oversight

Cypress Ridge Apartments, Oklahoma City, Oklahoma, Owner's Agent Received and Paid More Than $742,000 Contrary to HUD and Regulatory Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-07-30.

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

                                                                            Issue Date
                                                                                     July 30, 2009
                                                                            Audit Report Number
                                                                                     2009-FW-1014




TO:            Brenda L. Waters
               Acting Director, Kansas City Multifamily Hub, 7AHM

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

               //signed//
FROM:          Gerald R. Kirkland
               Regional Inspector General for Audit, Fort Worth Region, 6AGA

SUBJECT: Cypress Ridge Apartments, Oklahoma City, Oklahoma, Owner’s Agent
         Received and Paid More Than $742,000 Contrary to HUD and Regulatory
         Requirements


                                           HIGHLIGHTS

    What We Audited and Why

                 In response to a request from the U. S. Department of Housing and Urban
                 Development (HUD), we audited Cypress Ridge Apartments’ (Cypress) use of
                 HUD-insured mortgage loan proceeds and property operating funds governed by a
                 regulatory agreement.1

                 The audit objective was to determine whether the management agent/general
                 contractor2 (agent) used project and operating funds consistent with the regulatory
                 agreement and HUD regulations. Specifically, we wanted to determine whether
                 the agent (1) used loan proceeds for other than reasonable project expenses, (2)
                 used operating funds to pay other than reasonable operating expenses and
                 necessary repairs, and (3) paid distributions from other than surplus cash.

1
     HUD and ownership officials executed the regulatory agreement on December 14, 2005.
2
     Williams Commercial Property Management, Inc. was the owner’s management agent for the property and the
     HUD-approved general contractor for the rehabilitation project.
What We Found


           The agent obtained and used funds contrary to the regulatory agreement. It
           received loan proceeds totaling $356,400 without construction cost
           documentation to support the release of proceeds. From the operating account, it
           paid related entities and others $386,007 without required justification for
           payments. This condition occurred because the agent commingled property funds
           with the funds of other properties it managed without an accounting and
           justification of transactions. As a result, the agent drew and paid out amounts
           without assurances that it used the funds for legitimate expenditures. This
           condition put HUD at a greater risk of loss on the mortgage loan insured by the
           Federal Housing Administration (FHA), which later defaulted with a resulting
           loss to FHA of $3.75 million.

What We Recommend


           We recommend that the Acting Director of the Office of Multifamily Housing,
           Kansas City hub, require the owner to either support or repay HUD more than
           $356,000 for loan proceeds it received and support or repay HUD more than
           $386,000 paid out of the operating account. We also recommend that HUD’s
           Acting Director of the Departmental Enforcement Center take appropriate actions
           against the ownership and management agent for violating the project’s regulatory
           agreement.

           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


           On July 1, 2009, we provided a discussion draft report to the ownership of
           Greystone Apartments with written comments due by July 22, 2009. On July 8,
           2009, we held an exit conference with HUD and the ownership. At the exit
           conference, the ownership stated that it could not respond in writing to the
           findings and recommendations by July 22, 2009. The ownership did state that it
           eventually could support the costs reported and it intends to hire a certified public
           accountant to gather and present the support. On July 20, 2009, an attorney for
           the ownership requested an extension to respond by September 30, 2009. We
           denied the request and issued the report without comments.




                                             2
                            TABLE OF CONTENTS

Background and Objective                                                        4

Results of Audit
Finding:   The Agent Paid and Obtained More than $742,000 Contrary to HUD and   5
           Regulatory Requirements


Scope and Methodology                                                           9

Internal Controls                                                               10

Appendix
   A. Schedule of Questioned Costs                                              11




                                            3
                        BACKGROUND AND OBJECTIVE

Cypress Ridge Apartments (Cypress) is a 256-unit garden-style apartment complex in Oklahoma
City, Oklahoma. Greystone Apartments, Inc., the property owner, was the project sponsor and
borrower. Williams Commercial Property Management, Inc., (agent) was the management agent
that operated the property for the ownership. It also was the U. S. Department of Housing and
Urban Development (HUD)-approved general contractor for the property’s rehabilitation project.
William L. Sharpe, the president of Greystone Apartments, and a principal shareholder and
contact person for the ownership, owned Williams Commercial Property Management. On
November 17, 2003, eight individuals purchased controlling stock in the ownership entity with
plans to rehabilitate the property with funds from a Federal Housing Administration (FHA)-
insured loan. On December 14, 2005, Harry Mortgage Company3 (lender) and the owner entered
into a nonrecourse $5.87 million mortgage agreement that FHA insured under Section 221(d)(4)
of the National Housing Act. FHA provides insurance to protect lenders against loss from
defaults on mortgage loans made to rehabilitate housing units for moderate-income and displaced
families.

On December 14, 2005, HUD and the ownership executed a regulatory agreement that limited
property payments to reasonable operating expenses and necessary repairs and project payments
to amounts ordinarily paid for services, supplies, or materials in the area where the user
purchased the services or the supplies and materials. It also required the owner to keep at all
times books, contracts, records, documents, and other papers relating to the operations of the
mortgaged property and the execution of the project in a condition for audit.

On October 1, 2007, 22 months after obtaining the loan, the owner defaulted on its FHA-insured
mortgage loan. The agent had completed only 57 percent of the rehabilitation. Comparably,
contractors usually complete substantial rehabilitation within 12 months. In the appraisal, the
contractor estimated that it would take nine months to complete the rehabilitation.

The lender assigned the note to HUD, and HUD recorded the assignment on November 28, 2007.
HUD paid more than $4.2 million to settle the lender’s claim. On June 26, 2008, HUD sold the
mortgage loan for $484,376, a net loss of more than $3.75 million to the FHA insurance fund.

The audit objective was to determine whether the agent (1) used loan proceeds to pay reasonable
project expenses, (2) used operating funds for reasonable operating expenses and necessary
repairs, and (3) paid distributions from other than surplus cash. This is the second report on
Cypress, with the first report4 addressing processing and underwriting by the lender.




3
    HUD had approved Harry Mortgage Company to process loans under its multifamily accelerated processing
    program.
4
    Harry Mortgage Company, Oklahoma City, Oklahoma, Overstated the Financial Wherewithal of the Owner and
    General Contractor When Underwriting the Cypress Ridge Apartments’ $5.87 Million Loan under the
    Multifamily Accelerated Processing Program, Report Number 2009-FW-1010, dated June 26, 2009.


                                                    4
                                        RESULTS OF AUDIT

Finding: The Agent Paid and Obtained More than $742,000 Contrary to HUD
                  and Regulatory Requirements
The agent with the dual roles of management agent and general contractor did not fulfill its
responsibility to provide support for more than $742,000 in property operating funds disbursed
and project loan proceeds drawn. The lack of support occurred because the agent did not keep
required documentation to justify expenditures charged to the property and the project. As a
result, the agent had no assurances that it used operating funds for legitimate expenditures and
drew amounts to reimburse eligible rehabilitation costs. This condition put HUD at a greater risk
of loss on the FHA-insured mortgage loan, which later defaulted with a resulting loss to FHA of
$3.75 million.



    The Agent Did Not Provide
    Support for More Than
    $356,000 of the Construction
    Costs Reimbursed


                   The project did not have documentation to support construction draws totaling
                   $356,400, or 31 percent, of the $1.1 million that the owner received for the agent’s
                   rehabilitation work.5 Examples of missing support for construction draws included
                   payrolls without time sheets that supported all hours charged, payments to
                   MasterCard without receipts to show what the agent purchased, billings for overhead
                   and general requirements without explanation, and payments to vendors without an
                   invoice or other billing documents. The following table shows by draw that the
                   agent did not have sufficient support for eight of 11 draws.




5
      The lender wrote the checks to the owner, and the owner paid the agent, which deposited the payments into its
      construction bank account.


                                                          5
                         Supported and unsupported construction costs paid
                        Draw6         Paid       Supported Unsupported
                    Draw #2                 $ 15,729              $ 16,156   ($   427)
                    Draw #3                    96,099               91,545       4,554
                    Draw #4                    91,780               83,307       8,473
                    Draw #5                   105,175               54,927      50,248
                    Draw #6                   151,429               46,565    104,864
                    Draw #7                   197,278              197,284          (6)
                    Draw #8                    89,975               58,441      31,534
                    Draw #9                   127,537               65,484      62,053
                    Draw #10                  113,664              115,034     (1,370)
                    Draw #12                   70,827               27,244      43,583
                    Draw #13                   84,070               31,176      52,894
                    Totals                 $1,143,563             $787,163   $356,400


    Property Bank Account
    Payments Included
    Questionable Expenditures of
    More Than $386,000


                  A review of the property bank account disclosed unsupported payments totaling
                  $386,007, including $374,1947 paid to related entities. We classified the
                  payments as follows:

                          Operating account unsupported payments
                   Expenditure                              Amount
                   Related entities
                   Payroll                                                    $174,706
                   Williams Commercial Property Management.                    176,000
                   Other properties managed by the agent                        10,988
                   Owner                                                        12,500
                           Total related entities                             374,194
                   Other
                   Unknown payee                                                6,152
                   Landscaping                                                  2,500
                   Bank of Oklahoma                                             3,161
                           Total other                                         11,813
                   Total                                                     $386,007




6
     Draws 1 and 11 did not contain construction costs.
7
     This represents the gross amount paid to related entities.


                                                           6
                  This condition occurred because the agent did not keep documentation that
                  justified expenditures charged to the property as required by the regulatory
                  agreement.

     The Agent Did Not Provide an
     Accounting of Commingled Funding
     of Properties It Managed

                  Payments to and proceeds from related properties showed that the agent
                  commingled funds8 of properties it managed without a proper accounting. It
                  made payments from the property’s bank account to related parties and deposited
                  proceeds from related parties into the owner’s bank account without
                  documentation to justify transactions and account for the funding.

                  Thereby, the agent did not fulfill the provision of the regulatory agreement that
                  requires a contract agent to maintain records and documents in a reasonable
                  condition for proper audit. Although the property and project had separate bank
                  accounts, the agent wrote checks from the property and project bank accounts to
                  related properties and paid related party bills without documenting the
                  justification for the transactions. For example, the agent wrote checks to Golden
                  Oaks Apartments, for $1,750 on December 29, 2005, and $2,500 on July 5, 2006.
                  For both checks, the agent could not support the payments. On May 15, 2006, it
                  wrote a $4,000 check to Hillcrest Residence Apartments without an explanation in
                  the files. Altogether, the agent paid $5,900 to Hillcrest Residence Apartments
                  without support.

    The Unjustified Use of Funding Put HUD
    at Greater Risk of Loss on the Insured
    Mortgage Loan

                  The unjustified use of funds from the property and the rehabilitation project put
                  HUD at a greater risk of loss on its FHA-insured mortgage loan by not having
                  assurance that use of funding was prudent. This condition could result in less
                  funding to pay suppliers and subcontractors, resulting in liens on the property.
                  For this project, the agent did not complete the rehabilitation and defaulted on the
                  mortgage loan, which the lender eventually assigned to HUD. HUD lost more
                  than $3.75 million.




8
     HUD permits the use of a centralized operating account as long as deposits to and disbursements from the
     account are clearly traceable and the actual cash position of each and every project in the centralized account is
     easily identifiable at all times. In this instance, the entities maintained separate operating bank accounts. Thus,
     for the purposes of this report commingling refers to the payment of expenses for the project and the related
     parties without regard for the source of the funds or restrictions on the use of the funds.


                                                           7
Conclusion


             The agent violated the regulatory agreement in obtaining loan proceeds and using
             operating funds. This condition occurred because the agent commingled funds
             with the funds of other properties it managed without a proper accounting and
             documented justification. As a result, the agent had no assurances that it obtained
             and paid out more than $742,000 for eligible rehabilitation costs and legitimate
             expenditures. This put HUD at a greater risk of loss on the FHA-insured
             mortgage loan from which FHA lost more than $3.75 million.

Recommendations



             We recommend that the Acting Director of the Office of Multifamily Housing,
             Kansas City hub

             1A. Require the owner to either support or repay HUD $356,400 for loan
                 proceeds it received.

             1B. Require the owner to either support or repay HUD $386,007 paid out of the
                 operating account.

             We further recommend that the Acting Director of HUD’s Departmental
             Enforcement Center

             1C. Take appropriate actions against the ownership and management agent.




                                              8
                            SCOPE AND METHODOLOGY

The audit covered agent draws and Harry Mortgage Company releases of loan proceeds and
agent payments from the property operating and project bank accounts. To accomplish the
objective, we carried out the following:

     Reviewed requirements to draw project funds and pay out property operating funds,
     Reviewed agent disbursement procedures,
     Reviewed support for all of the more than $1.1 million in loan proceeds paid to the owner
     for reimbursement of project costs,
     Scanned the bank statements and payment register for curious and unusual payments that
     warranted in-depth review to establish the propriety of the payment,
     Reviewed a nonstatistical sample of $492,778 of the more than $1 million paid from the
     property’s operating account from December 2005 through March 2008,
     Interviewed the president of the property corporate owner,9 and
     Interviewed the HUD Director and her staff at the multifamily program center in Oklahoma
     City, Oklahoma.

We conducted the audit from August 2008 to May 2009 at the agent’s office located at 3033
Northwest 63rd Street, Suite 155, Oklahoma City, Oklahoma, and at the HUD multifamily
program center office in Oklahoma City, Oklahoma. The review period was December 14, 2005,
the date the parties executed the regulatory agreement, through March 31, 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.




9
    He is also the president of Williams Commercial Property Management, Inc., the management agent and
    general contractor for the project.


                                                      9
                              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 disbursements of operating funds to ensure compliance with HUD
                  and regulatory requirements.
                  Controls over the drawdown of mortgage loan proceeds.

              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 that the following items are significant weaknesses:

                  Controls over disbursements of operating funds were overridden and ineffective.
                  Controls over the drawdown of mortgage loan proceeds did not ensure that the
                  general contractor had sufficient construction costs to support the amount of the
                  drawdown.




                                               10
                                            APPENDIX

Appendix A

                   SCHEDULE OF QUESTIONED COSTS

         Recommendation number                                            Unsupported 1/

                       1A                                                    $356,400
                       1B                                                     386,007

                     Total                                                   $742,407




1/   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.




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