oversight

The Town of Clifton, VA's, Participation in the Single Family Property Disposition Discount Sales Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-12-21.

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

                                                                   Issue Date
                                                                            December 21, 2004
                                                                    Audit Report Number
                                                                            2005-PH-1003




TO:         Sean G. Cassidy, General Deputy Assistant Secretary for Housing, H



FROM:        Daniel G. Temme, Regional Inspector General for Audit, Mid-Atlantic Region,
               3AGA

SUBJECT: The Town of Clifton, VA’s, Participation in the Single Family Property
           Disposition Discount Sales Program


                                    HIGHLIGHTS

 What We Audited and Why

             In response to a congressional and departmental request, we audited the Town of
             Clifton’s participation in the U.S. Department of Housing and Urban
             Development’s (HUD) Single Family Property Disposition Discount Sales
             Program (Sales Program). Our objective was to determine whether the Town of
             Clifton (Town) complied with HUD's rules and regulations in administering the
             Sales Program. Specifically, we wanted to determine whether the Town
             appropriately participated under the Sales Program using the competitive sales
             method, re-sold rehabilitated properties at prices less than 110 percent of their net
             development cost, and re-sold the properties only to income-eligible homebuyers.

 What We Found


             The Town of Clifton did not fully comply with HUD's rules and regulations in
             administering its Sales Program. Specifically, the Town of Clifton could not
             adequately support property rehabilitation costs it claimed it made to the
             properties it sold under the program, and it sold several properties at sale prices


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         above the amount allowed by HUD requirements. However, we did find the
         Town of Clifton participated under the program using the competitive sales
         process and it did meet the requirements in selling the homes to income-qualified
         buyers.

         Focusing on properties with the highest dollar repair costs, we selected and
         reviewed 10 of the 89 properties the Town had purchased and re-sold under the
         program to see if sales were made to income-qualified buyers and that net
         development costs met the requirements of Mortgagee Letter 2001-30. The home
         inspection repair invoices the Town of Clifton provided us to support each
         property’s repair costs did not have sufficient detail to permit us to determine if
         the claimed costs were reasonable nor to verify contractor or vendor expenditures.
         However, our on-site physical home inspections of the 10 properties confirmed
         that some of the work itemized on the home inspection repair invoices had not
         been performed. In total, we identified $9,380 of charges for repairs that did not
         exist in seven homes and thus were ineligible. Also, for many other repairs we
         were not able verify if the work was necessary, reasonable or had actually been
         completed because the home inspection repair invoices lacked sufficient detail.
         Since we found the process used to identify and pay for repair costs was neither
         accurate nor reliable, we also question the remaining $205,615 in repair costs for
         the 10 homes we inspected.

         Further, since the rehabilitation costs are used in calculating the sale price of the
         homes, we determined the Town of Clifton exceeded the 110 percent of the net
         development costs requirement for at least five of the properties. By exceeding
         the allowable sales percentage, the homeowner’s mortgage was overstated and in
         turn the discounts received by the Town were not passed along to the
         homeowners. Since we could not verify the repair costs associated with the 10
         properties we reviewed, and in 7 cases we found evidence that repairs were paid
         for that were not actually completed, we question the full amount of the discounts
         ($140,475) the Town received when it purchased these 10 properties.

What We Recommend


         We recommend the Department require the Town of Clifton schedule an
         independent inspection of the 79 remaining homes it has processed under the
         discount Sales Program to verify that all work was satisfactorily completed. If
         work has not been done, the Town should pay down the homeowners’ mortgage
         by the appropriate amount. Additionally, the Department should review the
         deficiencies noted in this report and determine if the Town of Clifton should be
         reinstated to participate in the Sales Program. If the Town is reinstated, prior to
         reinstatement, require the Town of Clifton to set up controls and procedures that
         fully document and verify the claimed net development costs.




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           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


           The complete text of the Town of Clifton’s response, along with our evaluation of
           that response, can be found in Appendix B of this report.




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                           TABLE OF CONTENTS

Background and Objectives                                                      5

Results of Audit
      Finding 1: Support Documentation for Property Rehabilitation Costs Was   7
      Inadequate and Unreliable

Scope and Methodology                                                          13

Internal Controls                                                              14

Appendixes
   A. Schedule of Questioned Costs                                             15
   B. Auditee Comments and OIG’s Evaluation                                    16




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                       BACKGROUND AND OBJECTIVES

The purpose of HUD’s Single Family Property Disposition Sales Program is to dispose of
properties in a manner that expands homeownership opportunities, strengthens neighborhoods and
communities, and ensures a maximum return to the mortgage insurance funds. In an attempt to
provide increased affordable housing opportunities to low- and moderate-income homebuyers,
HUD permits non-profits and government entities to purchase HUD Real Estate Owned properties
at a discount. These discounts range from 10 to 30 percent off the “as is” appraised value of the
property. The entity must pass along the discounts received in order to increase homeownership
opportunities for low- and moderate-income families and individuals.

To sell the properties HUD uses several different formats. Our review concentrated on two of
them: the direct sales method and the competitive sales method. Under the direct sales method a
non-profit or government entity must be pre-approved by HUD to participate in the Sales
Program. Once they are approved, they are provided the first opportunity to purchase the homes.
Any homes not purchased by an approved non-profit or government entity will be offered for
sale under the competitive sales method. Under the competitive sales method, HUD offers to
sell the properties to the general public. Both non-profits and government entities can participate
in the competitive sales method; however, they do not have to be “pre-approved” by the
Department to participate in the program. Under the competitive sales method, HUD sells the
properties on an "as-is" basis, without repairs or warranties. Non-profits and government
agencies, which bid competitively during this period, and are the successful bidder without any
discount being considered, are then given the applicable discount off the gross sale price for that
property. Homes purchased under HUD’s Sales Program must be sold to an eligible purchaser,
whose income does not exceed 115 percent of the median income of the locality of the home.

In addition to selling the home to an eligible homebuyer, the program participants must pass on the
discount received from HUD to increase homeownership opportunities. In order to do this HUD
limits the net development costs allowed. The net development costs is composed of the allowable
property acquisition costs plus allowable rehabilitation, holding, and various other selling costs
entities incur when purchasing a HUD home at discount prices. The Department limits the eligible
costs and prohibits the entity from reselling the repaired properties at prices in excess of 110 percent
of the net development cost calculation. Appendix A of Mortgagee Letter 2001-30 identifies costs
allowed in calculating net development costs which states costs passed along must be “reasonable
and customary.” In addition, rehabilitation costs are to be “verifiable contractor and vendor
expenditures.”

The Town of Clifton used HUD’s Single Family Property Disposition Sales Program as a means
to raise revenue. The Town entered into an agreement on November 19, 2002, with a “for-
profit” entity, Commercial Lending Corporation (Commercial Lending), to handle all aspects of
the purchase, rehabilitation, and sale of the properties. The contractor paid for all purchase and
rehabilitation costs; or the Town would borrow funds from the contractor to cover these
expenditures.



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Using the competitive sales method under the program, over a 2-year period the Town of Clifton
purchased 98 homes across the State of Virginia for a total purchase price of $9,451,301. None
of the homes purchased were within the Town of Clifton’s geographic boundary, nor are they
required to be under the competitive sales program. In purchasing these homes, the Town
received $1,417,695 in discounts from HUD. During our audit period, 89 of the 98 properties
were re-sold for $10,581,823. Using the Town’s “government” status to purchase the properties,
the contractor divided approximately $721,164 in profits with the Town. Commercial Lending
received $322,337 in management fees and the Town received $399,305 in net income.

Our overall objective was to determine whether the Town of Clifton and its agent, Commercial
Lending Corporation, followed HUD's rules and regulations in administering HUD's Single
Family Property Disposition Discount Sales Program. To accomplish this, we wanted to
determine whether the Town appropriately participated under the Sales Program using the
competitive sales method, re-sold rehabilitated properties at prices less than 110 percent of their
net development cost, and re-sold the properties only to income-eligible homebuyers.




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                                 RESULTS OF AUDIT

Finding 1: Support Documentation for Property Rehabilitation Costs
Was Inadequate and Unreliable
The files maintained by Commercial Lending on behalf of the Town of Clifton did not provide
adequate documentation to support the repair costs it claimed it made on the properties it re-sold
under the program. In fact, from our review of a sample of 10 of the 89 properties the Town of
Clifton re-sold under the program, we found Commercial Lending paid for repairs for items that
did not exist in 7 of the homes. Thus, the net development costs used for calculating the sale
prices of the homes was not accurate and homeowners paid for repairs through their mortgages
that were not made. This occurred because the Town did not provide adequate oversight over
Commercial Lending to ensure it properly administered the program according to HUD
regulations. Further, Commercial Lending provided limited monitoring of its repair contractors,
which caused it to pay its repair contractors for repairs that were not performed. Consequently,
both entities delegated oversight functions in a manner that does not provide assurance low- and
moderate-income buyers received full value for the amounts paid.



 Documentation To Support
 Home Repair Cost Was Limited

               The only document Commercial Lending could provide us to support the repair
               costs it claimed that it incurred for each property was the home inspection repair
               invoice it had generated. No detailed documentation, such as invoices from its
               repair contractors, supported this document. Further, we noted several
               discrepancies with this document. Dollar values were missing in the “owners
               estimate” or “contractor estimate” columns, and start and completion dates were
               left blank. In addition, the description of the work performed was not sufficient
               enough to determine exactly what work was performed. For example, an
               inspection report stated a roof repair was made for $4,000; however, no
               information was provided to detail exactly what was done (i.e., replacing shingles,
               fixing leak, etc.). Thus, based on the documentation in the file, it is impossible to
               determine if the work claimed on the home inspection repair invoice had actually
               been completed and if the price paid was reasonable.




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    Commercial Lending Claims It
    Conducts Site Inspections To
    Ensure Only Needed Repairs
    Are Made and Paid For

                     According to Commercial Lending, once a home is purchased from HUD,
                     Commercial Lending inspects each home to identify what repairs it will need to
                     make before the property is re-sold. The Commercial Lending inspector
                     documents the results of the inspection by completing a home inspection repair
                     invoice, which includes a cost estimate for each identified repair item.
                     Commercial Lending uses the home inspection document to negotiate a final price
                     with primarily four repair contractors that it uses to make the home repairs. After
                     the repair contractor completes the repairs, Commercial Lending inspects the
                     property and then disburses payment based on the agreed price on the home
                     inspection repair invoice. Commercial Lending does not require the repair
                     contractors to support the repair costs with any other form of documentation.
                     Instead, Commercial Lending requests that the repair contractor sign and date a
                     certification form stating that all repairs specified on the home inspection repair
                     invoice were completed in a workmanlike manner. Our review of Commercial
                     Lending’s property files found that the certifications were sometimes signed 9 to
                     12 months after the work was performed or the date was left blank.

    On-Site Home Inspections
    Showed Not All Repairs Were
    Completed, Valid or Verifiable


                     Since we could not determine the repairs reported on Commercial Lending’s
                     home inspection repair invoice were actually necessary or completed by the repair
                     contractor, we decided to complete on-site home inspections for a sample of the
                     properties. We selected 10 of the 89 properties the Town had acquired during our
                     review period, with the highest claimed repair costs. The repair costs for these 10
                     properties totaled $214,9951. A HUD housing inspector accompanied us on the
                     inspections. In completing our physical inspections, we walked through each
                     house and compared Commercial Lending’s home inspection repair invoice to the
                     work we could see had actually been completed. In addition we interviewed the
                     homeowners. Since Commercial Lending’s home inspection repair invoices
                     lacked specific detail, for many items we were not able to determine if the repair
                     was necessary or had actually been completed. However, in 7 of the 10 homes
                     inspected we were able to identify a number of repairs listed on the home
                     inspection repair invoices that either did not exist or were not completed by the
                     repair contractor before the homeowners moved in. In total, we identified $9,380
                     of ineligible charges for repairs to items in the homes that did not exist.


1
    The total repair costs for the 89 properties totaled $1,054,723.

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                  For example,

                       •   Three home inspection repair invoices noted that repairs were made to
                           powder rooms that did not exist.
                       •   Three home inspection repair invoices noted that refrigerators were
                           provided to the homeowners; however, the homeowners provided receipts
                           showing that they had purchased the refrigerators themselves.
                       •   One home inspection repair invoice claimed a sliding glass door was
                           replaced in the family room of the home when there was no sliding glass
                           door in the home.
                       •   One home inspection repair invoice indicated a hot water heater had been
                           replaced. However, when we looked at the picture of the hot water heater
                           on the Federal Housing Administration appraisal (before the Town
                           acquired the property), we noted it had the same marks and tape on it as
                           the current “replacement” hot water heater.

                  Although these repairs and replacements were not completed, Commercial
                  Lending paid the vendors. In addition, the home inspection repair invoices for the
                  10 homes we inspected had “soft cost”2 items, totaling $52,935. We could not
                  determine whether these costs were justified or had actually been made because
                  the home inspection repair invoices lacked sufficient detail to describe the
                  specific nature of the repair(s). Further, the repair contractors were not required
                  to provide detailed documentation to support the repair costs, i.e., nature of repair,
                  labor, parts, etc. These included line items such as “repair air conditioner,”
                  “dumping fees,” “fence repair,” and “ceiling/wall repair.” Thus, since we found
                  the process Commercial Lending used to identify and pay for repair costs to be
                  inaccurate and unreliable, we question the remaining $205,615 in repair costs for
                  the 10 homes we inspected.

    Repair Costs Should Be
    Reasonable and Verifiable

                  According to Mortgagee Letter 2001-30, in reference to determining the
                  allowable net development costs, rehabilitation costs are the total verifiable
                  contractor and vendor expenditures incurred in the actual reconstruction, repair,
                  restoration and physical improvement of the property. The Town of Clifton and
                  Commercial Lending were aware of Mortgagee Letter 2001-30; however,
                  contractors were paid for repairs that were not actually performed. Commercial
                  Lending and the Town could have verified the costs by completing proper
                  inspections of the property and by obtaining appropriate work orders from the
                  repair contractors.



2
 For purposes of this audit, a soft cost is defined as the price of a repair item that we could not determine whether it
was completed or necessary.

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            The manner in which the Town of Clifton and Commercial Lending documented
            its claimed repair costs was consistent for the 10 properties we inspected and was
            consistent with the method used for the remaining 79 properties. This indicates
            that there are likely systemic deficiencies with the Town of Clifton’s overall
            administration of its discount Sales Program. Therefore, we have concerns about
            the reliability of documentation for claimed repair costs of $1,054,723 associated
            with all of the 89 properties that were in the program. However, since we only
            completed site inspections on 10 of the properties, we will request the Department
            to complete site inspections on the remaining 79 properties to determine if
            $839,728 in repair costs for those properties can be supported.

Incorrect Net Development
Costs Improperly Increased the
Sale Price of Several Homes


            As we noted above, in 7 of the 10 properties we inspected, Commercial Lending
            claimed charges for a number of repairs that were not done or appliances that had
            not been replaced. These “non-existent” costs were used by the Town to
            determine the net development costs and in turn the sale price of the home. When
            we recalculated the sale price of these 7 homes, we found in 5 instances the Town
            exceeded 110 percent of the net development costs by a total of $8,378. By
            exceeding the allowable sales percentage, the homeowner’s mortgage was
            overstated and in turn the discounts received by the Town when it purchased the
            homes was not passed along to the homeowners. Since we could not verify the
            repair costs associated with the 10 properties we inspected and, in 7 cases, we
            found evidence that repairs were paid for, when they were not actually completed,
            we question the full amount of the discounts ($140,475) the Town received when
            it purchased these 10 properties.

The Town of Clifton Provided
Limited Oversight of Its Agent

            The Town did not adequately monitor the activities of Commercial Lending
            because it did not actively participate in the administration of the Sales Program.
            As such, the Town did not ensure proper documentation and approvals were
            maintained to support repair costs; and its contractor fully complied with HUD’s
            program requirements. The weaknesses contributed to questionable payments for
            repairs that were not performed.

            Under the Town’s agreement with Commercial Lending, the Town delegated
            nearly all aspects of the administration of the program to its contractor. The
            Town representative emphasized the Town trusts Commercial Lending with the
            management of the program and allows it to control all repair costs. However, the



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            agreement does not relieve the Town of its responsibility for executing the
            program in compliance with HUD requirements.

            By not requiring Commercial Lending to obtain work orders and other supporting
            documentation to fully support the claimed repairs, the Town of Clifton cannot
            guarantee that the work was completed or was completed at a reasonable cost.
            Our inspections confirmed that not all the repairs claimed by Commercial
            Lending and its repair contractors had been completed and as such the Town of
            Clifton cannot rely solely on Commercial Lending reports. Consequently,
            payments for non-existent or unnecessary repairs increase the price of the homes
            and undermines the mission of providing affordable housing opportunities to low-
            and moderate-income homebuyers.

Income Eligible Recipients
Purchased Homes

            According to Mortgagee Letter 2001-30 and the Land Use Restriction Addendum,
            properties in the discount Sales Program must be sold to a purchaser whose
            income does not exceed 115 percent of the median income, when adjusted for
            family size, and for the area in which the property is located. Therefore, we
            reviewed the income eligibility for the home purchasers of the 10 properties we
            inspected. We also reviewed the income eligibility for the nine homes which
            were purchased with Federal Housing Administration loans. Based upon the
            information provided in Commercial Lending's files we determined that all of the
            purchasers fell below the 115 percent median income limitation.

Recommendations

            We recommend the Office of Housing:

            1A. Require the Town of Clifton to support the remaining $37,350 in discounts
                it received when it purchased the homes within the discount Sales Program
                for the (3 of 10) properties that had unsupported repair costs.

            1B. Require the Town of Clifton to pay down the mortgages for the properties
                our review showed incurred ineligible costs by $9,380.

            1C. Require the Town of Clifton to support $205,615 in unsupported repairs we
                could not verify during our on site inspections. For costs that remain
                unsupported the Town of Clifton should pay down the mortgages for those
                properties.

            1D. Require the Town of Clifton to pay the Department $103,125 in discounts it
                received when it purchased the homes within the Sales Program for the

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      seven properties (7 of 10) found to have non-existent repairs on its home
      inspection repair invoices.

1E. Require the Town of Clifton to schedule an independent inspection of the
    remaining 79 homes the Town of Clifton purchased under this program and
    verify that all stated repair work has been adequately completed. If it is
    found that repairs were inadequate or repairs were not made the Town of
    Clifton should pay down the mortgages of the homeowners by those
    amounts.

1F.   Review the deficiencies noted in this report and determine if the Town of
      Clifton should be reinstated to participate in the Sales Program. If the Town
      is allowed to participate in the Sales Program, require it to establish and
      implement controls and procedures that fully document and verify claimed
      net development costs.




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                         SCOPE AND METHODOLOGY

To accomplish the audit objectives, we

   •   Reviewed applicable HUD regulations relating to the Town’s participation in the Single
       Family Property Disposition Discount Sales Program.

   •   Conducted interviews with officials and employees of the Town of Clifton, Commercial
       Lending and HUD’s Single Family Division.

   •   Reviewed established procedures formulated by the Town of Clifton and Commercial
       Lending in administering the Sales Program.

   •   Reviewed home inspection repair invoices for 10 of the 89 properties that were sold during
       our audit period. The 10 homes selected for our sample were chosen because they had the
       highest amount of repair costs expended per home.

   •   Reviewed the income verification documents for the 10 homebuyers sampled during our
       inspection, to ensure income eligibility.

   •   Reviewed the income verification documents of the nine homebuyers that obtained Federal
       Housing Administration loans, to ensure income eligibility thereby ensuring that no risk was
       placed upon the Federal Housing Administration insurance fund.

   •   Examined records and related documents for the properties purchased and closed by the
       Town from HUD’s inventory of foreclosed properties.

We performed the majority of our fieldwork between June and September 2004 at the offices of
Commercial Lending Corporation, located at 7603 Maple Branch Road, Clifton, VA. The audit
generally covered the period of November 1, 2002, through May 31, 2004, but was expanded when
necessary.

We performed our review in accordance with generally accepted government auditing standards.




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                             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:

              •   Management Oversight Processes - Policies and Procedures that management
                  has in place to reasonably ensure that improper payments would not be made
                  or would be detected in the normal course of business.

              •   Monitoring of Contractor Performance - Policies and Procedures that
                  management has in place to ensure that adequate supporting documentation
                  substantiates the validity of the work performed.

              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:

              •   Lack of management oversight.

              •   Lack of adequate supporting documentation for repairs performed.



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                                   APPENDIXES

Appendix A

                SCHEDULE OF QUESTIONED COSTS

                  Recommendation      Ineligible 1/        Unsupported
                  Number                                   2/
                  1A                                          $ 37,350
                  1B                       $ 9,380
                  1C                                          $205,615
                  1D                       $103,125
                  Total                    $112,505           $242,965


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
     polices or regulations.

2/   Unsupported costs are those costs charged to a HUD-financed or HUD-insured program
     or activity when we cannot determine eligibility at the time of audit. Unsupported costs
     require a 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.




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Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         16
Ref to OIG Evaluation   Auditee Comments




Comment 1




                         17
Ref to OIG Evaluation   Auditee Comments




Comment 2




Comment 1




Comment 3




                         18
Ref to OIG Evaluation   Auditee Comments




Comment 1




                         19
                            OIG Evaluation of Auditee Comments

Comment 1

We are encouraged by actions the Town plans to implement to move forward in resolving the
outstanding issues, including the reimbursement of several questioned costs to the homeowners.
However, it will be HUD’s decision as to whether these proposed actions are acceptable or an
alternative course of action is warranted. Consequently, we have not removed any of the
questioned costs from the report.

Comment 2

As stated in the report, we only looked at a limited number of homes purchased by the Town to
determine if the work that was paid for was actually completed and to determine if the net
development costs were properly accounted for. Based upon our testing, we noted discrepancies
in 70% of the homes we visited. This high percentage should lead an objective observer to
conclude that the questioned costs are more than just an oversight by the Town or its agent. The
entire process used by the Town and its agent to document the work completed created an
environment where repair items could easily be added without any accountability. However, we
did adjust the report to take out the word “fraudulent”.

Comment 3

As explained at the exit conference, the OIG makes recommendations based upon what we
believe will correct the problems. The Department will then take those recommendations and
determine if they should be implemented or not. Since the Town did violate the 110 percent net
development requirement in the homes we reviewed, it will be HUD’s decision to determine if
the proposed corrective action by the Town will be enough to disregard this recommendation.




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