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If your board seems to be doing something ethically or financially unusual, shou
Very few actions you may initiate on the board are as consequential but also as necessary as knowing when and how to inform on your fellow board members. Learn how to spot the signs of trouble, avoid common mistakes, and decide when you should blow the whistle.
If your board seems to be doing something unusual – either
ethically or financially – should you question it?
And if you do, can you survive the consequences?
Larry Simms just thought that he was doing his job. As board president at the 165-unit Future Condominium in Manhattan at East 32nd Street, he was given a standard accounting form to sign: the so-called “rep letter,” which essentially said that, to the best of his knowledge, the financial reporting for the building was accurate. But he refused to sign it. The reason: he had found four areas that he could not verify as proper and that might actually have involved fraud (those included an unauthorized $15,000 bonus to the super and $61,000 of unauthorized overtime).
“I’ve always insisted – whatever my position on the board – in reviewing the actual invoices,” explains Simms, who is no longer on the board. “Because I know that if the agent understands that somebody’s looking at these things, they’re going to behave differently. I said, ‘Here are four instances of what looks like potential fraud. And none of these things should’ve happened. Now that they have happened and been identified, somebody has to rectify them.’”
That’s when it started: the charges of corruption against Simms, the attempts to get him to step down, the claims of theft of board property, the lawsuits, the verbal – even physical – attacks by neighbors who saw him as the enemy. It had become an uncivil war. Intentionally or not, Simms had inadvertently become a whistleblower.
The dictionary defines a whistleblower as “an employee, former employee, or member of an organization who reports misconduct to people or entities that have the power to take corrective action. Generally, the misconduct is a violation of law, rule, regulation, and/or a direct threat to the public interest.” If you’re on the board and you note something that seems unusual – either ethically or financially – should you “blow the whistle”? What does that involve? And what should you expect from your fellow board members?
Very few actions you initiate on the board are as consequential or as dangerous – and yet so necessary – as knowing when and how to inform on your neighbors. But like Terry Malloy, the tortured protagonist in the film On the Waterfront who testified against his friends, whistleblowing usually comes with a steep price. Although some may applaud you, a good number will probably end up hating your guts.
Signs of Trouble
Many get on the board for the wrong reasons – following a personal, not building-wide, agenda, for instance – while others find the power positively heady. “There are a lot of people that get to be in a position of power on a board that don’t have real estate experience or don’t have business experience, and can’t [differentiate between their interests and the corporation’s interests] and realize that you do have a fiduciary obligation when you’re on the board of a major corporation,” observes Morrell Berkowitz, a partner in the law firm of Gallet Dreyer & Berkey, who represents Larry Simms in two lawsuits against the Future Condominium “Usually, when there are problems, they are caused by people who say, ‘What can I get out of it?’”
Still, even if you suspect someone of self-dealing, you need to be sure of your facts. If something seems odd, experts say you should check it out quietly before acting publicly. It is crucial that you talk to other board members and – without making any accusations or charges – find out what you can. Being confrontational right off the bat is usually counterproductive: people will shut down and get defensive and you will find out little. “You start by asking questions,” Simms notes. “If you don’t get reasonably responsive answers, then you should begin to suspect a problem.”
To Robert Grant, director of management at Midboro, there were warning signs as soon as he took over management of a posh East Side co-op. “My take was that there were some real conflicts of interest. It was obvious from the day I started. A lot of the board members were art dealers, and ran galleries in their apartments in the upper floors, and the building’s not zoned for that. So right off the top, I started sensing something was wrong. I just noticed that the way they would decline or approve applications for apartment sales – sometimes it was tied into their own desire to buy those same apartments.” Grant eventually resigned the account.
If you suspect something and the board members are of little help, talk to your professionals (unless they’re the ones who are arousing your suspicions). See if there’s a simple explanation for the questionable action, since you may just be missing a key fact or misunderstanding an essential point. “The first place usually to go is to the professionals. Speak with the accountant or the attorney,” advises Mindy Eisenberg Stark, a forensic accountant, “because one of them generally is going to know what path you should take.”
“If you think the board has acted inappropriately, as a board member, you do have the right to contact the outside attorney, the outside auditor, the insurance carrier, and a managing agent on your own,” adds Aaron Shmulewitz, a partner in the law firm of Belkin Burden Wenig & Goldman.
What you don’t want to do is go public. At least not yet. “One of the worst things to do is to start a letter-writing campaign to the shareholders [before you have the facts..],” says Stark. “Because what you’re doing then is alarming people, and you cause the entire building to start choosing sides. You will start a ‘he-said-she-said’ kind of war.”
There are also liability questions that should concern you. If you’re wrong and you make an accusation to the shareholders, you could be held liable for defamation and other claims. The only legal reason to go public to the shareholders is if you are demanding that they use the information you are providing to remove one or more of the guilty directors from office. And if you do that, you’re crossing a point of no return. Things will get incredibly ugly very, very quickly.
“There’s a dual problem here,” explains James Samson, a partner in Samson, Fink & Dubow. “On the one hand, discussions by the board should stay within the board. You don’t get an open and frank discussion of the issues if the parties can’t feel like whatever they’re talking about is going to stay within the board. On the other hand, when you see wrongdoing, the board members have a duty to report it to the shareholders or to deal with it.”
The catch-22 is that after you offer your criticisms to the full board and/or the rest of the building, you will possibly be ostracized and forbidden access to useful information. For instance, Simms, the Future condo president, found that, once he was considered a whistleblower, the manager no longer allowed him to review the financial records. “I begged these guys,” he recalls, referring to the management firm. “I said, ‘You have a responsibility to seven equally elected members of the board who are fiduciaries. And you have to give financial information to each of them. I’m not telling you to favor me over anybody else. But you cannot under any circumstances cut off the flow of financial information to a board member.’” But that’s exactly what the manager did, reportedly under the board’s direction.
One step you can take is to wait for the next election and quietly campaign for change. Says Grant: “If it’s a member in the minority uncovering something, they should prepare really carefully and do a very intense campaign to get people’s proxies. They should have very private, discreet conversations with the shareholders explaining why they should give them their proxies to clean things up. And then they become the majority.”
Whistleblowers make mistakes. Typically, they trust too much and pay a price for it in the end. Most whistleblowers are “straight arrows” and believe in the system; so, when they find an oddity, their instinct is to turn to the president or the manager. They often don’t imagine that the president or the manager may actually be involved in the wrongdoing. A whistleblower is typically not cynical (but perhaps should be).
For instance, when a new board took over at an Upper East Side building – reformers had a narrow majority of four out of seven seats – they found a number of oddities. In one case, the board president had requested to be paid for contracting work that she had done. “And, of course, she was reminded that board members can’t get paid,” says a professional who had worked for the co-op. “Shortly after that, as the story goes, one of their contractors issued an invoice for the exact dollar amount that the president had been asking for. And the co-op promptly paid it, because this president was in control, and the property manager was under her spell and signed off on it. So this contractor got his money – coincidentally, the same amount that the president thought she should be given.”
To look into that issue and other matters, the reformers, in a closed executive session attended by six members (the former president was not present) hired a forensic accountant. He found a host of problems, including missing vendor invoices, a questionable payment of nearly $70,000 to the manager, and personal use of a lawyer by the ex-president for over $2,000 that was paid for by the co-op. But after the report was delivered, most of the board members lost their nerve – except for two directors, who then became defacto whistleblowers.
“I wanted to make sure that, when the time came, these people [on the board] would do the right thing – that they would not be afraid if the results found that [the former president] was involved in a lot of possible crimes,” recalls one of the two directors. “And I was wrong. What happened was, we got the report and we were talking amongst ourselves, and I realized that we needed to get the advice of somebody who is a criminal lawyer. There was a board member who said, ‘Well, how much, at most, does the forensic accountant think is missing?’ And I said, ‘It could be between $1 million and $2 million.’ And this woman said, ‘Well, $2 million, doesn’t seem like a lot of money.’ And then, this other board member said, ‘You know, maybe there’s another way, maybe we shouldn’t pursue this at all, maybe this could backfire.’ Something was weird.”
But the two determined directors met with a criminal lawyer anyway, who warned them: “Your board is in such deep trouble and you don’t realize it, because you have a fiduciary responsibility to report this. And if you don’t, five years from now, when somebody finds this report, they can come back and sue you in civil court about it, saying that you didn’t fulfill your fiduciary responsibility by not reporting it, and also that you didn’t take it to the authorities. This is a really huge issue. You’ve got to get a lawyer and you’ve got to protect yourself.”
So the two board members began calling their colleagues, saying, “Listen, we’ve got to meet. I’ve got to tell you what this lawyer said because there are some very serious implications.” Nobody wanted to meet. All of a sudden, everybody was busy. “And the next thing you know,” says one of the dissident directors, “we get this e-mail that the board had accepted our resignations. They were trying to force us off the board.”
So much for trust.
Other mistakes whistleblowers often make include not collecting enough evidence on the problem they’re trying to expose, not building support among colleagues and others, and not waiting for the right opportunity before they come forward.
Indeed, this last point is vitally important. Experts say that, when coming forward, timing is everything. “Once they blow the whistle, the stream’s going to dry up, so to speak,” observes Michael Kessler, president of Kessler International, a forensic accounting firm. “Nobody’s going to be cooperative anymore, especially when people know you’re going after them. I had a case where a prospective client started checking bills. She went to the Environmental Protection Agency (EPA) and pulled a contractor’s business records to see how much asbestos was removed from the building. What was reported to the EPA was considerably less than what she was being charged for. So, one of the documents had been falsified. And she’s got a number of incidents like that. My suggestion to her was to put it all together, and then we’ll make a request to see the books and records. If they deny her, then she has a perfect opportunity to go to law enforcement and say, ‘Not only have I found X, Y, and Z, but I also suspect there’s a lot more they’re not allowing me to see.’”
Some experts also suggest that you create a paper trail after you’ve gathered your facts. Explains Shmulewitz, the attorney: “You should certainly put your allegations in writing to the board, especially if you’re in the minority. If you believe that the other six people have done something inappropriate, one way to insulate yourself from liability down the road, should there be any shareholder lawsuits against the board and/or the individual directors, is to go on record having said that you were not involved in this and that you were demanding that they rectify the situation.”
Blow That Whistle?
Once you’re sure something that is possibly illegal is taking place, you need to consider your options very carefully. As a whistleblower, you can expect to be vilified, attacked, and isolated. Do you have the stamina for it? It is not just about speaking out; it is about fighting an ugly war of charges, countercharges, and (often) outright lies. You have to be tough. So does your family. So do your supporters.
“When you say that the board is a bunch of thieves, you’re going to be shunned,” warns Kessler. “You’re going to have your supporters behind you, no doubt about it; but the [accused] – if they are still in power – will see that you do not get what you used to be able to get.”
“It’s not pleasant,” admits Simms, the former board president, who adds: “It’s my home. My wife is here, my kids are here, and it’s very uncomfortable. There have been times when she would not go down to workout in the gym unless somebody went with her, because some of the people have said and done crazy things. So she did not feel safe. We raise our kids here, and we have to explain to them why people are saying bad things about their dad. I was physically assaulted in the lobby, in plain view of many witnesses.”
Adds another whistleblower currently involved in a dispute: “It’s horrible, because, on the one hand, what keeps me going is that I know that I’ve done the right thing and I know I’m on the right side. On the other hand, what price do I have to pay for it? I got accosted in the elevator the other day by a woman. She blocked the door – her hands were flailing all over the place – and I’m thinking, ‘Oh my God, is she going to strike me?’ It was ridiculous.”
Frightening as that is, such harassment can get even more serious. Berkowitz, the attorney, recalls a client he represented at an East Side co-op. When the board neglected to act on needed capital repairs that he had pointed out to them, this former board member called the Department of Buildings, which subsequently forced the co-op to perform the work. For the next year, however, the contractor used the whistleblower’s terrace as a dumping ground for supplies and debris – reportedly on the board’s orders. He saw it as retaliation and ended up suing the co-op.
With such incidents in mind, some say that it is important to consult with a lawyer before you blow the whistle. The consequences can be so severe – you can be falsely accused of the crimes yourself and your reputation ruined – that added protection is advisable. An East Side Manhattan co-op owner, who accused a board member of possible crimes, found herself named as the person who had misappropriated thousands of dollars in funds. Luckily, she had had a lawyer advising her from the start, and had protected herself with a paper trail, showing that all board expenses were authorized. She is now suing the board, and expects to win – and have the board pay her legal fees.
The Board’s Role
A whistleblower wouldn’t be necessary if the board did its job correctly. Many directors depend on the manager or the accountant to keep the building on course. That’s a dangerous mistake, since you are giving up control of your property to an outsider who doesn’t have the same stake in it that you do. Warns Mark Shernicoff, an accountant at Zucker & Shernicoff: “The board members can delegate, but it’s their [ultimate] responsibility. They have the obligation. They can’t rely on the professionals totally; we rely on the board. We’re not forensic accountants. We’re not cops, we’re not investigators. We can’t look at everything, so we rely on the existence of controls and on the integrity [of the board].”
When a board member raises serious questions, the board should probably turn to a forensic accountant, who will do a thorough review of all the paperwork backing up the numbers, interview the staff, the super, and, if necessary, contractors. “What we generally do is, we listen to what the problem is, what the suspicions are, and we go in and test the waters,” explains Stark, the forensic accountant. “Before we do a full-scale, expensive forensic audit, we go in and see what the issues are. We look at a limited test period, to at least see what’s going on in the building.”
“In most cases, the books and records are made readily available to us,” adds Kessler, the forensic accountant. “We conduct a forensic audit searching for irregularities. We do investigative work on some of the subjects that might be involved in the questionable transactions conducted. Then we issue a report and, upon the request of the board, either go to law enforcement and make a presentation or just issue the report. I’ve had situations where it’s frustrating, where you come up with clear-cut cases of fraud and nobody wants to do anything.”
Many boards ignore reported corruption, seeing it as the cost of doing business. They shouldn’t. “I constantly am amazed at how tolerant cooperatives are of corruption. It’s like they expect it,” Samson, the attorney, observes. “But the only way to root it out is to expose it immediately when the problem arises. As much as the rest of the board may want to put it under the rug and not embarrass somebody, the fact that it existed in the building is something every shareholder should know about, because that also prevents it from happening again.”
One East Side board director and whistleblower notes that the most important thing is to assemble the board and “get advice from a co-op lawyer and also a criminal lawyer. People think of co-op boards as their own little fiefdom or their own little kingdom, but actually they’re governed by the New York State corporation laws. This is a corporation and there are things that you have to abide by, and it’s really important that a board gets proper advice about the seriousness of what’s going on.”
The bottom line is accountability, or as some would put it, “the blame game.” Says Simms: “You’ve got people that have never done this before, who above all don’t read the bylaws. They have no clue as to what their fiduciary responsibilities entail. They don’t know what the board and what individual board members are allowed to do or required to do in any circumstance. They always wait for somebody to tell them. There’s no excuse for that in my book. They have to understand, first, their accountability to the owners, second, the accountability of professionals to the building through them. Most people that I’ve seen in board service do not understand that and are unwilling to do what’s necessary to hold outsiders, let alone each other, accountable. But, in the end, that’s your job.”
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