oversight

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)

                                                                 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.




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