oversight

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)

                                                                 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.

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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.




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