oversight

McKinley Assoc., Ann Arbor, MI

Published by the Department of Housing and Urban Development, Office of Inspector General on 1996-03-29.

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

                                                        AUDIT RELATED MEMORANDUM
                                                           96-CH-212-1807

March 29, 1996

MEMORANDUM FOR: Robert J. Turner, Director, Office of Housing, Michigan State Office


FROM: Dale L. Chouteau, District Inspector General for Audit, Midwest


SUBJECT:      McKinley Associates
              Multifamily Equity Skimming
              Ann Arbor, Michigan


We completed an audit of the books and records of five HUD-insured and HUD-held projects
owned by McKinley Associates. The five projects were insured under Section 223 (f) of the
National Housing Act. McKinley Associates managed the properties through its identity-of-
interest management agent, McKinley Properties, Inc. The projects were in the Ann Arbor,
Michigan area. The following table shows the project names and the number of units.


                                       Project            Units
                               Scenic Lake                477
                               Pinewood Village           252
                               Schooner Cove II           228
                               Park Place                 312
                               Glencoe Hills              583

The audit objectives were to determine whether the use of project operating funds was reasonable
and complied with the Regulatory Agreement and applicable HUD requirements. Our specific
objectives were to determine whether the owners: made distributions only from available project
surplus cash; assured that all project expenses were reasonable in amount and necessary to the
operations of each project; and made all needed repairs to the buildings.

The owners of McKinley Associates were Ronald Weiser, William C. Tyler, and D. Keith
Hayward. During the audit, Mr. Hayward was the official representative. The books and records
for the projects were at McKinley Properties. The Company's main office was at 320 N. Main
Street, Ann Arbor, Michigan.

Our audit covered the period January 1, 1991 to June 30, 1994. We extended the coverage as
necessary. We conducted the audit at McKinley Properties, Inc. between July and October 1994.
We concluded that McKinley Associates did not fully comply with the Regulatory Agreement
and other HUD requirements. Contrary to the Regulatory Agreement, the owners withdrew
$411,662 of project funds in excess of surplus cash from Glencoe Hills in 1994. During the
audit, the owners reimbursed the project account for these withdrawals. Therefore, no further
follow-up is needed regarding this issue.

Between 1991 and 1994, the owners also made other ineligible disbursements totaling $175,217
from the projects. Four projects were in default at the time the ineligible payments were made,
and HUD's most recent inspection of one project, Scenic Lake, found the project's physical
condition to be below average with required repairs totaling $133,350. HUD rated the other three
projects, Pinewood, Schooner Cover, and Park Place, satisfactory on their most recent
inspections. The remaining project, Glencoe Hills, was current on its mortgage, but had deferred
maintenance repairs totaling $156,870. Attachment 1 describes in more detail our finding
regarding the $175,217.

We provided our draft findings to Mr. Hayward and the Michigan State Office during the audit.
We held an exit conference on December 5, 1994. The auditee provided us written comments
to our draft finding and recommendations, which are summarized in the attached finding. A copy
of the complete comments is included in Attachment 2. The auditee did not agree with our
finding.

Please furnish us copies of correspondence or directives issued because of the audit. If you have
question, please contact me or my assistant, Kathleen Creighton, at (312) 353-7832.




Audit-Related Memorandum                      Page 2
                                                                                    Attachment 1




         McKinley Associates Made Ineligible
                  Disbursements
Between 1991 and 1994, McKinley Associates made ineligible disbursements totaling $175,217
from five HUD-insured projects. The disbursements were made to the identity-of-interest
Management Agent. The payments were for: legal costs; collection costs; project telephone
charges; general administration costs; travel and meal costs; and delivery expenses and
photocopy costs. The Agent's Treasurer told us he was unaware that certain management agent
costs could not be charged to the projects. Because of the ineligible disbursements, the projects
had fewer funds available for normal operations. Four of the projects were in default at the time
the ineligible payments were made. The remaining project had deferred maintenance totaling
$156,870.



                                     The Regulatory Agreement addresses the requirements for
 HUD Requirements
                                     payments of management fees and management costs.
                                     Paragraph 7(a) requires the owners to assure that all project
                                     expenses are reasonable in amount and necessary to the
                                     operation of the project. Paragraph B7(b) requires the
                                     owners to comply with the Secretary's administrative
                                     requirements regarding the payment and reasonableness of
                                     management fees and allocation of management costs
                                     between the management fee and the project account.
                                     Paragraph 7(d) allows the owners to purchase goods and
                                     services from identity-of-interest individuals. However, the
                                     charges leveled by those individuals may not be more than
                                     the costs that would be incurred in making arms-length
                                     purchases on the open market.

                                     The projects' Management Certifications say that the Agent
                                     agrees to comply with Lender and HUD requirements
                                     regarding payment and reasonableness of management fees
                                     and allocation of management costs. Paragraph 4(a) states
                                     that the Agent agrees to assure that all project expenses are
                                     reasonable and necessary to the operation of the project.

                                     HUD Handbook 4381.5 Rev-1, Management Documents,
                                     Agents and Fees, paragraph 2-14(B) requires that the
                                     Agent's overhead and office costs of front-line personnel



                                              Page 3                          Audit-Related Memorandum
Attachment 1



                                       who do not work at the project site be covered by its
                                       management fee. Paragraph 2-15(H) states that Agents may
                                       not impose surcharges or administrative fees on top of the
                                       actual costs. Figure 2-4 of the Handbook shows the types
                                       of overhead expenses. They include: supplies and
                                       equipment; transportation and phone calls to projects; and
                                       office space. Paragraph 2-14(A) states that the management
                                       fee must pay for salaries, fringe benefits, office expenses,
                                       fees and contract costs incurred in recruiting, hiring, and
                                       supervising project personnel, monitoring project
                                       operations, analyzing and solving project problems, and
                                       overseeing investments.

                                       Between January 1, 1991 and June 30, 1994, five
 Ineligible payments
                                       HUD-insured projects made ineligible payments totaling
 totaling $175,217 were
                                       $175,217 to the identity-of-interest Management Agent.
 made to the identity-of-
                                       The payments were for: legal costs; collection costs; project
 interest Management
                                       telephone charges; general administration costs; travel and
 Agent
                                       meal costs; and delivery expenses and photocopy costs. A
                                       table showing the payments by project and description of
                                       the payments follow.


  Account             SCENIC     PINEWOO     SCHOONER            PARK     GLENCOE
  Title                 LAKE           D       COVE II          PLACE        HILLS         Total
                                 TWNHSES

  Legal Costs          $51,112      $2,691       $16,236        $14,931      $17,415     $102,385

  Collections          $11,484      $6,567        $2,924         $2,931       $9,221      $33,127

  Telephone                107       1,360               393       516           938        3,314

  General Admin            141        104                486       516         1,981        3,228

  Travel/Meal              616        538                384       516           768        2,822

  Delivery/ Print          123       5,710          5,303         6,695       12,510       30,341

  TOTAL                $63,583     $16,970       $25,726        $26,105      $42,833     $175,217

                                       Legal Cost. The Management Agent charged the projects
                                       excessive legal fees. The Agent's legal staff prepared and
                                       filed tenant eviction notices, attended court hearings, and
                                       held telephone conferences. Between 1991 and 1993, the
                                       Agent charged the projects $35 per case and between $40
                                       and $110 per hour for staff time. HUD regulations permit
                                       the owners to purchase services from identity-of-interest
                                       individuals. However, the charges may be no greater than


Audit-Related Memorandum                        Page 4
                                                Attachment 1



they would be on the open market. If the Agent had used
outside attorneys, the projects' costs for processing
evictions would have been substantially less. Beginning in
1993, the Agent used outside attorneys to process eviction
cases. We reviewed the invoices submitted by the outside
attorneys. The average charge per case was $37. If the
Agent had used outside attorneys all along, the projects
would have paid $102,385 less in legal costs for tenant
evictions.

Collection Fees. The Agent improperly charged the
projects $33,127 for ineligible collection fees. The Agent
charged the projects for rents and rental assistance
payments collected for tenants still occupying their units, or
within the first month a tenant vacated the unit. Such costs
are included in the management fee.

Telephone Costs. The Management Agent charged the
projects $3,314 for telephone calls. These calls were made
from the Agent's office or mobile telephone to the project
sites. The Agent billed the projects on a pro-rated basis or
for actual costs. According to HUD regulations, telephone
calls to project sites were part of the Agent's overhead costs
and should have been paid from the management fee.
Therefore, such expenditures were not eligible project costs.

General Administrative Expenses. The projects improperly
paid $3,228 to the Management Agent for administrative
costs. The payments included the costs of a newsletter and
petty cash expenses such as, office supplies, food, and dry
cleaning. These administrative costs were part of the
Agent's overhead and therefore, ineligible project expenses.

Travel and Meal Costs. The Management Agent charged
the projects $2,822 for employee travel to the projects and
for meals. The Agent divided the costs among the projects
based on the number of units in each project. The costs of
travel to the projects and meals were part of the Agent's
overhead, and the Agent should have paid for them from
the management fee.

Delivery and Photocopy Expenses. The projects paid the
Management Agent $30,341 for postage and copying costs.
The Agent charged the projects for postage and copying


         Page 5                           Audit-Related Memorandum
Attachment 1



                           costs based on $.60 per unit per month. The copying costs
                           were for photocopies of the projects' bills at the Agent's
                           office. Such expenditures were not eligible project costs.

                           The Treasurer for the projects' general partnership said he
                           was not aware that the Agent could not charge certain
                           management agent costs to the projects. The Treasurer also
                           said the Agent undercharged the projects for allowable
                           costs such as payroll taxes and workers compensation. We
                           believe that undercharging the projects for allowable project
                           expenses was not justification for charging the projects for
                           ineligible costs.

                           The project's owners could have used the ineligible
                           disbursements to pay normal project expenses. Four of the
                           HUD projects - Scenic Lake, Pinewood, Schooner Cove,
                           and Park Place - defaulted on their mortgages. The
                           mortgage for Glencoe Hills was current. HUD's most
                           recent physical inspections showed the condition of Scenic
                           Lake and Glencoe Hills to be below average. Needed
                           repairs totaled $133,350 and $156,870, respectively. The
                           physical conditions of Pinewood, Schooner Cove, and Park
                           Place were satisfactory.



Auditee Comments           The auditee did not agree with the finding. The projects'
                           Chief Financial Officer provided the comments. Excerpts
                           from his comments on our draft finding follow. The
                           complete text is on Attachment 2.

                           The Agent provided the auditors with a summary of the
                           annual direct costs of the legal department. The hourly
                           direct cost of the department based upon annual salaries of
                           the staff plus taxes and fringe benefits was $50.45 per hour.
                           The auditors incorrectly calculated the hourly direct cost (of
                           staff time) by computing an average of the salary amounts
                           instead of combining them. The correct total hourly cost of
                           the department is the cost of the attorney and the support
                           staff divided by the total billable hours of the attorney
                           which is 52 weeks less 4 weeks for vacation and sick time,
                           or 1,920 hours.

                           The $35 flat rate charge per case is a standard practice used
                           by most attorneys doing tenant eviction cases. This cost


Audit-Related Memorandum            Page 6
                                                                   Attachment 1



                    covers (i) the time the staff spends on preparing the
                    paperwork for filing the case, (ii) time of the attorney
                    reviewing the filings, (iii) making the copies required; and
                    (iv) physically filing the case with the court.

OIG Evaluation of   After the auditee's submission of his comments we
Auditee Comments    re-evaluated our method for determining the allowable legal
                    expenditures. In reviewing the auditee's records we
                    determined that the auditee's outside attorneys charged an
                    average of $37 per case. In no instance, did the outside
                    attorneys charge a flat $35 charge on top of the hourly rate.
                    HUD regulations allow the owners to obtain legal services
                    from identity-of-interest individuals, but the charges may
                    not be more than the cost incurred for such services in the
                    open market. In this case, that was $37 per case.



Auditee Comments    The auditors fail to mention that the outside attorneys also
                    charge an hourly rate of $50 per hour by the first attorney
                    and $75 for the first two hours and $75 per hour for
                    additional hours by the second attorney that is the same or
                    greater than the rates charged by Agent's legal department.

                    The amount of the alleged excessive charges relating to
                    Glencoe Hills would increase the surplus cash calculation
                    at December 31, 1993, allowing a greater distribution, and
                    would not impact the property's cash position.

OIG Evaluation of   We reviewed the invoices submitted by the outside
Auditee Comments    attorneys for processing evictions. We found that the
                    outside attorneys charged an average of $37 per case. In
                    determining the average charge per case, we included all
                    outside attorneys' charges including any hourly billings.

                    Though Glencoe Hills may have surplus cash, the HUD
                    inspection done during our audit showed the project had
                    deferred maintenance totaling $156,870. So, the owners
                    should use the surplus cash to fix up the project.




                             Page 7                          Audit-Related Memorandum
Attachment 1




Auditee Comments           Telephone. The items pointed out by the auditors are
                           primarily for specifically identified long distance charges
                           originating from the Corporate Office for properties and
                           cellular phone charges that were allocated on a prorata
                           basis. Marketing staff who made the cellular phone charges
                           for all five properties worked at all properties and made
                           phone calls on their cellular phones for the properties. The
                           telephone charges are not ineligible property costs because
                           they directly benefitted the properties, not the Management
                           Agent.

                           The phone calls in question were made from the Agent's
                           office or cellular phone to the projects.

OIG Evaluation of          According to HUD regulations, telephone calls to the
Auditee Comments           projects' sites were part of the Agent's overhead costs, and
                           the Agent should have paid for them from the management
                           fee. Therefore, the phone calls were ineligible project
                           expenditures.


Auditee Comments           General Administration.        The auditors disqualified
                           reimbursements for the cost of producing a company
                           newspaper that was distributed to each of the property's
                           employees. The newsletter benefits the property employees
                           directly and the properties indirectly and not the Agent by
                           building team spirit and morale.

                           Petty cash reimbursements were for office supplies used at
                           the properties, food for employee and resident functions
                           and other property related goods and services. These are
                           reasonable property-related costs and are not part of the
                           Agent's overhead.

OIG Evaluation of          The costs of producing the Agent's newspaper was part of
Auditee Comments           the Agent's overhead costs and therefore, the Agent should
                           have paid them from the management fee.

                           Our finding questioned those petty cash reimbursements
                           that came from the Agent's petty cash and were charged to
                           the projects. During the audit we repeatedly requested that
                           the auditee produce evidence that the Agent made petty


Audit-Related Memorandum           Page 8
                                                                   Attachment 1



                    cash payments for the benefit of the projects. The auditee
                    produced no such evidence. In January 1995, after
                    receiving the auditee's comments, we again requested the
                    auditee provide support. The Agent's Treasurer told us he
                    decided not to look for the support because it was not cost
                    beneficial to spend the time. He considered the amounts as
                    minor. Therefore, we believe the Agent should pay back
                    the projects.



Auditee Comments    Travel and Meal Costs. Reimbursement to property
                    employees for meals and mileage while conducting
                    business for the properties is a reasonable property expense.
                    The amount of $2,822 for 3½ years for five properties does
                    not seem unreasonable. The auditors disqualified $653 of
                    reimbursements included in this amount for a company-
                    wide drawing for a one-week vacation for two people that
                    was performance based and open to employees of all
                    properties. Employees were eligible for the drawing only
                    if they achieved certain occupancy and delinquency
                    collection goals. This is a reasonable property expense that
                    directly benefitted the properties. The expense was charged
                    to all McKinley residential units on a prorata basis
                    according to the number of units at each property.

OIG Evaluation of   We did not question the reimbursement for meals and
Auditee Comments    mileage to the projects' employees. We only questioned
                    reimbursement to the Agent's employees that the Agent
                    paid from project funds. In January 1995, after receiving
                    the auditee comments, we again asked the auditee to
                    provide proof to support their assertion that the costs for
                    meals and travel were incurred for project employees rather
                    than Agent employees. The Agent's Treasurer told us it was
                    not cost beneficial for him to pursue the issue beyond
                    giving us a verbal explanation. Therefore, the Agent should
                    reimburse the project the amount of $2,822.

                    In January 1995 the Agent's Treasurer provided us a
                    memorandum explaining the marketing program that was
                    open to all Agent employees. The winner received a boat
                    cruise. The projects' Management Certification states that
                    the Agent agrees to assure that all project expenses are
                    reasonable and necessary to the operation of the project.



                             Page 9                          Audit-Related Memorandum
Attachment 1



                           Therefore, we disallowed the $653 charged to the projects
                           for the boat cruise drawing.

Auditee Comments           Delivery and Photocopy Expenses. The Agent charged
                           $.60 per apartment unit per month to reimburse the Agent
                           for the cost of postage for mailings for the property and to
                           reimburse for the cost of making copies for the property's
                           benefit. The postage was for mailing the payments of bills,
                           security deposit returns, delinquency demands and traces,
                           reports to HUD, auditor verification requests, federal, state,
                           and local tax returns and other required governmental
                           reports, with other property related correspondence. The
                           photocopy costs were for copies of the above items that
                           were necessary to keep for the properties and for various
                           report and management forms that were used by the
                           properties and maintained on site. The properties would
                           have incurred these costs directly if these items had been
                           posted from the properties and all copying and forms
                           reproduction had been completed at the sites. The cost of
                           overnight mail was charged to the properties when it was
                           necessary to send documents to a third party or to the
                           property overnight. Overnight mail costs were paid to non-
                           identity-of-interest third party vendors. The delivery and
                           printing expenses noted by the auditors are reasonable
                           property expenses.

OIG Evaluation of          HUD Handbook 4381.5, Management documents, Agents,
Auditee Comments           and Fees, Revision 1 requires that office and overhead
                           expenses of front-line personnel who do not work at the
                           project site to be paid from the management fee. Therefore,
                           the postage charges and photocopying from the Agent's
                           office are part of the Agent's overhead cost. During our
                           subsequent review of documentation provided by the
                           auditee, we reduced ineligible costs to allow for overnight
                           delivery charges.


Recommendations            We recommend that the Michigan State Office's Director of
                           Housing requires the projects owners to:

                           A.     Reimburse Glencoe Hills Apartments for ineligible
                                  and unsupported expenses totaling $42,833 paid to
                                  the Agent.


Audit-Related Memorandum           Page 10
                Attachment 1




Page 11   Audit-Related Memorandum
Attachment 1



                           B.    Repay HUD ineligible expenses totaling $132,384
                                 paid to the Agent from the projects that were in
                                 default - Scenic Lake, Pinewood, Schooner Cove II,
                                 and Park Place.

                           C.    Implement procedures and controls to ensure that all
                                 disbursements of projects funds are eligible and
                                 supported.

                           We also recommend that the Michigan State Office's
                           Director of Housing:

                           D.    Consider imposing administrative sanctions against
                                 the owners to the full extent of the law.




Audit-Related Memorandum          Page 12