A homeowners association in Northern California received millions from a construction defect claim. The board paid a fellow director $75,000 to manage the funds. In addition, the board member was allowed to receive commissions and trading fees on the funds.

Conflict of Interest. The director did not resign from the board--he continued as a board member and voted on matters directly affecting his control of the funds. Because he financially benefited from the use, management, and spending of the settlement monies, his votes ceased to be arm’s length. This created a glaring conflict of interest.

Accountability. Another problem with the arrangement was the director's unwillingness to follow the board's instructions. While an independent, third party financial manager will follow instructions (or face potential liability and loss of business), benefited directors often do not feel such constraints. They sometimes feel it is "their" money and will act outside the scope of their authority both as a director and a money manager. That occurred in this case.

Large Losses. Without board approval, the director invested $3 million in the stock market. His investments resulted in losses of $400,000 before the board took steps to regain control of the situation. Before it was all over, the amount of lost principal was close to $1 million.

RECOMMENDATION: Boards should NEVER pay fellow directors to manage their association's money; they should use outside professionals. Boards should adopt investment strategies that preserve capital while earning a reasonable return.