U.S. DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT
OFFICE OF INSPECTOR GENERAL
July 22, 2013
MEMORANDUM NO:
2013-PH-1804
Memorandum
TO: Gary O. Possage
Director, Office of Multifamily Housing, Pittsburgh Program Center, 3EHMLAV
Craig T. Clemmensen
Director, Departmental Enforcement Center, CACB
//signed//
FROM: John P. Buck
Regional Inspector for Audit, Philadelphia Region, 3AGA
SUBJECT: Review of the Administration of HUD Funds by Brownsville Apartments,
Brownsville, PA
INTRODUCTION
We conducted a review of Brownsville Apartments based on a referral from the U.S. Department
of Housing and Urban Development’s (HUD) Departmental Enforcement Center and the
Pittsburgh Office of Multifamily Housing due to concerns that project funds were used
inappropriately for purposes other than the operation of the project. This concern was due
largely to the owner’s lengthy history of being uncooperative with HUD. Our objective was to
determine whether the owner of Brownsville Apartments complied with the project’s regulatory
agreement.
METHODOLOGY AND SCOPE
To accomplish our objective, we obtained and reviewed
• The project’s regulatory agreement, rider to the regulatory agreement, section 236(s)
rehabilitation grant agreement, use agreements, restructuring commitment letter,
mortgage restructuring mortgage note, mortgage restructuring mortgage, rider to the
mortgage restructuring mortgage, housing assistance payments full Mark-to-Market
renewal contract, and operations manual;
Office of Audit Region 3
The Wanamaker Building, Suite 10205
100 Penn Square East, Philadelphia, PA 19107-3380
Visit the Office of Inspector General Web site at www.hudoig.gov.
• A payment register from the project’s operating bank account for the period January 2009
to November 2012 and documentation supporting selected payments;
• Bank statements for the project’s operating account for the period January to April 2009
and June 2009 to December 2012;
• Bank statements for the project’s payroll account for the period January 2009 to
November 2012;
• Bank statements for the project’s tenant security deposit account for the period January
2009 to December 2012;
• Payroll summary reports and Internal Revenue Service Forms W-2 for the period January
2009 to December 2012;
• Balance sheet and income statement reports for years ending December 31, 2010, and
December 31, 2011; and
• HUD regulations at 24 CFR (Code of Federal Regulations) Part 5, subpart H, and HUD
Handbooks 4381.5 and 4370.2, REV-1.
In addition, we interviewed the project’s owner and office manager, the project’s public
accountant, and HUD officials.
We performed our review from December 2012 to June 2013 at the management agent’s office
located at 406 Fallowfield Avenue, Charleroi, PA, and our office located in Pittsburgh, PA. Our
review generally covered transactions and events that occurred during the period January 2009
through November 2012 but was expanded when necessary to include other periods. The scope
of our review was limited due to the lack of cooperation from the owner in providing
documentation, answering questions, and meeting with us to discuss our results and provide
feedback. The owner did not respond to our repeated attempts to schedule an exit conference
and provide a written response to the draft audit memorandum. Therefore, the review was not
performed in accordance with generally accepted government auditing standards. The limitation
did not materially affect the results of the audit.
BACKGROUND
Brownsville Apartments is a 45-unit highrise building located in Brownsville, PA. All units
receive project-based Section 8 assistance based on a housing assistance payments contract,
which has an expiration date of April 30, 2021. The project’s owner is Sage Partners, LP. The
managing general partner of Sage Partners, LP, is Sage Partners, LLC, of which the owners are
members. Sage Partners, LLC, manages the project. The project has received the following
project-based Section 8 funding over the last 4 years:
2
Section 8 funds authorized
Year and disbursed
2012 $191,960
2011 203,562
2010 191,250
2009 169,375
Total $756,147
The project’s mortgage was initially insured under the Section 236 program. 1 In April 2001, the
project went through Mark-to-Market 2 restructuring through HUD’s Office of Affordable
Housing Preservation and entered into a regulatory agreement. As a result, the project’s first
mortgage was paid off and replaced with a nonperforming, 3 HUD-held mortgage restructuring
mortgage of $589,156. In addition, before the prepayment of the Section 236 mortgage, the
mortgage was decoupled from its interest reduction payments feature, and a grant agreement was
executed, whereby interest reduction payments were directed to the owner’s reserve for
replacement account. Therefore, the owner had no recurring debt service and no recurring
reserve for replacement payments.
HUD’s Departmental Enforcement Center 4 received seven financial referrals for the project
owner’s failure to file annual audited financial statements for the project’s fiscal years 2002
through 2008. Before our review, the enforcement center communicated with the owner on
many occasions about the financial management of the project, including the apparently
unauthorized use of project funds and was not able to obtain the documentary evidence to
support the use of these funds.
1
The Section 236 program, established by the Housing and Urban Development Act of 1968, combined Federal
mortgage insurance with interest reduction payments to the lender for the production of low-cost rental housing.
Under this program, HUD provided interest subsidies to lower a project’s mortgage interest rate to as low as 1
percent. This program no longer provides insurance or subsidies for new mortgage loans, but existing Section 236
properties continue to operate under the program. The interest reduction payment results in lower operating costs
and, consequently, a reduced rent structure.
2
In 1997, Congress established the Mark-to-Market program to help preserve the availability and affordability of
low-income rental housing while reducing the cost to the Federal Government of rental assistance provided to low-
income households using project-based Section 8 funds. Under this program, HUD resets the rents to the prevailing
market level and restructures the property’s mortgage debt, if needed, to permit a positive cash flow.
3
Mortgage payment requirements on a “nonperforming” mortgage are determined at the end of each of the project’s
fiscal years and are based on the amount of surplus cash realized by the project as reported by the owner in the
annual financial statements.
4
The Departmental Enforcement Center is part of the HUD Office of General Counsel and works with HUD’s
program areas, such as multifamily housing, in various capacities. The enforcement center’s primary goal is to
bring noncompliant owners into full compliance so that there is no compromise in the quality of America’s housing.
To a large extent, owners have agreed to work with HUD to prevent possible enforcement action. Such a proactive
stance on the part of owners is in the best interest of all parties, especially residents. In instances in which owners
fail to bring properties up to standard and when physical and financial deficiencies persist, the enforcement center
may take appropriate enforcement action, including administrative sanctions, such as civil money penalties,
suspension, and debarment, and possible referral to the U.S. Department of Justice for civil action and to HUD’s
Office of Inspector General when criminal activity is suspected.
3
In 2008, the enforcement center issued legal notices to the owner citing the owner’s failure to file
annual audited financial statements and the apparently inappropriate use of project funds.
Having received no correction to the enforcement center’s declared violations or response from
the owner, the enforcement center pursued civil money penalties for the owner’s failure to file
annual audited financial statements. This effort was intended to induce the owner to file,
resulting in HUD’s having more current project financial data from which to draw its
conclusions relative to the owner’s financial compliance.
In June 2009, HUD’s motion for default judgment was granted by the administrative law judge
in the civil money penalties case, and judgment in HUD’s favor was entered for civil money
penalties totaling $125,000. That judgment was forwarded to the financial litigation unit of the
U.S. Attorney’s Office for the Western District of Pennsylvania. However, because of the legal
structure of the owning entity, HUD’s civil money penalties judgment does not reach to the
individuals responsible for the operation of the project. Therefore, collection of the judgment
will likely be limited to a lien against the owner’s only asset, the project, against which HUD
already holds a mortgage in first lien position. The enforcement center decided not to pursue the
civil money penalties because the penalties appeared to be uncollectible.
In November 2012, an article in a local Brownsville newspaper reported that Brownsville
officials planned to cite the owner for failing to clean up a bed bug infestation that tenants said
the owner ignored despite their repeated complaints. According to the article, the residents told
borough authorities that the owner had not responded to their complaints about bed bugs, the
leaking roof, and the broken elevator and that the owner prohibited the local code enforcement
officer from entering the building to conduct an inspection. The owner did not respond to the
newspaper’s request for comment. The article also reported that in December 2010, the
building’s boiler broke, leaving tenants with no heat. The owner distributed space heaters, but
repairs to the boiler were not completed until the following March.
On December 20, 2012, the Director of HUD’s Philadelphia Office of Multifamily Housing sent
a letter to the owner of Brownsville Apartments as formal notice that the project was in violation
of its regulatory agreement. HUD listed the following violations and required corrective action
within 30 days to prevent default of the regulatory agreement:
• Failure to submit financial statements for the years 2002 through 2012 as required by
section 12(e) of the regulatory agreement.
• Failure to provide HUD with specific answers to questions relative to the income, assets,
liabilities, contracts, operation, and condition of the project as required by section 12(f) of
the regulatory agreement.
• Failure to keep books and accounts of the operations of the mortgaged property in
accordance with HUD requirements as required by section 4(e) of the rider to the
regulatory agreement.
4
The owner did not comply with HUD’s direction and failed to take the necessary corrective
action. HUD planned to declare the owner in default of its regulatory agreement but did not
want to impede our audit.
RESULTS OF REVIEW
Based on our limited review, we determined that the owner of Brownsville Apartments did not
comply with the project’s regulatory agreement. The owner did not maintain sufficient books
and records, failed to submit required financial statements, and failed to notify HUD as required
before permitting a new management agent to operate the project. The owner also used project
funds for ineligible expenses and could not demonstrate that all costs incurred were fair and
reasonable expenses related to the project.
The Project Lacked Sufficient Books and Records
The project did not have proper books and records. It did not have a general ledger or a chart of
accounts. The books for the project consisted of a listing of checks disbursed from the project’s
operating fund. Section 4(e) of the rider to the regulatory agreement notes that the books and
accounts of the operations of the mortgaged property and the project must be kept in accordance
with the requirements of HUD. HUD Handbook 4370.2, REV-1, requires books of original entry
to be kept current at all times, and postings must be made at least monthly to ledger accounts.
Project owners’ not properly maintaining the project’s books and accounts results in inaccurate
and incomplete reporting and restricts HUD’s ability to effectively monitor the financial
condition of the project. The project lacked controls to ensure that it maintained proper books
and records.
The Project Had Failed To Submit Annual Audited Financial Statements to HUD Since 2002
The owner had not submitted annual audited financial statements to HUD since 2002, the year
after the project’s mortgage was restructured. Section 12(e) of the project’s regulatory
agreement requires the project to submit annual audited financial statements. Without the
financial statements, HUD cannot determine how Section 8 funds are used, nor can it determine
how much money, if any, is owed by the owner against the HUD-held mortgage. HUD had
received no mortgage payments from the owner.
In response to our request for the project’s most recent 2 years’ audited financial statements, the
owner provided balance sheet and income statement reports for 2010 and 2011, prepared by a
public accounting firm. The public accounting firm’s reports on its reviews did not assert that it
audited the financial statements. Those reports could not be considered audited financial
statements because they were incomplete and did not comply with HUD requirements. The
reports did not include a statement of cash flows, a statement of retained earnings, a certification
by the borrower, the report on the internal control structure, the report on compliance with
applicable laws and regulations, and the supplemental data reports and notes as required by HUD
Handbook 4370.2, REV-1. In addition, the balance sheet and income statement reports were on
a cash rather than an accrual basis as required by the handbook.
5
Further, the person who prepared the documents was the same person who performed payroll
services for the project and, therefore, was not qualified to do an audit of the project’s financial
statements. The handbook requires that financial statements be audited by either a certified
public accountant or a licensed or registered public accountant having no business relationship
with the owner except for the performance of audit, systems work, and tax preparation. The
project lacked controls to ensure that it created and submitted annual audited financial statements
as required.
The Owner Did Not Comply With the Terms of the Owner-Management Certification
The owner failed to notify HUD that it allowed a new identity-of-interest management agent to
operate the project. Section 10 of the project owner’s and management agent’s certification for
multifamily housing projects for identity-of-interest or independent management agents makes
the owner responsible for submitting a new management certification to HUD before permitting
a new agent to operate the project and collect a fee. The last certification the owner submitted to
HUD was dated September 19, 1996, and identified The Information Management Group, Inc.,
as the management agent for the project for the life of the mortgage. However, the owner’s
identity-of-interest company, Sage Partners, LLC, had been the management agent since 2001.
The project lacked controls to ensure that it submitted a new management certification as
required.
The Project Incurred Ineligible Expenses
During the period January 2009 to November 2012, the project made the following ineligible
payments from its operating fund account
• $87,571 to the management agent (Sage Partners, LLC) for management fees. On
December 21, 2006, HUD notified the owner that it was no longer permitted to collect
management fees for the project due to the owner’s failure to address outstanding
management issues. On October 19, 2006, HUD directed the owner to hire a professional
management company to manage the project, but the owner did not comply with HUD’s
direction.
• $23,562 to the owner. Section 8(e) of the regulatory agreement states that owners must
not, without the prior written approval of the HUD Secretary, make or receive and retain
any distribution of assets or any income of any kind of the project except surplus cash.
• $520 for a Christmas party. Section 4(c) of the rider to the regulatory agreement limits
expenditures to reasonable operating expenses and necessary services and materials for
the project.
Additionally, as of December 2012, the project had not returned $27,209 in reserve for
replacement funds that was approved by HUD in 2007 to be used as emergency withdrawals
from the project’s reserve for replacement account to temporarily cover operating expenses until
the project received its July and August 2007 housing assistance payment funds. HUD controls
the project’s reserve for replacement account and releases funds to the project after reviewing
6
and approving a request for funds from the project. Reserve for replacement funds are to be used
only for capital improvements and emergency purposes. The project lacked controls to ensure
that it used project funds only for eligible expenses.
The Project Had Unsupported Expenditures
During the period January 2009 to November 2012, the project made the following unsupported
payments from its operating fund account
• $365,533 for salaries to the owner ($258,750) and three employees ($106,783). HUD
Handbook 4381.5 requires owners to provide a listing of the staff members whose
salaries will be paid from the project’s operating account. The list must include job titles,
approximate salary, a statement of each position’s duties, and whether the position is full
time or part time. HUD did not have these supporting documents, and the owner did not
provide them to us during our review. Further, according to HUD, the $68,000 average
annual salary drawn by the owner as an employee of the management agent was
excessive when compared to salaries paid at similarly sized multifamily projects in
western Pennsylvania. Section 4(c) of the rider to the regulatory agreement limits
expenditures to reasonable operating expenses.
• $244,595 to Lando Construction for repairs (roof, boiler, carpentry, drywall, plumbing,
etc.). Some invoices contained no information to describe the work performed. The
owner could not provide documents, such as contracts, cost estimates, or price quotes, to
support the reasonableness of the cost or to document why a contractor other than the low
bidder was selected to do the work. According to HUD Handbook 4381.5, HUD expects
owners and agents to solicit written cost estimates from at least three contractors or
suppliers for any contract, ongoing supply, or service that is expected to exceed $10,000
per year. For any contract, ongoing supply, or service estimated to cost less than $5,000
per year, the agent should solicit verbal or written cost estimates. A record of any verbal
estimate obtained should be made. Documentation of all bids should be retained as a part
of the project records for 3 years following the completion of the work.
• $31,563 to three individuals. The owner provided no documentation to support the
payments to these individuals. Section 4(c) of the rider to the regulatory agreement limits
expenditures to reasonable operating expenses and necessary services and materials for
the project.
• $23,810 to the project’s maintenance manager. The invoices contained no information to
describe the work performed. Contrary to HUD Handbook 4381.5, the owner could not
provide documents, such as contracts, cost estimates, or price quotes, to support the
reasonableness of the cost. The maintenance manager was paid $17,800 as an employee
during the audit period. In addition, the maintenance manager appeared to have been
connected to Lando Construction. The address on the maintenance manager’s invoice
was the same as the address shown on the invoices for Lando Construction. Also, the
invoice format for the maintenance manager and Lando Construction was the same.
7
• $18,230 to two banks for credit card charges. These payments were partial payments
against the account. The account carried an unpaid balance of $8,900 as of January 2009.
The unpaid balance had increased to $9,100 as of November 2012. During that period,
additional charges were made to the account for goods and services, including $3,366 for
finance charges on the unpaid balance. Although the owner provided the credit card
statements and receipts to support most of the current charges on the statements, neither
the statements nor the receipts contained information to identify the unit or area of the
project for which the goods and services were needed. Further, since the project did not
have a work order system for maintenance requests, we could not relate the purchases to
a project work order. Section 4(c) of the rider to the regulatory agreement limits
expenditures to reasonable operating expenses and necessary services and materials for
the project.
• $14,472 to the tenant security deposit account. Notes in the description field of the
payment register indicated that these payments were made to reimburse the tenant
security deposit account. Section 8(g) of the regulatory agreement notes that 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 of the account. It appeared that the owner had
been using these funds for temporary transfers to its operating account to cover project
expenses. For example, as of December 1, 2012, the bank statement for the tenant
security deposit account showed that the balance was only $118.
• $5,500 on two checks made out to “cash.” The owner provided no documentation to
support the payments. Section 4(c) of the rider to the regulatory agreement limits
expenditures to reasonable operating expenses and necessary services and materials for
the project.
• $3,000 to an individual. Although the owner provided a copy of a letter allegedly
documenting a conversation that occurred in January 2008 between the owner and the
individual to whom the payments were made, the circumstances described in the letter
were dubious. The letter stated that the individual agreed to provide cleaning services at
the project for a period of 12 months at a rate of $250 per month and that the individual
requested that payment be rendered for those services at the end of the year. No
documentation was provided to demonstrate that the services were performed. Section
4(c) of the rider to the regulatory agreement limits expenditures to reasonable operating
expenses and necessary services and materials for the project.
The project made the following unsupported payment from its reserve for replacement funds:
• $3,050 drawn down from the project’s reserve for replacement account for an emergency
biohazard cleanup of a unit. The owner requested and received $6,550 from its account
for this work; however, the project’s check register and bank statements showed that only
$3,500 was paid to the contractor for this work. Therefore, the $3,050 drawn down but
not paid to the contractor was unsupported.
8
The project lacked controls to ensure that it complied with HUD requirements to limit
expenditures to reasonable operating expenses and necessary repairs to the project that are
properly supported.
Summary
The owner of Brownsville Apartments did not comply with the project’s regulatory agreement.
The owner did not maintain sufficient books and records, failed to submit required financial
statements to HUD, and failed to notify HUD as required before permitting a new management
agent to operate the project. The owner also used project funds for ineligible expenses and could
not demonstrate that all costs incurred were fair and reasonable for expenses related to the
project. This condition occurred because the project lacked controls to ensure that it complied
with its regulatory agreement and applicable requirements and because of the owner’s
demonstrated cavalier attitude toward its responsibilities as an owner of a HUD-funded housing
project. As a result, the owner materially violated the terms of the project’s regulatory
agreement, and HUD could not determine whether mortgage payments were owed by the owner
against the HUD-held mortgage and, if they were owed, how much was owed. In addition, the
project incurred ineligible expenditures totaling $138,862 and unsupported expenditures totaling
$709,753.
RECOMMENDATIONS
We recommend that the Director of the Pittsburgh Office of Multifamily Housing
1A. Require the owner to deposit $138,862 from non-Federal funds into the project’s reserve
for replacement account for the ineligible costs identified by the audit.
1B. Require the owner to provide documentation to support the $709,753 in unsupported
disbursements identified by the audit or reimburse the project’s reserve for replacement
account from non-Federal funds for any disbursements that it cannot support.
1C. Require the owner to calculate and support the amount of funds required to be on deposit
in the tenant security deposit account and deposit funds into the account, if needed, so
that the balance in the account is equal to or exceeds the amount of funds required to be
in the account.
1D. Declare the project in default of its regulatory agreement and apply remedies available
under the regulatory agreement up to and including foreclosure.
We also recommend that the Director of HUD’s Departmental Enforcement Center
1E. Pursue administrative sanctions, as appropriate, against the owner for the regulatory
violations cited in this memorandum.
9
Appendix A
SCHEDULE OF QUESTIONED COSTS
Recommendation
Ineligible 1/ Unsupported 2/
number
1A $138,862
1B $709,753
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.
10
Review of the Administration of HUD Funds by Brownsville Apartments, Brownsville, PA
Published by the Department of Housing and Urban Development, Office of Inspector General on 2013-07-22.
Below is a raw (and likely hideous) rendition of the original report. (PDF)