Department of Housing and Urban Development, Office of Inspector General | Housing and Urban Development | SFDS Development Corporation, New York, NY had Weaknesses in its Financial, Procurement and Administrative Controls

SFDS Development Corporation, New York, NY had Weaknesses in its Financial, Procurement and Administrative Controls

Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-12-22.

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

Issue Date
December 22, 2009

Audit Report Number
2010-NY 1006

TO: Teresa Bainton, Director, Office of Multifamily Housing, New York,
2AHMLAP

FROM:
Edgar Moore, Regional Inspector General for Audit, New York/New Jersey
Region, 2AGA

SUBJECT: SFDS Development Corporation, New York, New York, Had Weaknesses in Its
Financial, Procurement and Administrative Controls

HIGHLIGHTS

What We Audited and Why

We audited the SFDS Development Corporation (agent), management agent for
three U.S. Department of Housing and Urban Development (HUD) subsidized
Section 202 elderly housing direct loan properties, in response to a complaint to
the Office of Inspector General (OIG) Hotline that alleged misappropriation of
HUD funds by the agent. The objective of our review was to assess the merits of
the complaint. It was expanded to assess the agent’s compliance with HUD
financial, procurement, and administrative regulations applicable to the Section
202 elderly housing program.

What We Found
The complaint had some merit, because as documented on page 5 of the report,
some ineligible salary costs were erroneously allocated to the projects. In
addition, weaknesses in the agent’s financial, procurement, and administrative
controls caused noncompliance with HUD regulations pertaining to the agent’s
management of the Section 202 properties. Specifically, the agent charged
ineligible and unsupported expenses to the projects, failed to make required
deposits to, or seek HUD approval for withdrawals from the replacement for
reserve account, did not always conduct unit inspections or procure services in a
prudent manner, and failed to file financial statements in a timely manner. As a
result, the projects were deprived of $177,406, and HUD lacked assurance that
$498,643 was disbursed for eligible expenses, units were properly maintained,
and services were obtained at the most economical price. In addition, HUD was
not made aware of the financial condition of the projects in a timely manner.

What We Recommend

We recommend that the Director of the New York Office of Multifamily Housing
instruct the owner/agent to repay ineligible costs charged to the projects, provide
documentation for unsupported costs, and if support cannot be provided, repay the
amount with nonfederal funds, and strengthen controls over financial,
procurement, and administrative functions.

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 discussed the results of our review during the audit and at an exit conference
held on November 30, 2009. We provided a copy of the draft report to agent
officials and requested their written comments by December 8, 2009, which we
received on that date. Agent officials generally agreed with our findings and have
taken, or plan to take, actions that are responsive to the report’s recommendations.
The complete text of the auditee’s response, along with our evaluation of that
response, can be found in appendix B of this report.

2
TABLE OF CONTENTS

Background and Objective 4

Results of Audit
Finding: The Agent Had Weaknesses in Its Financial, Procurement, and 5
Administrative Controls

Scope and Methodology 13

Internal Controls 15

Appendixes
A. Schedule of Questioned Costs and Funds to Be Put to Better Use 17
B. Auditee Comments and OIG’s Evaluation 18

3
BACKGROUND AND OBJECTIVE

The SFDS Development Corporation (agent) is the management agent for three projects that
received U.S. Department of Housing and Urban Development (HUD) Section 202 elderly
housing direct loans, as well as for seven other non-HUD-subsidized properties. The three
HUD Section 202-subsidized projects, located in New York, New York, are Casita Park, a
94-unit project; Mt. Pleasant, a 63-unit project; and Lucille Clark, a 61-unit project. The
three projects are considered owner managed, and the agent is governed by a 12-member
board of directors.

The Section 202 program is intended to help expand the supply of affordable housing with
supportive services for the elderly. It provides very low-income elderly residents with
options that allow them to live independently, but in an environment that provides support
activities, such as cleaning, cooking, transportation, etc. HUD provides loans to finance the
construction, rehabilitation, or acquisition of such projects, as well as rent subsidies to help
make the projects affordable. HUD provided interest-free loans of $10.1 million, $6.2
million, and $6.7 million to Casita Park, Mt. Pleasant, and Lucille Clark, respectively, which
do not have to be repaid as long as the projects remain affordable for low-income elderly
tenants for 40 years. The three projects received cumulative rental assistance subsidy
payments of $823,971 in fiscal year 2008.

The projects experienced cash flow difficulties and the agent had applied to HUD for a rent
increase at each of the projects. However, the requests were denied because the applications
were not filed on time and the projects had not filed required financial statements on time.
On September 30, 2008, the agent contracted with a consultant, approved by HUD, to
provide financial and advisory services. These services included paying bills, collecting
rents, and maintaining an accounting system in accordance with generally accepted
accounting principles. The agent pays for these services from the management agent fees it
earns. It retains responsibility for unit inspections and maintenance.

A complaint to the OIG Hotline alleged that the agent misappropriated HUD funds by
allocating excessive salary expense to the three HUD properties. Our initial review of the
complaint concluded that the agent did erroneously misallocate salaries of some of the
employee noted in the complaint to the HUD properties (see report page 5).

The objective of our review was to assess the merits of the complaint received by the Office
of Inspector General (OIG) Hotline alleging that the agent misappropriated HUD funds.
After an initial determination that the complaint had some merit, we expanded our review to
assess the agent’s compliance with HUD financial, procurement, and administrative
regulations applicable to the management of Section 202 elderly housing projects.

4
RESULTS OF AUDIT

Finding: The Agent Had Weaknesses in Its Financial, Procurement, and
Administrative Controls
Weaknesses in the agent’s financial, procurement, and administrative controls caused
noncompliance with HUD regulations pertaining to administration of the three Section 202
properties. Specifically, the agent (1) charged ineligible expenses to the projects, (2) lacked
adequate documentation to support costs, (3) incorrectly calculated and overcharged
management fees at one project, (4) failed to make required deposits to, or seek HUD approval
for withdrawals from the replacement for reserve accounts, (5) did not conduct required annual
inspections at one project, (6) did not always procure services in a prudent manner, and (7) failed
to submit financial statements in a timely manner. As a result, the projects were deprived of
$177,406, which could have been used for necessary expenses, and HUD lacked assurance that
$498,643 was disbursed for eligible expenses, units were properly maintained, and procurement
actions were executed in the most prudent manner. In addition, HUD was not made aware of the
financial condition of the projects in a timely manner.

Projects Charged Ineligible
Expenses

The agent charged the projects ineligible expenses of $146,867 related to the
allocation of employee salaries and the cost of a consultant. Section 11(c) of the
regulatory agreement1 provides that payments should be made for services
rendered that are reasonably necessary for the operation of the project. However,
salary costs of $136,867 were improperly allocated to the three projects during the
projects’ fiscal years 2006 through 2008. Specifically, excessive salary expense
of $136,867 was charged to the projects because the total salary of personnel who
worked at non-HUD projects was charged to the HUD-subsidized projects. This
occurred because the agent lacked a system to properly allocate salary costs
among the projects it managed.

In addition, during our audit, the agent reallocated salary costs based upon an
informal review, conducted by the consultant with whom it had recently
contracted, of time spent by employees at each of its projects. However, this
reallocation was based upon informal discussion with the employees involved and
not documented by formal activity reports. If salary costs are not properly
allocated among projects, HUD lacks assurance that the allocated expense is
reasonable and necessary.

1
The regulatory agreement specifies the responsibilities of the project owner in consideration for the Section 202
loan made by HUD.

5
Furthermore, the agent charged two of the three HUD-subsidized projects $10,000
for expenses of a consultant. HUD Handbook 4381.5, REV-2, provides that
expenses for services that are not front-line2activities should be paid from the
management fee. These types of expenses that should be paid from the
management fee include designing procedures to keep the project running
smoothly and in conformity with HUD regulations, preparing budgets required by
the owner or HUD, and analyzing and solving project problems. The consultant
was contracted to identify opportunities for greater efficiencies at the 10
properties managed by the agent, a service that would not appropriately be
considered a front-line activity, but rather be paid from the management fee.
Further, the agent lacked a rationale for the allocation of the expense to the two
HUD-subsidized properties. The agent improperly charged this expense to
Lucille Clark and Casita Park projects because it believed that the expense was
eligible as a front-line expense and it lacked a proper method to allocate the costs.
The agent said that it would adjust the projects’ records to reduce the amount due
it by these charges.

Costs Not Adequately Supported

The agent lacked adequate documentation to support $498,643 charged to the
three projects during the projects’ fiscal years 2006 through 2008. The expenses
include disbursements for insurance, supplies, telephone, taxes, accounting,
auditing, workmen’s compensation, health, and other benefits. Section 11 (c) of
the regulatory agreement provides that payments for services, supplies, or
materials be reasonably necessary for operation of a project, and section d
provides that books, contracts, records, documents, and all other related papers be
maintained in reasonable condition for proper audit and be subject to examination
and inspection by HUD and its duly authorized agents. The costs were not
adequately supported because the agent did not maintain documentation to
substantiate the costs paid. The agent said that its former accountant/bookkeeper,
with whom it has a legal dispute (see page 10), is withholding financial records,
including the documentation that should support these expenditures.
Consequently, HUD lacked assurance that $498,643 in project funds was used in
accordance with HUD rules and regulations.

The independent public accountant reports issued for the projects’ fiscal year
2007 reported internal control deficiencies relating to invoices not being approved
in accordance with agent procedures. Our review of disbursements for the audit
period disclosed that this condition continued and that the agent lacked adequate
controls over the approval of expenses. However, based upon the
recommendations of the HUD-approved consultant contracted in September 2008
to provide financial and advisory services, the agent established procedures to

2
Front-line activities include taking applications, screening and certifying residents, maintaining the projects, and
accounting for project income and expenses

6
strengthen controls to ensure that all disbursements were adequately reviewed and
documented before payment3. In addition, the agent has hired a chief financial
officer to manage the day-to-day financial operations.

Management Fee Incorrectly
Calculated

The agent incorrectly calculated management fees for the three HUD-subsidized
projects. Specifically, it charged Mt. Pleasant project excess management fees of
$30,539 and undercharged $17,636 for Lucille Clark and Casita Park projects.
HUD Handbook 4381.5, REV 2, section 3.2(b), provides that the management fee
should be calculated as a percentage of the amount of rental income collected, and
attachment 1 of the project owner’s/management agent’s certifications4 quoted a
management fee as a percentage of the rent collected for each of the projects.
This methodology is intended to provide the agent an incentive to maximize rent
collections and automatically increase the fee yield as rents increase. However,
rather than applying a percentage to the rents collected, the agent calculated the
monthly fee by multiplying the number of units in the projects by a fixed dollar
amount. Specifically, the agent used $51 in one year and $59 in two other years
for Mt. Pleasant, and used $44 each year for the other two projects. This occurred
because the agent was unaware of the proper methodology for calculating the fee.

Replacement for Reserve Not
Administered Properly

The agent did not ensure that monthly deposits were made to the projects’ reserve
for replacement accounts as required and inadvertently made withdrawals from
these accounts without HUD approval. Section 5(a) of the regulatory agreement
requires that a reserve for replacement account be established, into which monthly
deposits would be made as specified, and that withdrawals be made only after
written consent from HUD. The reserve for replacement account is intended to
ensure the availability of cash for replacement of capital items, such as heating/air
conditioning, plumbing, and roofing. The agent made the required monthly
deposits for fiscal year 2006 (December 2005 through November 2006) for the
Mt. Pleasant project; however, it did not make deposits for fiscal year 2007 and
2008. Further, deposits were not made in any of the three fiscal years for the

3
We did not review or test financial activity incurred since the agent instituted revised procedures; however, we
discussed the matter with the agent and reviewed these procedures, which if implemented, should provide adequate
controls.
4
The project owner’s/management agent’s certification specifies the responsibilities to HUD of the project owner
and management agent.

7
other two projects. As shown in the table below, the projects’ reserve for
replacement account was underfunded by $375,775.

Required Number Deficient
Project monthly Period not paid of deposits
deposit months 2006-
2008
Casita $6,900 Oct. 2005-June 2007 21 $144,900
Park
$3,405 July 2007-Sept. 2008 15 51,075

Lucille $4,498 Oct. 2005-Aug. 2007 23 $103,454
C. Clark
$1,998 Sept. 2007-Sept. 13 25,974
2008
Mt. $2,190 Dec. 2006-Nov. 2008 24
Pleasant $50,3725
Total $375,775

Required monthly deposits for Casita Park and Lucille Clark were higher for the
period October 2005 through August 2007 so that loans of $80,426 and $30,000,
respectively, to pay real estate taxes from the replacement for reserve account
would be repaid by the end of the projects’ fiscal year 2007. However, the loan
amounts had not been repaid.

This occurred because the projects experienced cash flow problems, did not have
the funds with which to make deposits, and did not request a waiver from HUD to
suspend the payments. The fiscal year 2007 independent public accountant’s
report noted that the required deposits were not made and recommended that the
agent request HUD approval to suspend the monthly deposit requirement. While
the agent responded to the report on February 4, 2009 that it would petition HUD,
it did not do so until October 6, 2009 after our inquiry.6

In addition, the agent made three withdrawals totaling $2,750 from the reserve for
replacement accounts of Lucille Clark and Mt Pleasant projects. Agent officials
stated that the withdrawals were erroneously made and should have been
disbursed from the projects’ operating account.

5
Mt. Pleasant funded its reserve account by an additional $2,188 in fiscal year 2006, therefore the amount of
deficient deposits shown is $2,188 less.
6
HUD has not responded to the request.

8
Annual Unit Inspections Not
Conducted as Required

Regulations at 24 CFR (Code of Federal Regulations) Subpart G Section 5.705
require annual unit inspections of HUD-subsidized housing. However, unit
inspections were not completed for the 94 units at Casita Park in 2008. This
condition occurred because the property manager for Casita Park was transferred
to another location in June 2008 and provisions were not made for unit
inspections. As a result, HUD lacked assurance that the units complied with
HUD unit maintenance standards. However, unit inspections for all units were
conducted the following year.

Procurements Not Always Made
in a Prudent Manner

The agent did not prepare cost estimates, solicit bids, or execute a contract with
two bookkeepers who provided services to the three HUD-subsidized properties
during the audit period at a cost of $18,850 and $43,505 in years 2006 and 2007,
respectively. In addition, the agent did not solicit cost estimates for legal services
obtained at a cost of $7,626 in 2006 and $8,627 in 2007.

HUD Handbook 4381.5, REV-2, section 6.50(a), provides that when an
owner/agent is contracting for goods or services, an agent is expected to solicit
written cost estimates from at least three contractors or suppliers for any contract,
ongoing supply, or service which is expected to exceed $10,000 per year; (b)
obtain verbal or written cost estimates for any contract, ongoing supply, or service
estimated to cost less than $5,000 per year; and (c) maintain documentation of all
bids as part of project records for three years after completion of the contract.
Section 4 of the management certification provides that the necessary verbal or
written cost estimates will be obtained and the reasons for accepting other than
the lowest bid will be documented.

The agent failed to procure services in a prudent manner because it lacked
controls to ensure compliance with HUD regulations and its own policies
concerning procurements. As a result, HUD could not be assured that the auditee
obtained the most economical and reasonable price available when procuring
services.

Financial Statements Not Filed in
a Timely Manner

Section 11(f) of the regulatory agreement requires that financial statements be
submitted to HUD 60 days after the projects’ fiscal year end. However, the agent
did not submit financial statements to HUD in a timely manner during the audit

9
period. Specifically, it submitted financial statements between 8 and 14 months
late for fiscal years 2006 and 2007, and those due for fiscal year 2008 for Casita
Park and Lucille Clark projects had not been submitted and were 10 months late.
This condition occurred because the agent’s books and records were not
adequately maintained. As a result HUD was not made aware of the financial
condition of the projects in a timely manner.

Section 7a of the management certification specifies that all records related to the
operation of the project, regardless of where they are housed, are considered the
property of the project. However, much of the projects’ fiscal years 2006 through
2008 financial records were kept by the projects’ former accountant/bookkeeper,
who refused to release the documents to the agent due to a dispute over payment
of the bookkeeper’s fees. After we initiated our audit, the agent instituted legal
action to regain control of these records; however, the issue has not yet been
resolved.

In May 2009, HUD imposed a $6,500 civil monetary penalty against the owner of
Mt. Pleasant for noncompliance with financial statement filing requirements for
fiscal years ending 2007 and 2008. HUD reached a settlement agreement on June
19, 2009, which required Mt. Pleasant’s owner to pay the penalty and submit the
financial statements within 120 days from the date of agreement. On June 19,
2009, Mt. Pleasant’s owner paid the penalty and submitted the 2007 financial
statements to HUD. The 2008 financial statements for Mt. Pleasant were
subsequently submitted on October 14, 2009.

Conclusion

Weaknesses in the agent’s financial, procurement, and administrative controls
caused noncompliance with HUD regulations pertaining to the Section 202
elderly housing projects. As a result, the projects were deprived of funds that
could have been used for necessary expenses, and HUD lacked assurance that
funds were disbursed for eligible costs and that procurement actions were the
most efficient. In addition, HUD was not made aware of the financial condition
of the projects in a timely manner. While the agent had taken actions to address
these weaknesses, additional action to reimburse the projects and strengthen
financial, procurement, and administrative controls to provide greater assurance
of compliance with applicable regulations is warranted.

Recommendations

We recommend that the Director of HUD’s New York City Office of Multifamily
Housing instruct the property owner /agent to

10
1A. Repay the projects from nonfederal funds the $146,867 disbursed from the
projects’ funds for employee services not received and the ineligible consultant
costs.

1B. Develop and implement a cost allocation plan for the allocation of costs to the
projects in accordance with HUD regulations.

1C. Strengthen controls over disbursements to ensure that all costs charged to the
projects are eligible in accordance with HUD regulations and the agent’s own
policies.

1D. Provide documentation to justify $498,643 in unsupported costs charged to the
HUD-subsidized projects. If documentation provided does not support the
costs, this amount should be repaid to the projects from nonfederal funds.

1 E. Strengthen controls over disbursements to ensure that documentation and
approvals exist before payments are made and that project funds are used in
accordance with HUD rules and regulations.

1F. Repay from nonfederal funds the $30,539 in excess management fees charged
a project and request HUD review and approval to charge the $17,636 in
management fees earned, but not collected from the other two projects.

1G. Implement procedures to ensure that the management fee is properly
calculated in accordance with HUD regulations.

1H. Repay the $2,750 incorrectly withdrawn from the reserve for replacement
accounts from the projects operating account.

1I. Establish procedures to ensure that the loan repayments and required monthly
deposits are made to the projects’ reserve for replacement accounts or seek
approval from HUD to suspend such deposits when sufficient cash is not
available.

1J. Strengthen controls to ensure that all project units are inspected on an annual
basis.

1K. Strengthen procurement procedures to achieve compliance with HUD
requirements to provide assurance that services are procured in the most
economical and prudent manner.

IL. Establish procedures to ensure that contracts identify that project records are
the property of the owner and appropriate action is taken to enforce contract
requirements.

11
IM. Implement procedures to ensure that financial statements are submitted to
HUD in a timely manner to avoid the imposition of future penalties and ensure
that HUD is aware of the projects’ financial condition in a timely manner.

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SCOPE AND METHODOLOGY

Our audit generally covered the period October 1, 2005, through November 30, 2008,7 and
was expanded when necessary. We conducted our fieldwork between March and
October 2009 at the offices of the management agent located at 1261 Fifth Avenue, New
York, New York.

To accomplish our objective, we

Reviewed federal law, multifamily housing regulations, and the applicable regulatory
agreements and project owner’s/management agent’s certifications to determine
applicable HUD requirements governing the operations of the Casita Park, Lucille
Clark, and Mt. Pleasant projects.

Reviewed the HUD project management files and discussed the projects with staff at the
HUD field office to identify any concerns about the projects.

Obtained an understanding of the management agent’s structure and reviewed the
organizational chart and duties of staff related to the projects reviewed.

Reviewed the available audited financial statements to identify any management and
internal control weaknesses and reportable conditions identified before our audit work.

Documented and evaluated financial and operational controls identified through an
internal control questionnaire and interviews with agent officials.

Interviewed the former accountant/bookkeeper and consultant, complainant, and an
agent board member to discuss complaint issues and records access.

Reviewed accounting records to evaluate whether the agent had a formal and
reasonable system for allocating salaries and other costs among its projects.

Reviewed and tested project accounting records to determine the extent to which the
agent complied with HUD record requirements, charged projects for costs that were
reasonable and necessary, and maintained adequate support for disbursements.

Reviewed procurement procedures and services procured to determine whether
proper procurement procedures were followed.

Reviewed and tested procedures for determining tenant rental subsidy and compliance
with unit maintenance standards. We selected three units nonstatistically from each

7
The period was October 1, 2005, through September 30, 2008, for two projects and December 1, 2005, through
November 30, 2008, for the third project.

13
of two projects to assess tenant eligibility and rental subsidy calculation and found no
problems; consequently, we did not expand our sample.

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
objective:

Program operations - Policies and procedures that management has
implemented to reasonably ensure that a program meets its objectives.

Validity and reliability of data - Policies and procedures that management
has implemented to reasonably ensure that valid and reliable data are
obtained, maintained, and fairly disclosed in reports.

Compliance with laws and regulations - Policies and procedures that
management has implemented to reasonably ensure that resource use is
consistent with laws and regulations.

Safeguarding of resources - Policies and procedures that management has
implemented to reasonably ensure that resources are safeguarded against
waste, loss, and misuse.

We assessed the relevant controls identified above.

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

15
Significant Weaknesses

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

The agent did not have adequate financial, procurement, and administrative
controls over its program operations and compliance with laws and regulations
when it did not establish adequate controls to ensure that costs charged to the
projects were for eligible and supported project expenditures (see finding).

The agent did not establish operational procedures for ensuring that
disbursements from the reserve for replacement account were made in
compliance with HUD regulations, contracts were adequately procured, and
books and records were maintained in accordance with HUD requirements (see
finding).

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APPENDIXES

Appendix A

SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT
TO BETTER USE

Recommendation Funds to be put
number Ineligible 1/ Unsupported 2/ to better use 3/
1A $146,867
1D $498,643
1F $30,539 $17,636
1H $2,750
________ ________ ______

Total $177,406 $498,643 $20,386

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/ Recommendations that funds be put to better use are estimates of amounts that could be
used more efficiently if an OIG recommendation is implemented. These amounts include
reductions in outlays, deobligation of funds, withdrawal of interest, costs not incurred by
implementing recommended improvements, avoidance of unnecessary expenditures
noted in preaward reviews, and any other savings that are specifically identified. In this
instance, if the auditee implements our recommendation, funds that were improperly
withdrawn from the replacement for reserve account will be available for use when
needed and projects will have paid the appropriate management fee.

17
Appendix B