oversight

The Owner of Wellston Townhouses in St. Louis County, Missouri, Violated Its Regulatory Agreement

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-06-29.

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

                                                                 Issue Date
                                                                          June 29, 2006
                                                                 Audit Report Number
                                                                              2006-KC-1011




TO:         Herman Ransom, Director, Office of Multifamily Housing,
            Kansas City HUB, 7AHM

            Margarita Maisonet, Director of the Departmental Enforcement Center, CV

            //signed//
FROM:       Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

SUBJECT: The Owner of Wellston Townhouses in St. Louis County, Missouri, Violated Its
         Regulatory Agreement


                                   HIGHLIGHTS

 What We Audited and Why

             We audited Wellston Townhouses, a 63-unit project located in St. Louis County,
             Missouri. We selected this project for audit based on a request from the U. S.
             Department of Housing and Urban Development’s (HUD) Office of Housing.
             Our audit objective was to determine whether the owner and management agent
             used project funds in compliance with the regulatory agreement and HUD’s
             requirements.


 What We Found

              Wellston Townhouses’ managing owner (owner) did not use project funds in
              compliance with the regulatory agreement. It also violated several other terms of
              the agreement. The owner violated the regulatory agreement because it viewed
              its projects as interdependent and not individually viable. These violations,
              totaling $304,660, adversely affected the project’s financial stability.



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What We Recommend

           We recommend that HUD take appropriate actions to correct deficiencies and
           ensure that these violations will not occur in the future.

           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 owner generally disagreed with our findings. We provided the draft report to
           the owner on May 9, 2006. The owner provided written comments on June 12,
           2006. The complete text of the owner’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                                              4

Results of Audit                                                       5
  Finding: Owner’s Actions Violated Regulatory Agreement

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 and OIG’s Evaluation                            13
   C. Schedule of Regulatory Agreement Violations                      18
   D. Regulatory Agreement Provisions                                  19




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                     BACKGROUND AND OBJECTIVES

Wellston Townhouses is a scattered-site project consisting of 63 Section 8 units located in St.
Louis County, Missouri. Townhouses Ltd., a profit-motivated partnership, owns the project.
The U.S. Department of Housing and Urban Development (HUD) insures the project under its
Section 221(d)(4) mortgage insurance program.

The owner signed a regulatory agreement on December 5, 1978, that governs the project’s
operations. Majestic Management has managed the project since March 1, 2005. Before that,
Human Development Community Development Corporation, a related entity, managed the
project and two other HUD-insured projects, one of which was assigned in 2004.

On December 31, 2003 and 2004, the project was in a negative surplus cash position.

Our audit objective was to determine whether the owner/management agent of this property used
project funds in compliance with the regulatory agreement and HUD’s requirements.




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                                 RESULTS OF AUDIT

Finding: Owner’s Actions Violated Regulatory Agreement
Wellston Townhouses’ managing owner (owner) did not use project funds in compliance with
the regulatory agreement. It also violated several other terms of the agreement. The owner
violated the regulatory agreement because it viewed its projects as interdependent and not
individually viable. These violations, totaling $304,660, adversely affected the project’s financial
stability.



  Regulatory Agreement
  Violations

               The owner did not follow the regulatory agreement requirements (see appendixes
               C and D). The owner
                          •   Allowed liens,
                          •   Improperly allocated shared payroll expenses,
                          •   Made unauthorized distributions,
                          •   Paid itself unallowable management fees,
                          •   Underfunded tenant security deposits,
                          •   Retained tenant rent credits, and
                          •   Withheld required financial reports and plans.


               Liens

               The owner allowed the sewer district to place liens on the project. As of
               December 31, 2005, the owner had not paid $158,491 in sewer fees, interest, and
               penalties. The sewer bill consisted of $101,338 for service and $57,153 for late
               fees, filing fees, and interest. The late fees, filing fees, and interest accumulated
               because the owner did not pay the project’s sewer expense. Penalties of this type
               are not ordinary or necessary for the project’s operation.

               Payroll Allocation

               The owner did not properly allocate payroll expenses for maintenance and
               administrative staff. The owner did not require these employees to track the time
               they spent performing duties for other projects. The books and records did not




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show that the $88,784 in payroll expenses during our audit period was reasonable
and necessary for project operation.

Asset Distributions

The owner, without prior HUD approval, distributed $40,271 in project assets
when there was no surplus cash. These distributions involved

    •   $22,589 reimbursed to related entities for prior advances and deposit
        errors without HUD approval,
    •   $8,817 in rents diverted by the owner after new management was in place
        and later repaid to the project, and
    •   $8,865 consisting of $5,453 in excess management fees paid in 2003,
        $2,642 paid to the City of St. Louis for water at another project, and $770
        paid to the management agent for a board of directors’ meeting.

Management Fee

The owner did not comply with HUD instructions in a timely manner. On
September 12, 2003, HUD instructed the owner to obtain independent project
management and not to pay itself management fees after November 1, 2003. The
project did not obtain new management until March 1, 2005. The owner collected
unallowable management fees totaling $33,420 after the stated deadline. This
amount includes $2,220 paid by a related entity and booked as an account
payable.

Tenant Security Deposits

The owner improperly used tenant security deposits. As of December 31, 2005,
the tenant security deposit account was underfunded by $12,056. This violation
began in 2003 when the owner transferred security deposit funds to the project’s
operating account.

Rent Credits

The owner improperly retained tenant rent credits. When retroactive changes at
recertification created rent credits the project manager did not issue refunds to
tenants. As of December 31, 2005, the project owed $3,034 to 26 tenants. Eleven
of the tenants were owed between $100 and $400.

Financial Reports and Plans

The owner did not submit required monthly accounting reports, action plan and
operating budget, or audited financial statements.




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          The owner did not comply with repeated requests for monthly accounting reports.
          The project manager prepared the required reports but stopped submitting them to
          HUD after being told to obtain a new management agent. HUD uses these reports
          to monitor the project’s revenues, disbursements, and obligations. HUD did not
          receive these reports from August 2003 through February 2005.

          The owner, as requested by HUD in April 2004, submitted both an action plan
          and current operating budget, but HUD rejected them. The owner did not
          resubmit the items. The action plan was intended to improve and/or correct
          financial, management, control systems, and operational deficiencies. HUD uses
          action plans and budgets to analyze the needs of the project and provide a means
          for monitoring its financial stability.

          The owner did not provide audited financial statements for 2004 as required by
          the regulatory agreement. After a new management agent was obtained in 2005,
          HUD’s Departmental Enforcement Center informed the owner that HUD was
          considering assessing civil money penalties of $32,500. The certified public
          accountant completed the 2004 audit report on March 31, 2006.



Owner’s Reasoning

          The owner viewed its projects as interdependent and not individually viable. The
          owner did not establish effective written procedures and controls because it
          wanted fiscal flexibility to meet expenses. The owner

                     •   Did not pay the sewer bills because this service could not be shut
                         off like other utilities,
                     •   Believed it was too time consuming and costly to accurately track
                         employee time,
                     •   Thought it was allowable to repay other entities without obtaining
                         HUD approval,
                     •   Had a standard practice of taking estimated monthly management
                         fees,
                     •   Felt entitled to management fees for work performed after HUD
                         had requested termination of its services,
                     •   Had a standard practice of using security deposits for operating
                         expenses and then reimbursing the account upon receipt of reserve
                         for replacement funds, and
                     •   Thought it was allowable to delay notifying tenants who were due
                         rent reimbursements.




                                          7
Financial Stability Affected


            The owner allowed the project’s financial stability to deteriorate through these
            regulatory agreement violations totaling $304,660, including unsupported payroll
            and liens on the property. (see appendix A). The owner repeatedly denied HUD
            access to financial reports needed to monitor the project’s condition. These
            reports would have indicated to HUD that the owner used project funds for
            unauthorized purposes and allowed the project’s financial stability to deteriorate.

Recommendations

            We recommend that the director of HUD’s Kansas City Multifamily Housing Hub
            require the owner to

            1A.     Develop and implement procedures and controls to ensure that future
                    disbursements of project assets comply with the regulatory agreement and
                    HUD’s requirements, including a cost allocation plan to maintain adequate
                    books and records.

            1B.     Pay $57,153 in sewer fees and interest from nonproject funds and initiate
                    action to pay $101,338 from project funds to cure sewer liens.

            1C.     Provide documentation to support the $88,794 in unsupported payroll
                    costs or reimburse the project’s reserve for replacement account the
                    applicable portion that cannot be supported as necessary to the project.

            1D.     Deposit $8,865 for improper owner distributions into the project’s reserve
                    for replacements or a restricted capital account which requires HUD
                    approval for release of the funds.

            1E.     Deposit $31,200 for disallowed management fees into the project’s reserve
                    for replacements or a restricted capital account which requires HUD
                    approval for release of the funds and eliminate the $2,220 account payable
                    HDC Retirement Village.

            1F.     Properly fund the tenant security deposit account with $12,056.

            1G.     Reimburse tenants from project funds $3,034 for their prepaid rent.




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We also recommend that HUD’s director of the Departmental Enforcement
Center

1H.   Pursue civil money penalties and administrative sanctions, up to and
      including debarment as appropriate, against the owner, management agent,
      and/or their principals/owners for their part in the regulatory violations
      cited in this report.




                               9
                         SCOPE AND METHODOLOGY

Our review generally covered the period from January 1, 2004, through December 31, 2005. To
achieve our objective, we conducted interviews with the project management staff, HUD
Departmental Enforcement Center staff, and HUD Office of Multifamily Housing staff. We also
reviewed federal laws, regulations, and requirements. We also reviewed sewer district records.

To determine whether the owner used project funds for reasonable operating expenses and
necessary repairs as required by the regulatory agreement, we reviewed the project’s

           •   Monthly accounting reports,
           •   Cash disbursements ledger,
           •   Bank statements,
           •   Check stubs,
           •   Supporting documentation,
           •   Audited financial statements, and
           •   Regulatory agreement.

We reviewed all disbursements that exceeded $250. Because we identified problems with shared
expenses, we also reviewed all payroll and office rent disbursements. During our audit period
there were 289 operating account disbursements totaling $339,238. We reviewed 203 of these
disbursements totaling $331,515.

As a result of this review, we identified the regulatory agreement violations addressed in the
finding. We discussed our results with the owner, as well as HUD staff, to obtain clarification
and agreement.

We performed audit work from October 2005 through March 2006, at Majestic Management’s
office, 3920 Lindell, St. Louis, Missouri. The audit was conducted 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:

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


              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 item is a significant weakness:

                  •   The owner did not have adequate procedures in place to ensure project
                      assets and income were distributed in compliance with the regulatory
                      agreement (see finding).




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                                   APPENDIXES

Appendix A

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

 Recommendation          Ineligible 1/    Unsupported      Funds to be put
        number                                     2/       to better use 3/
      1B                     $57,153                             $101,338
      1C                                       $88,794
      1D                      $8,865
      1E                     $33,420
      1F                     $12,056
      1G                                                            $3,034

     Totals                 $111,494           $88,794           $104,342
                                            Grand total          $304,660

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.

3/   “Funds to be put to better use” are estimates of amounts that could be used more
     efficiently if an Office of Inspector General (OIG) recommendation is implemented.
     This includes reductions in outlays, deobligation of funds, withdrawal of interest subsidy
     costs, costs not incurred by implementing recommended improvements, avoidance of
     unnecessary expenditures noted in preaward reviews, and any other savings which are
     specifically identified. Our estimate reflects only the initial year of these recurring
     benefits.




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Appendix B

            AUDITEE COMMENTS AND OIG’S EVALUATION




Comment 1




Comment 2




                            13
Comment 3




Comment 4




Comment 5




            14
Comment 6




Comment 7




            15
                 OIG’s Evaluation of Auditee Comments


Comment 1   The owner should have prevented local sewer company liens by properly
            paying the project’s sewer bill. The owner indicates that this nonpayment
            was the result of inadequate HUD funding. HUD was not responsible for
            paying the project’s sewer bill. It is the owner’s responsibility to properly
            pay the sewer bill. If the owner had paid this expense, it would have met
            its contractual obligation to keep the property free of liens and avoided
            violating the regulatory agreement.

Comment 2   The owner indicates that “... employees of the project provided equal time
            to each project.” This is representative of our concerns. When the owner
            does not properly allocate employee time between projects, HUD has no
            assurance that any of the projects’ expenses are reasonable and necessary
            or accurate. The owner has a contractual obligation under the regulatory
            agreement to only incur reasonable and necessary expenses. Expenses
            which benefit another project are not reasonable or necessary to Wellston
            Townhouses. The owner has previously indicated to OIG that they:

                   •       Do not keep timesheets or record the amount of time spent
                           on each project,
                   •       Employ three maintenance men and each project pays the
                           salary of one maintenance man who works on all projects,
                   •       Have a work order system, but it does not track which man
                           performed the work, time spent, supplies used or the
                           project charged, and
                   •       Allocate employee time based on what the project can
                           afford rather than how much time or supplies it requires.

            The owner should be required to properly allocate employee time to the
            project receiving the benefit. If the owner had properly allocated these
            expenses the owner would have met its contractual obligation to only
            incur reasonable and necessary project expenses and avoided violating the
            regulatory agreement.

Comment 3   The owner’s statement that “no funds of the development were used for
            any purpose other than the maintenance of the project” lacks validity. The
            payment of $5,453 in excess management fees paid in 2003, $2,642 paid
            to the City of St. Louis for water at another project, and $770 paid to the
            management agent for a board of directors’ meeting are all expenses that
            are not reasonable or necessary project expenses. The $22,589 reimbursed
            to related entities for prior advances and deposit errors and the $8,817 in
            rents diverted by the owner all benefited other projects and the owner and
            these assets were distributed without prior HUD approval. The owner
            should be required to obtain prior HUD approval before project assets are
            distributed to either the owner or to related entities. If the owner had


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            requested HUD approval prior to making disbursements for the owner’s or
            related entity’s benefit the owner would have met its contractual
            obligation and avoided violating the regulatory agreement. Requesting
            HUD’s approval and not getting it would have kept project funds for the
            project’s use and benefit.

Comment 4   HUD’s instructions were clearly stated in the September 12, 2003, letter.
            HUD told the owner not to pay itself management fees after November 1,
            2003. When the owner chose to ignore HUD’s instructions and pay itself
            management fees, these fees became unreasonable and unnecessary
            project expenses. The owner should have complied with HUD’s
            instructions. Since this was not the case, the owner did not meet its
            contractual obligation under the regulatory agreement to only incur
            reasonable and necessary project expenses.

Comment 5   The owner should have kept security deposit funds separate and apart
            from all other funds of the project in a trust account. The amount in this
            account should have always been equal to or more than the aggregate of
            all outstanding obligations under said account. Tenant security deposits
            should not, for any reason, be used for demands of the project. If the
            owner had maintained the tenant security deposit in the proper manner, the
            owner would have met its contractual obligation and avoided violating the
            regulatory agreement.

Comment 6   The owner’s comments are not responsive to the issue at hand. Tenants
            are owed refunds of rent they had over paid. The regulatory agreement
            requires that only the proper amount of rent be collected. If the owner
            collects excess rent, the owner must notify the tenant and refund the rent.
            Maintaining rent credits for use at move out to cover damages violates the
            regulatory agreement.

Comment 7   HUD was very clear in its instructions to the owner. The owner did not
            comply with repeated requests for monthly accounting reports and did not
            provide audited financial statements for 2004 as required by the regulatory
            agreement. The owner did submit both an action plan and current
            operating budget, but HUD rejected them. The owner did not resubmit
            these items. Forwarding the financial reports to the mortgage holder and
            the Board of Directors, Mr. Brown’s health and HUD’s release of funds
            have no bearing on these issues. The owner’s actions have violated the
            regulatory agreement.




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Appendix C


SCHEDULE OF REGULATORY AGREEMENT VIOLATIONS



                                                      Applicable
             Regulatory agreement violations           sections

                     Allowing liens                       8 (a)
      Improperly allocating shared payroll expenses   12 (c) 12 (d)
        Making unauthorized asset distributions       8 (b) 8 (e)
         Paying unallowable management fees               12(a)
         Underfunding tenant security deposits            8 (g)
              Retaining tenant rent credits               5 (b)
        Withholding financial reports and plans       12 (e) 12 (f)




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Appendix D

               REGULATORY AGREEMENT PROVISIONS
Paragraph 5 –
      (b) The maximum rent for each Section 8 unit is stated in the Housing Assistance
      Payments Contract and adjustments in such rents shall be made in accordance with the
      terms of the Housing Assistance Payments Contract.

Paragraph 8 –
Owners shall not without the prior written approval of the Secretary:
     (a) Convey, transfer, or encumber any of the mortgaged property, or permit the
       conveyance, transfer, or encumbrance of such property.
     (b) 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.
     (e) Make, or receive and retain any distribution of assets or any income of any kind of the
       project except surplus cash and except on the following conditions:
               (1) All distributions shall be made only as of and after the end of a semiannual or
               annual fiscal period, and only as permitted by the law of the applicable
               jurisdiction, and, in the case of a limited distribution mortgagor, all distributions
               in any one fiscal year shall be limited to six per centum on the initial equity
               investment, as determined by the Secretary which shall be cumulative;
               (2) No distribution shall be made from borrowed funds, prior to the completion of
               the project or when there is any default under this Agreement or under the note or
               mortgage;
               (3) Any distribution or any funds of the project, which the party receiving such
               funds is not entitled hereunder, shall be held in trust separate and apart from any
               other funds; and
               (4) There shall have been compliance with all outstanding notices of requirements
               for proper maintenance of the project.
     (g) Require, as a condition of the occupancy or leasing of any unit in the project any
      consideration or deposit other than the prepayment of the first month’s rent, plus a security
      deposit in an amount not in excess of one month’s rent (the gross family contribution in
      Section 8 units) to guarantee the performance of the covenants of the lease. Any funds
      collected as security deposits shall be kept separate and apart from all other funds of the
      project in a trust account the amount of which shall at all times equal or exceed the
      aggregate of all outstanding obligations under said account.

Paragraph 12 -
      (a) Any management contract entered into by Owners or any of them involving the project
      shall contain a provision that, in the event of default hereunder, it shall be subject to
      termination without penalty upon written request by the Secretary. Upon such request,
      Owners shall immediately arrange to terminate the contract within a period of not more
      than thirty (30) days and shall make arrangements satisfactory to the Secretary for
      continuing proper management of the project.


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(c) The mortgaged property, equipment, buildings, plans, offices, apparatus, devices, books,
    contracts, records, documents, and other papers relating thereto shall at all times be
    maintained in reasonable condition for proper audit and subject to examination and
    inspection at any reasonable time by the Secretary or duly authorized agents of the
    Secretary. Owners shall keep copies of all written contracts or other instruments which
    affect the mortgaged property, all or any of which may be subject to inspection and
    examination by the Secretary or duly authorized agents of the Secretary.
(d) The books and accounts of the operations of the mortgaged property and of the project
    shall be kept in accordance with the requirements of the Secretary.
(e) Within sixty (60) days following the end of each fiscal year, the Secretary shall be
    furnished with a complete annual financial report based upon an examination of' the books
    and records of mortgagor prepared in accordance with the requirements of the Secretary,
    certified to by an officer or responsible Owner and, when required by the Secretary,
    prepared and certified by a Certified Public Accountant, or other person acceptable to the
    Secretary.
(f) At request of the Secretary, or duly authorized agents of the Secretary, the Owners shall
    furnish monthly occupancy reports and shall give specific answers to questions upon
    which information is desired from time to time relative to the income, assets, liabilities,
    contract, operation, and condition of the property and the status of the insured mortgage.




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