(1)Existing law, the Davis-Sterling Common Interest Development Act, limits the personal liability of a volunteer officer or director of an association of a common interest development in excess of the coverage of specified insurance if certain conditions are met.

This bill would require the association to maintain fidelity bond coverage, as specified.

(2)The act requires a managing agent of a common interest development who accepts or receives funds belonging to the association to, upon written request by the board, deposit those funds into an interest-bearing account in a bank, savings association, or credit union in this state, provided certain requirements are met.

This bill would prohibit transfers greater than $10,000 or 5% of an associations total combined reserve and operating account deposits, whichever is lower, without prior written approval from the board.

(3)The act requires, unless the governing documents impose more stringent requirements, the association board to review various financial documents and statements on at least a quarterly basis.

This bill would require those reviews on a monthly basis. The bill would also require monthly reviews of the check register, monthly general ledger, and delinquent assessment receivable reports and would authorize these requirements to be met when every member of the board, or a subcommittee of the board including the treasurer and at least one other board member, reviews these documents and statements independent of a board meeting if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.

(1)Existing law, the Davis-Sterling Common Interest Development Act, limits the personal liability of a volunteer officer or director of an association of a common interest development in excess of the coverage of specified insurance if certain conditions are met.

This bill would require the association to maintain fidelity bond coverage, as specified.

(2)The act requires a managing agent of a common interest development who accepts or receives funds belonging to the association to, upon written request by the board, deposit those funds into an interest-bearing account in a bank, savings association, or credit union in this state, provided certain requirements are met.

This bill would prohibit transfers greater than $10,000 or 5% of an associations total combined reserve and operating account deposits, whichever is lower, without prior written approval from the board.

(3)The act requires, unless the governing documents impose more stringent requirements, the association board to review various financial documents and statements on at least a quarterly basis.

This bill would require those reviews on a monthly basis. The bill would also require monthly reviews of the check register, monthly general ledger, and delinquent assessment receivable reports and would authorize these requirements to be met when every member of the board, or a subcommittee of the board including the treasurer and at least one other board member, reviews these documents and statements independent of a board meeting if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.

(1)Existing law, the Davis-Sterling Common Interest Development Act, limits the personal liability of a volunteer officer or director of an association of a common interest development in excess of the coverage of specified insurance if certain conditions are met.

This bill would require the association to maintain fidelity bond coverage, as specified.

(2)The act requires a managing agent of a common interest development who accepts or receives funds belonging to the association to, upon written request by the board, deposit those funds into an interest-bearing account in a bank, savings association, or credit union in this state, provided certain requirements are met.

This bill would prohibit electronic transfers of those funds in and out of the account without prior approval from the board. The bill would also prohibit any electronic transfers from the operating and reserve accounts of the association without prior board approval. transfers greater than $10,000 or 5% of an associations total combined reserve and operating account deposits, whichever is lower, without prior written approval from the board.

(3)The act requires, unless the governing documents impose more stringent requirements, the association board to review various financial documents and statements on at least a quarterly basis.

This bill would require those reviews on a monthly basis. The bill would also require monthly reviews of the check register, monthly general ledger, and delinquent assessment receivable reports and would authorize these requirements to be met when an individual every member of the board reviews reviews, or a subcommittee of the board including the treasurer and at least one other board member, these documents and statements independent of a board meeting if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.

(1)Existing law, the Davis-Sterling Common Interest Development Act, limits the personal liability of a volunteer officer or director of an association of a common interest development in excess of the coverage of specified insurance if certain conditions are met.

This bill would require the association to maintain fidelity bond coverage, as specified.

(2)The act requires a managing agent of a common interest development who accepts or receives funds belonging to the association to, upon written request by the board, deposit those funds into an interest-bearing account in a bank, savings association, or credit union in this state, provided certain requirements are met.

This bill would prohibit electronic transfers of those funds in and out of the account without prior approval from the board. The bill would also prohibit any electronic transfers from the operating and reserve accounts of the association without prior board approval.

(3)The act requires, unless the governing documents impose more stringent requirements, the association board to review various financial documents and statements on at least a quarterly basis.

This bill would require those reviews on a monthly basis. The bill would also require monthly reviews of the check register, monthly general ledger, and delinquent assessment receivable reports and would authorize these requirements to be met when an individual member of the board reviews these documents and statements independent of a board meeting if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.

CONCURRENCE IN SENATE AMENDMENTS

CSA1 Bill Id:AB 2912

Author:(Irwin)

As Amended Ver:August 7, 2018

Majority vote

Original Committee Reference: H. & C.D.

SUMMARY: Requires common interest development (CID) board of directors (board) to review specified financial documents on a monthly basis, and prohibits electronic transfers of funds from homeowner association (HOA) accounts without prior board approval. Specifically, this bill:

1. Prohibits a managing agent of a CID from making electronic transfers of funds of more than 10,000, or 5% of the HOA's total combined reserve and operating account, whichever is lower without the written approval of the board of the HOA.
2. Requires, unless the governing documents of the HOA impose more stringent standards, the board to review the following on a monthly basis:
   1. A reconciliation of the HOA's operating and reserve accounts;
   2. The current year's actual operating revenues and expenses compared to the current year's budget;
   3. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts;
   4. An income and expense statement for the HOA's operating and reserve accounts; and
   5. The check register, monthly general ledger, and delinquent assessment receivable reports.
3. Allows these review requirements to be met when every member of the board, or a subcommittee of the board that includes the treasurer and one of the board members, reviews those documents and statements independent of a board meeting, if the review is ratified at the board meeting subsequent to the review and so long as that ratification is reflected in the minutes of that meeting.
4. Requires the HOA to maintain fidelity bond coverage for its directors, officers, and employees in an amount equal to or more than the combined amount of the reserves of the HOA and total assessments for three months, unless the governing documents require greater coverage amounts.
5. Requires bond coverage to include computer fraud and funds transfer fraud.
6. Provides that if the HOA uses a managing agent, the HOA's fidelity bond insurance shall cover include dishonest acts by that person or entity and its employees.

The Senate amendments:

1. Delete the prohibition on a managing agent of an HOA making electronic transfers of funds entirely and rather restrict the amount that can be transferred to $10,000 or 5% of the HOAs combined operating and reserve account with written board approval.
2. Make other technical amendments.

FISCAL EFFECT: None.

COMMENTS:

Background: There are over 50,000 CIDs in the state that range in size from three to 27,000 units. CIDs make up over 4.9 million housing units, which represents approximately a quarter of the state's housing stock. CIDs include condominiums, community apartment projects, and housing cooperatives, and planned unit developments. They are characterized by the following: 1) a separate ownership of dwelling space coupled with an undivided interest in a common property, 2) covenants and conditions that limit the use of common areas, and 3) management of common property and enforcement of restrictions by a HOA.

CIDs are governed by the Davis-Stirling Act as well as the governing documents of the HOA, including bylaws, declaration, and operating rules. CIDs are run by volunteer board who are elected by the members of the HOA and who are responsible for interpreting the governing documents and state law.

Existing law requires the HOA board to review financial documents and statements related to the HOA's accounts on at least a quarterly basis, unless the HOA's governing documents require more frequent review. This bill changes the frequency of review required by law from at least once a quarter to once a month, and adds a requirement to review the check register, monthly general ledger, and delinquent assessment receivable reports.

This bill also provides some flexibility in this monthly review requirement by allowing an individual board member—for example, the treasurer—to review these financial documents so long as the board ratifies that review at the next board meeting.

Existing law also sets out specific requirements for managing agents of CIDs and board members to follow when handling money belonging to the HOA. This bill prohibits any electronic transfers of funds from being made from the HOA's reserve or operating accounts of more than $10,000 or 5% of the combined total of the operating and reserve account without prior written board approval. Lastly, this bill requires the HOA to maintain fidelity bond coverage in specified amounts.

Purpose of the bill: According to the author, "there has been an increase in fraudulent activities related to the finances of HOAs. One example from a retirement community describes $110,000 discrepancies in HOA finances related to their management company. Current law provides some board actions intended to reduce fraudulent activity, but it is time for those laws to be updated. More regular review of an HOA board's financial records, and fidelity insurance to cover potential liability, will help protect HOAs from financial mismanagement. AB 2912 provides financial security to these volunteer boards that represent thousands of homeowners across California without placing overly burdensome requirements on their workloads."

Related legislation:

AB 690 (Quirk-Silva), Chapter 127, Statutes of 2017: Required a CID manager or management company to disclose certain information before entering into a management agreement with a HOA, and required the HOA annual budget to contain information relating to charges for certain documents.

AB 805 (Torres), Chapter 180, Statutes of 2012: Revised and recast the Davis-Stirling CID Act.

Analysis Prepared by: Lisa Engel / H. & C.D. / (916) 319-2085 FN: 0003989

 THIRD READING  

Bill No: AB 2912

Author:

Amended: 8/7/18 in Senate

Vote:

SENATE TRANS. & HOUSING COMMITTEE: 11-0, 6/12/18

AYES: Beall, Cannella, Allen, Dodd, Gaines, Galgiani, McGuire, Roth, Skinner, Vidak, Wiener

NO VOTE RECORDED: Morrell, Wieckowski

SENATE JUDICIARY COMMITTEE: 7-0, 7/3/18

AYES: Jackson, Moorlach, Anderson, Hertzberg, Monning, Stern, Wieckowski

ASSEMBLY FLOOR: 76-0, 5/14/18 (Consent) - See last page for vote

SUBJECT:

SOURCE: Community Associations Institute

DIGEST:

This bill requires the board of directors of a common interest development (CID) to review specified financial documents on a monthly basis and prohibits electronic transfers of funds from homeowner association (HOA) accounts without prior board approval.

ANALYSIS:

Existing law:

1. Requires a managing agent who accepts or receives funds belonging to the HOA to deposit those funds that are not placed into an escrow account or into an account under the HOA’s control, into a trust fund account maintained by the managing agent in a bank, savings association, or credit union in California. These funds shall be maintained in the account until disbursed in accordance with written instructions from the HOA.
2. Requires, upon written request of the HOA board, that the funds the managing agent accepts or receives on behalf of the HOA to be deposited into an interest-bearing account in a bank, savings association, or credit union in California, provided all the following requirements are met:
   1. The account is in the name of the managing agent as trustee for the HOA or in the name of the HOA.
   2. All funds in the account are federally insured.
   3. The funds in the account are kept separate, distinct, and apart from funds belonging to the managing agent or to any other person for whom the managing agent holds funds in trust.
   4. The managing agent discloses to the HOA board the nature of the account, how interest will be calculated and paid, whether service charges will be paid to the depository and by whom, and any notice requirements or penalties for withdrawal of funds from the account.
   5. No interest earned on funds in the account shall inure directly or indirectly to the benefit of the managing agent or the managing agent’s employees.
3. Requires the managing agent to maintain a separate record of the receipt and disposition of funds, including any interest earned.
4. Prohibits the managing agent from commingling HOA funds with the managing agent’s own money or with the money of others that the managing agent receives or accepts, unless a series of specified requirements are met, including that the funds were commingled prior to 1990 pursuant to agreement with each of the HOAs.
5. Requires the HOA board, unless the governing documents impose more stringent standards, to:
   1. Review a current reconciliation of the HOA’s operating accounts on at least a quarterly basis.
   2. Review a current reconciliation of the HOA’s reserve accounts on at least a quarterly basis.
   3. Review the current year’s actual reserve revenues and expenses, compared to the current year budget, on at least a quarterly basis.
   4. Review the latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts.
   5. Review an income and expense statement for the HOA’s operating and reserve accounts on at least a quarterly basis.
6. Requires the HOA board, unless the governing documents impose more stringent standards, to distribute an annual budget report to its members 30 to 90 days before the end of the fiscal year that includes specified information.

This bill:

1. Prohibits transfers of greater than $10,000 or 5% of an HOA’s total combined reserve and operating accounts, whichever is lower, without prior approval from the HOA board.
2. Requires an HOA board, unless its governing documents impose more stringent standards, to review all of the following on a monthly basis:
   1. A current reconciliation of the HOA’s operating accounts.
   2. A current reconciliation of the HOA’s reserve accounts.
   3. The current year’s actual operating revenues and expenses compared to the current year’s budget.
   4. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts.
   5. An income and expense statement for the HOA’s operating and reserve accounts.
   6. The check register, monthly general ledger, and delinquent assessment receivable reports.
3. Provides that the review requirements in 2), above, may be met when every individual member of the HOA board, or a subcommittee of the board consisting of the treasurer and at least one other board member, performs them outside a board meeting so long as the review is ratified at the next board meeting and the ratification is reflected in the minutes of the meeting.
4. Requires the HOA, unless its governing documents require greater coverage amounts, to maintain fidelity bond coverage for its directors, officers, and employees in an amount equal to or greater than the combined amount of the HOA’s reserves and total assessments for three months. The HOA’s fidelity bond shall also include computer fraud and funds transfer fraud. If the HOA uses a managing agent or managing company, the HOA’s fidelity bond coverage shall also include dishonest acts by that person or entity and its employees.

Background

A CID is a form of real estate in which each homeowner has an exclusive interest in a unit or lot and a shared or undivided interest in common-area property. Condominiums, planned unit developments, stock cooperatives, community apartments, and many resident-owned mobilehome parks all fall under the umbrella of CIDs. There are more than 50,000 CIDs in California, comprising over 4.8 million housing units – approximately one-quarter of the state’s housing stock. CIDs are governed by HOAs, and the Davis-Stirling Common Interest Development Act provides the legal framework under which CIDs are established and operate. In addition to the requirements of the Act, each CID is governed according to the recorded declarations, bylaws, and operating rules of the association, collectively referred to as the governing documents.

To pay for common expenses, an HOA charges annual assessments to each of its members. While the board is ultimately responsible for how the HOA’s money is safeguarded and spent, in practice property managers often handle much of the day-to-day financial operation of an HOA. Collectively, the estimated 52,000 HOAs in California have roughly $12.4 billion of homeowner assessments on deposit. Perhaps not surprisingly, there have been a series of large scale fraud and embezzlement schemes over the past decade involving HOA funds. These are only the cases that have been detected and prosecuted; it is possible that the problem runs much deeper.

Comments

1. Purpose. The author states that many HOA boards delegate the duty of managing the association’s finances to a single board member or a professional manager, sometimes with limited oversight. An HOA’s budget is dedicated primarily to updating the infrastructure and conducting maintenance within the community. There has recently been an increase in fraudulent activities related to HOA finances. The author cites an October 2017 case in a Sun City retirement community in Indio in which the management company found financial discrepancies of $110,000 connected to a former employee. While current law provides some board actions intended to reduce fraudulent activity, it is time for those actions to be updated. This bill will provide more tools to help board members and financial managers oversee HOA funds.
2. Increased frequency of board review of financial documents. Existing law requires HOA boards to review certain financial documents at least once per quarter. This bill, in an effort to heighten financial oversight of HOA finances, would require such review on a monthly basis. While the opposition objects to the lack of definition of the word “review,” existing law does not define it. Because board members are generally volunteers, they do not usually have particular expertise in finances and may not have a thorough understanding of the documents they are reviewing; however, more frequent review could help create a culture of greater financial vigilance.
3. Increased oversight of fund transfers. This bill initially required board approval of any electronic transfer. To address concerns about feasibility, this bill was amended in policy committee to instead require approval for transfers of a significant amount, as defined.
4. Mandated fidelity bond coverage. This bill imposes a new requirement on HOAs to procure and maintain fidelity bond coverage to cover their deposits in reserve as well as three months’ assessments. While this requirement would not deter fraud or embezzlement, it would help ensure that if an HOA does become a victim of fraud or embezzlement, the homeowners will not be left holding the bag as a result. In addition, requiring HOAs to maintain bond coverage could lead to tighter controls on HOA finances, since a bonding company is likely to require such controls as a precondition for providing coverage. To address opposition concerns, this bill was amended in policy committee to require HOA directors, officers, and employees to be covered.

Related/Prior Legislation

AB 690 (Quirk-Silva, Chapter 127, Statutes of 2017) required a CID manager or management company to disclose certain information before entering a management agreement with an HOA and requires the HOA annual budget to contain specified information relating to charges for certain documents provided by the CID manager or management company.

FISCAL EFFECT: Appropriation: Fiscal Com.: Local:

SUPPORT: (Verified 8/6/18)

Community Associations Institute (source)

California Association of Community Managers

OPPOSITION: (Verified 8/6/18)

Center for California Homeowner Association Law

Greater Sacramento Urban League

ARGUMENTS IN SUPPORT: The Community Associations Institute states that this bill will provide HOA boards and homeowners a more regular review of the HOA’s financial matters, reducing the opportunity for fraudulent activities to occur and providing protection to the homeowners of the HOA.

ARGUMENTS IN OPPOSITION: The Center for California Homeowner Association Law states that this bill, though well-intentioned, will only make the problem worse because it continues to assist with the circumvention of federal statutes and regulations governing the creation and monitoring of HOA accounts held in California financial institutions. The Center faults this bill for leaving key provisions of existing law intact and calls for more comprehensive reform in order to protect HOA homeowners.

ASSEMBLY FLOOR: 76-0, 5/14/18

AYES: Acosta, Aguiar-Curry, Arambula, Baker, Berman, Bigelow, Bloom, Bonta, Brough, Burke, Caballero, Calderon, Carrillo, Cervantes, Chau, Chávez, Chen, Chiu, Choi, Chu, Cooley, Cooper, Cunningham, Dahle, Daly, Eggman, Flora, Fong, Frazier, Friedman, Gallagher, Eduardo Garcia, Gipson, Gloria, Gonzalez Fletcher, Gray, Grayson, Harper, Holden, Irwin, Jones-Sawyer, Kalra, Kamlager-Dove, Kiley, Lackey, Levine, Limón, Low, Maienschein, Mathis, Mayes, McCarty, Medina, Melendez, Mullin, Muratsuchi, Nazarian, Obernolte, O'Donnell, Patterson, Quirk, Quirk-Silva, Reyes, Rodriguez, Rubio, Salas, Santiago, Steinorth, Mark Stone, Thurmond, Ting, Voepel, Waldron, Weber, Wood, Rendon

NO VOTE RECORDED: Travis Allen, Cristina Garcia

Prepared by:

8/8/18 10:36:06

**** END ****

SENATE JUDICIARY COMMITTEE

Senator Hannah-Beth Jackson, Chair

2017-2018 Regular Session

Bill No: AB 2912 (Author:Irwin)

Version: February 16, 2018

Hearing Date: July 3, 2018

Fiscal: No

Urgency: No

Consultant: TSG

SUBJECT

Association finances

DESCRIPTION

This bill would enact a series of measures designed to protect members of a homeowner association against misuse of association funds. Specifically, the bill would: (1) require board members to review association financial documents monthly; (2) prohibit electronic transfer of funds from associations’ financial accounts; and (3) require associations to maintain fidelity bonds to cover the amount of association reserves plus three months’ worth of assessments.

BACKGROUND

Common interest developments are self-governing groups of dwellings that share common spaces and amenities. They come in a wide variety of physical layouts: condominium complexes, apartment buildings, and neighborhoods of detached, single-family residences, for example. Some consist of thousands of units. Others are made up of just a handful. Dwellings within common interest developments currently account for approximately a quarter of the state’s overall housing stock, meaning that the laws covering such developments have a large impact on the population. In California, common interest developments are governed by the Davis-Stirling Act. (Civ. Code Secs. 4000-6150.)

The Davis-Stirling Act sets forth a system for common interest development self-governance. The owners of the separate properties within the common interest development are the members of the homeowners association. Association members vote for the board of directors of the association that oversees operation of the common interest development. The board manages the common interest development, frequently by hiring an individual or entity to do so on its behalf.

To pay for common expenses, homeowner associations charge annual assessments to each member of the association. While the board is ultimately responsible for how the association’s money is safeguarded and spent, in practice, property managers often handle much of the day-to-day financial operation of an association.

Collectively, the estimated 52,000 homeowners associations in California have roughly $12.4 billion dollars of homeowner assessments on deposit. This money makes a very tempting target for unscrupulous actors and, perhaps not surprisingly, there have been a series of large scale fraud and embezzlement schemes over the past decade involving homeowner association funds. (See Comment 3, below, for examples of the problem this bill is intended to address.) These are only the cases that have been detected and prosecuted; it is possible that the problem runs much deeper.

The Davis-Stirling Act contains several provisions regarding association accounting and financial oversight. (See Changes to Existing Law, below.) Citing the multiple recent incidents of fraud and embezzlement, the author and sponsor of this bill assert that greater protections are needed, a view that the opposition to the bill shares as well.

To provide some additional protections to homeowners against the theft of association funds, this bill would require some very minor changes to how associations manage their collective funds. Specifically, the bill would: (1) require board members to review association financial documents monthly; (2) prohibit electronic transfer of funds from associations’ financial accounts; and (3) require associations to maintain fidelity bonds to cover the amount of association reserves plus three months’ worth of assessments.

While none of these steps appear to be harmful, for the reasons outlined in the Comments to this analysis, it may be debatable whether the measures contained in this bill would do much to deter fraud or embezzlement from taking place. It may be that much more significant reform of homeowner association financial management regulations is needed and that this bill should be viewed as a positive but initial step.

CHANGES TO EXISTING LAW

Existing law provides that, absent more stringent requirements in the governing documents, a review of the financial state of the association shall be prepared in accordance with generally accepted accounting principles by a licensee of the California Board of Accountancy for any fiscal year in which the gross income of the association exceeds seventy-five thousand dollars ($75,000). A copy of the review of the financial statement shall be distributed to the members within 120 days after the close of each fiscal year. (Civ. Code Sec. 5305.)

Existing law sets forth “association documents” that must be made available to members of the association within 10 days of a request, including:

• balance sheets;
• income and expense statements;
• budget comparisons;
• general ledgers;
• executed contracts not otherwise privileged;
• written board approval of vendor or contractors proposals or invoices;
• reserve account balances and records of payments made from reserve accounts;
• check registers;
• invoices;
• receipt and canceled checks for payments made by the association;
• purchase orders approved by the association;
• credit card statements for credit cards issued in the name of the association;
• statements for services rendered; and
• reimbursement requests submitted to the association. (Civ. Code Secs. 5510 and 5520.)

Existing law requires the signature of at least two persons – either two members of the board of directors or an officer and a member of the board of directors – in order to withdraw funds from an association’s reserve account. (Civ. Code Sec. 5510(a).)

Existing law requires a managing agent of a common interest development who accepts or receives funds belonging to the homeowners association to deposit those funds into a trust fund account maintained by the managing agent, if the funds are not placed into an escrow account or into an account under control of the association. (Civ. Code Sec. 5380(a).

Existing law requires all association funds deposited by the managing agent in a trust fund account to be kept in California in a financial institution which is insured by the federal government, and to be maintained there until disbursed in accordance with written instructions from the association entitled to the funds. (Civ. Code Sec. 5380(a).)

Existing law requires, if the association board requests it in writing, all funds that the managing agent accepts or receives on behalf of the association shall be deposited into an interest-bearing account, provided that certain requirements are met, including, among other things, that:

• the account is in the name of the managing agent as trustee for the homeowners association or in the name of the homeowners association;
• all of the funds in the account are insured by a federal agency;
• the funds in the account are kept separate, distinct, and apart from the funds belonging to the managing agent or to any other person for whom the managing agent holds funds in trust, except as provided; and
• no interest earned on funds in the account inure directly or indirectly to the benefit of the managing agent or the managing agent’s employees. (Civ. Code Sec. 5380(b).)

Existing law authorizes a managing agent to commingle funds between multiple associations under specified conditions, including that: the managing agent was commingling such funds on or before February 26, 1990, and the managing agent maintains fidelity and surety bonds sufficient to protect the associations. (Civ. Code Sec. 5380(d).)

Existing law requires, unless the governing documents impose more stringent standards, the board to review the following on at least a quarterly basis:

• a current reconciliation of the homeowner association’s operating accounts and reserve accounts;
• the current year’s actual reserve revenues and expenses compared to the current year’s budget;
• the latest account statements prepared by the financial institutions where the homeowners association has its operating and reserve accounts; and
• an income and expense statement for the homeowner’s operating and reserve accounts. (Civ. Code Sec. 5500.)

This bill would prohibit electronic transfers of funds in or out of an association’s interest-bearing financial accounts without prior approval from the association board.

This bill would require the association board to review the following documents on a monthly basis, unless the association’s governing documents require more stringent standards:

• a current financial institution reconciliation of the association’s operating and reserve accounts;
• the current year’s actual operating revenues and expenses compared to the current year’s budget;
• the latest account statements prepared by the financial institutions where the association has its operating and reserve accounts;
• an income and expense statement for the association’s operating and reserve accounts; and
• the check register, monthly general ledger, and delinquent assessment receivable reports.

This bill would allow the board to satisfy the document review requirement by having an individual member of the board conduct the review independent of a board meeting, so long as the review is ratified at the board meeting subsequent to the review and that the ratification is reflected in the minutes of that meeting.

This bill would prohibit any electronic transfers of funds to be made from the association’s reserve or operating accounts without prior board approval.

This bill would require the association to maintain fidelity bond coverage in an amount equal to or more than the combined amount of the association’s reserves of and total assessments for three months, unless the governing documents require greater coverage amounts.

This bill would require the fidelity bond coverage to include dishonest acts by the managing agent or management company, computer fraud, and funds transfer fraud.

COMMENT

1. Stated need for the bill

According to the author:

Current law provides some board actions intended to reduce this fraudulent activity, but it is time to improve these safeguards. By requiring a more frequent review of associations’ financial statements and requiring associations to retain fidelity bond insurance in the case of embezzlement or financial mismanagement, AB 2912 provides added financial protection to these volunteer boards that represent millions of homeowners across California.

As sponsor of the bill, Community Associations Institute of California writes:

HOAs are not-for-profit entities governed by an elected Board of Directors that often delegate the duty of managing the finances to a Board Member or professional managers. Current law sets requirements for a HOA and managers on how to conduct business intended to reduce fraudulent activity, but more protective measures are needed. […] [AB 2912’s] measures would provide the Board and homeowners a more regular review of the financial matters of the HOA reducing the opportunity for fraudulent activities to occur and providing protection to the homeowners of the HOA.

2. Concerns expressed about the bill

In opposition to the bill, the Center for California Homeowner Law writes:

Why do owners – and the money – need this protection? Because fraud and embezzlement… is reaching alarming proportions. […] Despite the prosecutions, fraud and embezzlement seems to be escalating, not decreasing. Will AB 2912 stop fraud and embezzlement? Far from it. While the legislation is well-intentioned, we think it will instead do harm; it gives the impression that it’s solving a problem when its making the problem worse.

Specific concerns raised by the opponents to the bill are included with the Comment to which they correspond, below.

3. Examples of the problem that the bill is intended to address

As an indication of the need for this bill, the author points to the following incidents:

• in December 2017, C.L. was arrested on suspicion of embezzling more than $100,000 from his employer, Associa, while serving as a manager for a retirement community in Indio;
• in December 2016, R.W., a property manager, and his firm were charged with wire fraud in a scheme to defraud a San Diego homeowners association of $247,000;
• in September 2016, S.M.L. pleaded no contest to felony embezzlement and forgery after stealing over $100,000 from the San Mateo Woodlake Condominium Association;
• in 2013, C.B. was sentenced to prison for embezzling over $989,000 while serving as the controller for M&C Association Management Services, a company that provides homeowner association management services in Northern California; and
• in 2008, L.B. pleaded guilty to embezzling more than $100,000 from the Nevada County homeowners association of which she was the treasurer.

4. Increased frequency in board review of financial documents

Under existing law, association boards are supposed to review certain financial documents about the association at least once per quarter. Those documents are: current reconciliations of the association’s operating and reserve accounts; the current year’s actual reserve revenues and expenses compared to the current year’s budget; and an income and expense statement for the association’s operating and reserve accounts. In addition, the board is supposed to review the latest reserve and operating account statements from the financial institution where those accounts are held, though existing law does not specify how often. (Civ. Code Sec. 5500.)

This bill would require board review of these documents more frequently: once per month. It would also require the board to review additional documents: the check register, the general ledger, and a report on delinquent assessments still payable to the association. In this way, the bill seeks to heighten financial oversight of association finances.

There are a number of reasons why this increase in the frequency and type of documents that the board must review may not lead to much additional detection of fraud and embezzlement, however. As a preliminary matter, the board members of homeowner associations are usually volunteers. Only rarely do they happen to possess any particular knowledge about commercial finances or accounting. As a result, whether they examine documents once a quarter or once a month, it is doubtful that board members will have such a firm grasp on what they are seeing that they will be able to distinguish the normal from the nefarious. Next, fraud and embezzlement from a homeowner’s association is more likely to take the form of kickbacks, padding contracts, or invoices for work that goes unperformed. It is unlikely that any trace of these kinds of activities would show up in the sort of documents that this bill requires boards to review. Lastly, as the opposition to this bill points out, there is no standard for what constitutes a “review” of the financial documents. Is it enough that board members look at the pages once? For ten seconds each? Must they have their glasses on?

At the same time, however, since all of these points are as applicable to existing law as they are to the bill, it is hard to say that what the bill proposes would do any harm (though volunteer board members may be annoyed by the frequency with which they are now forced to “review” the association’s financials). Additionally, it is always possible that more frequent examination of association financial documents will deter nefarious activity to some degree by creating a culture of greater financial vigilance. Still, if the ultimate goal is to deter fraud and embezzlement, it may be necessary to go considerably beyond more frequent board review of financial documents to accomplish that aim.

Two final points about this aspect of the bill may warrant attention. Both tread somewhat beyond the ordinary jurisdiction of this Committee, but may be worth considering in light of the fact that the bill will not be reviewed by a policy committee versed in financial accounting. First, it should be noted that the bill proposes to change the “reconciliation” documents to be reviewed by the board from “current reconciliation of the association’s” operating and reserve accounts to “current financial institution reconciliation of the association’s” operating and reserve accounts. (Emphasis added.) As the opposition points out, financial institutions do not generally perform the function of reconciling accounts; that is the task of the account holder, so it is a little unclear what that proposed change is intended to accomplish. Second, the bill would newly require board review of the check register and of the general ledger. Given the other financial documents that must be reviewed, it may be worth inquiring what additional value mandating review of these two documents provides.

5. Prohibition on electronic funds transfers absent prior board authorization

This bill would prohibit electronic transfer of funds out of the association’s operating or reserve accounts without prior approval from the board. Since such transfers take place at the click of a button, the intention behind this provision seems to be to require greater vigilance in relation to such transfers.

While this requirement makes sense as a barrier to fraud and embezzlement in theory, in practice, it may not have as much of a deterrent effect as hoped. As the opponents point out, many, if not most, association payments are made electronically nowadays. Getting prior approval from the board for each individual electronic transaction is probably not feasible, so the practical effect of a rule requiring prior board approval for electronic funds transfers may be that the board provides blanket advance approval for a broad array of electronic funds transfers. If that turns out to be the case, then it would likely diminish the value of the provision as a tool for preventing fraud and embezzlement.

Ultimately, it may be that the amount of a transfer is more important than the mode of the transfer when it comes to how swiftly harm can be done to an association’s finances. With that in mind, the author might want to consider pinning the requirement for prior board approval to a certain quantity of money, rather than to the method used for removing that money from the association’s accounts. To factor in the wide range of different sizes of homeowners associations in California, the permissible amount could be pegged to a percentage or formula rather than a predetermined sum.

6. Mandated fidelity bond to cover association and property manager bad acts

This bill would impose a new requirement on homeowner associations to procure and maintain fidelity bond coverage to cover their deposits in reserve as well as three months’ worth of assessments. By the terms of the bill, the bond must cover dishonest acts by the managing agents or management company, as well as computer and funds transfer fraud.

Notably, such a bond requirement would not, in itself, deter fraud or embezzlement. It would, however, help to insure that if an association does become a victim of fraud or embezzlement, the homeowners will not be left holding the bag as a result. In that regard, this provision of the bill may be the most important component in terms of providing concrete protections for homeowners. As a practical matter, moreover, requiring associations to maintain bond coverage may lead to tighter controls on association finances, since a bonding company is likely to require such controls as a precondition for providing the coverage.

The opposition to the bill seems to approve of the concept of a fidelity bond requirement, but raises two related objections to the way the provision is currently written. First, the opposition argues that fidelity bonds only cover the entity that purchases the bond and its employees. Thus, the opposition argues, requiring the association to purchase the bond will still leave the association exposed to fraud or embezzlement committed by the property manager or the property manager’s employees.

The bill seems to anticipate this problem, and requires the fidelity bond to cover “dishonest acts by the managing agent or management company…” The opponents question whether such a bond product presently exists. If such bond coverage does not exist now, however, it seems likely that bonding companies might quickly begin to market such a product if the state’s roughly 52,000 homeowner associations suddenly came looking for it. Still, the author may wish to confirm that a product would be available to meet the bill’s proposed requirement before imposing it.

Second, and relatedly, the opposition believes that the managing agent, not the association, should be required to pay for the bond. That would appear to align with the usual use of a fidelity bond: to cover the person or entity who is handling money on behalf of someone else. Yet if the opposition’s argument about the scope of coverage of a fidelity bond is accurate, then having the managing agent purchase the fidelity bond would leave the association unprotected against fraud or embezzlement committed by the association’s officers or employees.

At the end of the day, which entity purchases the fidelity bond may not matter as much as the scope of the coverage. So long as the association, managing agent, and their respective officers and employees are covered, it should not matter who obtains the bond. It may not even matter in terms of who bears the burden of paying, since, if the managing entity is the one required to procure the bond, it will presumably pass that cost along to the association as part of its bill for services rendered.

7. Other opposition concerns

While deeply concerned about the prevalence of fraud and embezzlement in the homeowner association context, the Center for California Homeowner Law is nonetheless opposed to this bill. In the Center’s view, it does not go far enough to deter bad actors and protect homeowners. Much of the Center’s concerns relate to the existing law; the Center faults AB 2912 for leaving that existing law intact. From the Center’s point of view, more significant reform is needed.

The Center’s concerns about the changes that AB 2912 proposes are addressed in the preceding Comments. The following is a summary of the Center’s concerns that only relate to existing law. While these concerns do not necessarily reflect on AB 2912 directly, they help to contextualize the limited scope of the bill and may raise issues worth considering as part of a broader attempt to combat fraud and embezzlement in the homeowner association context.

1. Allowing managing agents to control association financial accounts

The Center asserts that Civil Code Section 5380 allows the managing agent of a homeowners association to open a bank account in the managing agent’s own name and deposit association funds into that account. The Center believes this is an invitation to fraud and embezzlement because it gives the managing agent primary control over the association’s money. The Center also maintains that this provision violates federal regulations requiring banks to exercise due diligence in ascertaining whether or not an account is titled in the name of the owner of the funds within.

It is not crystal clear that the statute permits what the Center alleges, however. It does appear that the managing agent can title the account in the managing agent’s name, but presumably the title must also expressly indicate that the account is held in trust for the association. If that is not the case, then it is unclear what the statute means when it says the account must be a “trust fund account.”

Regardless, it may be worth questioning why there is a need to give managing agents the option of opening accounts in trust for the associations they manage. Arguably, it would make better sense to require the account to be in the control of the association, which could then add or remove the managing agent as a signatory on the account as necessary and appropriate.

1. Allowing commingling of funds from multiple associations

Existing law generally forbids the managing agents of homeowner associations to commingle association funds with money belonging to anyone else. (Civ. Code Sec. 5380(b)(3) and (d).) There is a narrow exception, however, for managing agents that already commingled funds among multiple associations as of February 26, 1990, so long as those agents carry adequate surety and fidelity bonds pursuant to a written agreement with the association, among other things.

It is unclear how many managing agents fit this exception and continue to commingle funds. Unless there is a demonstrated need to continue doing so, however, it may be worth considering if this exception should be scrapped in favor of a universal rule against commingling funds. After all, as the Center points out, it makes little sense to require board members to review financial statements for commingled funds. There would be no way for the board members to know what parts of the statements were relevant.

1. Need to limit the number of signatories with access to the association’s accounts

The Center also criticizes the fact that existing law does not appear to place any limitations on the number of managing agent employees that can have access to the association’s funds. The Center writes: “[n]eedless to say, letting multiple persons access the accounts makes monitoring more difficult and creates more opportunities for fraud.”

8. Proposed Amendments

In order to address the issues set forth in the analysis, above, the author has offered to incorporate amendments into the bill that would:

• alter the intent language to indicate that further measures may be needed to adequately protect homeowners and associations against fraud and embezzlement;
• replace the prohibition on electronic funds transfer without prior board approval with a prohibition on transfers above a certain amount without prior board approval;
• retain existing law with regard to review of account reconciliations; and
• require every board member, or a subcommittee of the board consisting of the Board Treasurer and at least one other person, to review the association’s financial documents at least monthly.

The specific amendments are as follows:

Amendment 1

On page 2, in line 1, strike out “Legislature to” and insert:

Legislature, in enacting this bill, to take important initial steps to

Amendment 2

On page 2, in line 4, strike out “finances.” and insert:

finances, recognizing that still further action may be necessary to achieve that goal.

Amendment 3

On page 3, strike out lines 13 and 14 and insert:

(6) Transfers of greater than $10,000 or five percent of an association’s total combined reserve and operating account deposits, whichever is lower, shall not be made from the account without prior written approval from the board of the association.

Amendment 4

On page 4, in lines 14 and 15, strike out “financial institution”

Amendment 5

On page 4, in lines 17 and 18, strike out “financial institution”

Amendment 6

On page 4, in line 33, strike out “an” and insert:

every

Amendment 7

On page 4, in line 33, strike out “board” and insert:

board, or a subcommittee of the board consisting of the Treasurer and at least one other board member,

Amendment 8

On page 4, in line 35, strike out “meeting if” and insert:

meeting, so long as

Amendment 9

On page 4, in lines 39 and 40, strike out “no electronic transfers of funds may be made” and insert:

transfers of greater than $10,000 or five percent of the association’s total combined reserve and operating account deposits, whichever is lower, shall not be authorized

Amendment 10

On page 5, in line 1, after “prior” insert:

written

Support: California Association of Community Managers

Opposition: Center for California Homeowner Association Law; Greater Urban League of Sacramento

HISTORY

Source: Community Associations Institute of California

Related Pending Legislation: None known

Prior Legislation:

AB 690 (Quirk-Silva, Ch. 127, Stats. 2017) required a CID manager or management company to disclose certain information before entering into a management agreement with a homeowners association, and required the homeowners association annual budget to contain information relating to charges for certain documents.

AB 805 (Torres, Ch. 180, Stats. 2012) revised and recast the Davis-Stirling Common Interest Development Act.

Prior Vote:

Senate Transportation and Housing Committee (Ayes 11, Noes 0)

Assembly Floor (Ayes 76, Noes 0)

Assembly Judiciary Committee (Ayes 10, Noes 0)

Assembly Housing and Community Development Committee (Ayes 7, Noes 0)

**************

SENATE COMMITTEE ON TRANSPORTATION AND HOUSING

Senator Jim Beall, Chair

2017 - 2018 Regular

Bill No: AB 2912 Hearing Date: 6/12/2018

SUBJECT: Association finances

DIGEST: This bill requires the board of directors of a common interest development (CID) to review specified financial documents on a monthly basis and prohibits electronic transfers of funds from homeowner association (HOA) accounts without prior board approval.

ANALYSIS:

Existing law:

1. Requires a managing agent who accepts or receives funds belonging to the HOA to deposit those funds that are not placed into an escrow account or into an account under the HOA’s control, into a trust fund account maintained by the managing agent in a bank, savings association, or credit union in California. These funds shall be maintained in the account until disbursed in accordance with written instructions from the HOA.
2. Requires, upon written request of the HOA board, that the funds the managing agent accepts or receives on behalf of the HOA to be deposited into an interest-bearing account in a bank, savings association, or credit union in California, provided all the following requirements are met:
   1. The account is in the name of the managing agent as trustee for the HOA or in the name of the HOA.
   2. All funds in the account are federally insured.
   3. The funds in the account are kept separate, distinct, and apart from funds belonging to the managing agent or to any other person for whom the managing agent holds funds in trust.
   4. The managing agent discloses to the HOA board the nature of the account, how interest will be calculated and paid, whether service charges will be paid to the depository and by whom, and any notice requirements or penalties for withdrawal of funds from the account.
   5. No interest earned on funds in the account shall inure directly or indirectly to the benefit of the managing agent or the managing agent’s employees.
3. Requires the managing agent to maintain a separate record of the receipt and disposition of funds, including any interest earned.
4. Prohibits the managing agent from commingling HOA funds with the managing agent’s own money or with the money of others that the managing agent receives or accepts, unless a series of specified requirements are met, including that the funds were commingled prior to 1990 pursuant to agreement with each of the HOAs.
5. Requires the HOA board, unless the governing documents impose more stringent standards, to:
   1. Review a current reconciliation of the HOA’s operating accounts on at least a quarterly basis.
   2. Review a current reconciliation of the HOA’s reserve accounts on at least a quarterly basis.
   3. Review the current year’s actual reserve revenues and expenses, compared to the current year budget, on at least a quarterly basis.
   4. Review the latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts.
   5. Review an income and expense statement for the HOA’s operating and reserve accounts on at least a quarterly basis.
6. Requires the HOA board, unless the governing documents impose more stringent standards, to distribute an annual budget report to its members 30 to 90 days before the end of the fiscal year that includes specified information.

This bill:

1. Prohibits electronic transfers in or out of an HOA’s account, or in and out of an HOA’s reserve or operating accounts, without prior approval from the HOA board.
2. Requires an HOA board, unless its governing documents impose more stringent standards, to review all of the following on a monthly basis:
   1. A current financial institution reconciliation of the HOA’s operating accounts.
   2. A current financial institution reconciliation of the HOA’s reserve accounts.
   3. The current year’s actual operating revenues and expenses compared to the current year’s budget.
   4. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts.
   5. An income and expense statement for the HOA’s operating and reserve accounts.
   6. The check register, monthly general ledger, and delinquent assessment receivable reports.
3. Provides that the review requirements in (2) may be met when an individual board member performs them outside a board meeting provided the review is ratified at the next board meeting and the ratification is reflected in the minutes of the meeting.
4. Requires the HOA, unless its governing documents require greater coverage amounts, to maintain fidelity bond coverage in an amount equal to or greater than the combined amount of the HOA’s reserves and total assessments for three months. Coverage shall include dishonest acts by the managing agent or Management Company and for computer fraud and funds transfer fraud.

COMMENTS

1. Purpose. The author states that many HOA boards delegate the duty of managing the association’s finances to a single board member or a professional manager, sometimes with limited oversight. An HOA’s budget is dedicated primarily to updating the infrastructure and conducting maintenance within the community. There has recently been an increase in fraudulent activities related to HOA finances. The author cites an October 2017 case in a Sun City retirement community in Indio in which the management company found financial discrepancies of $110,000 connected to a former employee. While current law provides some board actions intended to reduce fraudulent activity, it is time for those actions to be updated. This bill will provide more tools to help board members and financial managers oversee HOA funds.
2. CID background. A common interest development (CID) is a form of real estate in which each homeowner has an exclusive interest in a unit or lot and a shared or undivided interest in common-area property. Condominiums, planned unit developments, stock cooperatives, community apartments, and many resident-owned mobilehome parks all fall under the umbrella of CIDs. There are more than 50,000 CIDs in California comprising over 4.8 million housing units, or approximately one-quarter of the state’s housing stock. CIDs are governed by HOAs. The Davis-Stirling Common Interest Development Act provides the legal framework under which CIDs are established and operate. In addition to the requirements of the Act, each CID is governed according to the recorded declarations, bylaws, and operating rules of the association, collectively referred to as the governing documents.
3. Opposition concerns. The Center for California Homeowner Association Law states that this bill, though well-intentioned, will only make the problem worse because it continues to assist with the circumvention of federal statutes and regulations governing the creation and monitoring of HOA accounts held in California financial institutions. The following outlines the amendments requested by the Center, along with the author’s and sponsor’s responses.
   1. Apply the bill’s provisions to any individual who handles association funds, not just the managing agent. The author and sponsor note that the definition of embezzlement in existing law already encompasses any individual who would touch or have control over an HOA’s finances (Penal Code Section 508).
   2. Prohibit accounts from being set up in either the name of the managing agent or the association. The author and sponsor note that existing law already prohibits an HOA account from being set up in solely the managing agent’s name (see “existing law,” #2a).
   3. Allow a third party to open an account only if specifically authorized by a board resolution. The author and sponsor state that they are looking into contractual agreements between HOA boards and managing agents to determine whether this suggestion is feasible.
   4. Prohibit funds from being commingled among different associations. The author and sponsor note that existing law already requires funds in an HOA account to be kept separate from funds belonging to the managing agent or any other person for whom the managing agent holds funds in the trust. Existing law also prohibits a managing agent from commingling HOA funds with his or her own funds, or with other accounts the managing agent may manage, unless a number of requirements are met. The only exception to this provision is accounts established prior to 1990, pursuant to negotiated language (see “existing law, #4).
   5. Refrain from using the word “review” without specifically defining it. The author and sponsor note that existing law already establishes a quarterly review requirement; this bill merely increases the frequency of that requirement to monthly (see “existing law,” #5).
   6. Require the third party handling the money, rather than the association, to purchase a bond to cover losses. The author and sponsor state that it is appropriate for the HOA to buy the bond in order to ensure it obtains the correct coverage; the agreements made between the board and the management company could individually dictate how insurance is purchased. The author and sponsor also feel that the cost should not solely be borne by the managing agent, as HOA officers, as well as managers, have been convicted of embezzlement.
4. Double referral. This bill has also been referred to the Judiciary Committee.

Related Legislation:

AB 690 (Quirk-Silva, Chapter 127, Statutes of 2017) — required a CID manager or management company to disclose certain information before entering a management agreement with an HOA and requires the HOA annual budget to contain specified information relating to charges for certain documents provided by the CID manager or management company.

Assembly Votes:

Floor: 76-0

Jud: 10-0

H&CD: 7-0

FISCAL EFFECT: Appropriation: Fiscal Com.: Local:

POSITIONS: (Communicated to the committee before noon on Wednesday,

June 6, 2018.)

SUPPORT:

Community Associations Institute (sponsor)

California Association of Community Managers

OPPOSITION:

Center for California Homeowner Association Law

Greater Sacramento Urban League

-- END --

Date of Hearing: May 8, 2018

ASSEMBLY COMMITTEE ON JUDICIARY

Mark Stone, Chair

ABPCA Bill Id:AB 2912

Author:(Irwin) – As Introduced Ver:February 16, 2018

PROPOSED CONSENT

SUBJECT: ASSOCIATION FINANCES

KEY ISSUE: SHOULD additional, common sense safeguards be established to protect homeownerS associations from potential financial fraud and embezzlement?

SYNOPSIS

According to the author, recent reported cases of fraud and embezzlement against homeowners associations (HOAs) highlight the need for stronger organizational protections. This bill seeks to establish additional common sense protections in the Davis-Stirling Act, the law that governs the authority and functions of HOA boards. Among other things, this bill increases HOA board oversight over its financial accounts by requiring monthly review of financial statements; establishes tighter control over electronic fund transfers, and requires the board to check every month on the check register and monthly general ledger. Lastly, in order to address a reported lack of insurance coverage among HOAs in cases of financial fraud, the bill would require the HOA to purchase fidelity bond insurance according to a specified calculation. The bill is sponsored by the Community Associations Institute and the California Association of Community Managers, and has no known opposition. This bill previously passed the Assembly Housing and Community Development Committee by a unanimous vote of 7-0.

SUMMARY: Establishes additional safeguards to reduce the opportunity for fraud or embezzlement by unscrupulous persons who are entrusted with managing the finances of a homeowners association (HOA). Specifically, this bill:

1. Prohibits a managing agent of a common interest development (CID) from making electronic transfers of funds in or out of an HOA account without prior approval from the board of the HOA.
2. Requires, unless the governing documents of the HOA impose more stringent standards, the board to review the following on a monthly basis:
   1. A current financial institution reconciliation of the HOA’s operating and reserve accounts;
   2. The current year’s actual operating revenues and expenses compared to the current year’s budget;
   3. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts;
   4. An income and expense statement for the HOA’s operating and reserve accounts; and
   5. The check register, monthly general ledger, and delinquent assessment receivable reports.
3. Allows these review requirements to be met when an individual member of the board reviews those documents and statements independent of a board meeting, if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.
4. Prohibits any electronic transfers of funds to be made from the HOA’s reserve or operating accounts without prior board approval.
5. Requires the HOA to maintain fidelity bond coverage in an amount equal to or more than the combined amount of the reserves of the HOA and total assessments for three months, unless the governing documents require greater coverage amounts.
6. Requires bond coverage to include dishonest acts by the managing agent or management company, computer fraud, and funds transfer fraud.

EXISTING LAW:

1. Requires a managing agent of a CID who accepts or receives funds belonging to the HOA to deposit those funds that are not placed into an escrow account into an account under control of the HOA. (Civil Code Section 5380 (a). All further references are to this code unless otherwise stated.)
2. Requires, at the written request of the board, the funds the managing agent accepts or receives on behalf of the HOA to be deposited into an interest-bearing account, provided that certain requirements are met, including, among other things, that:
   1. The account is in the name of the managing agent as trustee for the HOA or in the name of the HOA.
   2. All of the funds in the account are insured by a federal agency.
   3. The funds in the account are kept separate, distinct, and apart from the funds belonging to the managing agent or to any other person for whom the managing agent holds funds in trust, except as provided.
   4. No interest earned on funds in the account inure directly or indirectly to the benefit of the managing agent or the managing agent’s employees. (Section 5380 (b).)
3. Requires, unless the governing documents impose more stringent standards, the board to review the following on at least a quarterly basis:
   1. A current reconciliation of the HOA’s operating accounts and reserve accounts;
   2. The current year’s actual reserve revenues and expenses compared to the current year’s budget;
   3. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts; and
   4. An income and expense statement for the HOA’s operating and reserve accounts. (Section 5500.)
4. Requires the signatures of at least two specified board members for the withdrawal of money from the HOA’s reserve accounts. (Section 5510 (a).)

FISCAL EFFECT: As currently in print this bill is keyed non-fiscal.

COMMENTS: This bill, sponsored by the Community Associations Institute, seeks to increase HOA board oversight over its financial accounts, establish tighter control over electronic fund transfers, and generally protect HOAs from financial fraud.

According to the author, there have been a number of reported cases of fraud and embezzlement of funds perpetrated against homeowners associations in California, including the following:

1. In December 2017, C.L. was arrested on suspicion of embezzling more than $100,000 from his employer, Associa, while serving as a manager for a retirement community in Indio.
2. In December 2016, R.W., a property manager, and his firm were charged with wire fraud in a scheme to defraud a San Diego HOA of $247,000.
3. In September 2016, S.M.L. pleaded no contest to felony embezzlement and forgery after stealing over $100,000 from the San Mateo Woodlake Condominium Association. As the manager of the HOA, S.M.L. issued nearly 150 false invoices for improvement work that was never done. Her co-conspirator, M.M., would cash the checks and split the money with her.
4. In 2008, L.B. pleaded guilty to embezzling more than $100,000 from the Nevada County HOA of which she was the treasurer.
5. In 2013, C.B. was sentenced to prison for embezzling over $989,000 while serving as the controller for M&C Association Management Services, a company that provides HOA management services in Northern California.

More needs to be done to prevent fraud and embezzlement against HOAs, the author contends, stating:

Current law provides some board actions intended to reduce this fraudulent activity, but it is time to improve these safeguards. By requiring a more frequent review of associations’ financial statements and requiring associations to retain fidelity bond insurance in the case of embezzlement or financial mismanagement, AB 2912 provides added financial protection to these volunteer boards that represent millions of homeowners across California.

Background on common interest developments. There are nearly 50,000 common interest developments in California that vary in size and structure, but generally speaking, CIDs are multi-unit communities characterized by the following: (1) separate ownership of individual residential units coupled with an undivided interest in common property; (2) covenants, conditions, and restrictions (CC&Rs) that limit the use of both separate interests and common property; and (3) management of common property and enforcement of restrictions by a homeowners association.

Under the Davis-Stirling Act (Civil Code Section 1350 et seq.), which sets forth general rules governing common interest developments, each individual CID is subject to rules and regulations set forth by the association’s “governing documents." These governing documents include the recorded declaration and any other documents, such as bylaws, operating rules of the association, or articles of incorporation that govern the operation of the association. CIDs are governed by volunteer boards of directors who are elected by the members of the association and who are responsible for interpreting the governing documents and state law.

Increased board oversight over HOA's operating and reserve accounts. Existing law requires the HOA board to review financial documents and statements related to the HOA’s accounts on at least a quarterly basis, unless the HOA’s governing documents require more frequent review. This bill changes the frequency of review required by law from at least once a quarter to once a month. By requiring the board to review the HOA's financial statements more frequently, it is thought that the board will be in a better position to identify potential fraud or misuse of funds before a pattern of fraud is allowed to continue undetected. The bill also establishes an additional requirement for the board to review, on a monthly basis, the check register, monthly general ledger, and delinquent assessment receivable reports. To allow for flexibility, the bill clarifies that the monthly review requirement for the board may be fulfilled when an individual board member—for example, the treasurer—reviews these financial documents, so long as the board ratifies that review at the next board meeting and is reflected in the minutes of the meeting.

Prohibition on electronic fund transfers without board approval. Existing law also sets out specific requirements for managing agents of CIDs and board members to follow when handling money belonging to the HOA. This bill specifically prohibits any electronic transfers of funds from being made from the HOA’s reserve or operating accounts without prior board approval, including transfers by a managing agent. With most banking transactions now conducted through the electronic transfer of funds, this common sense measure updates the law to adapt to a common method of embezzling funds.

Increased insurance requirements. According to the author, many HOAs are not protected by insurance in the case of embezzlement or financial mismanagement. This bill requires the HOA to maintain fidelity bond coverage in an amount that is equal to or more than the combined amount of the reserves of the association and total assessments for three months. The bill clarifies that this coverage shall include dishonest acts by the manager or management company, and for computer fraud and funds transfer fraud. This is intended to mandate increased financial protection for HOA boards, and to allow insurance companies to handle the claims in any such situations.

REGISTERED SUPPORT / OPPOSITION:

Support

Community Associations Institute

California Association of Community Managers

Opposition

None on file

Analysis Prepared by: Anthony Lew / JUD. / (916) 319-2334

Date of Hearing: April 25, 2018

ASSEMBLY COMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT

David Chiu, Chair

ABPCA Bill Id:AB 2912 (

Author:Irwin) – As Introduced Ver:February 16, 2018

SUBJECT: Association finances

SUMMARY: Requires common interest development (CID) board of directors (board) to review specified financial documents on a monthly basis, and prohibits electronic transfers of funds from homeowner association (HOA) accounts without prior board approval. Specifically, this bill:

1. Prohibits a managing agent of a CID from making electronic transfers of funds in or out of a HOA account without prior approval from the board of the HOA.
2. Requires, unless the governing documents of the HOA impose more stringent standards, the board to review the following on a monthly basis:
   1. A current financial institution reconciliation of the HOA’s operating and reserve accounts;
   2. The current year’s actual operating revenues and expenses compared to the current year’s budget;
   3. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts;
   4. An income and expense statement for the HOA’s operating and reserve accounts; and
   5. The check register, monthly general ledger, and delinquent assessment receivable reports.
3. Allows these review requirements to be met when an individual member of the board reviews those documents and statements independent of a board meeting, if the review is ratified at the board meeting subsequent to the review and that ratification is reflected in the minutes of that meeting.
4. Prohibits any electronic transfers of funds to be made from the HOA’s reserve or operating accounts without prior board approval.
5. Requires the HOA to maintain fidelity bond coverage in an amount equal to or more than the combined amount of the reserves of the HOA and total assessments for three months, unless the governing documents require greater coverage amounts.
6. Requires bond coverage to include dishonest acts by the managing agent or management company, computer fraud, and funds transfer fraud.

EXISTING LAW:

1. Defines CID as a community apartment project, a condominium project, a planned development, or a stock cooperative.
2. Defines HOA as a nonprofit corporation or unincorporated association created for the purpose of managing a CID.
3. Requires a managing agent of a CID who accepts or receives funds belonging to the HOA to deposit those funds that are not placed into an escrow account into an account under control of the HOA.
4. Requires, at the written request of the board, the funds the managing agent accepts or receives on behalf of the HOA to be deposited into an interest-bearing account if certain requirements are met, including that the account is in the name of the managing agent as trustee for the HOA or in the name of the HOA.
5. Requires, unless the governing documents impose more stringent standards, the board to review the following on at least a quarterly basis:
   1. A current reconciliation of the HOA’s operating accounts and reserve accounts;
   2. The current year’s actual reserve revenues and expenses compared to the current year’s budget;
   3. The latest account statements prepared by the financial institutions where the HOA has its operating and reserve accounts; and
   4. An income and expense statement for the HOA’s operating and reserve accounts.
6. Requires the signatures of at least two specified board members for the withdrawal of money from the HOA’s reserve accounts.

FISCAL EFFECT: None.

COMMENTS:

Background: There are over 50,000 CIDs in the state that range in size from three to 27,000 units. CIDs make up over 4.9 million housing units, which represents approximately a quarter of the state’s housing stock. CIDs include condominiums, community apartment projects, and housing cooperatives, and planned unit developments. They are characterized by the following: 1) a separate ownership of dwelling space coupled with an undivided interest in a common property, 2) covenants and conditions that limit the use of common areas, and 3) management of common property and enforcement of restrictions by a HOA.

CIDs are governed by the Davis-Stirling Act as well as the governing documents of the HOA, including bylaws, declaration, and operating rules. CIDs are run by volunteer board who are elected by the members of the HOA and who are responsible for interpreting the governing documents and state law.

Existing law requires the HOA board to review financial documents and statements related to the HOA’s accounts on at least a quarterly basis, unless the HOA’s governing documents require more frequent review. This bill changes the frequency of review required by law from at least once a quarter to once a month, and adds a requirement to review the check register, monthly general ledger, and delinquent assessment receivable reports.

This bill also provides some flexibility in this monthly review requirement by allowing an individual board member—for example, the treasurer—to review these financial documents so long as the board ratifies that review at the next board meeting.

Existing law also sets out specific requirements for managing agents of CIDs and board members to follow when handling money belonging to the HOA. This bill prohibits any electronic transfers of funds from being made from the HOA’s reserve or operating accounts without prior board approval, including transfers by a managing agent. Lastly, this bill requires the HOA to maintain fidelity bond coverage in specified amounts.

Purpose of the bill: According to the author, "there has been an increase in fraudulent activities related to the finances of HOAs. One example from a retirement community describes $110,000 discrepancies in HOA finances related to their management company. Current law provides some board actions intended to reduce fraudulent activity, but it is time for those laws to be updated. More regular review of an HOA board’s financial records, and fidelity insurance to cover potential liability, will help protect HOAs from financial mismanagement. AB 2912 provides financial security to these volunteer boards that represent thousands of homeowners across California without placing overly burdensome requirements on their workloads."

Related legislation:

AB 690 (Quirk-Silva), Chapter 127, Statutes of 2017: Required a CID manager or management company to disclose certain information before entering into a management agreement with a HOA, and required the HOA annual budget to contain information relating to charges for certain documents.

AB 805 (Torres), Chapter 180, Statutes of 2012: Revised and recast the Davis-Stirling CID Act.

Double-referred: This bill was also referred to the Committee on Judiciary, where it will be heard should it pass out of this committee.

REGISTERED SUPPORT / OPPOSITION:

Support

Community Associations Institute of California (sponsor)

California Association of Community Managers

Opposition

None on file

Analysis Prepared by: Nicole Restmeyer / H. & C.D. / (916) 319-2085