oversight

The Owner and Management Agent for Rainbow Terrace Apartments, Cleveland, OH, Did Not Always Operate the Project in Accordance With the Regulatory Agreement and HUD's Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-09-28.

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

           Rainbow Terrace Apartments,
                 Cleveland, OH
        Section 221(d) Multifamily Insurance Program




Office of Audit, Region 5       Audit Report Number: 2018-CH-1009
Chicago, IL                                     September 28, 2018
To:            Daniel J. Burke, Director of Multifamily Midwest Region, 5AHMLA


               //signed//
From:          Kelly Anderson, Regional Inspector General for Audit, 5AGA
Subject:       The Owner and Management Agent for Rainbow Terrace Apartments, Cleveland,
               OH, Did Not Always Operate the Project in Accordance With the Regulatory
               Agreement and HUD’s Requirements




Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of Rainbow Terrace Apartments.
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 OIG post its
publicly available reports on the OIG website. 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.
                       Audit Report Number: 2018-CH-1009
                       Date: September 28, 2018

                       The Owner and Management Agent for Rainbow Terrace Apartments,
                       Cleveland, OH, Did Not Always Operate the Project in Accordance With the
                       Regulatory Agreement and HUD’s Requirements


Highlights

What We Audited and Why
We audited Rainbow Terrace Apartments based on our analysis of risk factors related to
multifamily projects in Region 5’s jurisdiction1 and the activities included in our fiscal year 2018
annual audit plan. Our objective was to determine whether the project’s owner and management
agent operated the project in accordance with the regulatory agreement and the U.S. Department
of Housing and Urban Development’s (HUD) requirements.

What We Found
The project’s owner and management agent did not always operate the project in accordance
with the regulatory agreement and HUD’s requirements. Specifically, the project’s owner and
management agent did not always provide sufficient documentation to support that project funds
were used for reasonable operating expenses or necessary repairs of the project. In addition, (1)
project funds were not used for reasonable expenses or necessary repairs of the project, (2)
excess management fees and unsupported bookkeeping fees were charged to the project, and (3)
tenants’ security deposits were not maintained in the project’s security deposit bank account. As
a result, HUD and the owner lacked assurance that more than $2.3 million in project funds was
used for reasonable operating expenses or necessary repairs of the project. In addition, more
than $141,000 in project funds was not used appropriately.

What We Recommend
We recommend that HUD require the owner to (1) support the reasonableness of or reimburse
the project from nonproject funds for disbursements from the project’s operating account without
sufficient documentation, (2) reimburse the project from nonproject funds for unreasonable
operating expenses or unnecessary repairs of the project, (3) use the project’s security deposit
bank account to deposit and disburse security deposits, and (4) implement adequate procedures
and controls to address the findings cited in this report.




1
    The region contains six States: Illinois, Indiana, Michigan, Minnesota, Ohio, and Wisconsin.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................4
         Finding: The Project’s Owner and Management Agent Did Not Always Operate the
         Project in Accordance With the Regulatory Agreement and HUD’s Requirements 4

Scope and Methodology ...........................................................................................9

Internal Controls ....................................................................................................11

Appendixes ..............................................................................................................12
         A. Schedule of Questioned Costs .................................................................................. 12

         B. Auditee Comments and OIG’s Evaluation ............................................................. 13




                                                             2
Background and Objective
Rainbow Terrace Apartments is a 484-unit Section 8-assisted multifamily project located in
Cleveland, OH. In December 2001, the U.S. Department of Housing and Urban Development
(HUD) insured the project’s mortgage of more than $14.8 million under section 221(d)(4) of the
National Housing Act and executed a regulatory agreement with the project’s owner, Vesta
Cleveland, Limited Liability Company. The Company entered into a management agreement
with Vesta Management Corporation (Vesta Corporation), an identity-of interest entity, to
manage the project in 2001.
In October 2017, the Company refinanced the project’s Federal Housing Administration (FHA)-
insured mortgage under a debt restructuring arrangement under HUD’s Mark to Market program,
resulting in a new mortgage amount of nearly $12.8.2 As part of the same arrangement, the
Company executed a second FHA-insured mortgage under section 223(f) of the National
Housing Act for nearly $7 million. Therefore, as of December 31, 2017, the Company’s FHA-
insured mortgage payable was nearly $20 million. The project has been in a non-surplus-cash
position since at least January 2015. The records are maintained at the project located at 7310
Carson Avenue, Cleveland, OH, and Vesta Corporation’s corporate office located at 175 Powder
Forest Drive, Weatogue, CT.
Our objective was to determine whether the project’s owner and management agent operated the
project in accordance with the regulatory agreement and HUD requirements. Specifically, we
wanted to determine whether (1) project funds were used only for reasonable operating expenses
or necessary repairs of the project, (2) the management agent charged the project the correct
management and bookkeeping fees, and (3) security deposit funds were deposited into and
refunded from its security deposit bank account.




2
    The Mark-to-Market program preserves the affordability and availability of low-income rental multifamily
    properties with federally insured loans. The purpose of the program is to reduce rents to market levels by
    restructuring existing debt to levels supportable by these rents.




                                                         3
Results of Audit

Finding: The Project’s Owner and Management Agent Did Not
Always Operate the Project in Accordance With the Regulatory
Agreement and HUD’s Requirements
The project’s owner and management agent did not always provide sufficient documentation to
support that project funds were used for reasonable operating expenses or necessary repairs of
the project. Specifically, (1) project funds were not used for reasonable expenses or necessary
repairs of the project, (2) excess management fees and unsupported bookkeeping fees were
charged to the project, and (3) tenants’ security deposits were not maintained in the project’s
security deposit bank account. These weaknesses occurred because the owner and management
agent lacked adequate procedures and controls for the operation of the project to ensure that
project funds were properly used and security deposits were managed in accordance with the
regulatory agreement and HUD’s requirements. As a result, HUD and the owner lacked
assurance that more than $2.3 million in project funds was used for reasonable operating
expenses or necessary repairs of the project. In addition, more than $141,000 in project funds
were not available for reasonable operating expenses or necessary repairs for the project.
The Project Lacked Sufficient Support for Nearly $2.3 Million Disbursed From Its
Operating Account
We reviewed 211 of the 1,563 check disbursements from the project’s operating account totaling
nearly $2.6 million. The project’s owner and management agent did not provide sufficient
documentation showing that nearly $2.33 million associated with 127 disbursements was for
reasonable project operating expenses. Of the nearly $2.3 million, the owner and management
agent did not provide sufficient documentation showing that (1) contracts associated with nearly
$1.8 million in disbursements to 11 payees were properly procured, (2) $484,615 in
disbursements was associated with a valid4 contract for security services and that the contracted
amount matched the invoices, and (3) $27,653 in disbursements was associated with a valid5
contract for cleaning services.

A representative of the project’s owner stated that three bids were not obtained for the contracts
associated with the 11 payees for various reasons, such as the need for specialized services,
existing relationships between the vendor and the management agent, a lack of contractors in the




3
    $1,785,966 + $484,615 + $27,653 = $2,298,234, or nearly $2.3 million
4
    The contract expired in 2006. In 2016, the owner and management agent discontinued using the security
    company.
5
    The contract expired in August 2015.



                                                       4
area, and the proprietary status of the good purchased. However, the project owner did not
provide sufficient documentation to support the rationale for not obtaining three required bids
and that the costs incurred for the procured goods or services were reasonable. Paragraph
6.50(a) of HUD Handbook 4381.5, REV-2, states that 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, which is
expected to exceed $10,000 per year. In addition, Vesta Corporation’s Property Management
Standard Operating Procedure Manual states that a minimum of three bids must be obtained for
every contract.

Further, for costs associated with 20 disbursements from the project’s operating account totaling
$39,690, the supporting invoices appeared to show duplicate work for floor installation and
cleaning services for the same units. According to the representative for the project’s owner, the
contractor who provided floor installation services would provide a credit for the questioned
amounts. The credit would be used to offset costs of future work. The other contractor provided
cleaning services for make-ready units. The representative for the project owner stated that some
units needed more than one cleaning to be ready for the next occupant. Therefore, those costs
were not duplicate. However, the representative for the owner did not provide documentation to
support that the vacant units needed to be cleaned more than once, especially since one of the nine
duplicate invoices for cleaning services had the same date and was for services performed at the
same unit as another invoice. The remaining eight invoices were usually 1 month after the initial
invoice.
In addition, for costs associated with two disbursements totaling $7,091, the supporting invoices
did not sufficiently detail the purchased services. The representative of the management agent
stated that the invoices were for emergency mold mitigation and rebuild services, due to damage,
and pest control. Because the invoices identified the provided service, the representative of the
management agent believed that they were sufficient. However, unlike other invoices from the
same contractors, the two invoices did not include specifics of the services provided or the
addresses of the units that received service.
Further, costs associated with 29 disbursements from the project’s operating account totaling
$46,024 were not for reasonable operating expenses or necessary repairs of the project. The
disbursements included (1) travel and overtime costs for supervisory staff from other projects,
(2) entertainment costs, (3) contract costs for HUD file reviews, (4) a payment error, and (5)
expenses for other properties. The project was in a non-surplus-cash position when the funds
were disbursed from the project’s operating account. Paragraph 6(b) of the project’s regulatory
agreement states that without the prior written approval of HUD, the owner must not convey,
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.

The representative for the project’s owner stated that the travel costs incurred by the regional
manager were appropriate operating expenses because the regional manager was acting as the
interim property manager at the time. However, according to figure 6-2 of HUD Handbook
4381.5, REV-2, travel expenses for the management agent’s supervisory staff must be paid from


                                                 5
management fee funds. The representative for the owner also stated that the travel and overtime
costs incurred by two maintenance leads for different projects were appropriate operating
expenses because these individuals had performed front-line tasks at the project. The
representative for the owner or management agent did not provide documentation showing that
the maintenance leads performed front-line tasks at the project when the expenses were incurred.

Further, regarding the HUD tenant file review services, the project owner stated that project
funds used to pay a contractor to perform HUD tenant files review services were allowable front-
line expenses. However, according to the management agent’s contract, these services were
included as part of the project’s monthly management fee. In addition, the representative for the
project owner stated that the expenses incurred for entertainment directly related to efforts to
promote community safety. However, entertainment expenses are not reasonable operating
expenses of the project. Regarding the expenses for other properties, the owner’s representative
stated that the contractor will provide a credit for services provided at different properties.
Excess Management and Unsupported Bookkeeping Fees Were Charged to the Project
We reviewed all 24 of the project’s monthly management and bookkeeping fees charged to the
project from October 2015 through September 2017 totaling $691,330. Based on the project’s
owner and management agent certification that was approved on January 25, 2005, the
management agent was allowed to earn a residential and miscellaneous income fee of 6 percent.6
At the time the certification was approved, the fee generated a yield of $39.68 per unit per
month. However, as a result of the last rent increase, dated February 1, 2014, the yield had
increased to $52.02 per unit per month, which was above the approved maximum yield.7 The
management agent charged the project $95,174 in excess management fees to the project. The
owner’s representative stated that the owner was not aware of the management fees newsletter or
related memorandums issued by HUD, which stated that the maximum yield was $44 per unit
per month.

In addition, the owner and management agent did not provide sufficient documentation to
support that $70,632 charged for bookkeeping fees for the project was reasonable because it was
based on a $6 per unit fee rather than the actual cost as required by paragraph 6-38(a)(2)(b) of
HUD Handbook 4381.5, REV-2, which states that the management agent may not impose
surcharges or administrative fees in addition to actual fees. The owner’s representative stated
that the cost for bookkeeping services for the project was higher than $6 per unit per month.
However, he did not provide documentation to support the actual monthly cost.




6
    The residential and miscellaneous income fee of 6 percent has been reduced to 5.13 percent as part of the
    mortgage restructuring arrangement under HUD’s Mark to Market program.
7
    The management fees newsletter, effective November 2014, and a memorandum for project owners and
    management agents, effective March 2016, both issued by the HUD’s Detroit Satellite Office, stated that the
    approved maximum yield was $44 per unit per month. The Detroit Satellite Office is an office of the Chicago
    Regional Office and service the States of Michigan and Ohio.



                                                        6
The Management Agent Did Not Use the Project’s Security Deposit Bank Account
The owner and management agent maintained a separate bank account for the project’s security
deposits. However, from October 2015 through September 2017, the project’s operating account
was used to deposit and refund tenants’ security deposits. According to paragraph 2-12(A)(2) of
HUD Handbook 4370.2, REV-1, CHG-1, and paragraph 6(g) of the project’s regulatory
agreement, any funds collected as security deposits must be kept separate and apart from all
other project funds. The owner’s representative believed that maintaining a balance that
exceeded the security deposit liability was sufficient to satisfy HUD’s requirements.
Conclusion
The weaknesses described above occurred because the owner and management agent lacked
adequate procedures and controls for the operation of the project to ensure that operating funds
were used and security deposits were managed in accordance with the regulatory agreement and
HUD’s requirements. As a result, HUD and the owner lacked assurance that more than $2.3
million8 in project funds was used for reasonable operating expenses or necessary repairs of the
project. In addition, more than $141,000 in project funds was not used appropriately.
Recommendations
We recommend that the Director of HUD’s Multifamily Midwest Region require the project
owner to
        1A.      Support the reasonableness of or reimburse the project $2,232,004 ($1,719,736 +
                 $484,615 + $27,653) from nonproject funds for the project funds disbursed
                 without sufficient procurement or contract documentation.
        1B.      Support or reimburse the project from nonproject funds $7,091, as appropriate, for
                 the project funds disbursed without sufficient supporting documentation.
        1C.      Reimburse the project from nonproject funds $46,024 for the project funds that
                 were not used for reasonable operating expenses or necessary repairs of the
                 project.
        1D.      Support or reimburse the project from nonproject funds $39,690, as appropriate,
                 for the project funds disbursed without sufficient documentation supporting that
                 the invoices were not for duplicate work.
        1E.      Implement adequate procedures and controls to ensure that project funds are used
                 for only reasonable operating expenses or necessary repairs when the project is in
                 a non-surplus-cash position.




8
    $1,719,736 + $484,615 + $27,653 + $70,632 + $39,690 + $7,091 = $2,349,417 or more than $2.3 million.
    Regarding the $1,719,736 in unsupported project disbursements, the actual unsupported amount was
    $1,785,966. However, the amount was reduced by parts of recommendations 1C and 1D ($28,867 of the
    $46,024 in funds not used for reasonable expenses or necessary repairs and $37,363 of the $39,690 in funds
    disbursed without sufficient documentation supporting that the invoices were not for duplicate work



                                                        7
1F.   Reimburse the project $95,174 from nonproject funds for management fees in
      excess of the maximum yield.
1G.   Support or reimburse the project $70,632 from nonproject funds, as appropriate,
      for the project funds disbursed to Vesta Corporation for bookkeeping fees without
      documentation showing that the bookkeeping fees charged were reasonable.
1H.   Implement adequate procedures and controls, including but not limited to
      ensuring that the project receives HUD’s communications to ensure that its
      management and bookkeeping fees comply with HUD’s requirements.
1I.   Implement adequate procedures and controls to ensure that its bookkeeping fees
      are based on actual costs.
1J.   Use the project’s security deposits bank account to deposit and disburse security
      deposits.




                                       8
Scope and Methodology
We performed our onsite audit work between February and June 2018 at the owner and
management agent’s corporate office located at 175 Powder Forest Drive, Weatogue, CT, and at
the project located at 7310 Carson Avenue, Cleveland, OH. The audit covered the period
October 1, 2015, through September 2017.

To accomplish our audit objective, we interviewed HUD staff and the management agent’s
employees. In addition, we obtained and reviewed the following:

       HUD’s regulations at 24 CFR (Code of Federal Regulations) Part 200; HUD Handbooks
        4370.2, REV-1, CHG-1, and 4381-5, REV-2; and the HUD Detroit Satellite Office’s
        management fees newsletter, effective November 2014, and memorandum, effective
        March 2016.
       The project’s audited financial statements from 2014 through 2017, financial records,
        bank statements, regulatory agreement, management agent agreement, operating
        agreement, and closing files.
       The management agent’s property management standard operating procedures manual.
       Data in HUD’s Integrated Real Estate Management System.

We reviewed the bank statements for the project’s operating account from October 2015 through
September 2017. The project made the following disbursements:

       69 disbursements (checks and transfers) to Vesta Corporation totaling nearly $809,000;
       1,563 checks totaling nearly $4.1 million to payees other than Vesta Corporation;
       203 electronic payments totaling nearly $5.6 million, mostly for the mortgage, taxes, and
        utilities;
       24 transfers into its utility reimbursement account totaling more than $337,000; and
       5 transfers into its escrow account totaling nearly $273,000.

Check Disbursements Review
During the survey, we selected a nonstatistical sample of 31 disbursements of the 1,563 check
disbursements from the project’s operating account to payees other than Vesta Corporation to
determine whether they were for reasonable and necessary project expenses. During the audit,
we selected 15 more disbursements (46 disbursements total). We used a nonstatistical sample
since we knew enough about population to identify items of interest that were likely to be
misstated or otherwise have high risk and we were not projecting the results to the population
that we did not review. Of the 46 disbursement reviewed, we had concerns with 19. We
identified the payees for the 19 disbursements and reviewed all disbursements for goods or
services related to the issues identified with the 19 payees from October 2015 through September
2017. Therefore, we reviewed 211 disbursements from the project’s operating account to payees
other than Vesta Corporation totaling nearly $2.6 million.



                                                9
Management and Bookkeeping Fees
During our survey, we selected a sample of 7 of the 69 disbursements from the project’s
operating account to Vesta Corporation, the owner and management agent for the project. We
found issues with two of the seven disbursements, which were payments of the project’s monthly
management and bookkeeping fees. Therefore, for the audit, we conducted a 100 percent
sampling selection method for our review of the project’s monthly management and
bookkeeping fees from October 2015 through September 2017 totaling $691,330. We selected
this method because the universe was small enough to review all of it. Therefore, our results will
not include a projection. We completed the review to determine whether the management agent
charged the project reasonable management and bookkeeping fees for the 24 months selected.

Data, Review Results, and Generally, Accepted Government Auditing Standards
We relied in part on data maintained by the management agent in its systems. 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 Multifamily
Midwest Region and the management agent’s executive vice president 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.




                                                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:

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

    The project owner and management agent lacked adequate procedures and controls for the
    operation of the project to ensure that operating funds were used and security deposits were
    managed in accordance with the regulatory agreement and HUD’s requirements (finding).




                                                  11
Appendixes

Appendix A


                          Schedule of Questioned Costs
                  Recommendation
                                   Ineligible 1/ Unsupported 2/
                      number
                          1A                              $ 2,232,004
                          1B                                    7,091
                          1C             $ 46,024
                          1D                                  39,690
                          1F               95,174
                          1G                                   70,632

                        Totals            141,198          2,349,417

                                               

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



              September 20, 2018

              Via Email (krandolph@hudoig.gov)

              Mr. Kornelius Randolph
              Assistant Regional Inspector General for Audit
              United States Department of HUD-Office of Inspector General
              477 Michigan Avenue, Room 1780
              Detroit, Michigan 48226


                      RE:          Response to September 6, 2018 Discussion Draft Audit Report regarding
                                   Rainbow Terrace (Report No. 2018-CH-100X)


              Dear Mr. Randolph:

                         Thank you for providing us with a copy of HUD OIG’s draft report concerning its
              recently completed audit of Rainbow Terrace, dated September 6, 2018 (the “Draft Report”). We
              write on behalf of Vesta Corporation and Vesta Management Corporation (the management
              company) and Vesta-Cleveland LLC (the owner) (collectively, “Vesta”) to address Vesta’s
              concerns with the Draft Report.

              We want to note from the outset that Vesta cooperated extensively with HUD OIG’s audit of
              Rainbow Terrace, including during multiple site visits and multiple corporate office visits, in
              extensive correspondence and conversations with the primary assigned auditor, and by providing
              voluminous records to conclusively support the costs and expenses incurred at the property. We
Comment 1     responded to every question raised during the course of the audit. We are disappointed that the
              Draft Report does not reflect or contain much of the information Vesta provided during this
              process, or any acknowledgment concerning Vesta’s extensive cooperation during the audit. We
Comment 2     also object to the inaccurate characterizations that leave the reader with




               In conjunction with this letter, we are providing additional documentation relevant to issues
              raised in the Draft Report, as referenced herein. We are providing that information under separate
              cover for HUD OIG’s review, and not for publication. If you intend to publish that information,
              please inform us first, so that we can address all necessary privacy and proprietary concerns.




                                           13
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation

              the incorrect impression that valuable services were not fully performed by third-party vendors.
              As an overall matter, unless specifically noted below, actual funds were spent on essential goods
              and services from vendors that provided value and improved conditions at Rainbow Terrace.
              HUD OIG has not found—and would have no basis to find—that the vendors did other than
              deliver the necessary services for which they were paid. We note that the initial assumption by
              HUD OIG at the start of the audit, as reflected in a prior interim summary, was that there were
              identity of interest vendors and that, for that reason, costs were not market based. We repeatedly
              rebutted that presumption. Vesta’s ownership and management of Rainbow Terrace has resulted in
              significantly positive operations to this property that is home to extremely low income families.
              Through its ownership and management of Rainbow Terrace, Vesta provides homes to largely
              single-parent households in an area of Cleveland that has faced significant challenges with respect
              to crime.

Comment 3                One very key point omitted entirely from the Draft Report is that the only money in
              question was, for the audit time period in question, Vesta’s money. This property was a for-profit
              owner without a limitation on distributions. Assuming, for argument’s sake, that funds should be
              repaid as alleged in the Draft Report, in part or whole, those funds would have been paid to the
              owner as surplus cash for the prior, audited years in question. In a very real sense, Vesta was
              simply and fully committing its own resources to project operations. For this Vesta should be
              thanked and praised.

                         Understanding this context is crucial to evaluating Vesta’s ownership and management
              of the property. Placing form over substance—and reality—the Draft Report recommends that
              HUD seek further clarification, or if not provided, reimbursement of more than $2 million in
              expenses, the majority of which are attributable to security services provided to ensure tenant
Comment 2     safety. Yet there is no dispute, nor can there be, that the services tied to the questioned expenses
              were provided, and that they benefited the residents. To the extent its findings are not clearly
              disputed by information provided by Vesta, as summarized below, HUD OIG has amassed what
              amounts to a series of de minimis administrative deficiencies.

                         We have organized this response to address the Draft Report’s findings in the following
              order: (1) management fees, (2) bookkeeping fees, (3) security deposits, and (4) reasonableness of
              questioned expenses. In addition, we include a section discussing certain regulatory and historical
              context that is relevant to the Draft Report.
                   A. Regulatory and Historical Context

              As the Draft Report discusses funds that HUD OIG asserts should be clarified further or
              reimbursed to the project, we believe it is important to place this recommendation in the
              appropriate regulatory context. Rainbow Terrace is a privately owned property that receives
              partial assistance from the government, including in the form of Section 8 Housing Assistance
              Payment (HAP) contracts and a Federal Housing Administration (FHA)-insured mortgage.




                                            14
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation

                         During the audit period Rainbow Terrace had a profit-motivated mortgage and did not
Comment 3     have a limitation on distributions. Accordingly, even if one were to take all of HUD OIG’s
              assertions in the Draft Report as true, any “reimbursement to the project,” as HUD OIG
              recommends, would result in funds repaid to Vesta as owner, not to the Section 8 program. Of
              note, Vesta has historically elected to keep its money in the project, as opposed to pulling it out (as
              a more cash-interested owner might do). Vesta’s continuing investment in the property should be
              applauded, not questioned.

                         The Draft Report also discusses the Mark-to-Market refinancing that took place in
              October 2017. This occurred outside of the audit period (October 1, 2015 to September 2017, see
Comment 4     Draft Rep. at 9), so it is unclear to us why it is discussed here. HUD OIG stated during the audit
              that the Mark-to-Market refinancing was outside of the audit period, and accordingly said it was
              not part of the audit. Nonetheless, as HUD OIG raises it in the Draft Report, we note that the
              Mark-to-Market process included a thorough review of the historical costs of the property by
              HUD and its third-party contractor. Upon reviewing the historical costs as part of this process,
              HUD and its contractor concluded that they were all reasonable, and did not identify any material
              deficiencies.

                   B.    Management Fees (Recommendations 1F, 1H)

Comment 5               The Draft Report concludes that Vesta should reimburse more than $95,000 alleged to
              be “management fees in excess of the maximum yield.” (Draft Rep. at 8). In drawing this
              conclusion, HUD OIG relies on HUD newsletters and memoranda that set a maximum yield per
              unit per month.

                         This conclusion and the corresponding recommendation contradict what HUD OIG
              conveyed to Vesta during the audit. When HUD OIG asserted, during a discussion in May 2018,
              that Vesta’s management fees exceeded the approved per-unit maximum for the region, Vesta
              asked where this maximum was published, because Vesta was not aware of it. The primary
              auditor responded that he had not found it published anywhere, but had discussed it with HUD.
              The primary auditor also stated that, if Vesta was not aware of the maximum, HUD OIG
              would not find against Vesta on this point. Upon further examination, no evidence was found
              or provided by HUD OIG that this per-unit maximum was communicated to Vesta or published
              for the public in accordance with law and HUD procedures.

                         Then, in July 2018, HUD OIG provided Vesta with what it said were the relevant
              newsletters and guidance setting forth the maximum. Vesta promptly confirmed that it was not
              aware of these materials until it received them in this context. Indeed, the documents do not
              indicate whether, when, or how they were circulated (nor, according to an internet search, do they
              appear to be available online). Vesta should not be required to reimburse funds attributable to
              management fees when it was not aware of a per-unit maximum and therefore lacked the
              opportunity to account for them in assessing its fees.




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                         We also note that HUD has been aware of Vesta’s 6% management fee since Vesta’s
              acquisition of Rainbow Terrace in 2001, and has never questioned it. Every year since 2001,
              Vesta has submitted its annual audit and financials to HUD, providing information as to the
              amount and rate of the management fee. Yet HUD never raised any questions to Vesta about the
              management fee. The last HUD-signed management agent certification (HUD Form 9839b)
              provided for the 6% management fee with no per-unit per-month maximum.

Comment 5                The recent Mark-to-Market refinancing also is relevant here. In connection with that
              closing in October 2017, Vesta agreed to reduce its management fee to 5.13%, as footnote 6 of the
              Draft Report notes. Neither during those discussions nor in the documents was there mention of a
              per-unit per-month cap on the fee, even though it is now alleged that there was such a cap.

                      Accordingly, we submit that HUD OIG’s recommendations corresponding to
              management fees (Recommendations 1F and 1H) must account for the following:

                       Vesta should not be required to reimburse the project for fees in excess of the maximum
                        yield, for the reasons stated above, and HUD should not now retroactively amend its
                        approval of the 5.13% fee approved through the proper processing with HUD. Future
                        approvals should be subject to properly noticed and implemented HUD requirements.

                   C.   Bookkeeping Fees (Recommendations 1G, 1H, 1I)

                        In the Draft Report, HUD OIG concludes that Vesta has not proven that its
              bookkeeping fee of $6 per unit per month was reasonable. We appreciate the point that while
              actual bookkeeping fees could be charged, a higher flat fee cannot. Of course, as occurred here, a
              flat bookkeeping fee that is lower than actual cost is entirely consistent with the purpose of the
              HUD Handbook guidance prohibiting additional fees on top of actual fees.

                          HUD OIG asserts that Vesta failed to provide documentation showing actual cost. This
              entirely is incorrect. Vesta did explain the actual fee and the methodology for the actual fee
Comment 6     calculation. Vesta provided this information, in specific detail, on July 24, 2018 (see July 24,
              2018 letter at 14). Vesta explained the components of its actual bookkeeping expense, which,
              when totaled, equate to more than 30% more than the $6 per unit per month it charged to the
              project. HUD OIG did not ask Vesta to produce further secondary back-up documentation
              showing its actual cost. Notwithstanding the foregoing, in further support of this amount, Vesta
              will provide, under separate cover, documentation that shows the actual compensation of each
              individual noted on the previously provided documentation.

                       Accordingly, we submit that HUD OIG’s recommendations corresponding to
              bookkeeping fees (Recommendations 1G, 1H, and 1I) must account for the following:




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Comment 6               Vesta should not be required to reimburse the project for bookkeeping fees because it
                         has provided sufficient documentation to support that the charged fee was significantly
                         less than actual cost. Taking less than actual cost reimbursement, sacrificing for the
                         project, and then being asked to pay sums on top of it, is a completely unsupportable
                         finding.

                        As stated above with respect to management fees, HUD should publish its office
Comment 5                specific management fee limit, where such exists, and in future processing instruct that
                         9839b forms be amended to include a per-unit per-month limit if, in fact, that is what
                         HUD intends by its approvals.

                   D.    Security Deposits (Recommendation 1J)

                          The Draft Report’s conclusions about Vesta’s handling of security deposits are
Comment 7     incorrect. Page 1 of the Draft Report (“Highlights”) asserts that security deposits “were not
              maintained in the project’s security deposit bank account.” This is completely false. Vesta did
              have a separate account for security deposits and a procedure in place for ensuring that the account
              balance covered or exceeded the full potential security deposit liability. The Draft Report on page
              7 confirms that Vesta maintained a separate bank account for security deposits. As Vesta
              repeatedly explained during the audit process, it kept this separate account funded so that the
              balance would meet, and often exceed, the total potential security deposit liability at any time.
              Vesta personnel track the security deposit liability against the balance in the account every month,
              and Vesta’s annual audits submitted to HUD contain a line item for “Tenant security deposits
              liability.”

                         Vesta maintains that its practice with respect to security deposits (i.e., establishing a
              fully separate account in which it maintained a balance equal to or greater than the total security
              deposit liability, in escrow) achieved the important goal of ensuring that potential deposit liability
Comment 8     was always escrowed separately from the Operating Account. This procedure is consistent with
              industry standard, and when reviewed by HUD program staff, never was raised as an issue.

              E.         Reasonableness of Expenses Incurred for Work by Vendors (Recommendations 1A,
                         1B, 1C, 1D, and 1E)

              In the Draft Report, HUD OIG challenges more than $2 million in disbursements to vendors who
Comments 2    performed work at and for the property, concluding that these expenses were not adequately
              supported reasonable operating expenses. Vesta vehemently disagrees with this conclusion, and
and 9         submits that it has provided voluminous documentation supporting the reasonableness of these
              expenses. For some expenses, it does not appear that HUD OIG fully reviewed or understood the
              information Vesta provided. For others, HUD OIG concludes that Vesta did not supply
              documentation to support a particular point, when in fact HUD OIG did not seek this
              documentation from Vesta. We address each questioned expense in turn below.




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                         We note that, with respect to these questioned expenses, Appendix A to the Draft
              Report does not list them by vendor. We have used information previously provided by HUD
Comment 10    OIG, along with descriptive information in the Draft Report, to determine which specific vendor
              costs HUD OIG is questioning. For some challenged expenses, we could not determine with
              certainty the line items to which they correspond. If the assumptions we have made are incorrect,
              please let us know.

                        1.    Reasonableness of Expenses – General Principles

                         The Draft Report uses the phrase “reasonable operating expenses,” but nowhere
              discusses what that means, or whether the expenses it challenges adhered to commonly accepted
Comment 11    principles of reasonableness. In fact, the Draft Report recommends that HUD require Vesta to
              “support the reasonableness” of the various challenged expenses, entirely ignoring the fact that
              Vesta has already provided HUD OIG with both factual and legal justifications for the
              reasonableness of the challenged expenses.

                         The definition of reasonable expense is an important benchmark here. A reasonable
              cost is one that does not exceed what a prudent person would incur, taking into account the
              circumstances existing at the time the decision to incur the cost is being made.2 In the Fair
              Housing context, what constitutes a reasonable project expense, in nature and amount, is left to the
              owner under the Regulatory Agreement in place at the time.

                         In responding to HUD OIG’s questions concerning the reasonableness of project
              expenses, Vesta pointed to the seminal case concerning reasonableness of expenses in the fair
              housing context, Arizona Oddfellow-Rebekah Housing, Inc. v. HUD, 125 F.3d 771 (9th Cir. 1997),
              which is highly relevant here. In Oddfellow, the Ninth Circuit identified a central principle
              pertaining to reasonableness of expenses: “to be operating expenses, expenses must primarily
              ‘benefit the project,’ rather than the owner.” Id. at 774. The court also stated the following:

              “In our view, “reasonable” is a broad and inherently amorphous term, not susceptible to precise
              definition. It is therefore telling that the Regulatory Agreement uses the term “reasonable,” rather
              than narrower or more precise language, to limit the set of permissible operating expenses. To us,
              this suggests a “hands off” approach, an intent to allow project owners to engage in a wide
              range of normal project operations without fear of violating the Regulatory Agreement.
              Therefore, while operating expenses that are extraordinary in amount or character may be
              “unreasonable,” we conclude that operating expenses that are typically or predictably
              incurred in the course of operating a project




              2
               See, e.g., OMB Circular A-122 at Attachment A, ¶ 3.




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                        and are within normal limits as to amount are “reasonable” for the
                        purposes of the HUD Regulatory Agreement.”

              125 F.3d at 776 (emphasis added).

Comment 2                The expenses Vesta incurred in operating Rainbow Terrace were reasonable, necessary,
              and benefited the project. Contracting vendors to perform specialized services and addressing
              issues effectively with known vendors are two examples of reasonable behaviors that benefited the
              project. Moreover, where, as here, there is no limitation on distribution, any cost savings would
              fall to Vesta as owner, not to the Section 8 program. Therefore (and consistent with Oddfellow),
              Vesta was particularly motivated to pay reasonable costs. At the same time, Vesta was
              incentivized to spend efficiently over the term of its operation of the property, and therefore to
              select vendors that could perform the work most effectively and efficiently, not just most cheaply.

                          HUD OIG asserts that entire amounts paid to vendors should be reimbursed (or further
              clarified) even where there is no question that the vendors provided the underlying services, to the
              property’s benefit. Even if HUD OIG disagrees that a particular amount associated with a vendor
              expense was reasonable, disallowing the entire amount, without regard for the services provided,
              is incorrect.

                        2.    Specific Vendor Expenses

                         Pages 4-6 of the Draft Report describe particular vendor expenses, divided into various
              groups by amount. HUD OIG does not dispute that these services were provided, or that they
              benefited the residents. Rather, HUD OIG concludes that the expenses were either (1) not
              reasonable operating expenses or necessary to the operation of the project, or (2) not supported by
              sufficient documentation during the audit process.

                         We respond to each of these questioned expenses, as grouped together by HUD OIG in
              the Draft Report, as follows.

                              a.   $484,615 -- Security services

                          This amount corresponds to payments to a security firm that provided services to the
              property for more than 13 years. HUD OIG does not dispute that these services were performed,
              or that they benefited the residents. Rather, HUD OIG recommends reimbursement of payments
              to this firm occurring between 2006 through 2016 because the parties’ contract reached its term in
              2006, and they did not execute another form contract.

Comment 12    Although the form contract reached its term in 2006, the parties mutually extended their
              relationship beyond that timeframe, at the same terms in the original contract. The continued
              performance by the vendor, and Vesta’s continued payment of invoices for that performance,




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              demonstrates the intent of both parties to continue the contractual relationship. Additionally, the
              invoices provided by the vendor referenced the contract number even after 2006, further
              evidencing the parties’ intent.

                          This vendor provided security services for Rainbow Terrace for thirteen years. For
              twelve of those thirteen years, it did so at exactly the same hourly rates stated in the original
Comment 12    contract. Only in 2016 did the vendor raise the rate for one category of security officers, and even
              then, the raise was modest (a $1.85/hour increase). There is no question that the rates charged by
              this vendor were reasonable – indeed, they were unchanged for more than a dozen years, which is
              virtually unheard of for hourly services with rates typically subject to standard yearly inflation,
              cost of living increases, and the like.

                              b.   $1,719,736 -- Pertaining to 11 payees performing various services

                         Given the general descriptions in the Draft Report and the summary nature of Appendix
Comment 10    A, we are unable to determine with certainty the line items to which this amount corresponds,
              aside from the fact that they correspond to 11 payees. We are making assumptions about the
              expenses to which this amount pertains, based on requests made and information exchanged
              during the audit process. If our assumptions are incorrect, please let us know.

                         HUD OIG does not allege that any of these challenged expenses are for services that
              were not provided, or services that did not benefit the residents. Instead, HUD OIG recommends
              further clarification or reimbursement of these expenses because they were not supported by
              documentation showing that Vesta obtained “three required bids” and that the costs were
              reasonable. (Draft Rep. at 4-5).
                         As you are aware, there is no procurement requirement or process applicable to
              privately owned properties receiving Section 8 HAP contracts. Similarly, there is no procurement
Comment 13    process for FHA mortgage insurance programs. While there are HUD procurement regulations at
              24 CFR Part 85, those regulations expressly do not apply to Section 8 HAP programs. See 53 Fed.
              Rg. 8050 (March 11, 1988). Consistent with Oddfellow, in the FHA context, the intent is to
              permit owners “to engage in a wide range of normal project operations” and to vest owners with
              the discretion to determine what expenditures are necessary to benefit the property.

Comment 13               We agree that guidance concerning bidding for project work is found in HUD
              Handbook 4385.1, REV-2. But this guidance is incomplete (as it discusses amounts from $1,000
              to $5,000 and above $10,000, but not the sums between $5,000 and $10,000) and, to the extent it
              does provide guidance, the two paragraphs appear to contradict one another (one discusses written
              evidence and the other only oral evidence). Even if the guidance in the HUD Handbook
              applicable to work exceeding $10,000 can be applied here, any deviation from that guidance
              necessarily must be viewed in the context of the work performed and the benefit to the project.
              Here, all costs incurred for Rainbow Terrace were of the nature and type typical of the operation
              of a multifamily apartment complex, and there is no question that these expenses benefited, and




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              were essential for the proper operation of, the project. Any oversight relating to bidding for
              work exceeding $10,000 is mitigated by other factors, including the steps Vesta took to
              evaluate the service provider, the overall reasonableness of the cost, the necessity of the
              work, and the benefit to the project from the work performed, as well as the discretion vested
              in Vesta as owner. Disallowing these costs would be an unfair penalty. There is no dispute
              that the services were performed and that Vesta paid for them. There is no allegation that
Comment 14    Vesta engaged in any sort of intentional misconduct or misappropriation of funds. To
              disallow $1.7 million in expenses—the majority of which pertain to security services
              provided to ensure tenant safety—simply because HUD OIG believes that Vesta failed to
              obtain “three required bids” (or, even worse, merely did not retain documentation to show
              that it did) is a draconian penalty that is wildly disproportionate to the administrative
              oversights alleged, and the regulatory and historical context.

                        Moreover, Vesta has explained (in detail, repeatedly, and with supporting
              documents) that there were mitigating circumstances that caused it to engage certain vendors
              without engaging in a three-bid process. HUD OIG acknowledges in the Draft Report that
              Vesta provided this information, but assigns it no weight whatsoever. These mitigating
              circumstances include situations where the vendor was providing specialized services; where
              the services sought were of a proprietary nature; where a dearth of available contractors
              prevented Vesta from obtaining three adequate bids; where urgent repairs necessitated
              immediate action; and where the vendor had previously performed quality work at
              reasonable rates on other projects for Vesta.

                         The last three circumstances (lack of available contractors, urgent repairs, and
              knowledge of cost and capability from prior work performed) are largely self-explanatory.
Comment 15    As to availability of vendors, Vesta identified and provided documentation detailing specific
              instances in which it contacted multiple vendors for bids, but only a fraction of them
              responded (some failed to respond entirely, while others informed Vesta that they provided
              different services than what was needed for the project). Vesta should not be penalized for
Comment 16    the fact that certain vendors it contacted ultimately declined to submit bids. As far as
              Vesta’s vetting of contractors based on their prior work with Vesta is concerned, it is
              inherently reasonable for Vesta to judge the capability, quality, and cost-efficiency of a
              vendor based on prior work performed. As concerns urgent repairs, Vesta notes that some of
              the challenged expenses pertain to necessary repairs made on an emergency basis. By way
              of example, if HUD OIG’s draft conclusions are adopted, expenses incurred for concrete
              repairs to the exterior of the property during winter in Cleveland – a matter directly affecting
              tenant safety on the premises – will be disallowed because Vesta did not seek “three required
              bids” before engaging the vendor to do the work.




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                        We address the other two circumstances (specialized services and proprietary
              services) as follows:

                                        i. Specialized Services

                         Over the years, Vesta has engaged certain members of specialty professions (law
              and accounting) to provide services for Rainbow Terrace. These individuals possess
Comment 16    particular, unique skills. The costs for their services were appropriate in nature and amount,
              reasonable in relation to the services rendered, and inured to the project’s benefit.

                         When it assumed ownership of the property, Vesta engaged a local attorney with
              particular and unique knowledge of local real estate tax abatements relating to affordable
              housing. Since that time, this attorney has consistently demonstrated high quality work and
              specialized knowledge of local real estate valuation at reasonable rates. HUD OIG did not
Comment 17    find that the services this attorney performs, or the rates charged, are unreasonable or
              unwarranted.

                         Dating back to 2001, Vesta also has worked with a national accounting firm with
              well-recognized expertise in HUD-assisted properties. This firm, too, has consistently
              demonstrated high quality work at reasonable rates. HUD OIG did not find that the services
              this firm performs, or the rates charged, are unreasonable or unwarranted.

                        We further note that Vesta disclosed the costs for these specialized professional
              services to HUD year after year without any objection, and therefore Vesta reasonably
              believed that HUD agreed that the costs for these specialized services were reasonable.

                         Professional services and unique services, such as legal and specialized accounting
              services, are often the subject of acquisition without bidding or competitive bidding. We are
              unaware of any applicable guidance in the HUD context, but note that other guidance advises
              that considering a service provider’s special and/or unique skill set is permissible, and that
Comment 13    the inquiry turns on reasonableness in relation to the services rendered. We have provided
              HUD OIG with cites to numerous cases showing that it is common for professional services
              involving unique and/or specialized skill not to be subjected to competitive bidding
              requirements. Further, to the extent it provides a logical construct, OMB Circular A-122
              states that professional services costs for work performed by persons who are members of a
              specialized profession and/or possess a special skill are allowable “when reasonable in
              relation to the services rendered and when not contingent upon recovery of the costs from the
              Federal Government,” and when the persons performing the services “are not officers of
              employees of the organization.” All of those criteria were satisfied here.

                                       ii. Proprietary Services

              While there are certainly services that can be provided by a number of different vendors, on
              occasion the service or good sought is so proprietary that engaging an ostensible competitor




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              to bid either is impossible, or would result in unnecessary additional costs. For example, during
              the audit period, Vesta needed to have upgrades done to the closed circuit television (CCTV)
              system on the property, which is a fundamental security measure. The company that designed and
              installed the CCTV system at Rainbow Terrace in 2012—which Vesta selected out of a number of
              bids—was engaged in 2016 to perform these upgrades to the system. HUD OIG asserts that the
              cost associated with this upgrade work should be reimbursed because Vesta did not obtain other
Comment 18    bids from other, outside companies to provide the upgrades. This ignores the fact that the vendor
              was selected in 2012 following a competitive bidding process during which Vesta evaluated the
              reasonableness of the costs it charged. But even setting that aside, having a new company come in
              and contend with updating another company’s proprietary installation does not make sense from a
              cost perspective. The cost necessarily would have included the time it would have taken the new
              vendor to understand the system, and it also very likely could have resulted in additional costly
              compatibility issues. This was explained to HUD OIG on multiple occasions, but completely
              ignored in the Draft Report. It was reasonable for Vesta to have the installing company make the
              upgrades.

                              a.    $27,653 -- Cleaning services

                        HUD OIG does not dispute that the janitorial company to which this amount was paid
              provided the services described, or that the services benefited the residents. Rather, HUD OIG
              recommends further clarification or reimbursement of this amount because it was incurred during
              a six-month period when the parties’ prior contract had expired and before they negotiated a new
              one. During this period, by mutual agreement of the parties, the company continued to perform
              (and was paid for) janitorial services. Accordingly, the project received the benefit of the services
              for which these funds were paid.

                              b.    $39,060 -- Floor installation and cleaning services

Comment 19               Given the general descriptions in the Draft Report and the summary nature of Appendix
              A, we are unable to determine with certainty the line items to which this amount corresponds.
              Setting that aside, Vesta is aware that a few de minimis errors in some of the invoices associated
              with these flooring and cleaning services were discovered during the audit. As HUD OIG notes in
              the Draft Report, with respect to the flooring services—which we believe to account for more than
              90% of this amount—Vesta proactively reached out to the vendor and obtained multiple credits
              from the vendor that will be applied to future work at Rainbow Terrace.

              As to the cleaning services, we note that Vesta explained to HUD OIG during the course of the
Comment 20    audit that a unit typically is cleaned at the time of tenant move-out, in anticipation of a new tenant
              moving in. Occasionally, the new tenant scheduled to move in ends up not being able to do so—
              either at the time scheduled, or at all—and the unit, once made ready for a tenant, ends up sitting
              vacant for weeks or longer. During this time, the unit may be viewed by various potential tenants
              who walk through it, or, even if it sits vacant, is gathering dust and lacking any fresh air.
              Accordingly, in these circumstances, it is necessary and proper to have




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              the unit re-cleaned before the new tenant moves in (as that tenant is entitled to a unit in the same
              condition as one that is turned over more immediately). To the extent there are other alleged
              errors in the invoices from the cleaning service not attributable to this circumstance, Vesta will
              work with the program office, and if an issue remains, determine the precise amount and address
              any issue(s) with the vendor.

                              c.   $7,091 -- Pest control and emergency mold mitigation

                         This amount consists of disbursements to a vendor who performed pest control services
Comment 21    at the property ($3,159.00) and another vendor who performed emergency mold mitigation
              ($3,931,86). Vesta supplied invoices for these expenses to HUD OIG. HUD OIG does not
              dispute that this work was performed, or that the services benefited the residents. Nonetheless,
              HUD OIG recommends these expenses be further clarified or reimbursed on the grounds that the
              invoices do not sufficiently describe what services were performed and where.

                         With regard to the pest control expense: Vesta’s contract with this vendor, which it
              supplied to HUD OIG during the audit process, set out a weekly fee that corresponded to
              scheduled exterminating for general pests. The contract detailed, by name, the types of pests
              covered. This “ongoing cycled service,” as the contract describes it, applied to all units at the
              property, not only to certain units. Accordingly, invoices for this weekly fee must be read in
              conjunction with the contract documents that appropriately set forth the scope and detail of the
              services.

                         The emergency mold mitigation expense was required based on real-time findings
              during restoration work on a unit damaged during a fire. The discovery necessitated additional,
              unexpected work, for which the vendor separately invoiced Vesta. Vesta provided HUD OIG with
Comment 22    the specific invoice corresponding to this work, which clearly states that it is for emergency mold
              mitigation. Of note, the vendor submitted this invoice on the same day it submitted an invoice for
              the balance of the overall restoration work on the unit.

                              d.   $46,024 – Pertaining to 29 disbursements

              Given the general descriptions in the Draft Report and the summary nature of Appendix A, we are
Comment 23    unable to determine with certainty the line items to which this amount corresponds. However, as
              described in the Draft Report, this amount pertains to disbursements incurred in connection with
              (1) travel and overtime costs for supervisory staff from other projects, (2) entertainment costs, (3)
              contract costs for HUD file reviews, (4) a payment error, and (5) expenses for other properties.
              Because Vesta has already acknowledged the payment error and the expenses for other properties
Comment 24    mistakenly attributed to Rainbow Terrace in the amount of $3,732.52, and said amount has
              already been reimbursed to Rainbow Terrace after HUD OIG brought it to Vesta’s attention, we
              do not address those again here. Below we address the three other types of expenses identified.




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                                          i.        Travel for supervisory staff

                          HUD OIG recommends reimbursement of travel and overtime costs incurred by three
              Vesta employees not typically assigned to Rainbow Terrace who performed work there on a
              temporary basis due to project need. Based on the analysis provided, these expenses appear to
Comment 25    total approximately $6,200 (it is not clear to us from the Draft Report whether HUD OIG objects
              to some or all of the travel expenses). Vesta has previously provided, and will again provide,
              detail concerning why these employees had to travel from their existing sites to Rainbow Terrace
              to assist the project.

                          For a limited time period, Rainbow Terrace was in between property managers
              (meaning, the existing property manager had departed and a replacement had not yet been hired).
              The property manager position is an allowable and justified site cost. The property was also short
              staffed in the office. During this time, Vesta asked a Regional Manager to step in on a temporary
              basis and perform project level work, acting as interim site manager while Vesta sought a new
              property site manager. None of the Regional Manager’s salary was allocated to or paid for by
              Rainbow Terrace. The expenses questioned correspond only to her travel, lodging, and food for
Comment 25    the time she spent going back and forth to the property. These incidental expenses are appropriate
              project expenses, particularly where the project was not incurring any charges for project manager
              work at the time, and therefore the operating account was actually realizing savings in the form of
              the money that otherwise would have been expended on a front-line project management.

                         In addition to the Regional Manager, two other employees assigned to other properties
              traveled to Rainbow Terrace to perform maintenance work there at certain time periods. The
              maintenance team also was short staffed at the time. HUD OIG asserts that Vesta did not provide
              documentation to substantiate that the tasks performed by these employees were front-line tasks.
              Of note, HUD OIG never even asked Vesta to provide this documentation.

Comment 26               Vesta did not pay any portion of these employees’ salaries out of project funds, even
              though it arguably could have per HUD Handbook 4381.5, REV-2, paragraph 6.39(c)(2), which
              allows for the payment of at least a portion of the salary of temporary supervisor out of project
              funds. The payment of these incidental expenses is particularly immaterial where Vesta was
              arguably entitled to allocate project funds for some portion of the employees’ salaries, but did not
              do so. To the extent there are particular travel expenses HUD OIG regards as ineligible for some
              other reason, please inform us, and we will work with HUD program staff to address those
              particular expenses.

                                         ii.        “Entertainment” expenses

              HUD OIG recommends reimbursement of expenses related to “efforts to promote community
              safety” (Draft Rep. at 6) on the grounds that they are impermissible entertainment expenses.
              These expenses were incurred in connection with “National Night Out,” which is not




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              entertainment in any traditional sense, but rather is an annual national program designed to
              promote safety in the community by increasing tenant awareness about and familiarity with local
              police programs. This is a very large apartment complex, physically spread over a campus-like
Comment 16    setting, but in an extremely low income area that houses thousands of school-age children. This
              outreach was not only reasonable but also, we submit, a basic effort to work with the community
              and promote community safety.

                                          i.        Review of tenant files

                         HUD OIG recommends reimbursement of expenses associated with Vesta’s
Comment 27    engagement of a contractor to review tenant files and identify and correct deficiencies in those
              files. HUD OIG does not dispute that the work was performed, or that review and shoring up of
              deficiencies in tenant files is a necessary and proper exercise. Rather, HUD OIG asserts that
              review of tenant files is not properly a front-line expense, and was part of the services
              encompassed in the monthly management fee.

                         As Vesta has previously explained, the contractor that performed this work is a
              consulting company with many years of experience in this specific type of work. The company
              was not “designing procedures [or] systems,” which is the type of work the HUD Handbook
              (4381.5, paragraph 6.39(b)(1)) states should be paid out of management funds instead of operating
              expenses. The work the company performed was precisely the sort of front-line operational work
              a project manager or other staff would perform, if those staff were fully in place and had sufficient
              availability to undertake this review among their many other duties (which they did not).

                                                                             * * *

Comments 2               In light of all of the above, we submit that Vesta has provided sufficient documentation
              and explanations (subject to the limited instances acknowledged above) to support that the
and 16        expenses questioned by HUD OIG in connection with Recommendations 1A, 1B, 1C, and 1D
              were reasonable operating expenses, as that term must be given full meaning. With respect to
Comment 28    HUD OIG’s Recommendation 1E, Vesta will work with HUD program staff for proper protocols
              for emergencies and engagement of unique or unusual services, and will provide supplemental
              training to its staff at Rainbow Terrace and appropriate higher-level managerial staff to ensure that
              there is consistent application of the protocol for engaging and working with vendors.

                         Thank you for the opportunity to provide this response. We welcome the opportunity to
              discuss the foregoing information with you as you finalize your report. If you would like to
              discuss any of the matters raised in this letter, please contact me.

                                                                             Sincerely,

                                                                      /s/ Richard Michael Price




                                               26
                         OIG Evaluation of Auditee Comments


Comment 1   Vesta’s representative stated that Vesta was disappointed that the report did not
            contain an acknowledgment concerning Vesta’s extensive cooperation during the
            audit. We expressed our appreciation for the cooperation of Vesta’s management
            throughout the audit.
Comment 2   Vesta’s representative stated that the report contains inaccurate characterizations
            that leave the reader with the incorrect impression that valuable services were not
            fully performed by third-party vendors. The audit report did not question the
            services provided, it stated that the project’s owner and management agent did not
            always provide sufficient documentation to support that project funds were used
            for reasonable operating expenses or necessary repairs of the project.
Comment 3   Vesta’s representative stated that the project owner was a for-profit owner without
            limitation on distribution. The project has been in a non-surplus cash position
            since at least 2015. The audit period was October 2015 through September 2017.
            Paragraph 6(b) of the project’s regulatory agreement states that without the prior
            written approval of HUD, the owner must not convey, 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 4   Vesta’s representative stated that it is unclear why the audit report discusses the
            Mark-to-Market refinancing that took place in October 2017. In our report, we
            included the Mark-to-Market refinancing information for the purpose of providing
            background information about the project. We did not use this information in our
            audit analysis.
Comment 5   Vesta’s representative stated that the conclusion that the project owner should
            reimburse the project more than $95,000 in management fees in excess of the
            maximum yield and the corresponding recommendation contradicts what HUD-
            OIG conveyed to Vesta Corporation during the audit and that Vesta should not be
            required to reimburse funds attributable to management fees when it was not
            aware of a per-unit maximum. The management fees newsletter, effective
            November 2014, and a memorandum for project owners and management agents,
            effective March 2016, both issued by the HUD’s Detroit Satellite Office, stated
            that the approved maximum yield was $44 per unit per month. The president of
            the project’s owner signed the regulatory agreement stating that the project would
            comply with HUD’s rules and regulations. Therefore, we believe it is the owner’s
            responsibility to be aware of HUD’s requirements. Vesta Corporation should
            work with HUD Multifamily Midwest Region’s Detroit Satellite office to resolve
            recommendation 1F in the audit report.
Comment 6   Vesta’s representative stated that it provided documentation supporting the actual
            bookkeeping fees incurred by the project through an explanation of the fees in a


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              letter dated July 24, 2018, and that it would provide, under separate cover,
              documentation that shows the actual compensation of each individual noted on
              the previously provided documentation. On September 21, 2018, Vesta
              Corporation provided a spreadsheet showing annual salaries for accounting staff
              and Vesta Corporation’s calculation of the actual bookkeeping cost per unit per
              month. However, Vesta Corporation did not provide documentation supporting
              the employment and salary information used for the calculation.
Comment 7     Vesta’s representative stated that the statement in the audit report regarding the
              security deposits not being maintained in the project’s security deposit bank
              account is completely false. We disagree. As stated in the audit report, from
              October 2015 through September 2017 the project’s operating account was used
              to deposit and refund tenants’ security deposits. Therefore, the owner and
              management agent did not use the security deposit bank account to deposit and
              withdraw security deposit funds.
Comment 8     Vesta’s representative stated that having a separate account for security deposits
              and a procedure in place ensuring that the account balance covered or exceeded
              the full potential security deposit liability is consistent with industry standards.
              According to paragraph 2-12(A)(2) of HUD Handbook 4370.2, REV-1, CHG-1,
              and paragraph 6(g) of the project’s regulatory agreement, any funds collected as
              security deposits must be kept separate and apart from all other project funds.
              Therefore, maintaining a separate security deposit account and having procedures
              in place regarding the account balance does not fully comply with HUD’s
              requirement since the project’s operating account was used to maintain and
              disburse tenants’ security deposits.
Comment 9     Vesta’s representative stated that for some questioned expenses it does not appear
              that HUD-OIG fully reviewed or understood the information Vesta Corporation
              provided and for some others HUD-OIG audit concluded that Vesta did not
              provide documentation to support a particular point, when in fact HUD-OIG did
              not seek the documentation from Vesta. Vesta Corporation did not specify the
              documentation it believed HUD-OIG did not review or understand. The audit
              staff met with the management agent and owner throughout the audit and
              requested documentation on more than one occasion regarding the expenses
              questioned in this audit report. In addition, with the exception of a spreadsheet to
              show its calculation for bookkeeping fees, Vesta did not provide documentation
              with its written response to the discussion draft audit report to support questioned
              expenses.
Comment 10 Vesta’s representative stated that it had used information previously provided by
           HUD-OIG, along with descriptive information in the draft audit report, to
           determine which specific vendor costs HUD-OIG is questioning. We provided
           supporting schedules on July 16, 2018 and on August 23, 2018, along with the
           draft finding outline.




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Comment 11 Vesta’s representative stated that the draft report entirely ignores the fact that
           Vesta has already provided HUD-OIG with both factual and legal justifications
           for the reasonableness of the challenged expenses. Although we received
           explanations for the questioned expenses, Vesta Corporation did not provide
           sufficient documentation to support that the costs were reasonable. Vesta
           Corporation should work with HUD Multifamily Midwest Region’s Detroit
           Satellite office to support that the costs were reasonable.
Comment 12 Vesta’s representative stated that although the form contract reached its term in
           2006 for one of the security services contractors, the parties mutually extended
           their relationship beyond the timeframe at the same terms in the original contract.
           However, according to the invoices we reviewed during the audit, the project was
           paying for security office dispatch services, which were not a part of the services
           provided under the expired contract and the hourly rate for the security officers
           was an additional $1.85 per hour.
Comment 13 Vesta’s representative stated that there is no procurement process for FHA
           mortgage insurance programs. Paragraph 6.50(a) of HUD Handbook 4381.5,
           REV-2, states that 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, which is expected to exceed $10,000 per year. In addition, Vesta
           Corporation’s Property Management Standard Operating Procedure Manual states
           that a minimum of three bids must be obtained for every contract.
Comment 14 Vesta’s representative stated that HUD-OIG audit disallowed $1.7 million in
           expenses. We did not disallow $1.7 million in expenses. The audit report stated
           that the owner and management agent did not provide sufficient documentation
           showing that contracts associated with nearly $1.8 million in disbursements to 11
           payees were properly procured.
Comment 15 Vesta’s representative stated that it identified and provided documentation
           detailing specific instances in which it had contacted multiple vendors for bids,
           but only a fraction of them responded. For the most recent security services
           provider, Vesta Corporation provided a list of contractors that supposedly
           responded to Vesta Corporation’s bid request. However, the list did not provide
           the contractors’ contact information, dates when the contractors were contacted,
           or any other information to support that the contractors had been contacted.
Comment 16 Vesta’s representative stated that it was inherently reasonable for Vesta to judge
           the capability, quality, and cost-efficiency of a vendor based on prior work
           performed. Paragraph 6.50(a) of HUD Handbook 4381.5, REV-2, states that
           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, which is expected to
           exceed $10,000 per year. In addition, Vesta Corporation’s Property Management
           Standard Operating Procedure Manual states that a minimum of three bids must


                                                29
              be obtained for every contract. Further, it did not provide support to show the
              costs it had paid for similar work.
Comment 17 Vesta’s representative stated that HUD-OIG did not find that the real estate tax
           abatements services, or the rates charged are unreasonable or unwarranted for the
           for the real estate tax abatements fees it questioned. HUD-OIG did not review the
           reasonableness of the fees due to the lack of procurement documentation.
Comment 18 Vesta’s representative stated that the cost of the upgrades to the closed circuit
           television (CCTV) system on the property was reasonable because the purchase of
           the CCTV system from the same contractor was properly procured 4 years before
           the upgrades. Vesta Corporation also stated that having a new company come in
           and contend with another company’s proprietary installation does not make sense
           from a cost perspective. However, Vesta Corporation did not provide any
           documentation supporting its statements.
Comment 19 Vesta’s representative stated that given the general description in the audit report,
           it was unable to determine with certainty the line items to which the $39,060 in
           floor installation and cleaning services corresponds. We provided lists of the
           questioned costs for the floor installation and the cleaning services as part of a
           documentation request via email dated July 16, 2018.
Comment 20 Vesta’s representative stated that occasionally units cleaned might need to be re-
           cleaned for various reasons. However, it did not provide documentation
           supporting that the cleaning expenses we questioned were for units that needed to
           be re-cleaned.
Comment 21 Vesta’s representative stated that the $3,159 disbursed to a vendor that performed
           pest control services was for ongoing cycled services described in the contract and
           that it applied to all units, not only to certain units and that invoices for this
           weekly fee must be read in conjunction with the contract documents. However,
           the weekly fee for 25 units in the contract was $300. We could not match that
           amount to the invoice. Further, if the units that were receiving services were not
           listed, there is no way of accounting for the services completed. In addition, the
           other invoices from this contractor included more specifics.
Comment 22 Vesta’s representative stated that the invoice for the emergency mold mitigation
           expense questioned clearly stated that it was for emergency mold mitigation.
           However, the invoice did not include the location (unit) and the size of the area
           where mold was mitigated. Other invoices from this same contractor included
           specifications of the work completed.
Comment 23 Vesta’s representative stated that given the general description in the audit report,
           it was unable to determine with certainty the line items to which the $46,024
           pertaining to 29 disbursements corresponds. We provided a list of the questioned
           costs pertaining to the 29 disbursements along with our finding outline on August
           23, 2018.



                                                30
Comment 24 Vesta’s representative stated that it had already acknowledged the payment error
           and the expenses for other properties mistakenly attributed to the project in the
           amount of $3,732.52 and had already reimbursed the project after HUD-OIG
           brought it to Vesta’s attention. However, Vesta did not provide support for the
           reimbursement. Therefore, it should work with HUD to address the
           recommendations.
Comment 25 Vesta’s representative stated that the travel expenses incurred by the three Vesta
           were necessary expenses. However, it did not provide any supporting
           documentation other than the above explanation. Further, HUD Handbook
           4381.5, REV-2, states that travel expenses for the management agent’s
           supervisory staff must be paid from management fee funds.
Comment 26 Vesta’s representative stated that the travel and overtime costs incurred by an
           interim site manager was appropriate because she was acting as the interim site
           manager. It also stated that the incurred expenses for two maintenance leads for
           different projects were appropriate operating expenses because these individuals
           had performed front-line tasks at the project. However, Vesta Corporation did not
           provide documentation showing that the maintenance leads performed front-line
           tasks at the project when the expenses had been incurred.
Comment 27 Vesta’s representative stated that project funds used to pay a contractor to perform
           HUD tenant file review services were allowable front-line expenses. The audit
           report did not state that the services were not allowable. It stated that according to
           the management agent’s contract, these services were supposed to be provided by
           the management agent as part of the project’s monthly management fee.
Comment 28 Vesta’s representative stated that it would work with HUD’s program staff for
           proper protocols for emergencies and engagement of unique services and would
           provide training to its staff. We acknowledge Vesta Corporation’s willingness to
           work with HUD and provide training to its staff.




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