oversight

Review of Management Controls over Disbursements, Lafayette Square Apartments, Macomb, Illinois

Published by the Department of Housing and Urban Development, Office of Inspector General on 2001-09-28.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                    U.S. Department of Housing and Urban Development
                                 Office of Inspector General, Rocky Mountain
                                           633 17th Street, North Tower, 14th Floor
                                                  Denver, CO 80202-3607
                                                        (303) 672-5452
                                                     Fax (303) 672-5006

OFFICE OF INSPECTOR GENERAL FOR AUDIT
                                                                                      Audit Memorandum
                                                                                      No. 2001-DE-1802

September 28, 2001

MEMORANDUM FOR: Edward J. Hinsberger, Director, Chicago Multifamily HUB, 5AHM




FROM: Robert Gwin, District Inspector General for Audit, 8AGA

SUBJECT: Review of Management Controls Over Disbursements
          Lafayette Square Apartments
          Macomb, Illinois

                                         INTRODUCTION

We completed a review of Lafayette Square Apartments, located in Macomb, Illinois. The objectives
of the review were to determine if:

    •   The management controls over the disbursements functions have been effectively established
        and implemented by the management agent and

    •   The disbursements, since the management agent changed in 1999, are allowable and
        reasonable.

We reviewed procedures and management controls over the disbursements and related financial
activities of the project and management agent between January 1, 1999 and June 30, 2000. The
scope was expanded as needed to cover subsequent activities. We accomplished the objectives by
evaluating: the management controls over the disbursements functions and procedures; related
accounting activities; and, the expenses for allowability and reasonableness. We reviewed records
relating to the project and interviewed individuals associated with the project and also HUD personnel.

We conducted the onsite work during July 2000. Additional information was subsequently obtained
from the project, persons associated with the project, and HUD. The completion of our review was
interrupted by situations which necessitated reassignment of staff. Considering this situation, we
conducted the review in accordance with Generally Accepted Government Auditing Standards.

                                           BACKGROUND

Lafayette Square Apartments was owned by Lafayette Square, Inc., a non-profit corporation, and
sponsored by Health Services Association. The owner’s Articles of Incorporation, dated June 9, 1978,
stated the purpose was to provide elderly and handicapped persons with housing facilities and services
specifically designed to meet their physical, social and psychological needs, and to promote their health,
security, happiness and usefulness in longer living. The Articles also stated that the Board of Directors
shall consist of not less than three nor exceed seven persons and shall have the specific authority to
designate an individual or committee to carry out the functions of the non-profit corporation with full
authority to act on behalf of the Board. Members of the sponsor’s Board of Directors also were
members of the owner’s Board.

Lafayette Square, Inc. signed an original FHA mortgage note for a direct loan, which was insured under
Section 202 of the Housing Act of 1959, as amended. The owner executed a Regulatory Agreement
with HUD dated October 1, 1981, and a Section 8 Housing Assistance Payments Contract effective
September 30, 1982, for 100 units. The project has a total of 101 units.

The sponsor functioned as management agent from the inception of the project until April 1999, at
which time the State of Minnesota, under a court order, seized the sponsor’s records and the entity was
effectively dissolved. The Board of Directors appointed Foster and Associates as Lafayette Square
Apartment’s management agent in May 1999.

The project is located at 100 West Jefferson Street, Macomb, Illinois. The management agent was
located in Kalispell and Whitefish, Montana. The management agent hired in July 2000 a fee
accountant, located in Kalispell, Montana to prepare the books of account for the project. Various
project records, from 1999 to the present, were maintained at these different locations.

                                         RELATED REVIEW

We initially conducted a review of the project’s records maintained by Health Services Association, the
project sponsor, located in St. Paul, Minnesota. Our review was conducted of the project sponsor’s
records that were seized by the State of Minnesota and provided to our office in Denver. Results of
this review of the project records were provided to the HUD Multifamily HUB in Chicago. HUD used
the results as the basis for initiating administrative actions against the project owner. On February 1,
2000, HUD issued a Notice of Potential Violations of Regulatory Agreement letter to the owner. HUD
questioned the project eligibility of costs totaling $315,639.12. The project owner has subsequently
provided information to HUD on the questioned costs. The resolution of the possible Regulatory
Agreement violations is still continuing.




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Health Services Association was also the project sponsor for two other HUD insured projects located
in Whitefish and Missoula, Montana. The sponsor’s records for these two Montana projects were also
seized by the State of Minnesota. The Board of Directors for each of these two project also appointed
Foster and Associates as management agent for the projects. A separate audit report is being issued
for our review of these two projects.

                                          AUDIT RESULTS

We reviewed the management controls over the disbursements functions and related accounting
activities. We also reviewed the reasonableness of the expenses from May 1999 through June 2000.
We expanded the review to June 2001 for specific expenses. We found that the project management
oversight by the project fee management agent and Board of Directors to be deficient. This is discussed
in the following finding:

Finding: Deficient Project Management Oversight
We reviewed the management controls over the disbursements functions and related accounting
activities as well as reviewed the reasonableness of the project expenses for the audit period. We noted
that the fee management agent has not carried out their responsibilities of managing the project. The
management agent has not executed the required management agreement with the project owner
detailing what services were to be provided and the basis for compensation. While the management
agent contracted for the establishment of the project’s books of account, the accounting records have
not been used in providing financial information to the onsite project managers for the daily operation of
the project. In addition, the official accounting records have not been independently audited for the
1999 and 2000 fiscal years as required by HUD. Furthermore, the management agent has not
administered the tenant selection, rent calculations and tenant payment and HUD rental assistance
collection activities but has allowed them to be performed by the onsite project managers or staff.

The fee management agent, located in Montana, has not exercised any meaningful oversight of the
Illinois located Lafayette Square Apartments project and its managers and staff. The onsite project
managers and staff have been effectively carrying out the daily operations of the project. Without a
management agreement and without the expected management services being provided, the total fee of
$112,943 paid to the management agent for the period from May 1999 through June 2001 is
questionable.

The Board of Directors has not fulfilled its responsibilities for oversight of the project. The Board has
not taken necessary action to ensure that the management agent is performing its required duties. The
Board has allowed its management agent to receive fees for administering the project even though many
of the required management agent services have not been performed.

    HUD Program Requirements: HUD requirements are set out in the Regulatory Agreement
    between the project and HUD as well as in various HUD regulations and handbooks. Basically, the
    fee management agent must follow certain requirements dealing with the overall oversight and



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administration of the project in conformity with the provisions of a written agreement with the
project ownership and with the applicable HUD requirements. Also, the Board of Directors as the
governing oversight body has the main responsibility that the project is administered in conformity
with provisions of the Regulatory Agreement with HUD and with specific HUD statutes and
requirements.

Management Agent Requirements: HUD requires the project owner and management agent to
submit to HUD for HUD’s review and approval a Management Agent’s Certification. The
Management Agent’s Certification requires the management agent to:

•   Execute a Management Agreement within 30 days of the approval of the Certification by HUD;

•   Calculate the management fee based on actual income collected;

•   Disburse management fees only after HUD approval of the management agent to manage the
    project;

•   Select and admit tenants, compute tenant rents and assistance payments, recertify tenants and
    carry out other subsidy contract administration responsibilities;

•   Comply with the Regulatory Agreement, Subsidy Contract, HUD Handbooks, and other HUD
    requirements;

•   Assure that all expenses of the project are reasonable and necessary; and

•   Establish and maintain the project’s accounts, books and records in accordance with the
    requirements.

The Certification also requires the owner to submit a new Management Agent’s Certification to
HUD before changing the expiration date or renewing the Management Agreement.

Project Governing Body Requirements: The Project Board of Directors is the overall governing
body for the project owner, Lafayette Square, Inc. This Board is obligated to ensure that the
Lafayette Square Apartments project is carried out in conformity with HUD statutes, regulations
and program requirements and to ensure that its management agent also complies with these
requirements.

Management Agent Not Providing Required Services

The owner and management agent signed a Management Agent’s Certification (Certification) on
May 10, 1999, with a twelve-month term. HUD did not sign the Certification until October 1999.
However, HUD considered the situation eligible for retroactive approval, so the effective date of the
Certification was May 1999. The owner and management agent did not submit a new Management




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Agent’s Certification to HUD when the original one expired in May 2000. Therefore, the
management agent has been receiving management fees without a valid Certification since May
2000.

The Certification required that a Management Agreement be executed. HUD Handbook 4381.5
stated that the Management Agreement must contain the scope of service; the length or term of the
agreement; and certain required clauses including, that management fees will be computed and paid
according to HUD requirements, and that HUD may require the owner to terminate the agreement
for specified conditions. The scope of service must describe the services the agent is responsible
for performing and for which the agent will be paid management fees.

No evidence was provided that the management agent has executed the required management
agreement with the project owner. Without an agreement, neither the project owner nor the
management agency can identify the specific services to be performed by the management agent as
well as the basis for any compensation.

The management agent was collecting a set amount as the management fee, instead of using the
actual income to calculate the fee each month. Initially, this was the same as the amount paid to the
prior management agent. In December 1999, the amount was changed to the amount determined
by HUD as the estimated monthly residential fee yield on the Certification. Therefore, the
management agent was not in compliance with the requirements for calculating the management fee.

The management agent, as of July 2000, had not established any formal books of account for 1999
or 2000. The management agent hired an accountant in July 2000 to prepare the books of account
for 2000. In August 2001, the accountant provided us Excel files of the books of account he had
prepared from January 2000 through June 2001 for the project. The current accountant in
establishing the project’s official books of account has had to take into consideration various factors
stemming from the records that were maintained by the former accountant.

While the prior management agent’s accountant completed a trial balance for 1999, the 1999
ending balance was questionable. The current accountant had to make an adjustment of
$18,564.26 in January 2000 to bring the books into balance with the bank. In December 2000, the
accountant wrote off an Accrued Interest Payable account for $31,499.91 because there was no
rationale for a payable on a direct loan with HUD. The accountant stated that the books of account
will have to be further adjusted to include the adjustments in the 1999 audited financial statements
report.

The HUD requirements included submitting an audited financial statements report within 60 days of
each fiscal year end. The project’s fiscal year end was December 31, so the report was due by
March 1. The CPA, hired to complete the audits, stated in June 2001, that he had not started the
audits for 1999 or 2000. The 1998 audit has been completed but it has not been properly
submitted electronically to HUD. Consequently, HUD considered the project to be three years
delinquent in submitting the audited financial statement reports. Ensuring that the project financial




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records are timely audited and submitted to HUD would be one of the responsibilities of the
management agent.

The project records showed no involvement by the management agent in the occupancy functions.
The onsite project managers fulfilled all these functions and there was no evidence of management
agent review or oversight.

The project records did not contain evidence of management agent involvement in the
disbursements functions. The project managers stated that the management agent gave telephone,
e-mail or faxed approval of the check requests; however, the project records did not show
management agent approval of the transactions. The management agent was not providing the
required budgets or other financial reports that would be beneficial to the project managers in the
administration of the project operations.

Project Managers Functioning Effectively

The onsite project managers were providing the majority of the services required in the
Management Agent’s Certification. They were performing all of the tenant occupancy functions.
They established and maintained a combined receipts and disbursements ledger and reconciled the
bank statement to this ledger monthly. They prepared and submitted the required Monthly Report
for Establishing Net Income to HUD. They were responsible for the day-to-day management and
maintenance of the project and determined the necessary project expenses. They submitted check
requests to the management agent for approval. They also submitted the check requests to a
member of the Board of Directors, who had possession of the check blanks but was not an
authorized signature on the bank account. The Board member wrote the checks and sent them to
the project managers, who signed and issued the checks. The project managers also submitted
weekly and monthly financial summary reports to the management agent.

Payroll Procedures Need Improvement

The onsite project management and staff were functioning without any specific guidance or written
instructions from the management agent. Even so, the project managers had established effective
procedures for most functions; however, the procedures over payroll were weak. The project
managers did have an old employee handbook as a payroll procedures guide. The handbook
required that time cards be prepared by the employees and approved by the project manager and
the management agent. Time cards were not prepared and the computer generated payroll
schedules did not have evidence of approvals. However, the management agent did not instruct the
project managers to comply with the employee handbook.

Personnel files containing wage rates and benefits information were not maintained at the project.
The project did not have documentation showing Board of Director authorization of wage increases
and benefit payments. For example, the full time employees were receiving annual IRA payments,
but the project records did not show authorization by the Board or approval of payment by the




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management agent. Despite these weak procedures, the regular payroll expenses were allowable
and reasonable.

Management Fee Disbursements Were Questionable

We reviewed the expenses for allowability and reasonableness. The project level expenses were
for allowable items and were reasonable. The one expense that was questionable was the
management fee. The payments to the management agent were questionable since the project
managers, not the management agent, were providing the majority of the required services. The
management fees paid, from May 1999 through June 2001, totaled $112,943. The full amount was
questionable since the project records did not show evidence that the management agent provided
the required services.

Lack of Effective Oversight

Neither the management agent nor the Board of Directors was effectively interacting with the
project. Distance was a factor in the lack of effective oversight. The management agent located in
Montana had never visited the project, so they did not have first hand knowledge of the project
status. As stated above, the management agent has not provided the services it was to provide as
specified in their Certification to HUD. Instead the onsite project staff has carried out the day-to-
day operations of the project.

The use of a remote management agent may not be the most beneficial form of oversight
management for the project. One possible alternative would be to utilize the services of a
management agent entity that is located in the same locality as the project. This would enable the
management agent to provide improved and accessible services to the project and its staff. Another
alternative would be to use a project administrator type of project management. This type of
management as authorized in HUD Handbook 4381.5 allows an individual hired by the project to
direct the day-to-day activities of the project and would report directly to the Board. This
individual or administrator would perform the duties and activities required by the management
agent. In effect, the onsite project managers have function in most instances as a project
administrator.

Distance has also been a factor in the lack of oversight by the project’s Board of Directors. Most
of the Board members live in Minnesota and have not had direct contact with the project or the
management agent. The Board’s involvement was usually limited to quarterly telephone
conferences, which usually did not include the project managers. The use of a management
organization structure that is located within the locality of the project to administer the project and its
activities would better serve the Board in its oversight responsibilities of the project.




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Auditee Comments

The Auditee provided written response to the draft memorandum report on September 26, 2001.
Basically, they disagreed with the audit finding. The Auditee states that the required management
agreement has been submitted to the Chicago HUD office and that the management agent has provided
management oversight and direction to the on-site staff. The response indicates that the on-site
personnel have day-to-day input into the expenditures and are part of the budget process. Any and all
needed information is available and provided to the on-site staff.

The Auditee indicates that they were granted an extension to have the annual audits performed. Part of
the problem in performing the 1999 annual financial audit was that some of the accounting records were
held by this office and unavailable to the independent project auditor.

The Auditee’s written response indicates that various documents and information have been supplied to
the Denver HUD office and that the HUD officials were aware of and accepted the practices and
procedures being followed by the Management Agent.

Evaluation of Auditee’s Comments

The Auditee’s response is not responsive to the finding.

The response indicates that the Management Agent has executed a management agreement with the
project. The Chicago HUD office is not aware of any management agreement being executed by the
Management Agent and owner. In addition, we were not provided a copy of the agreement during our
on-site review. Without the required agreement, a determination could not be made as to the exact
nature of services to be provided by the Management Agent or the basis for any compensation.

As stated in the finding, the Management Agent has not provided any direct supervision over the on-site
staff except in limited areas such as approving disbursements. Official accounting records for the
project were not established until after July 2000; however, as of May 2001, the on-site staff still had
not received any accounting or budget information from the Management Agent to be used in
administering the daily operations of the project.

The Auditee’s written response to the draft memorandum and related finding indicates that this office
has not provided needed information to the project’s independent auditor, thereby delaying the audit.
This is inaccurate since the independent auditor has not even started the audits for the 1999 and 2000
fiscal years. Furthermore, this office has not received any request to provide any information and/or
records to the independent auditor for Lafayette Square Apartments.

A lot of the information provided by the Auditee in their response related to situations and events that
occurred prior to our audit period and prior to the current Management Agent being appointed. Finally,
the auditee indicates that various documents and information has been furnished to the Denver HUD




                                                 Page 8                                     2001-DE-1802
Office and that the Denver HUD officials were aware of and accepted the practices and procedures
being followed by the Management Agent. This is not relevant since the Chicago HUD Office has the
responsibility for oversight of the Lafayette Square project, not the Denver HUD Office.

RECOMMENDATIONS

We recommend that the Office of Multifamily Housing:

    1A.     Require the management agent to provide documentation for the $112,943 paid in
            management fees showing evidence of effective fulfillment of the management agent services
            and to repay the fees received for any services not properly or adequately accomplished.

    1B.     Require the Board of Directors to determine if the management agent should be replaced.
            If the determination is to replace the management agent, provide assistance to the Board in
            selecting a new management agent, including consideration of utilizing a project
            administrator type of project management.

    1C.     Provide technical assistance to the Board of Directors and management agent in establishing
            effective procedures to ensure full compliance with the HUD requirements.

    1D.     Once the effective procedures under 1C above have been established, determine that the
            project management and related procedures are in compliance with HUD requirements.

These recommendations will be controlled under the Departmental Automated Audit Management
System. Within 60 days please furnish to this office, for each recommendation in this report, a status
report on: (1) the corrective action taken; (2) the proposed corrective action and the date to be
completed; or (3) why action is considered not necessary. Also, please furnish us copies of any
correspondence or directives issued because of the audit.

We appreciate the courtesies and assistance extended by the personnel of Lafayette Square, Inc. and
the Chicago Multifamily HUB. Should you have any questions, please contact Ernest Kite, Assistant
District Inspector General for Audit, at (303) 672-5452.




                                                 Page 9                                      2001-DE-1802
                              Appendix A

Auditee Comments




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                                                                                     Appendix B

Distribution
Secretary’s Representative, 5AS (2)
Director, Chicago Multifamily HUB, 5AHM (2)
Special Assistant for Multifamily Housing, HT, Room 6106
Deputy Secretary, SD, Room 10100
Chief of Staff, S, Room 10000
Assistant Secretary for Administration, A, Room 10100
Deputy Chief of Staff, S, Room 10226
Deputy Chief of Staff for Operations, S, Room 10226
Deputy Chief of Staff for Programs and Policy, S, Room 10226
Assistant Secretary for Congressional and Intergovernmental Relations, J, Room 10120
Senior Advisor to the Secretary, Office of Public Affairs, S, Room 10132
Deputy Assistant Secretary for Public Affairs, W, Room 10222
Special Counsel to the Secretary, S, Room 10234
General Counsel, C, Room 10214
Deputy General Counsel, CB, Room 10220
Office of Policy Development and Research, R, Room 8100
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7106
Director, Office of Department Operations and Coordination, I, Room 2124
Chief Procurement Officer, N, Room 5184
Chief Information Officer, Q, Room 3152
Chief Financial Officer, F, Room 2202
Deputy Chief Financial Officer for Operations, FF, Room 10166
Director, Office of Budget, FO, Room 3270
Director, Enforcement Center, V, 200 Portals Building
Director, Real Estate Assessment Center, X, 1280 Maryland Ave., SW, Suite 800
Departmental Audit Liaison Officer, FM, Room 2206
Headquarters Audit Liaison Officer, Public and Indian Housing, PF, Room P8202
Field Audit Liaison Officer, 6AF, (2)
Director of Scheduling and Advance, AL, Room 10158
Assistant Deputy Secretary for Field Policy and Management, SDF, Room 7108 (2)
Special Assistant to the Deputy Secretary for Program Management, SD, Room 10100
Acquisitions Librarian, Library, AS, Room 8141
Inspector General, G, Room 8256
The Honorable Joseph Lieberman, Chairman, Committee on Governmental Affairs, 340 Dirksen Senate
        Office Building, United States Senate, Washington, DC 20510
The Honorable Fred Thompson, Ranking Member, Committee on Governmental Affairs, 706 Hart
        Senate Office Building, United States Senate, Washington, DC 20510
The Honorable Dan Burton, Chairman, Committee on Governmental Reform, 2185 Rayburn Bldg.,
        House of Representatives, Washington, DC 20515



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Henry A. Waxman, Ranking Member, Committee on Governmental Reform, 2204 Rayburn Bldg.,
        House of Representatives, Washington, DC 20515
Ms. Cindy Fogleman, Subcommittee on Oversight and Investigations, Room 212, O’Neil House Office
        Building, Washington, DC 20515
Director, Housing and Community Development Issue Area, United States General Accounting Office,
        441 G Street, NW, Room 2474, Washington, DC 20548 (Attention: Stan Czerwinski)
Deputy Staff Director, Counsel, Subcommittee on Criminal Justice, Drug Policy and Urban Resources,
        B373 Rayburn House Office Building, Washington, DC 20515
Steve Redburn, Chief, Housing Branch, Office of Management and Budget, 725 17th Street, NW,
        Room 9226, New Executive Office Building, Washington, DC 20503
Andy Cochran, House Committee on Financial Services, 2129 Rayburn H. O. B., Washington, DC
        20515




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