oversight

The City of Modesto, CA, Did Not Use Community Development Block Grant Funds in Accordance with HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-07-03.

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

                    City of Modesto, CA
        Community Development Block Grant Program




Office of Audit, Region 9      Audit Report Number: 2018-LA-1005
Los Angeles, CA                                       July 3, 2018
To:            Kimberly Nash, Director, Office of Community Planning and Development, San
               Francisco, 9AD
               //SIGNED//
From:          Tanya E. Schulze, Regional Inspector General for Audit, 9DGA
Subject:       The City of Modesto, CA, Did Not Use Community Development Block Grant
               Funds in Accordance With HUD 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 the City of Modesto’s Community Development
Block Grant program.
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
213-534-2471.
                    Audit Report Number: 2018-LA-1005
                    Date: July 3, 2018

                    The City of Modesto, CA Did Not Use Community Development Block Grant
                    Funds in Accordance With HUD Requirements


Highlights

What We Audited and Why
We audited the City of Modesto’s Community Development Block Grant (CDBG) program. We
selected the City based on a hotline complaint (HC-2017-2082) regarding the City’s
rehabilitation program and the U.S. Department of Housing and Urban Development’s (HUD)
and the HUD Office of Inspector General’s risk assessments. The objective of the audit was to
determine whether the City used CDBG funds in accordance with HUD requirements, focusing
on its rehabilitation activities.

What We Found
The City did not use CDBG funds in accordance with HUD requirements. Specifically, it (1) did
not follow HUD’s and its own requirements for its rental and homeowner rehabilitation projects,
(2) drew CDBG funds in advance, (3) provided false information to HUD, (4) spent HUD funds
inefficiently, (5) misclassified some delivery costs, and (6) did not include all recipients in its
monitoring plan. These conditions occurred because of the City’s desire to show HUD that it
was close to meeting timeliness requirements, its disregard for HUD’s and its own requirements,
its lack of sufficient knowledge and capacity, and the failure of its policies and procedures to
ensure that it monitored all of its recipients of CDBG funds. As a result, the City was unable to
support that its use of more than $1.6 million in CDBG funds met HUD requirements, and it
improperly used $257,737 for duplicate costs.

What We Recommend
We recommend that the Director of HUD’s San Francisco Office of Community Planning and
Development require the City to (1) support that its use of more than $1.6 million in CDBG
funds met program requirements or repay the program from non-Federal funds, (2) repay the
program $257,737 for duplicate costs from non-Federal funds, (3) implement policies and
procedures to ensure that CDBG funds are used in accordance with program requirements, (4)
provide training to its staff to ensure sufficient knowledge of CDBG program requirements, and
(5) implement policies and procedures to ensure that it includes all of its CDBG recipients in its
monitoring plan and that it selects objective samples.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................4
         Finding: The City Did Not Always Use CDBG Funds in Accordance with HUD’s or
         Its Own Requirements ...................................................................................................... 4

Scope and Methodology .........................................................................................14

Internal Controls ....................................................................................................16

Appendixes ..............................................................................................................18
         A. Schedule of Questioned Costs .................................................................................. 18
         B. Auditee Comments and OIG’s Evaluation ............................................................. 20
         C. Criteria ....................................................................................................................... 28




                                                                     2
Background and Objective
The City of Modesto, CA, receives annual Community Development Block Grant (CDBG)
entitlement allocation funds from the U.S. Department of Housing and Urban Development
(HUD). HUD awards grants to entitlement community grantees to carry out a wide range of
community development activities directed toward revitalizing neighborhoods, economic
development, and providing improved community facilities and services. Federal regulations at
24 CFR (Code of Federal Regulations) 570.208 require that CDBG funds be used for eligible
activities that meet one of the three national objectives:

   •   provide benefit to low- and moderate-income persons,
   •   aid in the prevention or elimination of slums or blight, or
   •   meet a need having a particular urgency.

The City’s Community and Economic Development Department is responsible for the
administration and oversight of the CDBG program. The City received the following CDBG
program funds for its fiscal years 2015 and 2016.

                                  Program                       Amount
                                    year                      appropriated
                     2015: July 1, 2015 – June 30, 2016         $1,848,449
                     2016: July 1, 2016 – June 30, 2017          1,871,328
                            Total CDBG funds                     3,719,777


According to 24 CFR 570.902, HUD will review the performance of each entitlement recipient
to determine whether each recipient is carrying out its CDBG-assisted activities in a timely
manner. The City uses a revolving loan fund for its rehabilitation program. A revolving loan
fund is a separate fund, independent of other CDBG program accounts, set up for the purpose of
carrying out specific activities. These activities generate payments (program income) to the
revolving loan funds for use in carrying out the same types of activities. In the past, HUD did
not include the revolving loan fund balance in its calculation of program income for its
timeliness test; however, HUD notified the City in February 2017 that revolving loan funds
would be considered as program income in its May 2017 test. HUD notified the City in May
2017 that it did not meet the timeliness requirements.

Our audit objective was to determine whether the City used CDBG funds in accordance with
HUD requirements, focusing on its rehabilitation activities.




                                                 3
Results of Audit

Finding: The City Did Not Always Use CDBG Funds in Accordance
with HUD’s or Its Own Requirements
The City did not always use CDBG funds in accordance with HUD’s or its own requirements.
Specifically, it

   •   Did not follow HUD’s and its own requirements for rental rehabilitation projects.
   •   Did not follow HUD’s and its own procurement requirements for homeowner
       rehabilitation projects.
   •   Drew CDBG funds in advance.
   •   Provided false information to HUD concerning the timeliness of project completion.
   •   Spent HUD funds inefficiently.
   •   Misclassified some delivery costs.
   •   Did not include all of its CDBG recipients in its monitoring plan.
These conditions occurred because of the City’s desire to show HUD that it was close to meeting
timeliness requirements, its disregard for HUD’s and its own requirements, its lack of sufficient
program knowledge and capacity to efficiently administer the program, and the failure of its
policies and procedures to ensure that it monitored all of its recipients of CDBG funds. As a
result, the City was unable to support that more than $1.6 million in HUD funds met HUD
requirements and used $257,737 in ineligible funds on duplicate costs.

The City Did Not Follow HUD’s and Its Own Requirements for Rental Rehabilitation
Projects
The City could not support that $993,880 in CDBG funds used to rehabilitate four multifamily
rental properties met HUD requirements. The City partnered with the Housing Authority of the
County of Stanislaus (HACS) and the Stanislaus County Affordable Housing Corporation
(STANCO) to rehabilitate two properties each for $592,266 and $401,614, respectively. The
City did not follow HUD’s and its own requirements when it rehabilitated the projects. The
following table shows that procurement and contracting for all four rental rehabilitation projects
did not meet HUD requirements.




                                                 4
                       Rental rehabilitation project deficiencies

                       HACS         HACS         STANCO            STANCO            Total
                       project      project       project           project
                       no. 201      no. 608       no. 605           no. 901

     Independent           x           x               x                x               4
     cost estimate
    not performed
    Project scope of       x           x               x                x               4
       work not
       prepared
       Missing                                         x                x               2
    environmental
       review
    Environmental          x           x                                                2
      review not
      performed
        before
     commitment
       Incorrect                                       x                x               2
        national
       objective


Independent Cost Estimates Not Performed and Scopes of Work Not Prepared
The City did not perform independent cost estimates or prepare scopes of work for the four
projects. Regulations at 2 CFR Part 200 1 require that the City (1) maintain records sufficient to
detail the history of each procurement and (2) perform a cost or price analysis with every
procurement and make independent cost estimates before receiving bids or proposals (appendix
C). Regulations at 2 CFR 200.403(a) also state that costs must be necessary and reasonable. The
City’s Community and Economic Development Department supervisor for HUD programs stated
that the City rushed the rehabilitation projects to spend the funds before HUD’s 2017 timeliness
test 2 and relied on STANCO and HACS to perform the work and determine whether the costs
were reasonable. The City also stated that it did not develop a cost estimate because STANCO




1
  CFR 200.318(i) and 2 CFR 200.323(a)
2
  Regulations at 24 CFR 570.902 state that HUD will review the performance of each entitlement recipient to
determine whether each recipient is carrying out its CDBG-assisted activities in a timely manner. HUD performs
the tests 60 days before the end of its current program year.


                                                        5
and HACS were material experts and knew the properties best. Since the City did not perform
independent cost estimates or prepare scopes of work, it could not support that $592,266 spent
on the HACS projects and $401,614 spent on the STACNCO projects were reasonable.
Missing Environmental Reviews and Environmental Reviews Performed After Commitment of
Funds
The City could not support that it completed environmental reviews of the two STANCO
projects, and it completed environmental reviews for the two HACS projects after commitment
of funds. Requirements at 24 CFR Part 58 3 state that grantees must maintain a written record of
the environmental review and an environmental review must be completed before the
commitment of funds (appendix C). The City stated that it completed environmental reviews for
all four projects. However, it was unable to provide evidence that it completed environmental
reviews for the STANCO projects. For the HACS projects, the City performed environmental
reviews after commitment of funds.
Incorrect National Objective
The City did not ensure that the two properties rehabilitated by STANCO met one of HUD’s
CDBG national objectives in accordance with 24 CFR 570.200(a)(2) (appendix C). The
STANCO properties were transitional housing, which is considered a public facility, and the
reported national objective of low and moderate housing rehabilitation for multiunit residential
properties excludes public facilities. 4 The City needs to ensure that it adequately reported and
documented that the two STANCO transitional housing properties met one of HUD’s national
objectives.
HUD Funds at Risk Due to Lack of Written Agreements and Advanced Payments
The City put HUD funds at risk because it did not execute written agreements for the four
rehabilitation projects 5 and made payments to HACS and STANCO before work was completed.
This deficiency violated HUD requirements because at the time of payment, the City had not
received any goods or services, 6 and the City’s policy was to pay contractors on a reimbursement
basis.
These conditions occurred because of the City’s desire to show HUD that it was close to
meeting timeliness requirements and it disregarded HUD’s and its own requirements. As a
result of these issues, the City could not support that $592,266 spent on the HACS projects was
reasonable. It also could not support that $401,614 spent on STANCO projects was reasonable,
that its STANCO projects met one of HUD’s national objectives, and that its STANCO projects
did not have an adverse environmental impact.



3
  24 CFR 58.38 and 24 CFR 58.22(a)
4
  Guide to National Objectives and Eligible Activities for Entitlement Communities, Eligible Types of Properties
  and Public Facilities and Improvements (appendix C)
5
  24 CFR 570.506(4) (appendix C)
6
  2 CFR 200.405(a) (appendix C)


                                                         6
The City Did Not Comply With HUD’s and Its Own Procurement Policies for Homeowner
Rehabilitation Projects
The City did not procure construction services in accordance with HUD’s and its own
requirements for 10 homeowner rehabilitation projects totaling $173,508. Specifically, it

       •   Did not advertise all 10 projects for a sufficient amount of time. HUD requirements for
           the sealed bid method used by the City state that projects must be advertised to allow for
           sufficient response time before the date set for opening bids. 7 The City’s policies defined
           sufficient response time as allowing 8 days for a mandatory walkthrough. None of the
           projects reviewed allowed 8 days for the mandatory walkthrough, and four were
           advertised for only 1 day before the walkthrough.

       •   Did not obtain sufficient competition. The City’s policies state that it will obtain a
           minimum of three bids. However, it appeared that the City’s limited walkthrough period
           may have restricted competition because it received fewer than 3 bids on 8 of the 10
           projects.

       •   Potentially restricted competition through various arbitrary actions. 8 Regulations at 2
           CFR 200.319(a)(7) state that any arbitrary actions in the procurement process are
           considered restrictive to competition (appendix C).


These issues occurred because the City disregarded HUD’s and its own requirements. As a
result, the City could not ensure that costs were reasonable.




7
    24 CFR 200.320(c)(2)(i) (appendix C)
8
    Arbitrary actions included (1) awarding one project to a contractor that did not attend the mandatory walkthrough,
    (2) paying a contractor more than the contract amount without a change order, (3) not following its emergency
     repair procedures on four projects, and (4) bid opening before the advertised date.


                                                            7
                      Homeowner rehabilitation project deficiencies
        Property            Days before mandatory           Number of      Project cost
        identifier               walkthrough                  bids
            225                        3                         1                $2,883

            824                        1                         2                23,515
            933                        3                         3                29,992
            2321                       3                         1                18,951
            3456                       1                         3                10,000
            3931                       1                         2                 4,365
     4328 (February                    4                         2                 8,260
        contract)
       4328 (April                     7                         2                11,840
        contract)
            1421                       1                         2                50,638
            1100                 Not advertised                  2                13,064
    Total                                                                       173,508


The City Provided False Information to HUD
The City provided false information to HUD when it drew funds in advance for expenses related
to projects that were not complete and made false statements in its communications to HUD. In
all, the Community and Economic Development Department drew nearly $1.3 million in CDBG
funds in advance, which gave the appearance to HUD that the City had spent the funds, projects
had been completed, and the City was closer to meeting HUD’s timeliness requirements.
Included in this amount was $257,737 in ineligible duplicate costs and $45,304 in homeowner
rehabilitation costs for projects that we did not review and may not have met HUD requirements.




                                               8
                                       Activity                                                    Amount
          Advance draw for the STANCO projects 9                                                    $361,453
          Advance draw for the HACS projects 10                                                      592,266
          Duplicate cost for HACS projects (recommendation 1G)                                       257,737
          Advanced draws for five homeowner rehabilitation projects that did                          41,442
          not meet HUD requirements 11
          Advanced draws for the remaining eight homeowner rehabilitation                                45,304
          projects (recommendation 1H)
          Total advanced HUD draws                                                                     1,298,202

The City was able to draw the funds in advance because it disregarded HUD’s and its own
policies when it paid for work that was not complete and because the City’s procedures for HUD
voucher revisions did not require a second level of approval as did the initial draws.
Specifically, the City

    •   Drew $361,453 from voucher 6035061 in advance for the STANCO rental rehabilitation
        projects on April 25, 2017. This amount was equal to the full cost minus the retention
        amounts of the STANCO rental rehabilitation projects. However, STANCO did not
        complete the project until June 21, 2017.

    •   Drew $592,266 in advance from voucher 6035061 for the HACS rental rehabilitation
        projects on April 25, 2017, from revolving loan funds. This amount was equal to the full
        cost minus the retention amount of the HACS rental rehabilitation projects. However,
        HACS did not complete the project until February 9, 2018.

    •   Drew an additional $592,266 in entitlement funds from voucher 6036571 on April 28,
        2017, for the same HACS rental rehabilitation project cost.

    •   Revised the original voucher 6035061 on May 19, 2017. However, the City canceled
        only a portion of the voucher and left $257,737 in duplicate expenses. The City later
        used expenses paid as late as February 9, 2018, to support the nonduplicate portion of the
        draw.




9
  This amount was included as unsupported costs related to the STANCO rental rehabilitation projects
   (recommendation 1C).
10
   This amount was included as unsupported costs related to the HACS rental rehabilitation projects
   (recommendation 1B).
11
   This amount was included as unsupported costs related to the homeowner rehabilitation program
   (recommendation 1D).


                                                         9
     •   Drew $86,746 in advance for 13 homeowner rehabilitation projects. Five of these
         projects totaling $41,442 12 were included in our review, and we determined that the
         projects did not meet HUD requirements. However, it was unclear whether the
         remaining eight projects with at least $45,304 in HUD draws met HUD requirements,
         including procurement and eligibility.

     •   Requested advance contractor invoices for some of the homeowner rehabilitation
         expenses and submitted the invoices to the City’s accounting department before the work
         was completed. The City’s accounting department relied on the City’s Community and
         Economic Development Departments’ certifications that the work was completed and
         issued payment. The City stated that it intended to hold the checks until work was
         completed; however, some contractors cashed the checks shortly after the check issue
         dates.

The City also made false statements to HUD that did not accurately reflect the activities of its
CDBG program. On May 8, 2017, the City told HUD in an email that it did not cancel the full
amount of the duplicate draw for the HACS rental rehabilitation project because it had additional
eligible activity after the draw date. However, the City did not have sufficient eligible activity to
support the entire draw by May 8, 2017. The City also made several false statements in a letter
to HUD, dated June 5, 2017. For example, the City stated that

     •   Although the City did not meet HUD’s adjusted timeliness ratio, 13 it did meet the
         unadjusted timeliness ratio. 14 However, without the homeowner and rental rehabilitation
         advanced payments from the entitlement fund, the City would not have met the
         unadjusted ratio.

     •   It completed the environmental reviews for the rental rehabilitation projects on April 4,
         2017. However, the City could not support that it completed the environmental reviews
         by that date.

     •   Contracts for the rental rehabilitation projects were executed on April 5, 2017. However,
         the City did not support that it executed contracts with HACS and STANCO. In addition,
         HACS and STANCO did not execute agreements with their contractors until after April
         5, 2017.




12
   This amount was included as unsupported costs related to the homeowner rehabilitation program
   (recommendation 1D).
13
   To meet the adjusted timeliness ratio, the amount of CDBG program income the recipient has on hand, together
    with the amount of funds in its CDBG line of credit, cannot exceed 1.5 times the entitlement grant amount for its
    current program year.
14
   To meet the unadjusted timeliness ratio, the amount of entitlement grant funds in its CDBG line of credit cannot
    exceed 1.5 times the entitlement grant amount for its current program year.


                                                           10
       •    HACS and STANCO successfully rehabilitated 68 and 24 units, respectively. However,
            both HACS and STANCO completed their projects after the June 5, 2017, letter. HACS
            completed its projects on February 9, 2018, and STANCO completed its projects on June
            21, 2017.

This condition occurred because of the City’s desire to show HUD that it was close to meeting
timeliness requirements. As a result, HUD did not have accurate information when determining
the appropriate course of action for the City’s inability to spend HUD funds in a timely manner.

The City Spent HUD Funds Inefficiently and Misclassified Some Delivery Costs
The City charged the CDBG program for the rehabilitation administration costs (program
delivery costs) related to its rehabilitation program. For program year 2015, the City spent
$186,480 on actual homeowner rehabilitation costs and $323,563 on delivery costs. Therefore,
the program delivery costs represented 174 percent of the actual homeowner rehabilitation costs.
The delivery costs charged to the program were not reasonable or efficient in proportion to the
level of actual rehabilitation costs for work completed as required by HUD regulations at 24
CFR 200.403(a) and 200.404(a) (appendix C). As a result of the City’s lack of efficiency in the
administration of the rehabilitation program, all $323,563 in rehabilitation administration
expenses for program year 2015 were not supported.

The City misclassified some rehabilitation administration expenses in program year 2016.
Office of Community Planning and Development (CPD) Notice 13-07 states that grantees may
charge housing rehabilitation administration expenses (delivery costs) separately in HUD’s
Integrated Disbursement and Information System (IDIS 15). For other activities, general program
administrative expenses are subject to a 20 percent cap. For this reason, grantees must use care
in identifying which expenses they treat as rehabilitation administration expenses versus delivery
costs. The City charged expenses to the rehabilitation administration delivery activity that were
not rehabilitation related. The City did not always support that payroll expenses were
rehabilitation related. Specifically, it

       •    Charged $69,794 in employee payroll and benefits for City employees who did not work
            on rehabilitation-related activities.
       •    Charged $66,910 in payroll expenses to the rehabilitation delivery activity for its former
            environmental review specialist, who was incorrectly assigned to the rehabilitation
            administration cost center.
       •    Could not provide sufficient support to show that $13,263 in payroll and benefit expenses
            was for rehabilitation-related activities.




15
      IDIS is a nationwide database that provides HUD with current information regarding the program activities
     underway across the Nation. HUD uses this information to report to Congress and to monitor grantees. IDIS is
     the drawdown and reporting system for CDBG. Our assessment of the reliability of IDIS was limited to the data
     sampled, and the data were reconciled with data in City’s records. Therefore, we deemed the data sampled to be
     reliable for the audit conclusion; however, we did not assess the reliability of the systems that generated the data.


                                                               11
       •   Incorrectly charged $517 in miscellaneous expenses. 16

These issues occurred because the City lacked sufficient program knowledge and capacity to
properly and efficiently administer the program.

The City’s Monitoring Procedures Did Not Include All Recipients of Its CDBG Funds
The City did not ensure that it included all of its recipients of CDBG funds in its monitoring
schedule. Requirements at 24 CFR 570.501(b) state that the City is responsible for ensuring that
CDBG funds are used in accordance with all program requirements. The use of designated
public agencies, subrecipients, or contractors does not relieve the recipient of this responsibility.
The City’s monitoring efforts and policies and procedures were generally acceptable for its
public service subrecipients. However, the City selected only public service subrecipients for
monitoring and allowed subrecipients to select which files the City would review. This
condition occurred because the City’s policies and procedures for monitoring were not sufficient
to ensure that it monitored recipients of CDBG funds for compliance with program requirements
and that it selected objective samples.


Conclusion
The City did not always follow HUD requirements for rehabilitation projects and rehabilitation
administration, did not provide accurate information to HUD, and did not ensure that it included
all recipients in its monitoring plan. These conditions occurred because of the City’s desire to
show HUD that it was close to meeting timeliness requirements, its disregard for HUD’s and its
own requirements, its lack of sufficient program knowledge and capacity to efficiently
administer the program, and the failure of its policies and procedures to ensure that it monitored
all of its recipients of CDBG funds. As a result, the City was unable to support that its use of
more than $1.6 million met HUD requirements, drew $257,737 in ineligible funds for duplicate
costs, HUD relied on inaccurate information submitted by the City, and the City could not ensure
that all of its recipients of CDBG funds complied with program requirements.
Recommendations
We recommend that the Director of HUD’s San Francisco Office of Community Planning and
Development require the City to
1A.        Support that the $592,266 spent on the HACS rental rehabilitation projects was
           reasonable or repay the program from non-Federal funds.
1B.        Support that the $401,614 spent on STANCO rental rehabilitation projects was
           reasonable and met one of HUD’s national objectives and that it completed an
           environmental review or repay the program from non-Federal funds.




16
     Of the $517, $303 was for legal services not related to rehabilitation, $164 was for prorated moving costs for
     nonrehabilitation employees, and $50 was for prorated contract administration costs for a nonrehabilitation
     project.


                                                             12
1C.   Develop and implement policies to safeguard HUD funds by ensuring that its projects
      meet national objectives, have a completed environmental review, and have executed
      agreements for all projects and verify that work is complete before approving payment,
      including its rental rehabilitation projects.
1D.   Update policies and procedures to ensure that costs are reasonable, including preparing
      an independent cost estimate and a detailed scope of work for each project.
1E.   Support that $173,508 spent on homeowner rehabilitation project expenses was
      reasonable or repay the program from non-Federal funds.
1F.   Update and implement policies and procedures to ensure that all procurements are
      conducted in a manner that promotes full and open competition and avoids any arbitrary
      action in the procurement process, including ensuring that contractors are given sufficient
      time to respond to solicitations.
1G.   Repay from non-Federal funds $257,737 from voucher 6035061 for the duplicate draw.
1H.   Support that $45,304 drawn in advance met eligibility and procurement requirements and
      costs were reasonable or repay the unsupported amount from non-Federal funds.
1I.   Update its policies and procedures to ensure that the City issues payments to vendors and
      obtains reimbursement from HUD only after the City’s Community and Economic
      Development Department has verified that work is complete.

1J.   Support that $323,563 spent on rehabilitation administration charged in program year
      2015 costs was reasonable and benefited the City’s rehabilitation program or repay the
      program from non-Federal funds any amount determined to be unreasonable or ineligible.
1K.   Reclassify $69,794 in employee payroll and benefits for City employees that did not
      work on rehabilitation-related activities or repay the program from non-Federal funds.
1L.   Support that expenses were related to rehabilitation activities for $66,910 in payroll
      expenses charged to the rehabilitation delivery expenses activity for its former
      environmental review specialist or repay the program from non-Federal funds.
1M.   Support that expenses were related to rehabilitation activities for $13,263 in unsupported
      payroll or repay the program from non-Federal funds.
1N.   Reclassify $517 in miscellaneous expenses that was incorrectly prorated or repay the
      program from non-Federal funds.
1O.   Provide training for its staff to ensure sufficient knowledge of CDBG requirements
      regarding when to charge delivery costs, including when to charge payroll to
      rehabilitation administration, versus general administrative costs.

1P.   Implement policies and procedures to ensure that the City includes all recipients of
      CDBG funds in its monitoring plan and that it selects objective sample items for
      monitoring.


                                                13
Scope and Methodology
We performed our audit work at the City of Modesto located at 1010 10th Street, Modesto, CA,
from October 17, 2017, to April 10, 2018. Our review generally covered the period July 1, 2015,
to September 30, 2017.
To accomplish our objective, we performed the following:

   •   Reviewed HUD regulations and requirements.
   •   Interviewed appropriate City staff, partners, and contractors.
   •   Reviewed relevant City policies, procedures, and controls over the program.
   •   Reviewed HUD monitoring reports.
   •   Reviewed the City’s consolidated plans, consolidated annual performance and evaluation
       reports, and action plans.
   •   Reviewed reports from IDIS to obtain CDBG disbursements for the audit period.
   •   Reviewed relevant drawdowns (vouchers) and supporting documentation for program
       expenses.
   •   Reviewed the City’s audited financial statements for fiscal year ending 2016.
   •   Reviewed documentation from the sampled projects, including procurement
       documentation, subrecipient monitoring, and payroll certifications.
   •   Performed site visits to a sample of rental rehabilitation properties.

The audit universe for rehabilitation activities included one rental rehabilitation activity totaling
$993,880 and 44 homeowner rehabilitation projects totaling $528,296 for the period of October
1, 2015, to September 30, 2017. We nonstatistically selected and sampled the $993,880 rental
rehabilitation activity, which we reviewed for national objectives and other HUD requirements,
and $173,508 for 10 homeowner rehabilitation projects, which we reviewed for procurement
requirements.
The City drew 12 CDBG vouchers for the housing rehabilitation administration activity totaling
$760,298 for the period October 1, 2015, to September 30, 2017. We chose a nonstatistical
sample based on the largest voucher for program year 2016 totaling $204,692. We reviewed the
expenses charged by the City in this voucher to ensure that it documented that expenses were
rehabilitation related.
The City entered into agreements with 23 subrecipients for program years 2015 and 2016. We
randomly selected a nonstatistical sample of four monitoring files to review.
We cannot project the results of our audit samples to the universe. However, due to the
consistent issues with the former environmental specialist’s payroll expenses, we questioned all
salary expenses not reviewed as unsupported. In addition, because of the lack of efficiency in
the administration of the rehabilitation program, we questioned all rehabilitation administration
expenses for program year 2015 as unsupported.


                                                   14
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.




                                                15
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:

    •   Program operations – Policies and procedures that management has implemented to
        reasonably ensure that a program meets its objectives.
    •   Validity and reliability of data – 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.




                                                  16
Significant Deficiencies
Based on our review, we believe that the following items are significant deficiencies:

   •   The City lacked controls, including written policies and procedures, to ensure that
       program activities complied with HUD requirements for its rental rehabilitation projects
       (finding).
   •   The City’s internal controls were inadequate to ensure that management did not
       circumvent the policies and procedures in place regarding vendor payments and HUD
       draws (finding).
   •   The City lacked the capacity to efficiently administer its CDBG program to ensure that it
       complied with HUD requirements (finding).
   •   The City lacked controls, including written policies and procedures, to ensure that it
       included all of its CDBG recipients in its monitoring plan and selected objective samples
       when performing its reviews (finding).




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Appendixes

Appendix A


                           Schedule of Questioned Costs
                  Recommendation
                                   Ineligible 1/  Unsupported 2/
                      number
                         1A                               $592,266
                         1B                                401,614
                          1E                               173,508
                         1G             $257,737
                         1H                                 45,304

                          1J                               323,563

                         1K                                 69,794

                          1L                                66,910

                         1M                                 13,263

                         1N                                  517

                        Totals          257,737           1,686,739



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. In this instance, the $257,737 in ineligible costs represents a
     payment for duplicate costs.
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. In this instance, the unsupported costs represent
     (1) $993,880 for the unsupported rental rehabilitation projects, (2) $173,508 for the



                                              18
unsupported homeowner rehabilitation project costs, (3) $45,304 for the unverified
advance draws, (4) $323,563 for the unsupported 2015 rehabilitation administration
costs, (5) $69,794 for the unsupported payroll costs inappropriately charged to the
rehabilitation administration activity, (6) $66,910 for unsupported payroll expenses for
the prior environmental review specialist, (7) $13,263 for other unsupported payroll
costs, and (8) $517 for unsupported miscellaneous expenses.




                                         19
Appendix B
             Auditee Comments and OIG’s Evaluation



Ref to OIG
Evaluation    Auditee Comments




Comment 1




                               20
Comment 2




Comment 3




            21
Comment 3




Comment 4




Comment 5




            22
Comment 5




Comment 6




Comment 5




Comment 7




            23
Comment 8




Comment 9




            24
Comment 10




             25
                         OIG Evaluation of Auditee Comments


Comment 1   We acknowledge the changes and vacancies in the department created challenges
            and we recognize the City’s commitment to improving its processes, policies, and
            procedures.
Comment 2   We disagree that all rental rehabilitation projects funded and completed by the
            City met a national objective. As stated in the audit report, the STANCO projects
            did not meet the reported objective because the projects were transitional housing,
            which is considered a public facility. The reported national objective of low and
            moderate housing rehabilitation for multiunit residential properties excludes
            public facilities such as transitional housing. We acknowledge that the projects
            may be eligible under a different national objective. The City can work with
            HUD to identify an eligible national objective for the STANCO projects.
            We commend the City’s actions to address the issues identified in the report,
            including updating its policies to ensure future projects meet national objectives
            and costs are reasonable. We also commend the City for its commitment to work
            with HUD to address the issues identified during the audit.
Comment 3   We commend the City’s efforts to implement policies, process flows, and
            checklists to ensure its projects meet national objectives, have a completed
            environmental review and executed agreements, and work is complete before
            payment is issued. The City can work with HUD during the audit resolution
            process to provide support that the proposed policies and procedures have been
            approved and implemented.
Comment 4   We commend the City’s commitment in taking the steps necessary to ensure costs
            are reasonable. The City can work with HUD during the audit resolution process
            to provide support that the proposed policies and procedures have been approved
            and implemented.
Comment 5   We acknowledge that the City’s homeowner rehabilitation projects met a national
            objective. We also acknowledge the City’s efforts to update its policies and
            procedures to ensure its procurements are conducted in a manner that promotes
            full and open competition. The City can provide the approved policies and
            procedures to HUD during the audit resolution process.
Comment 6   We recognize that the City believed there were sufficient invoices to support the
            duplicate draw. However, it appears unlikely the City had sufficient invoices to
            support the draw because at the time of the draw, the City was requesting invoices
            in advance for projects that were not completed. It was also not able to fully
            support the draw until January 2018. The City will work with HUD during the
            audit resolution process to ensure it recognizes expenses in the program year in
            which the expenses occurred and repay all duplicate costs that were drawn in
            advance.


                                             26
Comment 7     We commend the City’s commitment in taking the steps necessary to ensure work
              is complete before requesting reimbursement from HUD. The City will work
              with HUD during the audit resolution process to provide support that the proposed
              policies and procedures have been approved and implemented.
Comment 8     We appreciate the City’s efforts to identify the correct funding source for the
              questioned expenses and modify its budget accounting structure, and its
              commitment to provide training to employees to ensure only eligible expenses are
              charged to the rehabilitation administration activity. The City will work with
              HUD during the audit resolution process to provide support that the proposed
              policies and procedures have been approved and implemented along with its
              training program.
Comment 9     We commend the City’s quick action to implement procedures to ensure it does
              not allow subrecipients to select which files are reviewed and its efforts to update
              policies and procedures to ensure it monitors all recipients of CDBG funds. The
              City will work with HUD during the audit resolution process to provide support
              that its policies and procedures have been approved and implemented.
Comment 10 The City provided attachments with its response. We did not include the
           attachments in the report because they were too voluminous; however, they are
           available upon request.




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Appendix C
                                             Criteria

24 CFR 58.22(a)
     Neither a recipient nor any participant in the development process, including public or
     private nonprofit or for-profit entities, or any of their contractors, may commit HUD
     assistance under a program listed in Sec. 58.1(b) on an activity or project until HUD or
     the state has approved the recipient's RROF and the related certification from the
     responsible entity. In addition, until the RROF and the related certification have been
     approved, neither a recipient nor any participant in the development process may commit
     non-HUD funds on or undertake an activity or project under a program listed in Sec.
     58.1(b) if the activity or project would have an adverse environmental impact or limit the
     choice of reasonable alternatives.

24 CFR 58.38
      The responsible entity must maintain a written record of the environmental review
      undertaken under this part for each project. This document will be designated the
      “Environmental Review Record” (ERR) and shall be available for public review.

24 CFR 570.200(a)(2)
      Compliance with national objectives. Grant recipients under the Entitlement and HUD-
      administered Small Cities programs and recipients of insular area funds under section 106
      of the Act must certify that their projected use of funds has been developed so as to give
      maximum feasible priority to activities which will carry out one of the national objectives
      of benefit to low- and moderate-income families or aid in the prevention or elimination of
      slums or blight. The projected use of funds may also include activities that the recipient
      certifies are designed to meet other community development needs having a particular
      urgency because existing conditions pose a serious and immediate threat to the health or
      welfare of the community where other financial resources are not available to meet such
      needs. Consistent with the foregoing, each recipient under the Entitlement or HUD-
      administered Small Cities programs, and each recipient of insular area funds under
      section 106 of the Act must ensure and maintain evidence that each of its activities
      assisted with CDBG funds meets one of the three national objectives as contained in its
      certification. Criteria for determining whether an activity addresses one or more of these
      objectives are found in §570.208.

24 CFR 570.200(a)(4)
     Compliance with environmental review procedures. The environmental review
     procedures set forth at 24 CFR part 58 must be completed for each activity (or project as
     defined in 24 CFR part 58), as applicable.

24 CFR 570.202
     (b) Types of assistance. CDBG funds may be used to finance the following types of
     rehabilitation activities, and related costs, either singly, or in combination, through the


                                                 28
       use of grants, loans, loan guarantees, interest supplements, or other means for buildings
       and improvements described in paragraph (a) of this section, except that rehabilitation of
       commercial or industrial buildings is limited as described in paragraph (a)(3) of this
       section.
       (9) Rehabilitation services, such as rehabilitation counseling, energy auditing, preparation
       of work specifications, loan processing, inspections, and other services related to assisting
       owners, tenants, contractors, and other entities, participating or seeking to participate in
       rehabilitation activities authorized under this section, under section 312 of the Housing
       Act of 1964, as amended, under section 810 of the Act, or under section 17 of the United
       States Housing Act of 1937;

24 CFR 570.501(b)
     The recipient is responsible for ensuring that CDBG funds are used in accordance with all
     program requirements. The use of designated public agencies, subrecipients, or
     contractors does not relieve the recipient of this responsibility.

24 CFR 570.503(a)
     Before disbursing any CDBG funds to a subrecipient, the recipient shall sign a written
     agreement with the subrecipient. The agreement shall remain in effect during any period
     that the subrecipient has control over CDBG funds, including program income. At a
     minimum, the written agreement with the subrecipient shall include provisions
     concerning the statement of work, records and reports, program income, and uniform
     requirements.

24 CFR 570.506
      Records to be maintained:
      Each recipient shall establish and maintain sufficient records to enable the Secretary to
     determine whether the recipient has met the requirements of this part. At a minimum, the
     following records are needed:

       (a) Records providing a full description of each activity assisted (or being assisted) with
       CDBG funds, including its location (if the activity has a geographical locus), the amount
       of CDBG funds budgeted, obligated and expended for the activity, and the provision in
       subpart C under which it is eligible.

       (4) For each activity carried out for the purpose of providing or improving housing which
       is determined to benefit low and moderate income persons: (i) A copy of a written
       agreement with each landlord or developer receiving CDBG assistance indicating the
       total number of dwelling units in each multifamily structure assisted and the number of
       those units which will be occupied by low and moderate income households after
       assistance; (ii) The total cost of the activity, including both CDBG and non-CDBG funds.
       (iii) For each unit occupied by a low and moderate income household, the size and
       income of the household; (iv) For rental housing only:




                                                 29
       (A) The rent charged (or to be charged) after assistance for each dwelling unit in each
           structure assisted; and
       (B) Such information as necessary to show the affordability of units occupied (or to be
       occupied) by low and moderate income households pursuant to criteria established and
       made public by the recipient;

24 CFR 570.902
     HUD will review the performance of each entitlement, HUD-administered small cities,
     and Insular Areas recipient to determine whether each recipient is carrying out its CDBG-
     assisted activities in a timely manner.
     (a) Entitlement recipients and Non-entitlement CDBG grantees in Hawaii. (1) Before the
     funding of the next annual grant and absent contrary evidence satisfactory to HUD, HUD
     will consider an entitlement recipient or a non-entitlement CDBG grantee in Hawaii to be
     failing to carry out its CDBG activities in a timely manner if:
     (i) Sixty days prior to the end of the grantee’s current program year, the amount of
     entitlement grant funds available to the recipient under grant agreements but undisbursed
     by the U.S. Treasury is more than 1.5 times the entitlement grant amount for its current
     program year; and
     (ii) The grantee fails to demonstrate to HUD’s satisfaction that the lack of timeliness has
     resulted from factors beyond the grantee’s reasonable control.
     (2) Notwithstanding that the amount of funds in the line of credit indicates that the
     recipient is carrying out its activities in a timely manner pursuant to paragraph (a)(1) of
     his section, HUD may determine that the recipient is not carrying out its activities in a
     timely manner if:
     (i) The amount of CDBG program income the recipient has on hand 60 days prior to the
     end of its current program year, together with the amount of funds in its CDBG line of
     credit, exceeds 1.5 times the entitlement grant amount for its current program year; and
     (ii) The grantee fails to demonstrate to HUD’s satisfaction that the lack of timeliness has
     resulted from factors beyond the grantee’s reasonable control.

2 CFR 200.318(i)
      The non-Federal entity must maintain records sufficient to detail the history of
      procurement. These records will include, but are not necessarily limited to the following:
      rationale for the method of procurement, selection of contract type, contractor selection
      or rejection, and the basis for the contract price.

2 CFR 200.319(a)(7)
      Any arbitrary action in the procurement process are considered restrictive to competition.

2 CFR 200.320(c)(2)(i)
      The invitation for bids will be publicly advertised and bids must be solicited from an
      adequate number of known suppliers, providing them sufficient response time prior to the
      date set for opening the bids.




                                                30
2 CFR 200.320(f)
      Procurement by noncompetitive proposals is procurement through solicitation of a
      proposal from only one source and may be used only when one or more of the following
      circumstances apply:
      (1) The item is available only from a single source;
      (2) The public exigency or emergency for the requirement will not permit a delay
      resulting from competitive solicitation;
      (3) The Federal awarding agency or pass-through entity expressly authorizes
      noncompetitive proposals in response to a written request from the non-Federal entity; or
      (4) After solicitation of a number of sources, competition is determined inadequate.

2 CFR 200.323(a)
      The non-Federal entity must perform a cost or price analysis in connection with every
      procurement action in excess of the Simplified Acquisition Threshold including contract
      modifications. The method and degree of analysis is dependent on the facts surrounding
      the particular procurement situation, but as a starting point, the non-Federal entity must
      make independent estimates before receiving bids or proposals.

2 CFR 200.403(a)
      Costs must be necessary and reasonable for the performance of the Federal award and be
      allocable thereto under these principles.

2 CFR 200.404(a)
      A cost is reasonable if, in its nature and amount, it does not exceed that which would be
      incurred by a prudent person under the circumstances prevailing at the time the decision
      was made to incur the cost. The question of reasonableness is particularly important
      when the non-Federal entity is predominantly federally-funded. In determining
      reasonableness of a given cost, consideration must be given to:
      (a) Whether the cost is of a type generally recognized as ordinary and necessary for the
      operation of the non-Federal entity or the proper and efficient performance of the Federal
      award.

2 CFR 200.405(a)
      A cost is allocable to a particular Federal award or other cost objective if the goods or
      services involved are chargeable or assignable to that Federal award or cost objective in
      accordance with relative benefits received.

2 CFR 200.415(a)
      To assure that expenditures are proper and in accordance with the terms and conditions of
      the Federal award and approved project budgets, the annual and final fiscal reports or
      vouchers requesting payment under the agreements must include a certification, signed by
      an official who is authorized to legally bind the non-Federal entity, which reads as
      follows: “By signing this report, I certify to the best of my knowledge and belief that the
      report is true, complete, and accurate, and the expenditures, disbursements and cash
      receipts are for the purposes and objectives set forth in the terms and conditions of the


                                                31
       Federal award. I am aware that any false, fictitious, or fraudulent information, or the
       omission of any material fact, may subject me to criminal, civil or administrative
       penalties for fraud, false statements, false claims or otherwise.(U.S. Code Title 18,
       Section 1001 and Title 31, Sections 3729–3730 and 3801–3812).”

Notice CPD 13-07
       Grantees must maintain adequate records and documentation in support of all costs, as set
       forth in 24 CFR 570.502 and 570.506, and Part 85.20, standards for financial
       management systems. Additionally, the grantee’s records should clearly show there is a
       consistent treatment of like costs under similar circumstances.

Notice CPD 13-07
       Housing rehabilitation administration is the only activity that has a separate IDIS matrix
       code that allows for the allocation of administrative costs as ADCs [activity delivery
       costs]. This category is used to charge housing rehabilitation administration costs for all
       CDBG-assisted housing rehabilitation and housing rehabilitation carried out using other
       funding sources that meet all CDBG program requirements. For other program-type
       activities, general program administrative costs are treated as PACs [program
       administrative costs] and subject to the 20 percent cap. For this reason, grantees
       operating programs must use care in identifying which costs can be consistently treated as
       ADCs (i.e., part of delivering a final cost objective) versus those costs that are identified
       as general administration costs.

Notice CPD 13-07
       It is important to recognize that staff time allocable as ADCs represents the actual time
       spent on implementing and completing an eligible CDBG activity.

Guide to National Objectives and Eligible Activities for Entitlement Communities (Chapter
2)
      Complying with National Objectives - Rehabilitation: Section 105(c)(3) of the
      authorizing statute, the Housing and Community Development Act of 1974, requires that,
      in order for an activity that involves the acquisition or improvement of property for
      housing to qualify as benefiting L/M [low and moderate] income persons, the housing
      must be occupied by such persons. Even though a particular housing activity may
      provide a clear benefit to an area containing predominantly L/M Income residents, it
      cannot qualify on that basis. Instead, the housing must be occupied by L/M Income
      households.

Guide to National Objectives and Eligible Activities for Entitlement Communities (Chapter
2)
      Eligible Types of Properties – CDBG funds may be used to finance costs of rehabilitation
      of nonprofit-owned, nonresidential buildings and improvements that are not considered to
      be public facilities or improvements under §570.201(c) of the CDBG program
      regulations.



                                                 32
Guide to National Objectives and Eligible Activities for Entitlement Communities (Chapter
2)
      Eligible Activities- The regulations specify that facilities that are designed for use in
      providing shelter for persons having special needs are considered to be public facilities
      (and not permanent housing), and thus are covered under this category of basic eligibility.
      Such shelters would include transitional facilities/housing for the homeless

Guide to National Objectives and Eligible Activities for Entitlement Communities (Chapter
2)
      Drawing Down Funds for Rehabilitation - The general Treasury rules for drawing
      Federal funds require that funds not be drawn until needed. In the CDBG program, this
      usually means that the grantee or subrecipient should not draw funds from the line of
      credit (the Treasury) in an amount greater than that which it expects to use within the next
      three business days.

Modesto Homeowner Rehabilitation Program Polices 4.7.5
     Housing Rehabilitation Specialist processes approved projects through the bid process.

Modesto Homeowner Rehabilitation Program Polices 10.2
     A minimum of three bids by California Licensed Contractors shall be obtained prior to
     bid approval consideration.

Modesto Homeowner Rehabilitation Program Polices 17.7
     Contractor progress payments shall be subject to Housing Rehabilitation Specialist
     verification, acknowledgement and certification that the work being invoiced for is
     reflective of the work verified through the Housing Rehabilitation Specialist’s progress
     inspection(s) and through the time period indicated on the payment request.

Modesto Homeowner Rehabilitation Program Polices 17.8
     Contractor payment requests will only be processed if signed by the Contractor,
     Homeowner, Housing Rehabilitation Specialist, and Housing Rehabilitation Specialist
     Supervisor. Invoices must be detailed enough to determine payment eligibility, along
     with accompanying documentation. All efforts will be made to reimburse qualified
     invoices within a 30-day time frame.

Modesto Purchasing Manual
     A bidder’s conference will be scheduled eight (8) days after the bid issue date. The
     department shall receive an email appointment. Vendors shall have the opportunity to
     ask questions for clarification of bid specifications.




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