MAGNOLIA LANE APARTMENTS
PROJECT MANAGEMENT OPERATIONS
CONWAY, SOUTH CAROLINA
2002-AT-1001
JUNE 5, 2002
OFFICE OF AUDIT
SOUTHEAST/CARIBBEAN REGION
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Issue Date
June 5, 2002
Audit Case Number
2002-AT-1001
TO: Glenda L. Fesperman, Acting Director, Columbia Multifamily Program
Center, 4EHM
FROM: Nancy H. Cooper
Regional Inspector General for Audit-Southeast/Caribbean, 4AGA
SUBJECT: Magnolia Lane Apartments
Project Management Operations
Conway, South Carolina
We completed an audit of Magnolia Lane Apartments, Conway, South Carolina. We conducted
the audit pursuant to a request by your office. This report contains two findings that require
follow-up action by your office to implement appropriate corrective action.
You have completed final action on recommendation No. 1A. Within 60 days please provide us,
for recommendations 1B and 1C 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
unnecessary. Also, please furnish us copies of any correspondence or directives issued because
of the audit.
Should you or your staff have questions, please contact Terry A. Cover, Assistant Regional
Inspector General for Audit, or Senior Auditor, Narcell Stamps, at (404) 331-3369.
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Management Memorandum
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Executive Summary
We conducted the audit of Magnolia Lane Apartments in response to a request by the
Department of Housing and Urban Development (HUD), Columbia State Office, Multifamily
Program Center. We reviewed certain aspects of project operations for compliance with HUD
requirements. Specifically, the audit objective was to determine if the mortgagor used project-
operating funds in compliance with the Regulatory Agreement and HUD requirements
specifically related to the distributions of earnings. We did not audit project construction
activities and costs.
The owner/manager of Magnolia Lane misused project operating and trust funds, and
encumbered project assets in violation of its Regulatory Agreement. Although funds were
available for at least six mortgage payments, the owner made no payments, causing the mortgage
default and subsequent assignment to HUD. Throughout the period of default, the owner ignored
HUD’s repeated requests for monthly accounting reports it needed to monitor project revenues
and disbursements. Also, the owner did not remit net project cash (funds remaining after
payment operating expenses) to HUD’s lock box as HUD requested.
The owner disbursed $185,129 in project operating and trust funds for ineligible distributions
($166,364), unreasonable and unnecessary costs ($15,558), and unsupported costs ($3,207.) The
distributions included $148,625 paid after the mortgage default, constituting an equity skimming
violation. The owner directly benefited from $82,434 of the ineligible disbursements. The
owner improperly encumbered a project escrow account for $100,000 to secure unspecified
notes, and spent $43,225 in tenant security deposits and prepaid rent which were required to be
held in trust accounts to cover the corresponding project liabilities. We attribute these conditions
to the owner’s failure to abide by HUD requirements specified in the Regulatory Agreement that
he signed.
We recommend that your office obtain mortgagee-in-possession (action completed) to secure
and protect HUD’s interest in this project. We further recommend that your office debar the
mortgagor and its individual principals from future participation in HUD programs; require the
owner to reimburse the project operating and trust accounts for $166,364 of ineligible
disbursements and $15,558 of costs found to be unreasonable and unnecessary; and require
adequate documentary support, or reimbursement, for $3,207 of unsupported costs.
We discussed the violations with the owner during the audit and at an exit conference on
April 25, 2002. The owner provided written responses to the draft report on May 9, 2002. The
owner disagreed with certain conclusions reached in finding 1 but he basically agreed with
finding 2. The owner’s written comments, minus the lengthy exhibits, are presented in Appendix
D. We considered the owner’s response in finalizing the report. The owner’s comments are
summarized within each finding. We will provide the owner’s comments with exhibits to your
office under separate cover.
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Executive Summary
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Management Memorandum i
Executive Summary iii
Introduction 1
Findings
1 Mismanagement of Project Funds and Assets Contributed to
Mortgage Default and Assignment 3
2 Misuse of Security Deposits and Prepaid Rent 13
Management Controls 15
Follow-Up On Prior Audits 17
Issue Needing Further Study and Consideration 19
Appendices
A Summary of Questioned Costs 21
B Schedule of Ineligible Distributions 23
C Schedule of Unreasonable and Unsupported Costs 25
D Auditee Comments 27
E Distribution 29
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Abbreviations
HUD United States Department of Housing and Urban Development
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Introduction
Background
Magnolia Lane Apartments, located in Conway, South Carolina, is a 48-unit profit motivated
project owned by Magnolia Lane Inc, (Mortgagor). HUD authorized and financed the project
under section 221(d)(4) of the National Housing Act. The stockholders in the mortgagor entity
were James C. Hicks, President (48 percent); Margaret L. Hester, Vice President (48 percent);
and Superior Construction Greenville LLC, general contractor (4 percent). Ms. Hester and Mr.
Hicks are sister and brother. Mr. Hicks (herein referred to as “owner”) managed, controlled, and
directed all aspects of the project and maintained the project’s books and records.
On November 2, 2000, the owner signed the substantial completion certificate for this newly
built project. However, after signing the certificate, he questioned the adequacy and
completeness of the general contractor’s work and refused to pay the contract retainage. On
January 29, 2002, the general contractor filed suit against the mortgagor seeking payment and
damages. We did not audit these issues since they were known to HUD and were being
reviewed by HUD’s Columbia State Office staff.
The owner made no mortgage payments from project operating revenues and allowed the
mortgage to go into default on April 1, 2001. The lender paid the only payments made on the
mortgage. For February and March 2001, the lender paid mortgage payments from the project’s
operating deficit and working capital reserve account. The lender filed an assignment of the
mortgage to HUD on July 10, 2001. HUD provided the mortgagor with an opportunity to submit
a workout plan to bring the mortgage current. The mortgagor submitted a work out plan, but
HUD rejected it because it did not meet requirements. As a result, the Columbia State Office
recommended foreclosure on the mortgage. Subsequently, HUD’s Headquarters’ Office decided
to sell the project in the upcoming July 2002 note sale versus foreclosure.
While the audit was in process, the Columbia State Office referred the mortgagor to HUD’s
Enforcement Center, issued limited denials of participation against the owner and his sister
(co-owner), and initiated steps to debar them. Also during the audit, the HUD Office of General
Counsel, working with the Enforcement Center, contacted the owner and demanded that he turn
over control of the project to HUD. Immediately following the April 25, 2002, exit conference
HUD’s staff again met with the owner and his attorney concerning the mortgagee in possession
agreement. The owner signed HUD’s mortgagee in possession agreement on April 25, 2002,
granting HUD control of the project. HUD’s contract manager arrived on site on April 26, 2002,
to take physical control of the project and assumed management of project operations.
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Introduction
The audit objective was to determine if the mortgagor used
Audit objectives and project-operating funds in compliance with the Regulatory
scope Agreement and HUD requirements specifically related to
the distributions of earnings. We did not audit project
construction activities and costs.
To accomplish the objective, we reviewed project records
at HUD’s Columbia, South Carolina, office and at the
office of an attorney representing the owner/manager of
Magnolia Lane Apartments in Conway, South Carolina.
The owner/manager arranged for us to review project
records at the attorney’s office. We also interviewed
officials at HUD’s Columbia and Atlanta offices, the
owner/manager, the owner’s attorney, and four tenants.
The audit covered the period December 1, 2000, through
December 15, 2001. During this period, the project
disbursed $244,194 from its operating account. We
reviewed $201,603, or 83 percent of the disbursements.
We selected and reviewed disbursements based on the
dollar amount and the type or name of the payee. We
conducted the audit from December 2001 through March
2002 in accordance with generally accepted government
auditing standards.
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Finding 1
Mismanagement of Project Funds and Assets
Contributed to Mortgage Default and
Assignment
Magnolia’s managing owner improperly disbursed $185,129 in project operating and trust funds,
while not making mortgage payments and ignoring HUD’s requests for monthly accounting
reports. The questioned disbursements consisted of $166,364 for ineligible distributions,
$15,558 for unreasonable costs, and $3,207 for unsupported costs. The ineligible distributions
included $148,625 disbursed after mortgage default and $108,162 after HUD specifically warned
the owner about improper distributions. The owner also encumbered project assets for $100,000
to secure unspecified notes. The misuse of funds contributed to the mortgage default and HUD’s
recommendation to foreclose on the mortgage. We attribute these conditions to the owner’s
failure to abide by HUD requirements.
At HUD’s request, the owner shall furnish monthly
Owner not occupancy reports and shall give specific answers to
responsive to HUD questions upon which information is desired from time to
time relative to income, assets, liabilities, contracts,
operations, conditions of the property, and the status of the
insured mortgage (Regulatory Agreement Section 9(f)).
HUD provided the owner with the form ”Monthly Report
for Establishing Net Income” used to prepare monthly
reports. The form provided for detailed reporting of project
cash balances, disbursements, and accounts payable.
The owner did not comply with HUD’s repeated requests
for monthly accounting reports and to HUD’s request to
remit net cash, after payment of operating costs, to HUD’s
lock box. The owner’s noncompliance was significant
considering that he made no mortgage payments and used
project funds for unauthorized purposes. HUD made the
following requests for monthly accounting reports and
remittance of project net cash:
Type Nature of HUD’s
Date Request Request
March 12, 2001 Letter Monthly Accounting
Report
May 22, 2001 Letter Monthly Accounting
Report
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Finding 1
July 18, 2001 Letter Monthly Accounting
Report
July 18, 2001 Letter Remit net cash (cash
remaining after
payment of costs for
operations and
maintenance) to HUD’s
lock box.
September 6, 2001 Meeting Monthly Accounting
Report
The owner did provide HUD with limited financial
information (balance sheet and operating statements)
during a September 6, 2001, meeting. However, the owner
never provided the requested monthly reports. This
violation deprived HUD of the financial information it
needed to monitor project revenues, disbursements and
obligations.
Near the completion of the audit, the owner also became
unresponsive to our requests for information. The owner
initially cooperated and provided information we requested
for the audit. However, as we prepared to finalize on-site
audit work, the owner did not respond to our written
request and repeated telephone calls to schedule a final visit
to update financial information through January 31, 2002.
We terminated on-site work without obtaining updated
financial data. We decided to report our findings based on
the information through December 15, 2001, rather than
delay the report while seeking additional records via legal
enforcement processes.
Distributions means any withdrawal or taking of project
Ineligible cash or any assets of the project including the segregation
distributions of cash for subsequent withdrawal, excluding payments for
reasonable expenses incidental to the operations and
maintenance of the project (Regulatory Agreement, Section
13(g)). Without HUD’s prior written permission, owners
shall not make or receive and retain any distribution of
assets or any income of any kind of the project except
surplus cash. Owners shall not make distributions from
borrowed funds, prior to completion of the project, or when
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Finding 1
there is any default under the Regulatory Agreement or
under the note or mortgage (Regulatory Agreement,
Section 6(e)). Any owner receiving such funds in violation
of the Regulatory Agreement shall hold such funds in trust
(Regulatory Agreement, Section 9(g)).
The owner disbursed $166,364 from project operating
funds for ineligible distributions, including $82,434 that
directly benefited the owner. Appendix B provides a
detailed listing of the expenditures summarized below:
Characteristics of the Distributions
Description Portion Portion
of After After Amount
Distributions Improper Mortgage Written Benefiting
Distribution Default Warning Owner
Transfers to
Money
Market
Account $53,000 $ 53,000 $ 53,000 $19, 832
Payments To
or For Owner 38,828 32,886 15,103 38,828
Washers and
Dryers 29,337 23,247 17,052 0
Repayment
of Loans 20,589 19,389 11,247 20,589
Legal Fees 13,501 12,301 9,411 0
Other 11,109 7,802 2,349 3,185
Totals $166,364 $148,625 $108,162 $ 82,434
Transfers to Money Market Account - The owner
transferred $53,000 from the operating account to a
money market account maintained in the name of the
mortgagor entity, Magnolia Lane, Inc. The owner
subsequently disbursed $19,832 to an identity-of-
interest firm, H&H Investments as partial payment on
four loans totaling $53,154, which the owner recorded
on the project books. The owner stated that he also
owned H&H Investments and that the loans resulted
from amounts H&H paid for project contractor fees and
construction costs. The loans were subordinate to the
defaulted mortgage. The owner also disbursed $15,000
for a legal retainer fee in a suit against the general
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Finding 1
contractor. The legal fee was a mortgagor expense
versus an expense incident to the operation and
maintenance of the project. As of December 15, 2001,
the owner had not spent the remaining $18,299
(including interest).
The construction cost ($53,154) H&H paid with
proceeds from the four loans were not included in the
independent public accountants report of the mortgagor
actual cost to construct Magnolia Lane. The owner
recorded the $53,154 cost and loans between January 2
and 4, 2001, by debits to the building asset account and
credits to notes payable. The transactions occurred the
week after the independent public accountant’s
December 31, 2000, audit cut-off date. The costs, if
related to construction, should have been included in
the independent public accountant’s certified costs.
The owner’s written response to the finding did not list
and specify the costs H&H paid for construction. We
did not pursue the issue because even if the
expenditures were for legitimate construction costs the
owner was prohibited from using operating funds to pay
for them.
Payments To or For Owner - The $38,828 included
$18,178 for excessive and ineligible 2001 management
fees, $18,900 for ineligible management fees attributed
to the prior year (2000), $1,335 for a duplicate
payment, and $415 for owner medical expenses.
The excessive 2001 management fee exceeded the
allowed fee based on the five percent fee rate stipulated
in the management certification the owner executed
with HUD. The owner claimed that he earned the 2000
fee due to the extraordinary time spent dealing with
construction problems. The owner received separate
compensation for managing construction through the
$267,724 profit and risk allowance paid from mortgage
proceeds and included in the project’s certified
construction cost. The duplicate payment was for a cost
the owner paid from project funds to a vendor (check
number 1242) and subsequently reimbursed himself for
the same cost by check number 1298.
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Finding 1
Washers and Dryers - The $29,337 required HUD’s
approval as a capital purchase. HUD staff stated they
did not authorize the owner to use project-operating
funds to purchase the units.
Repayment of Loans - The $20,589 was for payments
on a $50,000 personal note the owner obtained from a
local bank on January 12, 2001. The owner did not
deposit the loan proceeds to the project’s operating
account and we did not determine what the owner did
with the funds. The loan payments were not related to
project operations and they were subordinate to the
defaulted mortgage.
Legal fees - The $13,501 was for legal fees related to
construction issues between the mortgagor entity and
contractor. These costs do not qualify as project
operation and maintenance expenses.
Other - The $11,109 was for various costs attributed to
construction or the mortgagor entity versus expenses
for project operations and maintenance. The payments
included $5,789 for construction work and an extension
fee, $2,309 for non-mortgage interest, $2,135 for office
furnishings, and $876 for cash transferred to bank
accounts of the mortgagor and an affiliate, H&H
Investment Inc.
The above distributions violated the project Regulatory
Agreement and are subject to the double damages remedy
for unauthorized use of multifamily housing project assets
and income (12 USC 1715z-4). The $148,425 paid after
mortgage default is subject to remedy under the equity
skimming statute (12 USC 1715z-19). The distributions
included $108,162 disbursed after a HUD letter dated July
18, 2001, specifically warned the owner about using project
funds for improper purposes. The letter stated that until the
mortgage was current, you are prohibited from taking any
owner distributions, repaying any funds advanced to the
project, or repaying either interest or principal on any
project obligation junior to the HUD mortgage. The letter
cited the Federal Statutes related to equity skimming and
double damages.
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Finding 1
We interviewed the owner and his attorney to determine
why the owner continued to make improper distributions
after receiving the HUD notice. The owner claimed that he
did not receive the notice. HUD’s files show that it sent the
letter to the owner by certified mail at two different
addresses. The owner signed certified receipts for the both
copies of the letter, one on July 23, and the other on July
27, 2001.
The owner executed a Management Certification with
Unreasonable and HUD whereby he agreed to ensure that all expenses of the
unsupported costs project are reasonable and necessary. Section 9(c) of the
Regulatory Agreement provides that the mortgage property,
equipment, building, plans, office, apparatus, devices,
books, documents, and other papers thereto, shall at all
times be maintained in reasonable condition for proper
audit and inspection. The owner shall keep copies of all
written contracts or other instruments that may be subject
to inspection and examination. HUD Handbook 4370.2,
Financial Operations and Accounting Procedures,
paragraph 2-6E, provides that all disbursements from the
regular operating account (including checks, wire transfers
and computer generated disbursements) must be supported
by approved invoices, bills, or other supporting
documentation.
The owner disbursed $18,765 for costs that were not
necessary and reasonable ($15,558) and for unsupported
costs ($3,207). Appendix C provides a detailed listing of
the unreasonable and unsupported costs discussed below:
• Management fee $8,140 - We question management
fees paid to the owner/manager because he did not
fulfill management responsibilities. He did not comply
with the management certification, and with HUD
requests for information and to obtain professional
management. The owner caused significant violations
as noted by the audit. We calculated the $8,140 fee
based on the 5 percent fee rate applied to project
revenues as stipulated in the management certification.
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Finding 1
• Vehicle expenses $4,421 – The owner paid another
entity, Armfield, $4,000 for a 1993 model truck he sold
to the mortgagor entity, Magnolia Lane Apartments,
Inc. The owner provided a title that showed he owned
the truck and that he signed the title over to Magnolia
Lane. We did not determine why the owner made the
check payable to Armfield versus to himself. The
owner also paid $255 for insurance and a $165 tag fee
for the truck. HUD should assess the reasonableness of
the price the project paid for the truck and whether the
48-unit project needed the truck.
• Realty fees $2,997 - The owner paid fees to a firm that
assisted with renting up the project. The owner did not
execute a contract for the services. HUD questioned
the need for the services in a finding from its July 2001
monitoring of project operations. The owner did not
maintain invoices for some of the payments. In some
instances, the owner offset the fee against collections
and did not write checks for the payments. The owner
posted adjusting entries to record the non-check
transactions.
The owner also disbursed $3,207 for costs not supported by
invoices. Absent invoices showing the nature and purpose
of the expenses, eligibility cannot be determined. The
unsupported costs included $2,177 the owner paid to
himself for travel and other unspecified costs and $1,030
paid to vendors.
Without HUD’s prior written permission, owners shall not
Unauthorized convey, transfer, or encumber any of the mortgaged
encumbrance of property, or permit the conveyance, transfer or
assets encumbrance of such property (Regulatory Agreement,
Section 6(a)).
On February 1, 2001, the owner pledged $100,000 of the
project’s escrow account for operating deficit and working
capital as partial collateral for unspecified notes owed to an
individual. The owner executed an $80,000 personal note
with the individual on January 7, 1999, and another
$50,000 personal note on February 15, 2000. The notes
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Finding 1
were not recorded in the project’s general ledger.
Subsequently, the individual filed suit against the owner for
non payment of the note. The complaint showed the owner
used his home and project assets to secure the note.
“Although the audit did not include a review of
Auditee comments construction activities and costs, it is imperative that such
(summary) issues be considered in order to ensure that a fair and just
conclusion is reached regarding the project’s financial
records and expenditures. From the very inception of the
construction process, the owner, in addition to everyday
management activities associated with the property, was
forced to address significant problems brought on by the
contractor’s refusal to comply with the contract of
construction and other HUD requirements. To attempt to
analyze the project’s financial records outside this context
is both unfair and misleading. Particularly where many of
the obstacles the owner was forced to overcome were
perpetuated, if not directly caused by, the actions of certain
HUD representatives.”
The owner acknowledged that his lack of sophistication
regarding the regulatory requirements of HUD-insured
loans, as well as a corresponding lack of internal controls
did lead to several violations of the Regulatory Agreement.
“Any and all failures to adhere to said regulations were
either inadvertent or the result of the owners extreme
frustration experienced because of HUD’s refusal to assist
the property by helping him ensure the health, safety, and
welfare of his tenants.” The owner stated that at no point
did he ever intend to be anything but open and forthright
with regard to the management of project assets. The
owner stated that many of the irregularities noted in the
audit were made necessary by the negligence of the
contractor as well as HUD’s refusal to hold the contractor
accountable. The owner asks only that the findings and
recommendations made by the audit be considered in the
context of the situation in which he was placed. Given the
extreme shortage of revenue during the initial months of
operation the owner contends that he performed his
management and maintenance duties as best he could with
what was available to him.
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Finding 1
The project’s owner, not HUD, has the responsibility to
OIG response address and resolve all problems associated with the
project’s development and construction. The owner’s
responsibility included but was not limited to pursuing
legal actions, if warranted, to assure contractor
performance; providing the cash needed to fund the
project’s construction and operations; and assuring
compliance with the Regulatory Agreement and related
HUD requirements. The owner claimed that many of the
irregularities noted in the audit were made necessary by the
negligence of the contractor as well as HUD’s refusal to
hold the contractor accountable. The owner’s comments
reflect an unwillingness to recognize that it was his
responsibility to address and resolve those issues.
Generally, the owner’s written response reiterated
information and arguments we considered while conducting
the audit. We did revise the report to reduce unsupported
costs by $1,019 ($75 for check 1075 and $944 for check
1206). The owner produced information that showed
vendors reimbursed the amounts to the project’s operating
account.
Recommendations We recommend
1A. Continue ongoing efforts to complete the
mortgagee-in-possession to secure and protect
HUD’s interest in this project. (HUD has
completed final recommended action.)
1B. Debar the mortgagor and its individual principals
from future participation in HUD Programs.
1C. Require the owner to reimburse the project
operating and trust accounts for $166,364 of
ineligible disbursements and $15,558 of costs found
to be unreasonable and unnecessary. Also, require
adequate documentary support, or reimbursement,
for $3,207 of unsupported costs. You should
coordinate action on this recommendation with our
office.
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Finding 1
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Finding 2
Misuse of Security Deposits and Prepaid Rent
The owner improperly spent $43,225 of tenant security deposits and prepaid (last month) rent.
The owner was not authorized to collect last month rent from tenants. As a result, project
liabilities to tenants are not funded in trust accounts as prescribed by HUD regulations.
Furthermore, the unauthorized collection of prepaid rent placed an unnecessary financial burden
on tenants who moved into or wanted to move into the project. We attribute this violation to the
owner’s failure to abide by HUD requirements.
Without HUD’s prior written permission, owners shall not require as a condition of occupancy,
any consideration or deposit other than the prepayment of the first month rent plus a security
deposit in an amount not in excess of one month’s rent. Any funds collected as security deposits
shall be kept separate and apart from all other funds in a trust account. The amount of the trust
account shall at all times equal or exceed the aggregate of all outstanding obligations under said
account (Regulatory agreement, Section 6(g)).
At move-in, the owner required tenants to pay a security deposit and prepay the last month of
occupancy rent. HUD requirements allow collection of security deposits, but HUD procedures
do not allow, nor did HUD approve, the collection of prepaid rent.
The owner deposited the $43,225 of security deposits and prepaid rent into the project operating
account. As of December 15, 2001, the cash balance in the operating account was only $5,713,
substantially less than the $43,225 liability for security deposits ($23,950) and prepaid rent
($19,275) at that date. The balance in trust accounts should have equaled or exceeded the
aggregate of all outstanding obligations reflected by the liability accounts. As of
December 15, 2001, the general ledger trust account for security deposits contained a zero ($0)
balance.
The certified public accountant’s audit of the mortgagor’s cost certification, dated
February 19, 2001, contained a finding concerning the owner’s failure to maintain a separate
trust account to fund security deposits. The report indicated that the owner would establish and
fund a separate trust account for security deposits.
The owner stated that he spent the funds versus depositing them in trust accounts because the
project needed the money to pay operating costs. We disagree. The project generated sufficient
cash to pay all routine costs of project operations, fund trust accounts, and pay some mortgage
payments. The ineligible and unnecessary costs identified in Finding 1 ($181,922) would have
funded the $43,225 trust account plus six $21,132 mortgage payments. We conclude that the
owner did not make a good faith effort to pay any mortgage payments and his mismanagement of
project funds was a significant cause of the mortgage default.
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Finding 2
The OIG is correct, the funds have since been repaid in full
Auditee comments and a separate account has been established as required under
the Regulatory Agreement.
The owner provided documentation indicating that it had
OIG response funded the security deposit account. However, the owner’s
comments did not address actions, if any, taken to resolve
the prepaid rent issue.
Recommendations Recommendations under Finding 1 address all needed
recoveries. No further recommendations for Finding 2 are
deemed necessary. The prepaid rent trust accounts should
be funded with the funds recovered under Recommendation
1C and the money should be returned to the tenants.
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Management Controls
In planning and performing our audit, we considered management controls systems of Magnolia
Lane Apartments to determine our auditing procedures and not to provide assurance on
management controls. Management control includes the plan of organization, methods and
procedures adopted by management to ensure that its goals are met. Management controls include
the process for planning, organizing, directing, and controlling program operations. They include
the systems for measuring, reporting, and monitoring program performance.
We assessed the following management control category that we determined to be relevant to our
audit objectives:
• Controls over compliance with laws and regulations
• Controls over the safeguarding of resources
A significant weakness exists if management control does not give reasonable assurance that the
entity’s goals and objectives are met; that resource use is consistent with laws, regulations, and
policies; that resources are safeguarded against waste, loss, and misuse; and that reliable data are
obtained, maintained, and fairly disclosed in reports.
Significant weaknesses in the assessed controls existed with respect to the owner controlling and
managing the project without regard for HUD program requirements and prudent financial
management. We placed no reliance on the controls and instead sampled a large proportion of
project disbursements. The control weaknesses were the primary causal factors for Findings 1
and 2.
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Management Controls
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Follow-Up On Prior Audits
This was the first Office of Inspector General audit of Magnolia Lane Apartments mortgagor
operations.
The latest independent audit of Magnolia Lane Apartments was for the Mortgagors Certificate of
Actual Cost for the period ended December 31, 2000. The report contained one finding
concerning the owner’s failure to establish a separate trust account to fund security deposits
collected from tenants. The owner did not resolve the finding as reported in Finding 2 of this
report.
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Issue Needing Further Study and Consideration
As discussed in Finding 1, the owner pledged $100,000 of the project’s escrow account for
operating deficit and working capital as partial collateral for notes made from an individual.
HUD staff state they were not aware of the transactions that occurred before during and after the
period of project development (initial processing through construction). We did not audit the
project’s processing and construction. However, the transactions involved a lack of disclosures
that may have impacted HUD’s assessment of the owners’ ability to meet minimum equity
requirements when it approved the project. We believe HUD should review this issue and assess
its impact on the decisions HUD made relative to the owner and project.
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Issue Needing Further Study and Consideration
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Appendix A
Summary Of Questioned Costs
Recommendation Type of Questioned Costs
1
Number Ineligible Unreasonable2 Unsupported3
1C $166,364 $15,558 $3,207
1
Ineligible - Costs that are questioned because of an alleged violation of a provision of a law,
regulation, contract, grant, cooperative agreement, or other document governing the
expenditure.
2
Unreasonable - Costs that are questioned because they exceed the costs that would be incurred
by an ordinary prudent person in the conduct of a competitive business.
3
Unsupported - Costs charged to a HUD-funded or insured program or activity whose eligibility
cannot be determined at the time of audit since such costs were not supported by adequate
documentation.
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Summary of Questioned Costs
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Appendix B
Schedule Of Ineligible Distributions
Portion Portion Paid
Paid After HUD
Check Ineligible After Warning
Date Number Payee Costs Default Letter
Transfers to Other Accounts
10/26/01 1301 Conway National Bank $ 20,000 $20,000 $20,000
11/06/01 1310 Conway National Bank 10,000 10,000 10,000
11/27/01 1322 Conway National Bank 5,000 5,000 5,000
12/4/01 1333 Conway National Bank 8,000 8,000 8,000
12/12/01 1340 Conway National Bank 10,000 10,000 10,000
Subtotal $53,000 $53,000 $53,000
Unauthorized Payments to or for Mr. Hicks
Various Various James Hicks $18,178 $12,651 $9,568
06/15/01 1204 James Hicks 10,000 10,000
07/20/01 1223 James Hicks 4,700 4,700
08/9/01 1245 James Hicks 4,200 4,200 4,200
10/15/01 1298 James Hicks 1,335 1,335 1,335
1/18/01 1083 Conway Hospital 276
1/31/01 1091 Conway Anesthesia Associates 41
3/3/01 1117 Carolina Radiology 98
Subtotal $38,828 $32,886 $15,103
Unauthorized Payment for Washers and Dryers
2/2/01 1095 Colortyme 3,045
3/15/01 1119 Colortyme 3,045
4/20/01 1153 Colortyme 105 105
5/31/01 1185 Colortyme 6,090 6,090
8/03/01 1240 Colortyme 3,045 3,045 3,045
8/07/01 1244 Colortyme 3,045 3,045 3,045
8/17/01 1253 Colortyme 1,827 1,827 1,827
9/10/01 1270 Colortyme 4,263 4,263 4,263
10/5/01 1290 Colortyme 4,872 4,872 4,872
Subtotal $29,337 $23,247 $17,052
Unauthorized Repayment of Loans
1/12/01 1080 Conway National Bank 1,199
4/3/01 1133 Conway National Bank 3,321 3,321
4/18/01 1151 Conway National Bank 1,607 1,607
5/16/01 1179 Conway National Bank 1,607 1,607
7/2/01 1212 Conway National Bank 1,607 1,607
7/25/01 1225 Conway National Bank 1,607 1,607 1,607
9/05/01 1268 Conway National Bank 4,820 4,820 4,820
11/7/01 1316 Conway National Bank 4,820 4,820 4,820
Subtotal $20,589 $19,389 $11,247
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Schedule Of Ineligible Distributions
Portion Portion Paid
Paid After HUD
Check Ineligible After Warning
Date Number Payee Costs Default Letter
Unauthorized Payment of Legal Fees
1/2/01 1059 Stuart Adramson 500
1/19/01 1084 Thompson Law Firm 700
5/16/01 1178 Thompson Law Firm 1,890 1,890
6/20/01 1205 Richard Lovelace 1,000 1,000
8/16/01 1251 Richard Lovelace 4,000 4,000 4,000
9/18/01 1274 Richard Lovelace 1,411 1,411 1,411
9/18/01 1272 James Hicks 1,000 1,000 1,000
10/3/01 1285 Richard Lovelace 1,000 1,000 1,000
10/31/01 1308 Richard Lovelace 1,000 1,000 1,000
12/3/01 1330 Richard Lovelace 1,000 1,000 1,000
Subtotal $13,501 $12,301 $9,411
Other Unauthorized Payments
1/5/01 1066 Magnolia Lane Inc. 300
1/5/01 1067 Magnolia Lane Inc. 200
1/5/01 1068 H&H Investments 376
1/9/01 1076 Prudential Huntoon Paige 2,431
5/3/01 1171 Lowes 2,134 2,134
7/6/01 1217 Conway Air 2,569 2569
7/18/01 1222 Taryn McElhannon 750 750
8/10/01 1246 James Hawkins 2,309 2,309 2,309
8/11/01 1247 Taryn McElhannon 40 40 40
Subtotal $11,109 $7,802 $2,349
Total $166,364 $148,625 $108,162
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Appendix C
Schedule Of Unreasonable and Unsupported
Costs
Magnolia Lane Apartments
Unnecessary/
Unreasonable Unsupported
Date Check No. Costs Costs
Various Various James Hicks $ 8,140
1/24/01 1088 Agnis Armfield 4,000
2/26/01 1110 SCDPS 165
3/27/01 1130 State Farm 256
4/27/01 1158 Ray Realty 350
5/3/01 1168 Ray Realty 350
8/9/01 None Ray Realty 375
8/9/01 None Ray Realty 375
9/18/01 None Ray Realty 395
9/28/01 None Ray Realty 375
11/6/01 1313 Ray Realty 370
12/11/01 None Ray Realty 407
1/5/01 1061 James Hicks $ 300
2/21/01 1101 James Hicks 300
2/26/01 1109 James Hicks 300
5/21/01 1180 James Hicks 400
8/22/01 1257 James Hicks 377
9/5/01 1265 James Hicks 500
3/28/01 1131 CANNON'S 30
6/2/01 1187 Delaney Richardson 500
6/9/01 1198 Delaney Richardson 500
Total $ 15,558 $3,207
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Appendix D
Auditee Comments
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Appendix E
Distribution
Auditee
Principal Staff
Regional Directors
OIG Staff
South Carolina State Coordinator, Columbia, South Carolina, 3ES
Acting Director, Columbia Multifamily Program, 3EHM
Acquisitions Librarian, Library, AS
Sharon Pinkerton, Senior Advisor
Subcommittee on Criminal Justice
Drug Policy and Human Resources
B373 Rayburn House Office Building
Washington, DC 20515
Stanley Czerwinski, Associate Director
Resources, Community, and Economic Development Division
U.S. General Accounting Office
441 G Street N.W., Room 2T23
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
The Honorable Joseph Lieberman
Chairman
Committee on Government Affairs
706 Hart Senate Office Building
United States Senate
Washington, DC 20510
The Honorable Fred Thompson
Ranking Member
Committee on Governmental Affairs,
340 Dirksen Senate Office Building
United States Senate
Washington, DC 20510
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Distribution
The Honorable Dan Burton
Chairman
Committee on Government Reform,
2185 Rayburn Building
United States House of Representatives
Washington, DC 20515
The Honorable Henry A. Waxman
Ranking Member
Committee on Government Reform
2204 Rayburn Building
United States House of Representatives
Washington, DC 20515
Andy Cochran
House Committee on Financial Services
2129 Rayburn House Office Building,
Washington, DC 20515
Clinton C. Jones, Senior Counsel
Committee on Financial Services
U. S. House of Representatives
B303 Rayburn House Office Building
Washington, DC 20515
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Magnolia Lane Apartments, Project Management Operations, Conway, South Carolina
Published by the Department of Housing and Urban Development, Office of Inspector General on 2002-06-05.
Below is a raw (and likely hideous) rendition of the original report. (PDF)