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Others in the community have taken the opportunity to recount some of the major milestones of this past year, whether in the December Spirit magazine or elsewhere. There is no need to dwell on the presumed significance of some of those achievements, such as Pulte’s decision to proceed with our third recreation center; improvements to our recreation centers; parking lot lighting enhanced; and, oh, yes, the refurbishment of Trumpets.

But who should we thank for these efforts, some of which were really quite costly and amounting to the expenditure of over $500,000. Clearly, we must thank the board, even though as one homeowner commented to me, the ballroom walls went from being pleasantly elegant to being drab looking, but beyond that we must thank those homeowners who paid their dues to the association. After all, without money in the bank to carry on the business of the association, where would we be?

But whose money are we really talking about? In one sense, we are talking about a small portion of everyone’s assessments to finance what we understand to be a reserve fund. A reserve fund takes care of major improvements of the type noted above. The money in that reserve fund goes up and down as new money comes in from homeowner assessments and as projects are authorized and completed. That process is more or less a simplified description of how needed repairs and upgrades are handled.

In Sun City Anthem, we have a somewhat more complex system. Instead of one reserve fund, we have a total of six, of which the association’s reserve fund is by far the largest, totaling over $6 million. The other five reserve funds are for the separately administered Neighborhoods, like Pinnacle and the four Villa Neighborhoods. However, to simplify matters, let us assume for our purposes here that there are only two reserve funds, one for the association and one, say a combined fund, for the rest. I’ll call this combined fund the Neighborhood Fund, or “N” for short. In reality, though, there are five separate reserve fund accounts, one for each of the five Neighborhoods within Sun City.

From an accounting perspective, entities, whether corporate or not, nonprofit or not, have what are referred to as assets and liabilities. In general, liabilities are amounts owed to others, while assets support the activities of the organization, like cash, revenue, and investments, etc. For our purposes and in general accounting, a company’s assets equals their liabilities.1/ By definition, they balance each other out. For example, when a company buys a computer for $1,000, they acquire an asset, the computer, while at the same time they incur a liability, which is the amount owed to the vendor or retailer of the computer. In this instance, the value of the acquired asset, $1,000, is equal to the value of the liability incurred by the company in purchasing the computer, or $1,000.2/ No real issue here.

Assets may arise under a variety of circumstances, which we need not get into. Typically, though, when a new asset arises, a corresponding liability is created somewhere else. There are exceptions, of course, like a panhandler’s discovery of a large gold nugget. No corresponding liability there. But even our old panhandler might find his newly found treasure suddenly missing, stolen, if you will. Bad things can and do happen and thieves can present themselves in many different guises. So much for our old panhandler.

Sun City has all kinds of assets. In the summer of 2007, one such asset and its corresponding liability was an issue, a real pain the neck, and its disposition presented troubling options for the board. The prior board tried but failed to dispose of this potential asset/liability problem. Unfortunately, it couldn’t be disposed of in the normal course of business. It was simply too big for the board to ignore, valued at more than $500,000. Ultimately, the board’s icky fingers were all over this asset. It’s very existence posed a real threat to the board’s authority to govern as they wished. Adverse political consequences would result and linger on if the matter went unresolved. Something had to be done. Then, almost miraculously, as if someone on the board had a vision, a brilliant plan developed on how to dispose of this asset, making it literally disappear as if it never existed. The problem would disappear along with that potential asset and all would be well again, or so the board assumed.

Now I will set up an example that is more closer to home. It will attempt to demonstrate what the board was facing that summer and answer some questions about why things went down as they did. In our example, there will be four possible outcomes or options for the 2007-08 board of directors to consider. Each option is pretty straight forward, easily understood, and will be fully explained.

So that there will be no surprises, I believe it’s correct to say at the outset that our board of directors chose the least desirable and most risky of all options available, although the board apparently thought otherwise. Why so risky? The option chosen, which I list as option four, entails a good measure of deceit, is directed against a select group of homeowners, it severely hinders the board members fiduciary duty to serve such homeowners, it involves an accounting irregularity of significant proportions, and borders on potential criminality. The varied reasons the board settled on option four are immaterial. What’s interesting is to note that this particular option ostensibly provided members of the board with the greatest protection from having to justify their behavior and from having to accept personal accountability for their deeds.

For illustrative purposes only, there are only two reserve funds, a quite large multimillion dollar fund that I’ll call “A” for the Association Fund. The second fund I’ll call “N” for the Neighborhood Fund. In reality, this second fund is composed of five separate mini-reserve funds, but we can disregard that fact and the huge disparity in the size of these funds for our illustration. When mentioning “A” below, read “the Association,” or SCACAI, the “Board of Directors,” or simply the association’s reserve fund.

In our hypothetical example, we’ll deal with an asset and a liability. More specifically, we are dealing with a potential asset and a potential liability as if they were an asset or liability in order to simplify things.3/ For our purposes, a potential claim shall equal a potential asset for the party entitled to or making the claim, and a potential liability for the party against whom the claim is made. This should become more clear as we move along.

What’ this all about? As it turns out, at least in our hypothetical case, “N” (the Neighborhood Fund) has a potential asset they believe is worth, say, around $500,000.4/ Whether it’s $500,000 or some higher or lower amount is not important for our purpose here. What is important is that “N’s” claim is against the Association, “A.” Such a claim would make that amount a potential liability for “A,” something “A” would prefer not to have. Said differently, “N” has a potential claim on “A” in the amount of $500,000, while “A” has a potential obligation to pay “N” $500,000 for the value of “N’s” alleged asset. Some might consider “A’s” potential obligation to “N” to be what is called a contingent liability. All that means is that “A’s” potential liability arose from the outcome of some event or series of events, which may be in dispute. Those events are at the center of the fiduciary issue or potential dispute between “N” and “A.”

What everyone needs to understand is that the board would not have engaged in tinkering with the Neighborhood’s potential claim had the board not considered that claim as a potential liability of the association as well as a viable threat to the board’s authority over making budgetary decisions affecting the Neighborhoods. One might even suggest that the board in taking the dubious actions it did acted, at least in part, out of a sense of anxiety over these issues, among others I mention below.

While we have a pretty good idea of what “A” stands for, like RMI, the Board of Directors, the Association, and their legal counsel John Leach, we have less information on what exactly “N” is. Except for the venerable and dogged efforts of Norman McCullough, and occasionally yours truly, few homeowners would know about the existence of the Neighborhoods and the budgetary plight of their homeowners in the care of the association. In its present incarnation, “N” has no staff or organizational counterparts to “A,” except in the all important existence of those fund accounts that “A” administers.

Both “A” and “N” have operating and reserve funds to support their respective needs and services.5/ From a fiduciary standpoint, the funds are indistinguishable, with the board of directors acting as the sole granting authority for both “A” and “N.” The board sets the budget, determines assessment levels, and administers the operating and reserve funds for both “A” and “N.”

“A” is funded from assessments that are applicable to all homeowners. However, “N” is funded from special assessments that are applicable only to the 389 homeowners who make up the units in the five Neighborhoods.6/ In other words, “N” homeowners pay both annually mandated association and special assessments. The special assessments are designed to meet a variety of contractual obligations that “A” has to “N” homeowners.7/ The fiduciary duty exercised by members of the board ostensibly applies equally to the administration of all fund accounts in meeting the respective needs of both “A” and “N.”

Some will note the use of the word “ostensibly” when I referred to the director’s fiduciary duty being ostensibly applied equally to the administration of the funds for the association and the separate neighborhood accounts. That was no misstatement. There should be little doubt that the actions taken by virtually all Sun City directors in the 2007-08 period were unequally applied to the administration of these funds, thereby raising serious questions concerning whether they breached their fiduciary in the process.

To return to my point. In a nutshell, “A” had little interest in addressing “N’s” potential claim against “A,” that $500,000 reserves asset that “N” believed was owing. That looming potential claim became what I call the ”N” problem.

How the board came to the decision it did in addressing the “N” problem can best be illustrated by considering the options that were actually available. What you will discover is that the board had a number of available options to choose from, all perfectly viable, but eventually decided to choose the one option I believe placed certain board members and the association in the greatest jeopardy of all.

Now, with so many above-board options available to the board, why in the world would “A” even consider what many might view as a quite risky, perhaps even illegal, option by cooking the books in favor of “A” and against the fiduciary interests of “N”? Because we can, as former president Mike Dixon was alleged to have said.11/ That might suggest to some that if the president approves, it must be OK, that is, it must be legal. But is that necessarily true? When the board takes deliberate steps to modify the financial records of the association to the clear and substantial detriment of one set of homeowners while favoring others in the process, however inspired and clever that such efforts might be, is the result necessarily legal? I doubt it.

“A” was faced with a number of problems surrounding the “N” issue, ones they could not readily dismiss. The biggest one was the 2006 Reserve Study, which reported a huge shortfall in Neighborhood reserves. That figure alone sent up a huge red flag. By implication, even by mathematical interpolation, the magnitude of the all important figures for the transition year of 2005 would not be substantially different if the board had not decided to intervene in the reserve study process. If transition year shortfalls were not materially different than the reported shortfalls for 2006, there would be incredible pressure on the board to seek compliance with NRS 116 on the sufficiency, or lack thereof, of the Developer’s statutory contribution to reserves.12/ That’s exactly what happened in the Spring of 2007.

That pressure on the board ultimately provided partial relief to the shortfall in “N’s” reserve levels as a result of the April 2007 West/Dwyer Settlement Agreement with Pulte. The West/Dwyer SA, while significant, only met a relatively small part of the reported shortfall for “N”, based on the results reported by the 2006 Reserve Study(RS).

The magnitude of the shortfall in “N’s” reserves at transition, even after making allowances for the Developer’s subsequent contribution in 2007, was staggering, if we base that judgment on the results of that 2006 RS. How do we know this?

We know this because the board told us so in their 2007 budget presentation.13/ That presentation reported a level of fully-funded reserves for the Neighborhoods at $1,053,150. We also happen to know from association records the amount the declarant Pulte deposited in the Neighborhood accounts following transition in May 2005. That amount was $211,038, as shown by the blue column in the chart below.

As a percent of the fully-funded amount, that $211,038 represented ONLY 20% of the fully-funded amount. OK, but what about that 2007 West/Dwyer agreement that reportedly, according to Dixon-Berman, corrected everything. Let’s now add in the amount that was negotiated in behalf of the Neighborhoods in 2007. That amount, counting both cash and hardscape (rock), was portrayed by the board as filling in the gap of what was actually due. Let’s see if that’s really true. As stated in that negotiated agreement, that amount comes to an additional $281,678, as shown by the yellow column in the chart below.

Totaling this amount with the amount Pulte contributed and placed on deposit at transition, the Developer’s total contribution for “N” now amounted to $492,716. A significant amount, but just how significant was it in light of the all important fully-funded amount? That raised the Developer’s contribution for the Neighborhoods from 20% to 47% of the fully-funded amount that many considered due at the time of transition in 2005. While that 2007 agreement made some progress in raising the Developer’s contribution, it was far from the equitable relief that was required.

As you can readily see, the West/Dwyer agreement did not close the reserve shortfall gap, far from it. When you compare that total Developer contribution of $492,716 to the fully-funded level, or “the amount then due” at transition, or around $1,053,000, you get a potential deficit (shortfall) of $560,434, as shown by the red column in the chart below. While this amount is based on data from the 2006 RS, it does accurately display information that was available to the board at the time the board had decided to “augment” the Neighborhoods’ financial records for their own purposes in conducting the 2005 “look-back” reserve study.

That $560,434 shortfall reflects a potential shortfall in “N’s” reserves of roughly 53% of the amount required in order for the “N” reserves fund to be fully funded. That’s a staggering shortfall by anyone’s standard.

There is nothing like a good chart to illustrate the magnitude and seriousness of “N’s” plight and to draw attention to one of chief motivating factors the board had in embarking on their risky and deceitful plan to eliminate the prospect of any additional reported shortfall in Neighborhood reserves.

This chart pulls together information from a number of association sources to illustrate critical events on the issue of Neighborhood reserves. The height of the column shown reflects the level of fully-funded reserves as reported by the 2006 Reserve Study. That reported level was $1,053,000. To place that amount in perspective, also shown is the amount contributed by the Developer at transition, along with the amount the Developer added pursuant to the 2007 Settlement Agreement. As shown, the extent of the known shortfall in 2007 was $560,000, even following the Developer’s additional contribution in 2007.

When broken down for each Neighborhood homeowner, that shortfall amounts to an average of over $1,400 for each of the 389 homeowners. Who's going to make up that shortfall? Incredibly, in stealing away the Neighborhood’s reserves in the manner they did, the board actually expected to return to the scene of the crime and recover that shortfall through increased assessments. Isn’t that a definition of fraud?

Estimated Shortfall in Neighborhood Reserves at Transition
Source: 2006 Reserve Study, 2007 Settlement Agreement & the 2007 Budget Slide Presentation.

The existence of such a substantial projected shortfall presented a real problem for the 2007-08 board. On the one hand, the board’s own data reflected a potential shortfall in “N’s” reserves of over $500,000. What would be the board’s future response to that realization? Clearly, the board did not want to assume any responsibility for a subsequently reported shortfall in “N’s” reserves, an event that was bound to happen if the board had not gone ahead with their plans to tinker with the Neighborhood results and outcomes of the then newly ordered 2005 “look-back” reserve study.

To prevent that anticipated calamity from happening, the board moved quickly to inform their reserve study contractor, Diversified Facility Services, of their “need” to modify the financial database for the Neighborhoods. That decision and action, in turn, resulted in DFS’s elimination of any projected reserves shortfall being reported for the Neighborhoods. Mission accomplished.

As a result, the board’s decision and actions placed the entire burden of funding any future shortfalls in reserves not where it belonged but on the backs and pocket books of the 389 Neighborhood homeowners, just as the board had planned.

The same pressure that resulted in the Settlement Agreement in the final days of the 2006-07 board would now face the 2007-08 board. The magnitude of an expected shortfall in “N’s” reserves that would likely result from a hands-off 2005 “look-back” reserve study was simply too large for the board to accept or ignore. From the board’s perspective, something had to be done. Either the board had to accept the same basis on which West/Dwyer had relied in any future negotiations with Pulte, which was the 2006 Reserve Study, or the board had to reject that basis as a foundation for any future negotiations or any mutually agreeable disposition on “N’s” claimed asset, otherwise considered a potential liability of the association. It was one way or the other. In the end, the board purchased from Diversified the results they desired—the complete elimination of any additionally reported shortfall in reserves for the Neighborhoods. That decision most likely cost the Neighborhood reserve accounts upwards of $500,000.

For the many reasons already cited, the board was unwilling to address the “N” problem in an upfront manner by confronting the Developer anew or by negotiating with “N” over the value of “N’s” claim. Having rejected those options, the board decided on certain deceptive steps that would make any remaining ”N” shortfall literally disappear as if it never existed.14/ The details of those deceptive practices have been told and retold by me elsewhere and there is no need to repeat them here.

I have concluded that those board decisions concerning the 2005 “look-back” reserve study, however implemented, were not implemented in good faith, were primarily self-serving, wrong, and, yes, fraudulent. Those decisions constituted a substantial breach of duty against the legitimate interests of the 389 homeowners of the Neighborhoods there can be no doubt.

While one would like to be able to applaud the milestones enumerated by Roz Berman, I’m afraid that the deceitful and egregious actions of the 2007-08 board in addressing the 2006 reported reserves shortfall with the dubious results obtained from the 2005 “look-back” Reserve Study on Neighborhood reserves pales by comparison to her reported milestones.

Sun City voters might well have second thoughts about reelecting members to the board who decided it was quite OK to engage in such deceitful machinations, or in supporting those for a board position who condoned such efforts. The association had effectively robbed the Neighborhoods of potential reserves while justifying the siphoning of additional monies from already burdened homeowners to make up for the resulting shortfalls that the board had created by their actions.

The Board’s achievement in this matter must and will forever stand as a hallmark for Sun City Anthem in the self-serving exercise of power that was plainly contrary to the exercise of their fiduciary duty, duty the board wantonly abused and ignored in rejecting the interests of the Neighborhood homeowners. More than any other event in Sun City’s short history, this blight will stand as a glaring example of what can and did go terribly wrong in the exercise of governance in our community.

Understandably, Sun City Anthem may not be the appropriate model to others as an example of an active adult community that some have envisaged.

1/ A more fully explanation might emphasize the inflows and outflows of spendable resources, the inflows are revenues and the outflows are expenditures. The basic accounting equation is then stated as:
Assets + Expenditures = Liabilities + Fund Balance + Revenues
The balance sheets of nonprofit organizations will disclose only readily spendable resources and claims against those resources. Cash and receivables are reflected on the asset side of the statements, while payables constitute the major liability. Source: Financial Essentials for nonprofit Managers, at: http://www.apexcpe.com/publications/171009.pdf

2/ From the vendor’s perspective, the computer’s sale generates a receivable, or income, in this instance, $1,000. When paid, the vendor’s assets go up by $1,000. However, the vendor gave up a computer in their inventory, also an asset, which offsets the amount that was paid by the customer for the computer. In this simplified accounting example, everything is supposed to balance for all parties involved in the transaction.

3/ Whether an item is a potential asset or liability is a matter of judgment, event probability and value. In making a determining of value, one only has to establish that there is some probability of the event occurring, or whether an item has the potential to be an asset or liability. For example, a monetary claim has the potential of becoming an asset for one, while a liability for another.

4/ The valuation of any claim is subject to verification or audit and may be disputed.

5/ In the case of reserves, NRS 116.3115(2)(b) provides as follows: “The association shall establish adequate reserves, funded on a reasonable basis, for the repair, replacement and restoration of the major components of the common elements. The reserves may be used only for those purposes, . . . .”

6/ Of the 389 homeowners, 162 reside in the four duplex villas neighborhoods, while 227 reside in the Pinnacle neighborhood.

7/ Includes all Neighborhood common areas and in the case of the Villa Neighborhoods: (1) operating expenses consists of landscape maintenance; house insurance on the structure; garbage collection; electric bill on the landscaping clocks only; and a water bill on irrigation only; and (2) for reserve items to take care of future exterior painting and roofing needs. In the case of the Pinnacle Neighborhood: entry gate and street maintenance, etc., except homeowners are liable for house maintenance and repairs.

8/ The Settlement Agreement’s release of liability terms favoring Del Webb were extensive and included a provision whereby the Association in consideration of the payments and work promised “completely and forever release and discharge Del Webb from any and all past, present or future claims, demands, obligations, actions, causes of action, suits, debts, liens, judgments, indebtedness, liabilities, obligations, rights, damages, costs, . . . . against Del Webb that may arise from or be related to the Neighborhood Reserves for the Neighborhoods . . . .” and later in a separate section, the “Association expressly waives, and assumes the risk of waiving, any and all claims for damages which may exist as of this date, but of which Association does not know or suspect to exist, whether through ignorance, oversight, error, negligence, or otherwise, and which, if known, would materially affect Associations’ decision to enter into this Agreement.”

9/ Association legal counsel John Leach confirmed in writing that his counsel was not sought in this matter and that he knew nothing about the Settlement Agreement or its terms prior to its execution. Here is what John Leach wrote in a memo to President Mike Dixon on 23 July 2007: “While Association’s legal counsel was present at one of the meetings attended by the Board of Directors and the representatives of the Neighborhoods, neither he nor his firm participated in any meetings with Del Webb regarding the Neighborhood reserve deficiency. Furthermore, neither the Association’s legal counsel nor his firm participated in the preparation, review, or negotiation of the Agreement or any terms and conditions set forth therein.”

10/ In more general terms, cooking the books entails augmenting or falsifying data, typically financial data, to portray something of significance that does not really exist. Traditionally, companies that have cooked the books have engaged in the illegal practice of boosting (falsifying) earnings or revenue figures for some financial purpose, such as increasing a company’s stock valuation and to preserve the wealth and jobs of the decision makers.

11/ Mike Dixon has alleged that they did nothing wrong, relying on the contracted services of a professional reserve specialist to conduct the 2005 “look-back” reserve study. The board defends their actions in modifying the database for the Villa Neighborhoods as proper, even though any alleged and quite substantial surplus in reserves had vanished in the process. After all, according to the board, their proposed changes in the database that resulted in the elimination of any surplus were accepted by their reserve study contractor.

12/ At the time of transition in 2005, the Developer was required to deliver to the association, among other things, “a reserve account that contains the declarant’s share of the amount then due.” NRS 116.31038. Some view “the amount then due” as the fully-funded amount, meaning that the declarant is required to fund the reserves at the 100% level of funding as shown by the transition reserve study. The mandated 2005 reserve study was supposed to report the amount needed to fully fund the reserves. Problems with the original 2005 Study resulted in its then rejection by the board. The board then asked Pulte to obtain a new reserve study, which became the 2006 Reserve Study.

13/ See Slide 28 of the 2007 Budget Presentation.

14/ This effort culminated in the board’s decision to accept the results of the 2005 “look-back” Reserve Study on the 24th of April, 2008, at a regular meeting of the board. At the board’s discretion and direction, that study wiped out the existence of any previously reported net shortfall in Neighborhood reserves.