oversight

The Owner and Former Management Agents Lacked Adequate Controls Over the Operation of Lake Village of Auburn Hills, Auburn Hills, MI

Published by the Department of Housing and Urban Development, Office of Inspector General on 2014-09-29.

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

OFFICE OF AUDIT
REGION 5
CHICAGO, IL




                  Lake Village of Auburn Hills
                       Auburn Hills, MI

     Section 223(f) Multifamily Insurance Program




2014-CH-1010                                     SEPTEMBER 29, 2014
                                                        Issue Date: September 29, 2014

                                                        Audit Report Number: 2014-CH-1010




TO:            Barbara Chiapella, Director of Multifamily Housing Hub, 5FHMLA
               Craig Clemmensen, Director, Departmental Enforcement Center, CACB

               //signed//
FROM:          Kelly Anderson, Regional Inspector General for Audit, (Chicago Region) 5AGA

SUBJECT:       The Owner and Former Management Agents Lacked Adequate Controls Over the
               Operation of Lake Village of Auburn Hills, Auburn Hills, MI


    Attached is the U.S. Department of Housing and Urban Development (HUD), Office of
Inspector General’s (OIG) final results of our audit of the Lake Village of Auburn Hills
multifamily project.

    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 8M, requires that the 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
(312) 353-7832.




                                                  
                                            September 29, 2014
                                            The Owner and Former Management Agents Lacked
                                            Adequate Controls Over the Operation of Lake Village of
                                            Auburn Hills, Auburn Hills, MI



Highlights
Audit Report 2014-CH-1010


 What We Audited and Why                     What We Found

We audited the Lake Village of Auburn       The project’s owner and former management agents
Hills multifamily project as part of the    did not ensure that (1) adequate documentation was
activities in our fiscal year 2014 annual   maintained to support disbursements or that funds were
audit plan. We selected the project         used for reasonable operating expenses or necessary
based on a request from the U.S.            repairs of the project, (2) the project’s housing units
Department of Housing and Urban             were used for their intended purpose, and (3) tenants’
Development’s (HUD) Detroit Office of       security deposits were appropriately maintained. As a
Multifamily Housing. Our objective          result, HUD lacked assurance that more than $7.1
was to determine whether the project’s      million was used for reasonable operating expenses or
owner and former management agents          necessary repairs of the project and nearly $116,000 in
operated the project in accordance with     additional rental revenue was not lost. Further, more
the regulatory agreement and HUD’s          than $8,400 in project funds and nearly $134,000 in
requirements.                               lost rental revenue was not available for reasonable
                                            operating expenses and necessary repairs of the
 What We Recommend                          project. In addition, nearly $192,000 in tenant security
                                            deposits was not available to (1) pay for damages to
                                            the project’s housing units, (2) apply toward tenants’
We recommend that HUD require the           unpaid rent, or (3) reimburse households.
owner to (1) support or reimburse the
project for the unsupported
disbursements and rental credits; (2)
reimburse the project from nonproject
funds for the non-revenue-generating
housing units, ineligible expenditures,
and the underfunded security deposit
account; and (3) implement adequate
procedures and controls to address the
finding cited in this report. We also
recommend that HUD pursue double
damages, civil money penalties, and
administrative sanctions, as appropriate,
for the finding cited in this report.




                                                   
                           TABLE OF CONTENTS

Background and Objective                                                         3

Results of Audit

      Finding 1: The Project’s Owner and Former Management Agents Did Not
                 Always Operate the Project in Accordance With the Regulatory
                 Agreement and HUD’s Requirements                               4

Scope and Methodology                                                           11

Internal Controls                                                               14

Appendixes
A.    Schedule of Questioned Costs                                              16
B.    Auditee Comments and OIG’s Evaluation                                     17
C.    Federal and State Requirements                                            23




                                            2
                        BACKGROUND AND OBJECTIVE

Lake Village of Auburn Hills is a 584-unit market-rate multifamily rental housing project located
in Auburn Hills, MI. On June 12, 2008, the U.S. Department of Housing and Urban
Development (HUD) insured the project’s mortgage under section 223(f) of the National
Housing Act and executed a regulatory agreement with the project’s owner, Lake Village of
Auburn Hills, LLC. Wynnestone Communities Corporation and Wingate Management
Companies were the project’s former management agents.1 As of August 2014, Freedomview
Management Company, LLC, was the project’s management agent.

From June 2008 through December 2012, the project was in a non-surplus-cash position in
excess of $1 million. Further, in 2009 and 2011, HUD designated the project as a troubled status
entity. As of July 28, 2014, the project’s audited financial statement for its fiscal year 2013 had
not been received by HUD. The project’s records are located at 100 Lake Village Boulevard,
Auburn Hills, MI.

We selected the project for review based on a request from HUD management. Our objective was
to determine whether the project’s owner and management agents operated the project in
accordance with the regulatory agreement and HUD’s requirements. Specifically, we wanted to
determine whether (1) project funds were used for reasonable operating expenses or necessary
repairs of the project, (2) the project’s housing units were used for their intended purpose, and
(3) tenants’ security deposits were appropriately maintained.




1
 The general partner of the Lake Village of Auburn Hills, LLC, owned Wynnestone. Wynnestone, formerly
Amurcon Corporation, was the identity-of-interest management agent from June 2008 through February 2013.
Wingate Management Companies was the project’s management agent from March 2013 through February 2014.
                                                    3
                                RESULTS OF AUDIT


Finding 1: The Project’s Owner and Former Management Agents Did
Not Always Operate the Project in Accordance With the Regulatory
Agreement and HUD’s Requirements
The project’s owner and former management agents did not always ensure that (1) adequate
documentation was maintained to support disbursements or that funds were used for reasonable
operating expenses or necessary repairs of the project, (2) the project’s housing units were used
for their intended purpose, and (3) tenants’ security deposits were appropriately maintained. The
weaknesses occurred because the project’s owner and former management agents lacked
adequate procedures and controls to ensure that (1) disbursement and procurement
documentation was properly maintained and (2) HUD approved the project’s use of non-
revenue-generating housing units and application of rental credits. In addition, the project owner
disregarded its regulatory agreement and HUD’s requirements regarding the maintenance of
tenant security deposits. As a result, HUD lacked assurance that more than $7.1 million was
used for reasonable operating expenses or necessary repairs of the project and nearly $116,000 in
additional rental revenue was not lost. Further, more than $8,400 in project funds and nearly
$134,000 in lost rental revenue was not available for reasonable operating expenses and
necessary repairs of the project. In addition, nearly $192,000 in tenant security deposits was not
available to (1) pay for damages to the project’s housing units, (2) apply toward tenants’ unpaid
rent, or (3) reimburse households.


 The Project Lacked Sufficient
 Support for Disbursements
 From Its Operating Account

               Contrary to paragraphs 6(b) and 9(b) of the project owner’s regulatory agreement,
               the owner and former management agents were unable to provide sufficient
               support for more than $7.1 million disbursed from the project’s operating account.
               Further, more than $8,400 in operating funds was not used for reasonable or
               necessary project-related expenses or repairs. The funds were disbursed from the
               project’s operating account when the project was in a non-surplus-cash position.

               Disbursements to Wynnestone

               We reviewed 182 disbursements from the project’s operating account totaling
               nearly $6.6 million. Of the 182 disbursements, the project owner was unable to
               provide sufficient documentation to support 176 disbursements totaling nearly
               $6.5 million. Further, more than $6.4 million (99 percent) of the unsupported
                                                4



                                                  
                  disbursed funds represented transfers from the project’s operating account into
                  Wynnestone’s corporate account.2 Wynnestone provided an intercompany
                  transfer schedule to support the more than $6.4 million that was transferred to its
                  corporate account. The schedule identified nearly $1.9 million in payroll,
                  insurance, management fees, taxes, and miscellaneous costs paid by Wynnestone
                  on behalf of the project. It also showed that Wynnestone reimbursed the project
                  nearly $5.2 million. According to the corporate controller for the Silverman
                  Development Company, LLC,3 the amounts reported in the schedule were
                  reconciled to the corporate general ledger but were not verified to the source
                  documents.

                  Using the project’s bank statements, we identified 42 transfers from the
                  corporation to the project’s operating account between January 2011 and
                  December 2013 totaling more than $4.6 million. Nearly all of the reimbursements
                  were posted to the project’s general ledger as other loans and notes payable from
                  surplus cash.4 According to the corporate controller, the account entitled other
                  loans and notes payable from surplus cash was used to record only the transfers
                  between the project and the corporate account. As of December 31, 2013, the
                  other loans and notes payable from surplus cash account showed that the project
                  transferred more than $1.2 million to the corporation that was not reimbursed.

                  Disbursements to Other Payees

                  We reviewed 61 disbursements from the project’s operating account totaling
                  $648,126. Of the $648,126 in disbursements, the project’s owner and former
                  management agents did not provide sufficient documentation to support that (1)
                  $595,319 in disbursements was properly procured in accordance with HUD
                  Handbook 4381.5, REV-5, (2) $40,884 in disbursements was appropriately
                  disbursed and procured, and (3) $3,503 in purchasing service fees (markup)
                  charged by its identity-of-interest entities was reasonable.5

                  The remaining $8,420 in project funds was not disbursed for reasonable operating
                  expenses or necessary repairs of the project. These disbursements included
                  payments for (1) work completed at a different project, (2) yoga classes, and (3) a
                  duplicate expense.
 
 


2
  According to the project’s 2012 audited financial statements, the auditor issued a qualified opinion on the financial
statements and supplemental data, in part because there were distributions of partnership assets not applied to
specific invoices, resulting in potentially misstated accounts.
3
  An identity-of-interest company owned by the project’s general partner.
4
  The 42 transfers totaled $4,626,724 and the amount of reimbursements posted to the other loans and notes payable
account totaled $4,614,075.
5
  The project used identity-of-interest entities as purchasing agents to acquire supplies, equipment, and services.
                                                           5



                                                            
 
 
    The Project Lost Rental
    Revenue

                 Contrary to paragraph 6(h) of the regulatory agreement, the project had three non-
                 revenue-generating housing units. According to the project’s application for
                 mortgage insurance,6 all 584 units were intended to be revenue-generating units.
                 However, one housing unit was used as a maintenance shop, and the other two
                 units were models. Therefore, from June 2008 through December 2013, the
                 project lost $133,9237 in rental revenue by not leasing the three units.

                 Additionally, from July 2008 through December 2013, 20 individuals were
                 provided monthly rental credits. According to the director of finance and
                 assistant vice president for the Silverman Development Company, LLC, monthly
                 rental credits were given to individuals who worked for the project. However,
                 documentation, such as timesheets, pay stubs, or Internal Revenue Service Forms
                 W-2, was not provided to show that the individuals worked for the project and
                 that rental credits were part of their employment benefits. Documentation was
                 also not provided to show that HUD approved the use of rental credits. The
                 amount of lost rental revenue for the 20 individuals totaled $115,877.

    Tenants’ Security Deposits
    Were Not Appropriately
    Maintained

                 Before June 2011, tenants’ security deposits were not maintained in a separate
                 account in accordance with section 6(g) of the project owner’s regulatory
                 agreement and paragraph 2-9(a) of HUD Handbook 4370.2, REV-1, CHG 1.
                 Tenants’ security deposits were inappropriately deposited into and disbursed from
                 the project’s operating account.

                 From January 2011 through July 2014, the balance of the project’s security
                 deposit account did not equal or exceed the total outstanding obligations
                 associated with the account. As of July 31, 2014, the project’s security deposit
                 liability was $217,885; however, its security deposit bank account balance was
                 $26,317.8 Therefore, as of July 31, 2014, the project’s security deposit account
                 was underfunded by $191,568.

6
  Section C, item number 7, of the project’s application for multifamily housing project mortgage insurance under
section 223(f) (form HUD-92013), dated January 29, 2008
7
  Our methodology for this estimate is explained in the Scope and Methodology section of this audit report.
8
  The $26,317 includes the (1) $4,464 balance in the security deposit account controlled by Wynnestone and (2)
$21,853 balance in the security deposit account controlled by Freedomview.
                                                         6



                                                           
                         Underfunded security deposit account
           $300,000
           $250,000
           $200,000
           $150,000
           $100,000
            $50,000
                 $0




                                             Obligations       Balance

The Project Violated the
Regulatory Agreement and
HUD’s Requirements


           The weaknesses described above occurred because the project’s owner and former
           management agents lacked adequate procedures and controls to ensure that (1)
           disbursement and procurement documentation was properly maintained and (2)
           HUD approved the project’s use of non-revenue-generating housing units and the
           application of rental credits. In addition, the project owner disregarded its
           regulatory agreement and HUD’s requirements regarding the maintenance of
           tenant security deposits.

           Wynnestone was owned by the project’s general partner and was the project’s
           identity-of-interest management agent from June 2008 through February
           2013. According to the project’s general partner, the former employees of
           Wynnestone were responsible for disbursing funds from the project’s operating
           account to Wynnestone’s account and maintaining complete and accurate records
           of the accounting transactions. However, the general partner was responsible for
           the project, which included providing management and oversight of
           Wynnestone’s employees and ensuring that project funds were managed
           appropriately.

           According to the director of finance and assistant vice president for the Silverman
           Development Company, LLC, while working in the accounting department
           starting in August of 2012, the general partner would approve disbursements for
           accounts payable and transfers to the corporate account. In February 2013, when
           the Wingate began managing the project, the general partner continued to
           maintain control of the project’s operating account.
                                             7



                                              
                 Further, the general partner said that the loan underwriter did not include the three
                 non-revenue-generating units in the loan origination documents. However,
                 according to the project’s application for mortgage insurance, which was signed
                 by the general partner, all 584 units were intended to be revenue-generating
                 units. The general partner also did not notify HUD that the project had non-
                 revenue-generating units to obtain approval as required by the regulatory
                 agreement.

                 The general partner also said that he was not aware that the project’s security
                 deposit account was underfunded until our audit. However, on September 23,
                 2011, the Director of Asset Management of HUD’s Michigan State Office of
                 Multifamily Housing Programs sent a letter to the project regarding its monthly
                 accounting report review for July 2011. The letter stated that HUD had met with
                 the project’s management staff on January 20, 2011, to discuss the underfunded
                 security deposit account. The letter also stated that proof that the account was
                 fully funded was required within 30 days. Additional letters were sent in
                 November and December 2011 and January through March 2012. Further, the
                 project’s audited financial statements for 2010 through 2012 included a finding
                 that the project’s security deposit account was underfunded. In addition, the
                 summary of the auditee’s comments on the findings and recommendations in the
                 audited financial statements for 2010 and 2011 stated that management was aware
                 that the project’s security deposit account was underfunded. The project’s audited
                 financial statements for 2010 through 2012 included a certification from the
                 general partner on the completeness and accuracy of the financial statements and
                 supplemental data.

    Conclusion

                 The project’s owner and former management agents lacked adequate procedures
                 and controls to ensure that (1) adequate disbursement and procurement
                 documentation was maintained, (2) HUD approved the project’s non-revenue-
                 generating units and the use of rental housing credits, and (3) tenants’ security
                 deposits were maintained in accordance with the regulatory agreement and
                 HUD’s requirements.

                 As a result, HUD lacked assurance that more than $7.1 million9 in project funds
                 was used for reasonable operating expenses and necessary repairs of the project
                 and $115,877 in additional rental revenue was not lost. Further, $8,420 in project

9
 The $7,131,496 included (1) $6,491,790 in unsupported disbursements to Wynnestone, (2) $595,319 in
disbursements without procurement documentation, (3) $40,884 in disbursements that were missing supporting
eligibility and procurement documentation, and (4) $3,503 in unsupported fees for purchasing services.

                                                      8



                                                        
          funds and $133,923 in lost rental revenue was not available for reasonable
          operating expenses and necessary repairs of the project. In addition, $191,568 in
          security deposits was not available to (1) pay for damages to the project’s housing
          units, (2) apply toward tenants’ unpaid rent, or (3) reimburse households.

Recommendations

          We recommend that the Director of HUD’s Detroit Office of Multifamily
          Housing Programs require the owner to

          1A. Support or reimburse the project from non-project funds, as appropriate, for
              the $6,491,790 in project funds disbursed without sufficient documentation
              to support that project funds were used for reasonable operating expenses or
              necessary repairs of the project.

          1B. Support that the $595,319 of project funds disbursed without appropriate
              procurement documentation was used to pay for costs that were reasonable,
              or reimburse the project from non-project funds for the amounts that were
              not reasonable.

          1C. Support or reimburse the project from non-project funds, as appropriate, for
              the $40,884 in project funds disbursed without sufficient documentation to
              support (1) that project funds were used for reasonable operating expenses
              or necessary repairs of the project and (2) the reasonableness of the
              procurement.

          1D. Support or reimburse the project from non-project funds, as appropriate, for
              the $3,503 in purchasing service fees (markup) charged by its identity-of-
              interest entities.

          1E. Reimburse the project $8,420 from non-project funds for the disbursements
              that were not used for reasonable operating expenses or necessary repairs of
              the project.

          1F.   Reimburse the project $133,923 from non-project funds for the lost revenue
                associated with the three non-revenue-generating units.

          1G. Support or reimburse the project $115,877 from non-project funds, as
              appropriate, for the rental credits cited in this finding.

          1H. Reimburse the project’s security deposit account $191,568 from non-project
              funds.


                                           9



                                             
1I.   Implement adequate procedures and controls to ensure that (1) project funds
      are used for reasonable operating expenses or necessary repairs of the
      project, (2) rental revenue is not lost, and (3) the project’s security deposit
      account equals or exceeds the total outstanding obligations associated with
      the account.

We recommend that the Director of HUD’s Detroit Office of Multifamily
Housing Programs

1J.   Review the project’s non-revenue-generating units and application of rental
      credits to determine whether the non-revenue-generating units and credits
      are acceptable. If the units and credits are acceptable, HUD should provide
      approval to the project in writing.

We recommend that the Director of the Departmental Enforcement Center, in
coordination with the Director of HUD’s Michigan State Office of Multifamily
Housing Programs,

1K.    Pursue double damages remedies against the responsible parties for the
       unsupported and ineligible use of the project’s operating funds and
       improper management of the project’s security deposits cited in this audit
       report that violated the regulatory agreement.

We also recommend that the Director of HUD’s Departmental Enforcement
Center

1L.    Pursue civil money penalties and administrative sanctions against the
       responsible parties for the violations of the regulatory agreement cited in
       this audit report.




                                 10



                                    
                         SCOPE AND METHODOLOGY

We performed our onsite audit work between January 2013 and July 2014 at Wynnestone
Communities Corporation’s office located at 101 Southfield Road, Birmingham, MI. The audit
covered the period June 12, 2008, through December 31, 2013, but was adjusted as determined
necessary.

To accomplish our objectives, we reviewed

              Applicable laws; HUD’s regulations at 24 CFR (Code of Federal Regulations) Parts
               5, 200, and 207; HUD Handbooks 4350.1, 4370.1, 4370.2, and 4381.5, REV-2;
               HUD’s 2009 and 2011 management reviews; HUD’s Real Estate Assessment Center
               2008, 2009, 2010, 2011, and 2012 financial statement reviews; HUD’s monthly
               accounting report reviews; and the project owner’s regulatory agreement with HUD.

              The project’s accounting records and reports; disbursement records; contracts and
               agreements; entity filings; loan documents; operating and security deposit bank
               statements; general ledger; and annual audited financial statements for 2008,
               2009, 2010, 2011, and 2012.

              Wynnestone’s bank statements, general ledger, computerized databases, policies
               and procedures, and organizational charts.

              HUD’s files for the project.

We also interviewed the project’s employees and staff from Wynnestone and HUD.

Disbursements to Wynnestone

We reviewed the project’s payment documentation for disbursements to Wynnestone. The
project paid more than $7 million from its operating account through 212 disbursements to the
corporation between January 1, 2011, and December 31, 2013. We reviewed all 166 transfers
from the project’s operating account to Wynnestone’s general bank account totaling nearly $6.4
million and all 15 checks to Wynnestone totaling $72,303. In addition, we selected one transfer
from the project’s operating account to Wynnestone’s payroll account totaling $130,000. We
selected this one transfer because the amount was higher than the amounts for other monthly
payroll expenses. The results of our review were limited to the sample items selected and could
not be projected to the population.




                                               11



                                                 
Disbursements to Other Payees

We reviewed the project’s payment documentation for disbursements to non-identity-of-interest
parties. The project paid nearly $2.7 million from its operating account between January 1,
2011, and December 31, 2013, using 1,226 checks issued to its non-identity-of-interest
recipients.10 We selected a nonstatistical sample of 57 disbursements related to 834 transactions
totaling more than $578,000. We used a nonstatistical sample rather than using 100 percent
selection or representative selection sampling methods because we knew enough about the
population to identify a relatively small number of items of interest that were likely to be
misstated or otherwise have a high risk. In our assessment of high risk, we considered the payees
who received more than $100,000, disbursements to payees that were not reported in the
project’s check register, duplicate payments or disbursements, among other things. The results
of our review were limited to the sample items selected and could not be projected to the
population.

We reviewed the project’s payment documentation for disbursements to identity-of-interest
entities. The project paid more than $253,000 from its operating account between January 1,
2011, and December 31, 2013, through 33 disbursements to identity-of-interest entities other
than Wynnestone. We selected a nonstatistical sample of 4 disbursements from the project’s
operating account related to 67 transactions totaling nearly $70,000.11 We used a nonstatistical
sample rather than using 100 percent selection or representative selection sampling methods
because we knew enough about the population to identify a relatively small number of items of
interest that were likely to be misstated or otherwise have a high risk. In our assessment of high
risk, we considered the payees who received the largest disbursements. The results of our review
were limited to the sample items selected and could not be projected to the population.

Rental Revenue

We reviewed the project’s housing unit history ledger and identified the lowest rental rate charged
for housing units with floor plans similar to those of the maintenance shop and model units to
establish a conservative amount of monthly rent revenue associated with the non-revenue-
generating units. There are 2,029 days from June 12, 2008, through December 31, 2013.
Therefore, approximately 67 months of income that was included in the loan application was not
available to the project (2,029 / 365 * 12 = 66.7) as a result of the non-revenue-generating units.
To be conservative, we used 66 months in our calculation. We multiplied the lowest rent for
each non-revenue-generating unit by 66 months. We then multiplied the results by the 87.5
percent occupancy rate listed on project’s application for mortgage insurance.12 Further, we
10
   The 1,226 checks totaling nearly $2.7 million disbursed from the project’s operating account exclude 227 checks
totaling more than $12.4 million for regular and recurring operating payments for mortgage, services, and utilities,
such as electricity, gas, and waste management.
11
   The results of our evaluation of non-identity-of-interest and identity-of-interest disbursements were combined in
finding 1 of the audit report. The combined sample included 61 disbursements (57 + 4), 901 transactions (834 +
67), and $648,126 in project funds disbursed ($578,156 + $69,970).
12
   Section H, item number 2, of the project’s application for multifamily housing project mortgage insurance under
section 223(f) (form HUD-92013), dated January 29, 2008
                                                         12



                                                           
added the totals for each unit to determine the total rental revenue not collected. See the table
below.

                                               Lowest rent
                                                  rate for
                                  Vacant      occupied units
                Vacant unit      unit floor    with similar     Total        Lost
                   use           plan code      floor plans     rent*       rent**
                  Model           1X1 C3                $699     $46,134     $40,367
                  Model           2X2 D1                 730      48,180      42,158
               Maintenance
                   shop         2X2 D1 H                  890     58,740      51,398
               Totals                                  $2,319   $153,054    $133,923

       *Lowest rent rate x number of months
       **Total rent x occupancy rate

We obtained and reviewed the project’s transaction detail report from its OneSite system for all
rent credits from January 1, 2008, through December 31, 2013. We identified the number of
tenants who received rent credits from July 1, 2008, through December 31, 2013.

We relied in part on data maintained by Wynnestone and the project. Although we did not
perform a detailed assessment of the reliability of the data, we performed a minimal level of
testing and found the data to be adequately reliable for our purposes. We provided our review
results and supporting schedules to the Director of HUD’s Detroit Office of Multifamily Housing
Programs and the project’s owner during 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.




                                                 13



                                                    
                              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:

                     Effectiveness and efficiency of operations – Policies and procedures that
                      management has implemented to reasonably ensure that a program meets
                      its objectives.

                     Reliability of financial reporting – Policies and procedures that
                      management has implemented to reasonably ensure that valid and reliable
                      data are obtained, maintained, and fairly disclosed in reports.

                     Compliance with applicable laws and regulations – Policies and
                      procedures that management has implemented to reasonably ensure that
                      resource use is consistent with laws and regulations.

               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.

                                                 14



                                                   
Significant Deficiency

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

                   The project’s owner and former management agents lacked adequate
                    procedures and controls to ensure that (1) adequate disbursement and
                    procurement documentation was maintained, (2) HUD approved the
                    project’s non-revenue-generating units and the use of rental housing
                    credits, and (3) tenants’ security deposits were maintained in accordance
                    with the regulatory agreement and HUD’s requirements.




                                             15



                                                
                                   APPENDIXES

Appendix A

                 SCHEDULE OF QUESTIONED COSTS

                    Recommendation                          Unsupported
                                          Ineligible 1/
                        number                                   2/
                          1A                                 $6,491,790
                          1B                                    595,319
                          1C                                     40,884
                          1D                                      3,503
                          1E                       $8,420
                          1F                      133,923
                          1G                                    115,877
                          1H                   191,568
                         Total                $333,911       $7,247,373


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.




                                             16



                                               
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION

Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




Comment 3




                         17



                           
Ref to OIG Evaluation   Auditee Comments




Comment 4




Comment 4




Comment 4



Comment 5
and 6




                         18



                           
Ref to OIG Evaluation   Auditee Comments




Comment 5
Comment 6
Comments 5
and 7

Comment 8

Comment 9

Comment 10




                         19



                           
                         OIG’s Evaluation of Auditee Comments

Comment 1   The corporate controller for Silverman Development Company, LLC stated that
            the amounts questioned in our report represent transfers out of the project’s bank
            account and does not reflect the transfers back into the project’s bank account. As
            stated in the audit report, Wynnestone provided an intercompany transfer
            schedule; however, according to the corporate controller for the Silverman
            Development Company, LLC, the amounts reported in the schedule were
            reconciled to the corporate general ledger but were not verified to the source
            documents. Further, the project did not provide documentation to support the
            amounts reported in the schedule. Using the project’s bank statements, we noted
            amounts transferred back to the project; however the payments were posted to the
            project’s general ledger as other loans and notes payable from surplus cash.

Comment 2   The corporate controller stated that payroll is processed electronically through a
            third party and that the payroll disbursements are appropriate. In conjunction
            with its response, payroll documentation for one pay period from its third-party
            payroll processer was provided. The payroll records showed that all employees
            paid during our audit period were employees of Wynnestone. However,
            documentation, such as timesheets, pay stubs, Internal Revenue Service Forms
            W-2, or other support documentation to show that the individuals worked for the
            project was still not provided.

Comment 3   The corporate controller stated that management fees are a monthly recurring
            charge; however, we only considered 3 months of fees as supported. During the
            audit, the project’s accounting records showed that the project made three
            transfers and three check disbursements that were clearly identifiable as payments
            for 6 months of management fees. Management fees should not be a flat
            recurring charge. According to chapter 3 of HUD Handbook 4381.5, REV-2,
            section 3.2(a), management fees should be calculated charges since there are five
            major types of fees that, when added together, make up the overall management
            fee for a project. The five types of fees are: (1) residential income fee; (2)
            commercial income fee; (3) miscellaneous income fee; (4) special fees; and (5)
            add-on fees. In addition, section 3.2(b) of the handbook, states that fees derived
            from project income (residential, commercial, and miscellaneous) must be quoted
            and calculated as a percentage of the amount of income collected by the agent.
            Therefore, multiplying the fee percentage by the income collected would provide
            the actual amount of fee to be paid to the agent.

Comment 4   In its written response to the audit report, the corporate controller included
            additional information to add on to its schedule, which was provided during the
            audit, in regards to its transfers to the project. The listing of transfers also
            included transfers to and from the project’s security deposit account. As stated in
                                             20



                                               
                this audit report, according to the corporate controller for the Silverman
                Development Company, LLC., the amounts reported in the schedule were
                reconciled to the corporate general ledger but were not verified using source
                documents. The documentation provided was not sufficient to determine that the
                payments were for reasonable and necessary operating expenses. We revised the
                report to include the corporate controller’s statement that the account entitled
                “other loans and notes payable from surplus cash” from the project’s ledger was
                used only to record the transfers between the project and the corporate account.
                According to the regulatory agreement, all rents and receipts of the project should
                be withdrawn in accordance to the provisions of this agreement. Any owner
                receiving funds of the project other than by such distribution of surplus cash must
                immediately deposit such funds into the project’s bank account or hold such funds
                in trust.13 HUD’s Handbook 4370.2 states that deposits to and disbursements
                from the centralized account must clearly be traceable to each project. The actual
                cash position of every project in the centralized account must be easily
                identifiable at all times without exception.14 Further the handbook states that 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.15

                Section 6(g) of the regulatory agreement with HUD states that any funds collected
                as security deposits must be kept separate and apart from all other funds of the
                project in a trust account, the amount of which must at all times equal or exceed
                the aggregate of all outstanding obligations under that account. Therefore
                transfers to and from the corporate account for amounts that were to remain in the
                security deposit account were not allowed.

Comment 5       The corporate controller stated that the project is resubmitting its procurement
                documentation. HUD Handbook 4381.5, REV-2, chapter 6, section 4, paragraph
                6.50(a),(b),and (c) lists the requirements for procurement documentation. The
                documentation that was provided during the audit and with the comments was not
                sufficient to determine that proper procurement procedures were followed.

Comment 6       The corporate controller stated that the project was not notified that the
                documentation it provided was insufficient. We disagree. We held audit update
                meetings and provided the results of our reviews throughout the audit. The results
                included the lack of supporting documentation for payments and transfers.

Comment 7       The corporate controller stated that four of the missing checks were provided with
                its comments to the draft audit report. The checks supported the expenditures;


13
   Section 9(g) of the regulatory agreement with HUD
14
   HUD Handbook 4370.2, chapter 2, paragraph 6(A)(4)
15
   HUD Handbook 4370.2, chapter 2, paragraph 6(e)
                                                       21



                                                         
              however, they did not support the procurement of the incurred expenditures. We
              adjusted the audit report accordingly.

Comment 8     The corporate controller stated that there was an error in the mortgage agreement
              regarding the number of revenue generating units. As stated in the audit report,
              section 6(h) of the regulatory agreement states that owners must not, without the
              prior written approval of the HUD Secretary, permit the use of the dwelling
              accommodations of the project for any purpose except the use that was originally
              intended. According to the project’s application for mortgage insurance, all 584
              units were intended to be revenue-generating units. However, one housing unit
              was used as a maintenance shop, and the other two units were models.
              Documentation was not provided to support that the project received HUD’s
              approval to maintain non-revenue generating units.

Comment 9     The corporate controller stated that the project owner was investigating how and
              why the security deposits were underfunded. We commend the project owner for
              investigating how the security deposits were underfunded. The project owner
              should work with HUD to resolve the issue.

Comment 10 The corporate controller stated that through the end of our audit period,
           Wynnestone was that managing agent and that it had funded the project’s
           operating losses, payroll, and paid bills in excess of reimbursements to the
           corporation from the project. As stated in this audit report, Wynnestone ceased
           being the project’s management agent as of February 2013, yet maintained control
           of the project’s bank accounts. The documentation provided for the transfers
           between the project and the owner’s corporate account was not sufficient to
           determine that the transfers were allowable in accordance with the regulatory
           agreement or repaid. The repayments were posted to the project’s ledger as other
           loans and notes payable from surplus cash account. As of December 31, 2013,
           the other loans and notes payable from surplus cash account showed that the
           project transferred more than $1.2 million to the corporation that was not
           reimbursed.




                                              22



                                                
Appendix C

                 FEDERAL AND STATE REQUIREMENTS

Finding 1
Section 6(b) of the project’s regulatory agreement with HUD, dated June 12, 2008, states that
owners must not, without the prior written approval of the HUD Secretary, pay out any funds
except from surplus cash, except for reasonable operating expenses and necessary repairs.

Section 6(e) of the regulatory agreement states that owners must not, without the prior written
approval of the HUD Secretary, “(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 should 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 should
be made from borrowed funds, prior to the completion of the project or where there is any
default under this Agreement or under the note or mortgage; (3) any distribution of any funds of
the project, which the party receiving such funds is not entitled to retain hereunder, must be held
in trust separate and apart from any other funds; and (4) there must have been compliance with
all outstanding notices of requirements for proper maintenance of the project.”

Section 6(h) of the regulatory agreement states that owners must not, without the prior written
approval of the HUD Secretary, permit the use of the dwelling accommodations of the project for
any purpose except the use that was originally intended.

Section 9(b) of the regulatory agreement states that payment for services, supplies, or materials
should not exceed the amount ordinarily paid for such services, supplies, or materials in the area
where the services are rendered or the supplies or materials are furnished.

Section 9(c) of the regulatory agreement states that the mortgaged property, equipment,
buildings, plans, offices, apparatus, devices, books, contracts, records, documents, and other
papers relating to them must at all times be maintained in reasonable condition for proper audit
and subject to examination and inspection at any reasonable time by the HUD Secretary or his
duly authorized agents. Owners should keep copies of all written contracts or other instruments
that affect the mortgaged property, all of which may be subject to inspection and examination by
the HUD Secretary or his duly authorized agents.

HUD Handbook 4381.5, REV-2, chapter 6, section 4, paragraph 6.50, states that (a) when an
owner or agent contracts for goods or services involving project income, an agent is expected 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 or the threshold established by the
HUD area office with jurisdiction over the project. (b) For any contract, ongoing supply, or
                                                 23



                                                   
service estimated to cost less than $5,000 per year, the agent should solicit verbal or written cost
estimates to assure that the project obtains services, supplies, and purchases at the lowest
possible cost. The agent should make a record of any verbal estimate obtained. (c)
Documentation of all bids should be retained as a part of the project records for 3 years
following the completion of the work.

Section 9(g) of the regulatory agreement states that all rents and other receipts of the project
must be deposited in the name of the project with a financial institution in which deposits are
insured by an agency of the Federal Government. Such funds should be withdrawn only
according to the provisions of this agreement for expenses of the project or for distributions of
surplus cash as permitted by paragraph 6(e). Any owner receiving funds of the project other than
by such distribution of surplus cash must immediately deposit such funds into the project’s bank
account or hold such funds in trust.

Section 13(f) of the regulatory agreement states that “surplus cash” means any cash remaining
after “(1) the payment of: (i) all sums due or currently required to be paid under the terms of any
mortgage or note insured or held by the Secretary; (ii) all amounts required to be deposited in the
reserve fund for replacements; (iii) all obligations of the project other than the insured mortgage
unless funds for payments are set aside or deferment of payment has been approved by the
Secretary; and (2) the segregation of: (i) an amount equal to the aggregate of all special funds
required to be maintained by the project; and (ii) all tenant security deposits held.”

Section 13(g) of the regulatory agreement states that “distribution” means any withdrawal or
taking of cash or any asset of the project, including the segregation of cash or assets for later
withdrawal within the limitations of paragraph 6(e) and excluding payment for reasonable
expenses for the operation and maintenance of the project.

HUD Handbook 4370.2, chapter 2, paragraph 6(A)(4), states that deposits to and disbursements
from the centralized account must clearly be traceable to each project. The actual cash position
of every project in the centralized account must be easily identifiable at all times without
exception.

HUD Handbook 4370.2, chapter 2, paragraph 6(e), states that 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 be used only 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.

Section 6(g) of the regulatory agreement states that any funds collected as security deposits must
be kept separate and apart from all other funds of the project in a trust account, the amount of
which must at all times equal or exceed the aggregate of all outstanding obligations under that
account.
                                                 24



                                                    
HUD Handbook 4370.2, chapter 2, paragraph 9(a), states that in instances in which the
regulatory agreement allows the receipt of security deposits from project tenants, a separate bank
account should be established to maintain these funds. There should be one security deposit
account per project. Funds in the single security deposit account must not be commingled with
any other funds.

The Office of Management and Budget’s (OMB) guidance at 2 CFR 180.25 states that each
Federal agency implementing regulation (a) must establish policies and procedures for that
agency’s nonprocurement debarment and suspension programs and activities that are consistent
with the guidance. When adopted by a Federal agency, the provisions of the guidance have
regulatory effect for that agency’s programs and activities.

OMB’s guidance at 2 CFR 180.30 states that each Federal agency that participates in the
governmentwide nonprocurement debarment and suspension system must issue a regulation
implementing these guidelines.

Regulations at 2 CFR Part 2424 state that HUD adopts, as HUD policies, procedures, and
requirements for nonprocurement debarment and suspension, the OMB guidance in subparts A
through I of 2 CFR Part 180, as supplemented by this part. This adoption gives regulatory effect
for HUD to the OMB guidance as supplemented by this part.

Title 12, U.S.C. (United States Code) 1715z-4a, Double Damages Remedy for Unauthorized Use
of Multifamily Housing Project Assets and Income, allows the U.S. Attorney General to recover
double the value of any project assets or income that was used in violation of a regulatory
agreement or any applicable regulation, plus all cost relating to the action, including but not
limited to reasonable attorney and auditing fees.

Title 12, U.S.C. 1735f-15, Civil Money Penalties Against Multifamily Mortgagors, allows
HUD’s Secretary to impose a civil money penalty of up to $25,000 per violation against a
borrower with five or more living units and a HUD-insured mortgage. A penalty may be
imposed for any knowing and material violation of a regulatory agreement by the borrower, such
as paying out any funds for expenses that were not reasonable and necessary project operating
expenses or making distributions to owners while the project is in a non-surplus-cash position.

Section 554.607 of the Michigan Compiled Laws states that a security deposit may be used only
to “(1) reimburse a landlord for actual damages to a rental unit or any ancillary facility that are
the direct result of conduct not reasonably expected in the normal course of habitation of a
dwelling, or (2) pay a landlord for all rent in arrearage under a rental agreement, rent due for
premature termination of a rental agreement by a tenant, and utility bills not paid by a tenant.”




                                                25