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Bonding Against Theft

Polar vortexes and five feet of snow weren’t the only things sending shivers through New York City co-op and condo boards this past winter. The recent arrest of a property manager forced many boards to ask a pair of unsettling questions: Are we insured against theft? If so, is our insurance adequate?

The shivers began in January, when Alan Gorelick, executive vice president of Saparn Realty and a member of the Real Estate Board of New York, was charged in Manhattan Supreme Court with one count of larceny and nine counts of possessing a forged instrument. He is accused of stealing more than $600,000 from the Harway Terrace Mitchell-Lama co-op in Brooklyn, which his firm managed from 2001 to 2011. Over that period, Gorelick is alleged to have funneled the money into his company’s coffers “either by depositing checks from third parties written to the order of Harway Terrace or by depositing checks written against two of Harway Terrace’s accounts into Saparn’s business accounts,” according to the criminal complaint. At his February 5 arraignment, Gorelick pleaded not guilty to the charges. He is also under investigation for allegedly stealing more than $2 million from dozens of other buildings.

The news was a sobering reminder to boards of the importance of fidelity bonds – a form of insurance that covers policyholders for losses incurred as a result of fraudulent acts by specified individuals. The bonds are also known as crime policies and employee theft insurance.

Until a few years ago, such insurance was not even on the radar of many co-op and condo boards. Then the mortgage crisis hit. Suddenly, Fannie Mae and Freddie Mac, the government-sponsored giants that purchase many co-op and condo loans from the original lenders, announced that they would begin enforcing a rule that had been on the books – but widely ignored – for years. The rule states that co-ops and condos must carry a fidelity bond equal to 25 percent of the annual maintenance or common charges. As the recession deepened, numerous loan applications were denied for buildings that failed to meet this standard.

The Smart Shoppers

Today, most co-op and condo boards have crime insurance. The smart ones also insist that their management company carry a fidelity bond, even though such instruments cover theft only by employees of the management companies, not by the principals.

“Many buildings won’t sign on with a management company unless they [the management company] have insurance,” says Barbara Strauss, executive vice president of York International Agency, an insurance broker. “But co-ops and condos have to have their own policies as well, because you can’t depend on the management company’s bond to cover you if one of their employees is stealing from you. If they’re stealing from you, they might be stealing from others, and the limit on the management company’s policy may not be adequate.”

The good news is that fidelity bonds are not prohibitively expensive. One co-op with about $1 million in annual maintenance charges took out a policy with a $250,000 limit, in accordance with the federal rules. It cost the co-op about $725 per year.

Strauss advises her clients to buy insurance to cover three to four months of a building’s annual maintenance. She also advises boards to insure at least 10 percent of the reserve fund. “Buy a limit you feel comfortable with,” she says. “You can also buy a higer deductible to keep costs down.”

The mortgage crisis has caused a fundamental change in the way co-ops and condos approach fidelity bonds, according to several insurance agents. “Until the requirement was enforced, some buildings didn’t see the necessity of fidelity bonds,” says Ed Mackoul, president of Mackoul & Associates Insurance. “These days, pretty much everyone has it. A lot of lenders won’t close on a loan unless that requirement is met.”

Like Strauss, Mackoul advises boards to back up their insurance by insisting that their management company have its own fidelity bond. “Both can and should carry it for a number of reasons,” he says. “If the property manager takes off with money, why should the co-op or condo have to rely on its own coverage? There are also instances where a board member takes off with money, which is another reason why the co-op or condo needs its own policy.”

The Fannie Mae Selling Guide explicitly states that a fidelity bond must cover at least three months’ worth of a building’s annual maintenance charges. But more insurance might be required. “The policy must cover the maximum funds that are in the custody of the homeowners’ association (or co-op corporation) or its management agent at any time while the policy is in force,” the guide notes.

Implement Safeguards

According to Steven Lefland, assistant vice president and co-op project supervisor at Everbank, a Florida-based lender that works with Mackoul, a lower amount of coverage is acceptable if the board and managing agent adhere to one or more of the following three controls:

(1) Separate bank accounts are kept for the building’s working account and its reserve account – and the bank sends monthly statements directly to the board.

(2) The management company maintains a separate bank account and records for each of its buildings and is not authorized to make withdrawals from the reserve fund.

(3) Two board members sign every check drawn on the reserve fund.

When they stopped shivering over the news concerning Gorelick’s alleged theft, some boards and management companies got busy adopting the more stringent Fannie Mae guidelines. “In light of the Saparn Realty case, we have instructed our banks to send monthly statements directly to our board presidents, or treasurers, or both,” says Eric McPhee, executive vice president and director of risk management at Orsid Realty. In the past, statements were sent from the bank to the management company, which passed them along to the boards.

McPhee says it’s “a given” that each building has its own bank account and records – a way to prevent the once-common practice of “commingling” the accounts of several buildings, which proved an invitation to fraud in a number of buildings.

And as of March 1, he says, Orsid is “absolutely encouraging” boards to have two members sign every check drawn on the reserve fund. He adds that his company carries more than $1 million in fidelity insurance itself, and insists that each of the 100 co-op and condo buildings it manages in the city carry fidelity insurance of their own.

But no matter how many safeguards are in place, board members need to remain vigilant. “A board has to look at records and ask questions,” says Paul Brensilber, president of Jordan Cooper & Associates, which manages 45 co-ops and condos in the city. “At some point, the board is responsible. With boards, it’s always somebody else’s fault. And the insurance company needs to be on its toes, too.”

Every month, Brensilber says, his company gives boards a reconciled statement of every account in every building it manages. He adds, “The thing the board should think about is not how many properties their management company manages; they should worry about how the company is handling their building, how the back office operates. And you’ve got to use a respected accountant.”

In the end, an occasional case of the shivers might be just the thing to wake up co-op and condo boards and their management companies. “There’s always room for improvement,” says McPhee. “This Saparn Realty case sounds like it was planned out and thought out. It appears to be a different level of sophistication, the first time we’ve allegedly seen bank statements falsified.”

If that doesn’t wake boards up, it’s unlikely that anything will.

 

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