oversight

Jester Trails Apartments, Project Number FW 03 0014, Houston, Texas

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-02-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

  AUDIT REPORT




JESTER TRAILS APARTMENTS
   MULTIFAMILY PROJECT

     HOUSTON, TEXAS

        2004-FW-1002

    FEBRUARY 26, 2004

   OFFICE OF AUDIT, REGION 6
      FORT WORTH, TEXAS
                                                                 Issue Date
                                                                         February 26, 2004
                                                                Audit Case Number
                                                                         2004-FW-1002




TO:          Raynold Richardson
             Director, Multifamily Housing Program Center, 6EHM



FROM:        D. Michael Beard
             Regional Inspector General for Audit, 6AGA

SUBJECT: Jester Trails Apartments
         Project Number FW 03 0014
         Houston, Texas


We completed an audit of Jester Trails Apartments, a Section 221(d)(4) insured multifamily
housing project. The objective of our audit was to review the operations of the owner-managed
project and determine whether the project’s owner complied with the Regulatory Agreement and
HUD regulations. The audit resulted in five findings.

In accordance with HUD Handbook 2000.06 REV-3, within 60 days please provide us, for each
recommendation without a 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 Theresa Carroll, Assistant Regional
Inspector General for Audit, at (817) 978-9664, or me at (817) 978-9309.
Management Memorandum




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2004-FW-1002              Page ii
Executive Summary
We completed an audit of Jester Trails Apartments, a Section 221(d)(4) insured multifamily
housing project. The objective of our audit was to review the operations of the owner-managed
project and determine whether the project’s owner complied with the Regulatory Agreement and
HUD regulations.



  Owner failed to comply            Although the owner maintained the property in satisfactory
  with Regulatory                   condition, it did not comply with several provisions of the
  Agreement and other               Regulatory Agreement and other HUD regulations.
  HUD requirements.                 Specifically, the owner failed to maintain the books and
                                    records of the project. Thus, the owner cannot show it
                                    deposited rental receipts intact. In addition, the owner paid
                                    $55,475 for ineligible and unsupported personal expenses
                                    with the project’s operating funds. The owner also
                                    improperly obtained and used project funds to pay $42,431
                                    for a personal promissory note. Further, the owner
                                    received $32,254 in excess of the allowed management fee.
                                    Finally, the owner misused $24,127 in tenant security
                                    deposit funds. All of these violations occurred because the
                                    owner disregarded HUD’s requirements.

                                   The owner’s payments of ineligible and unsupported
 Project is in default.
                                   expenses depleted the project’s operating funds. Currently,
                                   the project is in default. However, the lender has indicated
                                   it wishes to prepay the mortgage to avoid a claim.

 Recommendations.                   We recommend HUD allow the lender to prepay the
                                    mortgage freeing the $2.13 million loan balance for better
                                    use. Further, HUD should require the owner to reimburse
                                    the project for the ineligible use of project funds totaling
                                    $140,073. HUD should also obtain documentation for the
                                    unsupported expenses of $14,214 and recover from the
                                    owner for the project any costs determined to be
                                    unallowable. If the owner does not repay the project for
                                    improper diversions of property funds, HUD should take
                                    civil action and other prescribed remedies. In addition,
                                    HUD should take administrative action against the owner
                                    and its members to prevent them from managing this or
                                    another HUD property.

                                    We presented our draft audit report to the owner and
 Owner Response.                    HUD’s staff during the audit. We held an exit conference
                                    with a member of the owner on February 13, 2004. That
                                    member provided written comments to our draft report.


                                        Page iii                                    2004-FW-1002
Executive Summary


                    We summarized her comments with each finding. The
                    complete text of her comments is at Appendix B.

                    Overall, the owner agreed with the findings and admitted a
                    member improperly took project funds. The owner stated
                    the project’s books and records are fully compliant and
                    procedures are in place for the current period, but records
                    for previous periods cannot be corrected. The owner
                    expressed confusion regarding the promissory note issues
                    and indicated it wished to clear the finding by refinancing
                    the property. The owner did not address the
                    recommendations of repaying the funds or HUD taking
                    administrative action against the members.




2004-FW-1002            Page iv
Table of Contents
Management Memorandum                                                    i



Executive Summary                                                      iii



Introduction                                                            1



Findings

1 Owner Failed to Maintain the Project’s Books and Records              5

2 Owner Paid Personal Expenses with Project Funds                       9

3 Owner Improperly Obtained and Paid for a Promissory Note            13

4 Owner Received Excessive Management Fees                            17

5 Owner Misused Tenant Security Deposit Funds                         21



Management Controls                                                   25



Follow-Up on Prior Audits                                             27



Appendices
   A. Schedule of Questioned Costs and Funds Put to Better Use        29

   B. Auditee Comments                                                31




                             Page v                          2004-FW-1002
Table of Contents


Abbreviations

CPA            Certified Public Accountant
FHA            Federal Housing Administration
HUD            U. S. Department of Housing and Urban Development
OIG            Office of Inspector General
OMB            Office of Management and Budget




2004-FW-1002                           Page vi
Introduction
Jester Trails Apartments (the project) is located at 2006 West 43rd Street in Houston, Texas.
We’re Rockin, L.L.C. (the owner) owns and operates the project. In February 1998, the owner
purchased and began rehabilitating the project with over $2.2 million in financing provided by
Arbor National Commercial Mortgage, L.L.C. and insured by the Federal Housing
Administration (FHA) of the Department of Housing and Urban Development (HUD). Once it
completed renovations, the owner began initial rental operations on January 5, 1999.

At closing, HUD approved the owner, consisting of four members and their ownership percents
as follows:
    • David Murray - 38.75%,
    • Linda Murray - 38.75%,
    • Ursula Cano - 15%, and
    • Key Partners, L.L.C., - 7.5%.

According to the project’s records, David Murray acquired the combined 22.5 percent member
interests of Ursula Cano and John Getrost in 2000. As a result, David Murray’s ownership
interest increased from 38.75 percent to 61.25 percent, making him the majority member.
However, the owner did not notify HUD when this change in ownership occurred and HUD
never approved this transfer. In addition, the two members filed a suit concerning the transfer of
these shares and the ownership of the property.

On June 3, 2003, Ms. Poole1, submitted documents to HUD showing the ownership of We’re
Rockin, L.L.C. consisted of:
    • Faith Ventures, Unlimited, Managing Member 1%,
    • Linda Poole, Member 41%, and
    • David Murray, Member 58% nonparticipating ownership.

Further, the owner indicated it had selected Sandersen, Knox and Belt, L.L.P., as the current
management agent. However, HUD did not approve this transfer of ownership or the new
management agent. HUD also questioned the validity of the previous transfer.



                                           The objective of our audit was to review the operations of
    Audit Objective.                       the owner-managed project and determine whether the
                                           project’s owner complied with the Regulatory Agreement
                                           and HUD regulations.

                                           To accomplish our audit objectives, we interviewed:
    Audit Scope and                        • HUD’s Houston Office Multifamily staff;
    Methodology.
                                           • HUD’s Fort Worth Office Enforcement Center staff;
                                           • HUD’s Houston Office Legal Counsel;

1
      Ms. Linda Poole was previously known as Linda Murray and is a member of the owner.

                                                Page 1                                     2004-FW-1002
Introduction


               • A Texas Secretary of State’s representative;
               • A Texas Comptroller of Public Accounts’
                 representative;
               • A partner at the CPA firm of Gainer, Donnelly, &
                 Desroches, L.C.;
               • A member of We’re Rocking, L.L.C.;
               • Staff at Jester Trails’ current management agent,
                 Sandersen, Knox and Belt, L.L.P; and
               • Jester Trails’ maintenance personnel and property
                 manager.

               We also reviewed:
               • The 1999 and 2000 audited financial statements;
               • The 2001 draft financial statements;
               • The 1999 and 2000 audit engagement letters;
               • HUD Enforcement Center’s review of the 2000 audited
                 financial statements referral and the owner’s response;
               • HUD Real Estate Assessment Center’s comments on
                 the 1999 and 2000 audited financial statements;
               • HUD’s Physical Inspection Report dated August 21,
                 2001;
               • The Regulatory Agreement and owner certification
                 between HUD and We’re Rockin, L.L.C.;
               • HUD’s program participant files for the project;
               • HUD’s Handbooks;
               • HUD’s management review dated February 18, 2003;
               • The by-laws and other documents relating to the
                 previous and current ownership/management of the
                 project; and
               • The project’s general ledgers, bank statements, copies
                 of canceled checks, and invoices for the audit period.

               In addition for 2002, we:
               • Tested the available rental records to determine if the
                   owner deposited rental receipts into the project’s
                   operating bank account intact.
               • Tested project disbursements to determine if the owner
                   made any unauthorized distributions or improper loans
                   to other properties. We selected a statistical sample
                   from the check register of 200 out of 470 disbursements
                   to determine if the owner made disbursements in
                   accordance with the Regulatory Agreement and HUD
                   Handbooks.
               • Reviewed the Tenant Security Deposit account to
                   determine whether the owner underfunded the account

2004-FW-1002       Page 2
                                                                       Introduction

                        and/or used the account for other than the return of
                        tenant deposits. We reviewed 100 percent or 24 of the
                        checks written on the tenant security deposit account.
                    •   Inspected the physical condition of the project’s exterior
                        and the interior of a few non-statistically selected units.

                    We expanded our review to include the year 2001 and the
                    period of January 1, 2003, to July 31, 2003, because of the
                    problems found in 2002. However, we only covered the
                    four problem areas discovered in 2002: personal expense
                    payments, promissory note payments, management fee
                    payments, and misuse of tenant security deposits funds.
                    Plus, we reviewed the 3 months of available rental receipts
                    records for 2003. We also expanded our review to include
                    the 1998 promissory note and associated closing
                    documents.

                    The owner did not maintain the books and records in
Scope Limitation.   compliance with the Regulatory Agreement. The owner
                    and the current management agent possessed only a few
                    project records for 2001; mainly a few vouchers and
                    invoices misfiled in the 2002 records. In accordance with
                    Government Auditing Standards, we relied on information
                    maintained in an independent CPA's workpapers for 2001
                    testing. Complete financial records for 2002 and 2003 also
                    did not exist. In addition, the owner did not maintain the
                    records for these years in an organized or logical manner.
                    Because the owner failed to maintain the records, we could
                    not audit rental receipts and revenue.

                    We also found the owner did not maintain reliable
                    computerized information. Thus, we mostly relied on third
                    party or source information like bank statements, canceled
                    checks, vouchers, and invoices to conduct the audit.
                    However, we had to rely on data in the unaudited financial
                    statements for 2001 and the general ledgers for 2002 and
                    2003 to determine rental revenue since the owner did not
                    have any other sources of information available. Further,
                    we had to estimate the management fee based on the
                    unverified rental revenue amount for the same reason.

                    We conducted the audit at HUD’s Houston Field Office, the
                    project, and the office of the current management agent in
                    Sugar Land, Texas. We performed the audit work from July
                    through November 2003. The audit covered the period
                    January 1, 2001, through July 31, 2003. The audit was

                         Page 3                                       2004-FW-1002
Introduction

               conducted in accordance with Generally Accepted
               Government Auditing Standards.




2004-FW-1002       Page 4
                                                                                                  Finding 1


                       Owner Failed to Maintain the
                       Project’s Books and Records
In violation of the Regulatory Agreement, the owner failed to maintain the books and records of
the project. As a result, the owner cannot show it deposited rental receipts intact. In addition,
the owner’s mismanagement has led to the project not producing sufficient revenue to keep it
viable. Currently, the project is in default. The lender has indicated it wishes to prepay the
mortgage. HUD should allow the lender to prepay and avoid a claim, which would free the
$2.13 million loan balance for better use.



     Criteria.                             The Regulatory Agreement and a HUD Handbook require
                                           the owner to keep the books and records in reasonable
                                           condition for a proper audit. The HUD Handbook also
                                           requires the books and accounts to be kept current,
                                           complete, and accurate.2

                                           The owner did not maintain the books and records in
     Owner failed to maintain              compliance with the Regulatory Agreement or HUD’s
     books and records.                    Handbook. The owner and the current management agent
                                           possessed only a few project records for 2001; mainly a
                                           few vouchers and invoices misfiled in the 2002 records.
                                           The independent Certified Public Accountant (CPA)
                                           possessed the most complete records available for 2001 in
                                           its working papers. However, HUD also had a few bank
                                           statements in its files. The owner did not have complete
                                           financial records for either 2002 and 2003. In addition, the
                                           owner did not maintain the records for these years in an
                                           organized or logical manner. The management agent
                                           believed that the CPA firm will have to render a disclaimer
                                           on the 2001 and 2002 financial statements because of the
                                           condition of the records.

                                           The owner only had rent rolls and rental receipt logs for 7
    Rental receipts are                    months out of the 31 months audited. The owner also did
    unauditable.                           not have deposit slips showing tenant unit or amount paid
                                           for any month, which prevented confirmation of rental
                                           deposits and receipts. For the 7 months reviewed, the
                                           owner apparently did not deposit all of the receipts for 2
                                           months. However, the owner’s lack of records prohibited


2
      Paragraph 9(c) of the Regulatory Agreement and HUD Handbook 4370.2, REV-1, Financial Operations and
      Accounting Procedures for Insured Multifamily Projects, Chapter 2-3A&B.

                                                Page 5                                         2004-FW-1002
Finding 1

                          an audit and a determination that the owner took rental
                          receipts for its members’ personal use.

                          The audited financial statements for 1999 and 2000 cited
  Owner previously took   the owner for diverting rental receipts to the members’
  rental receipts.        personal needs. In our opinion, the owner intentionally
                          kept poor records to prevent an audit from determining if it
                          took receipts during 2001, 2002, and 2003. Since the lack
                          of records appears intentional, HUD should take
                          administrative action to prevent the owner and its members
                          from managing this or another HUD property.

                          Jester Trails Apartments is currently in default of its July,
 Project is not viable.   August, September, October, and November mortgage
                          payments and is pending assignment to HUD. The
                          defaulted mortgage principal balance is $2,133,843. The
                          principal and interest outstanding since the last payment
                          made in June is $70,101. Late fees total $1,122. The total
                          amount owed on the mortgage as of November 13, 2003, is
                          $71,223.

                          On October 10, 2003, the lender, Arbor Commercial
                          Mortgage, L.L.C., requested an extension of an assignment of
                          the project to HUD. The lender along with it sister company,
                          Arbor Realty Trust, seek to prepay the Jester Trails
                          Apartments’ mortgage to avoid an insurance claim against
                          HUD. The project owner agreed with this solution. HUD’s
                          Directors’ of Multifamily in Houston and Fort Worth have
                          approved the mortgagor’s prepayment of the mortgage in lieu
                          of an assignment to HUD. Final approval is pending at HUD
                          Headquarters in Washington, D.C.



Auditee Comments          The owner agreed with the content of this finding. According
                          to the owner, it cannot correct the records prior to June 2003.
                          Further, the independent CPA will probably issue disclaimers
                          for 2001, 2002, and 2003, due to the lack of records.
                          However, the owner indicated the records are now fully
                          compliant and procedures are now in place. The owner did
                          not address the recommendations concerning the prepayment
                          of the mortgage or HUD taking administrative action against
                          the owner and its members. Yet, the owner indicated it is
                          seeking refinancing of the property.




2004-FW-1002                   Page 6
                                                                       Finding 1



OIG Evaluation of   We appreciate the owner admitting the finding was correct.
Auditee Comments    Further, we commend the minority member for establishing
                    controls and correcting the condition of the project’s books
                    and records after she took control of the project. However,
                    we still believe HUD should protect its interests and seek
                    prepayment of the mortgage and take action against the
                    owner and/or its members.




Recommendations
                    We recommend HUD:

                    1A. Obtain final approval from HUD Headquarters to
                        allow the lender to prepay the mortgage to avoid a
                        claim against HUD, resulting in $2.13 million funds
                        being put to better use by making the funds available
                        for another multifamily project.

                    1B. Take administrative action against the owner and its
                        members to prevent them from managing this or
                        another HUD property in the future.




                         Page 7                                     2004-FW-1002
Finding 1




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2004-FW-1002     Page 8
                                                                                                 Finding 2


                     Owner Paid Personal Expenses
                         with Project Funds
The owner paid $55,475 for ineligible and unsupported personal expenses with the project’s
operating funds. HUD limits the payment of project funds to reasonable operating expenses and
necessary repairs. In addition, HUD also requires an invoice, bill, or other supporting documents
to support all project disbursements. Even though the owner knew of these requirements, it
disregarded them. Since the project’s operating account funded these personal expenses, the
project lacks operating funds and is currently delinquent on its mortgage payments.



                                          The Regulatory Agreement prohibits the owner from
     Criteria.                            receiving project funds when a project does not have surplus
                                          cash. Specifically, the agreement says: "Owner shall not
                                          without the prior written approval of the Secretary: Assign,
                                          transfer, dispose of, or encumber any personal property of
                                          the project, including rents, or pay out any funds except
                                          from surplus cash, except for reasonable operating
                                          expenses and necessary repairs." In addition, HUD
                                          requires approved invoices, bills, or other supporting
                                          documentation for all disbursements from the Regular
                                          Operating Account.3

                                          In violation of HUD’s requirements, the owner paid a total
    Owner paid majority                   of $45,525 for ineligible and unsupported personal
    member’s personal                     expenses of the majority member from 2001 to 2003. The
    expenses.                             majority member had the project pay $38,261 for ineligible
                                          and $6,264 in unsupported expenses charged to five
                                          different business and personal credit cards. In addition,
                                          the project also directly paid $1,000 for automobile
                                          expenses of the majority member.

                                          In 2001, the owner used project funds to pay a total of $4,500
    Owner paid ineligible and             in ineligible and unsupported legal fees. HUD requirements
    unsupported legal fees.               prohibit the project from paying costs that are not supported
                                          project related expenses. According to the independent
                                          public accountant, the owner paid ineligible personal legal
                                          fees totaling $2,000. The owner also paid an additional
                                          $2,500 for unsupported legal fees. The owner could not
                                          provide supporting documentation to show the project
                                          incurred these legal fees.

3
      HUD Handbook 4370.2 REV-1, Financial Operations and Accounting Procedures for Insured Multifamily
      Projects, Chapter 2, Section 2-6E.

                                               Page 9                                         2004-FW-1002
Finding 2



                            The owner lacks support (such as an invoice or bill) for an
 Owner lacks support for    additional $5,450 paid by the project from 2002 to 2003. The
 additional expenses.       project wrote checks to such payees as a Circuit City account,
                            “reimbursements” to the majority member, a doctor, and
                            cash. In a few cases, the owner did not even document the
                            payee. Since HUD requires all disbursements to be
                            supported, the owner should either prove these items are
                            project expenses or repay the project for these unsupported
                            disbursements.

                            The owner and/or its members should not have received
 Project did not have       any disbursements from project funds because the project
 surplus cash.              did not have any surplus cash available at any time during
                            the 3 years reviewed. Jester Trails audited financial
                            statements showed a negative surplus cash balance of
                            $88,020 at the end of 2000. Although audited financial
                            statements do not exist for 2001 and 2002, based on
                            available information Jester Trails did not have surplus
                            cash available for those 2 years.

                            The owner knew personal expenses could not be paid with
 Owner disregarded          project funds. The minority member stated she was aware
 HUD’s regulations.         it was against HUD regulations to pay personal expenses
                            with project funds. In fact, she believed it was a common
                            business practice to keep personal expenses separate from
                            business expenses. She also stated she tried to explain this
                            practice to the majority member. However, according to
                            her, the majority member believed it was his business and
                            “the government had no business in his business.” Further,
                            in March 2001, the owner stated they had been provided
                            “the proper HUD rules and regulations needed to operate
                            the project.” Thus, the owner merely disregarded HUD's
                            regulations.

                            The owner’s improper payments put the project in default.
 Project is delinquent on   As of November 2003, the project is 4 months’ delinquent
 its mortgage.              on its mortgage. Currently, the owner owes $71,223,
                            including late fees and penalties. In addition, the project is
                            short of operating funds for reasonable expenses and
                            necessary repairs.




2004-FW-1002                    Page 10
                                                                         Finding 2

Auditee Comments    The owner agreed with this finding. The owner took steps to
                    prevent the managing member from having control or access
                    to the assets of the property. In addition, the owner stated no
                    further violations occurred since the minority member
                    established control in June 2003. However, the owner did
                    not address repaying the project for ineligible disbursements,
                    supporting questionable expenses or potential civil actions by
                    HUD.




OIG Evaluation of   We appreciate the owner did not dispute this finding. Since
Auditee Comments    the owner did not dispute the finding, HUD should seek
                    recovery of the improper disbursements. Further, if the
                    owner does not repay the funds, HUD should take civil
                    action.




Recommendations     We recommend HUD:

                    2A. Require the owner to repay the project $41,261 for
                        improper use of project funds.

                    2B. Obtain documentation or justification for $14,214
                        unsupported expenses and recover for the project any
                        costs determined to be unallowable.

                    2C. Take appropriate civil action and HUD prescribed
                        remedies if the owner does not repay HUD for
                        improper diversion of property funds.




                         Page 11                                     2004-FW-1002
Finding 2




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2004-FW-1002    Page 12
                                                                                             Finding 3


        Owner Improperly Obtained and Paid for a
                   Promissory Note
In violation of the Regulatory Agreement and without HUD approval, the owner obtained and used
project funds to pay $42,431 for a personal promissory note. The owner claimed that HUD was
aware of the note and stated they did not have sufficient personal funds to pay the note. However,
HUD was not made aware of this 1998 note until 2001. Plus, HUD did not receive the full
promissory note until 2003. Once aware of the project’s payments on the note, HUD told the
owners in 2001 they could only use surplus cash to make payments. Yet, the owner continued to
pay on the note with project funds even though the project did not have surplus cash. As a result,
the payments contributed to the depletion of the project’s operating funds causing the project to
default.



                                          The Regulatory Agreement prohibits the owner from
    Criteria.                             assigning their right to manage or receive rents and profits
                                          from the mortgaged property without obtaining the prior
                                          written approval of HUD’s Secretary.4 In addition, the
                                          owner shall not, without prior written approval, make or
                                          receive and retain any distribution of assets or any income
                                          of any kind of the project except surplus cash.5

                                          One day prior to closing in February 1998, the owner
    Owners obtained note                  obtained a promissory note without informing HUD or
    without HUD approval.                 obtaining HUD’s approval. HUD required the owner to
                                          fund initial operating and working capital escrow accounts.
                                          To fund the escrow accounts, the owner pledged its
                                          ownership interests as collateral on the promissory note.
                                          The owner also assigned to the lender the right to receive
                                          all dividends, other distributions, and other property and
                                          interests, which is a violation of the regulatory agreement.

                                          From 2001 to 2003, the owner improperly used $42,431 of
    Owner improperly used                 project funds to pay the promissory note. The owner’s note
    project funds to pay the              payments are improper because the project did not have
    note.                                 surplus cash available. Since this is a personal note, the
                                          owner was prohibited from using project funds to make the
                                          payments.




4
     The Regulatory Agreement, Paragraph 6(c).
5
     The Regulatory Agreement, Paragraph 6(e).

                                                 Page 13                                  2004-FW-1002
Finding 3



                           The owner stated HUD had full knowledge of the
Owner believed HUD         promissory note and did approve it. Further, the owner
approved the note.         stated that it used project funds to pay the note because it
                           did not have sufficient personal funds to make the
                           payments on the note.

                           Prior to 2001, HUD appears to be unaware of the note. The
HUD unaware of the note.   promissory note was not included in the project’s closing
                           file, not signed by HUD, and not recorded. HUD first
                           became aware of the note in 2001 when the owner filed its
                           delinquent 1999 and 2000 financial statements. Upon
                           reviewing the financial statements, HUD questioned the
                           note. Further, HUD told the owner it could only use
                           surplus cash to make payments on the note. To further
                           complicate matters, when HUD conducted its review in
                           2001, the owner did not provide the full note including the
                           pledge agreement. Thus, HUD did not know until our audit
                           in 2003 what the owner pledged as security for the note.

                           Since the owner received $42,431 of project funds it was
 Improper payments         not entitled to receive, the project had less funds to operate.
 contributed to the        As of November 2003, the owner is 4 months behind on the
 project’s default.        mortgage because the project lacks sufficient funds to make
                           the payments. As a result, the improper payments
                           contributed to the project’s default.



Auditee Comments           The owner expressed confusion regarding this finding.
                           According to the owner, the bank stated the note was proper
                           and the local HUD representative recollects some mention of
                           its approval. The owner hopes to resolve the issue by
                           refinancing the property. Yet, the owner did not address
                           repaying the project for the ineligible disbursement of project
                           funds.



OIG Evaluation of          We understand the confusion surrounding the complicated
Auditee Comments           nature of this finding. The owner did not provide any
                           evidence HUD was aware of the note at closing. HUD was
                           not aware and did not approve of the note at closing. In
                           addition once aware of the note, HUD prohibited the owner
                           from making any payments on the note unless the project had
                           surplus cash. Since the project did not have surplus cash,

2004-FW-1002                   Page 14
                                                                    Finding 3

                  HUD should seek recovery of the improper disbursements.
                  Further, if the owner does not reimburse the project, HUD
                  should take civil action.




Recommendations   We recommend HUD:

                  3A. Require the owner to repay the project $42,431 for
                      improper used of project funds.

                  3B. Take appropriate civil action and HUD prescribed
                      remedies if the owner does not repay HUD for
                      improper diversion of project funds.




                       Page 15                                  2004-FW-1002
Finding 3




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2004-FW-1002    Page 16
                                                                                             Finding 4


     Owner Received Excessive Management Fees
The owner received $32,254 in excess of the allowed management fee. Although the owner only
billed the project $42,215 for management fees, the majority member of the owner also received
a salary of $62,534 for overseeing operations. However, HUD requires the salary of supervisory
employees to be included in the management fee. Including the salary, the owner received a
total of $104,749 in management fees. For the years reviewed, the owner was only entitled to
receive an estimated management fee totaling $72,495.



                                           The Project Owner’s Certification for Owner Managed
    Criteria.
                                           Multifamily Housing Projects sets the management fee an
                                           owner can receive to self-manage a project. In the case of
                                           Jester Trails, the owner’s management fee was set at 6
                                           percent of residential rental income. According to HUD’s
                                           Management Agent Handbook, the owner was required to
                                           cover the cost of supervising and overseeing project
                                           operations out of the management fee.6 In addition, if other
                                           individuals are performing the front-line operations of the
                                           project, the salary of supervisory personnel may not be
                                           charged to the project account. Instead, their salary must
                                           be paid out of the management fee.7

                                           As the following table shows, the owner was paid a
    Owner paid both a                      management fee and the majority member received a
    management fee and                     salary. However, the owner did not include the member’s
    salary.                                salary in the management fee as required. As a result, the
                                           owner received $32,254 more in management fees than the
                                           Project Owner’s Certification allowed.




6
    HUD Handbook 4381.5, REV-2, Section 3.1.
7
    HUD Handbook 4381.5, REV-2, Sections 6.38 and 6.39.

                                               Page 17                                    2004-FW-1002
Finding 4



                                                       Excessive Management Fees
                                                                         2001        2002        2003     TOTALS
                                   Type of Expenses
                                   Salary/Contract Labor                $23,584      $29,000 $9,950 $62,534
                                   Management Fee                        22,475       13,600   6,140   42,215
                                   Total Owner Received                 $46,059      $42,600 $16,090 $104,749
                                   Less 6% Estimated Fee8                31,373       31,035 10,087    72,495
                                   Totals Excessive Fee                 $14,686      $11,565 $6,003 $32,254


                                              The owner either was aware or should have been aware of
    Owner did not follow                      the requirements but did not follow them. The majority
    requirements.                             member, who received all the fees, would not return calls to
                                              explain the excessive fees he received. The minority
                                              member said she was aware of HUD’s regulations, but she
                                              did not know the majority member was being paid both
                                              fees.



Auditee Comments                              The owner did not dispute the finding.. The owner has
                                              ensured that the managing member no longer has access to
                                              the assets of the property. However, the owner does not fully
                                              address repaying the project indicating instead that any loss
                                              of funds is the managing member’s responsibility.



OIG Evaluation of                             While we appreciate that the owner did not dispute the
Auditee Comments                              finding, the owner is ultimately responsible for repaying the
                                              project, regardless of who made the improper disbursements.
                                              Thus, HUD should seek recovery of the improper
                                              disbursements and take civil action if the project is not
                                              repaid.




8
      The estimated management fee is calculated based on the net rental revenue for 2001 and gross potential rent
      revenue for 2002 and 2003 since the owner did not maintain sufficient books and records to allow rental
      revenue to be verified to the rental receipts.

2004-FW-1002                                       Page 18
                                                                  Finding 4



Recommendations   We recommend HUD:

                  4A. Require the owner to repay the project $32,254 for
                      the excessive management fees.

                  4B. Take appropriate civil action and HUD prescribed
                      remedies if the owner does not repay HUD for
                      improper diversion of property funds.




                       Page 19                                2004-FW-1002
                   Finding 4




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 Page 20         2004-FW-1002
                                                                                                 Finding 5


    Owner Misused Tenant Security Deposit Funds
In violation of HUD’s requirements, the owner misused $24,127 in tenant security deposit funds.
Instead of fully funding and separately maintaining the account as required, the owner used $15,406
to pay for project operations and $8,721 for personal expenses. Even though the owner knew the
account should be fully funded, it used the tenant security deposit funds for project operations
because the project’s financial condition was precarious. In addition, the owner knew paying
personal expenses was prohibited. However, it continually used project assets to pay them.



                                          The Regulatory Agreement and a HUD Handbook requires
     Criteria.                            the owner to keep tenant security deposit funds separate
                                          from all other funds of the project in an amount equal to or
                                          exceeding all outstanding tenant security deposit
                                          obligations.9 Further, all payments from the account must
                                          be for refunds to tenants or for expenses incurred by
                                          tenants.10

                                          By inappropriately transferring $15,406 in tenant security
     Owner used tenant security           deposit funds to the project’s operating account, the owner
     deposit funds for project            avoided using its funds for project operations. For June
     operating expenses.                  2003, even though the general ledger showed the tenant
                                          security deposit liability was $24,627, the tenant security
                                          deposit bank account balance was only $500. Therefore,
                                          the owner underfunded the tenant security deposit account
                                          $24,127.

                                          The owner also used $8,721 of tenant security deposit
     Owner paid $8,721 for                funds to pay for expenses like repairing the majority
     personal expenses.                   member’s personal automobile. From 2002 to 2003, the
                                          owner wrote 37 checks on the tenant security deposit
                                          account. The owner wrote 3 of the 37 checks for the
                                          majority member’s personal expenses.




9
      Paragraph 6(g) of the Regulatory Agreement and HUD Handbook 4370.2, REV-1, Financial Operations and
      Accounting Procedures for Insured Multifamily Projects, Chapter 2-9A.
10
      HUD Handbook 4370.2, REV-1, Financial Operations and Accounting Procedures for Insured Multifamily
      Projects, Chapter 2-9B.

                                               Page 21                                        2004-FW-1002
Finding 5

                           Even though the owner knew of HUD’s requirements
Owner disregarded          regarding tenant security deposits, the owner disregarded
HUD’s regulations.         them. In its response to a 1999 independent audit finding
                           submitted to HUD, the owner admitted the tenant security
                           deposit account was underfunded. The owner also stated it
                           would not remove any funds out of the account. In
                           addition, in a December 2001 letter to HUD, the owner said
                           it would fully fund the account during 2002. Despite all of
                           these assurances to HUD, the owner did not fully fund the
                           account and continued taking funds out during 2002 and
                           2003.

                           The project does not have sufficient operating funds available
Project lacks funds to     to return every deposit to each tenant. In addition, the
return tenants’ deposit.   improper payments contributed to project’s default by further
                           reducing the amount of liquid assets available to the project.
                           Thus, HUD should seek recovery of the $24,127 from the
                           owner.



Auditee Comments           The owner attributed this finding to abuse by the managing
                           member. The owner stated that all previous residents entitled
                           to a refund were fully paid and no resident was denied a
                           refund of their deposit because of this abuse. However, the
                           owner did not address repaying the project.



OIG Evaluation of          We applaud the owner for taking action including restricting
Auditee Comments           the managing member’s access to the project assets.
                           However, the owner needs to repay the tenant security
                           deposit fund or HUD should seek civil action to recover the
                           improper disbursements.



Recommendations            We recommend HUD:

                           5A. Require the owner to fully fund the project’s tenant
                               security deposits by replacing the $15,406 used to
                               fund project operations and repaying the $8,721 spent
                               on personal expenses.

                           5B. Take appropriate civil action and HUD prescribed
                               remedies if the owner does not fully fund tenant

2004-FW-1002                   Page 22
                                             Finding 4

security deposits and does not repay the project for
improper diversion of funds.




Page 23                                   2004-FW-1002
Finding 5




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2004-FW-1002    Page 24
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 Management
                                      relevant to our audit objectives:
  Controls
                                      •   Program Operations - Policies and procedures that
                                          management has implemented to reasonably ensure that
                                          a program meets its objectives.

                                      •   Validity and Reliability of Data - Policies and
                                          procedures that management has implemented to
                                          reasonably ensure that valid and reliable data are
                                          obtained, maintained, and fairly disclosed in reports.

                                      •   Compliance with Laws and Regulations - Policies and
                                          procedures that management has implemented to
                                          reasonably ensure that resource use is consistent with
                                          laws and regulations.

                                      •   Safeguarding Resources - Policies and procedures that
                                          management has implemented to reasonably ensure that
                                          resources are safeguarded against waste, loss, and
                                          misuse.

                                      It is a significant weakness if management controls do not
  Significant Weaknesses              provide reasonable assurance that the processes for
                                      planning, organizing, directing, and controlling program
                                      operations will meet an organization's objectives.

                                      We determined that none of We’re Rocking’s management
                                      controls were reliable so we did not rely on them. We
                                      covered the significant weaknesses in our findings and
                                      recommendations.




                                          Page 25                                     2004-FW-1002
Management Controls




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2004-FW-1002           Page 26
Follow-Up on Prior Audits
This is the first audit of the Jester Trails Apartments, Houston, Texas, by the Office of Inspector
General.

Gainer, Donnelly, & Desroches, L.C, an independent audit firm, issued the 1999 and 2000
audited financial statements of the project on March 27, 2001, and August 30, 2001,
respectively. In the 1999 and 2000 audited financial statements, Gainer, Donnelly, & Desroches,
L.C. expressed a qualified opinion for the Report on Compliance – Major Program. In 1999
audit, the audit firm cited two findings: unauthorized distribution of project assets and
insufficient funds in the tenant security deposit fund. In the 2000 audit, the audit firm cited one
finding: unauthorized distribution of project assets. The audit firm had not cleared these
outstanding findings at the time of our audit. We included these issues in our audit objectives.
In addition, our report includes findings and recommendations covering these issues. The owner
has not submitted audited financial statements for 2001, 2002, and 2003 to HUD.




                                          Page 27                                      2004-FW-1002
Follow-Up on Prior Audits




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2004-FW-1002                 Page 28
                                                                                                    Appendix A

Schedule of Questioned Costs

Recommendation                                                                      Funds To Be Put
                                             1                              2
   Number                 Ineligible Costs           Unsupported Costs              To Better Use 3

        1A                                                                            $2,133,843
        2A                 $ 41,261
        2B                                                 $14,214
        3A                   42,431
        4A                   32,254
        5A                   24,127                         ______                    _________

      Totals               $140,073                        $14,214                   $2,133,843


             Total Questioned Costs and Funds Put To Better Use                      $2,288,130




1   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor
    believes are not allowable by law, contract or Federal, State or local policies or regulations.
2   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.
3
    Funds to be put to better use include quantifying savings that would be used more effectively if OIG
    recommendations were implemented. The Inspector General Act specifically provides that future monetary savings
    should be reported under the category “recommendations that funds be put to better use.”




                                                 Page 29                                           2004-FW-1002
Appendix A




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2004-FW-1002    Page 30
                             Appendix B

Auditee Comments




                   Page 31   2004-FW-1002
Appendix B




2004-FW-1002   Page 32