OFFICE OF AUDIT REGION 7 KANSAS CITY, KS The Temtor St. Louis, MO Section 220 Multifamily Insurance Program 2013-KC-1003 AUGUST 8, 2013 U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT OFFICE OF INSPECTOR GENERAL Issue Date: August 8, 2013 Audit Report Number: 2013-KC-1003 TO: Timothy J. Ferlin, Supervisory Project Manager, St. Louis Program Center, 7EHMLAX Craig T. Clemmensen, Director of Departmental Enforcement Center, CACB //signed// FROM: Ronald J. Hosking, Regional Inspector General for Audit, 7AGA SUBJECT: The Temtor Disbursed Project Funds for Ineligible and Unsupported Expenses Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector General’s (OIG) final results of our review of disbursements made by The Temtor. HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on recommended corrective actions. For each recommendation without a management decision, please respond and provide status reports in accordance with the HUD Handbook. Please furnish us copies of any correspondence or directives issued because of the audit. The Inspector General Act, Title 5 United States Code, section 8L, requires that OIG post its publicly available reports on the OIG Web site. Accordingly, this report will be posted at http://www.hudoig.gov. If you have any questions or comments about this report, please do not hesitate to call me at 913-551-5870. Office of Audit Region 7 400 State Avenue, Suite 501, Kansas City, KS 66101 Phone (913) 551-5870, Fax (913) 551-5877 Visit the Office of Inspector General Web site at www.hudoig.gov August 8, 2013 The Temtor Disbursed Project Funds for Ineligible and Unsupported Expenses Highlights Audit Report 2013-KC-1003 What We Audited and Why What We Found We selected The Temtor in St. Louis, The Temtor used project funds for ineligible and MO, for audit because the project unsupported expenses. This misuse included payments quickly defaulted on its mortgage and of developer fees, unsecured loans, and excessive requested a partial payment of claim. funds to the management agent. In addition, Temtor The project reached final endorsement transferred funds out of its tenant security deposit on January 30, 2012, and failed to make reserve account and submitted incorrect accounting timely mortgage payments beginning reports that concealed the transfers. March 1, 2012. Our audit objective was to determine whether Temtor’s project funds were used for ineligible expenses. What We Recommend We recommend that the Director of HUD’s St. Louis Office of Multifamily Housing Programs require the project owners to return $401,705 in ineligible disbursements to the project operating account and provide support for $316,883 disbursed for unsupported costs or return the funds to the project operating account. Additionally, we recommend that the Departmental Enforcement Center pursue appropriate administrative sanctions against the individuals involved, to include suspension, debarment, or limited denial of participation. TABLE OF CONTENTS Background and Objective 3 Results of Audit Finding 1: The Temtor Disbursed More Than $700,000 in Ineligible and Unsupported Payments From Its Project Accounts 4 Finding 2: The Temtor Diverted Tenant Security Deposits 7 Scope and Methodology 10 Internal Controls 11 Appendixes A. Schedule of Questioned Costs 12 B. Auditee Comments and OIG’s Evaluation 13 C. Ineligible and Unsupported Costs Detail 32 D. Criteria 35 2 BACKGROUND AND OBJECTIVE Steins Broadway Management and Rothschild Development collaborated to manage the renovation of the former Coca-Cola syrup plant, also known as The Temtor. The project also included a redevelopment of nine scattered sites located in the South Carondelet neighborhood of St. Louis, MO. The project consists of 109 residential units and 9 commercial units. To finance the construction, The Temtor project received approximately $14.4 million from a U.S. Department of Housing and Urban Development (HUD)-insured mortgage. HUD authorized the mortgage based on Section 220 of the National Housing Act (12 U.S.C. (United States Code) 1715k). Regulations are in 24 CFR (Code of Federal Regulations) Part 200 and 24 CFR 220.1. This program provides funding for good quality rental housing in urban areas that have been targeted for overall revitalization. The project also received approval for State and Federal historic tax credits, Brownfield tax credits, and tax-incremental financing. The project owners formed a limited liability company, 8000 Michigan, LLC, to administer project development and operations. The company selected Steins Broadway Management Company to perform the management duties. Temtor received initial endorsement on April 1, 2010, and final endorsement on January 30, 2012. Following final endorsement, the project began missing mortgage payments in March 2012. By December 2012, the project reported $748,517 payable to the HUD-insured mortgage holder. HUD’s control over the borrower is exercised by a regulatory agreement, form FHA-2466, signed at initial closing. The agreement outlines terms and conditions for the HUD-insured mortgage, such as what expenses could be paid with project funds. Our audit objective was to determine whether the project funds were used for ineligible expenses. 3 RESULTS OF AUDIT Finding 1: The Temtor Disbursed More Than $700,000 in Ineligible and Unsupported Payments From Its Project Accounts Temtor used project funds for ineligible and unsupported expenses. This condition occurred because Temtor chose to use project funds to benefit the project owners rather than making the mortgage payment. As a result, the more than $700,000 used to make improper payments was no longer available to make mortgage payments, contributing to the project’s default. Ineligible and Unsupported Disbursements Temtor used project funds for ineligible and unsupported expenses. These expenses included payments of developer fees, unsecured loans, and excessive funds to the management agent. Paid Developer Fees Temtor paid $282,000 in developer fees with project funds. These fees were development expenses, not operating expenses. The regulatory agreement required that project funds pay only for reasonable operating expenses and necessary repairs. Owners could use surplus cash to pay other expenses. The operating agreement also restricted the payment of developer fees. The agreement required payment of the bridge loans before payment of the developer fees with development funds. The Temtor used project funds to pay developer fees without paying the bridge loans in their entirety. While The Temtor could have paid developer fees with surplus cash, the project did not generate surplus cash during our audit period. Paid Unsecured Loans Temtor paid more than $69,000 on unsecured development or construction loans with project funds. These loans were development expenses, not project operating expenses. Paid Excessive Funds to Management Agent Temtor paid more than $50,000 to the management agent above the amount allowed by the project owner’s-management agent certification. The additional amounts included payments for accounting services, project management, office supplies, equipment lease, computer maintenance, phone and Internet services, and residential screening. These were either management agent expenses that should have been covered by the approved management fee or not related to The Temtor project. 4 Made Unsupported Payments Temtor made more than $316,000 in payments from project accounts without being able to provide invoices and other documentation to demonstrate that these payments were allowable. The payments included transfers to other accounts owned by the management group, cash withdrawals, and direct payments to third parties. Benefit to the Owners Temtor chose to use project funds to benefit the project owners rather than making the mortgage payment. The improper payments benefited the project owners since they also owned the development and management companies that received many of the payments. In addition, the loan repayments relieved personal obligations of the ownership group. More than $700,000 Improperly Disbursed More than $700,000 used to make improper payments was no longer available to make mortgage payments, contributing to the project’s default. The improper payments included ineligible payments of $401,705 and unsupported payments of $316,883. Details are included in appendix C. Disbursement Type Amounts Developer Fees $ 282,000 Unsecured Loans $ 69,418 Excessive Funds to Mgmt Agent $ 50,287 Ineligible Payments ‐ Sub‐total $ 401,705 Unsupported Payments $ 316,883 Improper Payments ‐ Total $ 718,588 The project reported $748,517 payable to the holder of the HUD-insured mortgage at the end of our audit period. Conclusion Temtor did not have adequate policies and procedures in place to ensure that disbursements were only for eligible project expenses. However, this report contains no related recommendations because after our audit period, Temtor changed management agents and the mortgage was assigned to HUD. The project regulatory and operating agreements established that members of the ownership group were individually liable to HUD if they received project funds 5 that they were not entitled to retain. The agreements further state the members agree to be liable for their own acts and deeds, or acts and deeds of others which they have authorized, in violation of the provisions of the HUD regulatory agreement. HUD should require that the project owners return the improper payments to the project operating account. Recommendations We recommend that the Director of HUD’s St. Louis Office of Multifamily Housing Programs require the project owners to 1A. Return the $401,705 in ineligible disbursements to the project operating account. 1B. Support the $316,883 disbursed for unsupported costs or return the funds to the project operating account. 6 RESULTS OF AUDIT Finding 2: The Temtor Diverted Tenant Security Deposits Temtor transferred funds out of its tenant security deposit reserve account and submitted incorrect accounting reports that concealed the transfers. This condition occurred because Temtor chose to use the security deposits for project expenses rather than following the HUD requirement to maintain the deposits apart from all other funds of the project. As a result, HUD was not able to effectively monitor the condition of the project, and the tenants were at risk of not being able to recover their deposits. Security Deposits Used for Operating Expenses Transferred Funds In March 2012, Temtor transferred $70,000 from its security deposit account to its operating account. Temtor returned $70,000 to its security deposit account from its operating account in April 2012. In May 2012, it transferred $73,000 from its security deposit account to its operating account. These transfers supported two mortgage payments of $78,419 each from the operating accounts to the holder of the HUD-insured mortgage. From March to September 2012, Temtor made multiple smaller transfers from its security deposit account to various other accounts. A member of the ownership group deposited $75,000 into the security deposit account in October 2012. Additional deposits made from the project’s rental account brought the balance of the security deposit account back to the reported level in November 2012. HUD Handbook 4370.2, REV-1, CHG-1, Financial Operations and Accounting Procedures for Insured Multifamily Projects, requires that all security deposits be segregated from other project funds and used only for refunds to tenants and payment of appropriate expenses incurred by the tenant. Incorrect Reports Temtor submitted incorrect accounting reports to HUD. It certified the security deposit account balances in the project’s monthly accounting reports. Between February and December 2012, Temtor overstated the security deposits in 8 of 11 months. The average amount of overstatement was $54,631. This overstatement effectively concealed the diversion of funds from HUD. 7 Security deposits reported vs. actual $100,000.00 $80,000.00 $60,000.00 $40,000.00 $20,000.00 $0.00 Reported Actual Shortages Covered by Owners The management agent stated that the project did not have adequate funds to cover operating expenses. He was also aware that using security deposits for operating expenses was not allowed. However, Temtor chose to use tenant security deposits as it preferred rather than following HUD requirements. Financial Risk HUD was not able to effectively monitor the condition of the project. The December 2012 project report indicated $748,517 in overdue payments on the HUD-insured mortgage. If the Temtor had accurately reported the use of security deposit funds to pay the mortgage, HUD would have been better able to take prompt corrective action. The security deposit account was not properly funded, placing the tenants at risk of losing their deposits if the project failed. Conclusion The Temtor placed tenant security deposits into its project operating account and filed inaccurate reports concealing the diversion. Because improper payments were made from project accounts during the audit period (see finding 1), these transfers increased the project’s ability to make the improper payments. HUD can impose various administrative sanctions against individuals who have acted improperly to protect the public interest. These sanctions include suspension, debarment, and limited denial of participation. 8 Recommendation We recommend that the Director of HUD’s Departmental Enforcement Center 2A. Pursue appropriate administrative sanctions for both findings against the individuals involved, to include suspension, debarment, or limited denial of participation. 9 SCOPE AND METHODOLOGY To accomplish our objective, we Interviewed HUD and project management, Reviewed Federal regulations and HUD handbooks, Reviewed independent public accountant reports, Reviewed the project operating and regulatory agreements, Reviewed the closing documents, and Reviewed project bank statements and supporting documentation. We reviewed monthly financial reports that were submitted to HUD by Steins Broadway Management Company. The company reported disbursements totaling approximately $4.8 million during our audit period. We selected for review payees that were paid more than $25,000 during the audit period. By targeting the payees that received the largest disbursements, our sample included 94.8 percent of the reported funds that were disbursed during our audit period. We compared the invoices and payment documentation provided by the auditee to the selected disbursements. We looked for support that the expenses were properly assigned to the project. We identified additional disbursements from the project accounts that were not disclosed in the monthly financial reports; thus, we included an additional sample in our review. We obtained the project operating and rental accounts’ monthly bank statements and supporting documentation. Unreported payments totaling approximately $1 million were made from the project operating or rental accounts during our audit period. We excluded payments that were less than $1,000 and transfer payments between the project’s rental and operating accounts. By targeting the payees that received the largest disbursements, our sample included 98.9 percent of the unreported funds that were paid during our audit period. We performed audit work from January through June 2013. We conducted audit fieldwork at The Temtor, 8125 Michigan Avenue, St. Louis, MO. Our review generally covered the period February 1 through December 31, 2012. We conducted the audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objective. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objective. 10 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 to ensure proper oversight of project disbursements. 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 Temtor did not have adequate policies and procedures in place to ensure that disbursements were only for eligible project expenses. 11 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS Recommendation number Ineligible 1/ Unsupported 2/ 1A $401,705 1B $316,883 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. 12 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Comment 2 Comment 3 13 Ref to OIG Evaluation Auditee Comments Comment 4 Comment 5 14 Ref to OIG Evaluation Auditee Comments Comment 6 Comment 7 Comment 8 15 Ref to OIG Evaluation Auditee Comments Comment 9 Comment 10 Comment 11 Comment 12 16 Ref to OIG Evaluation Auditee Comments Comment 13 Comment 14 Comment 15 17 Ref to OIG Evaluation Auditee Comments Comment 15 Comment 16 Comment 17 18 Ref to OIG Evaluation Auditee Comments Comment 18 Comment 19 Comment 20 19 Ref to OIG Evaluation Auditee Comments Comment 20 Comment 21 20 Ref to OIG Evaluation Auditee Comments Comment 22 Comment 23 Comment 24 Comment 25 21 Ref to OIG Evaluation Auditee Comments Comment 25 22 Ref to OIG Evaluation Auditee Comments Comment 25 23 Ref to OIG Evaluation Auditee Comments Comment 26 Comment 27 Comment 28 24 Ref to OIG Evaluation Auditee Comments Comment 28 25 OIG Evaluation of Auditee Comments Comment 1 In general, the auditee disagreed with our finding that project funds were used for ineligible and unsupported expenses. The auditee claims the various project tax credits are specifically excluded from the mortgaged property and should be excluded from the project. This claim fails to recognize the difference between the mortgaged property and the project as defined by the regulatory agreement. Mortgaged Property includes all property, real, personal, or mixed covered by the mortgage or mortgages securing the note endorsed for insurance or held by the Secretary (Regulatory Agreement, Section 13.d). The Project includes the mortgaged property and all of its other assets of whatsoever nature or wheresoever situate, used in or owned by the business conducted on said mortgaged property, which business is providing housing and other activities as are incidental thereto (Regulatory Agreement, Section 13.e) The various tax credits were excluded as collateral from the FHA-insured Construction loan but remain collateral for the $6 million bridge loan with Excel Bank (Loan Document Section I, Para. 1.1). Furthermore, HUD is not the lender and the relationship between the owner and HUD is governed solely by the terms of the Regulatory Agreement and cannot be modified, altered or changed by any other agreement. Under the Regulatory Agreement, all rents and other receipts of the project shall be deposited in a financial institution in the name of the project (Regulatory Agreement, Section 9.g). Such funds shall be withdrawn only in accordance with the provisions of the Agreement for expenses of the project or for distributions of surplus cash as permitted by Para. 6(e). Since the tax credit proceeds were deposited into the project bank accounts, as other receipts of the project, such funds may only be disbursed for reasonable operating expenses and necessary repairs. Moreover, such funds were pledged by the Owner to HUD as security under the Regulatory Agreement (Regulatory Agreement, Para. 12). We recognized the various tax credits were collateral for the bridge loan and the proceeds of their sale were to be paid to the lender. Where documentation supported tax credits being used to make bridge loan payments, we did not consider the payments to be ineligible payments. In addition, HUD form 92580, Maximum Insurable Mortgage, establishes the Mortgagors Equity Investment (tax credits) as essential to the project. HUD form 92580 documents project "Actual Costs" of $19.1 million. The form also documents a requirement of $4.7 million in Mortgagors Equity Investment in addition to the $14.4 million HUD insured loan to fund the project costs. Finally, the Owners warranted that they would not execute any other agreement with provisions contradictory of, or in opposition to, the provisions of the Regulatory Agreement; and, in any event the requirements of the Regulatory Agreement are 26 paramount and controlling as to their rights and obligations and supersede any other requirements in conflict (Regulatory Agreement, para. 15). Comment 2 We reviewed The Temtor Rental Account and The Temtor Operating Account. In general, the rent receipts were deposited into the rental account and the project expenses were paid out of the operating account. Funds were also transferred to the management agent (Steins Broadway Management) to pay project expenses. In addition, we found tax credits were deposited into the rental account and the operating account. The documentation did not support the auditee claim that accounts were segregated. See comment 1. Comment 3 See comment 1. Comment 4 Our audit found false reports were filed by the auditee. In addition, payments were made from project accounts that were not disclosed on the monthly reports provided to HUD. Therefore, HUD was not able to effectively monitor the condition of the project. We did not rely on the work of other non-HUD OIG auditors and experts to satisfy any of our audit objectives. The information obtained from these sources was used for background purposes only. Therefore we did not assess the validity of their findings. Comment 5 See comment 1. Comment 6 Section 6(b) of the Regulatory Agreement states, “Owners shall not without the prior written approval of the Secretary: Assign, transfer, dispose of , or encumber any personal property of the project, including rents, or pay out any funds except from surplus cash, except for reasonable operating expenses and necessary repairs.” Comment 7 The Request for Final Endorsement of Credit Instrument was signed by the Managing Member of the project on January 26, 2012. The managing member certified in this document that the construction of project is complete and all outstanding unpaid obligations were disclosed. After certification of completion, additional development costs cannot be charged to the project. Post final endorsement the only project expenses are operating expenses and necessary repairs. As noted in comment 2, the owner deposited the tax credit proceeds into the project’s rental and operating accounts. Comment 8 The excerpt from Department of Economic Development publication provided by the auditee caps the Developer Fee at 20% of the qualified rehabilitation expenditures. HUD form 92580 recognized $19,123,667 in total land and improvements for the project. To comply with the requirements of the publication, payments equal to 10% of the maximum allowable developer fee would be required. This would be ($19,123,667 * 20% * 10%) = $382,473. The 27 excerpt from the audited financial statements provided by the auditee indicates development fees of $2,623,640 had been paid to 8000 Developer LLC, (a related party) and $17,000,000 had been earned as of December 31, 2011. These amounts greatly exceed the amount required by the Department of Economic Development. The documentation provided does not support the auditee’s claim that additional payments to 8000 Developer LLC were required. In addition, we were not provided with documentation to support the auditee’s claim that the developer fees were returned to the project accounts. The restrictions regarding payment of the developer fees were included in The Temtor closing file. The Notes to Financial Statements included in the closing file stated "Unpaid developer fees of $9,162,670, do not accrue interest and, pursuant to the agreement, the fee shall be paid from development sources or net cash flow, but only after payment of all bridge loans and of excess development costs." Comment 9 It was certified on January 30, 2012 that all required Escrow Accounts and Reserves for the Project were fully funded. Construction and development reserves would not be used for project expenses. Comment 10 The response confirms our finding that $69,418 was paid for unsecured development or construction loans. As noted earlier, the managing member certified that the construction of the project is complete and all outstanding unpaid obligations were disclosed (see comment 7). The tax credits remain part of the project (see comment 1), and were not maintained in separate accounts (see comment 2). In addition, the Request for Final Endorsement of Credit Instrument did not list any HUD-approved notes. Comment 11 Project construction was outside the scope of our audit. The subject of increased development costs paid to the contractor were noted and resolved prior to closing. Comment 12 See comment 10 Comment 13 Steins Broadway Management president’s identity of interest relationship with the project was disclosed and documented on the Project Owner's/Management Agent Certification. We reviewed the payments for legal fees without considering the dual role of the Management Agent and revised our report accordingly. The auditee claimed legal expenses that exceeded the documented project legal expenses by $18,102. This will be included in the reported unsupported expenses. Comment 14 The auditee did not provide invoices or bills to support the reimbursements paid to the management agent/owner. During our audit, the management agent said he considered the reimbursements to be owner repayments for previous contributions, and could not be tied to specific expenses. The three payments totaling $11,840 will be included in the reported unsupported expenses. 28 Comment 15 We changed the heading in the table to read “excessive funds to management agent” to match up with the terminology in the body of the finding and to make it clear that we were not referring to the management fee itself. The $9,244 in ineligible costs included $5,452 for the lease of a copier that was not a project expense. Invoices show the copier was located at 7525 South Broadway. Steins Broadway Management, the management agent, was based at the project, 8125 Michigan Avenue. Therefore, the equipment lease was not a direct project expense. The management company paid a total of $2,743 for phone and Internet services. We determined the phone number was registered to Steins Broadway Condominiums, LLC which is located at 7525 S. Broadway St. Steins Broadway Condominiums, LLC is a separate entity organized by the management agent. HUD Handbook 4381.5 allows reimbursement for project related expenses such as bookkeeping and associated expenses, project checks, envelopes, postage, and air express delivery charges. From the description of the invoices, we determined that $565 was disbursed for office supplies that were not eligible project expenses. The management company paid for residential screening services for various addresses. We matched the addresses listed in the invoice against the project rent roll and determined that only 15 of the billed units were located in Temtor buildings. The amount billed for the remaining addresses, $483, was not a project expense. The audit reviewed the eligibility of actual expenses. We did not compare actual expenses to budgeted. Comment 16 HUD allows for payments of special management fees if a project has special needs or problems. As documented on the Management Agents Certification, this project did not seek nor receive approval for payment of special fees. In addition, HUD Handbook 4381.5 provides that salaries for preparing budgets required by the owner or HUD and analyzing and solving project problems must be paid out of the management fee funds rather than by the project. Accordingly, the financial analyst’s salary for preparing documents for the Partial Payment of Claim was not chargeable to the project. This would be an expense of the owner. Comment 17 As noted earlier, the managing member certified the construction of the project is complete and all outstanding unpaid obligations were disclosed. After certification of completion additional development costs cannot be charged to the project (See comment 7). Comment 18 We agree that repayment of the $10,000 would be a correct resolution of this improper payment. We removed the statement regarding direct payment to the 29 vendor on February 14, 2013. HUD will follow up to ensure collection and closing of the recommendation. Comment 19 8000 Michigan (The Temtor), 8000 Manager, and 8000 Developer are distinct entities. The claimed accounting and tax services for the latter two entities are not project expenses. Comment 20 The auditee provided documents to support the $234,551.75 wire made from the project operating account on February 2, 2012 was returned. The unsupported amount included in our finding was reduced based on this information. Comment 21 The Carpenter’s Union was restricted from releasing funds to the project until the HUD loan closed. The auditee did not document receipt of the loan proceeds from the Carpenter's District Council. Therefore, we were not able to tie the payment made on February 3, 2012 to the loan proceeds. Comment 22 The auditee provided additional documents to support the bridge loan payments made from the project operating account were funded by tax credits. The amount of unsupported payments included in our findings was reduced by $75,077.16 based on this information. Comment 23 We compared the invoices provided by the management agent to the disbursements reported in the monthly financial reports. The total disbursements exceeded the invoices by $5,763.70. We were not provided any additional documentation to describe these payments. Comment 24 The auditee did not provide any documentation in their response to support that these payments were made for eligible project expenses. Comment 25 The auditee agrees the security deposits were inappropriately used to fund project operations. However, the auditee added why they believe the project was underfunded. The following statements indicate the project was financially sound at closing. The managing member certified at closing the construction of project is complete and all outstanding unpaid obligations were disclosed (comment 7). The subject of increased development costs paid to the contractor were noted and resolved prior to closing (comment 11). It was certified on January 30, 2012 that all required Escrow Accounts and Reserves for the Project were fully funded (comment 9). This audit reviewed operations and did not include the development phase or final closing of the project. The project reached final endorsement on January 30, 2012. Our review generally covered February 1 through December 31, 2012. Comment 26 The auditee does not claim the charges have any connection to this project. 30 Comment 27 As stated in the auditee's response to the diversion of the tenant security deposits, the former management agent twice inappropriately and without authorization from the company or the knowledge of the managing member, used security deposits on an interim basis to fund operations. The members’ of the ownership group responsibility for these actions is established by the regulatory and operating agreements. In these documents the members, agree to be liable for their own acts and deeds, or acts and deeds of others which they have authorized. We modified the report to state this requirement. Comment 28 We reduced the amount of unsupported and ineligible payments based on the additional documents the auditee provided. This reduced the total amount of improper payments to $718,588. The more than $700,000 used to make improper payments was no longer available to make mortgage payments, contributing to the project's default. The report does not conclude this is the sole cause of the default. 31 Appendix C INELIGIBLE AND UNSUPPORTED COSTS DETAIL Inel i gi bl e Excessive funds to Developer Unsecured management Account Date Check # fees loans agent Unsupported Operating 2/7/2012 EFT* 15,000.00 Operating 2/10/2102 EFT 10,000.00 Operating 2/15/2012 EFT 4,000.00 Operating 2/15/2012 EFT 20,000.00 Operating 2/17/2012 EFT 10,000.00 Operating 2/28/2012 EFT 1,000.00 Operating 2/29/2012 EFT 1,000.00 Operating 4/17/2012 EFT 106,000.00 Operating 4/18/2012 EFT 40,000.00 Operating 4/23/2012 EFT 48,000.00 Operating 4/24/2012 EFT 12,000.00 Operating 4/25/2012 EFT 15,000.00 Operating 2/3/2012 Wire 25,376.00 Operating 8/17/2012 175 2,042.00 Operating 10/10/2012 188 1,000.00 Operating 2/3/2012 Wire 21,000.00 Operating 4/26/2012 Wire 20,000.00 See Note A Various See note A 9,244.06 See Note B 6/13/2012 See Note B 5,503.58 See Note B 7/20/2012 See Note B 5,503.58 See Note B 8/21/2012 See Note B 5,503.58 See Note B 9/21/2012 See Note B 5,503.58 See Note B 10/18/2012 See Note B 5,503.58 See Note C 4/24/2012 See Note C 3,525.00 See Note C 11/8/2012 See Note C 10,000.00 * EFT = electronic funds transfer 32 Inel i gi bl e Excessive funds to Developer Unsecured management Account Date Check # fees loans agent Unsupported See Note D 12/26/2012 See note D 18,102.07 See Note E 8/6/2012 See Note E 4,848.67 See Note E 10/25/2012 See Note E 3,395.53 See Note E 11/27/2012 See Note E 3,595.91 See Note A Various See Note A 5,763.70 See Note F 9/18/2012 See Note F 1,000.00 Rental 5/14/2012 Transfer 1,000.00 Rental 9/6/2012 Transfer 5,000.00 Rental 3/8/2012 Withdrawal 3,000.00 Rental 3/8/2012 Withdrawal 3,500.00 Rental 4/4/2012 Withdrawal 10,000.00 Rental 9/6/2012 Withdrawal 2,000.00 Operating 7/18/2012 EFT 2,550.00 Rental 9/10/2012 EFT 5,500.00 Rental 12/21/2012 EFT 1,000.00 Rental 12/24/2012 EFT 1,500.00 Operating 4/5/2012 130 3,100.00 Excel 2/28/2012 DBT CRD 2,250.00 Operating 2/3/2012 Wire 234,601.75 Operating 5/10/2012 144 1,800.00 Operating 5/11/2012 143 1,630.00 Operating 5/16/2012 146 1,745.00 Unsupported payment total 316,882.63 Ineligible payment totals 282,000.00 69,418.00 50,286.96 401,704.96 Improper payment total $ 718,587.59 33 Notes of Explanation A. The management company reported a total of $20,611.45 in office administration fees for the months from June through December 2012. The office administration fees included reimbursements for the office supplies, equipment lease, computer maintenance, phone and Internet services, and residential screening; $9,244.06 in office administration fees was ineligible overhead expenses or not related to Temtor project. Additional administration fees of $5,763.70 were not properly supported. Date Description Amount 06/15/12 Office administration $ 4,418.80 07/31/12 Office administration $ 1,544.76 08/24/12 Office administration $ 3,160.28 11/07/12 Office admin – Sept. $ 1,822.06 11/07/12 Office admin – Oct. $ 3,046.91 11/07/12 Office admin – Nov. $ 2,914.98 12/24/12 Office administration $ 3,703.66 Total $ 20,611.45 B. Steins Broadway Management received transfer payments for extra management activities. HUD guidance, the regulatory agreement, and the project owner’s-management agent certification established criteria for project management activities. The project management services were included in Steins Broadway Management Company’s standard management duties. The extra project management fees, $27,517.90, constituted ineligible expenses. C. We determined that the $10,000 disbursement reported by the management company on November 8, 2012, was ineligible. It was ineligible since it was transferred to the management agent’s bank account but not paid to the accounting company. Included with the $42,165 disbursement made on April 20, 2012, Temtor paid $3,525 for services not related to project operations. D. We reviewed the reimbursements to the management agent for legal fees without considering the dual role of the identity of interest management agent and revised our report accordingly. The auditee claimed legal expenses that exceeded the documented project legal expenses by $18,102.07. E. According to the monthly financial reports, three disbursements totaling $11,840 were transferred to Steins Broadway Management Company in August, October, and November 2012, notated as “invoice for May bills,” “reimbursement to owner,” and “owner reimbursement.” F. After the $1,500 transfer on September 18, 2012, $500 was transferred to the project operating account. Management withdrew the remaining $1,000 transferred to account 6177. The managing agent did not provide documentation supporting the eligibility of the payment. 34 Appendix D CRITERIA Excerpts From HUD Handbook 4370.2, REV-1, CHG-1, Financial Operations and Accounting Procedures for Insured Multifamily Projects 2-3 MAINTENANCE OF BOOKS AND ACCOUNTS C. In establishing a financial accounting system, auditing problems can be avoided by keeping operating funds separate from other project funds. Particularly when occupancy occurs prior to final closing, care must be taken to segregate construction and operating funds. Accounting of any construction expenses shall be in accordance with HUD Handbook 4470.1, Mortgage Credit Analysis for Project Mortgage Insurance, Section 207. 2-6 REGULAR OPERATING ACCOUNT E. All disbursements from the Regular Operating Account (including checks, wire transfers and computer generated disbursements) must be supported by approved invoices/bills or other supporting documentation. The request for project funds should only be used to make mortgage payments, make required deposits to the Reserve for Replacements, pay reasonable expenses necessary for the operation and maintenance of the project, pay distributions of surplus cash permitted and repay owner advances authorized by HUD. 2-8 SURPLUS CASH AND RESIDUAL RECEIPTS A. Basically, surplus cash is the cash remaining after all necessary and reasonable expenses of the project have been paid or funds have been set-aside for such payment. Specifically, the regulatory agreement defines surplus cash as any cash remaining after: 1. The payment of all sums due under the terms of any mortgage, all amounts required for funded reserve accounts, and all obligations of the project, and 2. The segregation of an amount equal to the aggregate of all special funds required to be maintained by the project and the segregation of all tenant security deposits held. 2-9 SECURITY DEPOSIT ACCOUNT A. In instances where the Regulatory Agreement allows the receipt of security deposits from project tenants, a separate bank account should be established to maintain these funds. In addition, individual states have specific regulations governing the handling of tenant security deposits and these regulations should be complied with. There shall be one Security Deposit Account per project. Funds in the single Security Deposit Account must not be commingled with any other funds, e.g., security deposit funds of other projects, operating accounts, managing agent accounts, etc. In cases where the funds in the project’s Security Deposit bank account exceed the amount that may be insured by the federal government ($100,000/bank), the project may open another bank account for the excess amounts. B. All disbursements from the Security Deposit account must be supported by approved invoices/bills or other documentation. Disbursements must be only for refunds to tenants and for payment of appropriate expenses incurred by the tenant. 35 2-10 DISTRIBUTIONS TO OWNERS A. Surplus cash distributions may not be paid from borrowed funds, prior to the completion of the project or when a project is in default or under a forbearance agreement. If the owner takes distributions when the project is in default or when the project is in a non-surplus cash position, the owner is subject to criminal and/or civil penalties. (See Appendix 1 - Criminal Statutes for a listing of civil and criminal statutes). The first year's distribution may not be paid until all required cost certification submissions have been made. Distributions are earned beginning with the day following the cut-off date for cost certification. Distributions to owners are not permitted on nonprofit (NP) projects. On limited dividend (LD) or profit-motivated (PM) projects, the regulatory agreement provides that distributions can be paid without prior HUD approval only: o if paid from surplus cash, o if paid as of and after the end of an annual or, if specified in the regulatory agreement, semiannual fiscal period. In effect, surplus cash generated at the end of one fiscal period is not available for distribution until the next fiscal period. Stated differently, distributions paid out early in fiscal year 1991, for example, may not exceed surplus cash available as of the end of fiscal year 1990. 2-11 REPAYMENT OF OWNER ADVANCES A. Advances made for reasonable and necessary operating expenses may be paid from surplus cash at the end of the annual or semi-annual period. Such repayment is not considered an owner distribution. It is considered a repayment of advances. Repayment of owner advances when the project is in a nonsurplus cash position will subject the owner to criminal and civil monetary penalties. (See Appendix 1, Criminal Statutes.) 2-12 CASH MANAGEMENT CONTROLS B. DISBURSEMENT CONTROLS 1. A request for a check must have supporting documentation (i.e., invoice itemizing amount requested with an authorized signature) in order for approval to be obtained to make the disbursement. 2. Checks must be approved by an individual authorized to approve checks. 3. The authorized check signer shall review supporting documentation before signing the check. 4. Supporting vouchers shall be marked canceled to prevent resubmission. 5. A monthly reconciliation shall be performed to ensure that all checks disbursed are accounted for (i.e., cashed, outstanding, or void). 6. Invoices should be marked “paid” and the check number and date should be posted to the invoice. Supporting vouchers shall also be marked “paid” to prevent resubmission. Excerpts From HUD Handbook 4381.5, REV 2, The Management Agent Handbook 6.39: MANAGEMENT COSTS PAID FROM THE MANAGEMENT FEE a. Expenses for services that are not front-line activities must be paid out of management fee funds, except for centralized accounting and computer services. 36 b. Salaries, fringe benefits, office expenses, fees, and contract costs for the following activities must be paid out of management fee funds. These costs include: (1) Designing procedures/systems to keep the project running smoothly and in conformity with HUD requirements. (2) Preparing budgets required by the owner or HUD, exclusive of rent increase requests and MIO Plans. (3) Recruiting, hiring, and supervising project personnel. (4) Training for project personnel that exceeds the line item budget for training expenses. (5) Monitoring project operations by visiting the project or analyzing project performance reports. (6) Analyzing and solving project problems. (7) Keeping the owner abreast of project operations. (8) Overseeing investment of project funds. (9) Ensuring that project positions are covered during vacations, sickness, and vacancies. Excerpts From HUD Handbook 4555.1, Section 220, Rental Housing in Urban Renewal Areas 1-7. ANNUAL FINANCIAL STATEMENTS. Mortgagors must keep their books and accounts according to Handbook 4370.2 Financial Operations and Accounting Procedures for Insured Multifamily Projects. They must also provide annual financial reports meeting the requirements in reference (7) of the Foreword. 1-8. REGULATORY AGREEMENT. The Secretary’s control over the mortgagor is exercised by a Regulatory Agreement, Form FHA 2466, which is signed at initial closing. Excerpts From First Amendment to the Second Amended and Restated Operating Agreement of 8000 Michigan, LLC, A Missouri Limited Liability Company Amendment to Section 4.16. Development Fees Development Fees. The Company has entered into Development Agreements with the Developer for its services in connection with each of the Company’s ten historic rehabilitation projects. In accordance with such Development Agreements, the Company shall pay the Developer the respective Developer Fees (including overhead) as set forth in Schedule D. The Developer Fees with respect to each property shall each be earned in full upon substantial completion of the respective rehabilitation project, in each case as evidenced by a Certificate of Substantial Completion executed by the project architect. The Developer shall be paid such portion of the Developer Fee as is available from Development Sources or Net Cash Flow but only after payment of all Bridge Loans in their entirety and the payment of Excess Development Costs. In all events the Developer Fee shall be paid in full by December 31, 2019 and, to the extent Cash Flow and other sources are insufficient to pay such fee in full, the Managing Member shall make a Capital Contribution to the Company in the amount necessary to pay the balance of the Development Fee. (page 65) “Article XI” HUD Requirements g. The Members, and any assignee of a Member, agree to be liable in their individual capacities to HUD with respect to the following matters: 37 (1) For funds or property of the Project coming into their hands, which by the provisions of the HUD Regulatory Agreement, they are not entitled to retain; (2) For their own acts and deeds, or acts and deeds of others which they have authorized, in violation of the provisions of the HUD Regulatory Agreement. (3) The acts and deed of affiliates, as defined in the HUD Regulatory Agreement, which the person or entity has authorized in violation of the provisions of the HUD Regulatory Agreement; and (4) As otherwise provided by law. (page 68) Excerpts From the Regulatory Agreement for Multifamily Housing Projects 6. Owners shall not without the prior approval of the Secretary: (b) Assign, transfer, dispose of, or encumber any personal property of the project, including rents, or pay out any funds except from surplus cash, except for reasonable operating expenses and necessary repairs. (e) Make, or receive and retain, any distribution of assets or any income of any kind of the project except surplus cash and except on the following conditions: 1) All distributions shall be made only as of and after the end of a semiannual or annual fiscal period, and only as permitted by the law of the applicable jurisdiction; 2) No distribution shall be made from borrowed funds, prior to the completion of the project or when there is any default under this Agreement or under the note or mortgage; (g) Require, as a condition of the occupancy or leasing of any unit in the project, any consideration or deposit other than the prepayment of the first month’s rent plus a security deposit in an amount not in excess of one month’s rent to guarantee the performance of the covenants of the lease. Any funds collected as security deposits shall be kept separate and apart from all other funds of the project in a trust account the amount of which shall at all times equal or exceed the aggregate of all outstanding obligations under said account. 9. (g) All rents and other receipts of the project shall be deposited in the name of the project in a financial institution, whose deposits are insured by an agency of the Federal Government. Such funds shall be withdrawn only in accordance with the provisions of this Agreement for expenses of the project or for distributions of surplus cash as permitted by paragraph 6(e) above. Any Owner receiving funds of the project other than by such distribution of surplus cash shall immediately deposit such funds in the project bank account and failing so to do in violation of this Agreement shall hold such funds in trust. Any Owner receiving property of the project in violation of this Agreement shall hold such funds in trust. At such time as the Owners shall have lost control and/or possession of the project, all funds held in trust shall be delivered to the mortgagee to the extent that the mortgage indebtedness has not been satisfied. (b) for their own acts and deeds or acts and deeds of others which they have authorized in violation of the provisions hereof. 38
The Temtor Disbursed Project Funds for Ineligible and Unsupported Expenses
Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-08-08.
Below is a raw (and likely hideous) rendition of the original report. (PDF)