oversight

The Lehigh County Housing Authority, Emmaus, PA, Risked HUD Assets for the Benefit of Nonfederal Entities

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-10-15.

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

                                                                   Issue Date
                                                                         October 15, 2004
                                                                   Audit Report Number
                                                                         2005-PH-1001




TO:        Malinda Roberts, Director, Office of Public Housing, Pennsylvania State Office,
             3APH



FROM:      Daniel G. Temme, Regional Inspector General for Audit, Philadelphia Region,
             3AGA

SUBJECT: The Lehigh County Housing Authority, Emmaus, PA, Risked HUD Assets for
           the Benefit of Nonfederal Entities


                                    HIGHLIGHTS

 What We Audited and Why

            We performed an audit at the Lehigh County Housing Authority (Authority) in
            response to a complaint. The complainants alleged the Authority used HUD
            funds improperly to benefit its affiliated nonfederal entity known as Valley
            Housing Development Corporation. Our audit objective was to determine
            whether the Authority improperly used HUD funds to develop and support its
            affiliated nonfederal entities. This is the first of two audit reports we will issue on
            this audit. The second report will address problems identified regarding
            disbursement of HUD funds to the Authority’s General Fund.

 What We Found


            The Authority improperly used HUD funds to develop and support its affiliated
            nonfederal entities. In this regard, it violated its Consolidated Annual
            Contributions Contract with HUD by guaranteeing tax credits and debt, estimated
            at $4.4 million for its affiliated nonfederal entities, and by improperly providing
                    its affiliated entities $95,634. 1 We found that $3.0 million of the $4.4 million in
                    HUD assets the Authority has pledged since 1988 remained at risk and that the
                    entities owed the Authority $93,834. Further, our audit identified an apparent
                    conflict of interest regarding the Executive Director’s relationship with the
                    Authority’s affiliated nonfederal entities.

                    These problems occurred because the Authority’s Board of Commissioners did
                    not provide adequate oversight over the Authority’s management, nor did it
                    ensure adequate internal controls were in place to detect and prevent these
                    problems from occurring. The control deficiencies created an environment that
                    allowed the Authority to put HUD funds at risk for the benefit of its affiliated
                    nonfederal entities.

    What We Recommend


                    We recommend that HUD take action, if appropriate, to declare the Authority in
                    substantial default of its Consolidated Annual Contributions Contract and direct the
                    Authority to take immediate action to remove its remaining improper pledges of
                    $130,000 in HUD assets. We also recommend that HUD require the Authority to
                    recover the remaining $13,100, which it improperly provided its affiliated entities, or
                    repay it from nonfederal funds. Lastly, we recommend HUD direct the Authority’s
                    Board of Commissioners to create internal controls to prevent, detect, and resolve
                    the improper pledging of HUD assets and conflict of interest situations.

                    For each recommendation without a management decision, please respond and
                    provide status reports in accordance with HUD Handbook 2000.06, REV-3.
                    Please furnish us copies of any correspondence or directives issued because of the
                    audit.

    Auditee’s Response


                    We discussed the report with the Authority during the audit and at an exit conference
                    on September 1, 2004. The Authority provided written comments to our draft report
                    on September 29, 2004. To its credit, the Authority was proactive, and provided
                    documents showing it had either removed, or was in the process of removing the
                    majority of its improper pledges of HUD assets. The Authority also provided
                    documents showing it had recovered all but $13,100 of the funds it improperly
                    provided its affiliated entities. The Authority’s Board of Commissioners further
                    passed a Board resolution to create internal controls to prevent, detect, and resolve
                    improper pledging of HUD assets, and apparent conflict of interest situations. The
                    complete text of the Authority’s response, excluding the aforementioned documents,
                    can be found in Appendix B of this report.


1
    $13,100 of the $95,634 was improperly given to two entities that were considered federal entities.


                                                            2
                            TABLE OF CONTENTS

Background and Objectives                                                          4

Results of Audit

      Finding 1: The Authority Improperly Pledged $4.4 Million in HUD Assets and   5
                 Improperly Provided Its Affiliated Entities $95,634

Scope and Methodology                                                              10

Internal Controls                                                                  11

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use               12
   B. Auditee Comments                                                             13




                                            3
                     BACKGROUND AND OBJECTIVES

The Lehigh County Housing Authority was established in 1975 under the Housing Authorities
Law of the Commonwealth of Pennsylvania to provide affordable housing for qualified
individuals in accordance with the rules and regulations prescribed by HUD. A five-person
Board of Commissioners appoints the Authority’s Executive Director and governs the Authority.
The Executive Director during the audit was John Seitz. The Executive Director and his Deputy
Executive Director had been serving in their respective positions for more than 20 years. The
Authority’s main administrative office is located at 635 Broad Street, Emmaus, Pennsylvania.

The Authority owns and manages 289 public housing units under its Consolidated Annual
Contributions Contract with HUD. The Consolidated Annual Contributions Contract defines the
terms and conditions under which the Authority agrees to develop and operate all projects under
the agreement. HUD authorized the Authority the following financial assistance from Fiscal
Years 2000 to 2003:

   •   $2.3 million Operating Subsidy to operate and maintain its housing developments.

   •   $1.6 million Capital Fund Program to modernize public housing units.

   •   $28.9 million to provide housing assistance through tenant-based Section 8 certificates
       and vouchers.

In 1982, the Authority created a nonfederal entity known as Valley Housing Development
Corporation. The Authority formed this nonprofit corporation to provide low- and moderate-
income households opportunities for low cost rental housing. A Board of Commissioners,
consisting of 11-21 members, governs the corporation. As of December 2003, the Valley
Housing Development Corporation held an interest in 46 limited partnerships in which it served
as the general partner. It primarily funded its limited partnerships through a combination of
private investment (in exchange for federal housing tax credits), commercial loans, and loans the
corporation made using funds it received in exchange for 1-year state tax credits. In total, these
partnerships operate more than 1,300 units of low-income housing.

Since November 1990, the Authority has assisted Valley Housing Development Corporation, for
a fee, to enable it to develop and operate its housing projects for low- and moderate-income
households. The Authority also shares common management with the corporation. In July
2003, however, several complainants alleged the Authority used HUD funds improperly to
benefit the Valley Housing Development Corporation. Given the complaints, the overall
objective of our audit was to determine whether the Authority improperly used HUD funds to
develop and support its affiliated nonfederal entities.




                                                4
                                      RESULTS OF AUDIT

Finding 1: The Authority Improperly Pledged $4.4 Million in HUD
Assets and Improperly Provided Its Affiliated Entities $95,634
The Authority violated its Annual Contributions Contract with HUD by guaranteeing $4.4
million of its affiliated nonfederal entities’ tax credits and debt and improperly providing its
affiliated entities $95,634. It also allowed apparent conflicts of interest to exist regarding its
Executive Director’s relationship with its affiliated nonfederal entities. We estimate that $3.0
million, of the $4.4 million in HUD assets the Authority has pledged since 1988, remained at
risk, and the entities owed the Authority $93,834.

This occurred because the Authority’s Board of Commissioners did not ensure adequate internal
controls were in place to detect and prevent these problems from occurring. The control
deficiencies created an environment that allowed the Authority to put HUD funds at risk for the
benefit of its affiliated nonfederal entities.




    The Authority Improperly
    Pledged $4.4 Million in HUD
    Assets


                 The Authority violated its Consolidated Annual Contributions Contract by
                 guaranteeing its Development Corporation’s tax credits and debt, estimated at
                 $4.4 million. In so doing, the Authority placed federal funds at risk by
                 improperly pledging assets covered by its contributions contract without prior
                 approval from HUD. We estimated that $3.0 million, of the $4.4 million in HUD
                 assets that the Authority improperly pledged since 1988, remained at risk. The
                 Consolidated Annual Contributions Contract prohibits the Authority from
                 encumbering or pledging its HUD assets without HUD’s prior approval.2 The
                 contract further states that encumbering assets or pledging Consolidated Annual
                 Contributions Contract assets as collateral for a loan constitutes grounds for
                 declaring the Authority in substantial default of its contributions contract.3
                 Nevertheless, we found the Authority improperly pledged and placed HUD assets
                 at risk as follows:

                 •   During 1989 and 1990, the Authority's Board Chairman and its Executive
                     Director indemnified four limited partnerships against possible losses totaling
                     $1.7 million in low-income housing tax credits. These agreements remain in

2
  Part A, Section 7, of the Consolidated Annual Contributions Contract, Covenant Against Disposition and
Encumbrances
3
  Part A, Section 17, Notices, Defaults, Remedies


                                                        5
    effect and do not identify specific assets the Authority will use to cover this
    contingent liability.

•   In August 2002, with approval of the Authority’s Board of Commissioners,
    the Authority’s Executive Director signed an agreement obligating it to
    guarantee $1.2 million for construction of a housing project for one of Valley
    Housing Development Corporation's limited partnerships. We found that the
    Authority’s guarantee of this $1.2 million construction project no longer poses
    a risk to HUD assets because the limited partnership completed the project in
    April 2004. However, the Authority’s Executive Director signed a related
    agreement in August 2002, whereby it continued to pledge $30,000 to
    guarantee payment of the project’s operating expenses.

•   During the 10-year period from October 1989 to June 1999, the Authority's
    Executive Director signed at least six guarantees for lines of credit totaling
    $500,000 for the Development Corporation. All of the credit lines were in
    place as of June 2004. The guarantees did not identify specific assets the
    Authority would use in the event it was required to pay off the debt.

•   In April 1988, the Authority’s Board Chairman signed an agreement
    obligating the Authority to guarantee two loans totaling $1.0 million from the
    Pennsylvania Housing Finance Agency to one of the Development
    Corporation’s limited partnerships. By signing this absolute and
    unconditional guarantee, the Chairman created a potentially large contingent
    liability and placed the Authority’s assets at substantial risk. According to the
    latest statement from the Pennsylvania Housing Finance Agency, as of May
    2004, the total outstanding balance on the loans was $754,500.

The Authority’s Executive Director could not tell us or provide documentation
showing the specific assets the Authority would use to cover these contingent
liabilities. In the absence of documents identifying the funds to pay these
contingent liabilities, there is substantial risk to the Authority’s Consolidated
Annual Contributions Contract assets if the entities go into default. Further,
Board resolutions were not available showing that the Authority’s Board of
Commissioners had approved these agreements.

We discussed these problems with the Executive Director during the audit, and he
began taking immediate action to withdraw the Authority’s improper pledges of
HUD assets. In July 2004, after we completed audit fieldwork, the limited
partnerships and the Finance Agency released the Authority from its guarantees
for the $1.7 million in low-income housing tax credits and the outstanding loan
amount of $754,500. Also, the Authority allowed a $250,000 guaranteed line of
credit to expire without renewal. On October 12, 2004, the Authority provided
documentation showing that a bank released the Authority from its guarantees for
a $150,000 line of credit. As a result, the Authority put to better use $2,853,711,




                                  6
                 of the $2,983,711, of HUD funds that were at risk. The Authority needs to
                 complete corrective actions on the remaining $130,000 of funds still at risk.

    The Authority Improperly
    Provided Its Affiliated Entities
    $95,634


                 We reviewed the 2003 general ledgers and bank statements for the Authority's
                 affiliated entities and found that it improperly provided the entities $95,634. The
                 Consolidated Annual Contributions Contract limits the use of HUD funds to
                 paying development and operation costs of the projects under the Contract with
                 HUD, and purchasing investment securities and other purposes specifically
                 approved by HUD.4 Contrary to the terms of the Contract, the Authority
                 improperly provided funds to its Development Corporation and other affiliated
                 entities from its General Fund5 without approved loan agreements or appropriate
                 entries in its accounting system.

                 For example, in October 2001, the Executive Director began reviewing the
                 financial condition of the Valley Housing Development Corporation and its
                 limited partnerships on a biweekly basis. In accordance with the Limited
                 Partnership agreements, he instructed staff to transfer funds from the Valley
                 Housing Development Corporation to the limited partnerships, as needed. If the
                 Development Corporation lacked sufficient funds to cover its limited partnerships'
                 cash shortages or to pay its own bills, he directed staff to use the Authority's
                 General Fund to cover the shortfalls. Although the transactions were recorded as
                 loans from the General Fund, we found that the Authority recouped only $1,800
                 of the $95,634 as of April 2004. However, since approved loan agreements and
                 appropriate entries did not exist in the Authority’s accounting system, it was
                 unlikely that the Authority would recoup the remaining $93,834. Therefore, since
                 the Consolidated Annual Contributions Contract limits the use of HUD funds, and
                 the Authority did not differentiate between federal and nonfederal funds in its
                 General Fund, the disbursement of $93,834 is ineligible.

                 Minutes from meetings of the Authority’s Board of Commissioners provided no
                 indication that the Board was aware that the Executive Director was directly
                 transferring cash from the Authority’s General Fund to support its affiliated
                 entities. However, the Authority did not have policies and procedures to prevent
                 such transfers from occurring.

                 By improperly providing funds to its affiliated entities, the Authority reduced the
                 amount of funds available for its own operating expenses and weakened its


4
  Part A, Section 9, Depository Agreement and General Fund
5
  The Authority’s General Fund contained both federal and nonfederal funding but did not differentiate between the
two. A subsequent audit report will address this problem in further detail.


                                                        7
                     financial position. After we discussed these problems with the Executive
                     Director, he took immediate action to recoup some of the funds. As of
                     September 30, 2004, the Authority had recouped $80,734 of the $93,834 that was
                     outstanding. Therefore, the Authority still needs to collect the remaining $13,100.
                     Additionally, we estimated the Authority could put $95,634 to better use over a
                     1-year period by implementing procedures to preclude the Authority from
                     improperly transferring funds to its affiliated entities.

    The Authority Allowed
    Apparent Conflict of Interest
    Situations to Exist


                     The Authority’s Executive Director violated the Consolidated Annual
                     Contributions Contract conflict of interest restrictions by improperly pledging
                     HUD assets to guarantee debt and tax credits of the Valley Housing Development
                     Corporation, in which he also served as the Executive Director and Assistant Vice
                     President, and its limited partnerships. The Consolidated Annual Contributions
                     Contract prohibits the Authority from entering into any contract or arrangement in
                     connection with any project under the Contract with any Authority employee who
                     formulates policy or who influences decisions with respect to the project(s). 6
                     Employees must disclose their interest or prospective interest to the Authority and
                     HUD. We found that the Authority's Board of Commissioners did not establish
                     controls to detect, prevent, and resolve these conflict of interest situations from
                     occurring.

                     We found that from 1990 to 2002 the Authority’s Executive Director signed at
                     least ten agreements, pledging up to $2.3 million in HUD assets for the benefit of
                     the Authority’s nonfederal entities. We believe an apparent conflict of interest
                     existed because most of the pledged assets guaranteed debt and tax credits of the
                     Valley Housing Development Corporation, in which he also served as the
                     Executive Director and Assistant Vice President, and its limited partnerships.
                     Despite the apparent conflict of interest, the Executive Director created large
                     contingent liabilities and placed the Authority’s assets at substantial risk.

                     In addition, we found that the Executive Director did not disclose to HUD a
                     financial interest he had with an outside business affiliated with the Authority’s
                     nonfederal entities, which we believe was also an apparent conflict of interest.
                     The Consolidated Annual Contributions Contract requires employees to disclose
                     their interest or prospective interest to the Authority and HUD. While HUD can
                     waive this requirement for good cause, the Executive Director did not disclose the
                     relationship to HUD or request a waiver.




6
    Part A, Section 19, Conflict of Interest


                                                      8
Recommendations


          We recommend that the Director, Office of Public Housing, Pennsylvania State
          Office:

          1A.     Review issues contained in this audit report, and if appropriate, initiate
                  action to declare the Authority in substantial default of its Consolidated
                  Annual Contributions Contract and take appropriate administrative action as
                  detailed in Section 17 (Notices, Defaults and Remedies) of the Contract.

          1B.     Require the Authority to take immediate action to withdraw its remaining
                  pledges of Consolidated Annual Contributions Contract assets and, thereby,
                  put $130,000 to better use.

          1C.     Require the Authority’s Board of Commissioners to pass Board resolutions
                  approving the development and implementation of procedures that ensure
                  the Authority does not encumber or pledge HUD assets without HUD
                  approval, and the Authority properly reports and resolves apparent conflict
                  of interest situations.

          1D.     Direct the Authority to recover all of the $13,100 remaining that it
                  improperly provided its affiliated entities during 2003 or repay it from
                  nonfederal funds.

          1E.     Require the Authority’s Board of Commissioners to pass a Board resolution
                  approving procedures to ensure the Authority does not improperly provide
                  HUD assets to its affiliated entities and, thereby, put $95,634 to better use
                  annually.




                                             9
                        SCOPE AND METHODOLOGY

We performed an audit from November 2003 through September 2004 of the Lehigh County
Housing Authority, located in Emmaus, Pennsylvania. The audit was conducted in accordance with
generally accepted government auditing standards and included tests of internal controls that we
considered necessary under the circumstances.

The audit covered transactions representative of operations current at the time of the audit and
included the period January 2001 through December 2003. We expanded the scope of the audit
as necessary. We reviewed applicable guidance and discussed operations with management and
staff personnel at the Lehigh County Housing Authority and key officials from HUD’s
Pennsylvania State Office.

To determine that the Authority improperly used HUD funds to develop and support its affiliated
nonfederal entities we:

    •   Reviewed all documentation provided by the Authority related to our audit objective,
        including partnership agreements, financial statements, general ledgers, bank statements,
        cashbooks, bank loan agreements, related correspondence, payment vouchers, and
        minutes from Board meetings.

    •   Reviewed the Authority’s available Independent Auditor’s Reports for Fiscal Years 2001
        and 2002.

    •   Reviewed HUD and Authority correspondence related to the audit and results of monitoring
        reviews HUD’s Pennsylvania State Office conducted.




                                               10
                              INTERNAL CONTROLS

Internal Control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

   •   Effectiveness and efficiency of operations,
   •   Reliability of financial reporting, and
   •   Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls


              We determined the following internal controls were relevant to our audit objectives:

              •   Policies, procedures, control systems, and other management tools implemented
                  to prevent the inappropriate use of HUD funds for nonfederal purposes.

              •   Policies, procedures, controls, and other management tools implemented to
                  detect, prevent, and resolve conflict of interest situations.

              We assessed the relevant controls identified above.

              A significant weakness exists if management controls do not provide reasonable
              assurance that the process for planning, organizing, directing, and controlling
              program operations will meet the organization’s objectives.

 Significant Weaknesses


              Based on our review, we believe the following items are significant weaknesses:

              The Authority did not

              •   Prevent Consolidated Annual Contributions Contract assets from being
                  encumbered, disbursed, or risked without HUD approval.

              •   Establish adequate controls to prevent, detect, and resolve apparent conflict of
                  interest situations.


                                                11
                                 Appendixes
Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

                  Recommendation             Ineligible 1/   Funds to Be Put
                        Number                               to Better Use 2/
                                1B                            $2,983,711 (1)
                                1D           $93,834 (2)
                                1E                            $ 95,634
                              Total          $93,834          $3,079,345


     (1) The Authority took action to remove its guarantees for $2,853,711 of this amount.
         The Authority needs to take action on the remaining $130,000 still at risk.

     (2) The Authority collected $80,734 of this amount. The Authority needs to collect the
         remaining $13,100.

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/   “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an
     Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
     expenditures during subsequent period for the activities in question. This includes costs
     not incurred, deobligation of funds, withdrawal of interest, reductions in outlays,
     avoidance of unnecessary expenditures, loans and guarantees not made, and other
     savings.




                                              12
Appendix B

                   AUDITEE COMMENTS


             Auditee Comments




                                13
Auditee Comments




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Auditee Comments




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Auditee Comments




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Auditee Comments




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Auditee Comments




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Auditee Comments




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Auditee Comments




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