Issue Date March 10, 2011 Audit Report Number 2011-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: Financial Management and Procurement Controls at Westbeth Artists Houses, New York, NY, Did Not Always Comply With Regulations HIGHLIGHTS What We Audited and Why We audited Westbeth Artists Houses (auditee) in response to a complaint submitted to the Office of Inspector General (OIG) hotline alleging that project funds were used to pay an executive director in violation of U.S. Department of Housing and Urban Development (HUD) regulations. Our audit objectives were to assess the merits of the complaint and determine whether project operations generally complied with HUD regulations pertaining to financial, procurement, and tenant certification processes. What We Found The complaint had merit because the duties of the executive director position for which project funds were disbursed were not adequately supported. In addition, although tenant certifications were properly performed, the project’s financial management and procurement processes did not always comply with HUD regulations. Specifically, project funds were used to pay expenses that were inadequately supported, deemed unnecessary and unreasonable, and ineligible. In addition, auditee officials did not always follow prudent procurement practices when executing contracts. These conditions occurred because auditee officials believed that the funds used to pay for the executive director’s position were not subject to HUD regulation and weaknesses existed in the project’s financial and procurement controls. As a result, auditee officials lacked assurance that (1) $304,485 expended for an executive director’s position and $28,351 disbursed for other expenses were properly supported, (2) $7,030 expended was for necessary and reasonable project- or housing-related costs, (3) $37,650 expended was for eligible expenses, and (4) services were obtained at the most economical price. What We Recommend We recommend that the Director of HUD’s New York Office of Multifamily Housing instruct auditee officials to (1) provide justification for the $304,485 expended for the costs related to the executive director’s position so that HUD can determine whether it is justified and provide documentation to substantiate the $28,351 in unsupported expenses, (2) reimburse the project from non-federal funds, $7,030 in expenses deemed unnecessary and unreasonable, along with the ineligible expenses of $37,650, and (3) ensure that controls over financial management and procurement processes are strengthened. 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 the audit with auditee officials during the audit and provided a draft report on January 21, 2011, which was discussed at an exit conference on January 31, 2011. Auditee officials provided written comments and exhibits on February 14, 2011 as requested in which they disagreed with the findings and recommendations. The complete text of the auditee’s response, except for the exhibits, which were too voluminous to include in the report, along with our evaluation of that response, can be found in appendix B of this report. The exhibits will be provided to the HUD field office. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: Financial Management and Procurement Controls Did Not Always 5 Comply With Regulations Scope and Methodology 11 Internal Controls 13 Appendixes A. Schedule of Questioned Costs and Funds To Be Put to Better Use 15 B. Auditee Comments and OIG’s Evaluation 16 C. Analysis of Executive Director Responsibilities According to Employment 38 Agreement 3 BACKGROUND AND OBJECTIVES Westbeth Artists Houses (auditee), which is located at 463 West Street, New York, NY, and is the site of a former industrial building abandoned in 1966, opened in 1970 as the first federally subsidized artists’ housing. In addition, there is an easement agreement relating to an abandoned railway line running through the development. The development is a 384 residential and 106 commercial unit Section 221(d)(3) multifamily building owned by the Westbeth Corporation Housing Development Fund Company, Inc., a not-for-profit housing company. The 384 residential units are to be provided at below-market rent to those performing or participating in a wide range of artistic activities, and the 106 commercial units and artists’ studios are to be provided at market rent. The development is governed by an uncompensated board of between 3 and 15 directors. The U.S. Department of Housing and Urban Development (HUD) entered into a regulatory agreement with the owners in 1968 in connection with a Section 221(d)(3)-insured mortgage. The provisions of this regulatory agreement were extended to cover a supplemental insured mortgage obtained on August 7, 1970. HUD’s financial interest in the property ended on August 26, 2009, when it entered into a loan sale agreement to sell the mortgage loan to the New York City Housing Development Corporation. The development continues to be subject to a HUD Section 8 housing assistance contract for which it provides project-based housing assistance for 77 apartment units. Section 221(d)(3) of the National Housing Act allows HUD to insure mortgage loans to facilitate new construction or substantial rehabilitation of multifamily rental or cooperative housing for moderate-income families, the elderly, and the handicapped. Property owners are ultimately responsible for ensuring that HUD-subsidized properties are operated in an effective and efficient manner. The regulatory agreement between the property owner and HUD specifies that the responsibilities of an owner are to maintain the development and its records in accordance with HUD requirements. However, property owners may contract with a management agent through a management agreement to oversee the day-to-day operations of the property and maintain the financial and accounting records. The property owner executed a project owner’s/management agent’s certification in January 2008 with Phipps Houses Services to serve as the management agent. The project owner’s/management agent’s certification provides that the agent and owner will comply with HUD requirements and contract obligations, that all expenses of the development are reasonable and necessary, and that the development’s accounts and records are established and maintained in accordance with HUD requirements. We initiated an audit in response to a complaint submitted to the Office of Inspector General (OIG) hotline alleging that project funds were used to pay an executive director in violation of HUD regulations. Our audit objectives were to assess the merits of the complaint and determine whether project operations generally complied with HUD regulations pertaining to financial, procurement, and tenant certification processes. 4 RESULTS OF AUDIT Finding 1: Financial Management and Procurement Controls Did Not Always Comply With Regulations Tenant certifications complied with HUD regulations; however, auditee officials did not always administer financial management and procurement controls in accordance with HUD regulations. Specifically, project funds were used to pay compensation for an executive director’s position, the duties of which were neither adequately supported nor considered necessary by HUD, and other expenses that were inadequately supported, deemed unnecessary, and ineligible. In addition, auditee officials did not always follow prudent procurement practices. These conditions occurred because auditee officials believed that the funds used to pay expenses for the executive director were not subject to HUD regulation and weaknesses existed in the auditee’s financial and procurement controls. As a result, auditee officials lacked assurance that $304,485 expended for an executive director’s costs and $28,351 for other expenses were properly supported, $7,030 expended was for necessary and reasonable project- or housing-related costs, $37,650 expended was for eligible expenses, and services were obtained at the most economical price. Executive Director Position Not Adequately Supported Disbursements on behalf of an executive director were unsupported because the duties assigned to that position were those normally expected of the management agent or the board of directors or had not been performed. While the project was reported to have been without an executive director since sometime in the 1970s, the board of directors authorized filling such a position during its June 29, 2006, board meeting. After conducting an executive search, auditee officials hired an individual on September 11, 2006, to serve as executive director for 1 year but did not renew the contract upon its expiration. On January 28, 2008, a member of the board of directors resigned and was hired as the executive director under a 1-year term of employment. Although the contract had not been renewed, the individual continued to serve in that position. Auditee officials had expended $304,485 through August 26, 2009,1 for compensation and the reimbursement of expenses related to this position as follows: 1 No exception is taken for payments related to the executive director’s position after this date because after HUD executed the loan sale agreement, it had no further financial interest in the project. However, section 2.10 of the agreement provides that assignment of the regulatory agreement does not affect any recourse HUD may have for breach of the regulatory agreement that occurred before the closing date. 5 Table 1: Expenditures related to the executive director position Calendar Salary and Bonus Other Grand total year benefits 2006 $38,394 $1,000 $366 $39,760 2007 $85,775 $0 $1,920 $87,695 2008 $94,364 $5,000 $1,223 $100,587 2009 $69,521 $5,000 $1,922 $76,443 Total $288,054 $11,000 $5,431 $304,485 The auditee structured the executive director’s position as an employee of the project, which operated under a 1-year employment contract, subject to renewal.2 The employment contract included an exhibit which detailed the duties expected of the executive director. Auditee officials maintained that such a position was needed due to the complex issues facing the development. However, analysis of these duties (see appendix C) disclosed that most of them were responsibilities that might normally be expected of the management agent and/or the board of directors and were tasks for which the owners contracted with other entities or that were not performed by the incumbent. For instance, the functions assigned to the executive director to oversee the management of all residential and commercial benefits, including admissions, in- house moves, studio, gallery, and community spaces, as well as managing the day- to-day operations of the development are functions normally expected of a management agent. The Project Owner’s/Management Agent’s Certification (form HUD-9839-B) provides that, among other duties, a management agent selects and admits tenants, computes tenant rents and assistance payments, recertifies tenants, and performs other subsidy contract administration responsibilities in accordance with HUD regulations. In addition, while the executive director was expected to develop and execute a strategic plan for the project’s future, auditee officials enlisted a consultant to develop a detailed guide outlining future possibilities for the development. Further, while fundraising was a duty assigned to the executive director’s position, the current executive director said that he had not engaged in any fundraising activity. Costs of the Executive Director Not Accurately Classified HUD Handbook 4370.2 provides that office salaries should be recorded under administrative expenses; however, $85,775 of the $304,485 in costs associated with the executive director’s position were misclassified in the calendar year 2007 2 This arrangement complies with HUD regulations because, while the regulatory agreement, paragraph 7(i), prohibits the owners from paying any compensation or making any distribution of income or other assets to any of its officers, directors, or stockholders, such prohibition does not extend to an employee, which was the status of the executive director. 6 financial statements filed with HUD. This statement did not present an accurate accounting to HUD of how project funds were being expended and may have caused HUD to not be aware of the extent to which expenses were being paid for an executive director. For instance, the $85,775 paid in 2007 as executive director compensation was reported as an operating and maintenance expense. In addition, the bonuses paid to the current executive director in 2008 and 2009 were reported as miscellaneous office expenses. When HUD became aware, through disclosure in the project’s 2009 budget-based rent application, that funds were being allocated to the executive director’s position, it disallowed the expense as a factor in determining the allowed rent because the development already had a management agent. Costs of the Executive Director Paid From Arbitration Funds The costs for the subject expenses were paid from funds awarded through arbitration relating to an easement through the project property. The award was compensation for damage to property owned by the project due to the failure of the easement grantee to meet certain maintenance obligations. The project owners deposited these funds into a segregated bank account administered by the owners and not the management agent. Auditee officials believed that these funds were not subject to HUD regulation because the funds were neither generated from the project’s business of providing housing nor from property subject to the project mortgage. However, guidance from HUD’s Regional Counsel concluded that the award of these funds did relate to the project, which is subject to the HUD-insured mortgage and, therefore, should be regarded as project income. Funds Expended for Inadequately Supported Costs Section 10(c) of the regulatory agreement provides that the books, contracts, records, documents, and other related papers must be maintained in reasonable condition for proper audit and subject to examination and inspection by HUD or its duly authorized agents. However, auditee officials lacked adequate support to substantiate $28,351 disbursed from project funds for legal and consulting costs. For example, auditee officials expended $12,445 for legal services without an invoice or written documentation of the service performed and $9,501 for consulting services related to mission and planning work, for which there was no written report or other documentation of the benefits received. This condition occurred due to weaknesses in financial management controls. As a result, auditee officials lacked assurance that $28,351 in project funds was properly supported in accordance with HUD regulations. 7 Funds Expended for Unnecessary Costs Section 7(b) of the regulatory agreement requires that project funds be used only for reasonable operating expenses and necessary repairs. Auditee officials expended $7,030 for three events that were deemed unreasonable and unnecessary. In the first instance, $5,773 was expended for food and liquor at a reception held for the executive director hired in 2006; in the second instance, $1,110 was expended for food, liquor, and a gift for a security guard’s retirement party; and in the third instance, $147 was expended for food for a board meeting. This condition occurred because of auditee official’s unfamiliarity with HUD regulations. As a result, $7,030 in project funds was unnecessarily used for nonproject- or housing-related expenses. Ineligible Expenses Auditee officials expended $37,650 from project funds for the following ineligible expenses: $31,840 for commercial leasing brokerage commissions, $5,000 for legal fees associated with the selling/refinancing of the property, $510 for legal fees associated with establishing a related nonprofit fundraising entity, and $300 to purchase a personal item from a tenant. Auditee officials explained that the $31,840 brokerage commission was compensation for leasing the project’s commercial space. However, paragraph 1(b) of the project owner’s/management agent’s certification requires that the agent manage the project for the term and fee described on the certification and that fee changes be made only with HUD approval. HUD officials further stated that a fee for commercial space leasing can be earned but only if approved by HUD as a special fee documented in the project owner’s/management agent’s certification. Nevertheless, no such approval was requested. The legal fees and personal item are not project-related expenses but are owner and tenant expenses, respectively. These conditions occurred due to auditee official’s unfamiliarity with HUD regulations. Consequently, the project was deprived of $37,650 that was spent on these ineligible items. 8 Prudent Procurement Practices Not Followed Auditee officials did not always solicit written or verbal cost estimates or execute written contracts as required by HUD regulations and the auditee’s own policy. HUD Handbook 4381.5, REV-2, section 6.50(a), provides that when an owner/agent contracts for goods or services, an agent is expected to solicit written cost estimates from at least three contractors or suppliers for any contract or ongoing supply or service that is expected to exceed $10,000 per year. Section 6.50(b) provides that for any contract or ongoing supply or service estimated to cost less than $5,000 per year, the agent should solicit verbal or written cost estimates, to ensure that the project obtains services, supplies, and purchases at the lowest possible cost, and should make a record of any verbal estimates obtained. Additionally, section 6.50(c) prescribes that documentation of all bids should be retained as part of the project records for 3 years following the completion of the work. In addition, the management agent’s bidding procedures require the purchasing department to bid purchase requisitions for all services/materials in excess of $2,000 and any individual item costing more than $1,000. Of 18 procurement actions reviewed, there was no evidence of written solicitations or verbal cost estimates for 15 actions or that a written contract had been executed in 3 cases. For instance, an architect was hired for $1,540, and services were procured to perform lead paint clearance testing for $21,658 without evidence that written or verbal cost estimates were obtained or that a written contract was executed. Without soliciting cost estimates and documenting work expected via a written contract, auditee officials lacked assurance that the most economical and efficient price was obtained for these services. Conclusion While the project is a complex operation that faces major challenges which may warrant approval of special management fees, the use of project funds for an executive director was not adequately supported as not being duplicative of other services obtained. In addition, weaknesses existed in the financial management and procurement controls of the project. These weaknesses occurred because of the project owners’ unfamilarity with HUD regulations. Consequently, the project owners incurred unsupported, unnecsssary, and ineligible expenses and did not administer procurement controls in accordance with HUD regulations. Therefore, the auditee lacked assurance that project funds were expended for reasonable and necessary costs, thus depriving the project of funds to pay for necessary expenses. 9 Recommendations We recommend that the Director of the HUD New York Office of Multifamily Housing instruct auditee officials to 1A. If the arbitration award funds are deemed subject to HUD regulation, provide justification for the $304,485 expended for an executive director’s position and, if adequate justification is not provided, reimburse the project from non-Federal funds. 1B. Provide adequate documentation for the $28,351 in unsupported expenses and, if adequate documentation cannot be provided, reimburse the project from non-Federal funds. 1C. Reimburse the project from non-Federal sources the $7,030 in expenses deemed unreasonable and unnecessary. 1D. Reimburse the project from non-Federal sources the $37,650 expended for the ineligible costs. 10 SCOPE AND METHODOLOGY The review focused on addressing whether the project inappropriately used funds to pay an executive director and generally complied with HUD regulations pertaining to financial and procurement processes. To accomplish the objectives, we Reviewed the regulatory agreement executed between HUD and the project owners in 1968; HUD Handbooks 4350.3, REV-1, 4370.2, REV-1, 4381.5, REV-2, which serve as guidance for the administration of projects such as the auditee; the loan sales agreement executed by HUD in 2009; and the project owner’s/management agent’s certifications approved by HUD on March 17, 2006, May 2, 2007, and April 18, 2008. Reviewed the project’s corporate by-laws, board meeting minutes, executive director’s employment contract, and procurement policy for the audit period to determine whether project policies complied with HUD regulations. Interviewed HUD Office of Multifamily Housing field office, Enforcement Center, and Regional Counsel staff to identify and obtain guidance on issues pertaining to the project. Interviewed management agent and independent public accountant officials to obtain an understanding of the project’s management controls and procedures. Analyzed the project’s audited financial statements and applicable financial records, including general ledgers, check registers, bank statements, expenditure vouchers, and supporting documentation for the audit period, to gain an understanding of the project’s financial operations. Obtained an understanding of the management agent’s structure and reviewed the organizational chart and duties of the project staff. Selected a sample of five Section 8 program tenant files to test whether the project properly recertified and determined tenant eligibility in accordance with HUD regulations. Selected a sample totaling $281,536, or 32 percent, of reported expenditures for professional fees and administrative, operating, and maintenance supply costs incurred during the audit period to assess compliance with HUD regulations. The audit period was from January 1, 2006, through June 30, 2008, and was expanded when necessary. We performed audit fieldwork from June through October 2010 at the project located at 463 West Street, New York, NY, and at the management agent’s office located at 902 Broadway, New York, NY. 11 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 objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. 12 INTERNAL CONTROLS Internal control is a process adopted by those charged with governance and management, designed to provide reasonable assurance about the achievement of the organization’s mission, goals, and objectives with regard to Effectiveness and efficiency of operations, Reliability of financial reporting, and Compliance with applicable laws and regulations. Internal controls comprise the plans, policies, methods, and procedures used to meet the organization’s mission, goals, and objectives. Internal controls 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: Effectiveness and efficiency of operations: Policies and procedures that management has implemented to reasonably ensure that a program meets its objectives. Reliability of financial reporting: Policies and procedures that management has in place to reasonably ensure that valid and reliable data are obtained, maintained, and fairly disclosed in reports. Compliance with applicable laws and regulations: Policies and procedures that management has implemented to reasonably ensure that resource use is consistent with laws and regulations and its procurement practices comply with HUD requirements. We assessed the relevant controls identified above. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, the reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or efficiency of operations, (2) misstatements in financial or performance information, or (3) violations of laws and regulations on a timely basis. 13 Significant Deficiency Based on our review, we believe that the following item is a significant deficiency: Auditee officials lacked adequate controls to ensure the reliability of financial reporting and compliance with HUD regulations when they did not maintain documentation to support expenses and disbursed funds for unsupported, unnecessary and unreasonable, and ineligible expenses. In addition, auditee officials did not comply with HUD’s and its own procurement regulations. 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Ineligible 1/ Unsupported Unreasonable or number 2/ unnecessary 3/ 1A $304,485 1B 28,351 1C $7,030 1D $37,650 _______ _______ Total $37,650 $332,836 $7,030 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or Federal, State, or local policies or regulations. 2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program or activity when we cannot determine eligibility at the time of the audit. Unsupported costs require a decision by HUD program officials. This decision, in addition to obtaining supporting documentation, might involve a legal interpretation or clarification of departmental policies and procedures. 3/ Unreasonable/unnecessary costs are those costs not generally recognized as ordinary, prudent, relevant, and/or necessary within established practices. Unreasonable costs exceed the costs that would be incurred by a prudent person in conducting a competitive business. 15 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 16 Ref to OIG Evaluation Auditee Comments Comment 1 Comment 3 Comment 2 17 Ref to OIG Evaluation Auditee Comments Comment 4 Comment 5 Comment 4 18 Ref to OIG Evaluation Auditee Comments Comment 5 Comment 6 Comment 7 19 Ref to OIG Evaluation Auditee Comments Comment 7 Comment 8 Comment 6 Comment 9 20 Ref to OIG Evaluation Auditee Comments Comment 9 Comment 10 21 Ref to OIG Evaluation Auditee Comments Comment 11 22 Ref to OIG Evaluation Auditee Comments Comment 11 Comment 12 23 Ref to OIG Evaluation Auditee Comments Comment 1 24 Ref to OIG Evaluation Auditee Comments Comment 13 25 Ref to OIG Evaluation Auditee Comments Comment 9 26 Ref to OIG Evaluation Auditee Comments Comment 11 Comment 9 27 Ref to OIG Evaluation Auditee Comments Comment 14 Comment 15 28 Ref to OIG Evaluation Auditee Comments Comment 16 Comment 17 Comment 18 Comment 19 29 Ref to OIG Evaluation Auditee Comments Comment 20 Comment 11 Comment 21 Comment 11 Comment 22 Comment 23 30 Ref to OIG Evaluation Auditee Comments Comment 23 Comment 3 Comment 24 31 Ref to OIG Evaluation Auditee Comments Comment 11 Comment 25 Comment 5 Comment 16 to 20 Comment 21 Comment 22 to 23 OIG Evaluation of Auditee Comments 32 OIG Evaluation of Auditee Comments Comment 1 The issue is not whether the board of directors was within its rights to create an executive director position but, rather, whether the costs incurred for the executive director position were adequately supported and complied with section 7(b) of the Regulatory Agreement for Non Profit and Public Mortgagors Under Section 221(d)(3) of the National Housing Act, As Amended (FHA Form No. 1733), which provides that the project owners “shall not without the prior written approval of the Commissioner … pay out any funds, except for reasonable operating expenses and necessary repairs.” Therefore, payment of other than reasonable operating expenses or necessary repairs without prior HUD approval would violate the regulatory agreement executed between HUD and the project. Comment 2 Section 221(d)(3) of the National Housing Act insures mortgage loans to facilitate the new construction or substantial rehabilitation of multifamily rental or cooperative housing for moderate-income families, the elderly, and the handicapped, and the terms of the regulatory agreement executed between HUD and the project owners provide that project funds must be used to maintain the project and for reasonable and necessary expenses. Expenses incurred that are determined to not be reasonable and necessary are to be repaid to the project from nonfederal funds unless previously approved by HUD. Comment 3 Section 2.10 of the loan sale agreement provides that the assignment of the regulatory agreement from the seller (HUD) to the purchaser (Housing Development Corporation) shall not affect any right that the seller has to seek recourse for a breach of the regulatory agreement, which occurred before the closing date. Accordingly, after the closing date, the seller may pursue claims against any person who violated or caused a violation of the regulatory agreement, and any funds recovered in settlement of any such claim will be retained by the seller. In this case, any recovered funds should be repaid to the project from nonfederal funds. Comment 4 While no specific documentation was provided for the existence or removal of an executive director, it is reported in an oral history of Westbeth that the executive director position was eliminated in the 1970s based upon HUD’s conclusion that it was an unnecessary project expense. No documentation was found to evidence that the project had later sought HUD’s approval for an executive director position. Comment 5 While we acknowledge that Westbeth is a complex, if not unique, project, the project owners did not request that HUD reconsider its previous denial of an executive director position as being unnecessary, nor have any special fees or add-on fees been requested from HUD as allowed by HUD Handbook 4381.5, REV-2, sections 3.6 and 3.7, respectively. Analysis of the 15 functions assigned to the executive director position, as detailed in the incumbent’s employment contract, disclosed that many of the duties are those normally expected of others. For instance, while overseeing the management of all residential and commercial benefits, including admissions, in-house moves, studio space, gallery space, and community space, as well as managing the day-to-day operations of the 33 development, are functions assigned to the executive director position, these are functions expected to be carried out by the management agent. Further, a consultant was reportedly hired to develop a detailed guide outlining future possibilities for the project’s development; however, the specifics of this plan or any other outcomes of this procurement were not provided during the audit. In addition, the incumbent stated that 5 of the 15 expected functions had not been performed. While no attempt was made to identify how much of the annual salary is attributable to each function, the costs incurred for the executive director position are considered unsupported since adequate justification for such a position has not been provided to HUD. Comment 6 Analysis of the duties assigned the executive director position disclosed that many are functions assigned by contract or internal project operating procedures to other officials. For instance, the project owner’s/management agent’s certification provides that, among other duties, a management agent selects and admits tenants, computes tenant rents and assistance payments, recertifies tenants, and performs other subsidy contract administration responsibilities in accordance with HUD regulations. In addition, Westbeth’s by-laws assign the president general supervision over the affairs of the project. Accordingly, OIG’s analysis was not based upon the possibility that others might perform duties assigned to the executive director position but, rather, that others were officially tasked with these duties. Consequently, the potential duplication of duties and prior and current HUD disapproval of an executive director position as unnecessary leads to a conclusion that the position is inadequately supported. Comment 7 As mentioned previously, section 2.10 of the loan sale agreement, dated August 26, 2009, between HUD (the seller) and the New York City Housing Development Corporation (the purchaser) specifies that “the assignment of the Regulatory Agreement from the Seller to the Purchaser shall not affect any right that the Seller may have to seek recourse for a breach of the Regulatory Agreement, which occurred prior to the Closing date.” The OIG review was initiated under this authority, and that is why any findings or recommendations from that review do not extend beyond August 26, 2009, the date of the sale, at which time HUD’s financial interest in the property ended. Comment 8 Project and management agent officials were advised of the nature and specifics of the complaint at the May 14, 2010, entrance conference. At that time, OIG stated that the review was initiated as a result of a complaint to the OIG hotline and a HUD field office request, both of which related to payment for an executive director, and that the complainant’s name would remain anonymous. Further, auditee officials have a fiduciary responsibility to address the complaint allegation. Comment 9 The OIG analysis was based upon and supported by a review and comparison of the duties assigned to the executive director’s position as documented in the employment contract for the position, the functions assigned to the management agent according to the project owner’s/management agent’s certification, and the board of directors’ responsibilities as noted in Westbeth’s by-laws. These three documents are the authority upon which the analysis was based. Further, the 34 regulatory agreement, as mentioned in comment 2, gives HUD the authority to declare a breach of agreement as a result of any unreasonable and unnecessary expenses incurred without prior HUD approval. Comment 10 While the board of directors has the authority to delegate its responsibilities, section 7(b) of the Regulatory Agreement for Non Profit and Public Mortgagors Under Section 221(d)(3) of the National Housing Act, As Amended (FHA Form No. 1733), provides that the project owners “shall not without the prior written approval of the Commissioner … pay out any funds, except for reasonable operating expenses and necessary repairs.” HUD reportedly determined in the 1970s that the costs of an executive director were an unnecessary expense, and when HUD became aware through disclosure in the project’s 2009 budget-based rent application that funds were being allocated to the executive director’s position, it disallowed the expense as a factor in determining the allowed rent. For this reason and our analysis that disclosed possible duplication among and nonperformance of duties assigned the executive director, we have recommended that the project provide HUD documentation to properly support the need for and costs associated with the executive director’s position. Comment 11 The authority of the board of directors is not being challenged, but, rather, additional support is requested for the necessity of incurring costs from project funds subject to section 7(b) of the Regulatory Agreement for Non Profit and Public Mortgagors Under Section 221(d)(3) of the National Housing Act, As Amended (FHA Form No. 1733), for the payment of the expense for an executive director’s position. Further, the specific compensation package is not being challenged but, rather, the need to adequately support the costs incurred to ensure compliance with the regulatory agreement. This is all the more imperative due to HUD’s prior and more recent determination in its review of a rent increase request that such a position is not warranted. Comment 12 In light of HUD’s prior and continued disapproval of costs incurred for an executive director position and our analysis of the position’s duties, which disclosed duplication with other officials’ duties, the project owners have not adequately supported the need or obtained the approval of HUD as required for an executive director’s position. Thus, this expense does not appear to be reasonable or necessary according to section 7(b) of the regulatory agreement. Comment 13 While the functions listed may be actual functions carried out by the executive director, these functions were not enumerated in the current employment contract for the position (which had expired and not been renewed), and our analysis was limited to the 15 tasks enumerated in the incumbent’s employment contract and confirmed by the incumbent as duties of the position. If these additional tasks are being conducted by the incumbent, the auditee should present them to HUD to further support its opinion that an executive director’s position may be needed. However, based upon the analysis of the employment contract, it is our position that there is a duplication of duties, which, absent further support, results in an unnecessary expense. 35 Comment 14 HUD Handbook 4370.2 provides that office salaries should be recorded under administrative expenses; however, $85,775 paid in 2007 as executive director compensation was reported as an operating and maintenance expense, and bonuses of $10,000 were misclassified as miscellaneous office expenses; therefore, as discussed with auditee officials during the audit and at a preexit conference on October 25, 2010, these expenses were misclassified; nevertheless, auditee officials acknowledge the misclassification and have offered to properly classify the expenses. Comment 15 The auditee disagrees with HUD regional counsel’s opinion on the classification of funds from the arbitration award as project funds; however, the auditee has not provided additional information to refute counsel’s opinion. Therefore, this issue will need to be addressed from a legal standpoint during the audit resolution process. Comment 16 During the audit and at a preexit conference on October 25, 2010, we discussed with auditee officials the tentative observations based upon our review, which included $177,745 in costs considered inadequately supported. After this conference, we reclassified $3,570 as costs associated with the executive director’s position, and auditee officials provided support for $141,082 but were unable to provide supporting documentation for the $33,093 cited in the draft report. Consequently, auditee officials were provided the detail of the $33,093 before the exit conference. Documentation submitted after the exit conference on February 14, 2011, with the auditee’s official comments provided additional support for $4,742 in costs, leaving $28,351 still being considered unsupported. Comment 17 Auditee officials did not provide support for $12,444 in legal fees paid on June 23, 2006. In their response to the draft audit report, auditee officials provided a copy of the May 25, 2006 board of directors’ minutes, annexed as exhibit B, as support of the approval to pay the $12,444, as well as a detailed time slip documenting the hours billed that totaled $12,444 during October 2005. However, while the detailed time slip accounts for the hours billed, the board of directors’ minutes document approval to pay $13,941 in legal fees incurred in March and April 2006, not October 2005. Therefore, the costs will continue to be regarded as unsupported. Comment 18 Auditee officials explained that the $4,233 represented the remaining balance of a February 2007 invoice and was part of a $14,000 payment made on January 22, 2008 to pay off the February 2007 invoice, full payment of a $9,059.41 March 2007 invoice, and partial payment of $707.16 for an April 2007 invoice; however, the February 2007 invoice was not provided. Therefore, the $4,233 is still considered unsupported. Comment 19 The documentation annexed as exhibit C supports $4,740 of the $5,373 OIG considered to be unsupported costs. Accordingly, we have revised the report to reflect that $4,740 is considered supported, but, absent further supporting documentation for the remaining $632 ($206 and $426 from the February 2008 invoice), this amount is still considered unsupported. 36 Comment 20 The documentation annexed as exhibit D refers to various invoices amounting to $9,500 for “mission and planning work with Board and ED [executive director], admin support, and food for retreat.” However, since there was no contract that detailed what was to be provided by this procurement or any written report or other product to evidence the services received, these costs are still considered unsupported. Comment 21 The attached November 16, 2006, board of directors’ minutes support board approval of $5,000 to be spent for a holiday reception but do not document approval of the $7,030 expended for the three events questioned in the report. Accordingly, absent further supporting documentation, the $7,030 is still considered an unnecessary expense. Comment 22 The management agreement, section 6 - Leasing and Renting, provides that the agent use all reasonable effort to keep the project rented by procuring tenants using resident selection criteria and leasing guidelines approved by the owner. Further, the project owner’s/management agent’s certification, paragraph 1(b), requires that the agent manage the project for the term and fee described on the certification and that fee changes be made only with HUD approval. Further, while the management fee being charged is a flat fee, as opposed to a percentage of rents collected as stipulated in the certification, there is no mention of a commercial leasing brokerage fee. Therefore, the $31,840 is still questioned as unsupported and should be repaid unless auditee officials request and receive HUD’s retroactive approval for a special fee, which can be allowed in special circumstances. Comment 23 Adequate support has not been provided to conclude that $5,000 of legal fees associated with selling/refinancing the property, $510 of legal fees for establishing a nonprofit fundraising entity, and a $300 purchase of a personal item for a tenant are reasonable and necessary project expenses in accordance with Section 7(b) of the Regulatory Agreement for Non Profit and Public Mortgagors Under Section 221(d)(3) of the National Housing Act, As Amended (FHA Form No. 1733). Therefore, these costs are still questioned. Comment 24 Since the funds expended for unsupported, unnecessary and ineligible costs deprived the project of the use of these funds, we have changed recommendations 1A through 1D to read that reimbursement be made to the project so that the funds may be spent for the benefit of the tenants. Comment 25 We sought the advice of HUD’s regional counsel, who concluded that the New York State Business Judgment Rule is not applicable to the condition questioned. As noted in comment 11, the authority of the board of directors is not being questioned but, rather, whether there is a breach of the regulatory agreement between HUD and the auditee. Therefore, this issue will be addressed during the audit resolution process with the HUD field office. 37 Appendix C ANALYSIS OF EXECUTIVE DIRECTOR RESPONSIBILITIES ACCORDING TO EMPLOYMENT AGREEMENT Duties assigned to the executive Duties Duties Duties Duties not expected of a expected of expected performed director’s position management the board of of agent directors consultants 1) Manage day-to-day operations: planning and oversight of operational activities, human resources, fundraising, financial management, internal systems, and external relations. 2) Develop and execute a strategic plan. 3) Liaison between onsite and offsite property management office and board of directors. 4) Receive/review property management and fiscal reports. 5) Oversee property manager’s compliance with regulatory and licensing authorities. 6) Oversee the development and adherence to operational and capital improvement budgets with fiscal officer, property management office, and finance committee. 7) Oversee management of all residential and commercial benefits amenities: admissions, in-house moves, studio, gallery, community spaces. 8) Liaison with tenant organizations and oversight of contractual obligations, risk management, and communications 38 Duties assigned to the executive Duties Duties Duties Duties not director’s position expected of a expected of expected performed management the board of of agent directors consultants 9) Represent and promote Westbeth Corp., Housing Development Fund Company, Inc., to external stakeholders. 10) Ensure that all materials representative of Westbeth Corp., HDFC, Inc., reflect a high level of professionalism. 11) Develop the organization’s annual fundraising strategy. 12) Hire and oversee staff and consultants to execute fundraising activities. 13) Identify funding trends; cultivate potential funders; and solicit grants, contracts, gifts, and other resources. 14) Plan and execute fundraising activities; e.g., fundraising events, newsletters, press releases, etc. 15) Develop and expand relationships with nonprofit, private, and public sectors to attract resources. 39
Financial Management and Procurement Controls at Westbeth Artists Houses, New York, NY, Did Not Always Comply With Regulations
Published by the Department of Housing and Urban Development, Office of Inspector General on 2011-03-10.
Below is a raw (and likely hideous) rendition of the original report. (PDF)