MAGNOLIA LANE APARTMENTS PROJECT MANAGEMENT OPERATIONS CONWAY, SOUTH CAROLINA 2002-AT-1001 JUNE 5, 2002 OFFICE OF AUDIT SOUTHEAST/CARIBBEAN REGION Table Exit Tableof Contents of Contents Exit 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. Table of Contents Exit Management Memorandum (This Page Left Blank Intentionally) 2002-AT-1001 Page ii Table Exit Tableof Contents of Contents Exit 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. Page iii 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Executive Summary (This Page Left Blank Intentionally) 2001-AT-1001 Page iv Table Exit Tableof Contents of Contents Exit Table of Contents 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 Page v 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Table of Contents Abbreviations HUD United States Department of Housing and Urban Development 2001-AT-1001 Page vi Table Exit Tableof Contents of Contents Exit 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. Page 1 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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. 2002-AT-1001 Page 2 Table Exit Tableof Contents of Contents Exit 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 Page 3 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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 2002-AT-1001 Page 4 Table Exit Tableof Contents of Contents Exit 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 Page 5 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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. 2002-AT-1001 Page 6 Table Exit Tableof Contents of Contents Exit 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. Page 7 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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. 2002-AT-1001 Page 8 Table Exit Tableof Contents of Contents Exit 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 Page 9 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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. 2002-AT-1001 Page 10 Table Exit Tableof Contents of Contents Exit 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. Page 11 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Finding 1 (This Page Left Blank Intentionally) 2002-AT-1001 Page 12 Table Exit Tableof Contents of Contents Exit 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. Page 13 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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. 2002-AT-1001 Page 14 Table Exit Tableof Contents of Contents Exit 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. Page 15 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Management Controls (This Page Left Blank Intentionally) 2002-AT-1001 Page 16 Table Exit Tableof Contents of Contents Exit 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. Page 17 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Follow-Up On Prior Audits (This Page Left Blank Intentionally) 2002-AT-1001 Page 18 Table Exit Tableof Contents of Contents Exit 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. Page 19 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Issue Needing Further Study and Consideration (This Page Left Blank Intentionally) 2002-AT-1001 Page 20 Table Exit Tableof Contents of Contents Exit 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. Page 21 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Summary of Questioned Costs (This Page Left Blank Intentionally) 2002-AT-1001 Page 22 Table Exit Tableof Contents of Contents Exit 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 Page 23 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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 2002-AT-1001 Page 24 Table Exit Tableof Contents of Contents Exit 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 Page 25 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Schedule Of Unreasonable and Unsupported Costs (This Page Left Blank Intentionally) 2002-AT-1001 Page 26 Table Exit Tableof Contents of Contents Exit Appendix D Auditee Comments Page 27 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 28 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 29 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 30 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 31 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 32 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 33 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 34 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 35 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 36 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 37 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 38 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 39 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 40 Table Exit Tableof Contents of Contents Exit Auditee Comments Page 41 2002-AT-1001 Table Exit Tableof Contents of Contents Exit Auditee Comments 2002-AT-1001 Page 42 Table Exit Tableof Contents of Contents Exit 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 Page 43 2002-AT-1001 Table Exit Tableof Contents of Contents Exit 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 2002-AT-1001 Page 44 Table Exit Tableof Contents of Contents Exit
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)