Issue Date October 22, 2008 Audit Report Number 2009-FW-1001 TO: Jesse Westover Acting Director, Office of Public Housing, 6FPH James E. Slater Director, Community Planning and Development Division, 6FD FROM: Gerald R. Kirkland Regional Inspector General for Audit, Fort Worth Region, 6AGA SUBJECT: The Fort Smith Housing Authority Made Inappropriate Guarantees, Did Not Follow Procurement Requirements, and Spent Program Funds on Questionable Activities HIGHLIGHTS What We Audited and Why We audited the Fort Smith Housing Authority (Authority) in response to a request from the U. S. Department of Housing and Urban Development’s (HUD) Office of Public Housing. The objectives were to determine whether the Authority and its instrumentality, North Pointe Limited Partnership (Partnership), spent HUD- provided funds in compliance with HUD’s rules and regulations for costs related to North Pointe Development (the development), including relocation activities, and whether they complied with federal procurement regulations. What We Found Between November 2006 and April 2007, the Authority and its instrumentality improperly encumbered Authority assets. Also, the Authority and its instrumentality did not comply with federal procurement regulations for three procurements. Further, between October 2006 and January 2008, the Authority inappropriately spent HUD program funds on activities that did not benefit those programs. What We Recommend We recommend that HUD require the Authority to Obtain the release of any encumbered assets and require the Authority to ensure that it will no longer encumber assets, Support or repay $400,000 to its HOME Investment Partnerships Program and more than $94,000 to its Community Development Block Grant program, Support or repay more than $30,0001 to its capital fund grants or HUD, as appropriate, for questionable costs, Ensure that it procures goods and services as required, Support or repay more than $9,700 to its Section 8 project reserve account, as appropriate, for unsupported expenses, Implement written procedures and controls to prevent the use of capital fund (low-rent) grants for unauthorized costs, and Implement written procedures and controls to ensure that its instrumentalities comply with federal procurement regulations. 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 draft report to the Authority and HUD on September 19, 2008, with comments due October 8, 2008. We held an exit conference with the Authority on September 26, 2008. The Authority provided a written response on October 7, 2008, and generally disagreed with the findings. We have included the complete text of the Authority’s response, along with our evaluation of that response, in appendix B of this report. Due to the volume, we did not include the attachments included in the Authority’s response. These are available for inspection upon request. 1 The Authority has repaid $4,440 of this amount. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: The Authority Inappropriately Placed Its Public Housing Assets at 5 Risk and Could Not Support Three Procurements Finding 2: The Authority Spent More Than $108,000 on Questionable Costs 9 Scope and Methodology 11 Internal Controls 13 Appendixes A. Schedule of Questioned Costs 15 B. Auditee Comments and OIG’s Evaluation 16 3 BACKGROUND AND OBJECTIVES In 1940, the Housing Authority of the City of Fort Smith, Arkansas, was created under Arkansas law to administer public housing programs under the United States Housing Act of 1937 (the Act). It later changed its name to Fort Smith Housing Authority (Authority). A five-member board of commissioners appointed by the mayor of the City of Fort Smith (City) governs the Authority with an executive director managing the day-to-day operations. The Authority also participates in other U. S. Department of Housing and Urban Development (HUD) programs. In 1995, the Authority entered into an annual contributions contract with HUD for the funding of its public housing programs. HUD provided nearly $1 million in annual contributions and subsidies for its two public housing facilities (448 units), Ragon Homes and Nelson Hall Homes. In 2005, the Authority planned to demolish and replace Ragon Homes with mixed financed developments. By August 2008, it had relocated Ragon Homes’ tenants in preparation for the demolition. North Pointe Development (the development) in Fort Smith, Arkansas, was the first phase of the Authority’s master plan to replace Ragon Homes. The development consisted of 40 low-income housing tax credit (LIHTC) units and 10 market rate units, which were not public housing units. 30 27 Less than or equal to 60% median area income 25 20 Less than or equal to 50% median area income 15 10 10 Less than or equal to 30% 10 3 median area income 5 Any income 0 LIHTC Market rate Private investors substantially own the development.2 On January 17, 2006, the Authority created North Pointe, Inc. (company), to serve as general partner in the development. The Authority was the company’s sole shareholder. Two of the Authority’s board members, its executive director, and its director of finance served within the company. On February 7, 2006, the company established North Pointe Limited Partnership (Partnership) to finance, construct, own and operate the development. As an instrumentality of the Authority, the Partnership was required to comply with the Authority’s annual contributions contract. The audit objectives were to determine whether the Authority and its instrumentality, the Partnership, spent HUD-provided funds in compliance with HUD’s rules and regulations for costs related to the development, including relocation activities, and whether they complied with federal procurement regulations. 2 Alliant Credit Facility, the limited partner of North Pointe Limited Partnership since April 1, 2007, owned 99.99 percent interest. The company, as general partner, owned the remaining interest. 4 RESULTS OF AUDIT Finding 1: The Authority Inappropriately Placed Its Public Housing Assets at Risk and Could Not Support Three Procurements In violation of requirements, the Authority inappropriately encumbered its assets, spent HUD funds for other than reasonable and necessary program costs, and could not support that it provided free and open competition for three procurements. As a result, it placed more than $2.2 million of its public housing assets at risk and spent more than $426,000 for unsupported costs. Further, the Authority cannot ensure that it received the best price for more than $4.2 million that it spent for goods and services. This condition occurred because the Authority misunderstood federal regulations related to instrumentalities and did not follow its procurement policies. The Authority Placed Its Public Housing Assets at Risk Between November 2006 and April 2007, Authority management violated its annual contributions contract by encumbering assets when it inappropriately entered into agreements that guaranteed the Partnership’s repayment of two loans and its’ performance as general partner. The violations occurred because Authority officials did not believe that they encumbered the Authority’s assets or violated requirements. The Authority did not have sufficient unrestricted reserves to cover the bank loans in the event of default. Therefore, Authority management put public housing assets at risk. While the agreements favored the investors, the loans were paid; thus, the loan guarantees were no longer active. However, the Authority also inappropriately guaranteed the company’s performance as general partner. This guarantee will remain active until all of the activities of the partnership agreement are completed. The Authority did not inform HUD of the guarantees as required.3 The Authority Guaranteed Two Bank Loans On November 28, 2006, the Authority guaranteed a $75,000 loan for the Partnership. The Authority granted its irrevocable and unconditional full faith and credit as a primary obligor for the complete performance of the Partnership’s obligations under the loan. Further, on April 3, 2007, the Authority unconditionally guaranteed the full and prompt payment of a $1.9 million construction loan. The loan guarantees were unsecured and did not identify specific Authority assets as collateral. As the following excerpt shows, the Authority could have been responsible for the loan payments if the Partnership had defaulted on the loans. 3 Annual contributions contract, part A, section 7. 5 Excerpt from the $1.9 million loan guarantee The Authority Guaranteed the Partnership’s Performance To induce the limited partner to invest in the Partnership, the Authority entered into an agreement with the limited partner on April 1, 2007. The Authority guaranteed the Partnership’s/general partner’s performance to the investors for almost every contingency including loss of tax credits, funding of development and operating deficits, and other general partner obligations set forth in the partnership agreements. The Authority also guaranteed that it would make a capital contribution to pay any unpaid portion of the $335,872 development fee. Further, it waived its right to defend enforcement of the agreements and agreed to pay the investors’ legal costs for enforcing the agreements against it. The Partnership Did Not Properly Procure a $4.2 Million Construction Contract The Partnership did not follow federal procurement regulations when it entered into the $4.2 million contract with ERC Construction Group, LLC (ERC), for construction of the development. Although it was subject to federal procurement regulations, the Authority wrongly believed that it did not need to follow the regulations because the Partnership was a private entity. As a result, the Partnership appeared to sole source the contract and did not adequately protect HUD’s interest. The Partnership generally used federal funds to pay for the $4.2 million construction contract. It used $400,000 in HOME funds, a $1.9 million construction loan guaranteed by the Authority, and about $1.9 million in tax credit equity. The Partnership, as an instrumentality of the Authority, did not procure the contract with full and open competition as required by HUD.4 In accordance with requirements, the Partnership solicited bids and rejected all of the bidders as permitted.5 However, in violation of procurement requirements, the Partnership 4 24 CFR (Code of Federal Regulations) 85.36(c). 5 24 CFR 85.36(d)(2). 6 then separately negotiated and contracted with ERC, which had not submitted a bid. Additionally, the Partnership did not require ERC to obtain a performance and payment bond for 100 percent of the contract amount as required by HUD.6 Federal regulations required the Partnership to get a 100 percent performance and payment bond from the contractor unless HUD had determined that its interests were adequately protected. HUD did not waive the bond requirement. The Partnership initially required the bidders to certify that they could get the required performance and payment bond, but when it contracted with ERC, it did not require a performance and payment bond for 100 percent of the more than $4.2 million contract. Instead, ERC provided a $630,000 irrevocable letter of credit, slightly less than 15 percent of the contract amount. The Authority Did Not Properly Procure Legal and Architectural Services The Authority provided no evidence that it prepared independent cost estimates and solicited quotes for the architectural and legal services before selecting the service providers as required by its own procurement policy and HUD requirements.7 As a result, it could not support that $26,048 capital funds that it spent on legal and architectural services from November 2005 through December 2006 was reasonable and necessary for its public housing program. In its fiscal year 2005 audit report, dated June 28, 2006, the independent auditor reported that the Authority had not followed its procurement policy. The audit report disclosed that the Authority agreed to review all services provided and contracts and ensure that it complied with its procurement procedures in the future. The independent auditor cleared the finding during the fiscal year 2006 audit. Following the 2005 financial audit, the Authority did not review the procurement of legal services to determine whether it complied with procurement procedures. The Authority continued to use the attorney throughout this audit period. When questioned about the legal services, the Authority could not support that it followed procurement requirements, although it entered into another contract with the attorney on May 7, 2008. Further, the Authority spent up to $7,368 of its capital funds for its instrumentality’s legal costs that were not approved by HUD as public housing activities. The legal services included various research regarding the limited partnership, such as reviewing articles and certificate and code provisions, 6 24 CFR 85.36(h). 7 HUD Handbook 7460.8, REV-2. 7 reviewing and revising by-laws, reviewing the HOME agreement and letter of intent, correspondence with and letters to the limited partner, and research regarding CDBG funds. The $7,368 is included in the $26,048 in improper procurements noted above. Recommendations We recommend that the Acting Director, Office of Public Housing, require the Authority to 1A. Obtain the release of any encumbered assets and implement procedures to ensure that it will no longer encumber assets. 1B. Support or reimburse $26,048 from nonfederal funds to its capital fund grants or HUD, as appropriate,8 for unsupported procurement activities and costs. 1C. Ensure that it procures goods and services as required by its own procurement policy and HUD procurement requirements. We recommend that the Director, Office of Community Planning and Development, require the Authority to 1D. Support or reimburse the HOME program $400,000 from nonfederal funds for unsupported procurement activities. 1E. Implement written procedures and controls to ensure that its instrumentalities comply with federal procurement regulations. 8 42 USC (United States Code) 1437(g). 8 Finding 2 The Authority Spent More Than $108,000 on Questionable Costs The Authority spent more than $108,000 for ineligible and unsupported costs. It spent more than $104,000 in CDBG and Section 8 funds to purchase land for planned housing developments. However, the land was not zoned for housing, and the City did not approve rezoning. Further, the Authority spent more than $4,000 in low-rent funds on costs not included in its public housing plan because it misclassified the costs. As a result, the funds were not available to fund other activities for the intended program beneficiaries. The Authority Spent $104,198 for Land That Could Not Be Used for Housing Purposes In October 2006, the Authority purchased land for $104,198, using $94,430 in CDBG funds and $9,768 in pre-2003 Section 8 administrative fee reserves. Authority officials planned to use the land for housing purposes as required by federal regulations.9 However, the zoning laws did not permit it. Further, the City’s planning commission did not approve a rezoning of the property so that the Authority could use it as planned. If the Authority cannot use the land for housing purposes as required by federal regulations, it should return the $104,198 to the CDBG and Section 8 programs. The Authority Inappropriately Spent $4,440 in Low-Rent Funds In violation of its annual contributions contract, the Authority inappropriately spent $4,440 in capital funds on mixed finance activities without HUD approval. Apparently, Authority officials misclassified the costs. The misclassification of funds reduced the funds available for the Authority’s public housing program. Specifically, from August 2007 through January 2008, the Authority spent $4,440 for credit checks of individuals who were not public housing tenants. Following discussions with the Authority’s executive director, the Authority repaid $4,440 to its capital fund grants. 9 24 CFR Parts 982 and 570. 9 Recommendations We recommend that the Acting Director, Office of Public Housing, require the Authority to 2A. Reimburse its capital fund grants or HUD, as appropriate, $4,440 from nonfederal funds for ineligible expenses (the Authority has already repaid $4,440 to its capital fund grants). 2B. Support or reimburse $9,768 from nonfederal funds to the pre-2003 Section 8 project reserve account, as appropriate, for unsupported expenses. 2C. Implement written procedures and strengthen controls to prevent the use of low-rent funds for unauthorized costs. We recommend that the Director, Office of Community Planning and Development, require the Authority to 2D. Support or reimburse the CDBG program $94,430 from nonfederal funds for land not used for CDBG purposes. 10 SCOPE AND METHODOLOGY Based upon the initial results, we modified the objectives. The initial objectives were to determine whether the Authority complied with HUD’s procurement regulations and whether it spent funds provided by HUD in accordance with HUD’s rules and regulations for the period October 1, 2005, through September 30, 2007. We modified the objectives to focus on procurement and costs related to the relocation and its instrumentality’s development activities. To accomplish the objectives, we expanded the audit period through January 31, 2008. We performed audit fieldwork at the Authority’s administrative office in Fort Smith, Arkansas, and our office in Oklahoma City, Oklahoma. To accomplish the objectives, we performed the following steps: Reviewed the Authority’s financial records, policies, and procedures. Reviewed the Authority’s audited financial statements, annual contributions contract, and annual performance plans. Reviewed loan and guarantee agreements related to the development. Reviewed relevant federal regulations and other criteria. Conducted interviews with HUD officials, Authority officials, and other individuals involved in development activities. Toured Ragon Homes and the development on February 12, 2008. Reviewed the $4.2 million construction contract for the development. Reviewed all of the Authority’s payments for apparent development and relocation activities not paid to the developer, which totaled $401,290. For the period October 1, 2005, through January 31, 2008, we reviewed the development agreement for the development. Using a nonstatistical method, we reviewed two of 15 payments from low-rent funds to the developer for relocation costs. The $18,257 in selected payments represented 9 percent of the $199,314 charged under the agreement. We reviewed the two samples to determine whether the developer had records to support costs charged for the development services. We compared the developer’s records to the invoices. The developer had records to support all of the charges for the two invoices. Since we found no discrepancies, we did not test the remaining $181,057. For the period October 1, 2005, through January 31, 2008, we reviewed $331,140 (12 percent) of $2,825,852 in payments from the Authority’s CDBG, HOME, and low-rent funds to determine whether the Authority complied with its procurement policy and HUD’s procurement requirements. The population did not include payments for the development or relocation activities. We used a nonstatistical sample to review the payments. For the sample of 20 payments, we selected five of the seven vendors with the top total payments and reviewed the largest payment to each vendor. For 13 of the remaining 15 samples, we selected payments that exceeded $5,000 each. We also reviewed the contracts for accounting and legal services. The 11 conclusions reached relate only to the sample items tested and cannot be projected to the entire population. We conducted the 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. 12 INTERNAL CONTROLS Internal control is an integral component of an organization’s management that provides reasonable assurance that the following objectives are being achieved: Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations. Internal controls relate to management’s plans, methods, and procedures used to meet its mission, goals, and objectives. Internal controls include the processes and procedures for planning, organizing, directing, and controlling program operations. They include the systems for measuring, reporting, and monitoring program performance. Relevant Internal Controls We determined the following internal controls were relevant to our audit objectives: Compliance with laws and regulations – Policies and procedures that management has implemented to reasonably ensure that resource use is consistent with laws and regulations. Safeguarding resources – Policies and procedures that management has implemented to reasonably ensure that resources are safeguarded against waste, loss, and misuse. We assessed the relevant controls identified above. A significant weakness exists if management controls do not provide reasonable assurance that the process for planning, organizing, directing, and controlling program operations will meet the organization’s objectives. Significant Weaknesses Based on our review, we believe the following items are significant weaknesses: Compliance with laws and regulations – Authority management violated the Authority’s annual contributions contract with HUD when it inappropriately encumbered the Authority’s assets, spent funds on nonprogram activities, and required tenants to waive their right to relocation assistance. Further, the 13 Authority and its instrumentality, the Partnership, did not comply with procurement regulations. Safeguarding resources – Authority management inappropriately encumbered public housing assets by guaranteeing payment of loans needed to fund private development activities. Further, management exposed the Authority to large contingent liabilities when it inappropriately guaranteed the Partnership’s performance regarding the development activity. 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation number Ineligible 1/ Unsupported 2/ 1B $ 26,048 1D 400,000 2A $4,440 2B 9,768 2D _______ 94,430 Totals $4,440 $530,246 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 policies or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. 15 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 Comment 1 Comment 2 16 17 Comment 3 Comment 3 18 Comment 1 Comment 1 Comment 3 19 Comment 1 Comment 3 Comment 1 20 Comment 4 21 Comment 1 22 Comment 2 Comment 5 23 24 Comment 5 Comment 6 25 Comment 7 26 Comment 7 Comment 8 27 28 Comment 7 Comment 9 29 30 Comment 10 31 OIG Evaluation of Auditee Comments Comment 1 We disagree with the Authority’s statement that it did not encumber public housing assets in violation of its annual contributions contract. In its response, the Authority wrote that PIH (Public and Indian Housing) 2007-15 (the notice) did not apply to its guarantees because HUD issued the notice after the Authority entered into the agreements. Contrary to the Authority’s opinion, HUD did not create new regulations under the notice, but clarified existing requirements. The notice was prepared to explain existing requirements regarding public housing activities, including mixed-finance development. Even though the guarantees were unsecured, they did not include language that would prohibit the lender or limited partner from claiming a judgment against public housing assets. The Authority had obligations to pay for costs that it guaranteed under the agreements. Furthermore, the Authority waived its right to a trial by jury. The Authority placed its public housing assets at risk. According to the $1.9 million guarantee, the lender could “receive a security interest in any property” without notifying the Authority. It could also assign or transfer all of the loan obligations without notifying the Authority. The Authority’s guarantee remained in effect should the lender assign or transfer the loan obligations to another entity. Thus, the lender could assign the obligations to any entity that had in its possession the Authority’s funds. The Partnership was fortunate that the contractor completed the construction project as planned. However, had there been problems with the construction, renting the units, and the project’s ability to pay its expenses, the lenders and the partnership had the Authority’s guarantees they could have used against the Authority. The Partnership guaranty will remain effective until all of the activities of the partnership agreement are completed. The Authority has guaranteed to fund development and operating deficits, loss of tax credits, and other general partner obligations set forth in the partnership agreements. The Authority will be responsible for tax credit shortfalls should the Internal Revenue Service limit or not allow the tax credits. Total tax credits over a 12-year period exceed $4 million. Comment 2 We disagree with the Authority’s assertion that the Partnership did not need to comply with federal procurement regulations at 24 CFR Part 85 because it was not the Authority’s instrumentality. Federal regulations required the Partnership to comply with 24 CFR Part 85 if the Authority exercised significant functions 32 within the entity. 10 The Authority believes that it lacked “effective control” over the Partnership to make it an instrumentality. The Authority stated that Alliant Credit Facility had "effective control" over the Partnership. This argument is flawed in that at the time of the ERC Construction procurement, Alliant was not in the Partnership and the Authority had effective control. DATE DESCRIPTION February 7, 2006 North Pointe Limited Partnership agreement signed by North Pointe, Inc. (company), the general and limited partner October 1 and 8, 2006 Advertisement for bids for construction of North Pointe development October 26, 2006 Bids received and reviewed; at least one, if not two, of the contractors met all the qualifications March 20, 2007 North Pointe, Inc. entered into the construction contract with ERC Construction that did not bid on the construction April 1, 2007 Alliant Credit Facility entered the Partnership as the limited partner; the company remained the general partner As the timetable above clearly shows, the company was the only partner of the Partnership. As previously explained, the Authority was the company’s sole shareholder. Two of the Authority’s board members, its executive director, and its director of finance served within the company. Thus, the Authority controlled the company and the company controlled the Partnership. As a result, the Partnership was the Authority’s instrumentality and was required to comply with federal procurement regulations. Comment 3 The Authority’s guarantees encumbered assets covered by its annual contributions contract. As stated in the finding, the Authority violated its annual contributions contract when it entered into the guarantees without informing HUD. The annual contributions contract precluded the Authority from entering into those agreements without prior HUD approval. 11 Comment 4 This was not the issue. We agree that the Authority did not pledge its public housing assets. Comment 5 We disagree with the Authority’s assertion that the Partnership was not the Authority’s instrumentality. The Authority had effective control over the 10 24 CFR 941.602. 11 Annual contributions contract, part A, section 7. 33 Partnership because the Authority owned 100 percent of the only partner. Thus, the Partnership was the Authority’s instrumentality. Comment 6 The Partnership did not comply with federal regulations at 24 CFR Part 85. The regulations state that any arbitrary action on the part of the contracting agency is restrictive of full and open competition. The Partnership chose ERC Construction based on the following arbitrary actions that were restrictive of open competition. Violating requirements,12 the Partnership did not support its noncompetitive procurement by determining that competition was inadequate. Upon reviewing and rejecting the bids, the Partnership rejected two qualified contractors because their bids exceeded the independent cost estimate. The Partnership should have met with the qualified bidders to discuss the differences between their bids and the cost estimate. If it determined that the cost estimate was good, it should have gone back through the request for proposal process. However, there is no evidence that the Partnership either began a new bidding process or worked with the qualified contractors to determine why their bids were higher than the estimate. Instead, the Partnership used the bids to negotiate and select a firm that did not even bid on the construction. Comment 7 We commend the Authority for acknowledging the improper expenditures and commitment to repay its capital fund account. The Authority should work with HUD to ensure that it repays the funds to the correct program or to HUD, as appropriate. Comment 8 The Authority stated that it intends to use the $104,198 land for affordable housing purposes, as required by federal regulations. The Authority needs to work with HUD to clear the recommendation by either successfully getting the land re-zoned or repaying the funds. Comment 9 Based on the Authority’s response, we have removed the matter from the report. Comment 10 Based on the Authority’s response and consultations with HUD, we removed the matter from the report. 12 24 CFR 85.36(d)(4). 34
The Fort Smith Housing Authority Made Inappropriate Guarantees, Did Not Follow Procurement Requirements, and Spent Program Funds on Questionable Activities
Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-10-22.
Below is a raw (and likely hideous) rendition of the original report. (PDF)