oversight

The Housing Authority of the County of Butler, Butler, Pennsylvania, Used HUD Assets Improperly to Develop and Support Its Nonfederal Entities

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-01-10.

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

                                                                  Issue Date
                                                                     January 10, 2006
                                                                  Audit Report Number
                                                                     2006-PH-1005




TO:         James D. Cassidy, Director, Office of Public Housing, Pittsburgh Field Office,
             3EPH


FROM:


SUBJECT: The Housing Authority of the County of Butler, Butler, Pennsylvania, Used
          HUD Assets Improperly to Develop and Support Its Nonfederal Entities



                                    HIGHLIGHTS

 What We Audited and Why

             We audited the Housing Authority of the County of Butler’s (Authority)
             administration of its affiliated nonfederal entities. We performed the audit as part
             of our fiscal year 2005 audit plan. Our audit objective was to determine whether
             the Authority properly used HUD assets to develop and support its affiliated
             nonfederal entities.


 What We Found

             The Authority used HUD assets improperly to develop and support its affiliated
             nonfederal entities. It violated its annual contributions contract with HUD by
             improperly using HUD assets as collateral to obtain two lines of credit totaling
             $1.1 million. As of August 2005, the Authority owed $888,792 on the lines of
             credit, placing significant HUD assets at risk. The Authority also did not properly
             record these loans in its financial records. These problems occurred because the
           Authority erroneously believed it could use HUD assets to support and develop its
           affiliated nonfederal entities.

           Additionally, the Authority did not properly allocate all applicable salary costs to
           its nonfederal entities, contrary to its annual contributions contract. As a result,
           from January 2002 to May 2004, the Authority improperly paid salaries estimated
           at $205,875 from federal funds for work its employees performed for its
           nonfederal entities. This occurred because the Authority did not have adequate
           internal controls in place to ensure it properly identified the source and allocation
           of its funds.

What We Recommend


           We recommend that the director, Office of Public Housing, Pittsburgh field
           office, notify the Authority that it improperly encumbered annual contributions
           contract assets and direct it to modify the financial instruments to exclude the
           assets. If the Authority does not withdraw the encumbrances of annual
           contributions contract assets, we recommend that the director advise HUD
           headquarters that the Authority is potentially in substantial default of its annual
           contributions contract and request that it send a notice of default to the Authority.
           We also recommend that HUD require the Authority to accurately and completely
           record its loans in its financial records.

           Additionally, we recommend that HUD require the Authority to recover
           $205,875 from its nonfederal entities for employee expenses not properly
           allocated to its nonfederal entities and to develop a reasonable method for
           allocating future salaries and expenses.

           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 December 15, 2005. The Authority provided written comments to
           our draft findings on December 22, 2005. The Authority generally agreed with
           our recommendations to remove the encumbrance of HUD assets and to properly
           allocate costs but disagreed with portions of our questioned costs. The complete
           text of the Authority’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

      Finding 1: The Authority Improperly Used HUD Assets as Collateral on Lines     5
      of Credit of $1.1 Million

      Finding 2: The Authority Did Not Properly Allocate All Relevant Salary Costs   8
      to Its Affiliated Nonfederal Entities

Scope and Methodology                                                                11

Internal Controls                                                                    12

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use                 13
   B. Auditee Comments and OIG’s Evaluation                                          14




                                            3
                      BACKGROUND AND OBJECTIVES

The Housing Authority of the County of Butler (Authority) was established in 1965 under the
Housing Authorities Law of the Commonwealth of Pennsylvania. The Authority entered into an
annual contributions contract in 1966 with the U.S. Department of Housing and Urban
Development (HUD) and agreed to provide affordable housing for qualified individuals in
accordance with the rules and regulations prescribed by HUD. The Authority’s main
administrative office is located at 114 Woody Drive, Butler, Pennsylvania.

The Authority owns and operates 466 public housing units under its annual contributions
contract with HUD. The 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 2002 to 2004:

   •   $1.6 million operating subsidy to operate and maintain its housing developments,

   •   $1.7 million Public Housing Capital Fund program to modernize public housing units,
       and

   •   $17 million to provide housing assistance through tenant-based Section 8 vouchers.

The Authority reported nine affiliated nonfederal entities in its financial statements. The
Authority’s chairman and executive director also serve as officers for eight of these entities. The
Authority formed these corporations in an effort to increase affordable housing opportunities
throughout Butler County and it provides management and consulting services for the entities. In
addition, the Authority is the developer, management agent, and service provider for the 139
housing units associated with these entities.

The overall objective of our audit was to determine whether the Authority properly used HUD
assets to develop and support its affiliated nonfederal entities.




                                                 4
                                        RESULTS OF AUDIT

Finding 1: The Authority Improperly Used HUD Assets as Collateral on
Lines of Credit of $1.1 Million
The Authority violated its annual contributions contract 1 with HUD by improperly acquiring two
lines of credit totaling $1.1 million with HUD assets. As of August 2005, the Authority owed
$888,792 2 on the lines of credit, placing significant HUD assets at risk. The Authority did not
record these loans on its books and used the lines of credit to develop and support its affiliated
nonfederal entities without HUD’s approval. These problems occurred because the Authority
erroneously believed it could use HUD assets as collateral on debt used to support and develop
the affiliated nonfederal entities.


    The Authority Put $1.1 Million
    in HUD Assets at Risk


                    The Authority violated its annual contributions contract by securing two lines of
                    credit totaling $1.1 million with HUD assets. It obtained these lines of credit from
                    a bank and used them to support seven affiliated nonfederal entities. It used its
                    administrative offices as collateral for a $554,000 line of credit in October 2003
                    and obtained a second $580,000 line of credit on its offices in March 2005,
                    increasing the amount of HUD assets used as collateral to $1.1 million. Since the
                    offices were purchased using HUD funds, the Authority placed federal funds at
                    risk by improperly encumbering assets covered by its contributions contract. As
                    shown below as of August 2005, the Authority owed $888,792 on the bank loans,
                    placing significant HUD assets at risk.

                                                                                                      Loan
                             Nonfederal entity                                   Property
                                                                                                     balance
      Historic Lafayette Associates                                         Historic Lafayette
      Historic Lafayette, Inc.                                              Apartments               $333,292
      Rolling Road Regency L.P.; Regency Associates, LLC;                   Rolling Road
      Butler Area Housing and Community Development Corp.                   Apartments               $145,000
      Redevelopment Authority of the County of Butler                       Vacant lot               $310,000
                                                                            Two single family
                                                                            homes
      Butler County Homeownership Corporation                               for resale               $100,500
      Total                                                                                          $888,792


1
    Annual contributions contract, part A, section 7, “Covenant against Disposition and Encumbrances.”
2
    Balance on bank loan as of August 2005.

                                                          5
                The annual contributions contract prohibits the Authority from encumbering or
                pledging its HUD assets without HUD’s prior approval. The contract further
                states that encumbering annual contributions contract assets as collateral for a
                loan constitutes grounds for declaring the Authority in substantial default of its
                contributions contract 3 . Also, the annual contributions contract requires that
                promptly upon acquisition of any project, the Authority should execute and
                publicly file a declaration of trust evidencing the covenant of the housing
                authority not to encumber the project to protect the interests of HUD 4 . The
                Authority failed to file a declaration of trust when it acquired its administrative
                offices, and it later improperly encumbered and placed significant HUD assets at
                risk.

                We discussed these problems with the executive director and he stated that based
                on the advice of the Authority’s counsel, he believed that the Authority was
                permitted to use its administrative offices as collateral on the lines of credit.
                However, he acknowledged that he now concurs that the Authority’s
                administrative offices were encumbered as collateral for the lines of credit. He
                further stated he would take actions necessary to remove the encumbrances.

    The Authority Did Not Properly
    Record the Loans in Its Books


                As previously discussed the Authority owed $888,792 on two lines of credit that it
                used to develop and support its nonfederal entities, placing significant HUD assets
                at risk. In addition to placing HUD assets at risk, the Authority failed to record
                these loans in its financial records.

                The Authority violated 24 CFR [Code of Federal Regulations] 85.20 5 and its
                annual contributions contract with HUD by failing to report these loans on its
                books. It is required to maintain complete and accurate books and to maintain
                effective control and accountability for all grant cash, real and personal property,
                and other assets to safeguard and assure they are used solely for authorized
                purposes. The Authority did not ensure the lines of credit it obtained and used for
                development of its nonfederal entities were properly recorded or disclosed to
                HUD.

                When we discussed these problems with the Authority, the comptroller informed
                us that the funds from the lines of credit were used for a program that pays all
                principal and interest. He stated that since that program guarantees the repayment,
                the Authority makes no entries in its financial records. However, our audit
                showed that the Authority violated 24 CFR 85.20 and its contributions contract


3
  Annual contributions contract, part A, section 17, “Notices, Defaults, Remedies.”
4
  Annual contributions contract, part A section 8, “Declaration of Trust.”
5
  24 CFR [Code of Federal Regulations] 85.20, “HUD’s Standards for Financial Management Systems.”

                                                     6
          with HUD by not properly disclosing the loans in its financial statements and by
          improperly risking HUD assets.

Recommendations

          We recommend that the director, Office of Public Housing, Pittsburgh field office

          1A.     Notify the Authority that it has improperly encumbered annual
                  contributions contract assets and direct it to provide evidence that the
                  financial instrument encumbering the assets has been changed to exclude
                  the assets, and thereby, put $888,792 to better use.

          1B.     If the Authority does not withdraw its encumbrances of annual
                  contributions contract assets, advise HUD headquarters that the Authority
                  is potentially in substantial default of its annual contributions contract, and
                  request that it send a notice of default to the Authority.

          1C.     Require the Authority to implement adequate procedures, including
                  obtaining a required declaration of trust on its administrative offices, to
                  ensure the Authority does not encumber HUD assets without HUD
                  approval.

          1D.     Require the Authority to accurately and completely record loans in its
                  financial records and properly report its loan balances in its financial
                  statements.




                                             7
Finding 2: The Authority Did Not Properly Allocate All Relevant
Salary Costs to Its Affiliated Nonfederal Entities
The Authority used federal funds improperly to support its affiliated nonfederal entities. It did
not properly prepare personnel activity reports or equivalent documentation to support services
provided by its executive director, management staff, accounting personnel, and staff members
contrary to its consolidated annual contributions contract 6 and Office of Management and
Budget Circular A-87 7 . These improper practices occurred because the Authority did not have
adequate internal controls in place to ensure it properly identified the source and allocation of its
funds. As a result, the Authority improperly paid $205,875 from federal funds from January
2002 through May 2004 for salary and benefits for Authority employees who worked to support
its nonfederal housing developments.



    The Authority Improperly Used
    $205,875 in Federal Funds


                 The Authority improperly paid $205,875 from federal funds from January 2002
                 through May 2004 for salary and benefits of Authority employees who worked to
                 support its nonfederal housing developments. The improper payments occurred
                 because the Authority’s internal controls did not ensure that it properly prepared
                 personnel activity reports or equivalent documentation to support services
                 provided by the executive director, management staff, accounting personnel, and
                 staff members. This practice was contrary to the Authority’s consolidated annual
                 contributions contract and Office of Management and Budget Circular A-87.

                 The Authority’s annual contributions contract with HUD requires it to maintain
                 records that identify the source and allocation of its funds. This key management
                 control is critical to ensuring the Authority spends federal funds, provided through
                 its annual contributions contract, only in accordance with the regulatory
                 requirements of each specific federal program. Further, the contract specifies that
                 the Authority can only withdraw federal funds for the payment of costs associated
                 with the development and operation of projects under its annual contributions
                 contract or other projects specifically approved by HUD. Thus, when employees
                 work on multiple programs, a distribution of salaries should be supported by
                 personnel reports or equivalent documents.

                 The Authority’s cost allocation procedures from 2002 through 2004 consisted of
                 allocating costs to each program based on a budgeted estimate of the time spent

6
  Annual contributions contract, part A, section 9, “General Fund” – The Authority may withdraw funds from the
general fund only for projects covered under the annual contributions contract.
7
  Office of Management and Budget Circular A-87 revised May 4, 1995, as further amended, August 29, 1997,
attachment B, paragraph 11 (h) (5), “Personnel Activity Reports.”


                                                        8
by each employee on a particular program. A total of $96,290 was budgeted in
2002 and 2003 for employees performing services for the nonfederal entities.
However, the Authority could not provide support for its budget estimate and its
procedures were not in accordance with Office of Management and Budget
Circular A-87, which requires a distribution of salaries or wages to be supported
by personnel activity reports or equivalent documentation. The circular further
states that budget estimates do not qualify as support other than on an interim
basis, and that quarterly budgets should be compared to actual costs based on
monthly activity reports. The monthly activity reports must account for the total
activity for which the employee is compensated.

In this regard the Authority could not provide personnel activity reports or other
equivalent documentation to support its budget estimates and did not perform
quarterly reconciliations. Since the Authority could not provide documentation to
support services provided by the executive director, management staff, accounting
personnel, and staff members, we estimated the total salary and fringe benefits
that the low-income housing fund paid to support the nonfederal entities. Our
estimate was calculated by multiplying the total salary and benefits costs paid to
12 individuals we identified as having worked on both the federal and the
nonfederal programs by the percentage the nonfederal units comprised of the total
units under the Authority’s management. We found the Authority managed 605
low-income housing units and that 139 of these units were not covered by its
annual contributions contract. As illustrated below, the percentage of employee
salaries that should have been allocated to the nonfederal entities was 23 percent
(139 nonfederal units divided by 605 total units).


    Nonfederal
      units
      23%




                                                                         Federal units
                                                                             77%


The Authority’s accounting records showed that total salaries and benefits paid to
the applicable individuals from January 2002 through May 2004 totaled
$1,313,761. We calculated the unsupported payments to be $302,165 because the
nonfederal units under management accounted for 23 percent of the Authority’s
total units. However, since the Authority allocated $96,290 in 2002 and 2003 to

                                 9
                 its nonfederal entities, we reduced the unsupported payments to $205,875.
                 Additionally, by ensuring it allocates and settles expenses related to its nonfederal
                 affiliated entities on a quarterly basis, the Authority would put $85,190 to better
                 use annually 8 .

                 The Authority’s executive director was aware of the requirements for allocating
                 costs in Office of Management and Budget Circular A-87. However, he
                 acknowledged the Authority’s recordkeeping was not adequate to properly
                 allocate costs to its nonfederal entities. He assured us that the Authority would
                 take steps to ensure it did not use HUD funds to support non-HUD projects.

    Recommendations


                 We recommend that the director, Office of Public Housing, Pittsburgh field office

                 2A.      Direct the Authority to provide adequate documentation to support the
                          $205,875 identified in the report or reimburse its public housing program
                          from nonfederal sources.

                 2B.       Require the Authority to develop a reasonable method for allocating
                          salaries and expenses to its nonfederal affiliated entities and ensure that
                          they are allocated and settled at least on a quarterly basis and, thereby put
                          $85,190 to better use.




8
 The $85,190 in funds to be put to better use was calculated by dividing the $205,875 by 29 months and multiplying
by 12 months for fiscal year 2005 since no allocation of nonfederal entity expenses was recorded.

                                                       10
                         SCOPE AND METHODOLOGY

We performed an audit of the Authority, located in Butler, Pennsylvania. The audit was conducted
from June through October 2005 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 2002 through August 2005. We expanded the scope of the audit as
necessary. We reviewed applicable guidance and discussed operations with management and
staff personnel at the Authority and from HUD’s Office of Public Housing, Pittsburgh field
office.

To determine whether the Authority properly used HUD assets to develop and support its
affiliated nonfederal entities, we

    •   Reviewed all documentation provided by the Authority related to our audit objective,
        including partnership agreements, legal documents, financial statements, general ledgers,
        bank loan agreements, related correspondence, time sheets, journal entries, salary
        expenses, operating budgets, and minutes from board meetings.

    •   Reviewed the Authority’s, Historic Lafayette Associates’ and Chicora Commons Limited
        Partnership’s available independent auditor’s reports for fiscal years 2003 and 2004.

    •   Reviewed HUD and Authority correspondence related to the audit and results of monitoring
        reviews HUD’s Pittsburgh Office of Public Housing conducted.

    •   Obtained and reviewed the legal opinion of the counsel to the inspector general regarding
        issues identified during the audit.




                                                11
                              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.

                  •   Proper allocation of costs to affiliated nonfederal entities.

              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 annual contributions contract assets from
                      being encumbered or risked without HUD approval.

                  •   The Authority did not properly allocate costs to its affiliated nonfederal
                      entities.

                  •   The Authority did not record these loans on its books.

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                                 Appendixes
Appendix A

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


                   Recommendation           Unsupported       Funds to be put
                          number                costs 1/       to better use 2/
                                  1A                                $888,792
                                  2A            $205,875
                                  2B                                $ 85,190
                                Total           $205,875            $973,982



1/   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.

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 at a later time 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.




                                               13
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION



Ref to OIG Evaluation   Auditee Comments




Comment 1

Comment 2




                         14
Comment 3

Comment 4



Comment 5




Comment 6




            15
16
17
Comment 1



            Comment 1




               18
                          OIG Evaluation of Auditee Comments


Comment 1   The Authority does not dispute that it reported nine affiliated nonfederal entities
            in the audited financial statements it submitted to HUD. The Authority is now
            stating however, that its independent auditors mistakenly identified nine
            nonfederal entities when in fact it has five. Our review of documentation provided
            by the Authority such as partnership agreements, tax credit applications, bylaws,
            and board minutes also identified nine affiliated nonfederal entities, confirming
            the findings of the independent auditors.

Comment 2   We are encouraged that the Authority has agreed to remove the encumbrance of
            this asset and that it has agreed to record all loans and report balances in its future
            financial statements. However, the Authority could not substantiate its statement
            that 60 percent of the cost of its administrative offices was paid with non-HUD
            funds.

Comment 3   The audit showed and the Authority acknowledged in its written response to the
            audit findings, dated October 24, 2005, that management did not clearly ensure
            that the Authority’s recordkeeping system precisely recorded and calculated the
            cost of services and the required detail of payments received by the affiliated
            nonfederal entities.

Comment 4   We requested and reviewed documentation to support these costs during the audit.
            Since the Authority states it is now reviewing additional documentation it did not
            provide us during the audit, we cannot comment on this additional documentation.

Comment 5   The Authority was the developer, management agent, and service provider for the
            three nonfederal properties associated with the 139 units during the audit period
            of January 2002 through May 2004. As such, Authority personnel did substantial
            work related to the properties during the audit period. Therefore, we used 139
            units in our calculation to estimate unsupported costs.

Comment 6   During the audit we specifically asked the Authority’s executive director and the
            comptroller to provide a list of employees working on the Authority’s affiliated
            nonfederal entities. They stated they couldn't provide a list because the housing
            authority had 37 employees and all of them have put some time in performing
            work for the nonfederal entities. However, we took a conservative approach and
            determined that only 12 employees would have been substantially involved with
            the nonfederal entities due to the nature of their positions.




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