Essential Housing Management, Inc., Winston-Salem, NC

Published by the Department of Housing and Urban Development, Office of Inspector General on 1995-10-26.

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

                                                   U.S. Department of Housing and Urban Development

                                                   District Office of the Inspector General
                                                   Richard B. Russell Federal Building
                                                   75 Spring Street, SW, Room 700
                                                   Atlanta, GA 30303-3388
                                                   (404) 331-3369

October 26, 1995                                    Audit-Related Memorandum
                                                    No. 96-AT-214-1804

MEMORANDUM FOR:            Daniel A. McCanless, Director, Multifamily Division, 4FHM

FROM:      Kathryn Kuhl-Inclan
           District Inspector General for Audit-Southeast/Caribbean, 4AGA

SUBJECT:       HUD State Office Request
               Essential Housing Management, Inc.
               Review of Charges for Front-Line Expenses
               Winston-Salem, North Carolina

We have completed a review of charges to HUD multifamily projects for front-line expenses by
Essential Housing Management, Inc. (EHM), Winston-Salem , North Carolina, for the three years
ended December 31, 1994. Our objective was to determine if EHM's charges for front-lin e
expenses were reasonable and properly supported. We initiated the review based on a request
from your former Housing Management Division for an audit of EHM because of possibl e
excessive charges by EHM to projects it managed.


EHM is a management company based in North Carolina. EHM operated under the name MBG,
Inc. from January 1, 1992 until N ovember 22, 1994. At December 31, 1994, EHM managed 56
HUD assisted or unassisted multifamily projects, and 190 other Farmers Home Administration
and conventional properties, in 7 states and the District of Columbia.

EHM's corporate records were located in Winston-Salem and Raleigh, North Carolina.


We interviewed EHM staff and reviewed EHM's records pertaining to charges to HUD projects
for front-line expenses. We also reviewed t he records documenting payments to EHM for front-
line expenses by three HUD projects: Meadowbrook Apartments, Willow Creek Apartments, and
Oak Knoll Apartments. We conducted our review from January through August 1995.

EHM charged an estimated $317,245 in excessive front-line expense fees to 41 HUD projects.
The fees were excessive because EHM duplicated costs for bookkeeping services in fees charged
to the projects, reducing money available to the pro jects to pay operating expenses and mortgage
payments. Eight of the projects defaulted on their HUD-insured mortgages, and the mortgages
were assigned to HUD.

Details of our finding and recom mendations are in Attachment 1. We discussed the finding and
recommendations with EHM's President, Chief Operating Officer, and Manager of HU D
Programs on August 24, 1995, and provided them a draft of the finding. The Chief Operating
Officer's written comments are summarized following the finding and are included verbatim in
Attachment 4.

Within 60 days, please give us, for each recommendation in the memorandum, a status report on:
(1) the corrective actions taken; (2) the proposed co rrective actions and the date to be completed;
or (3) why actions are considered unnecessary. Also, please furnish us copies of an y
correspondence or directives issued because of the review.

We provided a copy of this memorandum to EHM's President.

We appreciate you r cooperation during the audit. Should you or your staff have any questions,
please contact Rudy E. McBee, Assistant District Inspector General for Audit, at (615) 545-4368
or Bruce Milligan, Senior Auditor, at extension 4056.

     1 - Finding and Recommendations
     2 - Schedule of Excessive Charges
     3 - Schedule of Unsupported Costs
     4 - Auditee Comments
     5 - Distribution
                                                                             ATTACHMENT 1
                                                                                  Page 1 of 3

                          FINDING AND RECOMMENDATIONS

EHM Charged Excessive Front-Line Expenses To 41 Projects

EHM charged an estimated $3 17,245 in excessive front-line expense fees to 41 HUD projects it
managed. The fees were excessive because EHM charged two different fees which bot h
reimbursed EHM for the same bookkeeping services. The excessive charges reduced mone y
available to the 41 projects to pay operating expenses and mortgage payments. Eight of th e
projects defaulted on the HUD-insured mortgages, and the mortgages were assigned to HUD .
EHM's excessive fees included $94,029 charged to the 8 projec ts and $223,216 for the remaining
33 projects.

Actual, Reasonable Costs are Chargeable to Project

HUD allows management agents to charge reasonable expenses incurred for front-lin e
management activities to the project operating account, in addition to costs paid out of th e
management fee. Examples of front-line acti vities are taking applications, screening tenants and
accounting for project income and expenses. However, the charges may not exceed the amount
normally paid for such services, and may not exceed the agent's actual costs (HUD Handbook
4381.5 REV-2, The Management Agent Handbook, Paragraph 6.38). Owners of projects with
mortgages assigned to HUD m ust remit all remaining net cash to HUD each month after project
operating expenses have been paid (HUD Handbook 4350.1 REV-1, Multifamily Asse t
Management and Project Servicing, Chapter 10).

Fees Charged Were Excessive

From January 1, 1992 through December 31, 1994 , EHM charged three fees to 41 HUD projects
it managed: a fee for general manag ement services, a bookkeeping fee, and a fee for performing
front-line services. The general management fees were based on a percentage of incom e
collections. The bookkeeping and front-line fees were calculated on a per unit basis. Th e
average annual bookkeeping and front-line fees charged by EHM were:

        Per Unit Month Fee                     1992                1993            1994

        Bookkeeping                             $ 3.27             $ 3.29          $ 3.27
        Front-Line                                5.98               6.00            3.44
                                                                                          ATTACHMENT 1
                                                                                               Page 2 of 3

The fees charged the 41 HUD projects by EHM were excessive by approximately $317,245 1.
The fees were excessive because the bookkeeping and front-line fees reimbursed EHM for the
same services. EHM charged the front-line fees because it claimed to provide service s
chargeable to the project operating account. However, support for the calculation of the front-
line fees for 1992 and 1993 listed only the costs of EHM's accounting department includin g
salaries, payroll ta xes, employee benefits, rent and supplies. The front-line fees were excessive
by at least the amount of the bookkeeping fees because the bookkeeping fees reimbursed EHM
for maintaining the project accounting records.

The excessive fees of $317,245 are listed in Attachment 2 by project. For 1992 and 1993, the
excessive fees are the boo kkeeping fees which were less than the front-line fees. The excessive
amounts for 1994 are the front-line fees because they were less than the bookkeeping fees fo r
almost all of the projects.

The excessive charges reduced the mon ey available to the 41 projects to pay operating expenses
and mortgage payments. Eight of the 41 projects we nt into default from 1988 through 1992, and
the project mortg ages were assigned to HUD. EHM's excessive fees included $94,029 charged
to the 8 projects and $223,216 for the remaining 33 projects.

HUD Required EHM to Stop Charging Front-Line Fees in 1995

The HUD North Carolina State Office reviewed front-line fees in a March 1995 managemen t
review of EHM. HUD required EHM to discontinue the front-line fees retroactive to Januar y
1995 because the fees w ere duplicating charges to the projects for bookkeeping services. EHM
agreed to stop charging the front-line fees and refunded 1995 fees, but did not reimburse th e
projects for the excessive fees it received for the previous three years.

EHM Comments

In a September 12, 1995 letter, EHM's Chief Operating Officer (COO) agreed that support for
the fees charged seemed to include unallowabl e costs, but believed allowable costs were omitted
from the calculations. She said front-line fees charged for 1992 and 1993 were calculated b y
persons no longer employed by EHM, and they had been unable to determine how th e
calculations were made. The COO said HUD approve d the rate for front-line fees for 1994. She
said they were recalculating front-line fees for each year.

In a letter dated October 16, 1995, the COO provided a summary and numerous schedule s
detailing front-line and bookkeeping charges they believe are allowable and their conclusio n
regarding overcharg es. The summary indicated overcharges in 1992 and 1993, an undercharge
in 1994, netting to a total overcharge of $71,806. The C OO then subtracted amounts the projects
owed EHM (for unpaid management, bookkeeping and front-line fees) to arrive at

      EHM staff stated some projects may not have fully paid front-line, bookkeeping and management fees.
      Any such unpaid amounts would be recorded as accounts payable by the projects and accounts receivable
      by EHM, and could be used to reduce fee overcharges. It was not feasible for us to determine and verify
      such amounts for all projects.
                                                                              ATTACHMENT 1
                                                                                   Page 3 of 3

$45,303 she contended EHM owed the projects. She said she had a thick file of supportin g
documentation she would make available for review . The text of the COO's second letter, minus
the attachments, is in Attachment 4. We provided the attachments separately to the HUD State

Evaluation of EHM Comments

The HUD State Office approved EHM's front-line fee charges in 1994, but was unaware tha t
salaries of the same EHM staff were duplicated in the front-lin e and bookkeeping fees. The State
Office recognized the duplication duri ng the March 1995 review, and required EHM to stop the

Because of higher priority work, we did not return to EHM to review the supportin g
documentation for EHM's second response. The No rth Carolina State Office will need to review
the methodology and d ocumentation for EHM's computation, and determine whether to rescind
its prohibition against EHM charging front-line costs.


We recommend that you review EHM's October 16, 1995 letter and supporting documentation
and require EHM to:

1A.     Repay to HUD the excessive fees paid by the projects whose mortgages were assigned
        to HUD, estimated at $94,029.

1B.     Reimburse the other projects the excessive fees paid by the projects, estimated a t

1C.     Assure that project records are appropriately adjusted to reflect payables netted against
        EHM overcharges, and no longer owed to EHM.
                                                                             ATTACHMENT 2
                                                                                  Page 1 of 2

                                 Schedule of Excessive Charges

                       Project                       Excessive Charges
Project Name           Number               1992            1993         1994         Total

Projects with mortgages assigned to HUD:

Brookside               053-35536          $ 2,040        $ 2,040        $ 346       $ 4,426
Cinnamon Ridge          053-35492            1,200              -             -        1,200
Forest Hills            053-35389            5,712          5,712         5,549       16,973
Lakewood                053-35493            6,720          6,720           166       13,606
Longmeadow              053-35507            5,040          3,360             -        8,400
Meadowbrook             053-35473            6,384          6,384           814       13,582
Summertree              053-35472            6,048          6,048         5,875       17,971
Willow Creek            053-35489            8,400          8,400        1,071        17,871

 Sub-totals                                 41,544         38,664        13,821      94,029

Other projects:

Academy Village         053-35320            2,100           2,100        2,040       6,240
Balsom Grove            053-35438              840           1,680        1,632       4,152
Bay Tree                053-35451            2,100           2,100        2,040       6,240
Bramblewood             053-35378            5,760           2,880            -       8,640
Carriage House          053-35452            2,142           2,142        2,040       6,324
Casa Grande             053-35329            1,890           1,890        1,683       5,463
Cotton Dale             053-35417            1,008           1,008          979       2,995
Duplin                  053-35366            1,785           3,570        3,468       8,823
Erwin Elderly          053-EH236               540             540          918       1,998
Greenacre Terrace       053-35336            2,100           2,100        2,040       6,240
Heritage Ct.-NC         053-35388            1,512          1,512         1,469       4,493
Heritage Ct.-SC         054-35514            6,258           6,258        6,079      18,595
Heritage Homes         053-EH199             1,500           1,500        2,040       5,040
Hoffman Assoc.          053-35338            1,701           3,402        3,305       8,408
Meadow Wood             053-35402            2,100           2,100        2,040       6,240
Melvid Court            053-11020            1,512           1,512        1,346       4,370
Mountainside            053-35015            3,000           3,000        4,080      10,080
Oak Knoll               053-44101            7,560           7,560        7,344      22,464
Old Farm                053-35360            2,940           2,940        2,856       8,736
Plaza                   053-35286            2,604           2,604        2,530       7,738
Richmond Village        053-35420            1,680           1,680        1,632       4,992
Robin Ridge             053-35385              600             600          816       2,016
R.M. Wilson             053-35287            1,050           1,850        2,040       4,940
                                                                       ATTACHMENT 2
                                                                            Page 2 of 2

                           Schedule of Excessive Charges

                 Project                     Excessive Charges
Project Name     Number             1992            1993          1994          Total

Sandy Ridge      053-35403           1,092          1,092          1,061        3,245
Scotland Manor   053-35368           2,520          2,520          2,448        7,488
South Village    053-35424           1,680          1,680          1,632        4,992
Tanglewood       053-35364           2,226          2,226          2,162        6,614
Union Square     053-35552             720            720            979        2,419
University       053-35311           2,373          4,746          2,875        9,994
Virginia Dare    053-35371           2,856          2,856          2,774        8,486
Walnut West      053-35346             714          1,428          1,387        3,529
Woodland         053-35330           2,100          2,100          2,040        6,240
Yadkin Trail     053-35446           1,008          2,016          1,958        4,982

 Sub-totals                         71,571         77,912         73,733      223,216

 Totals                          $ 113,115      $ 116,576        $ 87,554    $ 317,245
                                                                                              ATTACHMENT 3

                              SCHEDULE OF UNSUPPORTED COSTS

                 Finding/Recommendation                   Unsupported Costs 2
                           1A                                  $ 94,029
                           1B                                   223,216

    Unsupported amounts do not obviously violate law, contract, HUD or local agency policies or regulations,
    but warrant being contested for various reasons such as lack of satisfactory documentation and HUD
                   ATTACHMENT 4

                                                                           ATTACHMENT 5


Secretary's Representative, 4AS
Comptroller, 4AF
Audit Liaison Officer, 4AFI
Director, Field Accounting Division, 4AFF
North Carolina State Coordinator, 4FS
Director, Multifamily Division, 4FHM (2)
Special Agent in Charge, Southeast/Caribbean, 4AGI
Chief Financial Officer, F (RM 10166) (2)
Director, Office of Internal Control and Audit Resolution, FOI (Room 10176) (2)
Associate     Director, US GAO, 820 1st St., NE Union Plaza,                      Bldg.   2 ,
      Suite 150,
 Washington, DC 20002, (2)
Housing - Federal Housing Comptroller, HF, (Room 5132) (3)
Assistant to the Deputy Secretary for Field Management, SDR (Room 7106)
President, Essential Housing Management, Inc.