AUDIT REPORT
LOS ANGELES COMMUNITY DEVELOPMENT BANK –
ECONOMIC DEVELOPMENT INITIATIVE GRANT/
SECTION 108 LOAN GUARANTEE PROGRAM
CITY OF LOS ANGELES
COUNTY OF LOS ANGELES
LOS ANGELES, CALIFORNIA
2002-SF-1003
SEPTEMBER 25, 2002
OFFICE OF AUDIT, REGION 9
SAN FRANCISCO, CALIFORNIA
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2002-SF-1003
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Issue Date
September 25, 2002
Audit Case Number
2002-SF-1003
TO: Roy A. Bernardi
Assistant Secretary for Community Planning and Development, D
//SIGNED//
FROM: Mimi Y. Lee
Regional Inspector General for Audit, 9AGA
SUBJECT: Los Angeles Community Development Bank - Economic Development
Initiative Grant/Section 108 Loan Guarantee Program
City of Los Angeles, County of Los Angeles
Los Angeles, California
Pursuant to a Congressional request, we performed an audit of the Los Angeles Community
Development Bank’s (LACDB) Economic Development Initiative (EDI) Grant/Section 108 Loan
Guarantee Program. Our audit was to determine whether allegations of mismanagement of
LACDB’s operations contained in a citizen’s complaint prompting the Congressional request, as
well as allegations of improper use of funds contained in another citizen’s complaint, had merit.
Specifically, we assessed LACDB’s compliance with Department of Housing and Urban
Development (HUD) and EDI Agreements’ requirements and reviewed LACDB’s policies,
procedures, and practices for administering and using EDI Grant and Section 108 Loan Guarantee
Program funds. The audit report contains three findings. We are providing a copy of this report to
LACDB, the City, and the County of Los Angeles.
In accordance with HUD Handbook 2000.06 REV-3, within 60 days, please furnish us, for each
recommendation without management decisions, a status report on: (1) the corrective action taken;
(2) the proposed corrective action and the date to be completed; or (3) why corrective action is
considered unnecessary. Additional status reports are required at 90 days and 120 days after report
issuance for each recommendation without a management decision. Also, please furnish us with
copies of any correspondence or directives issued because of the audit.
2002-SF-1003
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Management Memorandum
Should you or your staff have any questions, please contact me at (415) 436-8101, or Ruben
Velasco, Assistant Regional Inspector General for Audit, at (213) 894-8016.
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Executive Summary
Pursuant to a Congressional request, we performed an audit of the Los Angeles
Community Development Bank’s (LACDB) Economic Development Initiative
(EDI)/Section 108 Loan Guarantee Program. Our audit was to determine whether
allegations of mismanagement of LACDB’s operations contained in a citizen’s complaint
prompting the Congressional request, as well as allegations of improper use of funds
contained in another citizen’s complaint, had merit. Specifically, we assessed LACDB’s
compliance with Housing and Urban Development (HUD) regulations and EDI
Agreements’ requirements and reviewed LACDB’s policies, procedures, and practices for
administering and using EDI and Section 108 Loan Guarantee Program funds.
We found the allegations were partially correct. LACDB had not fully complied with
HUD regulations and EDI Agreements’ requirements. Specifically, LACDB:
ü Assisted 101 businesses that had not met the national objective standard of 51%
of creating or retaining jobs for low- and moderate-income persons. Similarly,
LACDB had not met the EDI Agreements’ requirement of creating jobs
predominantly for Empowerment Zone (EZ) target area residents;
ü Provided City-funded loans or investments to businesses located outside the EZ
target area in excess of the 25 percent funding limit; and
ü Invested over $26 million of City-funded venture capital businesses that provided
minimal benefit to EZ target area residents.
LACDB also did not exercise prudent business practices and incurred unreasonable and
unnecessary expenses in administering its program activities.
As of December 31, 2001, LACDB approved loans and
HUD And EDI investments that had not met HUD and EDI Agreements’
Requirements Not Met requirements. Of the 150 businesses receiving
$126,962,282 in assistance, LACDB approved
$69,028,264 in loans and investments to 101 businesses
that had not met the national objective standard of 51% of
creating jobs for low- and moderate-income persons.
Specifically, the 101 businesses assisted by LACDB only
created 149 of 1,357 (11 percent) jobs for low- and
moderate-income persons. In addition, LACDB spent over
$21 million of City-funded loans and investments to
businesses located outside the EZ target area in excess of
the 25 percent funding limit.
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Executive Summary
These deficiencies occurred because LACDB had
insufficient or did not follow established monitoring
controls needed to ensure borrowers’ compliance with job
creation requirements. In addition, LACDB may have
misunderstood the extent of its responsibility in assuring
job creation requirements were being met. The lack of a
control system to track the amount of loans and
investments being approved caused LACDB to over spend
outside the EZ target area. Consequently, funds
earmarked principally for economic revitalization
activities within the EZ target area were neither fully used
in accordance with the terms and conditions under which
the funds were approved nor met the national objective
criterion of low- and moderate-income benefit.
LACDB invested $26.1 million of City-funded venture
Investments In The capital businesses and incurred related management fees of
Venture Capital $2.6 million that provided minimal benefit to EZ target
Program Did Not area residents. Contrary to HUD requirements and the
Benefit EZ Target Area security purchase agreements, 12 of 14 businesses did not
Residents relocate into the EZ target area and did not create jobs
predominantly benefitting EZ target area residents. In fact,
only 32 of 505 jobs created by these 12 businesses went to
low- and moderate-income persons and only four of those
were EZ target area residents. Based on our review, we
concluded the financial viability of these investments was
questionable to assure the required benefit would
materialize because of the risky nature of early stage
venture capital investments.
The deficiencies occurred because LACDB did not
perform sufficient due diligence to include an evaluation
of whether borrowers could reasonably hire EZ target area
residents considering their job knowledge, skills, and
expertise versus job eligibility requirements. As a result,
LACDB’s investments into the venture capital program
did not provide the expected program benefits to the
intended beneficiaries, thus, hampered its efforts to
accomplish its mission of revitalizing the EZ target area.
Therefore, in our view, the $28.7 million in venture capital
investments and management fees could be considered a
questionable use of HUD funds.
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Executive Summary
Cost principles applicable for non-profit organizations
LACDB Spent Over state in order for costs to be eligible, they must be
$135,000 For reasonable, ordinary, and necessary for the operation of the
Unreasonable And organization or performance of the award. Contrary to
Unnecessary these principles, LACDB paid: (1) $12,229 for meals and
Expenditures other items paid with LACDB credit cards or reimbursed
to LACDB employees that were unnecessary LACDB
expenses; (2) $32,421 in unnecessary staff bonuses and
pay raises, contrary to LACDB’s normal personnel
practices; and (3) $90,500 in micro loan origination
intermediary fees we considered to be unreasonably high.
We attributed these deficiencies to LACDB’s lack of
familiarity with cost principles applicable to units of local
government and non-profit entities. As a result, these
expenditures prevented LACDB to further carry out other
eligible activities.
Since its inception in 1996, LACDB had already spent or
LACDB May Not Have committed almost one-half of the $435 million in HUD
Sufficient Time Left To funding. While the remaining $200 million in the City’s
Accomplish Its Goals Section 108 Loan Guarantees is still unused, this amount is
not specifically earmarked for use within the EZ target area.
Therefore, with just under three years remaining in its CDB
agreement with the City and the County of Los Angeles,
LACDB may not have enough time or grant funds to fully
accomplish its primary mission to provide a positive
investment environment and create/retain sustainable jobs
for residents and others within the EZ.
We are recommending HUD to (1) require the City and the
Recommendations County of Los Angeles to ensure LACDB establish and
implement, or follow monitoring controls and procedures
to ensure businesses’ compliance with job creation or
retention requirements, (2) determine what action or
adjustments to LACDB’s existing policies, procedures,
and practices should be taken to ensure the required level
of employment of low- and moderate-income persons will
be met, (3) instruct the City of Los Angeles to require
LACDB to discontinue making venture capital program
investments, and (4) take appropriate action pursuant to
the provisions of 24 CFR, Section 570.910, to the extent
assisted businesses are unable to meet the national
objective standard of 51% for creating or retaining jobs for
low- and moderate-income persons.
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Executive Summary
We discussed the findings with LACDB, the City of Los
Audit Results Discussed Angeles, and the County of Los Angeles officials and staff
With Auditee during the audit and at an exit conference held on
March 12, 2002. We also provided LACDB, the City, the
County, and HUD with a copy of the draft audit report for
comments on August 27, 2002. We received their written
responses on September 13 and 16, 2002. Their responses
and our evaluations are discussed in the findings and the
full text of their responses is included as Appendix E.
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Table of Contents
Management Memorandum i
Executive Summary iii
Introduction 1
Findings
1. LACDB Had Not Fully Met HUD And EDI Grant
Agreements’ Requirements 7
2. LACDB’s $28.7 Million City-Funded Venture Capital
Program Provided Minimal Benefit To The
Empowerment Zone 25
3. EDI Funds Used For Unnecessary Or Unreasonable Expenses 41
Management Controls 49
Follow Up On Prior Audits 51
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Appendices
A. Schedule Of Businesses Not Meeting National Objective 53
B. Schedule Showing Portion Of Funding Applicable
To National Objective Shortfall 57
C. Schedule of Venture Capital Investments 59
D. Schedule of Questioned Costs 61
E. Auditee Comments 63
F. Distribution Outside of HUD 89
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Abbreviations
CDB Community Development Bank
CDBG Community Development Block Grant
CFR Code of Federal Regulations
EDI Economic Development Initiative
EZ Empowerment Zone
HUD Department of Housing and Urban Development
LACDB Los Angeles Community Development Bank
NOFA Notice of Funds Availability
RFP Request for Proposal
OMB Office of Management and Budget
OIG Office of Inspector General
VP Vice President
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Introduction
The President signed the Economic Development Initiative
Background into law on April 11, 1994. It allows localities to carry out
economic development activities where public and private
dollars can be leveraged to create jobs and other benefits
especially for low- and moderate-income persons.
Originally, HUD did not designate Los Angeles as one of
six Empowerment Zones in 1994. In January 1995, the
City of Los Angeles and the County of Los Angeles were
awarded a Supplemental Empowerment Zone. HUD
upgraded Los Angeles to full empowerment zone status on
January 30, 1998, but the designation did not become
effective until January 1, 2000.
Geographically, the zone encompasses a 19-square mile
area made up of 36 low-income census tracts in the City of
Los Angeles that include sections of Central, South
Central, and East Los Angeles, as well as Pacoima and
five census tracts in the unincorporated county
communities of Willowbrook and Florence/Firestone. The
zone designation made the City and the County eligible for
special economic development funding through HUD to
create and capitalize a unique community development
bank called LACDB.
HUD’s funding for LACDB includes Section 108 Loan
EZ Program Funded Guarantees, EDI Grants, and Community Development
By Section 108, Block Grant (CDBG) entitlement funds. Under the
Economic Development Section 108 program, units of general local government
Initiative Grant, And pledge future years’ CDBG allocations as security for
CDBG Entitlement loans guaranteed by HUD. The full faith and credit of the
Program United States is pledged to the payment of all guarantees
made under Section 108. In the event a Section 108
funded activity fails to generate sufficient funds to repay
the Section 108 loan and there are insufficient EDI grant
funds or other assets available to be used to make the
payment, a community would be required to use its CDBG
funds to make the loan payment. EDI grants minimize the
potential loss of future CDBG allocations by either
providing a loan loss reserve, lowering the cost of
borrowing under Section 108, or providing other credit
and economic enhancements that reduce the risk the
pledged annual CDBG allocation would be required to
fund repayment shortfalls.
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Introduction
Pursuant to the December 1994 Notice of Fund
HUD Initially Funded Availability (NOFA), HUD approved $250 million in EDI
The Los Angeles and Section 108 funds for the Los Angeles “Supplemental
“Supplemental Empowerment Zone” target area, the same area originally
Empowerment Zone” nominated in the initial Los Angeles Empowerment Zone
With $250 Million application:
Amount
Funding Type (in millions)
City EDI Grant $100
City Section 108 Loan Guarantee $100
County EDI Grant $ 25
County Section 108 Loan Guarantee $ 25
Total $250
The City of Los Angeles and the County of Los Angeles
were required to spend at least 75 percent of their EDI
grant funds and an equal amount of matching Section 108
funds in the target area. The City received an additional
$200 million in Section 108 Loan Guarantees to be used in
any eligible area of the City, that were not linked as
matching funds for the EDI grants. The City also
appropriated $5 million of its CDBG entitlement for
administrative costs. The County chose to withhold an
additional $20 million, $10 million in EDI Grant funds,
and $10 million in Section 108 Loan Guarantees, which
the County can use in any eligible area within the County’s
five designated target area census tracts. In total, HUD
funding amounted to $455 million, of which $435 million
was used to fund LACDB. The other $20 million was not
restricted to LACDB program activities.
LACDB was incorporated on June 19, 1995, as a California
LACDB Is A nonprofit organization within the meaning of Section
California Nonprofit 501(c)(3) of the Internal Revenue Code. LACDB is
Entity Formed In 1995 organizationally independent from the City and the County
of Los Angeles. A 15-member Board of Directors governs
the LACDB. The Board is comprised of a diverse group of
business and community leaders with experience in
community development activities.
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Introduction
The mission of LACDB is to promote a positive investment
Mission Of The Bank environment and create/retain sustainable jobs for residents
and others within the Empowerment Zone. The purpose of
HUD’s funding was to provide the resources to the City and
the County of Los Angeles to revitalize the Empowerment
Zone target area through LACDB.
According to the EDI Agreements between HUD and the
The City And The City and the County of Los Angeles as “recipients” of the
County Are Responsible EDI Grants and matching Section 108 Loan Guarantees,
For LACDB’s Program the “recipients” agreed to carry out the “Approved
Compliance Project”, LACDB, on a timely basis and otherwise in
compliance with their agreements including the Act, the
NOFA, regulations, and approved application. The
“recipients” also agreed to assure, and to accept
responsibility for compliance by any other entities to
which they make grant funds available for, or which they
otherwise allow to participate in, LACDB. The
Agreements further stated the “recipient” requested and
HUD agreed the Community Development Bank be
authorized to assume responsibility for ensuring the EDI
Grant and Section 108 Loan Guarantee program
requirements are met.
From June 1996 through December 2001, LACDB closed
Volume Of Loans And 248 loans and investments totaling $126,962,282. LACDB
Investments Closed funded $27,705,603 from EDI and $99,256,679 of Section
108 funds as follows:
Year No. Of
Closed Loans Total EDI Section 108
1996 5 $ 1,987,813 $ 10,619 $ 1,977,194
1997 49 17,117,271 1,993,059 15,124,212
1998 51 37,126,793 3,937,629 33,189,164
1999 83 52,902,157 14,528,589 38,373,568
2000 47 14,137,507 5,117,330 9,020,177
2001 13 3,690,741 2,118,377 1,572,364
Total 248 $126,962,282 $27,705,603 $99,256,679
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Introduction
The status of LACDB’s loans and investments, as of
Status Of Loans And December 31, 2001, are shown below:
Investments
Percent
Category Amount of Total
Balance-Loan $20,736,557 16
Balance-Investments $23,688,591 19
Write-Offs $41,715,957 33
Repayments $40,821,177 32
Total $126,962,282 100
Of the 150 businesses that received over $126.9 million in
Additional Losses May loans and investments, 51 of these businesses with loan
Be More Likely to Occur balances of $41.7 million have been written off. LACDB
has received $40.8 million in loan repayments. Of the
remaining $44.4 million in its portfolio, $8.7 million was
already 90 days delinquent as of December 2001.
Additionally, 37 of the businesses had closed, including
six of the 14 businesses under its venture capital program.
The December 31, 2001 audited financial statements of its
venture capital program showed the estimated fair market
value of its stock investments was now only $18.2 million,
$7.9 million less than its original investments of $26.1
million. Further, we also noted investments of $2.4
million for three of these venture capital businesses had
been written off as uncollectible. On this basis, LACDB
not only did not comply with HUD and EDI grant
agreement requirements, but also, had already incurred
significant losses from its loans and investments to
businesses that had already closed. Judging from the
amount of loans written off ($41.7 million), plus the
amount of delinquent loans ($8.7 million), additional
losses may be more likely to occur.
The objective of our audit was to determine whether
Audit Objective, Scope allegations of mismanagement of LACDB’s operations
And Methodology contained in a citizen’s complaint that prompted the
Congressional request, as well as allegations of improper
use of funds in another citizen’s complaint had merit. In
addition, we also determined whether LACDB
administered the program in accordance with HUD and
EDI Agreements’ requirements.
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Introduction
To accomplish our objectives, we performed the
following:
· Reviewed pertinent HUD regulations, EDI
Agreements, Comprehensive CDB Agreement,
Zone Ventures Partnership Agreement, Office of
Management and Budget Circulars, and other HUD
requirements.
· Interviewed HUD, LACDB, City, and County of
Los Angeles officials and staff, attended Oversight
Committee meetings, and reviewed relevant files to
obtain an understanding of procedures and
practices for administering the EZ program. We
also obtained clarification on EDI Agreements’
requirements, and evaluated the extent of program
monitoring and oversight.
· Discussed with HUD, Headquarters program
officials, the applicability of HUD rules and
regulations relating to the eligibility and use of EDI
Grant and Section 108 loan guarantee funds.
· Evaluated the issues raised by the complainant that
prompted the Congressional request to determine if
they had merit. Specifically, we reviewed
LACDB’s use of EDI funds during 1998 and 1999
for administrative expenses to determine the
reasonableness and necessity of expenditures.
· Analyzed and validated EDI/matching Section 108
funding expenditures to determine whether
LACDB complied with EDI Agreements’
requirements to spend at least 75 percent of the
funds within the EZ target area.
· Analyzed and validated job creation/retention
statistics to determine whether LACDB complied
with EDI Agreements’ requirements to create or
retain at least one job for every $35,000 in loans
and investments, and the jobs were held by or
made available to EZ target area residents.
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Introduction
· Selected a non-representative sample of 13
businesses for site visits to determine reasons for
non-compliance. We selected these businesses
because they had significantly failed to hire EZ
target area residents.
· Selected a non-representative sample of 30
borrowers and reviewed relevant underwriting and
servicing files to determine whether underwriting
decisions were made in accordance with its
established policies and procedures, approval
processing procedures assured EDI Agreements’
requirements would be met, and LACDB approved
fund disbursements in accordance with established
procedures. We selected businesses that had the
larger funding amounts or that had defaulted or
closed.
· Interviewed Zone Ventures Management Company
officials to obtain an understanding of their
procedures and practices for administering the
venture capital program, and reviewed relevant
records to evaluate their bases for approving
venture capital investments.
Our audit generally covered the period from June 1996
through December 2001. Where appropriate, we extended
our review to cover other periods. We substantially
performed our audit fieldwork from February 2001
through March 2002.
We conducted the audit in accordance with generally
accepted government auditing standards.
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Finding 1
LACDB Had Not Fully Met HUD And EDI
Grant Agreements’ Requirements
LACDB approved $69,028,264 in loans and investments, as of December 31, 2001, to 101
businesses that had not met the national objective standard of 51 percent of creating or
retaining jobs for low- and moderate-income persons (See Appendix A). Although these
businesses created 1,357 of 2,062 projected jobs, only 149 (11 percent) went to low- and
moderate-income persons. More importantly, although the EDI grant agreements require
LACDB to create or retain jobs predominantly for EZ residents, only 66 of the 1,357 (5
percent) jobs created went to EZ target area residents. LACDB also spent over $21 million of
City-funded loans and investments to businesses located outside the EZ target area in excess
of the 25 percent funding limit.
These deficiencies occurred because LACDB had insufficient or did not follow established
controls needed to ensure borrowers’ compliance with job creation requirements. In
addition, LACDB may have misunderstood the extent of its responsibility for assuring job
creation requirements were being met. The lack of a control system to track the amount of
loans and investments being approved caused LACDB to over spend outside the EZ target
area. Consequently, HUD funds earmarked principally for economic revitalization activities
within the EZ target area were neither fully used in accordance with the terms and conditions
under which the funds were approved nor met the national objective criterion of low- and
moderate-income benefit.
Title 24, Section 570.208 (a)(4) of the Code of Federal
Code Of Federal Regulations (CFR), states in part: “… An activity designed
Regulations to create or retain permanent jobs where at least 51 percent
of the jobs, computed on a full time equivalent basis,
involve the employment of low- and moderate-income
persons. To qualify under this paragraph, the activity must
meet the following criteria: (i) For an activity that creates
jobs, the recipient must document that at least 51 percent of
the jobs will be held by, or will be available to, low- and
moderate-income persons.”
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Finding 1
HUD entered into EDI Grant Agreements with the City (E-
EDI Grant Agreements’ 95-EZ-06-0003) and the County (E-95-EZ-06-0002) of Los
Requirements Angeles (Recipients). In turn, the Recipients entered into a
Comprehensive CDB Agreement with LACDB mirroring
the provisions contained in the EDI Grant Agreements.
Specific provisions restricting the use of EDI grant funds
and matching Section 108 loan guarantee proceeds are as
follows:
a. Assisted activities must meet the national objective
criterion of low- and moderate-income benefit.
Consistent with the recipient’s proposal, each EDI grant
and matching Section 108 loan guarantee assisted activity
will meet the low- and moderate-income national
objective if (a) the assisted economic development
activity is located in the urban empowerment zone target
area and any jobs created/retained by an assisted
economic development activity are located in the target
area, or (b) the assisted economic development activity is
located outside of the urban empowerment zone target
area, but creates jobs 51 percent of which are held by or
made available to residents of the urban empowerment
zone target area.
b. For assisted economic development activities utilizing
the EDI grant funds and/or the matching Section 108
Loan Guarantee proceeds that are located in the
Empowerment Zone target area, such activities create
jobs predominantly held by or made available to
residents of the Empowerment Zone target area and any
economic development activity that creates jobs, the
amount of EDI and/or matching Section 108 Loan
Guarantee proceeds does not exceed $35,000 of
assistance per job created.
c. Activities must be located in or serve the EZ target area.
Generally, at least 75 percent of both the EDI grant funds
and no less than an equal amount of Section 108
proceeds must be spent for eligible economic
development activities within the EZ target area and
create jobs predominately for EZ target area residents.
Up to 25 percent may be spent within one mile of the EZ
target area provided 51 percent of the jobs created go to
EZ target area residents.
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Finding 1
LACDB Assisted 101 Businesses That Had Not Met
10102
The National Objective Standard
As of December 2001, LACDB approved $126,962,282 in
Over $69 Million In loans and investments to 150 businesses, however, 101 of
Loans And Investments these businesses that received $69,028,264 in assistance
Had Not Fully Met HUD (See Appendix A), had not met the national objective
Requirements standard of 51 percent of creating or retaining jobs for low-
and moderate-income persons. The 101 businesses created
a total of 1,357 jobs but only 149 (11 percent) went to low-
and moderate-income persons and only 66 (5 percent) went
to EZ target area residents.
Overall, LACDB assisted 150 businesses that created 2,731
LACDB Created 73% of 3,748 (73%) projected jobs, a shortfall of 1,017 jobs. Of
Of The Total Number the 2,731 jobs created, 339 went to EZ target area residents
Of Jobs Projected and 996 went to residents outside of the EZ target area but
who were presumed to be qualified under the national
objective criterion for low- and moderate-income benefit,
plus an additional 165 jobs went to other qualified low- and
moderate-income persons. The remaining 1,231 jobs went
to other individuals that were neither residents of the EZ
target area nor qualified as low- and moderate-income
persons.
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Finding 1
The following graph illustrates the job creation efforts by
LACDB:
EZ Residents
Shortfall 339
Low/Mod
1,017
1,161
1,231
Non-Low/Mod
LACDB’s overall job creation effort of creating/retaining
Only 339 Of The 2,731 jobs predominantly for EZ target area residents had been
Jobs Created Went To minimal. Contrary to the EDI Agreements’ requirement of
EZ Residents creating jobs predominantly for EZ target area residents,
only 339 of the 2,731 (12%) total jobs created as of
December 2001 went to EZ target area residents.
LACDB’s assisted businesses, however, also created an
additional 996 jobs under the presumptive benefit test.1 In
addition, these businesses created another 165 jobs for low-
and moderate- income persons, for a total of 1,500 (339 +
996 + 165) jobs that met the national objective criterion for
low- and moderate-income benefit. As of December 2001,
190 of the 1,500 jobs had been lost because the businesses
that created those jobs had closed.
We selected a non-representative sample of 13 businesses
We Selected 13 for on-site visits to determine the reasons for these
Businesses For On-Site businesses’ non-compliance with job creation requirements.
Visits We only interviewed officials of 10 of the businesses
because two had ceased operations and we were unable to
make contact with any official of the remaining business.
1
Under the presumptive benefit test (24 CFR 570.208(a)(4)(iv)), if an employee resides in or the assisted activity
through which he or she is employed is located in a census tract that meets the Federal empowerment zone eligibility
criteria, the employee shall be presumed to be a person of low- and moderate-income.
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Finding 1
Of these 10 businesses, six reported they had trouble with
meeting the job creation requirements due to business
problems. These problems included inability to begin
manufacturing and lack of resources to hire employees. The
president of one company stated it was impossible for a
business to create one job for every $35,000 received,
particularly in the technology field where people receive such
high salaries due to the highly specialized skills needed to
fulfill the job requirements. In addition, technology
companies typically lose money for the first couple of years.
Although some of these businesses had created jobs, they
claimed they were unable to reach EZ target area residents
because the specific qualifications required for the positions
made it difficult to find qualified EZ target area residents.
None of the businesses we visited, however, had any specific
plan or procedure to reach EZ target area residents for any
job openings available.
LACDB officials explained their primary responsibility was
to provide access to capital for businesses that otherwise
would be unable to obtain loans through conventional
financing. Therefore, LACDB’s emphasis was geared more
towards loan production and servicing rather than
compliance with job creation requirements.
Nonetheless, LACDB officials stated they were working on
Pilot Programs To Help two pilot programs to help businesses hire EZ target area
Businesses Hire Target residents. First was a training program to give EZ target
Area Residents Were area residents the skills necessary to work for companies
Unsuccessful under the venture capital program, a program where
LACDB purchased stock in starting technology companies
solely for investment purposes. At the time of our review,
this training program had not yet been implemented. The
other program was to be an attempt to link EZ target area
residents with the borrowers through a non-profit agency
called One-Stop Program.
We found, however, that LACDB’s efforts to use the
services of One-Stop program also had not been successful.
For example, LACDB claimed it sent 20,000 flyers out to
two zip code areas in the EZ target area with a postage paid
response card for the residents to indicate what kind of jobs
they were interested in. The responses were then to be sent
by LACDB to a One-Stop Program office. Only 168
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responded from one zip code area and none from the other.
None of the residents who responded were referred to
LACDB’s loan and investment recipients by One-Stop.
One-Stop also participated in a job fair to try and get jobs
for its clients, including those who responded to the
LACDB flyers. However, none of the businesses that
received funds from LACDB attended the job fair.
LACDB Approved Over $21 Million Of City-Funded
Expenditures In Excess Of The 25% Funding Limit
LACDB exceeded the required 25 percent funding limit and
HUD’s Intent Was To approved over $21 million to businesses outside the EZ
Assist Mostly Businesses target area. The EDI Agreements require at the end of the
Within The EZ Target program, at least 75 percent of the awarded EDI grant and
Area matching Section 108 funds will be spent within the EZ
target area and no more than 25 percent in the one-mile
buffer zone, or non-target area. Since the total amount of
EDI grant funds available to the City of Los Angeles was
$100 million, only $25 million of this amount plus an equal
amount of matching Section 108 funds could only be spent
in the non- target area.
The County of Los Angeles’s funded program activities did
not exceed the 25 percent funding limit.
The following table shows the breakdown of the City of
Los Angeles’ funded expenditures:
(in millions)
Non
Target Target
Fund Type Area Area2 Total Over
Section 108 $49.8 $43.1 $92.93 $18.1
EDI 21.5 28.4 49.94 3.4
Total $71.3 $71.5 $142.8 $21.5
Percentage 50 50 100
As shown above, LACDB spent $18.1 ($43.1 - $25 million)
million of matching Section 108 and $3.4 million ($28.4 -
2
Includes funds expended outside both the EZ target and non-target areas.
3
Excludes $2 million of supplemental Section 108 (not restricted by the 75/25-ratio requirement).
4
Includes $22,610,483 in administrative costs ($17,644,108 in the target area and $4,966,375 outside of target area).
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$25 million) of EDI grants outside the EZ target area above
the 25 percent spending limit.
The above table also shows that in total, $71.3 million, or
50 percent of total expenditures, was spent within the EZ
target area. This included $17.6 million in administrative
costs. For loans and investments alone, LACDB only spent
$53.7 ($71.3 - $17.6 million) million or 45 percent within
the EZ target area.
LACDB explained the reason for exceeding allowed
expenditures for non target areas was partly due to the $24
million in loans given to one borrower located in the non-
target area and another $21.3 million of investments in
venture capital companies that chose not to relocate into the
EZ target area once they received funding. While LACDB
approved investments to venture capital companies based on
written agreements with these companies to relocate into the
EZ target area, we did not find any evidence (i.e.,
commitments to occupy or lease agreements) LACDB should
have initially obtained from them to ensure they would
actually relocate after receiving the investment proceeds. As
a result, LACDB had very little or no leverage to enforce the
terms of the agreement once the investments were made. At
least two officials of the 10 businesses we visited informed
us they were unaware of the requirement to be located within
the EZ target area in order to be eligible for assistance.
LACDB had insufficient or did not follow established
Primary Cause Of The controls in its procedures to ensure borrowers’ compliance
Deficiencies with job creation requirements. LACDB’s post-funding
procedures required its staff to review businesses’ job
creation accomplishments and update job creation status
reports and have the reports reviewed by a supervisor on a
quarterly basis. If problems were identified, they were to
provide the businesses access to resources to assist them in
meeting job creation requirements. LACDB, however, did
not always validate job creation information provided by
the businesses nor conduct site visits to address deficiencies
in meeting job creation requirements.
For example, we reviewed 27 compliance files (12 venture
capital and 15 non-venture capital businesses) and found
minimal or no evidence of on-site monitoring. The extent
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of monitoring appeared to be only limited to desk reviews
by updating the quarterly status reports or reviewing the
quarterly venture capital status reports. We did not find any
evidence of follow-up or site visits to businesses
experiencing difficulties meeting job creation requirements.
During LACDB’s pre-funding processing LACDB
performed financial underwriting to qualify applicants for
funding5, and verbally discussed the job creation
requirements with the applicants; however, the businesses
did not submit written job creation plans or projections
until the funding was approved. In LACDB’s underwriting
credit summary and program compliance checklist, it stated
the aggregate amount of funds will not exceed $35,000 per
job created and the activity will create jobs predominantly
for EZ target area residents. However, we did not find any
documentation in the loan files evidencing specific analyses
performed by LACDB to support these determinations prior
to approving the loans. LACDB officials explained that no
specific or written analyses were conducted to make these
determinations. In our opinion, a specific review of the
applicant’s ability to create sustainable jobs, and
particularly that the applicant will be able to create jobs
predominantly for EZ target area residents, is important to
help assure the job creation requirements are fully met.
As a contributing factor, LACDB officials may not have
provided equal emphasis on both the financial and job
creation aspects of its program. LACDB may have also
misunderstood the extent of its responsibility for assuring
job creation requirements were being fully met. LACDB
officials stated they believed their primary purpose was to
provide access to capital for businesses that otherwise
would be unable to obtain loans through conventional
financing.
LACDB exceeded funding restrictions because of the lack
of a control system to track the amount of loans and
investments being approved in EZ target and non-target
areas. Since HUD requires LACDB to spend no less than
75 percent of the EDI Grant and an equal amount of
matching Section 108 funds in the EZ target area, LACDB
5
LACDB was unable to provide any underwriting documentation supporting its bases for approving the venture
capital investments. This is discussed separately in more detail in Finding 2.
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needed a control system to track the amount and location of
loans or investments at the time the new loans and
investments were being approved to ensure at least 75
percent of the funds were spent within the EZ target area.
Consequently, HUD funds earmarked principally for
Adverse Effect economic revitalization activities within the EZ target area
were neither fully used in accordance with the terms and
conditions under which the funds were approved nor met
the national objective criterion of low- and moderate-
income benefit.
Auditee Comments Los Angeles Community Development Bank (LACDB):
LACDB disagreed with the draft finding with respect to (1)
meeting the national objective of creating and retaining jobs
for low- and moderate-income persons, (2) OIG’s method
of allocating administrative expenses between the EZ target
and non-target areas, and (3) lack of control system to track
loans and investments. Details of its disagreements are
shown in sub-topics as follows:
(1) Meeting The National Objective of Creating Or Retaining
Jobs for Low- And Moderate-Income Persons
Job Creation Accomplishments
LACDB stated that while the report was accurate in stating
that, as of December 31, 2001, the businesses identified
had not yet met the HUD and EDI Grant Agreements’
requirements, LACDB contended its efforts at revitalizing
the Los Angeles Empowerment Zone are not yet
concluded. LACDB claimed businesses remain open and
jobs continue to be created and as of March 31, 2002, total
jobs created had increased from 2,731 to 3,445, of which
2,355 went to low and moderate-income persons.
Controls and Procedures
LACDB stated the federal regulations do not require that
LACDB ensure that job creation/retention activities are
fully met. The regulations require LACDB to document,
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not guarantee, that projected jobs “will be held by or made
available to” eligible low-and-moderate income persons.
Therefore, LACDB claimed it has met its obligations by
documenting these requirements in all financing
arrangements with borrowers and investees and by
maintaining records.
LACDB disputed OIG’s conclusion that LACDB’s pre-
funding compliance procedures were either insufficient or
not followed. LACDB stated its procedures required each
borrower to submit a preliminary job creation plan at the
time of application, which was then finalized prior to loan
approval and funding. Further, LACDB compliance staff
analyzed job creation plans for reasonableness.
LACDB also disagreed with OIG’s statement about lack of
documentation in the loan files evidencing specific
analyses performed by LACDB to support job creation
determination prior to approving the loans. LACDB
explained that it took a close look at the types of jobs that
were projected, focused on the number and range of jobs,
and discussed concerns with the business owner.
LACDB disputed OIG’s conclusion that LACDB’s post-
funding compliance procedures were either insufficient or
not followed. LACDB stated it had procedures in place to
refer borrowers/investees to One-Stop Workforce
Development Center to assist the borrowers with
employment needs. In addition, LACDB stated it
monitors the borrowers’ progress through its quarterly
reports.
Job Creation Monitoring Responsibility
LACDB agreed with OIG’s statement that it previously
misunderstood its level of responsibility for assuring its
customers were meeting job creation requirements.
LACDB erroneously believed that City, State, and
Federally funded programs were equipped to address the
needs of LACDB borrowers. LACDB acknowledged that
it is responsible to monitor job creation by its customers
and to assist those experiencing problems with hiring EZ or
other low-and-moderate income persons. In that regard,
LACDB stated it is committed to ensuring that its
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borrowers achieve their job creation requirements by
expanding its efforts in this area. The expanded efforts
will include: (1) conducting audits of borrowers’ job
creation potential; (2) hiring a job creation specialist; (3)
implement a prepayment penalty for borrowers that prepay
their loans prior to meeting the job creation requirements;
(4) expanding its outreach efforts; and (5) working with
HUD to help borrowers document that jobs were made
available to low- and moderate- income persons.
(2) Method Of Allocating Administrative Expenses
LACDB disagreed with OIG’s method of allocating the
administrative expenses between the EZ target area (75
percent) and non-target area (25 percent). LACDB
contended 100 percent of its administrative expenses
should be allocated into the EZ target area since all such
expenditures serve the EZ target area. LACDB’s basis for
its position included: (1) all administrative/ intermediary
expenses should be counted as “serving” the EZ target area,
which would consequently bring LACDB into compliance
with the EDI Agreements’ spending limits; and (2)
loans/investments funded in the EZ non-target area should
also be counted as “serving” the EZ target area.
(3) Lack of Control System To Track Loans And
Investments
LACDB disagreed with OIG’s conclusion that it exceeded
funding restrictions because of a lack of a control system to
track the amount of loans and investments to businesses
located inside and outside the EZ target area. LACDB
explained that it has a quarterly Closed Loan Report that
provides detailed information, previously reviewed by
LACDB’s outside auditors, showing its compliance with
funding limits.
City of Los Angeles (City):
The City disagreed with OIG’s conclusion that LACDB had
not met the national objective requirements. The City
contended the federal regulations state that for an activity
that creates jobs, the recipient must document that the jobs
will be held by, or made available to low- and moderate-
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income persons; thus, the federal job creation requirement
is met at the time job projections are documented.
Additionally, the City stated the draft report misrepresents
the benefits derived from LACDB activities because it
focuses on individual loans rather than aggregate results.
County of Los Angeles (County):
The County agreed with the finding. The County stated
that because of its due diligence and oversight of the loan
activity in the County EZ target area, many of the issues
identified for the LACDB program were not applicable to
the County. In addition, the County stated it will request
LACDB to consider HUD’s final recommendations in the
development of the next annual business plan and also to
reconsider its possible role in future economic development
activity in the EZ target area.
Office of Inspector Los Angeles Community Development Bank (LACDB):
General Evaluation of
Auditee Comments (1) Meeting The National Objective of Creating Or Retaining
Jobs for Low- And Moderate-Income Persons
Job Creation Accomplishments
We believe that the draft audit report clearly stated our
determination of LACDB’s job creation and retention
efforts was as of December 31, 2001, our audit cut-off date.
We did not imply LACDB’s job creation activities have
been concluded. In fact, one of our recommendations is for
HUD to determine whether, or when the businesses or
activities have been or will be completed in order to
determine whether these businesses have met the required
level of employment of low- and moderate-income persons
or not. Since we did not review LACDB’s reported
accomplishments as of March 31, 2002, we cannot
comment as to their accuracy and validity.
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Controls and Procedures
We disagree with LACDB’s interpretation of Federal
regulations claiming it has met its obligation of the
National Objective of creating and retaining jobs for low-
and moderate-income persons by documenting financing
arrangements with borrowers and investees and
maintaining records. While we agree there is no specific
language in the Federal regulations requiring it to ensure
job creation and retention should be fully met, compliance
to the Federal requirement’s National Objective of creating
and retaining jobs for low- and moderate-income persons is
not based on documentation but on actual jobs created or
retained. Documentation is a procedure to show what and
how many jobs were actually created or retained. Based on
its record, LACDB was short in accomplishing its goal to
create or retain permanent jobs where at least 51 percent of
the jobs computed on a full time equivalent basis, involve
the employment of low- and moderate income persons. To
fulfill the Federal requirement, we believe it is incumbent
upon LACDB to take proactive steps to ensure the national
objective of creating and retaining jobs for low- and
moderate-income persons is being met.
Our review did not support LACDB’s statements relating
to its pre-funding compliance procedures. Based on our
review of 15 non-venture capital loan files and
discussions with the Chief Credit Officer, we determined
that LACDB performed financial underwriting to qualify
applicants for funding and verbally discussed the job
creation requirements with the applicants. However, these
businesses did not submit written job creation plans or
projections until funding was approved. We did not find
any supporting documentation evidencing LACDB’s
claim that it conducted specific analyses of the jobs to be
created by the businesses. In our review of 15
underwriting files, we did not find any documentation in
the loan files evidencing specific analyses performed by
LACDB to support their determinations that the applicant
would be able to meet the public benefit and National
Objective requirements.
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We disagree with LACDB’s claim that its post-funding
compliance procedures are adequate. Even though
LACDB gathered job creation information from the
businesses and entered this information to update its
quarterly reports, LACDB did not always validate the job
creation information provided by the businesses or
conduct site visits to address any short fall in meeting job
creation requirements. In addition, LACDB’s policies
and procedures did not specifically require conducting
site visits to the businesses. In our opinion, site visits to
the businesses is important to validate the job creation
information provided, as well as to identify and remedy
problems encountered by businesses in meeting job
creation requirements.
Job Creation Monitoring Responsibility
LACDB’s previous misunderstanding of its responsibility
to ensure job creation requirements were being fully met by
the borrowers was a contributing factor to the businesses’
inability to fully meet job creation requirements. Since
LACDB has now acknowledged its responsibilities and has
identified additional ways to expand its efforts to monitor
borrowers’ compliance, we have no further comment on
this issue.
(2) Method Of Allocating Administrative Expenses
We disagree with LACDB’s contention that 100 percent of
its administrative expenses should be allocated to the EZ
target area. Since the EDI Agreements required that at least
75 percent of EDI grant funds must be spent for eligible
economic development activities within the EZ target area
and up to 25 percent may be spent within the EZ non-target
area, the related administrative expenses should also be
allocated using the same formula. We noted that in past
periods, LACDB was allocating its administrative expenses
using the same 75/25 percent ratio. Another acceptable
method would be to allocate expenses using actual
expenditures, but this would increase the overspent amount
even more. In our opinion, had LACDB complied with the
spending restrictions for its loans and investments, this
problem would not have occurred.
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(3) Lack of Control System To Track Loans And
Investments
We do not believe that the Closed Loan Report provided an
effective means to track expenditures. LACDB’s quarterly
Closed Loan Report was used as a mechanism to
summarize accomplishments; therefore, this report was
being prepared after the fact.
City of Los Angeles (City):
The City’s interpretation of the national objective
requirements is incorrect. The national objective
requirements are performance-based requirements that must
be met on an activity-by-activity basis, subsequent to
receiving the HUD funding, showing the number of actual
jobs created or retained. The actual numbers of jobs
created or retained for low- and moderate-income persons
serve as the basis for determining whether the national
objective requirements were being met. As it should be,
the draft finding focused on individual activities that had
not met the national objective requirements, however, the
draft finding also discussed the overall job creation and
retention efforts by LACDB.
County of Los Angeles (County):
Since the County agreed with the finding, we have no
further comment.
Recommendations We recommend you:
1A. Require the City and the County of Los Angeles to
ensure LACDB establishes and implements, or follows
monitoring control systems and procedures to ensure
businesses’ compliance with job creation and retention
requirements are fully met.
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1B. Determine whether, or when, the businesses or
activities funded by EDI Grant and Section 108 Loan
Guarantee funds listed in Appendix B have been or will
be completed.
1C. Determine and evaluate the reasons why the completed
and closed businesses identified in Recommendation
1B failed, and whether there were mitigating
circumstances for not meeting the required level of
employment of low- and moderate- income persons.
1D. Take appropriate action pursuant to the provisions of
24 CFR, Section 570.910, to the extent the completed
businesses or activities identified in Recommendation
1B were unable to meet the national objective standard
of 51% for creating/retaining jobs for low- and
moderate-income persons.
1E. Determine what action or adjustments to LACDB’s
existing monitoring policies, procedures, and
practices, should be taken to ensure the required level
of employment of low- and moderate-income persons
will be met for the uncompleted businesses or
activities identified in Recommendation 1B. Also, at
the completion of these businesses or activities,
determine the extent these businesses met the national
objective standard of 51% of creating/retaining jobs
for low- and moderate-income persons.
1F. Instruct the City and the County of Los Angeles to
require LACDB to revise and implement the policies
and procedures in accordance with the results of your
determination in Recommendation 1E. We also
recommend you take appropriate action pursuant to
the provisions contained in 24 CFR, Section 570.910,
to the extent that these businesses or activities
identified in Recommendation 1E did not meet the
national objective standard of 51% of
creating/retaining jobs for low- and moderate-income
persons.
1G. Instruct the City of Los Angeles to require LACDB to
restrict any future loans or investments involving the
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use of EDI grant funds only to businesses within or
willing to relocate into the EZ target area.
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LACDB’s $28.7 Million City-Funded Venture
Capital Program Provided Minimal Benefit To
The Empowerment Zone
LACDB invested about $26.1 million to 14 City-funded venture capital businesses and paid
about $2.6 million in related management fees to Zone Ventures Management Company
(Zone Ventures), which provided minimal benefit to the EZ. More specifically, we found:
ü the financial viability of the investments was questionable to assure the required
benefit would materialize because of the high probability of business failure
amongst venture capital businesses;
ü 12 of the 14 venture capital businesses did not meet the national objective standard
of 51 percent of jobs created or retained were held by or made available to low- and
moderate-income persons; and,
ü 12 of the 14 venture capital businesses did not locate in or move into the EZ target
area, in conflict with the basis upon which LACDB approved the investments.
In addition, contrary to the terms of the Partnership Agreement between LACDB and
Zone Ventures, Zone Ventures also did not locate into the EZ target area or create any jobs
for EZ target area residents, as required. We concluded Zone Ventures did not fulfill its
contractual obligation to ensure program requirements were fully met.
The deficiencies occurred because LACDB did not perform sufficient due diligence to assure
only those investments which could reasonably meet HUD eligibility requirements were being
approved for funding. LACDB also did not perform adequate monitoring of Zone Ventures
and venture capital businesses to ensure program compliance. As a result, LACDB’s
investments into the venture capital program did not provide the expected program benefits
to intended beneficiaries, thus, hampered its efforts to accomplish its mission of revitalizing
the EZ target area. Therefore, in our view, the $28.7 million in venture capital investments
and management fees could be considered a questionable use of HUD funds.
The 24 CFR 570.209 provides guidelines for evaluating and
HUD Underwriting selecting economic development activities eligible under 24
Requirements CFR 570.203. The regulations state the standards for
evaluating public benefit are mandatory, but the guidelines
for evaluating projects costs and financial requirements are
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not; however, grantees are expected to conduct basic
financial underwriting prior to the provision of financial
assistance. The guidelines serve as a framework for
financial underwriting and selecting HUD-assisted
economic development projects which are financially
viable and will make the most effective use of the HUD
funds. Further, the public benefit a grantee expects to
derive from the assisted activity will not materialize if the
project is not financially feasible.
The underwriting guidelines provide a project would be
considered financially viable if all of the assumptions about
the project’s market share, sales levels, growth potential,
projections of revenue, project expenses, and debt service
(including repayment of the HUD assistance if appropriate)
were determined to be realistic and met the project’s break-
even point. Generally, an economic development project
that does not reach a break-even point over time is not
financially feasible. In this regard, provisions should be
made for a negative cash flow in the early years of the
project while space is being leased up or sales volume built
up. It is also expected a financially viable project will
project sufficient revenues to provide a reasonable return on
equity investment.
Title 24, Section 570.208 (a)(4) of the CFR, states in part:
National Objective “… An activity designed to create or retain permanent jobs
Requirements where at least 51 percent of the jobs, computed on a full
time equivalent basis, involve the employment of low- and
moderate-income persons. To qualify under this paragraph,
the activity must meet the following criteria: (i) For an
activity that creates jobs, the recipient must document that
at least 51 percent of the jobs will be held by, or will be
available to, low- and moderate-income persons.”
HUD executed an EDI Agreement with the City of Los
EDI Eligibility Angeles, which provided the requirements in connection
Requirements with the economic development activities to be carried out.
The Agreement provided assisted activities must:
ü be located in or serve the qualifying urban EZ target
area,
ü create at least one job for every $35,000 of funding
received, and
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ü create jobs of which at least 51 percent are held by or
made available to EZ target area residents.
These eligibility requirements were subsequently passed
through to the assisted venture capital businesses in the
Program Compliance/HUD Addendum to the Securities
Purchase Agreement between each of the assisted
businesses and Zone Ventures.
HUD’s eligibility requirements were also incorporated into
Comprehensive the Comprehensive Agreement between the LACDB, the
Agreement City of Los Angeles, and the County of Los Angeles. The
Requirements business plan attached to the Comprehensive Agreement
also provides potential venture capital investments must
create or retain jobs within the eligible areas of the City and
should target companies owned or controlled by socially
and/or economically disadvantaged individuals. The plan
also states LACDB will seek transactions with high
probability for success, which in many instances must be
demonstrated by a minimum of two years of successful
operations. The LACDB will primarily invest in
companies in the development stage, expansion and growth
stage, or acquisition stage, and will generally avoid pure
“start-up” ventures or turn around and troubled situations.
LACDB contracted Zone Ventures to administer the
Zone Ventures venture capital program for a management fee of 2 ½
Partnership percent of LACDB’s $35 million commitment to the
venture capital program. The Zone Ventures Partnership
Agreement between Zone Ventures Management Company
(General Partner – 1%) and LACDB (Limited Partner –
99%) states the primary purpose of Zone Ventures is to
make venture capital investments in companies located in
the EZ, and its general purpose is to buy, sell, hold, sell
short and otherwise invest in securities of every kind; enter
into, make and perform all contracts and other
undertakings; and to engage in all activities and
transactions as may be necessary, advisable, or desirable to
carry out the foregoing.
Further, Zone Ventures’ General Partner covenants and
agrees to cause Zone Ventures to comply with the
provisions of each HUD Addendum executed on its behalf,
and shall use its best efforts to ensure each assisted
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company complies with the terms and conditions of the
HUD Addendum. The Agreement also provided Zone
Ventures will locate in the EZ target area and will use all
reasonable efforts to achieve the goal of hiring and
retaining EZ target area residents for at least 51 percent of
jobs it created and retained as a result of investments made.
Financial Viability Of The Investments Is
Questionable
Between February 1998 and December 2001, Zone
Ventures Partnership made stock investments totaling $26.1
million in 14 different venture capital businesses6. Based
on our analysis of the businesses’ performances, we
question the financial viability of the investments and their
ability to assure the required benefits would materialize
because of the high probability of business failure
stemming from the risky and volatile nature of the venture
capital businesses.
Generally, venture capital businesses are early stage start up
Businesses Have High companies funded by investors to develop high technology
Probability Of Failure products or services. In its response to the Request for
Proposal (RFP) leading to the creation of Zone Ventures
Partnership, Zone Ventures described early stage venture
capital investments as the segment of the venture capital
industry with the highest degree of investment risk. Zone
Ventures further stated: typically, portfolio companies have
no operating history, unproven technology, untested
management, and unknown future capital requirements. As
a result, there is no assurance there will be any success in
producing any profits or any return on capital.
Zone Ventures officials acknowledged these businesses
generally experience poor returns during the first three years
because the businesses are expending their resources heavily
on developing their envisioned products or services, to be
marketed at some point in the future. Consequently, these
businesses are highly dependent on the venture capital to
fund their operations, until such time when they can create
sufficient revenue to stabilize their operations. This,
6
LACDB’s initial venture capital investment was made prior to the contract with Zone Ventures.
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however, contradicts the business plan attached to the
Comprehensive Agreement, which stated LACDB would
generally avoid pure “start up” ventures.
Zone Ventures officials estimated the venture capital
Venture Capital businesses have about a 50 percent failure rate, but explained
Businesses Have A 50% their primary emphasis is on the potential financial success of
Failure Rate the investment as opposed to whether the business will be
able to create jobs for EZ target area residents. While there
is a high failure rate, the officials stated it is offset by the
potential financial returns of the businesses that do succeed.
Nevertheless, the program intent is to create sustainable jobs,
as opposed to making investments for the purpose of
obtaining financial returns.
LACDB officials stated their primary responsibility was to
provide businesses with access to capital and the justification
for the venture capital program was the potential phenomenal
financial returns on the investments. Further, the officials
explained funds received would not only help sustain
LACDB’s operations, but could be re-invested in the EZ
target area to offset any losses by other businesses that fail.
We disagreed with this justification. HUD’s goal is not to
gain financial returns on HUD-assisted activities. But rather,
each investment, on an individual basis, must meet HUD’s
eligibility requirements since it would be unreasonable, or
unallowable, to hold future businesses accountable for
meeting job creation requirements for businesses that failed
in the past.
Despite Zone Ventures’ and LACDB’s claimed emphasis on
the potential financial success of their investments, we noted
since the first investment was approved in February 1998,
LACDB has not yet received any returns on any of its
investments. In fact, 6 of 14 venture capital businesses had
closed or essentially ceased operations, at the time of our
audit. These six businesses received funding totaling
$7,066,526, of which $2,355,336 for three of these
businesses had already been written off as uncollectible.
Consequently, the EZ target area essentially did not receive
any benefit from these funds, nor can LACDB re-invest the
funds in the EZ target area.
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Zone Ventures was unable to provide any documentation to
Zone Ventures Did Not support the underwriting it performed as bases for approving
Support Bases For the venture capital investments, nor any documentation
Approving Venture showing any analyses of whether the venture capital
Capital Investments businesses could reasonably create the required jobs. Zone
Ventures officials explained they generally do not generate
any underwriting files, loan processing files, or similar types
of documentation. They claimed the investment decision
process consisted primarily of verbal discussions with the
entrepreneurs, review of the proposed business plan, and
research and knowledge of the industry. According to the
officials, the primary focus was to make investments in new
technologies Zone Ventures believed would succeed
financially. However, as discussed above, the financial
performance of these businesses, as of December 2001, did
not seem to support Zone Ventures’ claim. Without any
documentation supporting the bases of underwriting
decisions, HUD, the City of Los Angeles, and LACDB were
less assured HUD’s eligibility requirements would be met.
Venture Capital Businesses Had Not Met The
National Objective
As of December 2001, 12 of 14 venture capital businesses
had not met the national objective standard of 51 percent of
creating or retaining jobs for low- and moderate-income
persons.
Based on LACDB’s projections, stock investments totaling
None Of The Businesses $26.1 million in 14 different venture capital businesses (see
Fully Met Job Creation Appendix C) required these businesses to collectively
Requirements create 768 jobs. Of these 768 jobs, LACDB projected at
least 413 jobs would be held by, or made available to, EZ
target area residents. As of December 2001, these
businesses had not met the overall job creation
requirements, and more importantly, had significantly
failed to create jobs for EZ target area residents. For
example, although these businesses created 582 of the 768
(76%) projected jobs, only 7 (1%) of the 582 jobs created
went to EZ target area residents. An additional 102 jobs
went to residents outside of the EZ target area but who
were presumed-to-be qualified under the national objective
criterion for low- and moderate-income benefit. In total,
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only 109 (19%) of the 582 jobs created went to low- and
moderate-income persons.
We analyzed the jobs the venture capital businesses
Jobs Created Did Not intended to create to determine the reasons for EZ target
Benefit EZ Target Area area residents not being hired. Our analysis of the jobs
Residents As Required showed the jobs were predominantly (about three-fourths)
categorized as management or skilled jobs, as opposed to
unskilled jobs, therefore, these jobs may not be suitable to
most EZ target area residents. The management or skilled
jobs the venture capital businesses required and hired were
jobs that generally required specific skills and training,
beyond a high school education, such as chief technology
officers, vice presidents, engineers, computer programmers,
and marketing directors. Assuming the annual salary is
indicative of the skill level needed to perform the job, we
noted the annual salaries for the management and skilled
jobs ranged from $24,000 to $250,000. Likewise, unskilled
jobs were jobs, such as customer service assistants, office
assistants, and administrative support personnel, with
annual salaries ranging from $20,000 to $52,000.
To illustrate, below is a table showing the specific jobs that
one venture capital business planned to create, in
conjunction with receiving $1,980,000 in funding:
Management: Skilled: Unskilled:
Position Salary No. Position Salary No. Position Salary No. TOTAL
Chief Operating $100 - 1 Director, $75,000 24 Administrative $40,000 7
Officer $150,000 Technology Assistant
Chief $100 - 1 Director, $75,000 1
Technology $150,000 Strategy
Officer
VP – Human $100 - 1 Programmer $60,000 20
Resources $150,000
VP – Corporate $100 - 1 Director, $75,000 1
Development $150,000 Marketing
VP - Strategy $100 - 1
$150,000
TOTAL 5 46 7 58
As shown, the business planned to create 58 jobs, of which
51 jobs (88 percent) were management or skilled jobs, with
salaries ranging from $60,000 to $150,000. Only 7 of 58
(12%) of the jobs were classified as unskilled. This
business created only one job for a low- and moderate-
income person.
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In another example, the following table shows the jobs
another venture capital business planned to create, as a
condition to receiving $1,403,326 in funding:
Management: Skilled: Unskilled:
Position Salary No. Position Salary No. Position Salary No. Total
Chief Operating $75,000 1 Sr. Programmer $48,000 - 12 Receptionist $24,000 - 1
Officer $75,000 $36,000
Program Manager $60,000 - 2 Jr. Programmer $36,000 - 12 Administrative $24,000 - 1
$75,000 $48,000 Assistant $45,000
Chief Financial $60,000 - 1 Software $24,000 - 7
Officer $75,000 Quality $36,000
Assurance
Director, Business $48,000 - 1 Third Party $48,000 - 1
Development $90,000 Support/Sales $60,000
Artist/Designer $36,000 - 1
$48,000
Game Developer $50,000 - 1
$80,000
TOTAL 5 34 2 41
Again, this business planned to create 41 jobs, of which 39
jobs (95 percent) were management or skilled jobs, with
annual salaries ranging from $24,000 to $90,000. Only 2 of
41 (5%) jobs were categorized as unskilled jobs. This
business, however, is located within the EZ target area and,
therefore, even though only two of the 32 jobs created went
to EZ target area residents, the other 30 jobs were
presumed- to-be held by low- and moderate-income
persons.
We visited 4 of the 14 venture capital businesses to
EZ Target Area determine the reasons for not hiring EZ target area
Residents Did Not Have residents. Business officials were generally aware of the
The Qualifications For hiring EZ target area residents requirement, but explained
Available Venture EZ target area residents did not possess the qualifications
Capital Jobs and technical expertise to fill their vacancies. One official
stated the qualifications were so specific he had to advertise
the positions nationwide in order to get qualified applicants.
We discussed the comments made by the businesses with
Zone Ventures officials who generally agreed EZ target
area residents do not possess the skills necessary to qualify
for the specialized, highly technical jobs being created by
the businesses. Further, LACDB and Zone Ventures
officials also stated the businesses could not provide
training to EZ target area residents to enable them to
qualify for the jobs because they do not yet have the
resources or capability to implement a training program.
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These businesses are early stage start-up companies and
there is a “steep ramp-up”7 in hiring of people with the
needed skills to perform the jobs immediately and get the
business off the ground. Therefore, without a training
program these jobs may not be available to EZ target area
residents that do not already possess the necessary skills
and experience.
Zone Ventures’ Managing Partner informed us Zone
Zone Ventures Did Not Ventures’ primary focus was the financial performance of
Intend Jobs To Go To the venture capital businesses. Further, it was neither Zone
EZ Target Area Ventures’ intent that the EZ target area residents be hired
for the jobs listed on the loan agreements, nor did he
believe EZ target area residents could qualify for the jobs.
The Partner commented that with respect to meeting the job
creation requirements for EZ target area residents, HUD
needs to take a broader perspective, and any benefit to the
EZ target area would be in the long term. The Partner
further explained if the venture capital businesses became
successful, it would create a general build up of the
surrounding area, and the EZ target area residents would
then be driven to get a better education to qualify for the
better jobs. We disagreed with this logic. The funding was
approved for the specific purpose of revitalizing the EZ
target area through job creation for EZ target area residents,
based on venture capital businesses’ certification that they
would create the specific jobs detailed in the job creation
plans.
Venture Capital Businesses Failed To Locate In The
EZ Target Area
Contrary to the terms of the HUD Addendum between each
of the assisted businesses and Zone Ventures, we found 12
of the 14 venture capital businesses failed to locate in the
EZ target area. Instead, these businesses located in the non-
target area, except for one business that located outside
both areas. Zone Ventures officials explained there was
some confusion at the beginning of the program on the
7
The term “steep ramp-up” means that once the business is funded, it immediately hires all the key employees with
the necessary skills and expertise to develop the product or service to be marketed as quickly as possible. After this
initial hiring, it plateaus until the operations have stabilized.
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distinction between the target and non-target areas of the
EZ. The officials also stated the venture capital businesses
preferred locations outside the EZ target area because they
offered better amenities, such as eating facilities and
parking. Our discussions with officials at the four venture
capital businesses we visited stated they were unaware of
any distinction between the EZ target and non-target areas.
LACDB officials stated they were aware of the non-
compliance with the location requirement, but did not
require the businesses to re-locate because the confusion
stemmed from the fact their EZ map did not clearly
distinguish the target and non-target areas. LACDB’s lack
of enforcement, however, had adversely impacted their
overall compliance with the 25 percent funding limit for the
non-target area, as discussed in Finding 1.
Therefore, in our view, the venture capital businesses’ failure
to comply with program requirements, in conjunction with
LACDB’s failure to exercise sufficient due diligence
supporting its bases for approving the investments, the $26.1
million in venture capital investments could be considered a
questionable use of HUD funds (See Appendix C).
Contrary to the Partnership Agreement, Zone Ventures did
Zone Ventures Did Not not locate into the EZ target area and did not hire any EZ
Comply With The target area residents for the eight jobs it created. Both
Partnership Agreement LACDB and Zone Ventures officials claimed they were
unaware these requirements also applied to Zone Ventures
until we raised the issue during our audit. In addition, we
found Zone Ventures did not comply with Partnership
Agreement requirements to ensure venture capital companies
were also complying with program requirements. Therefore,
we concluded Zone Ventures did not fulfill its contractual
obligation to ensure HUD requirements were fully met and
the $2.6 million in management fees it received could also be
considered a questionable use of HUD funds.
Under the Zone Ventures Partnership Agreement, LACDB
Venture Capital committed $35 million in funding for venture capital
Program Investments investments and related management fees. As of
Should Be Discontinued December 31, 2001, LACDB had expended $28,679,535 of
the $35 million commitment, thus, leaving an unexpended
balance of $6,320,465. Based on the results of our review
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and evaluation of LACDB's venture capital program, we
believe LACDB should discontinue making venture capital
program investments. (See Appendix D).
In our opinion, the deficiencies occurred because LACDB
LACDB Did Not did not implement investment approval processing controls
Establish Adequate to assure only those investments that could meet the HUD
Controls eligibility requirements were approved for funding. Our
review disclosed LACDB did not provide Zone Ventures
with any written investment approval processing guidelines
or procedures to follow to determine whether investments
should be approved or not. Specific procedures were
needed that would require Zone Ventures to do analyses of
the feasibility of the venture capital businesses to create the
required total number of required jobs and of particular
importance, to meet the EZ target area resident job creation
requirements. Further, LACDB did not require additional
controls, such as written lease commitments, to assure the
venture capital businesses would locate or move into the
EZ target area prior to receiving investments proceeds.
LACDB also did not provide adequate oversight over the
LACDB Did Not venture capital program. LACDB officials stated they
Provide Adequate generally just relied on Zone Ventures to administer the
Oversight venture capital program. While LACDB officials were
aware of the venture capital businesses’ lack of compliance
with HUD eligibility requirements, they had not performed
any on-site monitoring of Zone Ventures or the venture
capital businesses, nor had they made any efforts to enforce
compliance with the requirements.
As a result, LACDB’s nearly $29 million in venture capital
LACDB’s Venture investments into the venture capital program did not
Capital Program Did provide the expected program benefits to intended
Not Accomplish Its beneficiaries, thus, hampered LACDB’s efforts to
Mission accomplish its mission of revitalizing the EZ target area.
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Auditee Comments Los Angeles Community Development Bank (LACDB):
LACDB disagreed with the draft finding. LACDB stated
there was nothing in HUD regulations precluding the use of
EDI grant or Section 108 funds for equity investments or
venture capital. Further, the suggestion in the draft report
that LACDB entered into a risky venture is consistent with
its mission. LACDB was created for the sole purpose of
creating jobs by providing capital to businesses that could
not otherwise obtain it. LACDB said the program has not
run its course, and the companies that remain in the
portfolio are the strongest, and still show potential to create
jobs and generate a return. Therefore, LACDB believes it
is premature to terminate the venture capital program.
LACDB believes that if the venture capital program is
terminated, this would ensure failure and could result in a
significant or total loss of LACDB’s investments.
LACDB also disagreed with the claim that it did not
administer the program with diligence because it fails to
take into account the oversight of each investments that was
exercised by LACDB’s Investment Committee when it
approved the investments.
City of Los Angeles (City):
The City of Los Angeles claimed venture capital
investments were part of the originally approved plan for
LACDB in which HUD determined them to be an eligible
federal expense. The City also stated it was confusing and
misleading to use the word “questionable” with respect to
venture capital investments and related management fees, if
OIG did not determine these expenditures as questioned
costs. Additionally, the City believes the $6.3 million in
unexpended funds under the Zone Ventures partnership
agreement should be deleted from the “Schedule of
Questioned Costs”, since these funds have not yet been
expended. The City stated that in 1998 when LACDB
invested in Zone Ventures, it anticipated that venture
capital investments would result in companies growing and
creating jobs, and fostering economic development.
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However, as experienced by many investors, the stock
market, and the technology sector in particular, such
investments have suffered losses in ways not imagined
several years ago. Therefore, the City is evaluating the
potential of the venture capital program portfolio in order to
determine the most prudent use of the funds in order to
meet HUD requirements.
County of Los Angeles (County):
No comments.
Office of Inspector Los Angeles Community Development Bank (LACDB):
General Evaluation of
Auditee Comments The draft finding did not state the use of EDI grant or
Section 108 funds for equity and venture capital
investments was prohibited under HUD regulations. Based
on our review of the venture capital program, we
questioned the financial viability of the investments and
their ability to assure the required benefits to Empowerment
Zone residents would materialize because of the high
probability of business failure stemming from the risky and
volatile nature of the venture capital businesses. Therefore,
in our view, the venture capital investments and related
management fees could be considered a questionable use of
HUD funds. Case in point, nearly half of the 14 venture
capital businesses have failed resulting in significant
investment losses. Consequently, we recommended
LACDB to discontinue making venture capital program
investments to prevent additional losses, thus, allowing
LACDB to put the unexpended funds to better use.
Contrary to its claim, LACDB did not administer its
venture capital program with sufficient due diligence. As
stated in the draft finding, LACDB neither established
adequate controls nor provided adequate oversight.
LACDB also did not implement investment approval
processing controls and did not provide Zone Ventures with
any written investment approval processing guidelines.
Specific procedures were needed to determine the
feasibility of the businesses to create the required number
of jobs, particularly with respect to HUD’s requirements in
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creating and retaining jobs for EZ target area residents. We
generally found that LACDB relied on Zone Ventures to
administer the programs. Even though LACDB was aware
of instances of non-compliances, it did not perform any on-
site monitoring of Zone Ventures or the venture capital
businesses to rectify issues of non-compliance.
City of Los Angeles (City):
The draft finding did not state venture capital investments
were an ineligible use of program funds. Based on the
results of our review of the venture capital businesses
funded by LACDB, however, we determined the financial
viability of those investments was questionable to assure
the required criterion of low- and moderate-income benefit
would materialize because of the high probability of
business failure amongst the venture capital businesses.
Our conclusion was further supported by the fact that the
majority of the businesses funded under the venture capital
program failed to create jobs for intended beneficiaries.
We included the $6.3 million in Appendix D, Schedule of
Questioned Cost, to report quantifiable monetary savings
that would be used more effectively if OIG
recommendations were implemented. This amount was
appropriately classified under the category “Funds Put To
Better Use”.
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Recommendations We recommend you:
2A. Instruct the City of Los Angeles to require LACDB to
discontinue making venture capital program
investments.
2B. Instruct the City of Los Angeles to require LACDB to
enforce the terms and conditions of the Partnership
Agreement against Zone Ventures to the extent
LACDB is unable to obtain full compliance.
2C. Require the City of Los Angeles and/or LACDB to
seek recovery of the $2,628,446 in management fees
from Zone Ventures, plus any additional amounts
paid after December 31, 2001, if the City of Los
Angeles and/or LACDB are unable to obtain full
compliance with the Partnership Agreement in
Recommendation 2B.
2D. Determine to what extent the venture capital
businesses listed in Appendix C have met HUD’s
public benefit criteria and national objective
standard of creating or retaining jobs for low- and
moderate- income persons.
2E. Take appropriate action pursuant to the provisions of
24 CFR 570.910, based on your determination in
Recommendation 2D.
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Finding 3
EDI Funds Used For Unnecessary Or
Unreasonable Expenses
Contrary to OMB Circular requirements, LACDB spent at least $135,150 in EDI funds for
expenses that were either unreasonable or unnecessary. LACDB paid:
ü $12,229 for meals and other expense items not essential to LACDB’s operation with
LACDB credit cards or reimbursed to LACDB employees,
ü $32,421 for unnecessary LACDB staff bonuses and pay raises given contrary to
LACDB’s normal personnel practices, and
ü $90,500 for unreasonably high fees to intermediary businesses for originating
microloans.
We attribute these deficiencies to LACDB’s lack of familiarity with cost principles
applicable to units of local government and non-profit entities. As a result, these
expenditures prevented LACDB from the ability to further carry out other eligible
activities.
Title 24 of the CFR 570.200(a)(5) states costs incurred with
OMB Circular
CDBG funds, whether charged on a direct or an indirect
Requirements
basis, must be in conformance with the applicable OMB
Circular. Attachment A of OMB Circular A-122, “Cost
Principles for Non-Profit Organizations”, provides general
principles for determining the allowability of costs, and states
in part that costs must be reasonable for the performance of
the award and be allocable thereto. The Attachment states: a
cost is reasonable if, in its nature or amount, it does not
exceed that which would be incurred by a prudent person
under the circumstances prevailing at the time the decision
was made to incur the costs. In determining the
reasonableness of a given cost, consideration shall be given
to whether the:
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ü Cost is of a type generally recognized as ordinary and
necessary for the operation of the organization or the
performance of the award.
ü Individuals concerned acted with prudence in the
circumstances, considering their responsibilities to
the organization, its members, employees, and
clients, the public at large and the Federal
Government.
We reviewed LACDB’s expenditures for administrative
expenses and found they used at least $135,150 of EDI funds
for unreasonable or unnecessary expenses relating to meals,
personnel, intermediary fees, and other expenses. Details of
these expenses are discussed separately below:
Meals and Other Expenses ($12,229)
We reviewed the LACDB corporate credit card usage and
LACDB’s expense reimbursement to its employees for 1998
and 1999 and identified $12,229 in meals and other expense
items we believe were unnecessary or imprudent uses of EDI
grant funds.
During 1998 and 1999, four senior LACDB managers
Credit Card Expenses charged $31,055 to their corporate credit cards. We
($7,261) identified $7,261 for meals, flowers, hotel movies and a
flight upgrade as unnecessary to LACDB’s operations, and
therefore, they should not have been paid with EDI funds.
Our review identified the following:
Description Amount
Meals for meetings $7,088
Flowers 106
Hotel movies and flight upgrade 67
Total $7,261
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We also reviewed employee expense reimbursements and
Employee Expense petty cash expenditures during 1998. We found $4,968
Reimbursement And spent for items such as meal expenses, birthday cakes and
Petty Cash Expenditures cards for LACDB staff. These types of expenses were not
($4,968) necessary to LACDB’s day-to-day operations, thus, were
also an unnecessary use of EDI funds.
Description Amount
Meals for business/committee $3,022
meetings, holiday parties, and office
grand opening
Meals, alcoholic beverages, and spa 1,238
charges
Birthday cards and cakes for LACDB 327
staff
Gift for staff member 46
Donations to local organizations 215
Staff AICPA membership dues 120
Total $4,968
LACDB Staff Bonuses and Pay Raises ($32,421)
LACDB’s normal practice is to give staff bonuses and pay
raises at the beginning of each calendar year in connection
with their annual performance evaluations. Consistent with
this practice, all employees received a pay raise (ranging
from 5 to 8 percent) on January 1, 1999. Additionally, in
February and March 1999, the corporate officers and nearly
all other staff received bonuses of differing amounts ranging
from $500 to $5,000. We also found, however, in July 1999,
LACDB’s former CEO/President gave seven staff members
additional bonuses and/or pay raises totaling $32,421.
Contrary to LACDB’s normal procedures, the former
CEO/President gave seven staff members a total of $5,500 in
bonuses in amounts of either $500 or $2,500, and three of
these staff members also received additional pay raises
totaling $26,921, which ranged from 13 to 21 percent. These
employees also received the usual beginning of the year
bonuses and pay raises in January 2000. In our opinion, the
additional bonuses and pay raises were unnecessary since
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LACDB has an established procedure for giving bonuses and
pay raises on an annual basis.
Unreasonable Intermediary Fees ($90,500)
We reviewed LACDB’s expenditures of EDI funds during
1998 for fees paid to intermediary businesses to originate
microloans on behalf of LACDB. We found the fees paid
were sometimes excessive or unreasonable in relation to the
microloan amount. Specifically during 1998, LACDB
made 20 microloans totaling $307,000, ranging from
$3,300 to $25,000. In exchange, the intermediaries
received a total of $90,500, and thus, the fee averaged
about 30 percent per microloan. The microloans ranged
from $3,300 to $25,000, and the related intermediary fees
paid were flat amounts of either $3,500 or $5,000 per
microloan. Therefore, the fees paid in relation to the
microloan amounts ranged from about 18 to 152 percent.
For example in one case, the intermediary received $5,000
(83 percent of the loan amount) to originate a $6,000
microloan for a photo shop. In another case, the
intermediary received $5,000 (152 percent of the loan
amount) to originate a $3,300 microloan to a toy store.
LACDB subsequently changed their practice of paying a
flat amount in February 2001, and changed the arrangement
to paying the higher of $1,000 or 10 percent of the
microloan amount. Therefore, since LACDB had already
addressed this problem, we are not making any
recommendation for corrective action.
We attributed the unnecessary or imprudent expenditures to
LACDB management’s lack of familiarity with OMB
Circular cost principles applicable to units of local
government and non-profit entities. As a result, these
expenditures prevented LACDB from the ability to further
carry out other eligible activities.
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Auditee Comments Los Angeles Community Development Bank (LACDB):
LACDB did not fully agree with the draft finding. Specific
comments as follows:
Intermediary Fees
LACDB contended the $90,500 in fees paid to microloan
intermediaries are necessary and reasonable. LACDB
disagreed with OIG’s conclusion that if the fee exceeded
the microloan amount, the fee was unreasonable or
excessive.
Staff Bonuses and Pay Raises
LACDB did not fully agree that the bonuses and pay raises
were unreasonable and unnecessary. LACDB stated it
believed special merit bonuses and pay raises to recognize
exceptional staff performance is necessary and a generally
accepted sound business practice and allowable, pursuant to
OMB Circular A-122. LACDB also pointed out that OIG’s
calculation of the total amount of bonuses in question was
understated and should have been $6,500, instead of $5,000
as reported. LACDB also stated OIG’s calculation of the
pay raises was also incorrect and should have been only
$12,627.
Meals and Other Expenses
LACDB contended that pursuant to OMB Circular A-122,
the expenses relating to the meals and other expenses items
were related to the performance of the award, in accordance
with LACDB’s established customs for improving
employer-employee relations, and therefore, reasonable.
City of Los Angeles (City):
No comments.
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County of Los Angeles (County):
The County essentially agreed with the finding, and
explained that in 1999 the County identified the
questionable expenses paid with credit cards during its
monitoring of LACDB and reported them to LACDB’s
management and accounting firm. Ultimately, both the use
of the credit cards was discontinued, and LACDB’s
management and accounting firm were replaced. With
regard to the salaries and bonuses, the County stated they
were made within the authority granted to LACDB’s Board
of Directors under the articles of incorporation and by-laws.
The County stated it will direct LACDB to comply with
HUD’s regulations.
Office of Inspector Los Angeles Community Development Bank (LACDB):
General Evaluation of
Intermediary Fees
Auditee Comments
Even though LACDB disagreed with OIG’s conclusion that
the fees were unreasonable, it may actually have recognized
that this payment structure was flawed since it changed the
fee structure of paying a flat amount to the higher of $1,000
or 10 percent of the microloan amount.
Staff Bonuses and Pay Raises
As stated in the draft finding, LACDB already had an
established practice of giving annual bonuses and pay raises
at the beginning of each calendar; therefore, it was
unnecessary to give additional bonuses and pay raises at
mid-year. Concerning the differences between the amounts
questioned in the draft finding versus the amounts pointed
out by LACDB in its response, LACDB should provide
HUD with documentation to support its position when
responding to the corrective actions required under
Recommendation 3B of this report.
Meals and Other Expenses
We disagree with LACDB’s explanation. In our opinion,
meals and other expense items were, unnecessary and
imprudent use of EDI grant funds. More specifically,
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expenditures for snacks or meals at meetings, holiday
parties, birthday cards and cakes, and gifts for staff members
do not necessarily add to the efficient day-to-day operations
of LACDB.
County of Los Angeles (County):
Since the County agreed with the finding, we have no
further comment.
Recommendations We recommend you require the City and the County of Los
Angeles to:
3A. Instruct LACDB to adhere to pertinent provisions of
OMB Circular A-122 concerning general principles
for determining cost allowability.
3B. Require LACDB to provide justification supporting
the eligibility of $44,650 in questioned costs.
3C. Reimburse the EDI Grant program from non-federal
funds for any unsupported questioned costs stated in
Recommendation 3B.
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Management Controls
In planning and performing our audit, we obtained an understanding of LACDB’s management
controls applicable to its administration of the EZ program through its HUD-funded loans and
investments activities that were relevant to the audit. Management is responsible for establishing
effective management controls. Management controls, in the broadest sense, include the plan of
organization, methods, and procedures adopted by management to ensure its goals are met.
Management controls include the processes for planning, organizing, directing, and controlling
program operations. They also include the systems for measuring, reporting, and monitoring
program performance.
We determined the following management control systems
Relevant Management were relevant to our audit objectives:
Controls
· Program administration and oversight practices to
assure program objectives are accomplished.
· Loan and investment processing and approval
procedures.
· Processing and approving loans and investments in
accordance with established underwriting
procedures.
· Monitoring borrowers’ compliance with program
requirements.
· Approving of funds in accordance with Federal
Government cost principles.
A significant weakness exists if management controls do
Significant Weaknesses not give reasonable assurance control objectives are met.
Based on the results of our review, we conclude the
following were significant weaknesses:
· Inadequate emphasis and oversight to assure timely
corrective action was taken to correct non-
compliances with HUD and EDI Grant Agreements’
requirements. (Finding 1)
· Insufficient controls to assure loans and investments
approved by LACDB met job creation/retention
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Management Controls
requirements and EDI Agreements’ spending limit
restrictions. (Findings 1 and 2)
· Non-compliance with established financial
underwriting policies and procedures. (Finding 2)
· Insufficient monitoring procedures and practices to
assure timely corrective action was taken to correct
borrowers’ non-compliances with EDI Agreements’
requirements. (Findings 1 and 2)
· Lack of familiarity with OMB Circular cost
principles to assure administrative expenditures
were reasonable and necessary. (Finding 3)
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Follow Up on Prior Audits
This is the Office of Inspector General’s (OIG) first audit of the Los Angeles Community
Development Bank.
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Appendix A
Schedule Of Businesses Not Meeting National
Objective
Funding Jobs Created
Customer Jobs
No. Location Total EDI Section 108 Projected Total EZ Residents % Total Low/Mod1 %
Written Off, Activity Closed – No Further Job Creation Expected.
038 NTA $18,000 $18,000 $0 1 0 0 0% 0 0%
016 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
017 NTA $24,521,811 $7,807,691 $16,714,120 701 111 2 2% 13 12%
011 TA2 $199,549 $0 $199,549 7 4 0 0% 0 0%
032 NTA $6,000 $6,000 $0 1 0 0 0% 0 0%
032 NTA $1,264,762 $0 $1,264,762 37 128 18 14% 18 14%
006 NTA $100,000 $0 $100,000 3 2 0 0% 1 50%
133 NTA $495,000 $321,750 $173,250 15 11 0 0% 0 0%
010 NTA $852,354 $0 $852,354 25 0 0 0% 0 0%
057 TA2 $19,900 $19,900 $0 1 0 0 0% 0 0%
081 NTA $742,500 $482,625 $259,875 22 5 0 0% 0 0%
063 NTA $500,000 $0 $500,000 15 9 0 0% 0 0%
062 NTA $692,604 $0 $692,604 20 8 0 0% 1 13%
014 TA2 $75,000 $0 $75,000 3 0 0 0% 0 0%
018 NTA $618,190 $0 $618,190 18 6 0 0% 0 0%
040 NTA $3,300 $3,300 $0 1 0 0 0% 0 0%
041 NTA4 $15,000 $15,000 $0 1 0 0 0% 0 0%
009 TA2 $635,000 $0 $635,000 19 13 0 0% 0 0%
019 NTA $590,697 $0 $590,697 17 9 0 0% 0 0%
008 OTHER3 $1,850,000 $0 $1,850,000 53 0 0 0% 0 0%
137 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
148 OTHER3 $1,485,000 $965,250 $519,750 43 9 0 0% 0 0%
064 NTA $15,000 $15,000 $0 1 0 0 0% 0 0%
050 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
116 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
003 NTA $847,078 $0 $847,078 25 9 0 0% 0 0%
103 NTA $1,733,198 $1,126,579 $606,619 52 24 1 4% 4 17%
066 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
015 TA2 $552,555 $0 $552,555 17 0 0 0% 0 0%
112 NTA $1,685,177 $1,095,365 $589,812 52 152 0 0% 6 4%
001 TA2 $925,000 $0 $925,000 27 147 17 12% 17 12%
075 NTA $340,000 $0 $340,000 10 16 1 6% 7 44%
026 NTA $16,000 $16,000 $0 1 0 0 0% 0 0%
044 NTA $20,000 $20,000 $0 1 0 0 0% 0 0%
104 NTA $925,650 $601,673 $323,977 28 8 0 0% 0 0%
Sub Total $41,869,325 $12,639,133 $29,230,192 1,222 671 39 6% 67 10%
Inactive – Activity Not Yet closed or Written Off But No Further Job Creation Expected.
096 NTA $1,738,440 $1,129,986 $608,454 52 13 0 0% 0 0%
127 NTA $15,000 $15,000 $0 1 0 0 0% 0 0%
090 NTA $82,680 $0 $82,680 3 0 0 0% 0 0%
1
Includes EZ residents, non-EZ residents but presumed to be qualified as low- and moderate-income persons, and other qualifying low- and
moderate-income persons.
2
Located in EZ target area (TA), but the business either did not create any jobs, or the jobs were prior to the January 1998 announcement of the
full EZ designation.
3
Located outside both the EZ target area and non-target areas (NTA).
4
County of Los Angeles funded loan.
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Appendix A
Funding Jobs Created
Customer Jobs
No. Location Total EDI Section 108 Projected Total EZ Residents % Total Low/Mod1 %
125 TA2 $15,000 $15,000 $0 1 0 0 0% 0 0%
093 NTA $15,000 $15,000 $0 1 0 0 0% 0 0%
140 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
061 TA2 $200,000 $200,000 $0 6 0 0 0% 0 0%
114 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
134 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
Sub Total $2,141,120 $1,449,986 $691,134 67 13 0 0% 0 0%
Loan Paid Off– No Further Job Creation Expected
074 TA2 $1,500,000 $0 $1,500,000 43 0 0 0% 0 0%
022 TA2 $882,549 $0 $882,549 26 8 4 50% 4 50%
035 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
029 NTA $25,000 $25,000 $0 1 34 0 0% 0 0%
092 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
036 NTA $9,500 $9,500 $0 1 0 0 0% 0 0%
021 NTA $386,177 $0 $386,177 22 132 16 12% 24 18%
043 TA2 $10,000 $10,000 $0 1 0 0 0% 0 0%
028 NTA $25,000 $25,000 $0 1 4 0 0% 1 25%
046 NTA $15,000 $15,000 $0 1 0 0 0% 0 0%
004 TA2 $577,194 $0 $577,194 17 0 0 0% 0 0%
Sub Total $3,480,420 $134,500 $3,345,920 115 178 20 11% 29 16%
Active – Further Job Creation Expected
115 NTA $572,177 $371,915 $200,262 17 22 0 0% 0 0%
154 OTHER3 $131,700 $0 $131,700 4 0 0 0% 0 0%
143 NTA $13,000 $13,000 $0 1 0 0 0% 0 0%
055 NTA $20,000 $20,000 $0 1 1 0 0% 0 0%
058 NTA $25,000 $25,000 $0 1 0 0 0% 0 0%
132 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
146 NTA $49,898 $0 $49,898 2 10 0 0% 3 30%
095 NTA4 $125,000 $0 $125,000 4 4 2 50% 2 50%
039 NTA $420,000 $0 $420,000 12 0 0 0% 0 0%
131 NTA $7,500 $7,500 $0 1 0 0 0% 0 0%
067 NTA $5,197,496 $3,378,373 $1,819,123 152 148 1 1% 5 3%
155 NTA $0 $0 $0 58 0 0 0% 0 0%
033 NTA $19,560 $19,560 $0 1 0 0 0% 0 0%
080 NTA $3,959,999 $2,574,000 $1,385,999 115 98 2 2% 16 16%
099 TA2 $10,000 $10,000 $0 1 0 0 0% 0 0%
025 NTA $265,000 $0 $265,000 8 4 1 25% 2 50%
068 NTA $25,000 $25,000 $0 1 17 0 0% 0 0%
120 NTA $100,000 $0 $100,000 3 3 0 0% 1 33%
113 NTA $20,000 $20,000 $0 1 0 0 0% 0 0%
071 NTA $4,000 $4,000 $0 1 0 0 0% 0 0%
030 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
126 NTA $10,000 $10,000 $0 1 0 0 0% 0 0%
145 NTA $15,000 $15,000 $0 1 0 0 0% 0 0%
045 NTA $4,800 $4,800 $0 1 1 0 0% 0 0%
142 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
152 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
088 TA2 $40,000 $0 $40,000 2 0 0 0% 0 0%
108 TA2 $25,000 $25,000 $0 1 0 0 0% 0 0%
122 NTA $11,000 $11,000 $0 1 8 0 0% 3 38%
119 NTA $1,299,446 $0 $1,299,446 38 2 0 0% 0 0%
070 NTA $60,000 $0 $60,000 2 12 0 0% 0 0%
091 NTA4 $25,000 $25,000 $0 1 2 0 0% 0 0%
023 NTA $800,000 $800,000 $0 23 5 0 0% 0 0%
027 NTA $200,000 $0 $200,000 6 11 1 9% 1 9%
139 NTA $7,000 $7,000 $0 1 0 0 0% 0 0%
124 NTA $25,000 $25,000 $0 1 1 0 0% 0 0%
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Appendix A
Funding Jobs Created
Customer Jobs
No. Location Total EDI Section 108 Projected Total EZ Residents % Total Low/Mod1 %
138 NTA $5,000 $5,000 $0 1 0 0 0% 0 0%
111 NTA $10,000 $10,000 $0 1 0 0 0% 0 0%
056 NTA $5,000 $5,000 $0 1 0 0 0% 0 0%
082 NTA $850,000 $0 $850,000 25 56 0 0% 1 2%
007 NTA $100,000 $0 $100,000 3 15 0 0% 3 20%
094 NTA $20,000 $20,000 $0 1 0 0 0% 0 0%
079 NTA $4,769,823 $875,942 $3,893,881 86 81 4 5% 15 19%
156 TA2 $200,000 $0 $200,000 15 0 0 0% 0 0%
054 NTA $10,000 $10,000 $0 1 0 0 0% 0 0%
147 NTA $1,980,000 $1,287,000 $693,000 57 10 0 0% 1 10%
Sub Total $21,537,399 $9,704,090 $11,833,309 658 501 9 2% 53 10%
$69,028,264 $23,927,709 $45,100,555 2,062 1,357 66 5% 149 11%
TOTAL
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Appendix B
Schedule Showing Portion Of Funding
Applicable To National Objective Shortfall
Total Jobs Projected Jobs Created OIG Review
Customer No. Funding No. Cost Total Low/Mod1 % Amount 2 (See Legend)
Written Off, Closed-No further job creation expected
038 $18,000 1 $18,000 0 0 0% $9,180 3
016 $25,000 1 $25,000 0 0 0% $12,750 3
017 $24,521,811 701 $34,981 111 13 12% $9,563,506 1,2
011 $199,549 7 $28,507 4 0 0% $101,769 1,2
060 $6,000 1 $6,000 0 0 0% $3,060 3
032 $1,264,762 37 $34,183 128 18 14% $467,172 3
010 $852,354 25 $34,094 0 0 0% $434,700 1,2
057 $19,900 1 $19,900 0 0 0% $10,149 3
063 $500,000 15 $33,333 9 0 0% $255,000 1,2
062 $692,604 20 $34,630 8 1 13% $263,190 1,2
014 $75,000 3 $25,000 0 0 0% $38,250 1.2
018 $618,190 18 $34,344 6 0 0% $315,276 1,2
040 $3,300 1 $3,300 0 0 0% $1,683 3
0413 $15,000 1 $15,000 0 0 0% $7,650 3
009 $635,000 19 $33,421 13 0 0% $323,850 1,2
019 $590,697 17 $34,747 9 0 0% $301,255 1,2
008 $1,850,000 53 $34,906 0 0 0% $943,500 3
137 $25,000 1 $25,000 0 0 0% $12,750 3
067 $15,000 1 $15,000 0 0 0% $7,650 3
050 $25,000 1 $25,000 0 0 0% $12,750 3
116 $25,000 1 $25,000 0 0 0% $12,750 3
003 $847,078 25 $33,883 9 0 0% $432,009 1,2
066 $25,000 1 $25,000 0 0 0% $12,750 3
015 $552,555 17 $32,503 0 0 0% $281,802 1,2
001 $925,000 27 $34,259 147 17 12% $360,750 3
075 $340,000 10 $34,000 16 7 44% $23,800 3
026 $16,000 1 $16,000 0 0 0% $8,160 3
044 $20,000 1 $20,000 0 0 0% $10,200 3
Sub Total $34,702,800 1,007 460 56 12% $14,227,311
Inactive – Businesses are not closed or written off, but no further job creation is expected
127 $15,000 1 $15,000 0 0 0% $7,650 3
090 $82,680 3 $27,560 0 0 0% $42,166 1,2
125 $15,000 1 $15,000 0 0 0% $7,650 3
093 $15,000 1 $15,000 0 0 0% $7,650 3
140 $25,000 1 $25,000 0 0 0% $12,750 3
061 $200,000 6 $33,333 0 0 0% $102,000 1,2
114 $25,000 1 $25,000 0 0 0% $12,750 3
134 $25,000 1 $25,000 0 0 0% $12,750 3
Sub Total $402,680 15 0 0 0% $205,366
Active – Further Job Creation Expected
154 $131,700 4 $32,925 0 0 0% $67,167 3
143 $13,000 1 $13,000 0 0 0% $6,630 3
055 $20,000 1 $20,000 1 0 0% $10,200 3
1
Includes EZ residents, non-EZ residents but presumed to be qualified as low- and moderate-income persons, and other qualifying low- and
moderate-income persons.
2
Portion of the loan amount applicable to the percentage difference between jobs created for low- and moderate-income persons and the national
objective standard of 51%.
3
County of Los Angeles funded loan.
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Appendix B
Total Jobs Projected Jobs Created OIG Review
Customer No. Funding No. Cost Total Low/Mod1 % Amount 2 (See Legend)
058 $25,000 1 $25,000 0 0 0% $12,750 3
132 $25,000 1 $25,000 0 0 0% $12,750 3
146 $49,898 2 $24,949 10 3 30% $10,479 3
039 $420,000 12 $35,000 0 0 0% $214,200 1,2
131 $7,500 1 $7,500 0 0 0% $3,825 3
155 $0 58 $0 0 0 0% $0 3
033 $19,560 1 $19,560 0 0 0% $9,975 3
099 $10,000 1 $10,000 0 0 0% $5,100 3
068 $25,000 1 $25,000 17 0 0% $12,750 3
120 $100,000 3 $33,333 3 1 33% $18,000 3
113 $20,000 1 $20,000 0 0 0% $10,200 3
071 $4,000 1 $4,000 0 0 0% $2,040 3
030 $25,000 1 $25,000 0 0 0% $12,750 3
126 $10,000 1 $10,000 0 0 0% $5,100 3
145 $15,000 1 $15,000 0 0 0% $7,650 3
045 $4,800 1 $48,000 1 0 0% $2,448 3
142 $25,000 1 $25,000 0 0 0% $12,750 3
152 $25,000 1 $25,000 0 0 0% $12,750 3
088 $40,000 2 $20,000 0 0 0% $20,400 3
108 $25,000 1 $25,000 0 0 0% $12,750 3
122 $11,000 1 $11,000 8 3 38% $1,430 3
119 $1,299,446 38 $34,196 2 0 0% $662,717 3
070 $60,000 2 $30,000 12 0 0% $30,600 3
0913 $25,000 1 $25,000 2 0 0% $12,750 3
027 $200,000 6 $33,333 11 1 9% $84,000 3
139 $7,000 1 $7,000 0 0 0% $3,570 3
124 $25,000 1 $25,000 1 0 0% $12,750 3
138 $5,000 1 $5,000 0 0 0% $2,550 3
111 $10,000 1 $10,000 0 0 0% $5,100 3
056 $5,000 1 $5,000 0 0 0% $2,550 3
082 $850,000 25 $34,000 56 1 2% $416,500 3
007 $100,000 3 $33,333 15 3 20% $31,000 3
094 $20,000 1 $20,000 0 0 0% $10,200 3
079 $4,769,823 86 $55,463 81 15 19% $1,526,343 3
156 $200,000 15 $13,333 0 0 0% $102,000 3
054 $10,000 1 $10,000 0 0 0% $5,100 3
Sub Total $8,637,727 282 220 27 12% $3,391,824
TOTAL $43,743,207 1,304 680 83 12% $17,824,501
Legend:
1 – LACDB’s underwriting credit summary and pre-funding checklist stated the activity will create jobs predominantly for EZ residents.
We did not find any documentation in the loan files evidencing specific analyses performed by LACDB to support the determination that
the activity will create jobs predominantly for EZ residents. The pre-funding checklist and credit summary also stated the aggregate
amount of funds made available will not exceed $35,000 per job if LACDB funds the project.
2 – Minimal or no evidence of post-funding monitoring maintained in LACDB’s compliance files. The extent of monitoring appeared to
be primarily only desk reviews through completion of LACDB’s quarterly national objective status report, and completion of public
benefit determination report upon closure of the business. We found little or no evidence of on-site monitoring or specific efforts made
with borrowers experiencing difficulties to ensure borrowers complied with job creation requirements.
3 – Business not included in OIG review sample.
3
County of Los Angeles funded loan.
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Appendix C
Schedule Of Venture Capital Investments
Funding Jobs Projected Jobs Created
Customer Section EZ Total OIG Review
No. Total EDI 108 No Cost Total Residents % Low/Mod1 % (See Legend)
Written Off, Activity Closed – No further Job Creation Expected
133 $495,000 $321,750 $173,250 15 $33,000 11 0 0% 0 0% 1,2
081 $742,500 $482,625 $259,875 22 $33,750 5 0 0% 0 0% 1,2
148 $1,485,000 $965,250 $519,750 43 $34,535 9 0 0% 0 0% 1,2
103 $1,733,198 $1,126,579 $606,619 52 $33,331 24 1 4% 4 17% 1,2
112 $1,685,177 $1,095,365 $589,812 52 $32,407 152 0 0% 6 4% 1,2
104 $925,651 $601,673 $323,978 28 $33,059 8 0 0% 0 0% 1,2
Sub Total $7,066,525 $4,593,242 $2,473,284 212 209 1 1% 10 5%
Inactive – Activity Not Yet Closed or Written Off But No Further Job Creation Expected
096 $1,738,440 $1,129,986 $608,454 52 $33,432 13 0 0% 0 0% 1,2
Sub Total $1,738,440 $1,129,986 $608,454 52 $33,432 13 0 0% 0 0%
Active – Further Job Creation Expected
115 $572,177 $371,915 $200,262 17 $33,657 22 0 0% 0 0% 1,2
067 $5,197,494 $3,378,373 $1,819,121 152 $34,194 148 1 1% 5 3% 1,2
080 $3,960,000 $2,574,000 $1,386,000 115 $34,435 98 2 2% 16 16% 1,2
023 $800,000 $800,000 $0 23 $34,783 5 0 0% 0 0% 1,2
107 $2,855,452 $1,856,044 $999,408 84 $33,993 45 1 2% 45 100% 1,2,3
098 $1,881,000 $1,222,650 $658,350 56 $33,589 32 2 6% 32 100% 1,2,3
147 $1,980,000 $1,287,000 $693,000 57 $34,737 10 0 0% 1 10% 1,2
Sub Total $17,246,124 $11,489,982 $5,756,141 504 360 6 2% 99 28%
TOTAL $26,051,089 $17,213,210 $8,837,879 768 582 7 1% 109 19%
Legend:
1 – Zone Ventures/LACDB did not have written underwriting documentation to support their basis for approving the venture capital
investment.
2 – Minimal or no evidence of post-funding monitoring maintained in LACDB’s compliance files. The extent of monitoring appeared to
be only limited desk reviews through (1) review of Zone Ventures’ quarterly portfolio report on the financial status of the businesses; there
was no evidence of any on-site monitoring or follow up on non-compliances by LACDB, and (2) completion of public benefit
determination report upon closure of business.
3 – Business located in EZ target area; therefore, business met national objective based on the presumptive benefit test.
1
Includes EZ residents hired, non-EZ residents but presumed to be qualified as low-and moderate-income persons, and other qualifying low- and
moderate-income persons.
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Appendix D
Schedule of Questioned Costs
Recommendation Unnecessary or Funds Put To
Number Unreasonable Unsupported Better Use Total
2A $6,320,4652 $6,320,465
2C $2,628,4461 2,628,446
3B $44.6503 44,650
Total $44,650 $2,628,446 $6,320,465 $8,993,561
Unnecessary costs are those that are not generally recognized as ordinary, prudent, relevant,
and/or necessary within established practices. Unreasonable costs exceed the costs that would be
incurred by the ordinarily prudent person in the conduct of a competitive business.
Unsupported costs are costs charged to a HUD-financed or HUD-insured program or activity and
eligibility cannot be determined at the time of audit. The costs are not supported by adequate
documentation or there is a need for a legal or administrative determination on the eligibility of
the costs. Unsupported costs require a future decision by HUD program officials. This decision,
in addition to obtaining supporting documentation, might involve a legal interpretation or
clarification of Departmental policies and procedures.
Funds put to better use relates to an action by management in response to the Inspector General’s
recommendations to prevent improper obligation or expenditure of funds to avoid further
unnecessary expenditures.
1
This amount represents the total management fee paid to Zone Ventures Management Company through December
31, 2001.
2
This amount represents the unexpended balance ($35,000,000 - $28,679,535) remaining on the $35 million capital
commitment under the Zone Ventures Partnership Agreement, as of December 31, 2001, for the venture capital
program.
3
This amount consists of expenditures of EDI funds paid for meals and other expenses ($12,229) not essential to
LACDB’s operations and unnecessary LACDB staff bonuses and pay raises ($32,421).
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Appendix E
Auditee Comments
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Appendix E
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Appendix E
FINDING 1: LACDB Had Not Fully Met HUD And EDI Grant Agreement’s Requirements
The LACDB does not agree with this finding.
While the report is accurate in stating that, as of December 31, 2001, the businesses identified
had not yet met the HUD and EDI Grant Agreement requirements, the LACDB contends that its
efforts at revitalizing the Los Angeles Empowerment Zone are not yet concluded. Businesses
remain open and jobs continue to be created. The LACDB’s renewed commitment to job creation
monitoring has yielded impressive results. We offer, as partial support for this statement, the
statistics presented in Figure 1.
Figure 1
Progress Toward Meeting Public Benefit and National Objective
As of As of Percent
Customer Jobs Documented Held By: 12/31/01 3/31/02 Change
Empowerment Zone Residents 339 746 120.1 %
Presumed Low/Mod Persons 996 1,283 28.8 %
Other Low/Mod Persons 165 306 85.5 %
Totals Low/Mod Employees 1,500 2,335 55.7 %
Total Jobs Created 2,731 3,445 26.1 %
Low/Mod Benefit 54.9% 67.8%
The OIG reports on page 11 that LACDB customers have created 2,731 jobs as of December 31,
2001. Of these, Empowerment Zone residents held 339 positions, employees presumed to be
low/mod persons held 996, and other low/mod persons held 165 positions. In total, LACDB-
financed activities have benefited 1,500 low/mod persons, nearly 55 percent of all jobs created. The
benefits have continued. In the first quarter of this year, the LACDB has documented that low/mod
residents of the City and County of Los Angeles held over two-thirds (2,335) of all jobs (3,445)
created by its customers. Empowerment Zone resident hiring has more than doubled to 756
positions, representing 22 percent of all persons hired.
The LACDB recognizes that the EDI grant agreements call for special emphasis on hiring of
Empowerment Zone residents. The LACDB has redoubled its efforts in this area, improving its
monitoring of borrower’s job creation and future prospects, enlisting the assistance of federally-
funded workforce preparedness centers, and hiring job creation specialists.
In the following section, we provide specific responses to statements presented by the OIG in
support of its findings.
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Appendix E
LACDB had insufficient controls or did not follow established controls in its procedures to
ensure borrower’s compliance with job creation requirements.8
Response: The federal regulations do not require that the LACDB ensure that job
creation/retention activities are fully met. The regulations require that the LACDB document, not
guarantee, that projected jobs “will be held by or made available to” eligible low- and moderate-
income residents.9 The federal regulations further state that the LACDB must maintain records; if
actual results show a pattern of substantial variation from anticipated results, the remedies
include taking actions reasonably within its control to improve the accuracy of the projections.10
The LACDB has met its obligations by documenting these requirements in all financing
arrangements with borrowers and investees and maintaining records.
We address the OIG’s comments on LACDB controls and procedures as follows.
Controls and Procedures
LACDB has well-established procedures and controls in place to ensure that job
creation/retention requirements are met by borrowers/investees. These procedures were followed
by LACDB staff in the origination and monitoring of loans and investments. The procedures are
contained in two documents, both of which were available to the OIG audit team. The Pre-
Funding Compliance manual was developed by outside counsel, in close consultation with the
City, County and HUD.11 A second companion manual of procedures was completed in April
1998, titled ”Post-Funding Compliance Procedures”, and deals with monitoring requirements.
The second manual was developed in close consultation with the County’s CDBG division and
the City’s CDD staff. The most pertinent procedures from both manuals, relating to job creation,
are as follows.
Pre-Funding Compliance Procedures
There are two fundamental analyses conducted in the pre-funding stage. First, the account officer
will require the applicant to complete and submit a “Job Creation Plan” in connection with its
request for financial assistance. The Job Creation Plan has evolved over time. At the LACDB’s
inception, the Job Creation Plan was contained in the loan application form and required the
applicant to identify the total number of jobs to be created and associated job titles. In 1998, the
8
See page 16 of the OIG audit report dated 8/27/02.
9
See 24 CFR 570.208(4)(i).
10
See 24 CFR 570.209(d).
11
The Pre-Funding Federal Program Compliance Checklist was drafted on December 13, 1996. The version
currently in use was finalized on July 1, 1997, contains 74 pages and involves four steps. Step One (“Threshold
Program Eligibility Requirements”), completed by the account officer and reviewed by compliance staff prior of
initiation of underwriting, involves determinations relating to the Public Benefit and National Objectives Criteria.
Steps Two through Four (relating to determinations on Federal Labor Standards, Environmental Assessment, Federal
Record-Keeping Requirements, Relocation Assistance, and Special Loan Determination Policy), are completed prior
to funding.
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Job Creation Plan was revamped as a separate attachment to the loan application. Each borrower
is required to submit a preliminary Job Creation Plan at time of application. The Plan is finalized
prior to loan approval and funding. The Plan requires the applicant to provide a quarter-by-
quarter description of employment build-up, by position and salary range. The Job Creation Plan
is analyzed for reasonableness by LACDB compliance staff.
The second analysis is conducted by the account officer during credit underwriting. The account
officer reviews the applicant’s business plan, historical trends, and financial projections. In
reviewing the applicant’s loan package, the account officer is required to verify that the applicant
has incorporated the projected jobs and labor expenses in the financial projections. The results of
this analysis are presented in the Credit Authorization, a document that summarizes the requested
financing, credit risks/mitigations, and staff recommendations.
Post-Funding Compliance Procedures
The post-funding procedures consist of monitoring, referral for assistance and corrective actions.
Following the funding of a loan/investment, the LACDB will refer the borrower/investee to the
appropriate One-Stop Workforce Development Center (now called WorkSource Centers). While
the number of City-certified centers has varied over time, there have been as many as 15 One-
Stops located in or serving the Empowerment Zone. Thus, the LACDB would refer a Pacoima
business to the One-Stop in Pacoima, a South Los Angeles business to a One-Stop in South Los
Angeles. These referral procedures were developed following a collaborative process involving
the Job Linkage Taskforce, a group organized by the City that included the LACDB, various
One-Stops, the Empowerment Zone Oversight Committee, and the Employment Development
Department. The role of the One-Stop is to identify employment needs, recruit, train and refer
eligible empowerment zone residents and other candidates to the employer.
The LACDB monitored referrals of borrowers to the One Stops, to ensure that borrowers were
utilizing these important publicly-funded resources and that the One Stops were assisting
borrowers.
Each borrower/investee is required to submit to the LACDB periodic information on its
employees.12 The documents supplied by borrowers/investees are reviewed and summarized by
LACDB compliance staff. The compiled information serves as the basis for the quarterly
National Objective Status Report, and other reports to the City, County and HUD. The LACDB
monitors the progress of job creation/retention activities of borrowers/investees through these
quarterly reports. Based on the quarterly information, LACDB staff will evaluate the progress of
borrower/investees in meeting the public benefit and national objective criteria. Key to making
these determinations is the availability of the quarterly information. In cases where borrowers
have not supplied current information; LACDB staff will contact the employer and request the
12
This requirement is documented in the HUD Addendum, a standard exhibit to the Business Loan Agreement and
the Securities Purchase Agreement with borrowers and investees, respectively. See CDB #006 (revised 4/14/98) for
the procedure on monitoring job creation/retention activities.
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documents.13 If a borrower is responsive to assistance, the LACDB will make a referral to the
appropriate One-Stop center. If a borrower is in non-compliance and unresponsive to LACDB
efforts, the LACDB can and has implemented procedures that include charging an additional
default interest margin of up to six percent over the contractual interest rate.14
We did not find any documentation in the loan files evidencing specific analyses performed by
LACDB to support these (job creation) determinations prior to approving the loans.15
Response: The LACDB disputes the OIG’s comments. In the course of underwriting a
prospective loan, LACDB staff took a close look at the types of jobs that were projected to occur.
The analysis focused on the number and range of jobs. The LACDB evaluated each job creation
plan to see if the business owner had prepared a thoughtful Job Creation Plan which included a
reasonable mix of white-collar to blue collar-positions; management/skilled and unskilled
positions; and salary ranges that appeared competitive. LACDB staff discussed concerns with the
business owner, resulting in revised Plan being prepared and submitted. The LACDB was
mindful of the fact the employer/owner was responsible for managing its business affairs and
avoided the potential liability arising from directing the employer/owner to revise its Plan in any
particular way.
Second, in the course of reviewing and approving financing commitments, the LACDB’s Board
of Directors and Credit Committee often commented on the need to fund businesses that
provided a “career ladder” of job opportunities. This meant that the LACDB should look for
businesses that had a range of management, skilled and unskilled positions, such that
empowerment zone residents qualifying for an entry-level position might have the promise of
growth and upward mobility within the business enterprise. The Board advised the LACDB to
avoid funding businesses that appeared to have a high number of low-wage, dead end jobs. By
focusing on businesses with a range of skill levels, it was hoped that the Bank might help to
break the cycle of poverty that has plagued the empowerment zone communities.
The LACDB contends that this approach has been implemented through its financing activities.
A range of occupations has been created, from entry level positions at Gold Graphics, South
Coast Metal Finishing and CNG Pleating; to moderate-skilled jobs created by Kids on the Move,
Hayes Protective Services and Royal Heirlooms; to more highly-skilled and higher paying jobs
like those created by the portfolio companies in the venture capital program.
It appears from the draft audit report that the OIG focused on the jobs being created by the Zone
Ventures portfolio companies. The OIG argues that these jobs provide a poor match with skill
levels possessed by empowerment zone residents. It is not uncommon for startup technology
companies to first employ teams of highly-skilled persons to launch operations. This well-
13
Pursuant to the agreements with each borrower/investee, the business is required to submit employment
information within 45 days of each quarter-end. For example, the employment information for the period ending
December 31, 2001 is due to the LACDB by February 15, 2002.
14
See Page 4 of LACDB Post-Funding Compliance Procedure CDB #006.
15
See page 16 of the OIG audit report dated 8/27/02.
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established practice helps contribute to the long-term success of almost any business. The
portfolio companies have high-skilled jobs, but also have and project to have many entry-level
and skilled positions in data entry, customer service and order fulfillment. These positions were
and will be available to EZ residents with real room for growth and real business and career
opportunities.
A final but important point. The task of identifying eligible empowerment zone residents for
hiring by LACDB borrowers remains a challenge. The LACDB continues to renew its
commitment to conduct expanded outreach to the empowerment zone communities to identify
additional employment candidates for its borrowers.
Government statistics bear out the challenge presented. As shown in Figure 2, in 1990, the City
portion of the empowerment zone had a labor force of 67,119 persons. By 2000, the labor force
had expanded modestly to 68,166, an increase of 1.6 percent. The number of persons
unemployed actually declined from 12,236 persons in 1990 to 9,335 persons in 2000, a decline of
almost 24 percent.
Figure 2
Incidence of Unemployment in the Empowerment Zone
1990 Census 2000 Census
Empowerment Zone Labor Force Unemployment Labor Force Unemployment
City EZ 67,119 12,236 (18.2%) 68,166 9,335 (13.7%)
Source: U.S. Bureau of the Census.
The LACDB draws two conclusions from these data. First, that its efforts have indeed contributed
to the revitalization of the empowerment zone, as measured by the steep decline in unemployed EZ
residents. Second, the diminishing pool of prospective hires to meet the national objective will
require aggressive tactics to identify and recruit empowerment zone residents. The LACDB remains
committed to its mission and will work with its borrowers to address the remaining unsatisfactory
levels of unemployment in the empowerment zone.
LACDB may have misunderstood the extent of its responsibility in assuring that job creation
requirements were fully met.16
Response: The LACDB did previously misunderstand its level of responsibility for job creation by
its customers. The LACDB acknowledges that it is responsible to monitor job creation by its
customers and intervene, where appropriate, to assist borrowers experiencing problems with hiring
Empowerment Zone and other low/mod residents.
LACDB’s previously approved business plans did not provide for any type of direct job
development assistance, as it erroneously believed that City, State and Federally funded programs
16
See page 17 of the OIG audit report dated 8/27/02.
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were equipped to address the needs of LACDB borrowers. While we will continue to work with the
available resources, LACDB management and staff will take a more direct hands on approach to
managing the linkages of EZ residents to LACDB borrowers.
LACDB monitors each active borrower’s progress relating to job creation on at least a quarterly
basis. The account officer, as well as compliance staff, maintains communications with all active
businesses and their owners or principals. When a business experiences a financial setback or
other difficulty, LACDB’s first objective is to help get the business back on strong financial
footing, the expectation being that a strong or growing business has substantially greater
prospects of fulfilling job creation requirements.
The deficiency in job creation is traceable to the nature of the businesses that are provided
financing. Basically, assisted businesses fall into one of four categories. First, those businesses
that are on target with their business plan and anticipated job growth. LACDB staff works closely
with these business owners, referring them to the appropriate One-Stop Workforce Development
Center (“WSC”) for assistance with identifying and hiring empowerment zone residents. Many
of these borrowers also participated in job fairs that were held in the empowerment zone or
which served empowerment zone residents. The second category is those businesses that
experienced a setback in executing their business plan, due to loss of key accounts or personnel,
changes in the economy or other unforeseen factors. Several of these businesses are still
projecting significant job growth and are being referred to CDD/WSC for assistance with hiring
EZ residents. The third category is those businesses that were unable to achieve their business
plans and have ceased operations. Businesses in this category have created the fewest jobs; there
is no prospect for future job creation. The fourth category consists of the Venture Capital
Program portfolio. While these businesses have created a significant number of jobs (561 jobs
through March 31, 2002), very few are held by EZ residents. The portfolio companies
experienced phenomenal job growth, outstripping the pool of experienced labor in the
empowerment zone. The LACDB still plans to work closely with the portfolio companies and the
resources available to identify and train empowerment zone residents that could fill positions
created by turnover and attrition. Finally, while approximately one-half of the portfolio
companies have closed, the remaining portfolio accounts for approximately 60 percent of the
total jobs created. Many of these jobs are considered entry-level positions, they include data entry
clerks, and customer services representatives and product fulfillment workers/warehouse
employees.
Expanded Job Creation Efforts
The LACDB is committed to ensuring that its borrowers achieve their contractual requirements
for job creation, for the ultimate benefit of empowerment zone and other low- and moderate-
income persons. Beginning in 2001, the LACDB revamped its activities directed at improving
overall job creation and hiring of Empowerment Zone and other low/mod residents by its
customers.
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1. Improving Job Creation by Borrowers/Investees
The LACDB is committed to significantly improve the job creation outcomes for its
borrowers and the Zone Ventures’ portfolio companies. To accomplish this, a detailed
improvement process has been developed that has the following key components:
· Auditing Borrowers/Investees to Assess Job Potential
· Creating a Databank of Empowerment Zone residents
· Linking EZ Residents to Job Openings
· Leveraging relationships with existing borrowers
· Intervening early with new borrowers
Successful execution of the strategy will require the active cooperation of LACDB
borrowers, Zone Ventures and its portfolio companies, assistance from the Empowerment Zone
Oversight Committee in identifying empowerment zone residents, and close collaboration with
the City’s Workforce Development Division and its newly constituted WorkSource system.
2. Job Potential Audit
To better determine each active borrower’s capacity to expand, create new jobs and
ultimately meet the public benefit of job creation, LACDB is conducting audits of job potential.
The audits focus on near-term job potential (i.e., over the next 90 days). LACDB will refer these
high potential job creators to the CDD/Worksource system for assistance. LACDB intends to
closely track each referral to monitor progress and coordinate assistance to its borrowers. The
LACDB expects that this focused effort will lead to improved results.
3. Hiring of Job Creation Specialist
The LACDB retained a job creation specialist in 2002 to assist with the expanded job
creation and monitoring activities. This contractor is dedicated to job creation monitoring, borrower
referrals, coordinating assistance and contact with CDD/Worksource system, community outreach,
and reporting.
4. Prepayment Penalty for Noncompliance
Beginning with new loans booked in the 2002 program year, borrowers who prepay their
loans in advance of the maturity date, and have not complied with the public benefit criterion will
be assessed a prepayment penalty equivalent to 20 percent of the original commitment amount.
5. Expanded Outreach
The LACDB is committed to an expanded collaboration with a wide range of government
and nonprofit organizations to identify Empowerment Zone residents that may benefit from jobs
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being created. To accomplish this, the LACDB intends to expand its calling program to meet with
the following organizations:
· City Council and County Supervisors offices
· Empowerment Zone Oversight Committee
· CDD/Worksource system
· Los Angeles Unified School District (principally adult programs)
· State and County agencies (including EDD, DPSS/GAIN, etc.)
· Community Development Corporations and other local nonprofits
· Governance bodies of the affected Enterprise Communities/Renewal
Communities
· Faith-based organizations
Moreover, the LACDB will continue to actively participate in job fairs and other
community-oriented activities that may attract empowerment zone residents.
6. Made Available To Criterion
Under existing HUD regulations, recipients can meet the national objective in certain
cases where the borrower has not hired the required number of empowerment zone residents, but
can document that jobs were made available to low- and moderate-income persons. The LACDB
will analyze each new loan and seek approval from the City, County and HUD for loans it
determines are suitable for this additional criterion. HUD has previously expressed its
willingness to allow the LACDB to qualify loans, on a case-by-case basis, using the made
available to criterion.
LACDB approved over $21 million of City-funded expenditures in excess of the 25% funding
limit.17
Response: The OIG’s audit findings state that, through December 31,2001, the LACDB has spent
only 50% of the funds within the EZ target area, instead of the required 75 percent. In footnote 4
to the text table on Page 15, the OIG allocates only $17.7 million of the $22.6 million in
administrative expenses to the EZ target area. The LACDB contends that 100% of its
administrative expenses are within the EZ, since all such expenditures serve the EZ. The basis
for this position is presented below.
· The EDI Grant Agreement states that the "assisted activities must be located in or serve
the qualifying urban Empowerment Zone target area".18 The agreement goes on to discuss
how the requirement may be met, principally in terms of funding limits.
17
See page 14 of the OIG audit report dated 8/27/02.
18
See Paragraph 4 of the Special Contract Conditions, EDI Grant Agreement dated October 31, 1995.
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· The LACDB funded loans/investments in the EZ target area in fulfillment of this
objective. These eligible expenditures have been properly allocated by the OIG towards
the 75% limit.
· The LACDB funded loans/investments in the EZ non-target area that also fulfilled the
primary objective. We believe that HUD created the opportunity for the LACDB to fund
activities in the non-target area specifically because the assisted businesses would serve
the EZ target area. The service requirement was fulfilled inasmuch as each assisted
business in the non-target area was contractually obligated to create jobs for the benefit of
the EZ target area (i.e., 51% requirement). The OIG may argue that the public benefit and
the national objective were not achieved; however, we contend that the regulations
require prudent underwriting and documentation of the obligation, not a guaranty of
outcomes.
· Therefore, all LACDB administrative/intermediary expenses should be counted as
"serving" the EZ target area. This would bring $4,459,754 in EDI expenses back to the
EZ side of the ledger, and eliminate the finding on exceeding the 25% funding limit.
· Further, the loans/investments funded in the EZ non-target area should also be counted as
"serving" the EZ target area. This would bring $22.9 million of Section 108 expenditures
back to the EZ side of the ledger.
LACDB exceeded funding restrictions because of the lack of a control system to track the amount
of loans and investments approved in the EZ target and non-target areas. 19
Response: LACDB has procedures and controls in place to track the source of funding for each
loan and investment it makes. This is critical since the LACDB’s programs encompass two political
jurisdictions and are funded by at least five different public sources.20 The funding controls have
been audited on a quarterly basis by CPA firms since 1996, first by KMPG and more recently by
Thomas Cobb Bazilio & Associates.
The principal source of information on this subject is the quarterly Closed Loan Report prepared by
the LACDB beginning in January 1998.21 The report provides detailed information that has been
reviewed by the LACDB’s outside auditors for compliance with the City and County EDI Grant
Agreements funding limits.
In August 1999, LACDB’s Chief Financial Officer informed the Bank’s business development and
intermediary programs that, with respect to the City EDI Grant Agreement, financing levels was
approaching the 25% funding limit for activities in the EZ non-target area. The CFO directed that
19
See page 17 of the OIG audit report dated 8/27/02.
20
City EDI grants, City Section 108 loan guarantees, City CDBG, County EDI grants and County Section 108 loan
guarantees.
21
This report lists the borrower name, aggregate commitments, business address, location eligibility (i.e., City EZ,
City SZ, County EZ, County SZ, etc.)
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business development efforts (for both direct and indirect lending) be refocused on the EZ target
area and other qualifying low- and moderate-income census tracts. These priorities were also
reflected in the 2000 Annual Business Plan submitted in October 1999. By this time, the LACDB
had already entered into the Zone Ventures limited partnership agreement and was contractually
obligated to fund activities up to the capital commitment level.
Judging from the amount of loans written off ($41.7 million) plus the amount of delinquent loans
($8.7 million), additional losses may be more likely to occur.22
Response: The OIG’s draft audit findings state that the LACDB has already incurred significant
losses from loans and investments to business that have already closed. The OIG further states that
judging from the amount of loans written-off ($41.7 million) and delinquent loans ($8.7 million),
additional losses may occur.
Assisted businesses that have not created the required number of jobs are, in most cases, the
same businesses that have failed or are failing. While the LACDB’s primary mission is to create
jobs for residents of the empowerment zone, it is restricted to assisting those businesses that are
unable to obtain financing from other lenders.23
The expectation is that the LACDB would assist good businesses starved by the lack of capital in
underserved communities to obtain needed financing that would enable the owners to grow their
business and hire new employees from the adjacent communities.
Several additional points need to be made. First and foremost, the LACDB was created for the
purpose of assisting the least-creditworthy businesses in the most distressed communities of Los
Angeles. The probability that a high proportion of businesses would experience difficulties in
executing their businesses and ultimately fail, was known at the inception of the program. This was
acknowledged in the 1994 NOFA, which offered a 100% matching EDI grant funds to offset the
expected high default risks of these assisted businesses, and in the original Business Plan approved
in 1995 at the inception of the Bank.
Secondly, LACDB applies highly conservative procedures to determine when and what to charge-
off. The procedure was developed by LACDB’s manager of loan administration, a former national
bank examiner, and has been reviewed and accepted by the Bank’s former auditor, a Big-5 CPA
firm.
Thirdly, the OIG gives no credit for recovery efforts by the LACDB that have led to the collection
of $4 million of federal funds from failed or closed businesses. The LACDB is equally diligent at
the back-end of a transaction, in order to effect maximum recovery of federally-funded assets. Each
loan charge-off is reviewed to determine the probability of recovery based on a number of factors,
including whether: (a) the business has ceased operations, (b) a scaled-down business can satisfy
the debt through a full or partial repayment, (c) the business’s pledged assets, guaranty and
22
See page 5 of the OIG audit report dated 8/27/02.
23
See 24 CFR 570.209(a)(3).
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LACDB’s collateral position are available to satisfy the debt, and (d) solvency of the business entity
(i.e., evidence of bankruptcy of business and/or guarantors). These and other relevant factors are
evaluated against the cost-effectiveness of available recovery options, which range from negotiating
compromise/settlement agreements to litigation and foreclosure actions. The LACDB also employs
other collection efforts that include reporting a borrower’s default to the national credit agencies
and to the GSA’s Excluded Parties List System.
FINDING 2: LACDB’s $28.7 Million City-Funded Venture Capital Program Provided
Minimal Benefit To The Empowerment Zone
The Los Angeles Community Development Bank does not agree with Finding 2 and the related
recommendations.
By way of background, there is nothing in HUD regulations or the 1994 NOFA that preclude the
use of EDI grant or Section 108 funds for equity investments or venture capital. Accordingly,
LACDB’s Venture Capital Program was included in its original Business Plan and has been
approved each year in subsequent business plans.
For purposes of this response, the conclusion reached in the OIG Report can be separated into
several logical tiers, suggesting that (1) LACDB entered into a risky venture capital scheme
pursuant to a contract that it did not enforce, (2) LACDB did not closely administer the contract,
and (3) the result is a substantial financial investment in companies that have both failed and not
met the requisite job creation requirement. The Report then goes on to recommend that HUD
instruct the City of Los Angeles to require LACDB to (1) discontinue making venture capital
program investments, (2) enforce the terms and conditions of the Partnership Agreement against
Zone Ventures to obtain full compliance, and (3) seek recovery of the $2,628,446 in Zone Ventures
management fees.
The suggestion that LACDB entered into a risky venture is consistent with our mission. As
echoed in other parts of this response, LACDB was created for the sole purpose of job creation
by getting capital to businesses that could not otherwise obtain it. Our market place is by
definition the risky commercial venture. However, it is premature to conclude that the venture
capital program has failed. The program has not run its course, and the companies that remain in
the portfolio are the strongest, according to an independent third-party review, and they still show
potential to create jobs and generate a return. A careful examination of the Partnership
Agreement has also led us to conclude that the most prudent course of action is for the LACDB
to continue the relationship with Zone Ventures.
Similarly, we believe that the claim that LACDB did not administer the contract with diligence is
also flawed because it fails to take into account the oversight of each investment that was
exercised by LACDB’s Investment Committee. The OIG does not describe the information
submitted by Zone Ventures to the LACDB Investment Committee for approval, nor the minutes
of Investment Committee/Board of Directors meetings that addressed those discussions. LACDB
carefully considered each investment that it ultimately approved. The fact that, in hindsight, some
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of the investments were not productive is not sufficient evidence of improper oversight. There
was oversight to the extent permitted by a limited partnership agreement that is typical of venture
capital arrangements.
While some of the companies have failed, and the program has not generated jobs in the
aggregate that are consistent with HUD requirements, we believe, however, that it is too early in
the program to conclude that it has failed entirely. Several of the companies show potential for
growth and job creation. Accordingly, not until we have reached the end of the program will we
know whether in the aggregate the program has performed in accordance with guidelines. We
believe that we should allow the program to reach its contractual conclusion.
Therefore, we disagree with the recommendation that the LACDB’s participation in the venture
capital program be terminated. To do so may ensure failure and could result in a significant or
total loss of LACDB’s investment. The fact that all of the investments have not performed as
hoped is no basis, in hindsight, for imposing a penalty on LACDB. In an effort to address these
concerns, the LACDB Board and management implemented an extensive review of available
options. Negotiations to improve the terms of the agreement were unsuccessful. After extensive
deliberation, it is the consensus of the LACDB Board that the best course of action is to continue
the contractual relationship with Zone Ventures.
FINDING 3: EDI Funds Used for Unnecessary or Unreasonable Expenses
The LACDB does not fully agree with the OIG analysis and subsequent findings.
Intermediary Fees 24
The OIG’s analysis compared the intermediary fees paid to the microloan commitment amount
and concluded that if the fee exceeded the microloan, the fee was unreasonable or excessive. The
OIG apparently did not consider either how the fee was determined or the scope of services
covered by the intermediary agreements. We offer the following additional chronology and facts
in support of our position.
In its July 6, 1995 approval of the various agreements and documents leading to the creation of
the Los Angeles Community Development Bank, the Los Angeles City Council required that “all
Request for Proposal (“RFP”) documents regarding the selection of intermediaries be approved
by the Council and the Mayor as part of an amended Business Plan.”25 This requirement was met.
On August 2, 1996, the LACDB issued a Request for Qualifications (“RFQ”) to organizations
interested in participating as financial intermediaries of the LACDB. The RFQ was developed to
identify a pool of potential intermediaries for each of the LACDB’s indirect lending programs
(i.e., microloan, business loan and commercial real estate loan programs). Based on the
qualifications received by September 30, 1996, the LACDB identified a pool of community-
24
See page 38 of the OIG audit report dated 8/27/02.
25
See Item 6 of Los Angeles City Council File No. 94-2167
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based organizations with the requisite experience and skills to market and underwrite, microloans
on behalf of the LACDB.
Given the public interest in serving the smallest and neediest of the borrower base, those small
businesses having capital needs of $25,000 and below, the LACDB Board of Directors
authorized staff to initiate an indirect lending program through the selection of microloan
intermediaries.
Accordingly, on March 31, 1997, the LACDB issued a RFP for its microloan intermediary
program to five organizations that satisfactorily responded to the aforementioned RFQ. The
Microloan Intermediary Program RFP outlined the following scope of services to be performed
by the organizations:
· Marketing and Outreach: The precise strategies being left to each organization, this task
involved penetrating the very-small business community as well as home-based
businesses to identify potential microloan applicants.
· Pre-screening for Threshold Eligibility: Conduct screening for location eligibility, and
ability to achieve public benefit and national objective.
· Initial Credit Assessment: Conduct an early assessment of the credit to determine whether
it merits further analysis.
· Technical Assistance: Provide assistance to the applicant in completing the loan
application, including assistance with the business plan.
· Credit Analysis: Conduct due diligence on cash flow, financial projections, loan pricing,
collateral, and credit history.
· Loan Presentation: Prepare a narrative summary, with supporting documents, for
presentation to the LACDB microloan credit committee.
· Loan Closing: Review LACDB-generated loan documents with the applicant.
· Post-Closing Relationship Management: Assist the LACDB with the collection of
periodic financial statements, job creation data, site visits, and technical assistance (as
appropriate).
As should be evident, the level of effort required of microloan intermediaries was substantive
and comprehensive. In a great many cases, the microloan intermediaries informed LACDB staff
that they were spending upwards of 80 to 100 hours on a single applicant.
A key feature of the RFP was the LACDB’s condition that financial intermediaries only be
compensated on a closed loan basis. This was viewed as a means to focus the intermediary on the
most probable microloan candidates.
By the April 30, 1997 deadline, four nonprofit, community-based organizations had submitted
proposals to the LACDB. Each organization submitted an estimate of the anticipated microloan
volume and fee estimates. Three of the respondents submitted fees of $5,000 per funded loan, the
fourth proposed a fee of $7,500 per funded loan. The LACDB eventually entered into contracts
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with the three respondents at $5,000 per funded loan, being unable to reach agreement with the
fourth respondent.
A final comment. In its draft audit report, the OIG comments that “in another case, the
intermediary received $5,000 (151% of the loan amount) to originate a $3,300 microloan to a toy
store.”26 The business that received the microloan was a home-based business operating out of a
HUD-subsidized housing project in Pacoima. The business needed extensive technical assistance
to prepare a business plan and loan application. With the funding, the small business was able to
relocate to a storefront along Van Nuys Blvd., within the federal empowerment zone and
purchase inventory. The LACDB believes this is exactly the type of enterprise that the microloan
program was designed to assist.
In conclusion, and based on our understanding of the underlying costs principles, we contend that
the $90,500 in fees paid to microloan intermediaries are necessary and reasonable.
Staff Bonuses and Pay Raises 27
The LACDB does not fully agree with the finding that mid-year bonuses and pay raises to
recognize outstanding performance were unnecessary and unreasonable. According to
Attachment A of OMB Circular A-122, paragraph 3(b), “a cost is reasonable when consideration
is given to constraints or requirements imposed by such factors as generally accepted sound
business practices.” We believe strongly that special merit bonuses and pay raises to recognize
exceptional staff performances is necessary and is a generally accepted sound business practice.
We would like to also point out that certain errors on page 37 of the OIG Draft Report, as
follows:
In July 1999, LACDB’s former CEO/President gave seven (the actual number is
nine) staff members additional bonuses and/or pay raises totaling $32,421 (the
actual amount is $31,753). Contrary to LACDB’s normal procedures, the former
CEO/President gave seven (actual number is nine) staff members a total of $5,000
(actual amount is $6,500) in bonuses in amounts of either $500 or $2,500, and
three of these staff members also received additional pay raises totaling $26,921
(actual amount is $25,253) which ranged from 13 to 21 percent.
In addition, the calculation of the pay raise amount is incorrect. The amount stated in the OIG
draft report was the total annual pay raises over a 12-month period. However, the three staff
members received their salary adjustments 6 months earlier, in July 1999 instead of January
2000. Hence, the more appropriate amount should be $12,627, 6 months of the total annual pay
raises.
26
See page 38 of the draft OIG audit report dated 8/27/02.
27
See page 37 of the OIG audit report dated 8/27/02.
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Appendix E
Meals for Meetings ($7,088) 28
These costs were primarily related to meetings with program advisors and loan applicants. Based
on our understanding of the applicable cost principles, we contend that the costs incurred were
reasonable for the performance of the award (Attachment A of OMB Circular A-122, paragraph
A(2)(a)); necessary for the operation of the organization (Attachment A of OMB Circular A-122,
paragraph A(3)(a)); and, were within generally accepted sound business practices (Attachment A
of OMB Circular A-122, paragraph A(3)(b)).
Meals for business/committee meetings, holiday parties, and office grand opening ($3,022)
29
Meals for business/committee meetings were costs primarily related to light snacks, coffee and
non-alcoholic beverages for onsite meetings of the LACDB Board of Directors. The volunteer
Directors were required to travel directly from their business locations to the LACDB’s
headquarters office in South Los Angeles for late afternoon meetings. The Board meetings
typically began at 4:00 p.m., lasting between 2 to 4 hours. Based on our understanding of the
applicable cost principles, we contend that the costs incurred were reasonable for the
performance of the award (Attachment A of OMB Circular A-122, paragraph A(2)(a)); necessary
for the operation of the organization (Attachment A of OMB Circular A-122, paragraph A(3)(a));
and, were within generally accepted sound business practices (Attachment A of OMB Circular
A-122, paragraph A(3)(b)).
Holiday party costs are allowable pursuant to Attachment B of OMB Circular A-122, paragraph
13 because they were other expenses incurred in accordance with the LACDB’s established
custom for the improvement of employer-employee relations, employee morale, and employee
performance.
Office grand opening costs are allowable pursuant to Attachment B of OMB Circular A-122,
paragraph 29, because the event was held as part of the general administration of the
organization.
Birthday cards and cakes for LACDB staff ($327) 30
Based on our understanding of the applicable costs principles, we contend that the costs incurred
were reasonable and are allowable pursuant to Attachment B of OMB Circular A-122, paragraph
13 as other expenses incurred in accordance with the LACDB’s established custom for the
improvement of employer-employee relations, employee morale, and employee performance.
Staff AICPA membership dues ($120) 31
28
See page 36 of the OIG audit report dated 8/27/02.
29
See page 37 of the OIG audit report dated 8/27/02.
30
See page 37 of the OIG audit report dated 8/27/02.
31
See page 37 of the OIG audit report dated 8/27/02.
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Appendix E
Based on our understanding of the applicable costs principles, we contend that these costs
incurred were reasonable and are allowable pursuant to Attachment B of OMB Circular A-122,
paragraph 30. It is also a generally accepted sound business practice for an organization to pay
for professional memberships for its technical and professional staff (Attachment A of OMB
Circular A-122, paragraph 3(b). This practice enables the LACDB to recruit and retain a licensed
CPA in its accounting unit.
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Appendix E
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Appendix E
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Appendix E
Auditee Comments
Audit Report
Los Angeles Community Development Bank
Economic Development Initiative Grant/Section 108 Guaranteed Loan Program
City of Los Angeles
County of Los Angeles
Los Angeles Community Development Bank (LACDB) Had Not Fully Met HUD and Economic
Development Initiative Grant Agreements’ Requirements
Auditee Comments:
Separate Unincorporated County Program
The LACDB Program in the Los Angeles County (County) Unincorporated Empowerment Zone
(EZ) target area was operated under a separate grant agreement and was much more significantly
controlled than the overall LACDB Program. Due to the County’s oversight of loan activity in
the County EZ target area, many of the issues identified for the LACDB Program were not
applicable under the County’s Program. In the County’s EZ target area, there were only a total of
six (6) businesses that received loans totaling $4,775,275. Of this amount, $4,332,275 went to
one (1) business, the Cambridge Steel Corporation. The remaining five (5) businesses received a
total of $443,000 in three (3) micro loans (below $25,000) and two (2) small business loans
(below $250,000).
Adopted Procedures to Meet HUD/EDI Requirements
County oversight of the LACDB was thorough and all due diligence was taken to insure that the
LACDB first developed and adopted pre-funding and post-funding procedures consistent with
the U.S. Department of Housing and Urban Development (HUD) and Economic Development
Initiative (EDI) requirements before any loans could be considered. In fact, the policies and
procedures of the LACDB in this area were initially drafted by County staff as technical
assistance to the LACDB. The LACDB was not permitted to issue loans in County areas until
these policies and procedures were adopted. Under these procedures, the County staff visited the
sites of each proposed borrower to verify location within the County’s EZ target area or buffer
zone, and to discuss job creation requirements with the assisted business.
Economic Factors Influence Job Creation
Following funding of the loans, County staff reviewed each quarterly report of the LACDB as to
progress made by the County businesses on their job creation goals. The first County loan was
funded in 1998, and the remaining loans were made in 1999. By the year 2000, the County was
aware of problems among the businesses in meeting their job creation requirements. In all cases,
these problems were directly related to poor economic performance by the businesses, which
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Appendix E
cannot be controlled by the LACDB. County staff met with LACDB monitoring staff to review
LACDB post-funding procedures, and in the case of the Cambridge Steel Corporation, with
corporate management, to evaluate the diligence of the LACDB and the businesses in achieving
the job creation goal.
It is essential that HUD recognize several factors that directly affected the ability of the assisted
businesses to create the minimum required number of jobs:
· The majority of the assisted businesses were marginal companies, and the major cause of
failure to meet job creation requirements was the economic failure of the businesses; and
· The volatile market conditions that not only affected large Fortune 500 companies, but
also small businesses that are most sensitive to changes in the economy such as the
Cambridge Steel Corporation.
Given the above factors that influence the businesses’ ability to create jobs, it is not reasonable to
expect the County to establish controls to offset economic factors. Short of managing the
assisted businesses, the County could not further assist the businesses to generate sufficient
earnings to create the minimum number of required jobs during the initial stages of loan
assistance. The one resource that most of the assisted businesses needed was access to grant
funds and other funding sources with fewer restrictions and longer terms. Unfortunately, the
LACDB did not have these types of funds to provide to the businesses.
Conclusion:
The main reason for the failure of businesses to meet their job creation goals was the economic
failure of the businesses themselves. These companies were not able to overcome the obstacles
imposed by under capitalization, poor area economics and the lack of grant funds. Based upon
our fiscal assessment of the companies at the time of assistance, if these businesses had
succeeded, all projected jobs would have been created.
The LACDB will be requested to consider HUD’s final recommendations in the development of
the next annual business plan and to reconsider its possible role in future economic development
activity in the EZ target area.
Finding No. 2: $28.7 Million City-Funded Venture Capital Program Provided Minimal
Benefit To The Empowerment Zone
Auditee Comments:
None.
Finding No. 3: EDI Funds Used for Unnecessary Or Unreasonable Expenses
Disputed Accounting Procedures
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Appendix E
The audit report states that “contrary to OMB Circular requirements” the LACDB paid $135,150
in EDI funds for expenses that were either unnecessary or unreasonable.
Credit Card Accounts Closed
In 1999, the County independently identified questionable expenses upon monitoring the
LACDB and reported them to the LACDB’s management and its accounting firm. When no
further action was taken by the auditors or the LACDB management to resolve those
expenditures, the auditors were replaced. Concurrently, LACDB management changed and at the
direction of the succeeding management, credit card practices and questionable expenditures
were discontinued and the accounts were closed at the direction of the LACDB Board. The
County’s share of questioned costs is $1,599.
LACDB Board Acted On Salaries and Bonuses
With respect to the $32,421 in disputed staff bonuses and pay raises, the County points out that
the cited adjustments were made by the LACDB Board of Directors within the limits of the
authority granted to the LACDB Board by their articles of incorporation and by-laws. Of the
$32,421, the County’s share of disputed costs is $4,206.
QUESTIONED COSTS
Questioned Cost City Share County Share
Credit Card Usage $10,630 $1,599
Salaries/bonuses $28,215 $4,206
Total $38,845 $5,805
Conclusion:
The LACDB will be directed to comply with HUD’s recommendations. The County’s total share
of questioned costs is approximately $5,805.
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Appendix F
Distribution Outside Of HUD
The Honorable Joseph Lieberman, Chairman, Committee on Governmental Affairs
706 Hart Senate Office Building, United States Senate, Washington, DC 20501
The Honorable Fred Thompson, Ranking Member, Committee on Government Affairs,
706 Hart Senate Office Building, United States Senate, Washington, DC 20510
Sharon Pinkerton, Senior Advisor, Subcommittee on Criminal Justice, Drug Policy & Human
Resources, B 373 Rayburn House Office Building, Washington, DC 20515
Andy Cochran, House Committee on Financial Services, 2129 Rayburn H.O.B.
Washington, D.C. 20515
Clinton C. Jones, Senior Counsel, Committee on Federal Services, U.S. House of
Representatives, B303 Rayburn H.O.B., Washington, DC 20515
Kay Gibbs, Committee on Financial Services
Stanley Czerwinski, Director, Housing and Telecommunications Issues, United States General
Accounting Office, 441 G Street, NW, Room 2T23, Washington, DC 20548
Steve Redburn, Chief Housing Branch, Office of Management and Budget
725 17th Street, NW, Room 9226, New Executive Office Building, Washington, DC 20503
Linda Halliday, Department of Veterans Affairs, Office of Inspector General, 810 Vermont Ave.,
NW, Washington, DC 20420
William Winthrow, Department of Veterans Affairs, Office of Inspector General, Audit
Operations Division, 1100 Main, Room 1330, Kansas City, Missouri 64105-2112
George Reeb, Assistant Inspector General for Health Care Financing Audits
The Honorable Dan Burton, Chairman, Committee on Government Reform,
2185 Rayburn Building, House of Representatives, Washington, DC 20515
The Honorable Henry A. Waxman, Ranking Member, Committee on Government Reform
2204 Rayburn Building., House of Representatives, Washington, DC 20515
William H. Chu, President and Chief Executive Officer, Los Angeles Community Development
Bank, 1241 South Soto Street, Suite 118, Los Angeles, California 90023
Lillian Y. Kawasaki, General Manager, Community Development Department,
City of Los Angeles, 215 West 6th Street, 3rd Floor, Los Angeles, California 90014
Carlos Jackson, Executive Director, Community Development Commission,
County of Los Angeles, 2 Coral Circle, Monterey Park, California 91755
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Los Angeles Community Development Bank - Economic Development Initiative Grant/Section 108 Loan Guarantee Program City of Los Angeles, County of Los Angeles Los Angeles, California
Published by the Department of Housing and Urban Development, Office of Inspector General on 2002-09-25.
Below is a raw (and likely hideous) rendition of the original report. (PDF)