Issue Date March 25, 2009 Audit Report Number 2009-FW-1007 TO: Raynold Richardson Director, Multifamily Program Center, 6EHM Henry S. Czauski, Acting Director, Departmental Enforcement Center, CV FROM: Gerald R. Kirkland Regional Inspector General for Audit, Fort Worth Region, 6AGA SUBJECT: The Owners of Stonebrook Apartments Phase I and Phase II, Baytown, Texas, Violated Their Regulatory Agreements with HUD HIGHLIGHTS What We Audited and Why We audited Stonebrook Apartments Phase I and Phase II (projects) to determine whether the projects’ owners complied with the regulatory agreements and U. S. Department of Housing and Urban Development (HUD) regulations. Specifically, we wanted to determine whether the owners (1) made unauthorized distributions of project funds when the projects were in a non-surplus-cash position, (2) fully funded the tenant security deposit accounts, and (3) supported disbursements with invoices or other supporting documentation. We selected the projects for review in accordance with our strategic plan and regional goals. In addition, the audited financial statements of the projects indicated potential unauthorized distributions and transfers. What We Found The owners and/or their management agents did not comply with the regulatory agreements and HUD regulations. Specifically, the owners and/or their management agents paid more than $187,500 in questioned costs. The questioned costs included unauthorized distributions ($81,035) from the projects’ operating and tenant security deposit accounts when the projects were in a non-surplus-cash position, underfunded tenant security deposit accounts ($27,514), ineligible ($20,644) and unsupported ($16,945) disbursements, duplicate payments ($7,235), excessive management fees ($26,134), and unreasonable and unnecessary bonuses ($8,000). Further, audit testing disclosed that they did not maintain accurate financial information, did not submit annual audited financial statements in a timely manner, and transferred the management of the projects without HUD’s approval. What We Recommend We recommend that the Director, Houston Multifamily Program Center, require the owners to (1) repay the projects $81,035 for unauthorized distributions, (2) fully fund the tenant security deposit accounts, (3) repay the projects $62,0131 for ineligible or unnecessary disbursements and either furnish supporting documentation or repay the projects $16,945 for unsupported expenses, and (4) correct and maintain the projects’ accounting records in compliance with the regulatory agreements. We also recommend that HUD’s Acting Director of the Departmental Enforcement Center seek civil money penalties and administrative sanctions, as appropriate, against the owners for violating the projects’ regulatory agreements. 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 a draft report to the owners on February 27, 2009, held an exit conference on March 12, 2009, and requested a written response by March 13, 2009. At the auditee’s request, we extended the response date to March 17, 2009. The owners provided written comments on March 17, 2009, and both agreed and disagreed with the findings and recommendations. HUD’s Office of Multifamily Housing agreed with our position and indicated that it will take corrective actions. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. The auditee also provided documents as attachments to the response that are not included in appendix B but are available upon request. 1 Ineligible and unnecessary disbursements of $20,644 +7,235 +26,134 +8,000 = $62,013. 2 TABLE OF CONTENTS Background and Objective 4 Results of Audit Finding 1: The Owners and/or Their Management Agents Paid More Than 5 $187,500 in Questioned Costs Finding 2: The Owners and/or Their Management Agents Did Not Maintain or 10 Submit Accurate Financial Information Scope and Methodology 14 Internal Controls 15 Appendixes A. Schedule of Questioned Costs 16 B. Auditee Comments and OIG’s Evaluation 17 3 BACKGROUND AND OBJECTIVE Stonebrook Apartments Phase I, a 184-unit apartment complex, and Stonebrook Apartments Phase II, a 192-unit apartment complex, are both located at 619 Rollingbrook Street, Baytown, Texas. In May 2000, Baytown Stonebrook Apartments, Ltd. (owner), a Texas partnership, developed Stonebrook Apartments Phase I. In August 2002, Stonebrook at Goose Creek, Ltd. (owner), a Texas partnership, developed Stonebrook Apartments Phase II. Financing for both projects, more than $10 million for Phase I and more than $9.8 million for Phase II, was provided by Davis-Penn Mortgage Company and insured by the Federal Housing Administration (FHA) under section 221(d)(4) of the National Housing Act. The owners for both projects remained the same throughout the audit period, but the individual partners of the partnerships changed. The two previous general partners for both projects were GT, L.C., owned by Mr. Gerald A. Teel, and TTDT, L.L.C., owned by Mr. Howard T. Tellepsen, Jr. The previous general partners requested the U. S. Department of Housing and Urban Development’s (HUD) approval to sell their partnership interests to the new partners in August 2005. The new partners for both projects included Management Solutions, Inc., a general partner,2 and seven limited partners. The new partners assumed control in August 2005, but the change in ownership was not recorded until November 2006. HUD did not approve the sale until April 24, 2007. The partners’ attorneys explained to HUD that the transfer did not cause dissolution of the partnership under the applicable Texas law. From May 2002 through our review period, three management agents managed the projects. Until July 2005, the management agent for both projects was Greystone Asset Management, L.P., which maintained its office and records at 3120 Southwest Freeway, Suite 410, Houston, Texas. Management Solutions, Inc., a related management agent, located at 400 North State Street, Fountain Green, Utah, managed both projects from August 2005 to July 2007. In July 2007, Management Solutions, Inc., transferred the management of the projects to another related entity, Starwood Management Company, Inc. Starwood Management Company, Inc., is located at 8299 Small Block Road, North Lake, Texas. Our objective was to determine whether the projects’ owners complied with the regulatory agreement and HUD regulations. Specifically, we wanted to determine whether the owners (1) made unauthorized distributions of project funds when the projects were in a non-surplus-cash position, (2) fully funded the tenant security deposit accounts, and (3) supported disbursements with invoices or other supporting documentation. 2 Management Solutions, Inc., was also the management agent of both projects. Mr. Wendell A. Jacobson is the president of the general partner and also the president of the management agent. 4 RESULTS OF AUDIT Finding 1: The Owners and/or Their Management Agents Paid More Than $187,500 in Questioned Costs The owners and/or their management agents violated the projects’ regulatory agreements and paid $187,507 in questioned costs. The questioned costs included unauthorized distributions, underfunded tenant security deposit accounts, ineligible and unsupported disbursements, duplicate payments, excessive management fees, and unreasonable and unnecessary bonuses. These improper payments occurred because the owners and/or their management agents disregarded the projects’ regulatory agreements and/or they were not familiar with HUD’s requirements and regulations, and did not have effective controls. Their actions unnecessarily depleted the projects’ operating resources and increased the risk of default on the projects’ FHA- insured loans. The Owners Made Unauthorized Distributions In violation of the regulatory agreements,3 the previous owners of the partnerships made unauthorized distributions totaling $119,073 from the projects when the projects did not have surplus cash. The previous owners made the unauthorized distributions when they transferred the management of the projects and their ownership interests in the partnerships in 2005. They distributed all of the funds in the projects’ bank and tenant security deposit accounts to themselves. A portion of the tenant security deposit funds was returned to the new partners and, ultimately, to the projects which reduced the total amount of the unauthorized distributions to $81,035, as shown in the table on the next page. 3 Section 6(e) of the regulatory agreement states that without prior HUD approval, the owner shall not make or receive and retain any distribution of assets or any income of any kind of the project except surplus cash and except on certain other conditions. Section 13(g) of the regulatory agreement states that “distribution” means any withdrawal or taking of cash or other assets of the project other than for mortgage payments or reasonable expenses. 5 Unauthorized Distributions Phase I Phase II Totals Project funds distributed $35,851 $24,605 $60,456 Plus tenant security deposit funds distributed 26,515 32,102 58,617 Total funds distributed $62,366 $56,707 $119,073 Less tenant security deposit funds transferred to new partners (17,935) (20,103) (38,038) Plus tenant security deposit funds not transferred to new partners 8,580 11,999 20,579 Outstanding unauthorized distributions $44,431 $36,604 $81,035 The previous owners knew that they could not make distributions if the projects did not have surplus cash; however, they disregarded this regulatory agreement requirement. The Current Owners Underfunded the Tenant Security Deposit Accounts The current owners had not fully funded the projects’ tenant security deposit accounts since they acquired their ownership interests in the projects.4 The table below shows the amounts by which the projects’ accounts were underfunded as of June 30, 2008. Underfunded Tenant Security Deposits Phase I Phase II Totals Amount of deposits required $43,053 $43,814 $86,867 Less actual bank account balance (18,282) (20,492) (38,774) Amount underfunded $24,771 $23,322 $48,093 Less amount of unauthorized distributions in previous section (8,580) (11,999) (20,579) Remaining underfunded amount $16,191 $11,323 $27,514 The owners did not fully fund the accounts because they either ignored the regulatory agreements or did not understand them. Consequently, funds might not have been available to refund the tenants when needed. 4 Section 6(g) of the regulatory agreement states that any funds collected as security deposits shall be kept separate and apart from all other funds of the project in a trust account, the amount of which shall at all times equal or exceed the aggregate of all outstanding obligations under said account. 6 The Owners and/or Management Agents Made Ineligible and Unsupported Disbursements The owners and/or management agents used project funds for $20,644 in ineligible disbursements, $16,945 in unsupported disbursements, and a $7,235 duplicate payment.5 Ineligible expenses included payments for personal expenses such as fees to an aquarium in Kemah, Texas; gasoline purchased in Lake Charles, Louisiana; food purchased in Las Vegas, Nevada; and other such purchases for an individual related to the owners and for legal fees to transfer the ownership interests of the projects. The unsupported disbursements included office expenses when the new partners acquired the projects and expenses which lacked support to show that they were for the projects. The duplicate payment occurred when the management agent paid one contractor twice for the same invoice. The above condition occurred because the owners and/or management agents did not have effective controls. The Management Agents Paid Excessive Management Fees The management agents paid themselves at least $26,134 in duplicate and incorrectly calculated management fees during the audit period. The management fees paid exceeded the 6 percent allowable management fees contained in the management agent certification. The management agents paid excessive management fees because they were not familiar with HUD’s requirements and regulations regarding the management fees. On two occasions, in August 2005 and July 2007, both the prior and current management agents paid themselves $22,131 in management fees for operating the projects. Only one payment should have been made to either the incoming or outgoing management agent. Both the prior and current management agents improperly calculated the management fees by including tenant security deposits as revenue when making the calculation. Tenant security deposits are not project revenue; therefore, management fees derived from tenant security deposits are not allowable.6 Testing for eight months showed that Management Solution, Inc., and Starwood Management 5 Section 6(b) of the regulatory agreement states that without prior HUD approval, the owner shall not assign, transfer, dispose of, or encumber any personal property of the project, including rents, and shall not pay out any funds except for reasonable operating expenses and necessary repairs. HUD Handbook 4370.2, REV-1, paragraph 2-6E, requires that all disbursements from the regulatory operating account be supported by approved invoices/bills or other supporting documentation. 6 HUD Handbook 4381.5, REV-2, section 3.2(b), relating to allowable management fees from project funds, states that fees should be derived from project income (residential, commercial, and miscellaneous). 7 Company were overpaid $4,003. Since the excess charges occurred in all months tested, we concluded that they occurred throughout the period during which Management Solutions, Inc., and Starwood Management Company managed the projects. As a result, the owners will need to determine the total amount of the overpayments and ensure that those funds are returned to the projects. The Owners Paid Unreasonable and Unnecessary Bonuses The owners and/or management agents did not overcharge the projects for normal payroll expenses. However, they paid unreasonable and unnecessary bonuses of $8,000 to the employees for meeting the projects’ “income goal”. The bonuses should be disallowed 7 because the employees misreported income by recording deposits as having been received in future months once the project reached its goal for the current month (see discussion in detail in finding 2). Conclusion The owners and/or their management agents violated the regulatory agreements and incurred $187,507 in questioned costs when they made unauthorized distributions, underfunded the tenant security deposit accounts, used the projects’ funds for ineligible and unsupported expenses, made a duplicate payment, overcharged for management fees, and paid unreasonable and unnecessary bonuses. The questioned costs reduced the availability of cash needed to fund the projects’ operations. Recommendations We recommend that the Director, Houston Multifamily Program Center, 1A. Require the owners to repay $81,035 to the projects, $60,456 to the projects’ operating accounts and $20,579 to the tenant security deposits accounts, for unauthorized distributions. 1B. Require the owners to deposit an additional $27,514 into the projects’ tenant security deposit accounts to fully fund them. 1C. Require the owners to repay $27,879 for ineligible disbursements and a duplicate payment ($20,644 + $7,235). 7 Section 9(b) of the regulatory agreement states that payments for services, supplies, or materials shall not exceed the amount ordinarily paid for such services, supplies, or materials in the area where the services are rendered or the supplies or materials furnished. 8 1D. Require the owners to either furnish supporting documentation or repay the projects $16,945 for unsupported expenses. 1E. Require the owners to repay $26,134 for excessive management fees. 1F Require the owners to have the management agent recalculate the management fees for the months not tested to determine the amount of overcharges and repay any overpayment of management fees to the projects. 1G. Require the owners to repay the projects $8,000 for unreasonable and unnecessary bonuses. 1H. Require the owners to implement effective controls over the project disbursements to ensure that future distributions and expenditures comply with the regulatory agreement. 9 Finding 2: The Owners and/or Their Management Agents Did Not Maintain or Submit Accurate Financial Information The owners and/or their management agents did not maintain accurate financial information as HUD required8 because they instructed their staff to record current deposits for future months, once the project reached its goal for the current month, and classify routine maintenance and repairs as capital improvements. In addition, the owners and management agents did not ensure that staff adequately allocated income and expenses between the two projects, deposited rental receipts in a timely manner, and properly accounted for tenant security deposits when the partnerships were sold. Further, the owners did not submit annual audited financial statements in a timely manner as required and transferred the management of the projects without HUD’s approval. These conditions occurred because the owners and/or the management agents ignored HUD’s requirements and regulations or did not understand them, or did not have effective controls. Consequently, HUD and other stakeholders could not reasonably assess the financial condition of the projects. The Owners Did Not Accurately Report Rental Receipts or Deposit Them in a Timely Manner The owners and/or their management agents did not accurately report the rental receipts for the months in which they were received and deposited. For example, the July and August 2007 rental receipts were received and deposited in the projects’ bank accounts in July and August 2007; however, because the projects had reached the “income goal” set for those months, the staff changed the computerized general ledgers to record the deposits as having been made in September 2007. The reported revenue indicated that the owners and/or management agents did so to show the projects had a steady income stream or a steady increase in income each month. Also, the owners and/or management agents did not always deposit rental receipts daily as required by their operations manual. For instance, rental receipts totaling $196,010, received between November 9, 2007, and December 26, 2007, were deposited in January 2008. The conditions occurred because, according to the current management agent’s staff, the owners instructed them to record the current deposits received as if they had been received in future months once the project reached its goal for the current month. The projects’ profit and loss statements, therefore, reflected only what was posted in the general ledgers and not what the projects actually collected from August 2005 to June 2008. Consequently, the projects’ income was underreported. 8 Sections 9(c) and (d) of the regulatory agreement require the owner to keep the books and accounts of project operations in condition for a proper audit and in accordance with HUD requirements. HUD Handbook 4370.2, REV-1, paragraph 2-3B, requires that financial records be complete, accurate, and updated on a monthly basis. 10 The Owners Misclassified Maintenance and Repairs The owners and/or their management agents also instructed staff to classify routine maintenance and repairs, such as carpet replacements and flooring or roofing repairs, as capital improvements. The misclassification of maintenance and repairs as capital improvements incorrectly increased the projects’ assets and decreased the amount reported as expenses. The Owners Did Not Adequately Allocate Income and Expenses The owners and/or their management agents did not adequately allocate income and expenses between the two projects. For example, the current partners charged $462,159 in payroll expenses to Phase I, but charged $354,845 to Phase II for the period July 2005 to June 2008, although the employees worked for both projects and Phase I has 184 units while Phase II has 192 units. According to the management agent’s staff, expenses other than payroll were allocated equally to the projects; however, the table below shows that the management agent’s staff did not evenly split expenses based on the amounts reported in the projects’ 2006 audited financial statements. Expense allocations Financial Statement Categories Phase I Phase II Tenant charges $119,028 $0 Advertising and marketing 54,947 12,305 Property & liability insurance 106,319 58,250 Mortgage insurance premium 0 78,116 The inadequate allocation of the projects’ income and expenses overstated or understated the project income for each project and did not clearly disclose the transfer of funds between the projects in the financial records. The Owners Did Not Properly Maintain or Account for Tenant Security Deposits The current owners did not properly establish or maintain the projects’ tenant security deposit accounts. Although the current owners assumed ownership of the projects in August 2005, they did not establish the tenant security accounts until February 2007. Further, after establishing the accounts, the owners and/or their management agents did not use the accounts properly. Specifically, they did not 11 maintain the tenant security deposit funds separately, as required, and did not treat them as a liability of the projects. Instead, they deposited and refunded the tenant security deposit funds out of the projects’ operating bank accounts. The owners and/or their management agents also inaccurately reported tenant security deposits transferred by the previous partners as owners’ contributions. The general ledgers and bank statements indicated that the previous partners transferred $17,935 in tenant security deposit funds from Stonebrook Phase I and $20,103 from Stonebrook Phase II to the new partners in August 2005 when they transferred the management and ownership to the new partners. The current partners deposited the tenant security deposits into new accounts and reported the amounts as owners’ contributions, which incorrectly increased the partners’ equity in the financial reports. Audited Financial Statements Were Not Submitted in a Timely Manner The owners failed to submit the audited financial statements in a timely manner as required.9 The annual audited financial reports for the fiscal years ending December 31, 2005; December 31, 2006; and December 31, 2007, were due to HUD on the 90th day following the end of each fiscal year. The owners, however, submitted the 2005, 2006, and 2007 reports on September 6, 2006; May 29, 2007; and July 31, 2008, respectively. The Owners Transferred Management Agents without HUD’s Approval Management agents are subject to HUD approval, and management fees may be paid only to the person or entity approved by HUD to manage the project.10 In violation of this requirement, the current partners transferred the management of the projects from Management Solutions, Inc., to its related entity, Starwood Management Company, Inc., in July 2007 without informing HUD and/or obtaining HUD’s approval. 9 Section 9(e) of the regulatory agreement requires the owner to submit audited annual financial statements within 60 days following the end of each fiscal year. HUD extended the period to 90 days in 24 CFR (Code of Federal Regulations) 5.801(c)(2). 10 HUD Handbook 4381.5, REV-2, paragraphs 2-2 and 3-1. 12 Conclusion The owners’ failure to maintain accurate financial records prevented HUD and other stakeholders from properly assessing the projects’ true financial condition. The owners also violated the regulatory agreement when they did not submit the annual audited financial reports in a timely manner as required and transferred the management of the projects without reporting to HUD or obtaining HUD approval. The owners were responsible for implementing the required financial and accounting controls, obtaining HUD approval of the new management agent, and submitting the audited financial reports in a timely manner to ensure compliance with the regulatory agreement and HUD requirements. Recommendations We recommend that the Director, Houston Multifamily Program Center, require the owners to 2A. Correct and maintain the projects’ accounting records in accordance with HUD requirements. 2B. Submit annual audited financial statements in a timely manner. 2C. Obtain the services of a HUD approved management agent for both projects. 2D. Submit the monthly accounting reports for both projects to HUD. We further recommend that the Director of HUD’s Departmental Enforcement Center 2E. Seek civil money penalties and administrative sanctions, as appropriate, against the owners for the regulatory agreement violations disclosed in this report. 13 SCOPE AND METHODOLOGY Our objective was to determine whether the projects’ owners complied with the regulatory agreement and HUD regulations. To accomplish our objective, we Reviewed background information and the criteria that control the insured multifamily housing projects. Reviewed various reports, databases, and documents to determine existing conditions at Stonebrook Apartments. The data included available independent public accountant reports for fiscal years 2005, 2006, and 2007; information contained in HUD’s Real Estate Management System; and documents maintained by the multifamily project manager assigned to monitor the project. Inspected the projects’ common areas to determine overall physical condition. Reviewed disbursements and deposits in the accounting records and supporting documentation to determine whether they appeared appropriate. We reviewed and tested a nonstatistical sample of 60 disbursements. The selected sample included various vendors, accounts, and transactions that were, based on our professional judgment, likely to have a high risk of error. We expanded the sample and selected six more disbursements that equaled $500 or greater for the vendors or contractors for which disbursements were ineligible or unsupported. The conclusions reached in this report relate only to the sample items tested and have not been projected to the universe of approximately 4,400 disbursements. Reviewed tenant security deposit accounts. Reviewed fund transfers into and out of the projects’ bank accounts and contacted the independent public accountant to obtain the working papers which supported his or her findings. Conducted interviews with the previous partner, staff of the current management agent, the project manager, and HUD officials. The current management agent’s staff provided computerized general ledgers and check registers for the period August 2005 to June 2008 in excel files. We assessed the computerized data and found that the disbursements contained in the projects’ general ledgers and check registers were sufficiently reliable as the disbursements were recorded in the check registers and the check register entries were located in the general ledgers. The allocation of expenses, however, was inadequate and the maintenance and repair expenses were misclassified (see finding 2). The results of our disbursement tests, therefore, are based on our review of source documentation, check vouchers, invoices, and bank records. We performed the audit between August 2008 and January 2009 at the projects’ office, the current management agent’s office, and HUD’s Houston field office. Our review period was January 1, 2005, to June 30, 2008. 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 objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. 14 INTERNAL CONTROLS Internal control is an integral component of an organization’s management that provides reasonable assurance that the following controls are achieved: Program operations, Relevance and reliability of information, Compliance with applicable laws and regulations, and Safeguarding of assets and resources. Internal controls relate to management’s plans, methods, and procedures used to meet its mission, goals, and objectives. They include the processes and procedures for planning, organizing, directing, and controlling program operations as well as the systems for measuring, reporting, and monitoring program performance. Relevant Internal Controls We determined that the following internal controls were relevant to our audit objectives: Controls over compliance with laws and regulations and Controls over disbursements. 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 Weakness Based on our review, we believe that the following item is a significant weakness: Controls over compliance with laws and regulations were ineffective or nonexistent. Controls over disbursements did not ensure that the property funds were expended for only reasonable and necessary expenses. 15 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation Ineligible 1/ Unsupported 2/ Unreasonable or number unnecessary 3/ 1A $81,035 1B 27,514 1C 27,879 1D $16,945 1E 26,134 1G $8,000 Totals $162,562 $16,945 $8,000 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 the audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. 3/ 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. 16 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 17 Comment 1 Comment 2 Comment 1 Comment 2 18 Comment 1 Comment 3 19 Comment 4 20 Comment 5 21 Comment 6 22 23 Comment 7 Comment 8 24 Comment 9 Comment 10 25 Comment 11 Comment 12 26 27 28 OIG Evaluation of Auditee Comments Comment 1 According to the response, the owners fully funded the tenant security deposit accounts as of December 31, 2008, which is after we conducted the audit of the projects. We acknowledge and appreciate the owners’ efforts to correct the finding. HUD will need to verify that the accounts are fully funded before the recommendation will be closed. Comment 2 The owners agreed with the unauthorized distributions but did not assume the previous partners’ liability and would attempt to retrieve the unauthorized withdrawn funds from previous partners. However, the owners agree to repay the unauthorized distributions whether they recover from the previous owners or not. We considered the owners’ alternative recommendation but did not change our recommendation. Comment 3 The new owners disputed that they either ignored the regulatory agreements or did not understand them and claimed that the property manager simply failed or overlooked in making the appropriate transfers of funds in a timely manner. The regulatory agreements required the funds to be maintained separately and fully funded and the amounts must at all times equal or exceed the obligations. The accounts had been underfunded for an extended period which does not support the owner’s claim. We did not revise our conclusion. Comment 4 The owners disagreed that they made ineligible and unsupported disbursements, and they had refunded the duplicate payment. The owners; however, did not provide any document to support their claim. We; therefore, did not change the finding and recommendations. The owners claimed that the transactions we determined to be unsupported were few compared to the numerous transactions they were processing; therefore, did not support our conclusion that they did not have effective controls. We believe that the existence of such errors and our ability to find them without reviewing all transactions demonstrates their lack of effective controls. Comment 5 The owners agreed that they paid excessive management fees, and they contacted the Departmental Enforcement Center and repaid $13,864 of duplicate management fees. They were also in the process of recovering the overpaid management fees from the previous owners. Further, the owners agreed to recalculate the management fees for the months not tested to determine and repay the amount of overcharges. We compliment and appreciate their prompt action to correct this issue. Comment 6 The owners disagreed that the bonuses were unreasonable and unnecessary and stated that they only paid leasing bonuses. The owners and/or management agents paid both leasing bonuses and bonuses for meeting “income goal” which was misstated. We did not question leasing bonuses. 29 Comment 7 The owners stated that they have discontinued the “goal oriented” management plan, agreed to deposit the rental receipts in a timely manner, and agreed to provide monthly accounting reports to HUD but disagreed that the “goal oriented” plan was detrimental to the operational and financial performance of the projects. We recognize the owner’s efforts to correct the deficiencies. Comment 8 The owners maintained that it was not erroneous to classify routine maintenance and repairs as capital improvements under the IRS code. According to the IRS Publication 535, Business Expenses, usually the investment in the business asset that adds value to it, lengthens the time to use it, or adapts it to a different use would be a capital improvement. The routine maintenance and repairs; therefore, usually should not be capital improvements. Comment 9 The owners agreed to review their books and records for 2006 and make the adjustment entries if needed. The owners did not address other inadequate expenses such as payroll which still incurred as of June 30, 2008, our ending audit period. We revised a statement regarding the disclosure of the transfers in the financial records. Comment 10 The owners claimed that some of the tenant security deposits were inadvertently misclassified into projects’ operating accounts, and they were not sure whether they had misclassified tenant security deposits from the previous owners. We disagree with the claim that the owners inadvertently misclassified some of the tenant security deposits into the projects’ operating accounts because the tenant security deposit bank statements as of December 31, 2008, that the owners provided as attachments showed that they deposited and refunded the tenant security deposit funds out of the projects’ operating bank accounts. Further, the 2007 audited financial statements clearly disclosed that the owners classified tenant security deposits obtained from the previous partners as owners’ contributions. Comment 11 The owners claimed that they are not responsible for late submission of the annual audited financial statements because they had no control over their independent auditors. The owners’ regulatory agreements with HUD and HUD regulations specified that it was the owners’ responsibility to submit the annual audited financial statements within 90 days following the end of each fiscal year. Comment 12 The owners claimed that they did not transfer the management agent but subcontracted the management of the projects to their related entity. The owners did not inform and obtain HUD’s approval to transfer or subcontract the management of the projects. 30
The Owners of Stonerook Apartments Phase I and Phase II, Baytown, Texas, Violated Their Regulatory Agreements With HUD
Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-03-25.
Below is a raw (and likely hideous) rendition of the original report. (PDF)