Issue Date April 8, 2004 Audit Case Number 2004-AT-1004 TO: Karl H. Kucen, Acting Director, Memphis HUB, 4KPH FROM: James D. McKay Regional Inspector General for Audit, 4AGA SUBJECT: Cookeville Housing Authority Cookeville, Tennessee INTRODUCTION We have completed a review of the Cookeville Housing Authority’s (Authority) activities with its related nonprofit organization, Holladay Homes, Incorporated (HHI) and Judge O.K. Holladay Homes, L.P. The review focused on the Authority’s development of Willow Heights, a mixed-financed public housing development. We performed the review as part of our audit of the Department of Housing and Urban Development’s (HUD) oversight of Public Housing Agency development activities with related nonprofit entities. Our objective was to determine whether the Authority complied with laws and regulations and properly safeguarded resources when it conducted business with HHI and Judge O.K. Holladay Homes, L.P. To accomplish our objective, we reviewed applicable HUD regulations, the Authority’s Annual Contributions Contract (ACC), and other requirements. We also interviewed Authority management and staff and reviewed various documents including: financial statements, general ledgers, bank statements, minutes from Board meetings, check vouchers, and invoices. We also reviewed HHI’s general ledgers, bank statements, and bank loan documents. We performed our on-site review from June 9, 2003, through June 12, 2003, and covered the period October 1, 1999 to May 31, 2003. We performed our review in accordance with generally accepted government auditing standards. We discussed our review results with the Authority during our review and met with them for an exit conference on February 20, 2004. We received the Authority’s written comments to our draft on March 12, 2004. The Authority generally disagreed with the draft, but did not provide sufficient evidence to support significant changes to the draft. Based on the Authority’s comments, we removed our discussion pertaining to the Authority’s failure to allocate costs and made other minor changes to the Finding and recommendations. In accordance with HUD Handbook 2000.06 REV-3, within 60 days, please provide us, for each recommendation without management decision, a status report on: (1) the corrective action taken; (2) the proposed corrective action and the date to be completed; or (3) why action is considered unnecessary. Additional status reports are required at 90 days and 120 days after report issuance for any recommendation without a management decision. Also, please furnish us copies of any correspondence or directives issued because of the audit. Should you or your staff have any questions, please contact me at (404) 331-3369, or Gerald Kirkland, Assistant Regional Inspector General for Audit, at (865) 545-4368. SUMMARY Authority management violated its ACC with HUD by inappropriately guaranteeing performance by its related nonprofit corporation. Also in violation of its ACC, the Authority advanced $392,861 to Judge O.K. Holladay Homes, L.P. prior to obtaining approval of its mixed-finance proposal from HUD Headquarters. Further, the Authority incurred questionable costs of $367,067, $42,772 for the LP’s operating costs and $324,295 for development costs in excess of HUD approved expenditures. Additionally, the Authority’s Executive Director, who was also the Executive Director and Secretary/Treasurer of HHI, violated conflict of interest restrictions. These actions occurred because the Board of Commissioners did not establish sufficient controls to monitor the nonprofit and ensure transactions adhered to Federal regulations. We recommend the Director of the Office of Public Housing: Of the ineligible costs of $42,772, require the Authority to furnish evidence of repayment from Judge O.K. Holladay Homes, L.P. for remaining ineligible costs of $18,015, and discontinue advancing funds for operating expenses; Require the Authority to provide written evidence of HUD Headquarter’s approval to fund cost overruns, provide support for the source of the $324,295 in excess of the amounts originally authorized by HUD, and repay any unauthorized amounts to the Authority from non-Federal sources; Require the Authority to obtain written HUD approval prior to any future pledge or encumbrance of Authority assets; Ensure the Board of Commissioners takes appropriate measures to prevent future conflict of interest situations; and, Require the Board of Commissioners to establish adequate controls to monitor Authority interactions with its nonprofit and ensure transactions comply with the ACC and other HUD requirements. 2 BACKGROUND The Authority was organized under the laws of the State of Tennessee. The Authority was to develop and operate public housing units in compliance with its ACC with HUD. A seven-member Board of Commissioners governed the Authority with members appointed by the Mayor of Cookeville. Leon Delozier was the Board Chairman and C. Dow Harris was the Executive Director during our audit period. On July 19, 2001, the Authority’s Executive Director created HHI, a non-profit organization, to serve as the general partner in the limited partnership (LP), Judge O.K. Holladay Homes, L.P. The other partner was Apollo Housing Capital, LLC (Apollo). The LP was created by the Authority to develop 30 public housing units to replace 30 previously demolished units at the Willow Heights development, formerly known as Judge O.K. Holladay Homes. The new units would be financed with funds from several sources, including Capital Funds, Operating Reserves, and low-income housing tax credits. The Authority served as the developer. The Authority’s Board members also served as HHI’s Board and the Authority’s Executive Director was HHI’s Secretary/Treasurer. The Authority’s financial records were maintained primarily at its central office located at 235 West Jackson Street, Cookeville, Tennessee. 3 Finding 1 - The Authority Inappropriately Guaranteed Performance, Advanced Funds Prior to Approval, and Incurred Questionable Costs of $367,067 Authority management violated its ACC with HUD by inappropriately guaranteeing performance by its related nonprofit corporation. Also in violation of its ACC, the Authority advanced $392,861 to the LP prior to obtaining approval of its mixed-finance proposal from HUD Headquarters. Further, the Authority incurred questionable costs of $367,067, $42,772 for the LP’s operating costs and $324,295 for development costs in excess of HUD approved expenditures. Additionally, the Authority’s Executive Director, who was also the Executive Director and Secretary/Treasurer of the nonprofit, violated conflict of interest restrictions. These actions occurred because the Board of Commissioners did not establish sufficient controls to monitor the nonprofit and ensure transactions adhered to Federal regulations. Criteria Part A, Section 7 of the ACC, Covenant Against Disposition and Encumbrances, states that with the exception of entering into dwelling leases with eligible families for dwelling units in the projects covered by this ACC, and normal uses associated with the operation of the project(s), the housing authority shall not in any way encumber any such project, or portion thereof, without the prior approval of HUD. In addition, the housing authority shall not pledge as collateral for a loan the assets of any project covered under this ACC. Part A, Section 9 of the ACC, Depository Agreement and General Fund, states that the Authority may withdraw funds from the General Fund only for: (1) payment of the costs of development and operation of the projects under ACC with HUD; (2) the purchase of investment securities as approved by HUD; and, (3) such other purposes as may be specifically approved by HUD. Part A, Section 19 of the ACC, Conflict of Interest, prohibits the Authority from entering into any contract or arrangement in connection with any project under the ACC in which any Authority employee who formulates policy or who influences decisions with respect to the project(s), has an interest, direct and indirect, during his or her tenure or for one year thereafter. The Authority Inappropriately Guaranteed Nonprofit Performance In violation of its ACC, the Authority inappropriately guaranteed HHI’s performance and agreed to fund any development cost overruns. On March 1, 2002, the Authority’s Executive Director signed an Affiliate Guaranty (Guaranty Agreement) between the Authority and Apollo. The Guaranty Agreement was part of the Partnership Agreement between HHI (the general partner) and Apollo. The Guaranty Agreement provided that in order to induce Apollo to enter into the Partnership, the Authority would irrevocably and unconditionally fully guarantee the due, prompt and complete performance of each of the following obligations: • payment and performance by the general partner, HHI, of each and every obligation of the general partner due under the Partnership Agreement; 4 • payment and performance by the Developer (the Authority) of each and every obligation of the Developer under the Development Agreement; and, • prompt and complete payment of all costs and expenses incurred by Apollo in collection of the enforcement of this Guaranty Agreement against the Guarantor. The Guaranty Agreement also granted to Apollo, in its uncontrolled discretion, and without notice to the Authority, the power and authority to take several actions, including: (a) modifying or waiving any terms of the Partnership Agreement, the Development Agreement and/or any other obligations guaranteed hereby; (b) taking and holding security for the payment of the indebtedness and/or performance of the other obligations guaranteed hereby and to impair, exhaust, exchange, enforce, waive or release any such security; and, (c) directing the order or manner of sale of any such security as Apollo, in its discretion, may determine. The one-sided Guaranty Agreement is an open-ended contingent liability for the Authority and violates the ACC. An attorney for the Cookeville Housing Authority expressed concerns about the Guaranty Agreement. In his December 18, 2001, memorandum to the Authority, the attorney wrote in part, “…affiliate status means that Cookeville Housing Authority irrevocably and unconditionally guarantees any and all obligations of the General Partner under the Partnership agreement. This guaranty is made for the ‘benefit of’ Apollo, the Limited Partner. In addition, the guaranty grants Apollo the unfettered discretion to modify, accelerate, or to take and order the sale of security with regard to any indebtedness or obligations guaranteed by Cookeville Housing Authority. Also, the Guaranty provides that the Cookeville Housing Authority waives practically every defense imaginable…this agreement is extremely one sided…it places all potential liability on Cookeville Housing Authority while giving Cookeville Housing Authority seemingly no way to challenge it, even meritorious defenses.” The attorney expressed several other concerns; however, despite his legal advice, the Authority’s Executive Director signed the agreement. In addition, the Authority entered into a Development Agreement with the LP in which it pledged to fund cost overruns for the project. This agreement required the Authority to make loans to the partnership for funding cost overruns during construction. According to this agreement, any such loans could only be repaid to the Authority under certain circumstances. Any amounts not reimbursed after final closing could not be reimbursed or charged to the limited partners, but would have to be borne by the Authority. 5 The Authority Incurred Questionable Costs Title 24 of the Code of Federal Regulations (CFR), Part 941, Subpart F, provides requirements for developing mixed-financed housing. It requires in part that prior to developing such housing, authorities must obtain approval by HUD Headquarters. Title 24, Part 941.306, provides that no funds can be used in excess of approved amounts without written approval from HUD. Further, Part 941.602(c), provides that any action or approval that is required by HUD shall be done by HUD Headquarters unless the field office is authorized in writing by Headquarters to carry out a specific function. On March 14, 2001, the Authority submitted a mixed-finance proposal to HUD’s Office of Public Housing Investments for the development of Willow Heights. HUD subsequently approved the proposal including the projected use of $641,213 of operating reserves and $412,989 of Capital Funds. However, prior to submitting the proposal or obtaining HUD approval, the Authority spent $559,361 for the project. It spent $166,500 from a HOPE VI demolition grant and $392,861 of public housing funds. While the use of the $166,500 of HOPE VI funds was authorized by the grant agreement, the use of the public housing funds was not. Thus, the Authority violated Part A, Section 9 of the ACC. Authority management acknowledged that they did not get HUD involved until after plans and construction had begun. The Authority entered into a Reimbursement Agreement with the LP on December 31, 1999. The Agreement required the LP to reimburse the Authority for all obligations incurred in connection with the development. We also found the Authority obtained a $1.8 million line of credit bank loan to fund project development costs pending receipt of tax credit funds. As of May 31, 2003, the Authority had withdrawn $1,754,978 from the line of credit. As the Authority paid expenses from the loan proceeds, it increased the amount due from the LP. The Authority also recorded the payments made from the HOPE VI grant, Capital Funds, and other sources as amounts due from the LP. As of July 31, 2003, the LP owed the Authority $1,563,012. However, HUD only approved the use of $1,220,702. Thus, the Authority spent $342,310 more than the amount approved. Further, the Authority spent $42,772 for the LP’s salary expenses, which were ineligible costs. The LP had reimbursed $22,956 of the ineligible expenses, and the Authority made adjustments of $1,801. Thus, the unpaid balance of the ineligible expenses was $18,015. We question the additional $324,295 the Authority spent. Unpaid balance due the Authority: Public housing funds $ 1,267,977 HOPE VI funds 166,500 Capital funds 128,535 Total unpaid balance due the Authority $ 1,563,012 Less HUD approved funding 1,220,7021 Excess expenditures $ 342,310 Less remaining ineligible expenses 18,015 Unsupported costs $ 324,295 1 $641,213 operating reserves + 412,989 Capital Funds + $166,500 HOPE VI = $1,220,702. 6 Conflict of Interest The Executive Director violated ACC conflict of interest restrictions. As previously discussed, on March 1, 2002, the Executive Director signed a Guaranty Agreement, as part of a Partnership Agreement, whereby he placed Authority assets at substantial risk to the benefit of Apollo. He also signed the Development Agreement between the Partnership and the Authority on behalf of both the LP and the Authority. At the time, the Development Agreement put Authority assets at further risk because it committed the Authority to advance funds to the Partnership to pay any development cost deficiencies. In another instance, he signed a Reimbursement Agreement with the Partnership on behalf of both the Authority and the LP. Inadequate Controls The Office of the Inspector General's Program Integrity Bulletin for Public Housing Commissioners provides that the Commissioners have ultimate responsibility for public housing operations including approving policies and procedures, and ensuring that the public housing agency acts legally and with integrity in its daily operations. Our review showed that weak controls contributed to the ACC violations. Specifically, the Board had not established sufficient controls to effectively monitor the nonprofit and ensure transactions adhered to Federal regulations. AUDITEE COMMENTS The Authority did not agree with the Finding. Generally, the Authority claimed that all of its development activity was performed with full approval and knowledge of the Nashville HUD Field Office. The Authority also clarified that portions of the Finding incorrectly referred to HHI when the discussions should have stated the LP. Regarding the inappropriate guarantees, the Authority makes several arguments. The Authority claimed that the guaranty agreement between the Authority and Apollo Capital, LLC, while extremely one-sided and onerous in its language, presented minimal risks to the Authority. Similarly, the Authority claims that the risk associated with its guarantee to fund cost overruns was minimal. The Authority also provided a discussion pertaining to HUD’s authorization of a $1.8 million loan the Authority obtained. The Authority explained that HUD entered into two Subordination Agreements and a Memorandum of Understanding with the bank, thus allowing the Authority to acquire the loan. The Authority explained that cost overruns did occur, but that HUD approved $200,000 for cost overruns. It stated that another $112,000 being held in retainage by Apollo was not approved. However, elsewhere in its comments, page 7, it claimed that all excess costs were approved by HUD. The Authority believed that since no director or officer of the Authority had any material or non-material financial interest with the non-profit, there was no conflict of interest. The Authority claimed that it properly allocated costs. 7 OIG EVALUATION OF AUDITEE COMMENTS We considered the Authority’s comments pointing out that we had incorrectly discussed some items, such as the amounts paid and the balance owed the Authority for development costs as being attributable to HHI. We have corrected the Finding to show the funds were paid on behalf of and are owed by the LP. While the Authority’s risk pursuant to the various guarantees may have been minimal, the fact remains that its ACC prohibited such guarantee agreements without prior HUD approval. Regarding the $1.8 million loan, we were aware that HUD had entered into the agreements with the bank. Thus, we did not question whether the Authority encumbered assets to obtain the loan. Our discussion in the Finding about the $1.8 bank loan is presented for informational purposes to explain the source of funds and how transactions were recorded. Thus, the Authority’s discussion about HUD knowledge for the loan is moot. The Finding questioned the source of $324,295. The Authority’s explanation that $312,000 of cost overruns occurred may account for the costs. The Authority claimed it obtained HUD approval for $200,000 of the cost overruns. According to 24 CFR 941.602(c), any such approval was required to be made by HUD Headquarters, unless the field office was authorized in writing to grant approval. The Authority did not provide evidence of HUD approval. As such, we did not revise the Finding. While the Authority Board and Executive Director may not have had any financial interest in the non-profit, they did have an interest. While that interest may have been primarily fiduciary, the ACC clearly prohibits any interest, direct or indirect. To allow the Executive Director to sign documents on behalf of multiple entities that place the Authority at risk is clearly a conflict. Fortunately, at least to this point, the only actual loss to the Authority was that it had to fund cost overruns, which still have not been fully repaid. We did not revise this portion of the Finding. During our review, the Authority’s controller told us the Authority did not allocate certain costs. As stated in the draft report, we did not review the allocations of costs, but because of the controller’s statement, we recommended that HUD review the Authority’s cost allocation for reasonableness and require the Authority to repay any costs that were not properly allocated. We removed the discussion and the recommendations from the Finding. Since the developments are completed, the future risk to the Authority is substantially reduced. As such, we revised the recommendation requiring the Authority to terminate the guarantee agreements. 8 RECOMMENDATIONS We recommend the Director of the Office of Public Housing: 1A. Of the ineligible costs of $42,772, require the Authority to furnish evidence of repayment from Judge O.K. Holladay Homes, L.P. for remaining ineligible costs of $18,015, and discontinue advancing funds for operating expenses. 1B. Require the Authority to provide written evidence of HUD Headquarter’s approval to fund cost overruns, provide support for the source of the $324,295 in excess of the amounts originally authorized by HUD, and repay any unauthorized amounts to the Authority from non-Federal sources. 1C. Require the Authority to obtain written HUD approval prior to any future pledge or encumbrance of Authority assets. 1D. Ensure the Board of Commissioners takes appropriate measures to prevent future conflict of interest situations. 1E. Require the Board of Commissioners to establish adequate controls to monitor Authority interactions with HHI and the Partnership and ensure transactions comply with the ACC and other HUD requirements. 9 MANAGEMENT CONTROLS Management controls include the plan of organization, methods and procedures adopted by management to ensure that its goals are met. Management controls include the processes for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance We determined the following management controls were relevant to our audit objectives: o Safeguarding Resources – Policies and procedures that management has implemented to reasonably ensure that resources are safeguarded against waste, loss and misuse. o Compliance with Laws and Regulations – Policies and procedures that management has implemented to reasonably ensure that resource use is consistent with laws and regulations. To assess the relevant controls, we: o interviewed Authority staff; o reviewed Authority general ledgers, bank statements, and other accounting and administrative records; o reviewed HHI general ledgers, bank statements, loan documents; and, o reviewed the Authority’s financial statements. A significant weakness exists if management controls do not provide reasonable assurance that resource use is consistent with laws, regulations, and policies; and, that resources are safeguarded against waste, loss, and misuse. Based on our review, we identified the following significant weaknesses: o Safeguarding Resources - Authority management inappropriately pledged Authority assets and guaranteed HHI performance and agreed to fund any cost overruns (Finding, pages 4, 5). o Compliance with Laws and Regulations - Authority management violated its ACC with HUD by inappropriately guaranteeing performance (Finding, pages 4, 5) by its related nonprofit corporation and advancing $392,861 to HHI prior to obtaining HUD approval of the mixed-finance proposal. Further, the Authority incurred questionable costs of $342,310, $18,015 for HHI’s operating costs and $324,295 for development costs in excess of HUD approved expenditures. (Finding, page 6). Also, the Authority’s Executive Director, who was also the Executive Director of the nonprofit, violated conflict of interest restrictions. 10 FOLLOW-UP ON PRIOR AUDITS This is the initial OIG audit of this Authority. Kendall L. Davis, Certified Public Accountant, completed the most recent audit of the Authority’s financial statements for the 12-month period ended September 30, 2001. His report did not contain any findings. 11 Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation Ineligible2 Unsupported3 1A $ 42,772 1B $ 324,295 2 Ineligible costs are those that are questioned because of an alleged violation of a provision of a law, regulation, contract, grant, cooperative agreement, or other agreement or document governing the expenditure of funds. 3 Unsupported costs are those whose eligibility cannot be clearly determined during the audit since such costs were not supported by adequate documentation. An administrative determination may be needed on these costs. 12 Appendix B AUDITEE COMMENTS 13 14 15 16 17 18 19 20 21
Cookeville Housing Authority Cookeville, Tennessee
Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-04-08.
Below is a raw (and likely hideous) rendition of the original report. (PDF)