oversight

Housing Our Communities, Mesa, AZ, Did Not Administer Its Neighborhood Stabilization Program in Accordance with HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2011-12-08.

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

                                                              Issue Date
                                                                       December 8, 2011
                                                              Audit Report Number
                                                                           2012-LA-1001




TO:        Maria F. Cremer, Acting Director, San Francisco Office of Community Planning
           and Development, 9AD

           Dane Narode, Associate General Counsel for Program Enforcement, CACC



FROM:      Tanya E. Schulze, Regional Inspector General for Audit, Region IX, 9DGA

SUBJECT: Housing Our Communities, Mesa, AZ, Did Not Administer Its Neighborhood
         Stabilization Program in Accordance With HUD Requirements


                                  HIGHLIGHTS

 What We Audited and Why

            We audited Housing Our Communities’ (subrecipient) Neighborhood
            Stabilization Program (NSP1) subgrant from the City of Avondale.

            The audit was started primarily because the U.S. Department of Housing and
            Urban Development, Office of Inspector General’s (HUD OIG) audit plan
            includes objectives to review Housing and Economic Recovery Act grantees and
            because a previous HUD OIG audit of the City of Mesa found indications that the
            subrecipient did not have appropriate procedures in place for procuring
            construction contractors and determining labor costs.

            The objective of the audit was to determine whether the subrecipient complied
            with HUD’s program requirements related to procurement, conflicts of interest,
            and cost eligibility for its NSP1 subgrant.
What We Found


           The subrecipient did not comply with HUD’s NSP1 requirements related to
           procurement, conflicts of interest, and cost eligibility. The subrecipient awarded
           32 of its 44 NSP1 construction rehabilitation contracts to an affiliated for-profit
           entity that was operated by one of the subrecipient’s key officials. For 26 of these
           contracts, the subrecipient did not attempt to ensure open and free competition as
           required. Without proper controls in place, subrecipient officials allowed this
           affiliated entity to bill inflated amounts and arranged to receive a portion of the
           excessive costs as a return payment. The subrecipient also charged unsupported
           employee labor costs to its NSP1 subgrant.

What We Recommend


           We recommend that the Acting Director of the San Francisco Office of
           Community Planning and Development require the subrecipient to support or
           reimburse HUD for ineligible and unsupported costs totaling $787,004 charged to
           its NSP1 subgrant. We also recommend that the Associate General Counsel for
           Program Enforcement seek civil or administrative action or both based upon the
           violations cited in this report.
           For each recommendation in the body of the report without a management
           decision, please respond and provide status reports in accordance with HUD
           Handbook 2000.06, REV-4. Please furnish us copies of any correspondence or
           directives issued because of the audit.

Auditee’s Response


           We provided a draft report to the subrecipient on October 13, 2011 and the City of
           Avondale on October 20, 2011, and held an exit conference with subrecipient and
           City officials on October 25, 2011. The subrecipient provided written comments
           on November 10, 2011. It strongly disagreed with our report and
           recommendations. The City also provided a written response on November 10,
           2011 in which it provided some explanatory comments and generally indicated
           agreement with the report recommendations.

           The complete text of the auditee’s and the City’s responses, along with our
           evaluation of those responses, can be found in appendix B of this report. The
           auditee and the City also provided additional documentation with their responses.
           We did not include this in the report because it was too voluminous; however, it is
           available upon request.




                                            2
                            TABLE OF CONTENTS

Background and Objective                                                              4

Results of Audit
Finding: The Subrecipient Did Not Administer Its Neighborhood Stabilization Program   5
         in Accordance With Requirements

Scope and Methodology                                                                 17

Internal Controls                                                                     19

Appendixes

       A. Schedule of Questioned Costs                                                20
       B. Auditee Comments and OIG’s Evaluation                                       21
       C. Schedule of NSP1 Properties and Questioned Costs                            41




                                             3
                      BACKGROUND AND OBJECTIVE

The Neighborhood Stabilization Program (NSP1) was authorized under Division B, Title III, of
the Housing and Economic Recovery Act of 2008 (HERA) and provides grants to all States and
selected local governments on a formula basis. HERA appropriated $3.92 billion in NSP1 funds
for emergency assistance for redevelopment of abandoned and foreclosed-upon residential
properties. NSP1 was established for the purpose of stabilizing communities that have suffered
from foreclosures and abandonment. Generally, NSP1 funds must be used to buy, rehabilitate,
and resell foreclosed-upon and abandoned homes. As long as the funds are used for this
development, grantees may decide how to use the funds and what specific redevelopment
activities to undertake.

Housing Our Communities (subrecipient) is a U.S. Department of Housing and Urban
Development (HUD)-approved nonprofit housing counseling agency and has prior experience
performing housing rehabilitation using HUD funding. On March 9, 2009, the City of Avondale,
AZ, entered into an agreement with the subrecipient to administer more than $2.2 million of the
City’s NSP1 grant funding to perform housing counseling, manage a downpayment loan
assistance program, and perform housing rehabilitation services for homes that were previously
foreclosed upon. The subrecipient was required to comply with HUD’s NSP1 regulations
including requirements related to procurement, conflicts of interest, and cost eligibility.

As of September 23, 2011, the grantee had drawn down more than $2.1 million of the NSP1
subgrant funding. Remaining funds included $13,541 for property rehabilitation, $12,817 for
counseling, and $34,419 for downpayment assistance.

The objective of the audit was to determine whether the grantee administered its NSP1 grant in
accordance with HUD’s program requirements related to procurement, conflicts of interest, and
cost eligibility.




                                               4
                                 RESULTS OF AUDIT

Finding: The Subrecipient Did Not Administer Its Neighborhood
         Stabilization Program in Accordance With Requirements
The subrecipient did not comply with NSP1 requirements related to procurement, conflicts of
interest, and cost eligibility. It awarded 32 construction rehabilitation contracts to an affiliated
for-profit entity, and in 26 of these cases, the subrecipient did not attempt to ensure open and free
competition as required. Subrecipient officials allowed this related-party entity to bill inflated
amounts and arranged to receive a portion of the inflated charges as a return payment. The
subrecipient also charged unsupported employee labor costs to the NSP1 subgrant. These
problems occurred because the subrecipient failed to implement adequate controls to ensure
compliance with NSP1 requirements. As a result, the subrecipient incurred construction and
labor costs totaling $787,004 that were unsupported or ineligible.



The Subrecipient Did Not
Follow NSP1 Procurement
Requirements

               The subrecipient awarded NSP1 construction contracts to a related-party entity
               without following required procurement procedures. The regulations at 24 CFR
               (Code of Federal Regulations) 84.43 required that the subrecipient conduct all
               procurement transactions in a manner to provide, to the maximum extent
               practical, open and free competition. These regulations further required that the
               subrecipient be alert to organizational conflicts of interest and exclude from
               competing contractors that had developed the project specifications or statements
               of work. Additionally, the regulations at 24 CFR 84.45 required that the
               subrecipient conduct a cost or price analysis for each procurement action,
               including an evaluation of each element of cost to determine its reasonableness,
               allocability, and allowability.

               The subrecipient awarded 26 of its 44 NSP1 construction contracts for amounts
               totaling $387,365 to its own subsidiary company, HFM Builders, without
               obtaining multiple price quotations or otherwise attempting to ensure open and
               free competition as required. This arrangement further violated the NSP1
               procurement requirements because, as discussed below, HFM Builders had a
               prohibited conflict of interest with both the subrecipient and one of its key
               officials. Also, the subrecipient’s property development director drafted the
               contract specifications and statements of work, yet also was affiliated with HFM
               Builders. The subrecipient did not document that a valid cost analysis was
               performed as required.




                                                 5
           For two additional NSP1 projects, the subrecipient awarded three construction
           contracts totaling $29,420 to contractors other than HFM Builders without
           ensuring open and free competition or documenting that a valid cost anlysis was
           performed.

           Because the subrecipient did not document that the costs associated with these
           contracts were eligible in accordance with NSP1 procurement requirements, the
           associated costs totaling $416,786 were unsupported.


Subrecipient Officials Violated
NSP1 Conflict-of-Interest
Requirements


           The subrecipient awarded NSP1 construction contracts without following HUD’s
           NSP1 requirements related to conflicts of interest. The regulations at 24 CFR
           84.42 required that the subrecipient’s employees, officers, or agents not
           participate in the selection, award, or administration of a contract supported by
           Federal funds if a real or apparent conflict of interest was involved. This
           regulation specified that such a conflict would arise if the employee, officer, or
           agent; any member of his or her immediate family; or an organization which
           employed any of these parties had a financial or other interest in the firm selected
           for an award.

           The subrecipient did not comply with these requirements because it awarded 32 of
           its 44 NSP1 construction contracts (including the 26 contracts noted above)
           totaling $435,049 to its for-profit subsidiary company, HFM Builders. This entity
           had a conflict of interest with both the subrecipient and two of its key employees.
           For example,

                  As an employee of the subrecipient, the property development director
                  signed construction contracts with HFM Builders. However, this same
                  individual was a director of HFM Builders and managed its operations.

                  The property development director administered the NSP1 construction
                  activities as an employee of the subrecipient yet also administered the
                  activities of HFM Builders. For example, as an agent of the subrecipient,
                  he inspected construction work that was completed under contracts with
                  the company he managed, HFM Builders. This individual also submitted
                  invoices to the subrecipient as an agent of HFM Builders and then
                  approved these invoices as an agent of the subrecipient.

                  The property development director was an employee of the subrecipient
                  and also had a financial interest in HFM Builders because he received
                  payments as a result of the NSP1 contracts that were awarded to this
                  entity. In this case, he had an incentive to facilitate higher NSP1


                                             6
                construction contract amounts because the payments he ultimately
                received were based upon a percentage of the construction contract
                amounts. As discussed below, this arrangement resulted in contract
                amounts that were apparently excessive.

                The subrecipient’s vice president, who processed and approved NSP1
                payment requests to the City of Avondale, was an immediate family
                member of the property development director. Because the property
                development director had a prohibited conflict of interest with HFM
                Builders, as discussed above, the vice president, as a family member, also
                had a prohibited conflict of interest.

                The subrecipient awarded contracts to HFM Builders, yet also received
                payments from HFM Builders as a result these contracts. These funds
                were then available for use at the subrecipient’s discretion. The
                subrecipient, as an entity, had an incentive to facilitate higher contract
                amounts because the return payments from HFM Builders were based
                upon a percentage of the contract amount.
         Because the subrecipient did not document that the costs associated with these 32
         construction contracts were eligible in accordance with NSP1 requirements
         related to conflicts of interest, HUD did not have adequate assurance that the
         NSP1 grant funds were expended in accordance with program requirements. The
         associated contract amounts totaling $435,049 were unsupported.

The Subrecipient Incurred
Ineligible NSP Construction
Costs


         Subrecipient officials took advantage of the arrangement discussed above and the
         associated lack of procurement and contract administration controls by billing
         inflated construction costs and arranging to convert a portion of the NSP1 grant
         funds for discretionary use by the subrecipient and personal use by one of the
         subrecipient’s key officials. Office of Management and Budget (OMB) Circular
         A-122, Attachment A, Paragraphs A.2 and A.3, require that to be allowable under
         an award, the subrecipient’s costs must be adequately documented and
         reasonable. It states:

         “A cost is reasonable if, in its nature or amount, it does not exceed that which
         would be incurred by a prudent person under the circumstances prevailing at the
         time the decision was made to incur the costs. The question of the reasonableness
         of specific costs must be scrutinized with particular care in connection with
         organizations or separate divisions thereof which receive the preponderance of
         their support from awards made by Federal agencies. In determining the
         reasonableness of a given cost, consideration shall be given to:


                                          7
             a. Whether the cost is of a type generally recognized as ordinary and necessary for
             the operation of the organization or the performance of the award.

             b. The restraints or requirements imposed by such factors as generally accepted
             sound business practices, arms length bargaining, Federal and State laws and
             regulations, and terms and conditions of the award.

             c. Whether the individuals concerned acted with prudence in the circumstances,
             considering their responsibilities to the organization, its members, employees, and
             clients, the public at large, and the Federal Government.”

             The subrecipient did not comply with these requirements for its NSP1 grant
             because it incurred construction costs that were not ordinary and necessary and
             not subject to the restraints imposed by sound business practices or arms-length
             bargaining. As discussed below, subrecipient officials awarded NSP1
             construction rehabilitation contracts to a related-party entity and then used this
             arrangement to divert a portion of the grant funds without regard for their
             responsibilities to the intended program beneficiaries or the Federal Government.

Subrecipient Officials Used a
“Shell” Entity To Bill Inflated
Amounts

             After awarding 32 construction contracts to HFM Builders, subrecipient officials
             used this entity as a “shell” or “paper company” to generate inflated construction
             invoices. HFM Builders did not perform actual construction services related to
             these contracts. Subrecipient officials had an informal arrangement with an
             individual who agreed to act as the general contractor and manage the actual
             construction work. This individual coordinated the use of subcontractors and paid
             for labor and materials using his personal funds. The only apparent service
             performed by HFM Builders was to generate inflated invoices. The subrecipient’s
             property development director, acting as an agent of HFM Builders, accepted
             invoices from the individual who performed the work and created new invoices
             on HFM Builders letterhead that included an additional 20 percent charge.

             The subrecipient’s property development director then “submitted” the inflated
             invoices to himself, acting as an agent for the subrecipient, and approved the
             inflated invoices. These invoices were apparently also approved by the
             subrecipient’s president.

             Funds from the 20 percent charge added by the HFM Builders shell entity were
             then paid back to the subrecipient and were available for use at the subrecipient
             officials’ discretion. Subrecipient officials used a portion of these funds to issue
             checks to the property development director, thus effectively converting a portion




                                               8
                  of the NSP1 funds for his personal use. The diagram below demonstrates the role
                  of the subrecipient’s property development director under this arrangement.



 Property                        Property                          Property                   Property
 development director            development director              development director       development director

      • Awarded contracts             • Created inflated                • Approved inflated        • Personally received
        to HFM Builders                 invoices including a              invoices (as an            a check for a
        with no                         20% markup (as an                 agent of the               portion of the
        competition (as an              agent of HFM                      subrecipient)              inflated amounts
        agent of the                    Builders)
        subrecipient)




                  The subrecipient used the inflated invoices from HFM Builders to support NSP1
                  draw requests to the City of Avondale. In total, the subrecipient billed $72,852 in
                  added fees associated with this billing arrangement. Because HFM Builders did
                  not perform a valuable and necessary service, this added 20 percent charge was
                  unnecessary.

                  It should be noted that in addition to the 20 percent markup charge added by its
                  subsidiary, the subrecipient charged a fixed fee of $4,900 per property for
                  overseeing the grant. For example, for one property, the subrecipient billed
                  $4,900 for “homebuyer assistance,” and its subsidiary received $4,600 as a result
                  of its 20 percent markup on construction costs. These amounts received by the
                  subrecipient totaled approximately 40 percent of the total construction costs
                  charged to the NSP1 grant in this case. These costs were in addition to a $2,600
                  fee charged by the subrecipient for counseling and education services. As
                  discussed later in this report, these labor costs were also not properly supported.

Subrecipient NSP1
Construction Costs Appeared
Excessive

                  In addition to the 20 percent markup amount added by the subrecipient’s
                  subsidiary, HFM Builders, the subrecipient’s NSP1 construction costs appeared
                  significantly excessive and in some cases, unnecessary. With the assistance of a
                  HUD OIG inspector-appraiser, we analyzed the subrecipient’s NSP1 construction
                  rehabilitation costs on a sample basis by comparing the contract costs to

                        1. Construction cost estimation data sources,
                        2. Actual costs for the labor and materials based on invoices and receipts
                           from the individual who managed the construction work, and
                        3. Costs for similar work charged by other general contractors under the
                           subrecipient’s NSP1 grant.



                                                               9
        Note that this analysis only included a sample of the subrecipient’s NSP1 projects
        and was not designed to establish an exact amount of the excessive charges for
        each project. However, the results of this review demonstrated a pattern of
        excessive and unnecessary charges to the NSP1 grant associated with contracts
        between the subrecipient and its subsidiary, HFM Builders.

        For a nonstatistical sample of 4 of the 32 contracts awarded to HFM Builders, the
        appraiser first evaluated the reasonableness of the project construction costs by
        comparing the contract costs to two cost estimation data sources including
        “RSMeans” and the Housing Developer Pro 3 cost estimation software program.
        Based upon his evaluation of these data, review of pricing data from local
        suppliers, and experience in the construction trade, the appraiser concluded that
        the contract costs were clearly excessive and, therefore, not reasonable in
        accordance with the cost requirements of OMB Circular A-122, Attachment A,
        Paragraph A.3.

        After determining that the costs appeared generally excessive based upon a
        review of cost estimation data sources, we obtained and reviewed documentation
        showing the actual labor and materials costs to determine whether the amounts
        paid were commensurate with the amounts billed to the NSP1 grant. For a
        nonstatistical sample of 4 of the subrecipient’s 32 NSP1 contracts awarded to
        HFM Builders, we obtained invoices and receipts from the individual who
        performed the construction work. The documentation provided did not include
        receipts for some of the contract work. However, the invoices and receipts
        demonstrated a pattern of contract costs that were unreasonably high with respect
        to the actual costs. As shown in the table below, the costs for the four sample
        contracts reviewed were between 67 and 161 percent more than the actual costs
        shown on the receipts and invoices provided. According the HUD OIG
        appraiser, the excess amounts charged far exceeded a reasonable profit amount of
        approximately 10 percent that would be expected in an arm’s-length transaction.


               HFM Builders’ total contract costs vs. actual costs
                                                             Percentage
                                                Difference   difference   Contract
                                                 between      between     amounts
                     HFM                         contract     contract    for work
                    contract     Actual costs   and actual   and actual    with no
    Property          total     documentation      costs        costs      receipts
1819 N. 120th
Drive                 $29,634         $17,794      $11,840         67%        $197
11372 W. Davis        $42,105         $22,412      $19,693         88%       $1,644
11820 W. Virginia     $29,586         $16,891      $12,695         75%       $1,442
11166 W. Garfield     $18,492          $7,074      $11,418        161%       $2,628




                                         10
        The following table includes examples of contract costs from the four sample
        properties that were not reasonably commensurate with the amounts billed to the
        NSP1 grant.

      Specific examples: HFM Builders’ contract costs vs. actual costs
                                                                Excess
                                                               between     Percentage
                                       HFM                     contract    more than
                                      contract      Actual    and actual   the actual
           Contract item              amount         cost        costs        cost
6185-replace central air
conditioning unit-14 SEER*                $6,583     $4,750       $1,833         39%
Replace 8 windows,1 sliding glass
door                                      $8,302     $5,485       $2,817         51%
2820-install shade screens                $1,769      $836         $933         112%
Flooring removal                          $4,650     $2,250       $2,400        107%
Plugs, switches, cover plates              $1,714     $607        $1,107        182%
Window replacement                        $11,730    $6,676       $5,054         76%
Custom window package                     $12,952    $8,008       $4,584         57%
6175-heat pump replace - 16 SEER          $10,932    $6,850       $4,082         60%
5970-carpet and pad - living room          $7,080    $1,492       $5,588        374%
* SEER = seasonal energy efficiency ratio

        Costs under contracts with HFM Builders were also excessive compared to
        amounts charged by the subrecipient’s other NSP1 contractors. Further, HFM
        Builders bid lower amounts when some form of competitive procurement was
        used. We reviewed available procurement documentation for the subrecipient’s
        44 NSP1 construction contracts to identify pricing variation between contractors
        for specific costs. Since each contract included different rehabilitation work, we
        only compared the costs for specific rehabilitation work items that appeared
        substantially similar between the contracts. The table below includes a
        comparison of amounts charged or bid by (1) HFM Builders under contracts with
        no competition, (2) HFM Builders under contracts with some form of
        competition, and (3) other contractors under contracts with some form of
        competition. These examples further demonstrate a pattern of excessive costs
        associated with the subrecipient’s contracts with HFM Builders that were awarded
        in violation of procurement and conflict-of-interest requirements.




                                            11
                                                       HFM              HFM
                                                  Builders’ avg.    Builders’ avg.      Other
                                                     cost - no          bid -        contractors’
                 Contract item                     competition       competition       avg. cost
 6720-trap replace                                            $58              $38             $34
 7595-receptacle-GFCI,* countertop-15
 AMP**                                                       $78              $19             $38
 6645-shutoff valve                                         $109              $60             $37
 7735-light fixture globe                                   $200              $56             $25
 8722-carbon monoxide detector-GCI***                       $210              $94            $149
 7810-smoke detector-hard wired                             $147             $133             $67
 7010-commode replace-1.6 GPF**** GCI                       $255             $193            $181
 6810-kitchen faucet-single lever GCI                       $331             $232            $185
 8017 Energy Star ceiling fan light fixture                 $474             $380            $229
 7819-fan-light fixture-Energy Star                         $456             $375            $215
  * GFCI = ground fault circuit interrupter
  ** AMP = ampere: a unit of electrical current
  *** GCI = ground circuit interrupter
  **** GPF = gallons per flush


Some Construction Costs
Appeared Unnecessary


           Some of the rehabilitation work under the subrecipient’s contracts with HFM
           Builders appeared unnecessary. As part of its NSP1 subrecipient agreement with
           the City of Avondale, the subrecipient was required to comply with the property
           rehabilitation standards specified in the Maricopa County HOME Consortium
           Minimum Basic Housing Standards. Also, in accordance with OMB Circular A-
           122, Attachment A, Paragraph A.3.a, the subrecipient was required to ensure that
           all costs charged to the NSP1 grant were necessary for the performance of the
           award.

           The appraiser reviewed a nonstatistical sample of four of the subrecipient’s NSP1
           contracts and identified contract costs for the sample contracts that appeared
           unnecessary under the applicable requirements. For example, three of the four
           contracts included replacement of water shutoff valves, drainpipe traps, and
           toilets, although the home inspections completed before the repair work did not
           indicate a need for these items. Two of the four contracts included replacement
           air conditioning units, and two included replacement of all windows in the homes,
           although there was no indication that this replacement was necessary.

           The appraiser inspected a nonstatistical sample of 35 of the subrecipient’s NSP1-
           assisted properties and found that the contract repairs were generally completed in



                                                  12
                 accordance with the contract. However, the appraiser noted that many of these 35
                 properties included similar types of repair items that appeared unnecessary.

    The Subrecipient Charged
    Unsupported Labor Costs


                 The subrecipient charged unsupported employee labor costs to its NSP1 subgrant.
                 OMB Circular A-1221, Attachment B, Paragraph 8.m, requires that the
                 subrecipient account for the actual costs incurred (including direct and indirect
                 salary costs) to determine the amount that can be charged to the grant. The
                 circular does not include provisions for charging profit or other increments above
                 cost to Federal grants. It also requires that costs be adequately documented.
                 Pertaining to salary and wage costs, it states:

                 “Charges to awards for salaries and wages, whether treated as direct costs or
                 indirect costs, will be based on documented payrolls approved by a responsible
                 official(s) of the organization. The distribution of salaries and wages to awards
                 must be supported by personnel activity reports, as prescribed in subparagraph
                 (2), except when a substitute system has been approved in writing by the
                 cognizant agency.”

                 The subrecipient failed to comply with these requirements when it billed the
                 NSP1 grant a fixed amount for its services without regard for its actual costs. The
                 subrecipient incurred $114,959 for counseling services and $207,576 for
                 “homebuyer assistance” services. The subrecipient did not provide
                 documentation to support the amount of these charges. For example, the
                 subrecipient did not provide time sheets and did not have an indirect cost
                 allocation plan. Subrecipient officials stated that this violation of NSP1
                 requirements occurred, in part, because the City of Avondale allowed the
                 subrecipient to bill labor charges using a flat fee amount.

    The Subrecipient Lacked
    Adequate Internal Controls


                 The problems discussed above occurred and were allowed to continue because the
                 subrecipient did not implement controls to ensure that it complied with
                 procurement, conflict-of-interest, and cost eligibility requirements. The
                 subrecipient had written policies and procedures in place related to procurement
                 and conflicts of interest; however, the involved subrecipient officials chose not to
                 implement these policies. The subrecipient did not have written policies and
                 procedures regarding construction contract administration, such as procedures for


1
  Compliance with OMB Circular A-122 is required by 24 CFR Part 570, subpart J, compliance with which is
required by the NSP1 notice (Federal Register Volume 73, Number 194, dated October 6, 2008).


                                                      13
             approval of contractor payment requests, procedures for approving draw requests,
             and procedures for ensuring compliance with applicable property rehabilitation
             standards. The subrecipient did not implement adequate controls over its
             financial management systems to allow for proper allocation of labor costs among
             multiple activities and ensure the eligibility of its labor costs in accordance with
             OMB Circular A-122, Attachment B, Paragraph 8.m,. For example, the
             subrecipient did not maintain adequate time sheets or activity reports and did not
             have a method for properly allocating indirect costs.

             We observed the following additional issues related to the subrecipient’s failure to
             implement adequate internal controls over its NSP1 construction activities.

                    For one NSP1 project, the construction contract with HFM Builders
                    included a charge for $4,500 to paint the interior of the home. However,
                    there was no indication that this work was necessary, and the homeowners
                    stated that this work was not performed by the contractor.

                    For one NSP1 project, the subrecipient submitted a draw request to the
                    City of Avondale that claimed payment for a $5,579 change order when
                    the change order was for only $1,075. It appeared that this false claim was
                    made to draw enough funds to pay the 20 percent charge added by the
                    subrecipient’s shell company, HFM Builders.

                    For two NSP1 projects, the subrecipient did not have written contracts
                    with the construction contractor.

                    For seven NSP1 projects, the subrecipient entered into written contracts
                    with HFM Builders before establishing the property’s scope of work.

                    For one NSP1 project, the subrecipient submitted a payment request for
                    construction work (totaling $7,784) to the City of Avondale before a
                    construction contract had been executed.


Conclusion


             The subrecipient failed to follow procurement, conflict-of-interest, and cost
             eligibility requirements, resulting in ineligible and unsupported NSP1 grant costs
             totaling $787,004. Because the subrecipient did not have adequate documentation
             to support the eligibility of these costs, HUD did not have adequate assurance that
             the NSP1 grant funds were used for eligible purposes in accordance with program
             requirements. These violations were particularly significant in this case because
             subrecipient officials employed an arrangement to effectively convert a portion of




                                              14
                  the NSP1 funds for their own use. Also, there was a pattern of apparently
                  excessive costs under the associated contracts.

    Recommendations

                  We recommend that the Acting Director, San Francisco Office of Community
                  Planning and Development:

                  1A.      Require the subrecipient to reimburse HUD $72,852 for ineligible costs
                           charged to the NSP1 grant as part of inflated invoices from the
                           subrecipient’s subsidiary, HFM Builders (see appendix C).

                  1B.      Require the subrecipient to provide support or reimburse HUD for contract
                           amounts associated with the 29 construction contracts that were awarded
                           in violation of applicable procurement requirements. This amount
                           includes $387,365 for the 26 contracts awarded to HFM Builders and
                           $29,420 for the 3 contracts awarded to other contractors (see appendix C).
                           Supporting documentation should include evidence showing that
                           applicable procurement requirements were met and documenting that all
                           costs incurred under the contracts met the applicable cost eligibility
                           requirements of OMB Circular A-122. 2

                  1C.      Require the subrecipient to provide support or reimburse HUD $362,197
                           for contract amounts associated with the 32 construction contracts that
                           were awarded in violation of applicable conflict-of-interest requirements
                           (see appendix C). Supporting documentation should include evidence
                           showing that applicable requirements related to conflict of interest were
                           met and documenting that all costs incurred under the contracts met the
                           applicable cost eligibility requirements of OMB Circular A-122.2 This
                           amount includes the amounts associated with these contracts ($435,049)
                           less the costs reported under recommendation 1A ($72,852) that were
                           already established as ineligible.




2
  Cost eligibility should be determined based upon review of receipts or invoices, along with documentation
evidencing payment, for the actual cost of labor and materials purchased through vendors or subcontractors.
Because the contracts were awarded under a conflict-of-interest arrangement, invoices from the subrecipient’s
subsidiary, HFM Builders, or other affiliated parties are not reliable for establishing the eligibility of cost amounts
under the contracts. Documentation supporting the eligibility of costs should also include evidence that the repair
items specified in the construction contracts were necessary in accordance with the applicable property rehabilitation
standards.



                                                          15
1D.   Require the subrecipient to provide support or reimburse HUD $322,535
      for unsupported labor costs billed to the NSP1 grant. Cost eligibility
      should be determined based upon review of documented payrolls and
      activity reports that meet the requirements of OMB Circular A-122,
      Attachment A, Paragraph 8.m.

1E.   Require the subrecipient to implement adequate controls to ensure
      compliance with applicable regulations related to procurement, conflicts
      of interest, and cost eligibility for any further activities involving the use
      of HUD funding.

We recommend that HUD’s Associate Counsel for Program Enforcement

1F.   Pursue civil or administrative sanctions, as appropriate, against the
      subrecipient based upon the violations cited in this report.




                                16
                        SCOPE AND METHODOLOGY

We performed our audit from February to September 2011 at the grantee’s offices at 251 West
Main Street, Mesa, AZ. The audit generally covered the period January 2009 to December 2010,
although some of the transactions reviewed occurred outside these dates.

To achieve our objective, we

       Reviewed HUD handbooks, the Code of Federal Regulations, Federal Registers, OMB
       circulars, and other requirements and directives that govern NSP1.

       Reviewed subrecipient accounting records and policies and procedures.

       Reviewed the subrecipient’s NSP1 subrecipient agreement with the City of Avondale.

       Reviewed procurement documentation provided by the subrecipient for the 44 NSP1-
       assisted construction rehabilitation projects to determine whether NSP1 procurement
       procedures complied with NSP1 requirements.

       Interviewed subrecipient staff and HUD Office of Community Planning and
       Development program staff.

       Reviewed a nonstatistical sample of four NSP1 contracts awarded to HFM Builders and
       compared the contract costs to two cost estimation data sources including “RSMeans”
       and the Housing Developer Pro 3 cost estimation software program.

       Reviewed a nonstatistical sample of four NSP1 contracts awarded to HFM Builders and
       compared the contract cost amounts shown on invoices and receipts obtained from the
       individual who performed the construction work.

       Reviewed available procurement documentation for the subrecipient’s 44 NSP1
       construction contracts to identify pricing variation among contractors for specific costs.

       Reviewed a nonstatistical sample of four NSP1 contracts and identified contract costs that
       appeared unnecessary.

       Conducted site visits to 35 NSP1 construction rehabilitation project sites to evaluate the
       completeness of the rehabilitation.

       Researched the Lexis-Nexis public records database and Arizona Corporation
       Commission Web site for possible affiliations and conflicts of interest.

       Examined payment invoices submitted by the subrecipient for counseling and
       rehabilitation services.


                                                17
       Evaluated whether the subrecipient’s labor costs charged complied with OMB
       requirements.

We were unable to determine the portion of the subrecipient’s labor costs that was ineligible
because complete documentation regarding the actual costs was not available for us to review
and validate at the time of the audit.

We were also unable to determine the portion of the subrecipient’s construction costs that was
eligible because detailed and complete documentation regarding the actual costs was not
available for us to review and validate at the time of the audit.

We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                               18
                              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
               objective:

                      Policies and procedures that were implemented to ensure that program
                      activities complied with applicable laws and regulations.
                      Policies and procedures to provide reasonable assurance that funds were
                      used only for authorized purposes.
               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.

 Significant Deficiency


               Based on our review, we believe that the following item is a significant deficiency:

                      The subrecipient did not have controls in place to ensure compliance with
                      NSP1 requirements related to procurement, conflicts of interest, and cost
                      eligibility (finding).


                                                 19
                                     APPENDIXES

Appendix A

                 SCHEDULE OF QUESTIONED COSTS


                 Recommendation            Ineligible 1/     Unsupported 2/
                        number
                               1A              $72,852
                               1B                                   $29,420
                               1C                                  $362,197
                               1D                                  $322,535
                             Total             $72,852             $714,152


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. Ineligible costs for recommendation 1A represent the
     unnecessary markup amounts that were added to construction invoices by the
     subrecipient’s subsidiary, HFM Builders.

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.

     Unsupported costs for recommendation 1B represent costs associated with three contracts
     awarded (to contractors other than HFM Builders) in violation of NSP1 procurement
     procedures.

     Unsupported costs for recommendation 1C represent the amounts associated with the 32
     contracts the subrecipient awarded in violation of conflict-of-interest requirements, less
     the amount that was already determined as ineligible under these contracts for
     recommendation 1A. A portion of the unsupported costs related to recommendation 1C
     is also unsupported under recommendation 1B. This is because the 26 contracts awarded
     to HFM Builders in violation of NSP1 procurement requirements (recommendation 1B)
     were also awarded in violation of conflict-of-interest requirements (recommendation 1C).
     To avoid “double counting,” the unsupported amounts associated with these 26 contracts
     are only included under recommendation 1C of this appendix. Unsupported costs for
     recommendation 1D represent labor costs billed to the NSP1 grant that were not
     adequately supported with payroll and activity reports.



                                             20
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                         21
Comment 2




            22
Comment 3


Comment 4




Comment 5




Comment 6




Comment 7




            Names have been redacted for privacy reasons




                                   23
Comment 8



Comment 9




Comment 10




Comment 11



Comment 12



Comment 13




             24
Comment 14


Comment 15




             25
Comment 16




             26
Comment 17



Comment 18


Comment 19




Comment 20




Comment 21




             27
Comment 22




Comment 23




Comment 24



Comment 25




             28
Comment 26




             29
                         OIG Evaluation of Auditee Comments

Comment 1   The subrecipient stated that it disagrees with the audit report, and that the tone of
            the report was not appropriate. The subrecipient stated appropriate audit
            procedures were not followed.

            We disagree. The audit was conducted in accordance with generally accepted
            government auditing standards and we believe that the evidence obtained provides
            a reasonable basis for the findings and conclusions presented in the audit report.
            Also, we note that the subrecipient had multiple opportunities to respond to the
            audit findings and we considered all information that the subrecipient provided
            before the audit report conclusions were finalized. We also considered the
            subrecipient’s input regarding the report wording and tone, and made changes
            where appropriate. As indicated in the audit report, we believe the violations
            were significant and warrant pursuit of civil or administrative sanctions.

Comment 2   The subrecipient stated that its subsidiary company, HFM Builders, was not a
            “shell entity” and that its function was not to generate inflated invoices. They
            indicated that HFM Builders was initially created in 1998 as a means to limit
            liability and to protect the subrecipient’s non-profit status. Although the
            subrecipient’s response did not describe any specific services that were performed
            by HFM Builders, it stated the goal of this entity “was to be efficient, responsive
            and focused on HOC matters”.

            Regardless of the subrecipient’s initial intentions or goals for HFM Builders, the
            audit found this entity was used to inflate construction costs charged to the NSP1
            grant. Because this entity had no employees, did not perform the ordinary
            services of a general contractor and was apparently used only as “paper company”
            to generate invoices that included an added 20% fee, we believe the word “shell”
            accurately describes how this entity was used for the subrecipient's NSP1 grant.

Comment 3   The subrecipient stated that it provided “administrative services” to HFM
            Builders and received proceeds that were used to pay “acceptable and standard
            costs” for these services.

            We agree that the subrecipient’s property development director performed a
            service for HFM Builders; however, the only apparent service provided was to
            generate inflated invoices (see finding). When asked about his role with HFM
            Builders, the property development director stated “basically I would handle the
            invoice from” (the contractor) “to HFM and from HFM to HOC. That is basically
            it”. He further noted that HFM Builders was a “pretty creative” means to “help
            with income”. We disagree that costs for processing inflated invoices were
            “standard” or “acceptable” because NSP1 requirements prohibit unnecessary
            costs.




                                              30
Comment 4   The subrecipient stated that HFM Builders “engaged” a consultant that paid for
            materials, and the consultant was then reimbursed.

            We note that this individual performed the services of a general contractor such as
            hiring trade subcontractors, purchasing labor and materials, managing
            construction work etc… and was not reimbursed based upon the “cost of
            materials” as suggested in the subrecipient’s response. Payments to this
            individual were correlated to the construction contract amount and therefore he
            was paid as a general contractor typically would be under a fixed price contract.

Comment 5   The subrecipient stated that Housing Our Communities is the current shareholder
            of HFM Builders and that no one individual owned, controlled, or had a financial
            interest in HFM Builders.

            We agree that the subrecipient was a shareholder of HFM Builders and find this
            does not conflict with any facts stated in the audit report. However, as noted in
            the audit report, the subrecipient and at least one of its key officials had a conflict
            of interest, including a prohibited financial interest in the activities of HFM
            Builders. By awarding NSP1 construction contracts to this affiliated company,
            the subrecipient violated the procurement and conflict of interest requirements for
            the NSP1 program (see finding).

Comment 6   The subrecipient stated they faced challenges that required “extra effort” due to
            limited timelines and challenging conditions because some of the properties had
            previously been foreclosed. Although the subrecipient’s response is not clear in
            this regard, it appears to suggest that costs identified as ineligible (such as the
            20% fee paid to its subsidiary) were warranted due to the effort that was required.
            They also noted their goal was to use energy efficient products and that some
            items required replacement because they had been sitting unused for months and
            were rendered unusable.

            Because the subrecipient’s NSP1 grant was specifically for the purpose of
            rehabilitating foreclosed properties, we disagree that work on such properties
            involved “extra effort” and “special challenges” beyond what was already
            contemplated in the subrecipient agreement. Furthermore, in accordance with its
            subrecipient agreement and NSP1 program requirements, the subrecipient was
            only entitled to reimbursement of its actual costs determined in accordance with
            the requirements of OMB Circular A-122. It should be noted that nearly all of
            the properties assisted through the subrecipient’s NSP1 activities, had previously
            been foreclosed, yet had already been re-purchased by new homebuyers before
            any rehabilitation was performed and some only required minimal repairs.

            We agree that NSP1 requirements allow for payment of actual costs for
            replacement of items that were not functional and this does not conflict with any
            conclusions in the audit report.




                                              31
Comment 7       The subrecipient stated that its property director administered the activities of
                HFM Builders at the direction of the subrecipient’s president and did not have
                ultimate decision making power. We agree that the property development
                director administered the activities of HFM Builders at the direction of the
                subrecipient’s president and find that this does not conflict with any facts cited in
                the audit report.

Comment 8       The subrecipient stated that invoices were approved by the subrecipient’s
                president and this individual had “the final authority”.

                We find that the subrecipient’s assertion here does not conflict with any facts
                cited in the audit report.

Comment 9       The subrecipient stated it should not be required to reimburse costs due to the
                procurement and conflict of interest violations and that the audit tests used to
                evaluate cost reasonableness only considered 3% of its activity.

                We disagree. Supporting documentation and reimbursement of ineligible
                amounts is necessary because the subrecipient violated procurement and conflict
                of interest requirements. As stated in the audit report, the subrecipient and one of
                its employees had an incentive to facilitate higher NSP1 construction costs and
                HUD does not have adequate assurance that the amounts charged under these
                contracts were reasonable. Also, the audit sample testing demonstrated a pattern
                of excessive charges underscoring the need to require support for the amounts
                charged.

                The audit report describes three separate audit tests that were used to evaluate
                whether the subrecipient's NSP1 construction costs appeared excessive3. All three
                tests identified indications that costs were excessive for the contracts reviewed.
                Two of these tests evaluated four sample contracts and the third test evaluated
                information from all 44 of the subrecipient's NSP1 contracts. We note that the
                subrecipient’s response does not dispute that the costs were excessive for the
                examples identified in the audit report.

                The audit recommendation states the subrecipient should be required to provide
                support or reimburse HUD for the applicable contract amounts. Therefore, the
                recommendation indicates that any amounts that can be properly supported in
                response to the audit recommendation should not have to be repaid.

Comment 10 The subrecipient stated that it did not convert federal funds for discretionary or
           personal use.



3
 The three tests used to evaluate the reasonableness of construction costs are presented under the sub-
heading “Subrecipient Construction Costs Appeared Excessive” in the audit report.


                                                    32
              We disagree. As stated in the audit report, the subrecipient awarded construction
              contracts to its own subsidiary in violation of the procurement and conflict of
              interest requirements and the subrecipient then used its subsidiary as a “shell” or
              “paper company” to bill inflated invoices that included an unnecessary 20% fee.
              A portion of the funds derived from the inflated charges were available for use at
              the subrecipient’s discretion and a portion of the funds were used to write checks
              to the subrecipient’s property development director. These payments to the
              property development director were apparently paid in addition to his salary.

Comment 11 The subrecipient stated that its invoices were approved by its finance director and
           should have therefore “met any and all proper accounting tests”. The
           subrecipient also asserts that it did not have a “billing scheme”.

              We disagree. Approval by the subrecipient’s own finance director does not
              constitute full compliance with HUD requirements. As described in the audit
              report the subrecipient used a process to generate inflated invoices and submitted
              these for reimbursement with NSP1 program funds (see finding one). We
              removed the term “billing scheme” as requested by the subrecipient. However,
              we could not remove the statement in its entirety without impacting the report
              message. Therefore, we replaced “billing scheme” with “billing arrangement”.

Comment 12 The subrecipient requested that the term “self-dealing” be removed from the audit
           report. The subrecipient states that it “always fully disclosed” its relationship
           with HFM Builders to “all of its government jurisdictions and directly to HUD
           itself”.

              We removed the term “self-dealing” from the final report since it will not
              materially impact the report message. We note that the audit report did not state
              that simply having a subsidiary for-profit entity is prohibited. However, the audit
              report found that the subrecipient awarded contracts to its subsidiary in violation
              of procurement and conflict of interest requirements and used this entity to bill
              inflated amounts to its NSP1 subgrant.

Comment 13 The subrecipient stated that its payroll charges were approved by the
           subrecipient’s president and that the City of Avondale approved a flat-fee
           schedule as “the cognizant agency”.

              We agree it appears the City of Avondale and the subrecipient agreed to use flat
              fees for labor costs. However, as stated in the audit report, the subrecipient did
              not comply with OMB Circular A-122 which requires that the distribution of
              salaries and wages to awards must be supported by personnel activity reports as
              prescribed within the Circular. Compliance with OMB Circular A-122 is required




                                               33
              under the NSP1 program and under the subrecipient’s written agreement with the
              City of Avondale. The subrecipient’s response asserts that “the cognizant
              agency” approved its use of a flat fee schedule indicating that it would qualify for
              the exception to the labor cost documentation requirements specified in OMB
              Circular A-122. We note that this possible exception in the regulations relates to
              the establishment of indirect cost rates. Furthermore, the Circular defines the
              “cognizant agency” that can provide such an exception as a “Federal agency”.
              Therefore, any agreement with the City of Avondale would not provide a valid
              exception to the labor cost documentation requirements.

Comment 14 The subrecipient stated it made records available that “were proof of time spent
           on each individual client…” yet these reports were not considered during the
           audit.

              We disagree. During the audit and the exit conference, the subrecipient
              acknowledged that it did not maintain timesheets and the subrecipient did not
              provide any further documentation that would support the labor costs charged to
              the NSP1 grant. Further, while client records may support that some services
              were provided, these records would likely not include information required to
              properly support the amounts billed such as an accounting of the total activity for
              which employees were compensated. As stated in the audit report, we
              recommend that the subrecipient be required to provide support or reimburse
              HUD for the unsupported labor costs billed to the NSP1 grant. Cost eligibility
              should be determined based upon review of documented payrolls and activity
              reports that meet the requirements of OMB Circular A-122, Attachment A,
              Paragraph 8.m.

Comment 15 The subrecipient stated that it disagrees with the audit report recommendations
           and that, because some rehabilitation work was completed, it should not have to
           reimburse the entire amount of the labor and materials costs. It also notes that
           OIG agreed to remove the word “personnel” from Recommendation 1F.

              The audit recommendation states the subrecipient should be required to provide
              support or reimburse HUD for the applicable contract amounts. Therefore, any
              amounts that can be properly supported in response to the audit recommendations
              should not have to be repaid.

              The word “personnel” was removed from recommendation 1F, at the
              subrecipient’s request; however, we note that this wording change will not impact
              any possible actions that could be taken in response to the audit findings.

Comment 16 Avondale stated their intention was to treat the subrecipient as a “developer” and
           this would “enable HOC to use its subsidiary to perform rehabilitation work”.
           They noted that, at the time the NSP funds were awarded, HUD’s NSP1 program
           guidance did not clearly state that a developer was prohibited from providing both
           counseling and development services.



                                               34
Regardless of Avondale’s initial intentions, Housing Our Communities was, in
fact, a subrecipient under the terms of its agreement with the City of Avondale
and, therefore, the program requirements specified in the audit report were
correct. The subrecipient agreement clearly identified Housing Our
Communities as a “subrecipient” and stated that the HUD regulations applicable
to subrecipients would apply. For example,

       Section 16.1 (a) stated “The Subrecipient agrees to comply with OMB
       Circular A-110…and maintain necessary source documentation for all
       costs incurred”. As noted in the audit report, HUD’s implementation of
       OMB Circular A-110, at 24 CFR part 84, required that the subrecipient
       conduct all procurement transactions in a manner to provide, to the
       maximum extent practical, open and free competition.

       Section 18.4 (a)(3) stated “The Subrecipient shall undertake to ensure that
       all subcontracts let in the performance of this Agreement shall be awarded
       on a fair and open competition basis”.

       Exhibit 1 to the first amendment of the subrecipient agreement section 18
       (e) required compliance with the written procurement procedures
       submitted with the subrecipient's proposal. These written procurement
       policies referred to in the subrecipient agreement recited the requirements
       of 24 CFR 84.43 by stating “All procurement transactions shall be
       conducted in a manner to provide, to the maximum extent practicable,
       open and free competition”. The procedures also recite the requirements
       of 24 CFR 84.42 by stating “No employee, officer or agent shall
       participate in the selection, award or administration of a contract
       supported by Federal funds if a real or apparent conflict of interest would
       be involved”.

       Section 16.1(b) stated “The subrecipient will administer its program in
       conformance with OMB Circulars A-122, Cost Principles for Non-Profit
       Organizations…”. As noted in the audit report, OMB Circular A-122,
       Attachment B, Paragraph 8.m, required that the subrecipient account for
       the actual costs incurred to determine the amount that can be charged to
       the grant.

       Section 16.3 (c) stated “Payments will be made for eligible expenses
       actually paid by the Subrecipient (reimbursement)”.




                                35
                     Section 18.4 (a)(c) stated “The Subrecipient agrees to abide by the
                     provisions of 24 CFR section 570.611 with respect to conflicts of interest,
                     and covenants that it presently has no financial interest and shall not
                     acquire any financial interest, direct or indirect, which would conflict in
                     any manner or degree with the performance of services required under this
                     agreement”.

              Furthermore, Housing Our Communities, in this case, would not have qualified as
              a “developer” under HUD requirements because they were paid on a cost
              reimbursement basis, did not take ownership or control of the subject properties,
              and did not accept any risk by investing their own funds. Because the
              subrecipient was not a developer, any ambiguity in HUD’s requirements
              concerning whether or not a developer could also perform counseling services
              was inconsequential.

Comment 17 Avondale stated that only the amount considered to be ineligible should be
           disallowed and not the entire contract amount.

              We agree, however the audit report did not classify the entire contract amounts as
              “ineligible”. The contract amounts were classified as “unsupported” in
              recommendations 1B and 1C because the subrecipient did not support that the
              contract amounts were eligible under HUD’s NSP1 requirements (see finding
              one). The audit recommendation already states the subrecipient should be
              required to provide support or reimburse HUD for the applicable contract
              amounts. Therefore, any amounts that can be properly supported in response to
              the audit recommendation should not be classified as ineligible.

Comment 18 The City of Avondale stated they were not aware of and did not approve the 20%
           “administrative fee” charged by the subrecipient's subsidiary HFM Builders and
           they agreed that the subrecipient should repay the amounts associated with these
           fees.

              This response indicates agreement with the audit report recommendation 1A and
              therefore we concur with this response.

Comment 19 Avondale stated HFM Builders was viewed as “an asset” that would facilitate the
           subrecipient’s “developer role” and serve as a “contractor”.

              As stated for our response to Comment 16 above, Housing Our Communities was
              a subrecipient and should not have awarded construction rehabilitation contracts
              to HFM Builders without following the applicable procurement and conflict of
              interest requirements specified in both the subrecipient agreement and HUD
              regulations.

Comment 20 Avondale pointed out that HUD OIG used a non-statistical sample to evaluate
           whether construction costs appeared excessive and that the sample results cannot


                                              36
                be extrapolated. Avondale stated that items such as product brands or “hidden
                work not normally visible” should be considered when determining if costs were
                appropriate.

                We agree that non-statistical samples cannot be used to make statistical
                projections. However, the audit report did not attempt to extrapolate the sample
                results. The audit report states that “…this analysis only included a sample of the
                subrecipient’s NSP1 projects and was not designed to establish an exact amount
                of the excessive charges for each project”. Furthermore, the audit report
                recommends that the subrecipient provide proper support for all of the
                subrecipient’s 32 NSP1 contracts (a 100% sample) that are in question to
                determine the actual amount of excessive costs. This supporting documentation is
                necessary because the subrecipient did not follow procurement and conflict of
                interest requirements and therefore, HUD does not have adequate assurance that
                the amounts were reasonable and eligible under the NSP requirements. The
                results of the audit sample testing demonstrated a pattern of excessive and
                unnecessary charges which underscores the need for HUD to require supporting
                documentation in response to these violations.

                Also, note that the audit report describes three separate audit testing procedures
                that were performed to evaluate whether the subrecipient's NSP1 construction
                costs appeared excessive4. All three tests identified indications that costs
                appeared excessive for the contracts reviewed. Two of these tests evaluated four
                sample contracts and the third test evaluated information from all 44 of the
                subrecipient's NSP1 contracts.

Comment 21 Avondale stated that its “cursory review of rehab costs” found some costs
           appeared excessive, however, their “preliminary screening” found the majority of
           the costs could be substantiated. They also stated they plan to analyze the
           contract costs and provide an “itemized list of reasonable and substantiated costs”.

                We agree that costs appeared excessive. We also agree that further analysis is
                needed to establish the eligibility of the contract costs with consideration given to
                the specific items that were actually purchased including detail such as product
                brands, types, and quantities actually installed. Please note that audit report
                recommendations 1B and 1C state that HUD should require supporting
                documentation for the contract costs including invoices, receipts, and
                documentation evidencing payment for the actual cost of labor and materials
                purchased through vendors and subcontractors.

Comment 22 Avondale agreed that the subrecipient may have incurred some unnecessary
           construction expenses and noted that further research is needed to identify which
           costs were unnecessary. Avondale also commented that improvements intended
           to increase energy efficiency or conservation were permitted under the NSP1
4
 The three tests used to evaluate the reasonableness of construction costs are presented under the sub-
heading “Subrecipient Construction Costs Appeared Excessive” in the audit report.


                                                    37
              program and that the rehabilitation standards specified in its contract with the
              subrecipient were the “minimum standards”.

              We agree that some rehabilitation costs appeared unnecessary and that additional
              information is required to support that the costs were necessary.
              Recommendations 1B and 1C state that documentation supporting the eligibility
              of costs should include evidence that the repair items specified in the construction
              contracts were necessary.

              While Avondale may consider the rehabilitation standards specified in the
              subrecipient agreement as only a “minimum threshold”, we note that, NSP1
              requirements including OMB Circular A-122 Attachment A, Paragraph A.3
              required that all costs be reasonable meaning the nature or amount of the costs
              does not exceed that which would be incurred by a prudent person under the
              circumstances. This circular also stated that costs should be ordinary and
              necessary for the performance of the award. Therefore, these requirements would
              prohibit wasteful spending such as replacing existing, functional double pane
              windows in a home with new double pane windows. This requirement would also
              prohibit work such as removing a brand new bathtub and installing a different one
              for the purpose of upgrading or replacing other functional items without
              documenting that they needed replacement. Also, we note that Avondale’s
              rehabilitation standards did specify some limitations for rehabilitation work. For
              example, these standards stated that “primary windows are not to be replaced
              unless they are rotted and are permitting the infiltration of air or rain” and that the
              entity “will not install ceramic tile, vinyl tile, indoor/outdoor carpeting or wood
              covering in kitchen areas”. These standards also specified that the purpose of the
              rehabilitation is to “provide decent, safe and sanitary housing to low and
              moderate-income individuals; it is not a method to provide remodeling and/or
              renovation”. Therefore, these standards would prohibit replacement of functional
              items that do not exhibit conditions that would indicate replacement is necessary.

Comment 23 Avondale acknowledged that it paid a fixed fee for counseling and education
           services. They also stated that they have documentation from a “counseling
           database” and payroll records that can be “extrapolated” to support the labor costs
           charged.

              As stated in the audit report, the subrecipient failed to comply with the NSP1
              requirements when it billed a fixed amount for its services without regard for its
              actual costs. The subrecipient did not maintain required personnel activity reports
              to support the distribution of salaries and wages to the NSP1 grant and did not
              provide any documentation in response to HUD OIG’s request for this
              information. Subrecipient officials specifically stated that the charges were fixed
              and did not claim that these charges were based upon activity logs or any other
              distribution of the actual time worked. As stated in the audit report
              recommendation 1D, the subrecipient should be required to provide support or
              reimburse HUD for the unsupported labor costs. Cost eligibility should be



                                                38
              determined based upon review of documented payrolls and activity reports that
              meet the requirements of OMB Circular A-122, Attachment A, Paragraph 8. m.

Comment 24 Avondale acknowledged that it paid a fixed fee for “homebuyer assistance”
           services and that this fee was intended as a “developer fee”. They indicated that
           HUD requirements prohibit using a single agreement for both developer and
           education services and that this requirement was not clear when they entered into
           the NSP1 agreement with Housing Our Communities.

              As stated in the HUD OIG response for Comment 16 above, Housing Our
              Communities was, in fact, a subrecipient in this case and should have charged
              only actual, properly documented labor costs. The written subrecipient agreement
              between Avondale and Housing Our Communities clearly identified Housing Our
              Communities as a “subrecipient” and specifically stated that the HUD regulations
              applicable to subrecipients will apply including OMB Circular A-122 which
              stated that charges to awards for salaries and wages will be based upon
              documented payrolls and personnel activity reports. Also, because Housing Our
              Communities was not a developer and would not have qualified as a developer
              under HUD requirements, any ambiguity in HUD’s requirements concerning
              whether or not a developer could also perform counseling services under a single
              agreement was not relevant.

Comment 25 Avondale agreed it appears the subrecipient lacked adequate internal controls
           “based on preliminary observations”. However, they stated they were “unable to
           substantively respond to this item within the allotted response time…”.

              We agree that the subrecipient appeared to lack adequate internal controls. As
              stated in the audit report, the subrecipient did not implement controls to ensure
              that it complied with procurement, conflict of interest and cost eligibility
              requirements. We note that Avondale may provide any further relevant
              information in response to the audit findings to the HUD staff responsible for
              addressing the audit report recommendations during the resolution process.

Comment 26 Avondale stated that the subrecipient “contributed to successfully converting 46
           foreclosed properties to owner-occupied units at an average cost of $45,800 per
           unit” and the program results should be considered when finalizing the report and
           determining future actions.

              We agree that most of the repair work that the subrecipient listed on the
              rehabilitation contracts with its own subsidiary company was found to be
              complete and this is stated in the audit report. However, the subrecipient did not
              successfully administer its subrecipient agreement in accordance with the NSP1
              procurement, conflict of interest and cost eligibility requirements and this resulted
              in unsupported and ineligible costs totaling $787,004. Also, as noted in the audit
              report, the subrecipient’s NSP1 construction costs appeared significantly
              excessive and in some cases, unnecessary. We appreciate Avondale’s openness to



                                               39
the report finding and recommendations and its’ willingness to work with OIG
and HUD in resolving the deficiencies cited in the report.




                               40
Appendix C
      SCHEDULE OF NSP1 PROPERTIES AND QUESTIONED COSTS


               Recommendation 1A            Recommendation 1B              Recommendation 1B     Recommendation 1C
                                       3 contracts (for 2 properties)                        32 contracts awarded to HFM
                                       awarded to other contractors 26 contracts awarded to      Builders in violation of
 Property        Ineligible markup           with inadequate             HFM Builders with        conflict-of-interest
 number              identified                procurement            inadequate procurement         requirements
     1               $4,764.80                                              $30,039.93                $30,039.93
     2                $767.97                                               $3,797.48                  $3,797.48
     3               $5,007.68                                              $21,442.46                $21,442.46
     4               $3,874.76                                              $25,108.56                $25,108.56
     5                $740.00                                               $4,440.00                  $4,440.00
     6               $2,104.00                                              $13,424.00                $13,424.00
     7                                          $25,747.27
     8               $474.00                                                $3,138.00                  $3,138.00
     9              $4,394.20                                               $13,237.20                $13,237.20
    10              $4,614.68                                               $26,767.40                $26,767.40
    11              $5,453.60                                               $29,585.60                $29,585.60
    12              $3,032.00                                               $18,492.00                $18,492.00
    13              $1,835.40                                               $11,012.40                $11,012.40
    14              $7,161.48                                               $42,968.88                $42,968.88
    15              $1,277.20                                               $10,674.20                $10,674.20
    16              $2,048.00                                               $12,288.00                $12,288.00
    17              $1,537.00                                               $9,582.00                  $9,582.00
    18              $4,559.00                                               $27,354.00                $27,354.00
    19              $2,342.00                                               $13,352.00                $13,352.00
    20
    21              $1,224.00                                                  $4,944.00              $4,944.00
    22
    23              $3,281.80                                                 $16,768.80             $16,768.80
    24               $639.00                                                  $3,834.00              $3,834.00
    25              $1,848.00                                                 $11,088.00             $11,088.00
    26              $2,336.60                                                 $14,019.60             $14,019.60
    27              $2,401.80                                                 $14,760.80             $14,760.80
    28               $345.50                                                                         $3,455.00
    29               $717.00                                                                         $7,170.00
    30
    31                                                                                               $16,353.20
    32              $2,792.20
    33                                                                         $2,281.00              $2,281.00
    34
    35
    36
    37               $303.10                                                                          $3,031.00
    38
    39               $296.50                                                   $2,965.00              $2,965.00
    40                                           $3,673.10
    41               $679.00                                                                         $12,104.50
    42                                                                                               $5,570.00
    43
    44
   Total            $72,852.27                   $29,420.37                   $387,365.31            $435,049.01

Less $72,852.27 already classified as ineligible under recommendation 1A                             $362,196.74



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