oversight

Multifamily Project Deficiencies Resulted in More Than $1.1 Million in Cost Exceptions for Mohegan Commons, Norwich, Connecticut

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-02-04.

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

                                                                 Issue Date
                                                                          February 4, 2008
                                                                 Audit Report Number
                                                                          2008-BO-1004




TO:         James Barnes, Acting New England Hub Director, Multifamily Housing, Boston
              Regional Office, 1AHMLA
            Henry S. Czauski, Deputy Director, Departmental Enforcement Center, CV


FROM:       John A. Dvorak, Regional Inspector General for Audit, Region 1, 1AGA


SUBJECT: Multifamily Project Deficiencies Resulted in More Than $1.1 Million in Cost
         Exceptions for Mohegan Commons, Norwich, Connecticut

                                   HIGHLIGHTS

 What We Audited and Why

             We audited Vesta Mohegan, LLC (Mohegan Commons), after completing an
             audit of the owners’ related project, Vesta Moosup, LLC (Moosup Gardens). The
             Moosup Gardens audit (OIG Audit Report Number 2007-BO-1006) disclosed cost
             exceptions totaling more than $700,000 related to unauthorized distributions and
             repayments of owner advances while in a non-surplus-cash position and
             unreasonable payments to identity-of-interest (related) companies. Our audit
             objective was to determine whether the owners used project funds in accordance
             with the regulatory agreement.


 What We Found


             The owners did not use project funds in accordance with the regulatory
             agreement. We identified questioned costs and opportunities for funds to be put
             to better use totaling $1,194,242 (see appendix A). Specifically, the owners (1)
             used $58,342 in project funds for unnecessary and unreasonable operating costs;
                   (2) included more than $593,000 in unreasonable relocation costs, and other
                   questionable costs in the cost certification, causing the U.S. Department of
                   Housing and Urban Development (HUD)-insured mortgage to be overinsured by
                   $341,160; and (3) repaid $200,9471 in member advances when the project was in
                   a non-surplus-cash position. These cost exceptions were due to weak internal
                   controls, a lack of policies for related company transactions, and inadequate
                   accounting procedures. These violations of the regulatory agreement may subject
                   the owners to monetary penalties.


    What We Recommend


                   We recommend that the Acting New England Hub Director for Multifamily
                   Housing require the owners to (1) repay the project for the questioned operating
                   costs from nonproject funds, (2) make a principal payment or establish an escrow
                   with the lender from nonproject funds to pay down the amount of overinsurance,
                   and (3) reimburse the project from nonproject fund sources for the ineligible
                   member advance repayments, and remove the unreasonable member advances
                   accrued from the project’s accounting records.

                   Further, we recommend that HUD pursue sanctions as appropriate against the
                   responsible parties for the unreasonable disbursements cited in this report.

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


    Auditee’s Response


                   We provided the draft audit report to the owners on December 20, 2007, and
                   requested a response by January 15, 2008. We discussed the draft audit report at
                   an exit conference on December 21, 2007, and received the owners’ written
                   comments on January 15, 2008, after the owners were granted two extensions.
                   The owners generally disagreed with the report findings.

                   The text of the owners’ response, along with our evaluation of that response, can
                   be found in appendix B of this report. Please note that the referenced attachments
                   were not included in the report because of their size, but are available upon
                   request.



1
    $259,804 - $58,857 reimbursed as of April 2007.


                                                      2
                            TABLE OF CONTENTS

Background and Objectives                                                          4

Results of Audit
      Finding 1: The Owners Charged More Than $60,000 for Services That Were
                 Unnecessary and Unreasonable for Operating and Maintaining the    5
                 Project
      Finding 2: The Owners Included Unreasonable and Unnecessary Expenses in
                 Their HUD-Insured Mortgage Cost Certification
                                                                                   8
      Finding 3: The Owners Repaid More Than $259,000 in Advances When the
                 Project Was in a Non-Surplus-Cash Position
                                                                                  13

Scope and Methodology                                                             15

Internal Controls                                                                 16

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use              18
   B. Auditee Comments and OIG’s Evaluation                                       19
   C. Summary of Related Companies                                                30




                                            3
                            BACKGROUND AND OBJECTIVES

Mohegan Commons (project) is a multifamily, 184-unit apartment complex located in Norwich,
Connecticut. The project receives Section 8 rental assistance from the U.S. Department of Housing
and Urban Development (HUD) for 88 subsidized units, and the owners charge market rental rates
for the remaining 96 units. The project also receives interest reduction payments under Section 236
of the National Housing Act (Act).

The owners, HDASH, LLC, and its related company Vesta Equity 2003, LLC,2 purchased the
property in December of 2003 and embarked on substantial unit rehabilitations. The owners
financed the purchase and renovations, and HUD insured the mortgage through Section 221(d)(4) of
the Act. The Act authorizes HUD to insure lenders against loss on mortgage defaults and assists
owners in the construction or rehabilitation of housing for eligible families by making capital more
readily available.

The project remained operational during the rehabilitation period; and the $6.9 million in
renovations, completed in August of 2005, included new doors and windows, kitchen and bathroom
cabinets, bathroom accessories, new appliances and fixtures, drywall, electrical fixtures, and paint.
The heating and hot water systems were also segregated for operation that is more efficient.
Exterior work included new sidewalks, sealing the parking lot, landscaping, site lighting, and
upgrading the closed circuit television monitoring system. The owners also added a Neighborhood
Network Computer Center (learning center) and community room.

The owners submitted their final “Mortgagor’s Certificate of Actual Cost” (form HUD-92330) to
HUD on March 28, 2006, to determine the amount of mortgage insurance HUD would provide.
The original mortgage amount was approximately $9.2 million. As of December 18, 2007, the
unpaid principal balance was approximately $8.9 million, and the owners were current on their
mortgage payments.

Our audit objective was to determine whether the owners used project funds in accordance with the
regulatory agreement. Specifically, we wanted to determine whether the owners/management agent
(1) obtained goods and services that were reasonable and necessary project expenses and whether
the costs were properly supported, (2) included only reasonable and adequately supported costs on
the “Mortgagor’s Certificate of Actual Cost,” and (3) repaid any advances or loans to their related
companies when the project was in a non-surplus-cash position.

The issues identified in our report deal with administrative and internal control activities that we feel
are necessary to bring to the owners’ attention now. Other matters regarding the owners’
management may remain of interest to our office as well as other federal agencies. Release of this
report does not immunize any individual or entity from future civil, criminal, or administrative
liability or claim resulting from future action by HUD and/or other federal agencies.



2
    See appendix C for a description of the project’s related companies.


                                                            4
                                      RESULTS OF AUDIT

Finding 1: The Owners Charged More Than $60,000 for Services That
Were Unnecessary and Unreasonable for Operating and Maintaining the
Project
The owners charged the project $60,907 for services that were unnecessary and unreasonable for
operating and maintaining the project. This amount included charges of $32,287 for unnecessary
Internet service provided to all tenant units and $28,620 to pay their related management
company for unreasonable temporary employee services. This condition occurred when the
project was in a non-surplus-cash position. These unnecessary and unreasonable charges were
incurred because of inadequate accounting procedures and management controls. These charges
contributed to operating losses and the project’s non-surplus-cash position and may subject the
owners to sanctions under the federal equity skimming statutes.



    Owners Charged More Than
    $32,000 for Unnecessary
    Internet Services


                   The owners paid a vendor $32,287 from project operating funds to provide
                   Internet services to the project’s 184 housing units during the period July 1, 2005,
                   through August 31, 2007. The owners provided the services as an additional
                   amenity to attract new tenants and to further the goals of the project’s learning
                   center, which also provided Internet access and educational opportunities to
                   residents. The service agreement with the vendor also provided no-cost local
                   phone and cable service for the property’s exercise and social rooms and no-cost
                   local phone, facsimile, and Internet service for the property’s main office.
                   Although the project obtained some no-cost benefits, Internet service at the unit
                   level was not necessary for operating or maintaining the project. Therefore, the
                   costs were not eligible project costs and must be repaid to the project because the
                   owners’ regulatory agreement with HUD requires that project funds be used only
                   for reasonable expenses necessary for the operation and maintenance of the
                   project.3




3
    “Regulatory Agreement for Multifamily Housing Projects,” form HUD-92466, approved on December 9, 2003.


                                                       5
    Owners Charged More Than
    $28,000 for Temporary
    Employee Services


                 The owners’ related management company also charged the project $28,620 for
                 unreasonable temporary employee services. It charged $2,565 during the
                 rehabilitation period and $26,0554 after normal operations began. The costs were
                 unreasonable because they were already paid for as part of the management
                 agent’s fee.5 In addition, the owners did not maintain records to show who
                 provided the services, what services they provided, or whether the services were
                 actually provided. This condition occurred due to inadequate accounting
                 procedures and weak management controls.


    Project Was in a Non-Surplus-
    Cash Position


                 The project was in a non-surplus-cash position for the entire period of review.
                 Federal statutes prohibit HUD-insured multifamily project owners from using
                 project funds for unreasonable and unnecessary expenses when the project is in a
                 non-surplus-cash position. A major concern of HUD’s mortgage insurance
                 programs is the inappropriate use of project funds, which can contribute to
                 mortgage defaults, the need for additional financial assistance from HUD, and
                 losses to HUD through the sale of devalued foreclosed properties. In addition, an
                 inappropriate and willful use may be subject to civil money penalties. Since the
                 owners paid for these unnecessary and unreasonable expenses when the project
                 was in a non-surplus-cash position, they may be subject to these penalties.



    Conclusion

                 The owners charged the project $60,907 for services that were unnecessary and
                 unreasonable to operate and maintain the project. These charges occurred due to
                 inadequate accounting procedures and management controls and weakened the
                 project’s financial position. The project incurred more than $516,0006 in
                 operating losses during 2004 and 2005. The questioned charges in this finding,
                 the more than $593,000 in unreasonable relocation costs paid to the owners’
                 related companies (finding 2), and reduced occupancy rates during construction
                 contributed significantly to these operating losses. The $58,3427 charged after

4
  The project paid $8,565 in cash and accrued $17,490 in payables ($8,565 + $17,490 = $26,055).
5
  “The Management Agent Handbook,” HUD Handbook 4381.5, REV-2, section 6.39(b)(9).
6
  $228,202 in losses during 2004 and $287,923 during 2005 (before depreciation expenses).
7
  $32,287 for Internet service charges and $26,055 for temporary employee service charges total $58,342.


                                                        6
                 normal operations began should be repaid to the project operating account and
                 removed from the project’s accounting records, and the $2,565 charged during
                 construction should be repaid to reduce the HUD-insured mortgage (see finding
                 2). Since the owners charged these unreasonable costs when the project was in a
                 non-surplus-cash position and increased the profitability of their related
                 companies by allowing excessive charges from the related companies to the HUD
                 project, the owners may be sanctioned under the federal equity skimming statutes.


    Recommendations



                 We recommend that the Acting New England Hub Director for Multifamily
                 Housing require the owners to

                 1A.      Repay the project’s operating fund $40,8528 from nonproject sources and
                          remove $17,4909 in payables from its accounting records for the
                          unnecessary and unreasonable project costs. The repayment should be
                          deposited into the project’s replacement reserve account or another
                          restricted account that requires HUD approval for the release of funds.

                 1B.      Implement adequate written procedures and controls to ensure that future
                          disbursements for project expenses comply with the regulatory agreement
                          and HUD’s requirements.

                 1C.      Obtain an unrelated management agent to manage the project.10

                 We also recommend that the Director of the Departmental Enforcement Center

                 1D.      Pursue all administrative and/or civil monetary penalties against the
                          owners, their related management agent, and their principals for the
                          regulatory agreement violations disclosed in this report.11




8
  $32,287 paid for Internet services and $8,565 paid for temporary employee services total $40,852.
9
  Accrued for temporary employee services.
10
   In implementing recommendation 1C, HUD should consider all of the issues discussed in this report.
11
   In implementing recommendation 1D, the Deputy Director should consider all the issues discussed in this report.


                                                         7
                                      RESULTS OF AUDIT

Finding 2: The Owners Included Unreasonable and Unnecessary
Expenses in Their HUD-Insured Mortgage Cost Certification

The owners included more than $593,000 in unreasonable relocation costs in their cost
certification. The costs were unreasonable because the owners

      •   Exceeded the amount that HUD initially approved for relocation services,
      •   Did not show that their related company incurred costs, and
      •   Failed to show that the amount paid did not exceed what would have paid on the open
          market.

The owners failed to maintain adequate records for the amounts charged to their related
companies. In addition, the owners included more than $118,000 in unreasonable operating
costs including unpaid and unnecessary interest payments and excessive salary costs in their
operating statement. This condition occurred due to weak accounting controls over cash
disbursements and related party transactions.

HUD disallowed some of the relocation costs during its final cost certification; however, these
costs caused HUD to overinsure the mortgage by more than $341,000, contributed to
unnecessary operating losses, and may subject the owners to sanctions under the federal equity
skimming statutes.



     Related Company Costs Were
     Unreasonable


                 The $593,793 charged for related company relocation services12 was unreasonable.
                 The costs were unreasonable because they exceeded the $119,231 HUD approved.13
                 HUD initially approved the owners to charge the project an average of $4,258 per
                 tenant to move 28 tenants. However, the owners charged the project an average of
                 $9,125 per tenant to move 92 tenants, a volume increase of more than 200 percent
                 and a cost increase of more than 600 percent, with no credible explanation for the
                 cost disparity. The costs were also unreasonable because one related company
                 incurred no costs, yet it billed the project $324,123. In addition, the owners could
                 not show that the costs paid to their companies were comparable to costs that would



12
   On their “Mortgagor’s Certificate of Actual Cost,” form HUD-92330, signed March 28, 2006, in support of their
HUD-insured mortgage.
13
   “Multifamily Summary Appraisal Report,” form HUD-92264, approved on December 3, 2003.


                                                        8
                   have been paid on the open market as required by their regulatory agreement14 and
                   certification to HUD.15

                   In addition, the $593,793 in improper relocation costs charged to the project was
                   capitalized as part of the building improvements, and should be removed from the
                   project’s balance sheet. The $343,939 paid to the owners’ related companies must
                   be returned to the project and the $249,854 recorded as an account payable must be
                   removed from the project’s books.

                   The unreasonable relocation costs were due to weak internal controls for accounting
                   and related party transactions. For example, the related companies did not enter into
                   a contract to establish the scope and cost of work to be performed. In addition, they
                   did not maintain adequate records to support the costs they incurred. The owners’
                   related companies’ records also did not show which employees provided services,
                   what services they provided, or the number of hours they spent providing these
                   services. The project maintained invoices for some of the costs charged; however,
                   invoices were missing for $170,100 in charges.


     Owners Charged the Project
     More Than $118,000 in
     Unreasonable and Unnecessary
     Operating Costs


                   The owners included $118,710 in improper charges on the “Statement of Project
                   Operations” they certified and submitted to HUD in support of their HUD-insured
                   mortgage as follows:

                         Description                                         Amount
                        Learning center startup costs                          $60,000
                        Loan interest to related company                        38,211
                        Bad debts                                               17,934
                        Related company temporary employee costs                 2,565
                        Total                                                 $118,710

                   •   The $60,000 in learning center startup costs was not paid.

                   •   The owners supported only $40,633 of the $58,567 in bad debt expense they
                       reported. This condition occurred due to weak internal controls for
                       accounting and the owners’ failure to maintain adequate records for bad debts.
                       Specifically, the project’s books and records did not identify which tenants

14
     “Regulatory Agreement for Multifamily Housing Projects,” form HUD-92466, approved on December 9, 2003.
15
     “Project Owner’s/ Management Agent’s Certification,” form HUD-9839-B, signed July 29, 2003.



                                                       9
                         were responsible for the debts, how much they owed, the nature of the debt, or
                         how much they repaid. Therefore, the remaining $17,934 in bad debt expense
                         was unsupported.

                   •     The $38,211 in loan interest was not recorded on the project’s records and was
                         not paid.

                   The inappropriate related company temporary employee costs were discussed in
                   finding 1.


     The Mortgage Was
     Overinsured by More Than
     $341,000

                   The owners included $593,793 in unreasonable relocation costs on the cost
                   certification they submitted to HUD. HUD disallowed $333,458 in relocation
                   expenses and allowed credits of $8,894 and $44,240 during final cost
                   certification. Our audit identified $379,04516 in additional unreasonable and
                   unsupported costs that increased the mortgage amount HUD insured by $341,160,
                   calculated as follows:

                       Description                                                        Amount
                       Total land and improvements                                        $10,504,431
                        Less: HUD disallowed unreasonable relocation costs                  (333,458)
                        Add: HUD miscellaneous credits                                          8,894
                        Less: unreasonable and unsupported costs                            (379,045)
                       Audited adjusted total land and improvements                         9,800,822
                        Statutory percentage ( 90% of line 6)                               8,820,740
                       Audited maximum insurable mortgage (in multiples of $100)            8,820,700
                        Add: HUD adjustment for Section 8                                      44,240
                       Audited maximum insurable mortgage                                   8,864,940
                       HUD-approved maximum insurable mortgage                              9,206,100
                       Overinsured amount                                                    $341,160


     Project Was in a Non-Surplus-
     Cash Position


                   The project was in a non-surplus-cash position for the entire period of review.
                   Federal statutes prohibit HUD-insured multifamily project owners from using

16
     $260,335 ($593,793 - $333,458) + $118,710 = $379,045.


                                                       10
                    project funds for unreasonable expenses when the project is in a non-surplus-cash
                    position.

                    The project also incurred more than $516,00017 in operating losses during 2004
                    and 2005. The more than $593,000 in unreasonable relocation costs paid to the
                    owners’ related companies (finding 2), and reduced occupancy rates during
                    construction contributed significantly to these operating losses.

                    A major concern of HUD’s mortgage insurance programs is the inappropriate use
                    of project funds, which can contribute to mortgage defaults, the need for
                    additional financial assistance from HUD, and losses to HUD through the sale of
                    devalued foreclosed properties. In addition, an inappropriate and willful use may
                    be subject to civil money penalties. Since the owners paid their related companies
                    unreasonable amounts for relocation services when the project was in a non-
                    surplus-cash position, they may be subject to these penalties.



     Conclusion


                    The owners paid more than $593,000 in unreasonable costs to their related
                    companies for relocation services, and included this cost in their cost certification
                    as building improvements when the project was in a non-surplus-cash position. In
                    addition, the owners included more than $118,000 in unreasonable and
                    unsupported operating costs in their cost certification. These conditions were
                    caused by weak internal controls over related party transactions and accounting.
                    In addition, these costs contributed to unnecessary operating losses and caused
                    HUD to overinsure the mortgage by $341,160.


     Recommendations



                    We recommend that the Acting New England Hub Director for Multifamily
                    Housing require the owners to

                    2A.     Repay the project $343,939 paid to the owners’ related companies from
                            nonproject funds, with the amounts reimbursed placed in the project’s
                            reserve for replacement or a restricted capital account that requires HUD
                            approval for release of the funds, and reduce the building improvements
                            account for the same amount.



17
     $228,202 in losses during 2004 and $287,923 during 2005 (each before depreciation expenses).


                                                         11
2B.   Remove the $249,854 accounts payable for relocation costs to the owners’
      related companies from the project’s books and reduce the building
      improvements account for the same amount.

2C.   Make a $341,160 principal payment or establish an escrow with the lender
      from nonproject funds to pay down the amount of overinsurance, with the
      amounts reimbursed placed in the project’s reserve for replacement or a
      restricted capital account that requires HUD approval for the release of the
      funds due to unreasonable costs during construction.

2D.   Implement adequate written procedures and controls to ensure that future
      disbursements for project expenses comply with the regulatory agreement
      and HUD’s requirements.




                                12
                                       RESULTS OF AUDIT

Finding 3: The Owners Repaid More Than $259,000 in Advances When
the Project Was in a Non-Surplus-Cash Position
The owners repaid $259,804 in advances when the project was in a non-surplus-cash position18
and without HUD approval. The owners paid expenses directly on the project's behalf and
advanced other cash to the project’s accounts to cover operating shortfalls. However, owners
can only repay the advances from available surplus cash. The improper repayments of the
advances were due to weak internal controls and a lack of policies for related company
transactions. The repayments negatively influenced the project’s precarious financial condition.
In addition, these violations reduced the availability of cash needed for project operations and
may jeopardize the future financial operations and physical condition of the project.



     Owners Improperly Repaid
     Member Advances

                  During the period December 23, 2003 (the project’s inception), through
                  December 31, 2006, the owners improperly repaid $259,804 for member
                  advances. The owners paid expenses on the project's behalf and advanced other
                  funds during this period to cover operating shortfalls. However, the project was
                  in a non-surplus-cash position during this period. Owners can only repay the
                  advances made for reasonable and necessary operating expenses from surplus
                  cash at the end of the annual or semiannual period unless otherwise approved by
                  HUD.19 Repayment of owner advances when the project is in a non-surplus-cash
                  position or without HUD approval is a violation of the regulatory agreement and
                  may subject the owners to criminal and civil monetary penalties.

     More Than $58,000 Was
     Returned to the Project’s Bank
     Accounts

                  The financial analysts from the HUD Real Estate Assessment Center (REAC)
                  identified $58,857 in unauthorized member advance repayments and referred the
                  matter to the HUD Departmental Enforcement Center (DEC). DEC required the
                  owners to reimburse the project. The owners repaid the amount questioned in


18
   “Surplus cash” is the cash remaining after all necessary and reasonable expenses of the project have been paid or
funds have been set aside for such payment.
19
   “Financial Operations and Accounting Procedures for Insured Multifamily Projects,” HUD Handbook 4370.2,
REV-1, CHG-1, paragraphs 2-6.E and 2-11.A.


                                                         13
                   April 2007. Therefore, the balance of improper member advance repayments was
                   $200,947.20

     Project Financial Performance
     Was Rated High Risk

                   The HUD Real Estate Assessment Center (REAC) division rated the project’s
                   financial performance as a high risk to HUD. The REAC review of the
                   underlying financial ratios for the last two years of annual financial statements,
                   which measures a project’s performance based on standards that are objective,
                   uniform, and verifiable, indicated significant deficiencies. HUD had also notified
                   the owners of serious compliance issues including the unauthorized repayments of
                   owner advances noted above, unauthorized management fees, and late submission
                   of their 2006 financial statements. The high risk is of concern to HUD, which
                   must maintain public trust in the management of assets funded with HUD
                   financial assistance.


     Conclusion


                   The project owners improperly repaid their related companies $259,804 for
                   advances when the project was in a non-surplus-cash position. This action was a
                   violation of the owners’ regulatory agreement with HUD. However, the owners
                   repaid $58,857, leaving a balance of $200,947. These problems occurred due to
                   weak internal controls and the lack of policies regarding related company
                   transactions. As a result, these funds were not available for normal project
                   operations and contributed to the high risk rating by REAC. This condition may
                   also jeopardize the future financial operations and physical condition of the
                   project.


     Recommendations


                   We recommend that the Acting New England Hub Director for Multifamily
                   Housing require the owners to

                   3A.      Reimburse the project $200,94721 from nonproject fund sources for the
                            ineligible member advance repayments. The reimbursement should be
                            deposited into the project’s replacement reserve account or another restricted
                            account that requires HUD approval for the release of funds.


20
     ($259,804 - $58,857).
21
     $259,804 in total member advance repayments less $58,857 reimbursed in April 2007.


                                                        14
                         SCOPE AND METHODOLOGY

Our audit generally covered the period December 23, 2003, through December 31, 2006, but we
expanded it when necessary. We conducted our fieldwork from April through November 2007.
We carried out our audit work at the management agent’s office in Weatogue, Connecticut, and the
local HUD Hartford (Connecticut) field office.

To accomplish our audit objectives, we

   •   Reviewed federal laws and regulations and the owners’ regulatory agreement with HUD and
       obtained an understanding of the owners’ corporate structure as it relates to the project.

   •   Reviewed the project management files at the local HUD field office.

   •   Interviewed and held meetings with the project owners, controller, selected project staff, and
       HUD personnel and officials.

   •   Reviewed the project’s financial statements and independent public accountant’s reports.

   •   Reviewed supporting documentation for related company loans and advances to ensure
       compliance with HUD’s requirements.

   •   Reviewed supporting documentation for the owners’ cost certification, form HUD-92330, to
       determine whether HUD overinsured the project’s mortgage.

   •   Reviewed supporting documentation for management fees to ensure that they were properly
       supported, accurately calculated, and within HUD-approved limits.


We conducted this performance audit in accordance with generally accepted government
auditing standards. Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions
based on our audit objectives. We believe that the evidence obtained provides a reasonable basis
for our findings and conclusions based on our audit objectives.




                                                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:

                  •   Controls over the repayment of owner advances and related party
                      transactions.

                  •   Controls over payments, accounting, and maintaining adequate support for
                      project development and operating costs.

                  •   Controls over the payment of management fees.

                  •   Controls over compliance with applicable laws and regulations and
                      provisions of contracts or grant agreements.

              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.




                                               16
Significant Weaknesses


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

               •   Controls over payments, accounting, and maintaining adequate support for
                   project development and operating costs (see finding 1 and finding 2).

               •   Controls over payments to related companies for relocation services to
                   ensure that they were reasonable and properly supported (see finding 2).

               •   Controls over the repayment of owner advances and related party
                   transactions (see finding 3).




                                            17
                                    APPENDIXES

Appendix A

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

Recommendation          Ineligible 1/   Unreasonable or    Funds to be put               Total
       number                            unnecessary 2/     to better use 3/
            1A                                 $40,852             $17,490            $58,342
            2A                                $343,939                               $343,939
            2B                                                   $249,854            $249,854
            2C                                $341,160                               $341,160
            3A            $200,947                                                   $200,947
         Totals           $200,947            $725,951           $267,344          $1,194,242


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/   Unreasonable/unnecessary costs are those costs not generally recognized as ordinary,
     prudent, relevant, and/or necessary within established practices. Unreasonable costs
     exceed the costs that would be incurred by a prudent person in conducting a competitive
     business.

3/   Recommendations that funds 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 not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other savings,
     which are specifically identified. For recommendations 1A and 2B, if our
     recommendations are implemented, the project will not repay its management agent for
     unreasonable and unnecessary accrued temporary employee services, or repay its
     members for unreasonable accrued relocation costs once the project realizes surplus cash.




                                            18
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         19
Comment 1




            20
Comment 2




Comment 3




            21
Comment 4




Comment 5




            22
Comment 6




Comment 7




            23
Comment 8




Comment 9


Comment 10




Comment 11




Comment 12


Comment 13




             24
Comment 14




Comment 15




Comment 16



Comment 17



Comment 18




             25
OIG Evaluation of Auditee Comments

Comment 1   We do not dispute the owners’ comments that HUD’s policy promotes providing
            tenant services to provide a wholesome environment. However, the costs must
            still meet the test of necessity and reasonableness. Further, the owners stated that
            HUD was advised that the owners would be providing Internet access to the
            residents during the application process. HUD program officials advised us that
            they were only aware of and approved Internet access for residents through the
            computers located in the new learning center. HUD program officials were not
            made aware of nor did they approve subsidizing Internet access to individual
            units. We coordinated this issue with HUD program officials throughout the
            audit, and continue to maintain our position that Internet costs to individual units
            were not necessary/reasonable project costs.

            We concur that amount of unreasonable Internet costs requiring repayment may
            be reduced by the value of the services provided at no cost. However, the
            owner’s response provided no documentation to support the value of these
            services. In addition, the contract between the owners and Internet provider
            provides for both parties to share in the profits obtained related to the sale or use
            of names of residents for purposes of third party vendor marketing. Therefore, if
            the owners received any income from the sales of these services the income
            received should be paid returned to the project or used to offset the amount
            requiring repayment.

            Therefore, we continue to question the costs as unreasonable in the report and
            recommendations 1A.

Comment 2   The owners’ response provided no evidence to show which employees provided
            these services, the services they provided, the amount of time they spent, or the
            associated costs. The owners’ records clearly showed that the temporary
            employee costs were for “… additional staff to cover sick time, special projects,
            and vacation” and the amount charged was “an estimated amount upon which
            sales tax is charged,” which were paid for as part of the management fee. We do
            not understand how the owners could make the statement that “these charges were
            for additional employees required at the project during the audit period” when
            they do not know who the employees were, what services they provided, and how
            much time they worked for the project. Therefore, our audit position remains
            unchanged.

Comment 3   We concur that reduced occupancy rates during construction reduced project
            income and contributed to operating losses. However, we do not concur that
            HUD’s delayed funding of more than $44,000 for enhanced vouchers contributed
            significantly to the operating losses. We also continue to maintain that the
            unreasonable relocation costs contributed significantly to these losses and the
            project’s non-surplus-cash position. Thus, we changed the report to read, “The
            project incurred more than $516,000 in operating losses during 2004 and 2005.



                                              26
            The questioned charges in this fining, the more than $593,000 in unreasonable
            relocation costs paid to the owners’ related companies (finding 2), and reduced
            occupancy rates during construction contributed significantly to these operating
            losses.” We also concur that the project did have positive income in 2007, but
            still sustained an operating loss after depreciation expenses.

Comment 4   We continue to question the costs as unreasonable in the report and
            recommendation 1A (see comments 1 and 2). We concur that if the owners
            provide verifiable evidence to support a reasonable cost for the free business
            phone, facsimile, and Internet services currently being provided to the project,
            they could be considered an offset to our questioned costs. However, if the
            owners received any income from the sales of services provided to Mohegan
            Common tenants because of the profit sharing provisions of the contract between
            the owners and Internet provider, the amount requiring repayment may be reduced
            accordingly.

Comment 5   Based on the nature of the related party relocation costs questioned, and the
            totality of the deficiencies in this report, our recommendation remains unchanged.

Comment 6   We do not concur with the owners reasoning that based on the amount HUD
            approved they should have been allowed to charge $391,736 to the project for
            relocation services. The owners’ related companies should have charged the
            project only for the costs they actually incurred, could support, and HUD
            approved. During our audit and in their written comments the owners did not
            provide documentation to support the more than $593,000 dollars their related
            companies charged the project for relocation services nor justify why their related
            company charged the project more than $323,000 dollars when it did not have any
            employee costs. Nonetheless, the owners maintain that their companies should
            have been paid for relocation services. We cited the owners’ lack of internal
            controls because they failed to maintain adequate records to support their charges.
            For example, the owners’ related companies did not show which employees
            provided services, what services they provided, or the number of hours they spent
            providing these services. In addition, the project maintained invoices for some of
            the costs charged; however, invoices were missing for $170,100 in charges.
            Therefore, we continue to maintain the related company relocation costs were
            unreasonable and the owners’ internal controls require improvement.

Comment 7   The owners signed and certified the cost certification for costs incurred prior to
            August 19, 2005, the cost certification date. The owners included $60,000 for
            “Learning center start-up costs incurred as of the cost certification date.” The
            invoices provided in the owners’ response are for costs incurred after the cost
            certification date, thus, are not eligible for inclusion in the cost certification, and
            should not have been included in the mortgage amount that HUD insured.
            Therefore, our conclusion and recommendations remain unchanged.




                                               27
Comment 8     The owners provided supporting documentation to show the project incurred
              $40,633 in bad debts during the cost certification period of December 23, 2003,
              through August 19, 2005. Therefore, we reduced the amount of questioned bad
              debt costs to $17,934 ($58,567 reported on the cost certification - $40,633 in bad
              debts actually incurred) and adjusted their effect on the mortgage amount HUD
              insured.

Comment 9     We maintain that the mortgage was overinsured. However, we reduced the
              amount to $341,160 based on the reduced amount of questioned bad debt
              expenses. See comments 6, 7, and 8.

Comment 10 We concur the project’s mortgage was current. However, the project also was in
           a non-surplus-cash position and incurred more than $920,000 in losses after
           deprecation and more than $516,000 before depreciation during 2004 and 2005.
           Thus, we changed the report to read, “The project also incurred more than
           $516,000 in operating losses during 2004 and 2005. The more than $593,000 in
           unreasonable relocation costs paid to the owners’ related companies and reduced
           occupancy rates during construction contributed significantly to these operating
           losses.” See also comment 3.

Comment 11 We maintain our conclusion and the conditions noted in this finding. See
           comments 6-9.

Comment 12 We maintain our recommendation, and renumbered it from 2A to 2C. See
           comments 6 and 7.

Comment 13 The owners’ response provided no support to show they implemented adequate
           written procures and controls. Therefore, we maintain our recommendation and
           renumbered it from 2B to 2D.

Comment 14 We reviewed the development costs cited in the owners’ attachment. We concur
           that advances repaid from the project’s development account for supported
           preacquisition costs are eligible. We reduced the total amount questioned
           accordingly. However, all advances repaid from the project’s operating account
           are ineligible and must be reimbursed. In addition, the owners did not support the
           $110,000 repayment on 11/14/2005 from the project’s development account, and
           must be reimbursed. Because the development account is closed, the remaining
           balance to be repaid for preacquisition costs can only be repaid from surplus cash
           at the end of the fiscal period.

Comment 15 The project’s financial performance was analyzed and rated by HUD’s Real
           Estate Assessment Center division. The HUD review is based on an analysis of
           the underlying financial ratios for the last two years of annual financial
           statements, which measures a project’s performance based on standards that are
           objective, uniform, and verifiable, indicated significant deficiencies.




                                              28
Comment 16 We reduced the total amount of questioned costs accordingly (see comment 14).
           However, we maintain the significance of our finding.

Comment 17 We reduced the total amount of questioned costs accordingly (see comment 13).

Comment 18 We do not concur with the owners’ reasoning that based on the amount HUD
           approved they should have been allowed to charge $391,736 to the project for
           relocation services. The owners’ related companies should have charged the
           project only for the costs they actually incurred, could support, and HUD
           approved. See comment 6.

              In addition, we moved this recommendation to remove the account payable to
              from Finding 3, Recommendation 3B to Finding 2, Recommendation 2B.

              We also added related Recommendation 2A requiring the owners to repay the
              project $343,939 and reduce the building improvements account for the same
              amount.




                                            29
Appendix C

                  SUMMARY OF RELATED COMPANIES

Mohegan Commons (the project), also known as Vesta Mohegan, LLC, is owned by HDASH,
LLC (99 percent) and Vesta Equity 2003, LLC (1 percent). HDASH is owned by two members,
“the owners.”

Vesta Corporation performs no functions for the project and is the parent holding company for
its wholly owned subsidiaries, Vesta Equity Corporation and Vesta Management Corporation.
RFD Acquisition Corporation owns Vesta Corporation. J&Z Investment Company owns RFD
Corporation. J&Z Investment Company’s shareholders are the project owners’ family members
(70 percent) and nonrelated investors (30 percent).

Vesta Equity Corporation performs no functions for the project but owns Vesta Equity 2003,
LLC. Vesta Equity 2003, LLC, was created to perform management functions on behalf of the
project.

Vesta Management Corporation is the legal entity that manages the project’s day-to-day
operations such as renting apartments, collecting rents, maintenance, and other daily property
operational tasks.




                                               30