oversight

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)

                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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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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                                            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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                            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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                                                                                      Finding 2


 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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                                                                               Finding 3


                            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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                                                                            Finding 3




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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        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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                              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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              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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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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Auditee Comments




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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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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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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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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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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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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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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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