auditors may uncover mistakes or criminal actions in the course of preparing a certified audit, but there is no substitute for board oversight. "If you are on a board you are the only one other than the agent who knows the day-to-day operations of the building, and I think every board member should review every bill and sign every check, it certainly reduces the chances of defalcations," observes Esposito, the accountant. "I had a client who asked us to review the bills for the painting in the hallway and all the proper approvals were there, both for the check and the bill, but I have no idea if the work was done. Someone in the building would know if that was done."
So what can a board do to protect itself? Perhaps the most important aspect of ensuring a thorough audit is the relationship between the board of directors and the accountant. From interviewing and checking references for the accountants to feeling comfortable with them, boards have to be involved.
"We feel the accountant is a critical component of the team," says Levine, the treasurer. "I believe that the board themselves should be comfortable with the accountant," and in the best-case scenario, "the accountant is someone who is responsible to the board, and becomes a team player in planning for the financial aspects of the building."
Therefore, it is important to get to know your accountant. Before hiring him, find out about his experience: how well versed is he or she in co-ops and condos? You should have one who has a lot of experience in the area.
When interviewing an accountant, says Burt Wallack, president of Wallack Management, boards "should ask for references to make sure they in fact do other co-ops and condominiums. They should ask for a minimum of 15 names [as references] and then call them randomly." Each co-op or condo has different needs, points out Wallack. If a cooperative has an "80/20" tax status problem, for example, it should be looking for auditors who have experience in that area.
Is your accountant user-friendly? When he speaks to the board, does the board understand what he or she is talking about? Are the members comfortable enough to ask questions until they are satisfied they understand the answers?
Ask about the experience level of the person who is actually doing the audit. Who is the accounting firm sending? A principal in the firm or junior accountants? Be sure to ask about the firm's oversight procedures. Who double checks the work and signs off on the final report? The most important thing for the board is to have confidence in the oversight procedures an accounting firm has in place in the back office. Does a principal or experienced CPA review the results? Company principal Charles Zucker actually audits buildings himself, going through the original bills and invoices, the cancelled checks, and the bank reconciliations and bank statements.
Look at consistency. Does the same person come every year, or is it a new person every time (a trend in some large firms)? Talk to your accountant; tell him or her with what you would feel comfortable.
Ask about "homework." Do the auditors request monthly reports from the managing agent? What kind of research do they do before the annual audit and how close are they in contact with the board treasurer and the managing agent during the year. "I like auditors who are punctual in their work," offers Mark Nachman, a chief financial officer with Wallack Management. "We pay taxes on a quarterly basis and some auditors send the information without me calling them, while others I have to be on the phone with. I like auditors who are easily accessible, who return phones calls and who are responsive."
Visits are an important consideration, too. Find out how often the auditor will be at the building during the year and if he or she will be accessible when the board treasurer has to reach them. Does the auditor have e-mail? It can be very helpful, quickening access to the reports for the auditor and to the board treasurer or managing agent. If the board treasurer calls with a question, how quickly will the auditor return the call?
Depending on the type of audit you prepare, ask about thoroughness. What does the auditor review at the year-end audit? What information do they request to see? Do they read all the invoices, bank statements, and bills, or do they do a sampling? What formulas do they use to detect problems? Do they check the backs of checks? Look for phony invoices? What controls do they use to make sure the building is not being double-billed?
There are a whole slew of tests that auditors perform to make certain that a building's records are in order. For instance, they can double-check work orders against board minutes to make sure the contractors are doing the work that was requested, and double-check change orders with the building's managing agent and board of directors.
"We check the approval processes," explains Esposito, whose firm sends out senior accountants for the audits. "We check a sample of invoices to see if items are properly approved. We will check the checks to see if they are properly signed. We check the disbursement: from purchase order to approval to payment of the invoice right down to the cancelled check."
Finally, review cost issues. What do you get for your money? What will an auditor do in the process of a compilation, and how much does it cost? What goes into a certification and how much does that cost? What do you get for the money - semi-annual, quarterly, or year-end reports? And what kinds of services are available outside a certification, how necessary are they and how much do they cost?
In the final analysis, asking such questions now can help avoid headaches - or worse - in the future. "I would say the board absolutely has to review financial statement monthly. We've been doing that for some years, and I can't conceive that a board can be doing its job unless it does that," says Jaan Vaino, condo president. The board "has to question each line item, at least periodically, and has to focus on any significant variances, and especially has to look at receipt of common charges and arrears. It doesn't take a lot a time to go through the highlights of the financial statements in a board meeting."
And once the accountant is hired, the board finance committee "should meet with them at least twice yearly," insists Wallack. "A lot of co-ops and condos don't do that," adds a managing agent who requested anonymity, "and it's a mistake, because the board is the building's watchdog. Although the management agencies do their best, they make mistakes and it's important that their accounting firm does a proper job. I find one of the biggest problems is that the accounting firm comes in January and February and does their job and doesn't look at information the rest of the year."
Boards must know how the systems work, says Lowery, and have "some familiarity with all the expenses have listed as operating expenses and how these items get charged out on the books and the records of their accounts. "They should be able to weigh what their financial position is, and whether or not increases are sufficient to operate. Otherwise, how do you know?"
Most important, board members should know that accountants do not consider themselves the building's watchdog. "We are conservative by nature," explains Esposito, who points to the carefully worded statements on the building's financials that a certified audit is a "fair presentation" of the building's financials. That has to do with the theory of auditing, explains Prisand. "A fair presentation is based on testing and sampling and there is a materiality threshhold and in a fair presentation there is room for error, as long as it is not significant. And a 'fair presentation' is the best thing that any accountant can say about any financial statement."