ADRE Audit & Investigation - Property Management Audits on the Rise?
Our firm has handled countless property management audits for our California real estate brokers and salespersons and the regulatory action in the Golden State is pretty high. However, we have not seen as much from our Arizona clients, until recently, which leads us to believe there may be a trend in new audits and investigations in the Grand Canyon State.
Is the Arizona Department of Real Estate conducting trust fund audits?
The simple answer is yes. If there are complaints, or possibly even a random audit, a brokerage based in Maricopa County or other parts of the state could be subjected to an audit.
Common violations in DRE audits
Here are a few DRE property management violations to note:
(1) Failure of the broker to supervise licensed real estate activity;
SOURCE: A.R.S. 32-2153(A)(21)
Grounds for denial, suspension or revocation of licenses; letters of concern; provisional license; retention of jurisdiction by commissioner; definitions.
21. As a licensed broker, failed to exercise reasonable supervision over the activities of salespersons, associate brokers or others under the broker's employ or failed to exercise reasonable supervision and control over the activities for which a license is required of a corporation, limited liability company or partnership on behalf of which the broker acts as designated broker under section 32-2125. This is where the problems with the so-called "rent-a-broker" come in. A broker who is designated broker for a Arizona real estate office, but not overseeing the day to day activities, the trust fund accounting, not handling complaints etc. This can be a big deal.
See also: AAC R4-28-1103
Bonus Materials: Broker Supervision & Control Audit Declaration Form
(2) Failure to notify the DRE (in writing) of off-site record storage;
SOURCE: A.R.S. 32-2151(B)(2)
2. "The broker shall retain a complete record of all monies received in connection with a real estate transaction in the main or branch office of the designated broker in this state or at an off-site storage location in this state if the broker provides prior written notification of the street address of the off-site storage location to the department. A broker's records shall be kept according to generally accepted accounting principles and shall include a properly descriptive receipts and disbursement journal and client ledger. The broker shall keep any computerized records in a manner allowing reconstruction in the event of destruction of electronic data. The broker shall maintain a trust fund account bank reconciliation and client ledger balance on a monthly basis and shall remove any interest earned on a trust fund account at least once every twelve months. A broker shall not permit advance payment of monies belonging to others to be deposited in the broker's personal account or to be commingled with personal monies. It is not considered commingling if, when establishing a trust fund account, a broker deposits monies not exceeding three thousand dollars to keep the account open or to avoid charges for an insufficient minimum balance."
See also A.R.S. 2151.01(A)
A. Each licensed employing broker shall keep records of all real estate, cemetery, time-share or membership camping transactions handled by or through the broker and shall keep employment records, including copies of employment status, for all current and former employees. The records required by this section shall include copies of earnest money receipts, confirming that the earnest money has been handled in accordance with the transaction, closing statements showing all receipts, disbursements and adjustments, sales contracts and, if applicable, copies of employment agreements. The records shall be open at all reasonable times for inspection by the commissioner or the commissioner's representatives. The records of each transaction and employment records shall be kept by the broker for a period of at least five years from the date of the termination of the transaction or employment. The records shall be kept in the employing broker's principal office or licensed branch office in this state or at an off-site storage location in this state if the broker provides prior written notification of the street address of the off-site storage location to the department.
Attorney Steve Tip: Click here for information on WHAT PROPERTY MANAGEMENT RECORDS MUST BE KEPT IN ARIZONA!
(3) Failure to provide required notices when opening and/or closing a broker trust account;
SOURCE: AAC R4-28-303(E)(11)
(4) Property management agreements are not reviewed or signed by the broker;
(5) Trust funds are placed into an account NOT properly designated as a Client-Trust account, as can be verified by the signature cards;
SOURCE: The trust fund MUST BE "designated" as a trust account. If it is not, your landlord's money is not protected from a bankruptcy trustee, the IRS or other possible creditors who can levy your bank accounts. This is a big issue and many banks such as Bank of America, Chase, Wells Fargo, Citimortgage and others I have talked to do not understand what a property management trust fund account is. This creates BIG PROBLEMS with property management compliance in Arizona.
REQUIRED WORDING FOR ARIZONA TRUST FUNDS ACCOUNT: Here is what the statute says in Arizona and the designated broker needs to make sure THE PROPER WORDING IS USED, or this constitutes a compliance violation that is taken pretty serious.
Per A.R.S. 32-2174. Property management accounts
A. All property management accounts shall be designated as trust accounts and shall include descriptive wording, substantially similar to one of the following, in the trust account title:
1. "Trust account"
2. "Fiduciary account"
3. "In trust for (individual or entity name)"
4. "Trustee for (individual or entity name)"
5. "Fiduciary for (individual or entity name)"
Resource: Here is a list of banks in CALIFORNIA who according the C.A.R. (California Association or Realtors) understands what a property management trust account is, and can help you get setup properly. Make sure they do business in Arizona. C.A.R. list of trust fund banks.
Attorney Steve Tip: Failure to designate an account as a trust account can lead to charges of "comingling" (See A.R.S. 32-2151(B)(2)) (this occurs where "trust funds" end up in your own personal or business account. They need to be separated. They sometimes refer to comingling as "embezzlement" which is obviously a word noone wants to hear.
(6) Leases do not state the disposition of deposits. This may require the brokerage to update the tenant lease agreements.
(7) Other miscellaneous trust fund rules
B. A broker's trust account is required for all of the owner's monies, except if the owner directs the broker to deposit the monies directly into the owner's account. The broker shall not have access to the owner's account. Trust accounts may be interest bearing.
C. The designated broker for a property management firm may authorize either a licensee or an unlicensed natural person in the direct employ of the broker to transfer monies or to be a signatory on the property management firm's trust accounts. If the person who is designated to sign on behalf of the designated property management broker is an unlicensed person, that person shall be a bona fide officer, member, principal or employee of the property management firm. The broker may require dual signatures on checks and may use a facsimile signature according to the broker's business policies and procedures. The designation of a licensed or unlicensed person to transfer monies or to be a signatory on trust accounts does not lessen the broker's responsibility or liability for any monies handled.
D. Within three banking days after receiving monies that are not subject to dispute or contingency, the property management firm shall deposit the monies in either the owner's direct account or the property management firm's trust account for the benefit of the owner. A property management firm may remit an owner's monies under its control to or for the owner by any lawful means available.
E. Each rental agreement executed by a property manager shall include a provision that clearly states the disposition of any tenant deposits.
(8) Unauthorized practice of law. There are some situations that may be tempting to get involved in, but every property management company needs to be cautious about providing legal advice and engaging in other acts which could be deemed the "unauthorized practice of law" or UPL. The Arizona State Bar or Attorney General's office could take issue with some activities such as:
- Representing homeowners, HOA or tenants in mediation
- Preparing legal contracts
- Providing legal advice on contractual or commercial lease matters, residential leases etc.
- Preparing documents to be filed in any judicial, quasi judicial or administrative proceeding
- Negotiating legal rights (for example negotiating an easement)
NOTE: It should be "proper to prepare late payment notices and eviction notices relating to the property being managed" according to the State bar article noted above if incidental to the business. Always check with real estate counsel if you are not sure. Read the above article for more information on this topic.
I will be posting a few more violations of Arizona law when more time permits. So make sure to bookmark this page for future updates.
How can my brokerage prepare for the investigation?
Here is my TOP 5 LIST of things you can do to get ready for a ADRE property management audit or investigation of your business practices:
- Seek legal counsel (it is goo to go through a dry run of what you can expect, and to help prepare you for some of the issue that might arise during the audit). We have helped many brokers in the past and we do this on a low flat rate fee. If you ever thought about aligning your company with real estate counsel, now is probably a good time to forge that relationship, and frankly we believe we are the best firm to help you!! : )
- Gather all of your transactional documents (here is a list of the documents you should be keeping in your AZ real estate business);
- Make sure all your contracts are in place (check your tenant agreements, and owner management agreements). Is everything signed, reviewed and is the broker following the contracts?
- Review your property management trust fund accounting, bank records, reconciliations, and signature cards (see above, make sure your account is properly designated as a trust account);
- Make sure your corporate and employee/agent records are up to speed and that you are keeping all records ONSITE including employment records.
There are many other things to consider, but contact us at the number below to discuss items that may be applicable to your business. We have helped numerous brokers, sales agents, property managers, mortgage lenders and other real estate professionals over the last 11 years. We can help you too.
AZ Real Estate Compliance Resources
- ADRE model policies and procedure manual
- AZ Department of Real Estate FAQ page
- Arizona property management leasing forms (AAROnline)
- Helpful AZ DRE Audit Guide
Contact a Maricopa County Property Management Law Firm
If you are in Maricopa, Pinal, Yuma, Coconino, Pima, Yavapai, or other Arizona county, call us at (877) 276-5084. We handle cases from Tucson up to Flagstaff and over to Lake Havasu. We offer flat rate legal fees for many of the cases we work on. You can also fill out the contact form below to have a representative of our law firm contact you. Normally we are able to get back to you within the hour. PLEASE MAKE SURE TO LEAVE YOUR PHONE NUMBER!!