oversight

Bethany Housing, Inc., South Pasadena, Florida, Did Not Conduct Proper Oversight of Project Operations Resulting in Financial Harm to the Project

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-09-18.

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

                                                                   Issue Date
                                                                        September 18, 2008
                                                                   Audit Report Number
                                                                        2008-AT-1013




TO:        James D. Branson, Director, Jacksonville Multifamily Housing Hub,
            4HHMLAS

           Henry S. Czauski, Acting Director, Departmental Enforcement Center, CV

           Donnie R. Murray, Regional Counsel, 4AC


FROM:      James D. McKay, Regional Inspector General for Audit, 4AGA

SUBJECT:   Bethany Housing, Inc., South Pasadena, Florida, Did Not Conduct Proper
            Oversight of Project Operations Resulting in Financial Harm to the Project


                                  HIGHLIGHTS

 What We Audited and Why


           We audited Bethany Towers Apartments as part of our annual goal for auditing
           multifamily projects and in response to an audit request from the U.S. Department
           of Housing and Urban Development’s (HUD) Tampa, Florida, Multifamily
           Division that reports to your office. We focused the audit on the nonprofit
           owner’s and management agents’ compliance with the project’s regulatory
           agreement, applicable laws, and other HUD requirements pertaining to the sale
           and transfer of ownership interest in the project, use of project assets, identity-of-
           interest relationships, necessity and reasonableness of project costs, and record
           keeping.
What We Found

           The owner and its undisclosed identity-of-interest (IOI) management agent did
           not provide proper oversight and management of the project’s financial affairs.
           The owner, (a) executed an unauthorized agreement to sell the project, (b)
           diverted $90,000 in funds paid towards the purchase to its church sponsor, (c)
           selected an undisclosed IOI management agent, (d) allowed financial harm to the
           project from IOI dealings, (e) incurred more than $16,000 in ineligible/improperly
           supported costs, and (f) maintained inadequate books and records. To illustrate,
           the owner exposed the project to financial harm by allowing the purchaser to
           interfere with its ability to raise cash for the project. This condition contributed to
           the project’s mortgage default in February 2008 and the project’s inability to pay
           recurring project costs and accounts payable that totaled more than $239,000.


What We Recommend


           We recommend that the Director of HUD’s Jacksonville Multifamily Housing
           Hub (a) determine whether to declare the project in technical default of its
           regulatory agreement and initiate foreclosure proceedings, (b) require the owner
           to repay or support more than $106,000 in questioned costs, which include the
           diverted funds discussed above, and (c) require the owner to establish and
           implement policies and procedures to ensure compliance with HUD requirements.
           We recommend that the Acting Director of the Departmental Enforcement Center
           take appropriate administrative action against the owner and its IOI agent for the
           most significant reported violations. We also recommend that HUD’s Regional
           Counsel, in coordination with HUD’s Director, Jacksonville Multifamily Housing
           Hub, and HUD’s Office of Inspector General, seek double damages against the
           owner for diverting $90,000 received for the sale of the project.

           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 provided the owner our discussion draft audit report on August 11, 2008 and
           held the exit conference on August 21, 2008. The owner provided written
           comments on August 21, 2008. The owner generally disagreed with the finding.



                                              2
The text of the owner’s written response along with our evaluation of that
response can be found in appendix B of this report. We did not include the
owner’s attachments because they included discussion of tentative conclusions
which we did not include in the draft provided for the exit conference.




                                3
                              TABLE OF CONTENTS

Background and Objectives                                                    5

Results of Audit
       Finding 1: The Project Was Financially Harmed by the Owner’s and an   6
                  IOI Agent’s Mismanagement and Violation of Requirements

Scope and Methodology                                                        14

Internal Controls                                                            16

Appendixes
 A.   Schedule of Questioned Costs                                           17
 B.   Auditee Comments and OIG’s Evaluation                                  18
 C.   Schedule of Diverted Purchase Proceeds                                 27
 D.   Schedule of Ineligible and Unsupported Costs                           29
 E.   Other Matter for Consideration Involving Tax Issues                    30




                                               4
               BACKGROUND AND OBJECTIVES

Bethany Housing, Inc. (owner), owner of Bethany Towers Apartments, was established on
October 17, 1968, as a 501(c)(3) nonprofit charitable organization formed by New Hope Church,
formerly known as Bethany Reformed Church. The organization was formed to provide rental
housing for lower income elderly or handicapped families. On June 26, 1970, the owner entered
into a regulatory agreement with the U.S. Department of Housing and Urban Development
(HUD) and acquired Bethany Towers Apartments, a 210-unit elderly high rise located in South
Pasadena, Florida. HUD insured the mortgage under the Section 236(j)(1)/202 Supportive
Housing for the Elderly program.

The project was owner managed when on July 1, 2005, the owner contracted with an identity-of-
interest (IOI) management firm to manage the project. In February 2007, HUD conducted an on-
site review of the project. Based in part on the seriousness of deficiencies identified in the
review, HUD required the owner to terminate the services of the IOI agent, although at the time,
HUD was not aware that the agent was an identity of interest. The firm resigned on March 4,
2007, and the owner selected an independent firm, which assumed management of the project in
April 2007.

HUD requested that we audit the project due in part to findings and concerns noted by its
February 2007 review. The objectives of our audit were to determine whether the owner and the
management agents operated the project in accordance with HUD’s regulatory agreement,
applicable laws, and other requirements related to (a) the sale and transfer of ownership interest
in the project, (b) use of project assets, (c) identity-of-interest relationships, (d) necessity and
reasonableness of project costs, and (e) record keeping.




                                                 5
                                RESULTS OF AUDIT


Finding 1: The Project Was Financially Harmed by the Owner’s and an
IOI Agent’s Mismanagement and Violation of Requirements
The owner and its IOI agent did not provide proper oversight and management of the project’s
financial affairs. Specifically, the owner,

             Allowed the execution of an unauthorized agreement to sell the project,
             Diverted or allowed the diversion of $90,000 in project funds,
             Allowed the purchaser to select an IOI agent to manage the project,
             Allowed financial harm to the project due to IOI dealings,
             Incurred more than $16,000 in ineligible/inadequately supported costs, and
             Did not maintain adequate books and records

The owner had not established or did not provide and follow policies and procedures to control
compliance with HUD requirements. The violations occurred because the owner and its IOI
agent did not enforce and comply with program requirements. The violations resulted in
financial harm to the project that has jeopardized its ability to continue providing affordable
elderly housing.




 The Owner Executed an
 Unauthorized Agreement to Sell
 the Project

              The owner executed an agreement to sell the project without notifying HUD and
              obtaining HUD approval for the transaction. Section 7(a) of the regulatory
              agreement provides that project owners shall not, without the prior written
              approval of HUD, convey, transfer, or encumber any part of the mortgaged
              property or permit the conveyance, encumbrance, or transfer of any such property.
              The owner did not disclose the unauthorized sales agreement to HUD. HUD
              learned of the agreement in November 2007, through an attorney for the parent
              organization of the now-defunct church that sponsored the project’s ownership
              entity, almost three years after the December 2004 sales agreement. In addition to
              lacking HUD’s approval, the sales agreement was inappropriate, because

                      The agreement constituted an unauthorized sale of the project. The
                      agreement required the execution of a warranty deed that was to be held in
                      escrow. It also required payments totaling $60,000 per year (payable
                      $15,000 per quarter) starting 90 days from the effective date of the
                      agreement (December 14, 2004). The final payment was due within 45

                                                6
                  days of the seller’s final payment on the HUD-insured loan, due in 2012.

                  However, as detailed in appendix C, the owner executed a ministry
                  agreement that arranged to pay all proceeds from the sale to the project’s
                  church sponsor and not to the project. Section 10(g) of the project’s
                  regulatory agreement provides that all rents and other receipts of the
                  project shall be deposited in the name of the project in a bank account, the
                  deposits of which are insured. As discussed below, through this
                  arrangement, the owner diverted $90,000 of the sales proceeds for
                  nonproject use.

           During the audit, we discussed the above conditions with HUD officials as we
           assessed and learned more about the undisclosed sale. On March 26, 2008, HUD
           wrote to the owner, requiring that it either cancel the agreement or HUD would
           declare a technical default, request the lender to accelerate the mortgage, and
           begin foreclosure action. The owner and purchaser later provided representation
           letters to us, stating that the sale agreement was no longer in effect.


The Owner Diverted or Allowed
the Diversion of $90,000


           The owner and a principal in the IOI agent diverted or were responsible for
           allowing the diversion of $90,000 in proceeds the purchaser paid to acquire the
           project. The diversions occurred between February 2005 and December 2006
           when the project was not in a surplus-cash position. Section 10(g) of the
           regulatory agreement provides that all rents and other receipts of the project shall
           be deposited in the name of the project and used in accordance with the provisions
           of this agreement for expenses of the project and remittances to the commissioner.
           Title 12 U.S.C. (United States Code) § 1715z-4a(c) provides for double damages
           for unauthorized use of multifamily assets and income. Title 12 U.S.C. § 1715z-
           19 provides for sanctions for misuse of project assets and income when the
           project is in default or in a non-surplus-cash position. The $90,000 diversion,
           detailed in appendix C, consisted of

                  $90,000 paid toward the purchase of the project that the owner and a
                  principal in its IOI agent allowed to be diverted. The owner did not
                  deposit the funds to the project’s operating account, and a principal in the
                  IOI agent, who was aware of the payments, did not account for the funds
                  and their use in the project’s general ledger. As previously discussed, the
                  owner sold the project without HUD’s approval, and HUD required the
                  owner to cancel the agreement. However, during the audit, we determined
                  that before HUD required the owner to cancel the agreement, the
                  purchaser defaulted on the purchase agreement and forfeited the $90,000
                  to the project. Section 10 of the purchase agreement provided that in the
                  event of default by the purchaser, the seller could retain all deposits paid

                                            7
                   or agreed to be paid by the purchaser as liquidated damages. As discussed
                   in appendix C, the $90,000 was diverted to the project’s now defunct
                   church sponsor.


The Owner Allowed an Undisclosed
Purchaser to Select an Affiliate as
the Project’s Management Agent



            The owner and the unauthorized purchaser caused HUD to approve an
            undisclosed IOI agent to manage the project. Section 10 of the regulatory
            agreement stipulates that the owner shall provide for the management of the
            project. Contrary to this requirement, section 8 of the addendum to the December
            2004 sales contract provided that the owner would engage the services of a
            qualified managing agent to be selected by the buyer. The owner provided the
            names of two different management agent firms to HUD for approval to manage
            the project. Both firms included a principal of the firm that had the December
            2004 agreement with the owner to purchase the property. The owner and the IOI
            agent’s principal concealed the purchase agreement from HUD and the identity of
            interest that existed between them and the two proposed management firms.
            Specifically

                   On May 19, 2005, HUD approved the Project Owner’s/Management
                   Agent’s Certification, form HUD-9839-B for the first proposed agent. In
                   section 12 of the certification, the owner and agent checked the box stating
                   that no identity of interest existed among the owner, the agent, and any
                   individual or companies that regularly did business with the project. The
                   owner and agent knew that the statement was not true.

                   On October 13, 2005, HUD approved the Project Owner’s/Management
                   Agent’s Certification, form HUD-9839-B, for the second proposed agent.
                   In section 12 of the certification, the owner and agent checked the box
                   stating that no identity of interest existed among the owner, the agent, and
                   any individual or companies that regularly did business with the project.
                   The owner and agent knew that the statement was not true.

            The records showed that only the second firm executed a management agreement
            and assumed management of the project. We observed that the owner and agent
            executed the management agreement on July 1, 2005, which was before HUD
            approved the Owner/Management Agent Certification. Approximately 21 months
            after execution of the management agreement, HUD required the owner to replace
            the agent because of its poor performance. The IOI agent relinquished
            management to a new, independent management agent, effective April 4, 2007.
            HUD then requested that we audit the project due to concerns it had about the
            owner and the released IOI agent’s performance. These events occurred without

                                             8
           HUD’s knowledge of the identity-of-interest that existed between a principal in
           the IOI agent, the purchaser, and the owner. HUD officials stated that they would
           not have approved the IOI agent if they had known about the identity of interest.


The Project Was Financially Harmed by
Actions of the Undisclosed Purchaser


           A principal in the purchasing entity prevented the owner from seeking HUD
           program funding available through a local government entity’s HUD funded
           Community Development programs. The regulatory agreement, section 7(c),
           provides that the owner shall not, without the prior approval of the commissioner,
           convey, assign, or transfer any right to manage the mortgaged property. HUD’s
           staff had worked to assist the owner in obtaining funding assistance through the
           government entity. In addition, HUD’s staff stated that the potential funding
           amounted to approximately $1 million in forgivable loans and that the funding
           was virtually assured if the owner had applied for the assistance. The project
           provided the local government entity with a repair estimate of more than $2.2
           million. The local government entity’s representative acknowledged that it was
           considering the project for multiple-year funding, but it would not confirm the
           amount or the final funding prospect.

           A member of the project’s board provided an e-mail, dated August 25, 2007, that
           showed that the purchaser would not allow the owner to pursue the funding,
           because it would have obligated the project beyond the 2012 acquisition date
           stated in the previously discussed unauthorized sales agreement. The owner and
           purchaser concealed the agreement from HUD. The owner’s failure to pursue the
           assistance deprived the project of possible funding it could have used to pay for
           improvements and to prepare vacant units for rent. The funding would have
           released the project’s limited operating revenues to pay debt service and routine
           expenses. The following chart shows the vacancies, estimated lost revenue,
           monthly income or loss, and repair expenditures for the last nine months in 2007.




                                            9
                                                      Estimated     Monthly revenue less
                     Total    Vacant     Vacancy         lost       operating expense and    Expenditure
       Month         Units     units      Rate        revenue*      debt service (deficit)    for repair
 April 2007          210        22        10.48          $ 5,220             $ 12,736             370
 May 2007            210        19         9.05            3,915               (3,508)          7,076
 June 2007           210        24        11.43            6,090               (6,415)          4,941
 July 2007           210        25        11.90            6,525                 4,176          2,934
 August 2007         210        28        13.33            7,830             (31,660)          28,842**
 September 2007      210        25        11.90            6,525                11,589          2,072
 October 2007        210        32        15.24            9,570               (3,044)          1,026
 November 2007       210        34        16.19           10,440               (2,330)            936
 December 2007       210        36        17.14           11,310                 6,700          3,426
 Repair Expense                                                                               $51,623
 Average                                                                                       $5,736
  *Based on a sustaining 95 percent occupancy rate.
**Includes an extraordinary $25,000 air conditioning repair charged to accounts payable.

                 With $2.2 million in estimated repairs and only $5,736 in monthly average repair
                 expense the project did not have the cash needed to repair the increasing number
                 of vacant units and to make them available for rent. The increasing vacancies and
                 the declining revenues eventually led to a mortgage default in February 2008.
                 These conditions are consistent with comments cited in the project’s annual audits
                 for fiscal years ending August 31, 2007, 2006, and 2005. For each of these years,
                 the certified public accountants included similar notes to the financial statements
                 that questioned the project’s ability to continue as a going concern unless it
                 reversed the trend of increased vacancies (all three reports) and repair and
                 rehabilitation expenses (the two latest reports). The 2007 report stated that these
                 conditions over the past several years made it difficult for the project to meet
                 current obligations. The 2007 audit showed that on August 31, 2007, the project
                 had more than $239,000 in current operating accounts payable, excluding the
                 current mortgage payable and outstanding repairs.

 Questioned Costs

                 The owner and former agent incurred more than $16,000 for questioned costs
                 detailed in appendix D. The amount consisted of $3,692 for ineligible costs and
                 $12,994 for costs that were not properly supported. Section 7(b) of the regulatory
                 agreement provides that the owner shall not without the prior approval of the
                 Commissioner pay out any funds except for reasonable operating expenses and
                 necessary repairs. Section 10(c) of the regulatory agreement provided that the
                 books, contracts, records, documents and other papers related thereto shall at all
                 times be maintained in reasonable condition for proper audit. The owner and the
                 IOI agent both executed management certifications, whereby they agreed to
                 ensure that all expenses would be reasonable and necessary. The amounts
                 included

                          $3,692 for ineligible costs that consisted of $2,854 for holiday meals and
                          $838 for legal fees. The holiday meals for tenants were not necessary

                                                       10
                   project costs. The invoice for the legal services was billed to an IOI
                   affiliate of a principal in the firm that had an undisclosed and unauthorized
                   agreement to acquire the project.

                   $12,994 for costs not properly supported that consisted of $12,505 for
                   legal expenses and $489 for office and travel expenses. The legal
                   expenses included a $10,191 charge that was not supported by an invoice
                   and $2,314 in charges supported by invoices that did not sufficiently
                   describe the services rendered. The owner could not provide adequate
                   documentation to show the purpose of the expenses and to support that
                   they were reasonable project costs. The file showed that the office and
                   travel expenses were to reimburse a former project manager for expenses
                   paid from her personal account. The amount was not supported by proper
                   documentation and evidence that she paid the expenses.

Inadequate Books and Records


            The owner and its IOI agent did not maintain the project books and records in
            reasonable condition for proper audit, nor did they make all records available for
            examination as required by sections 10(c) and (d) of the regulatory agreement.
            This condition hampered our ability to assess the project’s financial condition and
            to identify the audit universe from which to select audit samples. We made
            repeated requests for all project records for the period covered by the review.
            Specifically, the owner and its prior IOI agent did not

                   Record in the project’s general ledger the receipt and disbursement of the
                   previously discussed $90,000 that an unauthorized purchaser paid toward
                   the acquisition of the project.

                   Maintain cancelled checks for 62 disbursements included in our sample.
                   We did not question the payment amounts because they were for routine
                   type costs and in most instances we could match the check numbers and
                   amounts to corresponding entries on project bank statements.

                   Maintain daily collection reports for rental receipts for September 2006
                   through March 2007.

                   Deposit all rental collections directly to the project’s operating account.
                   The IOI agent deposited rent collections to the project’s operating and
                   payroll accounts. All project collections should have been made to the
                   project’s operating account. HUD questioned this condition based on its
                   February 2007 monitoring of the project.




                                            11
Conclusion


             The owner and its prior IOI agent did not provide proper oversight and
             management of the project’s financial affairs. The owner had not established or
             did not provide and follow policies and procedures to control compliance with
             HUD requirements. Our review identified an unauthorized sale of the project,
             more than $106,000 in diverted funds and questioned costs, IOI dealings that
             financially harmed the project and contributed to a default on the project’s
             mortgage, and inadequate books and records. The violations occurred because the
             owner and its IOI agent did not comply with and enforce program requirements.
             The IOI dealings resulted in financial harm to the project that has jeopardized its
             ability to continue providing affordable elderly housing.

Recommendations

      We recommend that the Director of the Jacksonville Multifamily Housing Hub

             1A.    Determine if the cited violations warrant providing the owner a notice of
                    HUD’s intent to declare a technical default and if the violations are not
                    resolved within the allowed time declare the project in technical default of
                    its regulatory agreement and initiate foreclosure proceedings.

             1B.    Require the owner to pay the project $90,000 for forfeited acquisition
                    proceeds not deposited to the project account and used for project
                    purposes if the Regional Counsel determines that the sales agreement was
                    an enforceable contract.

             1C.    Require the owner to reimburse the project account $3,692 spent for
                    ineligible party and legal expenses.

             1D.    Require the owner to properly support or reimburse the project account for
                    $2,803 paid for inadequately supported legal, office, and travel expenses
                    and require the owner to properly support or write off the $10,191 legal
                    expense shown as an accounts payable.

             1E.    Require the owner to establish and implement policies and procedures to
                    ensure compliance with HUD requirements.

      We recommend that the Acting Director of the Departmental Enforcement Center

             1F.    Take appropriate administrative action against the owner for the
                    unauthorized sale of the project, providing false certifications to HUD,
                    allowing the purchaser to interfere with the management and financial
                    affairs of the project, and for not maintaining proper books and records.

                                             12
    1G.    Take appropriate administrative action against the IOI agent for providing
           false certifications to HUD, and for not maintaining proper books and
           records, which includes its knowledge and failure to properly account for
           $90,000 in purchase proceeds paid by its affiliate.

    1H.    Take appropriate administrative action against a proposed IOI agent for
           providing a false certification to HUD.

We also recommend that HUD’s Regional Counsel, in coordination with HUD’s
Director, Jacksonville Multifamily Housing Hub, and HUD’s Office of Inspector
General

    1I.    Seek double damages against the owner for diverting $90,000 received for
           the sale of the project if the Regional Counsel determines that the sales
           agreement was an enforceable contract.




                                   13
                       SCOPE AND METHODOLOGY

We performed the audit from January to July 2008 at locations in South Pasadena, Tampa, and
Orlando, Florida, including the HUD multifamily field offices, and at the project. We did not
review and assess general and application controls over computer-processed data for the
project’s general ledger. Instead, we conducted other tests and procedures to assure the
integrity of the computer-processed data that were relevant to our audit objectives. The tests
included but were not limited to a comparison of the computer-processed data to supporting
contracts, bids, invoices, monthly accounting reports, reserve for replacement funds requests,
and other supporting documentation such as bank statements and third-party verifications. The
tests revealed that the general ledger maintained by the owner and its IOI agent did not record
all project transactions and that the ledger was not reliable. We observed no data integrity
concerns with the ledger maintained by the owner’s most recent management agent. The
supplemental procedures applied during the audit were sufficient to accomplish the objectives
of the audit.

The audit generally covered the period September 1, 2004, through December 31, 2007. We
adjusted the period when deemed necessary. To accomplish our objectives, we

       Reviewed HUD’s monitoring reports and files for the project, including monthly
       accounting reports submitted by the former and current management agents;

       Researched applicable statutes, HUD handbooks, the Code of Federal Regulations, the
       project’s regulatory agreement, contracts (e.g., management agreements, and
       owner/management certifications), and other applicable program requirements;

       Reviewed and obtained an understanding of the owner’s and agent’s procedures and
       internal control environment;

       Interviewed HUD officials in Tampa, Orlando and Jacksonville; the project owner; and
       the former and current agents;

       Reviewed the project’s audited financial statements for fiscal years ending 2004, 2005,
       2006, and 2007;

       Toured the project to obtain a general idea of its type, size, and condition;

       Reviewed the project’s financial records such as general ledgers, bank statements,
       check vouchers, cancelled checks, invoices, contracts, bid documents, and other
       supporting documentation for $727,536 of the $4,423,652 disbursed for capital and
       routine expenditures during the audit period. We selected transactions based on
       concerns raised by HUD, vendor characteristics, significant dollar amounts, and other
       factors considered relevant to the selection of the audit sample. The results of the
       review apply only to the items selected and cannot be projected to the universe


                                              14
We conducted the audit in accordance with generally accepted government auditing standards.




                                             15
                             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 and procedures that the owner and management agent have put in
                      place to reasonably ensure that the project is operated in accordance with
                      the regulatory agreement, applicable laws, and other HUD requirements.

         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 had not established or did not provide and follow policies and
                      procedures to control compliance with HUD requirements (see finding 1).




                                               16
                                       APPENDIXES

Appendix A

                  SCHEDULE OF QUESTIONED COSTS



               Recommendation
                   number                 Ineligible 1/           Unsupported /2
                     1B                         $90,000
                     1C                           $3,692
                     1D                                                     $12,994
                    Total                        $93,692                    $12,994


 1/   Ineligible costs are those that are questioned because of an alleged violation of a provision of
      a law, regulation, contract, grant, cooperative agreement, or other agreement or document
      governing the expenditure of funds.

 2/   Unsupported costs are those for which eligibility cannot be clearly determined during the
      audit since such costs were not supported by adequate documentation. A legal opinion or
      administrative determination may be needed on these costs.




                                                 17
 Appendix B
        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                             18
Comment 1




            19
Comment 2




Comment 3



Comment 4




Comment 2




            20
Comment 5




Comment 6




            21
Comment 7




Comment 8




Comment 9




Comment 10




             22
Comment 11




Comment 1




             23
                           OIG Evaluation of Auditee Comments

The owner generally disagreed with the finding and recommendations, as indicated below.

Comment 1     The owner stated that the imposition of double damages is not appropriate
              because the board of the directors’ as it currently exists, is not the same board that
              authorized the sale. We disagree with the owner’s comment. The project’s
              ownership entity, Bethany Housing Inc., and its board were responsible for
              compliance with HUD requirements and the consequences associated with
              violations, such as the cited statute for double damages. Periodic changes in the
              composition of the board of directors did not alter or excuse the owner’s
              responsibility to ensure compliance with HUD requirements.

              HUD and enforcement officials will make the decision on double damages
              considering, among other factors, the impact the violations had on the project and
              its tenants.

Comment 2     The owner’s response to the draft report was the first time it raised a legal
              question about the sales agreement being invalid and unenforceable. The owner
              is correct in its claim that the sales agreement contained a provision that stated it
              was contingent upon certain events happening, mainly that HUD regulations were
              followed and that the final mortgage payment was made. The owner maintained
              that since the agreement was not authorized, it was invalid and of no force or
              effect and that any repayment of money paid under the agreement would result in
              an unjust enrichment to Bethany. During the audit we consulted with HUD’s
              Regional Counsel Office and were informed that the funds forfeited through the
              sales agreement were project funds. However, the owner’s response raised a new
              legal question about the enforceability of the sales agreement. Based on the
              owner’s comments we revised our recommendations, where appropriate, to
              recognize the need for a legal interpretation concerning the validity and
              enforceability of the sales agreement.

              We noted, however, that the owner’s position that the agreement is not
              enforceable is not consistent with their past actions on issues governed by the
              agreement. The owner and purchaser implemented the agreement without
              seeking and obtaining HUD’s prior approval and they concealed the agreement
              from HUD who did not learn of it until almost three years later. By that time the
              purchaser had paid $90,000 towards the acquisition to the project’s now defunct
              church sponsor. On April 11, 2008, the owner wrote the parent organization of
              the church recognizing the cash they received from the sale and invited them to
              redirect the funds to meet the project’s financial needs. The owner provided no
              evidence of a response. Also, on April 4, 2008, the owner wrote a letter to the
              purchaser that stated

                     “While there are a variety of legal issues surrounding this agreement, we
                     believe that in the most fundamental form of analysis, substantial and
                                                24
                   repeated failure to pay option payments when due constitutes a breach of
                   the option agreement and voids the further obligations of that agreement,
                   Stoltz v. Truitt 940 So.2d 521 (Fla. App. 1st Dist. 2006); see also
                   Paragraph 2 of Addendum to Purchase and Sales Agreement. Moreover,
                   by their very nature, options payments rendered prior to the option
                   holder’s cessation of payments remain the property of the optionee.”

            Based on the above, until our review, the owner operated on the basis that the
            sales agreement was a binding contract and enforced it against the purchaser.
            This is demonstrated by the above April 4, 2008, letter where the owner asserted
            its right to keep option payments forfeited under the agreement. The forfeited
            payments were made to and retained by the project’s now defunct church sponsor
            and are the subject of discussion in the above April 11, 2008, letter to the church’s
            parent organization. Also, pursuant to the alleged void sales agreement and
            contrary to the project’s regulatory agreement, the owner allowed the purchaser
            and the IOI agent selected by the purchaser to mismanage and cause financial
            harm to the project. These two conditions are discussed on pages 8 to10 of the
            report.

Comment 3   We agree with the owner’s comment and we revised the report to delete the
            statement that the ministry agreement made no mention of the sales agreement.

Comment 4   The owner implied but provided no support to show that a HUD official was
            aware of the sales agreement prior to the date we cite in the report.

Comment 5   The owner restated that the current board of directors had no involvement and had
            no knowledge of the owner selecting a management agent that had a prior interest
            through an undisclosed agreement to purchase the project. As stated in comment
            1 above, periodic changes in the composition of the board of directors did not
            alter or excuse the owner’s responsibility to ensure compliance with HUD
            requirements.

Comment 6   The owner commented that (a) they had no proof that the project would be
            financially better off if the actions never occurred, (b) the actions were not those
            of the owner but were rather the actions of the purchaser, and (c) the economy
            took a downturn and it is impossible to state with certainty that the vacancies
            resulted from them not obtaining the assistance mentioned in the report. The
            owner further commented that the board inherited a project with inadequate
            reserves and enormous deferred maintenance.

            We recognize that we could not determine the full adverse impact the violations
            had on the project although we identified a funding restriction that harmed the
            project. The unauthorized purchase agreement, executed in December 2004,
            prohibited the owner from seeking other funding without the purchaser’s
            approval. The restriction violated the project’s regulatory agreement which
            prohibited the assignment of management to another party without HUD’s
            approval and which the owner did not did seek or obtain.
                                             25
             We identified an instance where the purchaser prevented the owner from
            following through on an effort to obtain public funding through a local
            government entity. As stated in the report, the funding amount was not certain
            but HUD officials stated the project was almost certain to receive funding
            approval. The project needed and would have benefited from any approved
            funding. In this instance, the owner complying with the sales agreement
            restriction financially harmed the project although the extent of the harm is not
            quantifiable. A HUD legal representative stated that the owner selling the future
            ownership of the property took away the right of the owner to refinance and gave
            away its ability to obtain funds to correct physical deficiencies or other problems
            by refinancing. This was significant considering the owner’s recognition that the
            project had limited reserves and enormous deferred maintenance coupled with
            increasing vacancies detected by past independent audits and our review. In
            addition, the nonprofit project owner was eligible to receive HUD assistance and
            could have made annual applications for such assistance through a local
            government entity. The owner files contained no documentation to show it
            sought to obtain such funding.

Comment 7   The owner stated that generic billing codes were used to protect client attorney
            privilege and all of the unsupported legal charges were due to mold issues and
            evictions. The owner provided additional documentation following the exit
            conference to support some of the transactions. Based on that documentation, we
            revised the report to allow $4,383 of the legal fees. The owner did not provide
            documentation needed to resolve our concerns about inadequate support for the
            remaining legal fees.

Comment 8   We reviewed and assessed the owner’s explanation for the escrow deposit. We
            agree that the $15,000 payment mentioned in the response and the additional
            $15,000 escrow payment questioned in the draft report were both separate and
            apart from the sales proceeds paid under terms of the December 2004 sales
            contract. We revised the report to delete the two $15,000 escrow payments and
            we reduced the diverted fund amount from $120,000 to $90,000.

Comment 9   The owner commented that the holiday meals provided to the residents were a
            goodwill gesture which made good business sense considering the project
            vacancies. The meals were not necessary project costs.

Comment10   We agree with the owner’s comment that the $10,191 was an accounts payable.
            We revised our recommendation to recognize this fact.

Comment11   The owner commented that all the auditor’s requests were complied with and that
            everything was located and provided to us. As stated in the report, the owner did
            not locate and provide all requested records for the period the project was
            managed by a prior IOI agent.



                                             26
Appendix C
         SCHEDULE OF DIVERTED PURCHASE PROCEEDS


              Check
             Number             Date                  Recipient               Amount      Notes
          001981*             Feb. 3, 2005    Nonprofit sponsor church          $15,000   A, B
          002123*             May 3, 2005     Nonprofit sponsor church          $15,000   A. B
          Wire transfer      July 28, 2005    Nonprofit sponsor church          $15,000   A, C
          Wire transfer      Oct. 12, 2005    Nonprofit sponsor church          $15,000   A, C
          Wire transfer      Apr. 17, 2006    Nonprofit sponsor church          $15,000   A, C
          Wire transfer      Dec. 19, 2006    Nonprofit sponsor church          $15,000   A, C
                                              Total                             $90,000
         * Cashier checks with the purchaser shown as the remitter of the funds.

 Notes

 A. These payments, though due to the project, were diverted and paid to the project’s now
    defunct church sponsor who was not authorized to receive them. We obtained a record of
    the payments from the project’s escrow agent. According to the agent, the payments were
    made by the purchaser toward the acquisition of the project. However, we found no record
    of the payments in the project’s general ledger. Section 10(g) of the regulatory agreement
    provides that all rents and other receipts of the project shall be deposited in the name of the
    project and used in accordance with the provisions of this agreement for expenses of the
    project and remittances to the commissioner. In each instance, the remitted funds were
    paid directly from the purchaser’s bank account or by cashier’s checks that show the
    purchaser as the remitter of the funds.

    The owner violated requirements by arranging for the project’s church sponsor to receive
    all of the proceeds from the project’s sale. To accomplish this, the president of the
    project’s ownership entity executed a “ministry agreement” between the project and the
    church sponsor. The agreement required the project to make seven $60,000 annual
    payments (payable in quarterly installments of $15,000) to the church ($420,000 in total)
    and a final $1 million payment at the closing of the sale in 2012. The ministry agreement
    stipulated that the payments were for ministry services provided to the project over the past
    40 years. Such services, even if supported, are not eligible under the regulatory agreement.
    The president of the ownership entity, who was also the pastor of the now-defunct church
    sponsor, signed the project sales agreement and the ministry agreement.

    The owner and the purchaser either knew or should have known that the payments
    belonged to the project. The payments should have been paid to the project or held in trust
    as required by section 10(g) of the project’s regulatory agreement. We determined that two
    principals of the purchasing entity later represented themselves as principals in two
    separate management firms that the owner submitted to HUD for approval to manage the

                                                      27
   project. In both instances, each certified (one on April 14, 2005, and the other on June 22,
   2005) that they would comply with the project’s regulatory agreement and other HUD
   requirements. The management firms’ certifications to be approved as the project’s
   management agent show that they either knew or should have known HUD requirements
   for recognizing and accounting for project assets. They and the owner should have known
   that all payments made toward the purchase of the project should have been payable to the
   project only.

B. These payments were made payable to the project but were endorsed and deposited to the
   account of the project’s now-defunct church sponsor.

C. Documentation accompanying the wire transfers showed the purchaser as the originator
   and the project’s now-defunct church sponsor as the recipient.




                                             28
Appendix D
    SCHEDULE OF INELIGIBLE AND UNSUPPORTED COSTS


                                                                                         OIG's position
                   General       Cancelled                                                             Not
  Transaction       ledger         check                         Total                              properly
       date           ID         provided        Expense type   Amount     Allowed    Ineligible   supported
   Mar.13, 2006      1015            No             Legal       $ 2,460     $1,158      $ 838        $    464
    Oct. 4, 2007      273           Yes             Legal          5,000      3,150                     1,850
   July 15, 2007 10092006           n/a *           Legal         10,191                               10,191
  Dec. 15, 2006      3201            No             Meal             609                    609
  Nov. 15, 2005     12237            No             Meal             575                    575
  Dec. 14, 2005     12258            No             Meal             501                    501
  Nov. 17, 2004     11831            No             Meal             581                    581
  Dec. 15, 2004     11852            No             Meal             588                    588
  Aug. 15, 2006      3061            No         Reimbursement        311                                 311
  Aug. 15, 2006      3061            No         Reimbursement        118                                 118
  Aug. 15, 2006      3061            No         Reimbursement         60                                  60
       Total                                                    $20,994     $4,308       $3,692      $12,994
* This amount was recorded as accounts payable.




                                                     29
Appendix E
                      OTHER MATTER FOR
              CONSIDERATION INVOLVING TAX ISSUES

The cancelled sales agreement for Bethany Towers Apartments involved tax considerations that
may be of concern to the Internal Revenue Service (IRS), although the tax issues may not
involve a direct violation of HUD’s multifamily program requirements. The issue is whether a
501(c)(3) tax-exempt owners of a HUD-insured multifamily project may sell the project to a for-
profit owner without an appraisal to support that the sale occurred at the project’s fair market
value and whether the profits from the sale must be retained by the tax-exempt owner for
dedicated exempt purposes. This issue came to our attention from the cancelled sales transaction
that involved the project. We observed that the sale

       Provided for a $1.42 million sales price to a for-profit purchaser without obtaining or
       documenting an appraisal to establish the project’s market value. IRS Publication 557,
       Tax-Exempt Status for Your Organization, paragraph 501(c)(3), Excess Benefit
       Transaction, provides that organization assets must be disposed of at fair market value.
       The sales agreement provided that the official transfer would coincide with the project’s
       2012-scheduled mortgage maturity and payoff date of the project’s HUD-insured loan.
       The sales price appeared low, considering that in 2004 the project’s tax value was more
       than $6.8 million. Based on past tax valuations, we estimated that the project would be
       worth more than $10 million by the 2012 date scheduled to close the transaction. The
       for-profit purchaser would reap a windfall from the purchase based on the project’s 2004
       tax value and would profit even more based on our estimate of the project’s 2012 tax
       value.

       The prior president of the ownership entity stated that the purchaser’s offer appeared to
       be reasonable. The president signed the sales agreement on behalf of the project’s owner
       and was the minister of the project’s now-defunct church sponsor.

       Allowed a potential windfall to the profit-motivated purchaser that would deprive the
       project’s ownership entity of assets that should have been permanently dedicated to
       exempt purposes. IRS Publication 557, Tax-Exempt Status for Your Organization,
       paragraph 501(c)(3), Dedication and Distribution of Assets, provides that assets of an
       organization must be permanently dedicated to an exempt purpose. This means that
       should an organization dissolve, its assets must be distributed for an exempt purpose
       described in the chapter or to the federal government or to a state or local government for
       public purpose. If the assets could be distributed to members or private individuals or for
       any other purpose, the organizational test is not met.

These conditions, though no longer an issue because the sale was cancelled, should be
considered during the owner’s ongoing negotiations to possibly sell the project to another for-
profit entity. According to HUD officials, there are many 501(c)(3) tax-exempt owners of
multifamily projects with mortgages that will be paid off within a few years that may be
                                                30
prospects for purchase by for-profit entities. We recognize that the associated IRS issues may
not involve a direct violation of HUD requirements. HUD should be mindful of the IRS
requirements and take appropriate measures to ensure that when approving such sales, it does not
inadvertently authorize sale transactions that allow 501(c)(3) tax-exempt owners to violate IRS
requirements.




                                              31