oversight

Campaige Place at Jackson, Phoenix, Arizona, Did Not Use Its Project Funds in Compliance with HUD's Regulatory Agreement and Other Federal Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-03-18.

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

                                                                 Issue Date
                                                                         March 18, 2009

                                                                 Audit Report Number
                                                                          2009-LA-1008




TO:         Thomas W. Azumbrado, Director, San Francisco Multifamily Hub, 9AHMLAP



FROM:       Joan S. Hobbs, Regional Inspector General for Audit, Los Angeles, 9DGA

SUBJECT: Campaige Place at Jackson, Phoenix, Arizona, Did Not Use Its Project Funds in
           Compliance with HUD’s Regulatory Agreement and Other Federal
           Requirements


                                     HIGHLIGHTS

 What We Audited and Why

      We audited Campaige Place at Jackson (Campaige Place) to determine whether it used its
      project funds in compliance with the U.S. Department of Housing and Urban
      Development’s (HUD) regulatory agreement and other federal requirements. We
      performed this audit because Campaige Place defaulted on its HUD-insured $10 million
      mortgage, and the project owed more than $500,000 in interest and back payments for
      principal.

 What We Found


      Campaige Place did not use its project funds in compliance with HUD’s and other federal
      requirements. Specifically, we determined that

          A.   Owner advances of $73,750 were repaid when the project had no surplus cash,
          B.   Tenant security deposit accounts were underfunded by $57,608,
          C.   An unexplained payable of $26,328 was mistakenly recorded as a liability,
          D.   Support was incomplete or missing for operating expenses of at least $8,341, and
          E.   Management expenses of $20,714 were inappropriately charged to the project.
    The expenditures we questioned partially contributed to Campaige Place’s operating cash
    shortfalls. As a result of the project’s operating cash shortfall, Campaige Place had fallen
    behind in its mortgage payments and, near the end of our audit, the mortgage was
    assigned to HUD.


What We Recommend


    We recommend that the director of the San Francisco multifamily hub require the
    project’s owner/agent to repay or support questioned costs of $160,413 less $81,284
    already repaid or supported and to remove the unsupported payable of $26,328 from the
    project’s accounts. We also recommend that the director require the project to establish
    controls to ensure compliance with HUD’s regulatory agreement and other federal
    requirements.

    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 our discussion draft report to Campaige Place on February 11, 2009 and
    held an exit conference with the project’s officials on February 18, 2009. The project
    provided comments on February 26, 2009. The project generally agreed with the
    substance of our report.

    The complete text of the auditee’s response, along with our evaluation of that response,
    can be found in appendix B of this report. However, the attachments to the response will
    be made available upon request.




                                             2
                           TABLE OF CONTENTS

Background and Objective                                                         4

Results of Audit
      Finding 1: Owner’s Advances Were Repaid While the Project Was in a Non-    5
                 Surplus-Cash Position
      Finding 2: Tenant Security Deposits Were Underfunded                       7
      Finding 3: An Unexplained Payable Was Mistakenly Recorded as a Liability   9
      Finding 4: Documentation to Support Operating Expenses Was Not Complete    11
      Finding 5: Management Expenses Were Paid from Project Operating Funds      13

Scope and Methodology                                                            15

Internal Controls                                                                16

Appendixes
   A. Schedule of Questioned Costs                                               18
   B. Auditee Comments and OIG’s Evaluation                                      19
   C. Criteria                                                                   38




                                           3
                      BACKGROUND AND OBJECTIVE

Campaige Place at Jackson (Campaige Place) is a 302-unit multifamily project insured under
Section 221(d)(4) of the National Housing Act, 12 U.S.C. (United States Code) 1715. U.S.
Department of Housing and Urban Development (HUD) statutory and regulatory provisions
authorized the Federal Housing Commissioner to regulate the borrower through a regulatory
agreement.

Campaige Place Phoenix One, also known as Campaige Place at Jackson, was formed as a
limited partnership under the laws of the State of Arizona on May 9, 2000, for the purpose of
constructing and operating a low-income rental housing project for the downtown Phoenix,
Arizona, workforce. The partnership was between NewHom Management, as a general partner,
with .01 percent interest and John Hancock Corporate Tax Credit Fund, as the limited partner,
with 99.99 percent interest. This owner-managed multifamily project was developed with a $10
million HUD-insured mortgage and $4.5 million in tax credit funds. The project consists of 100
percent affordable units and has always charged rents less than the tax credit limit.

During our audit, we noted that the downtown Phoenix economy remained difficult for
affordable housing and that the market conditions contributed to the project’s financial problems.
Therefore, our audit focused on the extent to which the project’s expenditures were allowable
and reasonable. Specifically, our objective was to determine whether Campaige Place used its
project funds in compliance with its regulatory agreement with HUD and other federal
requirements.




                                                4
                                 RESULTS OF AUDIT

Finding 1: Owner’s Advances Were Repaid While the Project Was in a
Non-Surplus-Cash Position
Campaige Place repaid a total of $73,750 in owner’s advances from 2005 through 2008 while in
a non-surplus-cash position. This condition occurred because the owner/agent had insufficient
knowledge of HUD’s requirements regarding repayment of owner’s advances. The project’s
repayment of the owner’s advances from affiliates while in a non-surplus-cash position partially
contributed to the project’s operating cash shortfalls.




 The Project Repaid $73,750
 in Owner’s Advances


       Campaige Affordable Housing - Company B, an affiliate of the project, advanced a total
       of $461,000 to the project from January 2005 through November 2008. Financial records
       showed that the project repaid advances that totaled $73,750 during the audit period:
       three repayments in 2005 (in January, February, and April), one repayment in March
       2007, and two in 2008 (in July and September). As of November 2008, the balance of
       the advances payable to the affiliate was $854,974 instead of $928,724 as it should have
       been.


                                         Payable to affiliate* ending
                    Year                                                 Repayment
                                                  balances
         2005                                                  $ 523,974      $ 26,750
         2006                                                    558,974             0
         2007                                                    742,974        22,000
         2008 (As of November)                                   854,974        25,000
         Total                                                                $ 73,750
       *Campaige Affordable Housing - Company B



 The Project Was in a
 Non-Surplus-Cash Position


       Since its inception in 2003, Campaige Place had not been in a surplus-cash position.
       Review of the project’s 2005, 2006, and 2007 financial statements showed net losses
       before depreciation. Operating expenses increased each year, while rental income fell



                                                  5
    short of projections. Additionally, the surplus (deficiency) cash amounts for 2005, 2006,
    and 2007 were $(368,555), $(266,719), and $(378,516), respectively.

    Campaige Affordable Housing - Company B advanced funds to the project during deficit
    periods. HUD allows repayment of such owner’s advances subject to its approval only
    when the project has surplus cash (see criteria in appendix C). According to the
    regulatory agreement, the project’s surplus cash position should be computed at the end
    of the annual or semiannual periods. The project’s repayment of owner’s advances while
    in a non-surplus-cash position violated the regulatory agreement. Because Campaige
    Place repaid $73,750 in owner’s advances while in a non-surplus-cash position, its
    financial situation became more difficult.

    The owner/agent acknowledged insufficient understanding of HUD rules and regulations
    regarding repayment of owner’s advances. After our audit work was completed, the
    owner/agent took corrective actions to resolve some of the discrepancies. Campaige
    Affordable Housing – Company B repaid $15,000 to the project on January 27, 2009.


Recommendations


    We recommend that the director of the San Francisco multifamily hub require the owner
    of Campaige Place to

    1A.   Reimburse HUD’s Federal Housing Administration insurance fund $73,750 less
          amounts repaid after the completion of the audit ($15,000) for the ineligible
          disbursements cited in this report.

    1B.   Ensure that controls are in place to determine the project’s surplus-cash position in
          accordance with its regulatory agreement and only make distributions or
          repayment of owner’s advances when authorized.




                                            6
Finding 2: Tenant Security Deposits Were Underfunded
During our audit, project records showed a liability of $57,608 for tenant security deposits.
However, the tenant security deposit bank account was underfunded because its balance ranged
from $0 to $20,000. This condition occurred because project management disregarded financial
statement audit findings and HUD rules and regulations regarding security deposits. As a result,
the tenants’ security deposits were not safeguarded and were at risk of being diverted by
management for unauthorized uses.



 The Security Deposit Account
 Had Been Underfunded for Years


       Originally, the project had two separate bank accounts designated for tenant security
       deposits; however, it did not deposit the security deposit collections into these bank
       accounts dollar for dollar. The project commingled receipts for tenant security deposits
       with rent receipts and other revenue by keeping all of the funds in the project’s operating
       bank account. Over time, the tenant security deposit accounts became underfunded; i.e.,
       the balance of the tenant security accounts was less than the aggregate of all outstanding
       obligations. At the time of our audit, the project had no separate bank account designated
       for tenant security deposits, and the recorded liability was $57,608. In November 2008,
       the project opened a new security deposit account, and management transferred an initial
       amount of $20,000 into the account. After we completed our work, the owner/agent
       provided documentation to show that the tenant security deposit account had been fully
       funded as of December 31, 2008.

 Tenant Security Deposits Were
 Not Safeguarded

       The financial statement audit reports for years 2005 through 2007 disclosed the project’s
       noncompliance under HUD regulations and the project’s regulatory agreement regarding
       tenant security deposit requirements. According to HUD regulations, deposits paid by a
       tenant at the time a unit is rented (security deposits) should be placed into an account
       specifically for tenant deposits and held until the tenant vacates the unit (see criteria in
       appendix C). According to the owner, management did not heed the findings because
       local real estate practices did not require segregation of tenant deposits. As a result, the
       tenants’ security deposits were not safeguarded and were at risk of being diverted by
       management for unauthorized uses.




                                                 7
Recommendations


    We recommend that the director of the San Francisco multifamily hub require the
    management (owner/agent) of Campaige Place to

    2A.   Fully fund the security deposit account for the liability amount of $57,608 less
          amounts deposited during the audit.

    2B.   Establish controls to ensure that all tenant security deposits are safeguarded and
          maintained in the designated security depository bank accounts in compliance with
          the regulatory agreement.




                                            8
Finding 3: An Unexplained Payable Was Mistakenly Recorded as a
Liability
The project mistakenly recorded a professional service fee of $26,328 as an operating expense.
Management initially stated that this was a development expense that had not yet been paid to
the project’s architect but did not provide documentation to support this assertion. Management
had inadequate internal controls over classification and support of project operating expenses.
As a result, liabilities were overstated.




 Management Failed to Support
 a Questioned Cost



       Campaige Place recorded a payable in 2004 for an architect fee of $26,328. HUD
       questioned this cost in July 2008 and determined that it was an unallowable development
       expense. During our review this amount was still recorded as past due in the aged
       accounts payable; however, the owner/agent could not provide an invoice or other
       documentation as support.

 Management Had Inadequate
 Controls Over Project
 Expenses


       Campaige Place was the owner/agent’s first HUD-insured property and, therefore,
       management’s experience with HUD rules was limited. HUD requires the owner/agent
       to maintain documentation for project expenses and to establish a financial accounting
       system that segregated operating funds from other project funds (see criteria in appendix
       C). In this instance, the project’s failure to follow HUD requirements occurred because
       there were inadequate controls over the classification and support of project operating
       expenses. After our audit work was completed, the owner/agent stated that the former
       controller mistakenly entered the payable without supporting documentation.
       Management also confirmed that all of the architectural fees for the project had been paid
       in full. The owner/agent planned to remove this expense from the project’s liabilities.
       By leaving this payable in its accounts, Campaige Place had overstated its liabilities.




                                               9
Recommendation


    We recommend that the director of the San Francisco multifamily hub require the
    management (owner/agent) of Campaige Place to

    3A.   Confirm that the $26,328 in unallowable expense has been removed from the
          project’s books.

    3B.   Establish controls to ensure all recorded transactions are properly classified and
          adequately supported.




                                            10
Finding 4: Documentation to Support Operating Expenses Was Not
Complete
The project did not always provide detailed vendor invoices to support expense items paid with
its corporate credit card. This condition occurred because management did not have adequate
internal controls to ensure expenses were properly supported. Without the proper supporting
documentation, auditors and other reviewers could not verify that expenses were eligible and
recorded accurately. As a result, we questioned $8,341 in expenses based on the sampled
transactions tested.



 Credit Card Statements Were
 Paid with Incomplete or Missing
 Invoices


       Campaige Place management (owner/agent) used an affiliate’s American Express
       corporate credit card to pay for operating expenses for all six projects that it owned and
       managed. When the credit card statement was received, management allocated the
       charges to whichever project had incurred the expense. However, expense items were
       not always adequately supported by detailed vendor invoices. The following table shows
       details of the unsupported transactions pertaining to Campaige Place that were identified
       in a test sample.

                                                                             Unsupported
             Date                        Item                   Expense
                                                                               amount
          Aug. 3, 2007    Allied Forces                         $1,443.48       $1,443.48
          Oct. 1, 2007    Uniforms                                 258.60          258.60
          Oct. 1, 2007    Minimart supplies                        450.23          136.59
          Oct. 1, 2007    Advertising - Phoenix New Times        2,580.00        2,580.00
          Oct. 1, 2007    M&R - materials                        1,817.10          817.11
          Oct. 1, 2007    Newspaper                                500.00          500.00
          Nov. 1, 2007    M&R - materials                          447.92          447.92
          Nov. 1, 2007    Tenant incentive                         540.94          477.56
         Nov. 27, 2007    Cox Communications                        54.96           54.96
         Dec. 31, 2007    Newspaper                              1,625.00        1,625.00
                          Total                                                 $8,341.22




                                                11
Controls over Documentation of
Expenses Were Inadequate


       Management did not have adequate internal controls to ensure expenses were properly
       supported. The above expenses were paid with inadequate supporting documentation,
       which was not in compliance with requirements outlined in the HUD handbook (see
       criteria in appendix C). As a result, the project’s records could not provide assurance that
       the unsupported expenses were reasonable and properly allocated to Campaige Place.
       We questioned $8,341 in unsupported costs. After our audit work was completed, the
       auditee provided supporting documentation for $6,210 in questioned expenses and repaid
       a total of $2,131 for the unsupported amounts using nonfederal funds.



Recommendations




       We recommend that the director of the San Francisco multifamily hub require the
       management (owner/agent) of Campaige Place to

       4A.   Provide documentation to show the unsupported costs of $8,341 were either repaid
             using nonfederal funds, or are now adequately supported.

       4B.   Establish controls to ensure expenses are properly supported.




                                                12
Finding 5: Management Expenses Were Paid from Project Operating
Funds
The project used its operating funds to pay for management (owner/agent) expenses to supervise
project staff and oversee project operations. The owner/agent had an insufficient understanding
of HUD rules and regulations regarding allowable management costs because Campaige Place
was its first HUD-insured project. As a result, $20,714 in operating funds was not available for
project expenses, including the mortgage payments.



 Management Expenses Were Paid from
 Project Funds


       Management charged unallowable expenses to the project for management agent staff
       travel and incentives. Our review of a limited number of transactions from the years
       2005 through 2007 identified the following unallowable expenses:
                                    Ineligible project expenses
             Date        Description                                         Amount
         Apr. 29, 2005   Lease commission                                      $9,000.00
         July 26, 2005   Lease commission                                       1,000.00
         Feb. 10, 2006   Lease commission                                       3,210.00
         Feb. 10, 2006   Lease commission                                       1,000.00
         Apr. 30, 2007   Lunch                                                     27.14
         Apr. 30, 2007   Airfare                                                  108.80
         Apr. 30, 2007   Rental car                                                87.39
          May 2, 2007    Per diem                                                 118.00
          June 1, 2007   Travel – auto                                            575.48
          July 1, 2007   Travel                                                 1,007.20
         July 31, 2007   Per diem                                                 590.00
          Aug. 1, 2007   Travel                                                   380.63
          Aug. 7, 2007   Per diem                                                 590.00
          Nov. 1, 2007   Airfare                                                  256.80
          Nov. 1, 2007   Travel                                                   952.64
          Nov. 1, 2007   Employee incentive                                       206.01
         Nov. 30, 2007   Airfare                                                  247.30
         Nov. 30, 2007   Travel                                                   860.08
         Nov. 30, 2007   Meals                                                     99.03
         Dec. 31, 2007   Ground transportation                                    362.04
         Dec. 31, 2007   Lunch                                                     35.92
                                              Total                           $20,714.46



                                               13
    The management owner/agent’s director of operations stated that management staff
    traveled to Campaige Place to hire employees, provide training, and perform inspections.
    However, these tasks were the responsibility of management and, therefore, the travel
    costs should have been paid by management from the fee it received. Campaige Place
    paid the owner/agent a fee of 3.6 percent of its residential, commercial, and
    miscellaneous income collected. This management fee should have been used to pay for
    services that were not front-line activities; for example, management staff travel,
    recruiting, hiring, training, monitoring, filling staff vacancies, and supervising project
    personnel (see criteria in appendix C). In addition, because the project collected a
    management fee on its commercial leases, management costs such as brokerage
    commissions should be paid from that fee.

Operating Expenses Were
Overstated


    As a result of charging management expenses to the project, operating expenses were
    overstated, and insufficient funds were available to pay front-line project expenses and
    other eligible costs, including mortgage payments. After our audit work was completed,
    the auditee repaid $335 of the total amount owed to the project.

Recommendations


    We recommend that the director of the San Francisco multifamily hub require the
    management (owner/agent) of Campaige Place to

    5A.   Reimburse HUD’s Federal Housing Administration insurance fund $20,714 less
          amounts already repaid ($335) for ineligible project expenses cited in this report.

    5B.   Establish controls to ensure that costs covered by management fees are not paid
          from operating funds.




                                            14
                        SCOPE AND METHODOLOGY

The audit covered the use of project funds for the period January 1, 2005, through December 31,
2007. However, to quantify the results of two findings, we extended the scope to November
2008. Our audit was performed at Campaige Place located in Phoenix, Arizona, and at the
management agent’s office in San Diego, California. We performed our audit work from
September 15 through November 30, 2008.

To perform our audit, we

       Reviewed applicable laws, regulations, and guidance issued by HUD (see criteria in
       appendix C);

       Reviewed pertinent financial records maintained by the project on site and at the
       corporate office of the owner/agent;

       Interviewed staff from the project and the owner/agent;

       Reviewed HUD files and interviewed HUD officials in the Phoenix Office of Multifamily
       Housing; and

       Physically inspected the property.


Specifically, our audit included the review of Campaige Place’s financial records and the
management agent’s accounting system, policies, and procedures. We reviewed transactions
from 2005 through 2007 and tested a non-statistical sample of receipts and disbursements for
support, accuracy, and compliance with HUD rules and regulations. We did not project our
results to the universe of transactions in our audit scope.

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.




                                               15
                              INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives 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:

              Administering the project’s operations in compliance with applicable laws and
              regulations,

              Maintaining complete and accurate records, and

              Safeguarding the project’s resources.

       We assessed the relevant controls identified above.

       A significant weakness exists if management controls do not provide reasonable assurance
       that the process for planning, organizing, directing, and controlling program operations will
       meet the organization’s objectives.




                                                16
Significant Weaknesses



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

        The project did not have adequate controls in place to ensure that


                Project financial transactions complied with applicable laws and regulations
                (findings 1, 2, 3, 4, and 5).

                Tenant security deposits were adequately safeguarded (finding 2).

                Project financial records were complete and accurate (finding 4).




                                             17
                                   APPENDIXES

Appendix A

                 SCHEDULE OF QUESTIONED COSTS

            Recommendation                   Ineligible 1/         Unsupported 2/
                number
                  1A                               $73,750
                  2A                               $57,608
                  3A                                                       $26,328
                  4A                                                        $8,341
                  5A                               $20,714


                  Totals                          $152,072                 $34,669

1/   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
     that the auditor believes are not allowable by law; contract; or federal, state, or local
     polices or regulations.

2/   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.




                                             18
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                                  19
Comment 1




            20
Comment 2




Comment 3




            21
Comment 4




Comment 5




            22
Comment 5




            23
Comment 5




Comment 6




            24
Comment 6




Comment 7




Comment 8




            25
Comment 9




Comment 10




Comment 11




Comment 12




             26
Comment 13




             27
Comment 13




Comment 14




Comment 15

Comment 14




Comment 16




             28
Comment 17




Comment 18




             29
Comment 19




Comment 20




             30
Comment 21




Comment 22




             31
Comment 23




             32
33
                          OIG Evaluation of Auditee Comments

Ref to OIG Evaluation           Auditee Comments


Comment 1   We acknowledge the auditee’s comments regarding the difficult rental housing
            market in downtown Phoenix. The report did not address this issue in detail
            because it was beyond the scope of our audit objective. Specifically, our
            objective was to determine whether Campaige Place used its project funds in
            compliance with its regulatory agreement with HUD and other federal
            requirements. To meet this objective our audit focused on the extent to which the
            project’s expenditures were allowable and reasonable. Out report did note the
            difficult downtown-Phoenix rental market—the Background and Objective
            section stated: During our audit, we noted that the downtown Phoenix economy
            remained difficult for affordable housing and that the market conditions
            contributed to the project’s financial problems.

             The report noted, on page 5, that owners/affiliates of Campaige Place had
             advanced more than $900,000 to the project. Such advances were in accordance
             with the Partnership agreement between the general partner (NewHom
             Management) and the limited partner (John Hancock). The agreement contained
             an operating deficit guarantee which required NewHom to advance funds to the
             project during the initial operating period if it incurred operating deficits

Comment 2    We recognize that the total amount of costs we questioned was significantly less
             than the amount past-due on the HUD-insured mortgage. However, the
             unallowed uses of operating funds did contribute to the project’s inability to meet
             its obligations. We changed the report language to state that the expenditures we
             questioned partially contributed to the project’s operating cash shortfalls.

Comment 3    We changed the language in the Highlights section to acknowledge up front that
             the auditee has already repaid, or provided additional supporting documentation
             for, some of the costs questioned in the report. However, the report correctly
             stated that costs totaling $160,413 plus an unsupported payable of $26,328 were
             questioned as a result of our audit. Each finding contained information regarding
             specific amounts either repaid or supported after our audit work was completed.
             See comments below for our evaluation of the auditee’s position on specific
             items.

Comment 4    We added language in the general recommendation section to acknowledge the
             amount which the auditee either repaid or supported with additional
             documentation after the audit was completed.

Comment 5    We modified the report to state that the repayments of owner advances from
             affiliates while in a non-surplus-cash position partially contributed to the project’s
             operating cash shortfalls. We recognize that the total amount advanced by



                                               34
              affiliates greatly exceeded the amount that was improperly repaid. However, this
              was not the basis of the finding. The funds advanced to the project and the
              repayments to the project were two separate transactions and did not offset each
              other. HUD Handbook 4370.2, REV-1 states clearly that repayment of owner
              advances when a project is in a non-surplus-cash position is a violation of HUD
              regulations (tantamount to diversion of funds) which can subject the owner to
              criminal and civil monetary penalties. Therefore, we did not recognize mistaken
              repayments as being offset by subsequent advances.

Comment 6     We acknowledged the $15,000 repayment made on January, 27, 2009 as a result
              of the audit. As stated in our response in Comment 5, we cannot offset the other
              repayments by subsequent advances that were made. Thus, $58,750 was still
              outstanding for this finding. Regarding the auditee’s implementation of new
              control procedures over repayments of advances, after the report is issued HUD
              officials will verify that any corrective actions are responsive to the final
              recommendations.

Comment 7     The report acknowledged that the tenant security deposit account was fully
              funded after our field work was completed. However, the underfunded account
              remains a report finding and a questioned cost. We modified recommendation 2A
              to require full funding of the tenant security deposit account less amounts already
              deposited.

Comment 8     We agree that the caption for finding 3 inaccurately characterized the questioned
              cost. We modified the caption to state: An Unexplained Payable Was Mistakenly
              Recorded as a Liability.

Comment 9     We modified the title to state: Management Failed to Support a Questioned Cost

Comment 10 The auditee’s comments understated the significance of the unsupported liability.
           Management had been submitting monthly accounting reports to HUD (with an
           attached schedule of aged open invoices) that showed this payable as overdue.
           Our report noted that HUD questioned the cost as early as July 2008, yet the
           undocumented payable remained on the project’s operating accounts at the time
           of our review. By failing to determine the nature of this liability and investigate
           why it had not been paid for four years, management did not practice due
           diligence over expenses allocated to the project. After our audit work was
           completed, the auditee obtained confirmation that the architect (to whom the
           expense was originally attributed) had been paid in full. Therefore, we modified
           the finding text to more accurately portray the questioned amount as an error.

Comment 11 Recommendation 3A was modified to require confirmation that the $26,328 in
           unallowable expense has been removed from the project’s books.

Comment 12 We agreed that recommendation 3B was not necessary because the project will
           not incur any more development costs. We removed this recommendation and



                                              35
              recommendation 3C is now shown in the report as 3B.

Comment 13 The report acknowledged that, after audit work was completed, the auditee
           provided supporting documentation for $6,210 in questioned expenses and repaid
           $2,131 to the project. OIG verified the supporting documentation provided by the
           auditee.

Comment 14 Recommendation 4B required the project to establish controls to ensure expenses
           are properly supported. After the report is issued, HUD officials will verify that
           corrective actions, including the training and oversight procedures referred to in
           the auditee’s comment, were adequately implemented.

Comment 15 Recommendation 4A properly addressed an issue that was identified as a result of
           the audit. After our report is issued, HUD officials will verify that corrective
           actions were taken.

Comment 16 HUD’s Office of Multifamily Housing regularly issues notices and other guidance
           to clarify and update its comprehensive handbooks. Like the auditee, OIG relied
           on HUD’s published guidance to arrive at its conclusions. HUD officials will
           evaluate OIG’s conclusions and recommendations during the formal audit
           resolution process. Accordingly, any policy changes would be made by HUD
           program offices, and not OIG.

Comment 17 We modified the report to acknowledge the additional repayment of $75.64
           deposited on February 26, 2009 for a total repayment of $334.89 for the
           questioned management expenses paid from project funds.

Comment 18 We questioned the eligibility of the brokerage commissions paid to lease the
           project’s commercial spaces primarily because the project collected a
           management fee percentage on its commercial rents as it did on the housing units.
           The management fees were designed to cover management services not
           performed by front-line staff, such as supervising and overseeing project
           operations. According to HUD Handbook 4381.5, paragraph 3-6, the owner can
           propose a special management fee to accomplish a specific task such as
           ―obtaining or renewing a lease for commercial space at the project.‖ However,
           HUD officials noted that no special fees were requested in this instance, and
           concurred with our conclusion.

Comment 19 We determined that commissions paid to an affiliate of the management agent
           were management expenses. HUD officials concurred that the task of reviewing
           the commercial leases was a management responsibility. Although the auditee
           stated that the review expense was incurred in lieu of legal fees, we note that the
           affiliate was not a lawyer, and therefore the expense cannot qualify as a legal
           expense.




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Comment 20 We determined that travel expenses for management agent staff to temporarily fill
           in vacant front-line positions on site were management expenses. HUD
           Handbook 4381.5 REV-2, paragraph 6-38, Figure 6-2 clearly states that travel
           expenses for the agent’s supervisory staff are costs to be paid from the
           management fee. We note that figure 6-2 also shows that the salary for a
           supervisory (management) employee designated to replace a project employee for
           hours worked at the project above and beyond the first 40 consecutive hours may
           be charged to the project. In addition, HUD Handbook 4381.5 REV-2, paragraph
           6-38(b)(3) specifies that a reasonable hourly rate can be used to bill the project
           for time spent by agent staff performing front-line functions. HUD officials
           concurred with our conclusion.

Comment 21 We acknowledge that the HUD Handbook is ambiguous regarding the
           allowability of recruiting expenses. Although the handbook can be interpreted to
           state that recruiting costs for front-line staff are chargeable to the project, the
           auditee did not provide documentation of the recruiting activity. Instead the cost
           was for travel expenses, and the handbook clearly states that travel expenses for
           the agent's supervisory staff should be paid from the management fee (see
           comment 20). HUD officials concurred with our conclusion.

Comment 22 As reported under finding 5, the total amount of unallowed management expenses
           we identified during our audit was $20,714.

Comment 23 The report acknowledged repayment of $335 for the questioned ineligible
           expenses that should have been paid from the management fee received. We
           considered the auditee’s response regarding the remainder of the ineligible
           expense items, and our conclusions are presented under comments 17 through 21.




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Appendix C

                                         CRITERIA

Finding 1

1. HUD Handbook 4370.2, REV-1, paragraph 2-11, states that advances made for reasonable
and necessary operating expenses may be paid from surplus cash at the end of the annual or
semiannual period. Such repayment is not considered an owner distribution. It is considered a
repayment of advances. Repayment of owner advances when the project is in a non-surplus-cash
position will subject the owner to criminal and civil monetary penalties.

Finding 2

2. HUD Handbook 4370.1, REV-2, paragraph 2-21, states that deposits are paid by a tenant at
the time a unit is rented. The deposit is placed into an account specifically for tenant deposits
and held until the tenant vacates the unit. A security deposit may be applied to pay for any
damages caused by the tenant.

3. HUD Handbook 4370.1, REV-2, paragraph 3-9, states that under the regulatory agreement,
tenant security deposits must be fully funded. A security deposit deficiency will often indicate a
diversion of funds. The diversion could be for payment of project operating costs or for the
personal use of the owner or management agent.

4. HUD Handbook 4370.2, REV-1, paragraph 2-12, states that any funds collected as security
deposits must be kept separate and apart from all other project funds in an account maintained in
the name of the project. The balance of the account must not at any time be less than the
aggregate of all outstanding obligations under the account for security.

Finding 3

5. HUD Handbook 4370.2, REV-1, paragraph 2-3, states that in establishing a financial
accounting system, auditing problems can be avoided by keeping operating funds separate from
other project funds. Particularly when occupancy occurs before final closing, care must be taken
to segregate construction and operating funds. Accounting of any construction expenses shall be
in accordance with HUD Handbook 4470.1, Mortgage Credit Analysis for Project Mortgage
Insurance, section 207.

Finding 4

6. HUD Handbook 4370.2, REV-1, paragraph 2-1, states that the financial operations and
accounting requirements of a HUD-insured multifamily project must include maintenance of
books and accounts; completeness and accuracy of books and accounts; auditable paper trail,
invoices, etc.; treatment of specific transactions such as surplus cash and residual receipts;



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distribution to owners; cash controls; and use of management agreements.

7. HUD Handbook 4370.2, REV-1, paragraph 2-12, states that a request for a check must have
supporting documentation (i.e., invoice itemizing amount requested with an authorized
signature) in order for approval to be obtained to make the disbursement.

8. HUD Handbook 4981.5 REV-2, paragraph 3-6, states:

   a.Use of Special Fees. In addition to the percentage-based fees described above, owners may
   agree to pay special management fees if a project has special needs or problems. Proposing
   special fees (rather than adjusting the fee percentage) is an appropriate and cost effective way
   to address specific project conditions that should be temporary in nature.

   b.Circumstances When Special Fees Are Allowed. Agents may earn special management
   fees only if all six conditions listed below are met.
   (1)The agent did not cause the problem the fee is designed to address.
   (2)The fee is tied to the correction of specific problems or the accomplishment of specific
   tasks. Examples of such tasks include:
           (a)Renting-up the project (unless compensation for this is provided from a
           supplemental management fund);
           (b)Obtaining or renewing a lease for commercial space at the project;
           (c)Completing significant rehabilitation work or utility conversion;
           (d)Reducing vacancies or improving rent collections;
           (e)Reducing a specific excessive expense (e.g., utility costs or property taxes); and
           (f)Processing membership transfers at cooperatives.

Finding 5

9. HUD Handbook 4381.5, REV-2, paragraph 6-38, states:

    a. Front-line Costs and Day-to-Day Activities

    (1) Reasonable expenses incurred for front-line management activities may be charged to
        the project operating account. HUD Handbook 4370.2, Financial Operations and
        Accounting Procedures for Insured Multifamily Projects, provides a complete listing of
        allowable expenses. Front-line activities include:
        o     taking applications;
        o     screening, certifying, and recertifying residents;
        o     maintaining the project; and
        o     accounting for project income and expenses.

    Figure 6-2 provides examples of front-line management costs.

    (2) If front-line management functions for several properties are performed by staff of the
         agent operating out of a single office, the following conditions apply.




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       (a) The agent must prorate the total associated costs among the projects served in
           proportion to the actual use of services. Allowable total associated costs include:

          (i)Salaries and fringe benefits of personnel performing front-line duties; and
          (ii) Actual office expenses, fees, and contract costs directly attributable to the
            performance of front-line duties.

       (b) The agent may not impose surcharges or administrative fees in addition to actual
           costs.

       (c) The cost of performing front-line management functions off-site may not exceed the
           total cost of performing these functions at the property.

   (3) The salaries of the agent's supervisory personnel may not be charged to project accounts,
       with the exception of supervisory staff providing oversight for centralized accounting
       and computer services for the project.

10. HUD Handbook 4381.5, REV-2, paragraph 6-39, states:

        a.    Expenses for services that are not front-line activities must be paid out of
              management fee funds, except for centralized accounting and computer services.
        b.    Salaries, fringe benefits, office expenses, fees, and contract costs for the following
              activities must be paid out of management fee funds. These costs include
                   (1) Designing procedures/systems to keep the project running smoothly
                           and in conformity with HUD requirements.
                   (2) Preparing budgets required by the owner or HUD, exclusive of rent
                           increase requests and MIO [management improvement and operating]
                           Plans.
                   (3) Recruiting, hiring, and supervising project personnel.
                   (4) Training for project personnel that exceeds the line item budget for
                           training expenses.
                   (5) Monitoring project operations by visiting the project or analyzing
                           project performance reports.
                   (6) Analyzing and solving project problems.
                   (7) Keeping the owner abreast of project operations.
                   (8) Overseeing investment of project funds.
                   (9) Ensuring that project positions are covered during vacations, sickness,
                           and vacancies.




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