oversight

Villa San Carlos Garden Apts., Santa Cruz, CA

Published by the Department of Housing and Urban Development, Office of Inspector General on 1998-03-24.

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

                             Audit Report
                             District Inspector General for Audit
                             Pacific/Hawaii District
                             Report: 98-SF-212-1001                    Issued: March 24, 1998



TO:            Janet L. Browder, Director, Multifamily Housing Division, 9AHM


FROM:          Glenn S. Warner, District Inspector General for Audit, 9AGA

SUBJECT:       Villa San Carlos Garden Apartments
               Multifamily Mortgagor Operations
               Santa Cruz, California


At the request of the Multifamily Asset Management Branch of HUD’s Office of Housing,
California State Office, we conducted an audit of Villa San Carlos Garden Apartments (proj-
ect 121-44153) whose mortgage loan the U.S. Department of Housing and Urban Develop-
ment insured under section 236 of the National Housing Act.

The report’s two findings describe misuse of project assets and problems with the project’s
physical condition as well as other aspects of the project’s management. Within 60 days,
please furnish us a status report on (1) the corrective action taken, (2) the proposed corrective
action and the date to be completed, or (3) why action is not considered necessary for each
recommendation in the report. However, we request that action not be taken on the rec-
ommendations until you have consulted with us.

If you or your staff have any questions, please contact senior auditor Mark Pierce at 436-
8101.
                                                                     98-SF-212-1001




Executive Summary
We reviewed operations of Villa San Carlos Garden Apartments. Our objective
was to determine whether the use of project assets complied with the regulatory
agreement between the owner and HUD. We concluded that the project was not
managed in accordance with HUD’s requirements. There was unnecessary and
unsupported use of assets. In addition, management practices were inadequate for
procurement of services and materials, and for handling employee time and atten-
dance records.

                    As the project’s management agent, Creative Property Man-
Asset Misuse
                    agement (CPM) collected or disbursed unnecessary amounts
totaling $188,803 from Villa San Carlos Garden Apartments (VSC). Also, the
propriety of CPM’s receipt and disbursement of an additional $98,377 was not
supported. Subsequent to CPM’s involvement, the president of the VSC board of
directors incurred additional improper expenses of $15,000. These events oc-
curred due to management and owner disregard of HUD requirements and VSC
policies, poor oversight by the VSC board, and poor accounting and record keep-
ing. As a result, the project experienced cash deficiencies and deferred mainte-
nance. The level of deferred maintenance more than doubled to over $1 million,
resulting in poor living conditions for residents.

                               Additionally, we noted that procurement practices
Other Deficient Practices
                               were inadequate and the employee time and at-
tendance records appeared to be unreliable. These occurred because of insufficient
oversight by the VSC board and poor management practices of the agent.

                        With minor exception, the owner generally agreed with
Auditee Response
                        the audit’s conclusions. CPM declined to comment.

                         We are recommending that HUD: assure that acceptable
Recommendations
                         and competent management is in place to run the project,
obtain compensation for the misuse of project assets, and take other actions to cor-
rect the noted problems.




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Table of Contents
Management Memorandum ..................................................................i

Executive Summary.............................................................................ii

Introduction.........................................................................................1

Findings

         1. Agent and Board President Made Unnecessary and
            Unsupported Use of Project Assets ......................................4

         2. Other Poor Management Practices Were Noted..................25

Management Control.........................................................................28

Prior Audit Findings ..........................................................................29

Appendices

         1. Schedule of Unnecessary, Unreasonable, and
         Unsupported Amounts.............................................................30

         2. Auditee Comments .............................................................31

         3. Distribution ........................................................................37




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Acronyms
CPM   Creative Property Management (former management agent/property
      manager for the project)

HUD   U.S. Department of Housing and Urban Development (insurer of the
      project’s mortgage loan)

OIG   Office of Inspector General, U.S. Department of Housing and Urban
      Development (performed the subject audit)

USC   United States Code (federal law)

VSC   Villa San Carlos Garden Apartments (the project) or Villa San Carlos,
      Incorporated (project owner/mortgagor), depending upon the context




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Introduction
BACKGROUND

                Villa San Carlos Garden Apartments (project) is a 200-unit hous-
The Project
                ing development located in Santa Cruz, California. The project
owner and mortgagor, Villa San Carlos, Incorporated, is a non-profit organization
established in February 1971 to provide housing for low and moderate income
families and individuals. The mortgagor’s articles of incorporation established a
three-member board of directors to conduct its affairs.

The project is subject to a mortgage insured pursuant to section 236 of the Na-
tional Housing Act, with a balance of $2,274,836 as of December 31, 1995. In
compensation for the insurance, the mortgagor agreed to be subject to HUD
regulations over project operations. These requirements are contained or refer-
enced in a contract known as a regulatory agreement.

In addition, the project receives subsidies from HUD for many of its low-income
tenants under the section 8 program. Under this program, the mortgagor is con-
tractually obligated to assure the tenants receiving assistance are eligible, that as-
sistance amounts are proper, and that the housing is safe, decent and sanitary.

                In February 1993 Victor Camacho, president of the VSC board
Management
                of directors, and E. R. Silva, president of Creative Property
Management, entered into a management certification agreement, a standard HUD
form. HUD approved this agreement in May 1993. CPM continued to manage
VSC until August 31, 1996, when the agreement was terminated.

CPM was a Fairfield, California-based company operated by E. R. Silva, who was
the owner and president. CPM handled no additional HUD subsidized housing
projects while managing Villa San Carlos. It was CPM’s practice to maintain VSC
records at the project site in Santa Cruz, except for payroll records kept in
Fairfield.

Benno Pabst, President of U.S. Prime Property Management, began managing
Villa San Carlos in September 1996. Mr. Pabst has maintained office space on-site
in the project’s administration office, and has been given the position of “project
administrator.” Mr. Pabst does not manage any other HUD subsidized housing
projects. HUD has not approved U.S. Prime Property as the management agent of
VSC and has taken exception with the cost of the additional position.




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                    On August 20, 1996, the Multifamily Asset Management
Audit Request
                    Branch of HUD’s Office of Housing, California State Office,
requested that the Office of Inspector General perform an audit of the project.
The request cited long-standing issues related to fiscal incompetence or possible
misuse of project assets.

AUDIT OBJECTIVES AND SCOPE

                          We reviewed project operations to determine if the
Purpose and Extent
                          mortgagor’s and the management agents’ use of project
assets complied with the regulatory agreement and other HUD requirements. The
audit generally covered the period from February 1993 to August 1996, the period
Creative Property Management maintained management control over Villa San
Carlos. Audit work was performed intermittently from August 1996 to September
1997.

The primary methodologies for this work included:

   •   Review of pertinent files on the project and the agent maintained by HUD
       California State Office, the Villa San Carlos administration office, and
       Creative Property Management’s office.

   •   Interviews of San Francisco HUD program officials, Villa San Carlos on-
       site staff, the Villa San Carlos board president, the president of U.S. Prime
       Property Management, and the president of Creative Property Manage-
       ment.

   •   Consideration of the project’s management control structure and assess-
       ment of risk exposure to determine audit procedures.

   •   Analysis of available audited financial statements of the project.

   •   Review of project accounting records and substantive tests of selected fi-
       nancial activities and transactions.

   •   Direct confirmations with selected vendors.

This report reflects our consideration of auditee comments. We obtained written
comments from the president of the VSC board of directors (see Appendix 2) and
discussed the audit’s conclusions in person on January 26, 1998 with the board
president, and the project’s administrator Benno Pabst and public accountant
Dennis Lorette. CPM, the former management agent, ignored our attempts to
obtain its comments. The board president advised us that CPM’s owner declined
to provide comments.



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            We conducted the review in accordance with generally accepted
Standards
            government auditing standards.




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Findings
Finding 1
Agent and Board President Made Unnecessary and
Unsupported Use of Project Assets

We concluded that $302,180 of project funds were used for unnecessary or
unsupported purposes. CPM improperly received or disbursed $188,803.
CPM also received or disbursed an additional $98,377 in unsupported
amounts. After CPM’s management of the project ended, the VSC president
of the board of directors incurred additional ineligible expenses of $15,000.
These events occurred due to management and owner disregard of HUD and
VSC policies, lack of oversight by the VSC board, and poor accounting and
record keeping. As a result, the project operated with cash deficiencies and
suffered deferred maintenance; causing tenants to reside in unacceptable
conditions and unnecessarily increasing HUD’s insurance risk. The level of
deferred maintenance more than doubled in less than four years to over $1
million, resulting in poor living conditions for residents.


                                    The regulatory agreement between HUD and
Requirements on Asset Use
                                    the project owner, Villa San Carlos, Inc., was
signed on July 12, 1971. The agreement states that the owner cannot encumber or
pay out any project funds, except for reasonable operating expenses and necessary
repairs. Payments for materials and services shall not exceed amounts ordinarily
paid for such items. The books and accounts of the project’s operations are to be
kept in accordance with HUD requirements. Also, the owner is to maintain the
mortgaged premises, accommodations, grounds, and equipment in good repair and
condition.

E. R. Silva, President of CPM, and Victor Camacho, president of the VSC board,
had entered into a management certification agreement on February 10, 1993. The
agent agreed to assure that all expenses of the project are reasonable and neces-
sary, exert reasonable efforts to maximize project income, take advantage of all
discounts, and maintain documentation supporting their endeavors. The agent also
agreed to establish and maintain the project’s accounts, books and records in ac-
cordance with HUD’s requirements, generally accepted accounting principles, and
in a condition that will facilitate audit. The agent also agreed to comply with the
project’s regulatory agreement, HUD handbooks and notices, and HUD require-


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ments regarding payment and reasonableness of management fees and other
charges. HUD Handbook 4381.5 REV-2, The Management Agent Handbook,
establishes criteria for determining eligible management fee and charges.

Section 421 of the Housing and Community Development Act of 1987 (Public
Law 100-242) contains double damages civil remedy for unauthorized use of mul-
tifamily housing project assets and income, codified under United States Code, title
12, section 1715z-4a. Under this statute, assets used in violation of the regulatory
agreement, as well as unsupported uses of assets, are subject to civil remedy. In
addition, the 1989 HUD Reform Act provides for civil penalty amounts ranging
from $1,000 to $25,000 per violation on program participants who knowingly and
materially violate program statutes, regulations and handbook requirements.

CPM improperly received project funds in excess of actual cost incurred and
authorized management agent fees. In addition, the agent and the owner of VSC
made unnecessary and unsupported disbursements of project funds to vendors.
We have categorized these violations of the regulatory agreement as follows.

                          Issue                   Unnecessary   Unsupported
                                                   Amounts       Amounts
           I     Management fees                     $32,933        $29,747
           II    Payroll                             117,187         51,944
           III   Security deposit transfers           13,000
           IV    Workers compensation insurance       23,917          4,867
           V     Miscellaneous disbursements            1,766        11,819
           VI    Disbursements by owner               15,000
                              Totals                $203,803        $98,377



I. MANAGEMENT FEES

Between 1993 and 1996 CPM received management fees of $32,933 in excess of
HUD directives, including the HUD handbooks and the management certification.
The agent also collected another $29,747 in unsupported management fees. Based
on the documentation available, the agent cannot show that the amount was rea-
sonable and necessary for the project.

The management certification provided that the agent receive 13 percent of resi-
dential, commercial, and miscellaneous income collected. HUD’s approval on
May 19, 1993 limited the fee to 13 percent of residential and miscellaneous income
collected. The agreement states that if the agent is notified of an excessive man-
agement fee, within thirty days the agent will reduce the compensation to an
amount HUD determines to be reasonable and refund all excessive fees collected.
Also, HUD may adjust the management fee percentage each time HUD approves a
rent increase.



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HUD Handbook 4381.5 REV-2, The Management Agent Handbook, established
criteria for determining how the management fee is computed. Income for the
purpose of determining a fee does not include: interest earned on invested security
deposits, reserves, or other project funds; section 8 special claims for unpaid rent,
vacancy loss, debt service, or resident damages; HUD flexible subsidy funds; re-
funds from property tax or utility rate appeals; proceeds from property damages or
liability insurance policies; recovered legal fees and court cost; or replacement re-
serve and residual receipts reimbursements.

                  From 1993 to 1996 CPM received $32,933 in excessive man-
Excessive Fees
                  agement fees. This includes $21,632 collected as the monthly
management fees and $11,301 in back-fees and adjustments in addition to the
monthly fee.

The management certification stated that CPM was entitled a fee of thirteen per-
cent of residential rent income and miscellaneous income collected. However,
with approval of an October 1993 rent increase, HUD imposed a dollar limit. The
limitation allowed CPM to continue to charge the project thirteen percent of in-
come collected, but not to exceed $9,000 per month. Beginning in 1996 HUD al-
lowed an increase to $10,000.

Management fees collected by the agent for the period of October 1992 to Sep-
tember 1993, before the fee limitation was set into place, were computed based on
thirteen percent of income collected. Then from October 1993 to August 1996
CPM charged the maximum cap amounts.

However, the documentation provided by CPM showed that certain income was
improperly included into the agent’s fee calculations. The agent did not remove
not-sufficient-fund (NSF) rent checks from his calculations. When the NSF checks
were honored in succeeding months they were included again as rent collected,
which resulted in the agent double charging a fee on that income. In addition, in-
eligible income was used in the agent’s computation, including: excess income due
HUD, replacement reserve withdrawals, security deposit interest, property tax re-
funds, transfers of funds between VSC accounts, and discrepancies which did not
match the project accounting reports.

   •   The agent’s documentation showed that for each month between February
       1993 and May 1996, excess income due HUD was included into the fee
       computation.

   •   In April 1993 the agent listed $13,005 as income collected and included the
       amount into the fee calculation. The VSC monthly accounting reports
       showed that this amount was actually a transfer from the savings account.
       There were similar instances in which transfers between accounts were




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       listed as income: February 1993, March 1993, May 1993, June 1994, and
       April 1996.

   •   In May 1993 laundry income of $1,137 was included twice in the fee cal-
       culation, once as laundry income and then again as unidentified miscellane-
       ous income. Similar errors occurred in September 1993, October 1993,
       March 1994, October 1994, December 1994, September 1995, October
       1995, December 1995, and April 1996.

   •   In July 1993 $14,600 in withdrawals from the replacement reserve were in-
       cluded in the agent’s determination of the fee. Replacement reserve with-
       drawals were also included in fee computations for March 1993, April
       1993, August 1993, October 1993, February 1994, November 1994, Sep-
       tember 1995, and April 1996.

The amounts the agent computed as management fees were to be limited by the fee
ceiling. Fees computed based on eligible or ineligible income in excess of the ceil-
ing were correctly not collected by the agent in November 1993, and from May
1994 to December 1995. However, fees based on eligible income were below the
ceiling in October 1993, December 1993 to April 1994, and January 1996 to June
1997. Since the agent charged the amount of the ceiling during these months, the
difference of $6,441 between the proper fee and the ceiling was solely attributable
to fee calculations based on ineligible income. Before the fee ceiling was estab-
lished, the agent received excessive fees based on ineligible income each month.
This resulted in additional ineligible fees of $15,191 for the period of October
1992 to September 1993. Thus, the agent collected excessive monthly manage-
ment fees of $21,632 during his term as the VSC agent.

           Period             Fee Based on      Fee Ceiling   Monthly Fee      Excessive
                             Eligible Income                   Collected         Fee
   Oct. 1992 to Sept. 1993           $86,397           none      $101,588       $15,191
   Oct. 1993                            7,234        $9,000          9,000        1,766
   Nov. 1993                            9,482         9,000          9,000             0
   Dec. 1993 to April 1994             42,273        45,000         45,000        2,727
   May 1994 to Dec. 1995             195,839        180,000       180,000              0
   Jan. 1996 to June 1996              58,052        60,000         60,000        1,948
   July 1996 to Aug. 1996              23,125        20,000         20,000             0
                                                                                $21,632



In addition to the above monthly fees, the agent received back fees and adjust-
ments of $11,301. Although CPM had already received the maximum fee allowed,
the agent still collected additional fee adjustments of $2,000 on November 17,
1994 and $1,300 on December 28, 1995. The agent also collected back fees of
$958 on May 2, 1996, $5,000 on August 15, 1996, and $2,043 on September 1,
1996.


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Based on documentation provided by the agent, the back fees for the period of
February 1993 to September 1993 were based on ineligible income. In addition,
the agent had already been paid the maximum fee allowed under the $9,000 ceiling
between October 1993 and December 1995. Thus, any back fees accrued by CPM
during this period violated the HUD-imposed limitation. The agent stated that he
believed the fee limitation imposed by HUD was actually $10,000 per month from
when the maximum limit was first imposed, so he charged that amount. However,
CPM could not substantiate this assertion. Thus, the back fees and adjustments
received by CPM totaling $11,301 were excessive.

                       The agent also collected unsupported management fees
Unsupported Fees
                       that included $749 collected based on unsupported in-
come, and questionable fees of $28,998 collected for the period of October 1992
to January 1993.

CPM included inadequately supported miscellaneous receipts of $1,910 for March
1993 and $3,849 for February 1993 in the computation of management fees. CPM
received $749 in fees based on these receipts. These miscellaneous receipts were
included in the VSC accounting reports, but there was no documentation to ex-
plain the income source. As a result, the agent cannot show that the fees were
based on eligible income.

Also, the agent received fees totaling $34,156 for alleged services between Octo-
ber 1992 and January 1993. The agent collected these fees for the period in ques-
tion on May 19, 1993, the date HUD approved the management certification. The
management agreement between CPM and the owner was dated September 15,
1992, corresponding with the amount collected. However, the owner did not sign
the management certification until February 10, 1993. VSC had previously at-
tempted to obtain HUD approval to allow CPM to manage the project, but HUD
rejected the request on October 9, 1992. Due to HUD’s rejection of CPM, the
agent was not supposed to provide management services to the project. However,
HUD officials told us that since CPM was eventually approved, the agent could
collect fees for the previous period in which he was providing management serv-
ices to VSC.

Nevertheless, we noted no substantive evidence that CPM was providing manage-
ment services to the project until February 1993. There was no documentation
available to show that CPM was preparing or signing project related reports or
correspondence until February 1993. In addition, CPM did not establish a payroll
account or bank accounts for the project until February 1993. The agent waited
until February 1993 to charge the project for his administrative assistant. Also,
letters subsequently issued by CPM to third parties implied that CPM did not begin
handling VSC affairs until February 1993. Of the $34,156 charged for the period




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in question, $5,158 was based on ineligible income with which we already took
exception above, leaving a net amount of $28,998.

II. PAYROLL

The project paid $117,187 for unnecessary payroll-related expenses to the agent
and insurance vendors between February 1993 and August 1996. The agent also
collected $51,944 for payroll without maintaining proper documentation to show
that the amount was proper.

                           Description               Topic     Itemized
                                                    Amount     Amount
               Non-project employees                $85,994
                 Consultant                                     $17,625
                 Agent’s wife                                    15,773
                 Agent’s assistants                              33,856
                 Employer taxes                                   2,437
                 Health benefits                                 13,546
                 Worker’s compensation insurance                  2,757
               Unnecessary disbursements             31,193
                 Excessive transfers                              7,431
                 Payroll advances                                 1,400
                 Double payments                                 11,576
                 Excess taxes                                     9,154
                 Excess processing fees                           1,632
               Unsupported payroll costs             51,944
                Payroll processing                               18,671
                Employee payroll 1993                            26,399
                Taxes 1993                                        6,874
                              Totals               $169,131    $169,131



HUD Handbook 4381.5 Rev-2, states that costs covered by the agent’s monthly
fee include: the selection and establishment of an accounting system and internal
management control procedures; visits to spot check performance of on-site staff,
bookkeeping expenses attributable to the agent’s company; and overhead expenses
(such as the agent’s supplies and equipment, transportation, and phone calls to
project, regularly scheduled long distance calls from project to agent, office space,
data processing, etc.). Thus, expenses covered by the monthly fee include salaries,
fringe benefits, office expenses, fees, and contract costs for the following activities:
designing procedures/systems to keep the project running smoothly and in confor-
mity with HUD requirements; recruiting, hiring, and supervising project personnel;
training for project personnel that exceeds the line item budget for training ex-
penses; monitoring project operations by visiting the project or analyzing project
performance reports; and analyzing and solving project problems.




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The handbook also states that the agent may not impose surcharges or administra-
tive fees in addition to actual costs of reimbursable expenses. The cost of per-
forming front-line management functions off-site may not exceed the total cost of
performing these functions at the property. An agent’s generalist staff must docu-
ment hours spent and duties performed on front-line activities for each project and
those spent on the central office functions.

                                The agent collected and paid out $85,994 from the
Non-project Employees
                                project for employees not performing front-line
services for the project. This included the employees’ salaries of $67,254, payroll
taxes, health benefits, and workers’ compensation expense of $18,740.

The agent collected $67,254 from the project for the entire salaries of CPM em-
ployees not performing any substantial front-line project duties. This included a
consultant, Charles Amaral; the agent’s wife; and three administrative assistants.
These costs were to have been borne by the monthly management fee.

Charles Amaral was employed by CPM between June 1993 and February 1994 at a
cost to the project of $17,625. According to the agent and project personnel, Mr.
Amaral worked at the project site to help convert the project over to CPM’s oper-
ating and reporting procedures. This included training and supervising employees
on the implementation of the agent’s procedures and establishing computer sys-
tems. The consulting services of Mr. Amaral were not listed as a separate expense
on the monthly accounting reports submitted to HUD, but were charged to the
project for eight months through payroll charges.

The functions performed by Mr. Amaral were management in nature which the
project already compensated for as part of the agent’s monthly fee, with the possi-
ble exception of implementing and training the project staff on the computer sys-
tem. However, no documentation was available to separate the effort attributable
to possible eligible activities. Still, the effort to implement the agent’s computer
system and train the three members of the office staff would not have been mate-
rial. Thus, we take exception to the entire amount.

The agent collected $15,773 for compensation to his wife, who was supposedly
acting as a consultant for VSC between August 1995 and August 1996. The agent
stated that as a consultant, his wife spent two days a month preparing and review-
ing the monthly ABC report required by HUD. However, the VSC occupancy
specialist prepared the two most extensive portions of the report, which showed
the project’s disbursements and accounts payable. The agent’s wife was reviewing
the occupancy specialist’s work and preparing the summary page of the ABC re-
port. Time spent reviewing the work of the occupancy specialist was supervisory
activity which is included as part of the management fee.




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The agent charged $33,856 to the project for compensation paid to his administra-
tive assistants. The agent maintains that these employees were preparing and re-
viewing the monthly accounting reports required by HUD, before his wife per-
formed these functions. He also said they performed additional unspecified and
undocumented project-related activities.

The agent stated that the three employees replaced one another, performing the
same function. However, the agent only had the personnel file for one. Her ap-
plication to CPM on January 5, 1994 was for a receptionist position. Her prior
experience was in sales and as a receptionist. The résumé prepared by the agent,
upon her termination, listed her as an administrative assistant. The résumé listed
some bookkeeping activities, but it was not evident what the nature of these ac-
tivities were or whether they were performed for the project or the agent. The
administrative assistant declined to speak with us about her duties at CPM.

Subsequent to the agent’s management of the project, the occupancy specialist has
prepared the entire monthly report. She spends less than half an hour preparing
the summary page of the report. The VSC staff were unaware that the agent’s
wife or assistants had ever assisted with the monthly report. In addition, on April
10, 1993 the agent stated in a letter to HUD that all project accounting, except for
the general ledger, would be included as part of the management fee. We consider
the charges for the agent’s wife and assistants to prepare a part of the monthly re-
port as unreasonable, since the occupancy specialist could have prepared the entire
report at no additional cost to the project.

The project paid CPM at least $2,437 in employer payroll taxes for the three ad-
ministrative assistants. This amount includes $1,975 in FICA and $462 in Medi-
care. We found no evidence, however, that payroll taxes for Charles Amaral or
the agent’s wife were charged to the project.

The project also paid $13,546 for the health benefit costs of non-project employ-
ees: $5,193 to Pacific Care for the agent’s personal health coverage between June
1994 and August 1996; $1,797 to Pacific Care for an administrative assistant’s
health coverage between September 1994 and October 1995; $6,343 to Pacific
Care for health benefits of an agent employee, whose salary was not charged to the
project, between June 1994 and June 1996 (project staff could not identify this
person as ever having worked for or having been associated with the project); and
finally, $213 was paid to Ameritas Insurance for an administrative assistant’s den-
tal benefits between May 1994 and September 1995.

The project paid an estimated $2,757 for the workers’ compensation insurance ex-
pense of the non-project employees. The documentation provided by the VSC
workers’ compensation vendor, California Indemnity Insurance (CII), listed three
such employees under the agent’s workers’ compensation policy between 1993
and 1994. The premium paid is based on the actual payroll incurred, so the cost



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increases with additional payroll. We estimate that as much as $2,757 may be at-
tributable to the three employees, based on an average percentage for all employ-
ees. We realize that certain employees may have differing rates, so the actual
amount may be lower, but the vendor could not provide information on rates
charged for individual employees.

                                    CPM collected or paid $31,193 from the
Unnecessary Disbursements
                                    project for other unnecessary payroll related
expenses. This amount includes excessive payroll transfers, double collections of
employee deductions, excess payroll taxes collected, and unreasonable payroll
processing fees. In addition, CPM provided payroll advances to VSC staff directly
from project accounts and never credited the project’s payroll for these amounts.

The agent transferred excessive amounts totaling $7,431 from project accounts to
the CPM payroll account. The transfers included $1,500 on July 27, 1994, $4,238
on August 30, 1994, and an excess $1,693 in September 1994. The bank state-
ments and payroll reports show that all payroll expenses due had already been col-
lected. Thus, the additional payroll transfers are unreasonable.

CPM paid payroll advances of $1,400 directly from the project operating account.
The advances included $600 on May 16, 1995 and $800 on September 22, 1995
(checks 1847 and 1993). The payroll reports did not reflect any reduction in the
employees’ salaries after the advances. As a result, the project paid for the em-
ployees’ salary twice.

CPM double charged the project $11,576 for employee deductions. Specifically,
the agent collected deductions directly from the project as payroll expenses which
were also deducted from the employees’ gross salary for payments to the Internal
Revenue Service and the Family Support Division for two project employees be-
tween January 1994 and August 1995.

The project paid the agent $9,154 in excessive payroll taxes. The payroll reports
were prepared by an independent payroll processing vendor and listed the amounts
that were due as payroll taxes for each pay period. However, amounts paid to the
agent for payroll taxes between August 1993 and December 1994 exceeded the
amounts listed on the payroll reports by $9,154. This included amounts in excess
of the actual tax of: $1,137 on August 15, 1993, $2,019 on September 15, 1993,
$1,230 on March 1, 1994, $800 on May 1, 1994, $1,000 on August 1, 1994, and
$2,968 on December 31, 1994.

The agent received excessive payroll processing fees between May 1996 and
August 1996 totaling $1,632. CPM contracted through a vendor to process the
payroll, issue payroll checks, and provide payroll reports. According to CPM, the
amounts collected from the project consisted of a flat two percent fee on payroll;
however this exceeded the amounts paid to the payroll vendor. Between May



                                                                               12
                                                                      98-SF-212-1001


1996 and August 1996 CPM collected $2,164 in processing fees. The invoices
and payroll reports provided by the vendor showed that they only received $532
for the period. The additional fees were collected by the agent to allegedly reim-
burse CPM for additional time spent processing the payroll. However, CPM kept
no records on time spent processing the VSC payroll, and we believe it is unrea-
sonable to charge the project for additional payroll processing when the project is
already paying a payroll processing vendor. Any time spent by the agent reviewing
the payroll reports or time cards would be supervisory activity which is compen-
sated by the management fee.

                                    The management certification states that the
Unsupported Payroll Costs
                                    agent agreed to assure that all project expenses
are reasonable and necessary and to maintain copies of such documentation. Also,
the agent agreed to establish and maintain the project’s accounts, books and rec-
ords in accordance with HUD’s administrative requirements, generally accepted
accounting principles, and in a condition that will facilitate audit. However, the
agent collected $51,944 from the project for unsupported payroll related expenses,
including payroll processing fees, employee salaries, and taxes.

The agent collected $18,671 in payroll processing fees from VSC between 1993
and April 1996 in addition to the amounts listed on the payroll reports as having
been paid directly to the vendor after November 1995. The agent did not maintain
documentation to support the reasonableness of the $18,671 charge. Part of the
unsupported amount was attributed to the cost of having the payroll processing
vendor, Payroll Masters, prepare the payroll reports. Amounts paid to the payroll
vendor to prepare the payroll reports would be acceptable project expense. How-
ever, the agent has included an additional ineligible surcharge on payroll as his own
payroll processing fee (see ineligible processing discussed earlier). However, due
to the lack of documentation, all amounts paid to the vendor during the period
February 1993 to April 1996 could not be determined.

The agent was paid $26,399 for payroll without maintaining adequate documenta-
tion: $24,691 for pay dates of February 16, 1993 to April 1, 1993 and $1,708 for
pay dates of April 15, 1993 to June 15, 1993.

According to monthly accounting reports and bank statements, the agent was paid
$26,691 for employees’ salaries between February 16, 1993 to April 1, 1993.
However, no payroll records were available to show that these costs were only for
front-line employees. Since we already took exception to the salary attributable to
a non-project administrative assistant (identified from information provided by the
insurance carrier), the net amount considered to be unsupported is $24,691.

There was additional unsupported payroll of $1,708 for the pay dates of April 15,
1993 to June 15, 1993. A comparison of the amounts listed on the payroll reports
to the amounts paid and listed on the monthly accounting reports as employee sal-



                                                                                  13
                                                                   98-SF-212-1001


ary shows a discrepancy of $1,708. There was no support available to confirm if
the amount paid to the agent was attributable to project employees.

The agent collected $6,874 in unsupported employer payroll taxes from VSC in
1993. The payroll taxes for the pay dates of February 16, 1993 to June 15, 1993
were not listed on available payroll reports.

III. SECURITY DEPOSIT TRANSFERS

HUD Handbook 4370.2 REV-1, Financial Operations and Accounting Proce-
dures for Insured Multifamily Projects, dated May 1992 states that security de-
posit funds cannot be commingled with operating or agent accounts. Disburse-
ments from the account can only be for refunds to tenants or payment of appropri-
ate expenses incurred by the tenant. These disbursements must be supported by
approved invoices and/or bills.

The agent improperly transferred $13,000 from the VSC security deposit account
to his own account between 1993 and 1995. This included $8,000 on April 7,
1993 sent to the agent’s payroll account even though all payroll due during this
period had been collected from the operating account. On July 27, 1994 the agent
was responsible for a bank-originated withdrawal of $2,000 from the market rate
security deposit account. This amount was not issued as a check to a vendor or
tenant, and was not re-deposited into one of the project’s accounts. In addition,
on September 7, 1995 $3,000 was transferred from security deposit account to the
agent. There was no apparent legitimate basis for these transfers.

IV. WORKERS’ COMPENSATION INSURANCE

The agent collected $26,039 in 1996 for excessive and unsupported workers’
compensation insurance charges. In addition, in 1995 the agent failed to obtain a
refund of approximately $2,745 for the project.

In 1996 the agent collected $26,039 for workers’ compensation insurance from
VSC. Of that amount, $21,172 was excessive and $4,867 was for unsupported
payments. The agent claimed that he had made payments to the workers’ compen-
sation vendor, California Indemnity Insurance, for the project’s employees. The
only documentation that the agent could provide was a rate proposal from Califor-
nia Indemnity Insurance (CII) which would have required deposits and payments
matching the amounts CPM collected from VSC.

The $26,039 consisted of: $6,039 paid to CPM on check 2183, dated February 15,
1996; $5,000 transferred to the agent on May 21, 1996; $7,500 paid to the agent
on check 2285, dated May 16, 1996; $2,500 transferred to the agent in July 1996;
and two payments of $2,500 each were issued on checks 2365 & 2342 in July
1996. The latter two checks were accepted by the bank without a payee listed and


                                                                              14
                                                                     98-SF-212-1001


the endorsement on the back of the check. The agent stated that these payments
were for workers’ compensation insurance. However, anyone may have cashed
these two checks.

The workers’ compensation vendor for VSC, California Indemnity Insurance (CII)
could only provide insurance policy documentation up to February 1996. The
policy had been terminated after February 1996, and no new policies had been es-
tablished between February 1996 and August 1996. The project’s insurance agent
maintained that the workers’ compensation insurance was subsequently provided
by Golden Eagle Insurance. Two Golden Eagle representatives independently
stated that the company held a workers’ compensation policy with CPM between
February 1996 and August 1996. They stated that CPM only paid $4,867 for the
policy during the entire period. The vendor required a notice of consent from
CPM to reveal any additional information, but the agent did not forward the con-
sent form we provided. Thus, we consider the $21,172 collected for workers
compensation insurance excessive. The remaining $4,867 is unsupported because
CPM provided no documentation to show the policy was only for project employ-
ees.

The agent did not obtain an estimated refund of $2,745 that had been available to
the project. The 1995 workers’ compensation premium paid to CII was based on
an estimate of payroll for the year. At the end of the year CII would normally
conduct an audit of actual payroll and determine if any adjustments to the premium
were required. CII representatives stated that CPM had not sent the payroll
documentation. As a result, the 1995 premium paid was closed based on the ear-
lier payroll estimate. The project could have received a refund or credit if the ac-
tual payroll was below the estimated payroll. Based on eligible employee compen-
sation for the period, we estimate that the project would have been entitled to a
refund of $2,745.

V. MISCELLANEOUS DISBURSEMENTS

The agent collected $1,766 in other excessive reimbursements from the project. In
addition, the agent collected $11,819 from the project without maintaining proper
support to demonstrate the reasonableness of the payments.

The agent made two transfers of $2,000 from the VSC operating account in April
1996. The first $2,000 collected on April 1, 1996 was a legitimate collection for
payroll that was due for that period. The second collection of $2,000 on April 17,
1996 was listed in the monthly reports submitted to HUD as reimbursements to
CPM, for payments made on behalf of the project to Colonial Pacific and CA
Dental. However, the amount transferred to CPM for the project’s Colonial Pa-
cific expense had already been collected by the agent from the project’s operating
account in February 1996. In addition, one of the payments to CPM for the proj-
ect’s CA Dental expense had already been collected from the project’s operating


                                                                                 15
                                                                        98-SF-212-1001


account in March 1996. Documentation provided by the vendors confirmed that
CPM made only one other payment on behalf of the project, totaling $234. Sub-
sequent account information CPM provided to us for activity between CPM and
VSC did not list the April 17, 1996 payment for $2,000. Thus, we consider
$1,766 ($2,000 less $234) to be excessive.

Additional payments and transfers of $11,819 were made to the agent with no
support showing they were proper uses of project funds. On February 22, 1993
$3,829 was transferred to the agent, even though this same amount had already
been paid by VSC on check 1001 during the same month. On December 24, 1993
$2,000 was transferred from the operating savings account. Then on January 6,
1994 $1,798 was transferred from the operating savings account. On December
27, 1994 another $1,500 was transferred from the project to the agent. On June
20, 1994 $2,007 was listed as a deposit posted incorrectly and transferred to the
agent, without any support to show why CPM was entitled to the funds. On No-
vember 17, 1994 $685 was paid to CPM on check 1605. The monthly report
submitted to HUD listed that this amount was paid to Tiger Software. There was
no documentation to support any of these payments. The agent told us that all
transfers were reimbursements of project expenses paid by CPM, but he could not
provide sufficient information or documentation to show that they were for neces-
sary project purposes.

VI. DISBURSEMENTS BY OWNER

The president of the VSC board of directors made an inappropriate disbursement
of $10,000 in 1996 for an appraisal of the project. In addition, starting May 1997
the owner began paying (and, we have been advised, continues to pay) an unau-
thorized management agent $5,000 a month. This activity occurred after CPM
stopped providing management services for the project.

The president paid $10,000 out of project funds to First Western Bank for an ap-
praisal of the project in anticipation of refinancing the project. This was done
without informing HUD or obtaining its approval. Upon learning of president’s
intent to refinance, HUD specifically prohibited VSC from prepaying the loan.
(The deed of trust note for VSC states that the debt evidenced by the note may not
be prepaid, either in whole or in part, until the final maturity date without the prior
written approval of HUD.) Since there was no authorization to sell or refinance
the project, there was no need to incur the expense of an appraisal. Further, the
board president advised us that the appraisal report has never been received. Thus,
the project received no benefit from the $10,000 disbursement.

The president also authorized monthly payments of $5,000 for management serv-
ices to Benno Pabst of Prime Property Management. However, HUD had already
rejected the agent’s application to become the management agent of the project.
(The regulatory agreement states that the owner shall provide for the management


                                                                                    16
                                                                               98-SF-212-1001


of the project in a manner satisfactory to HUD.) Mr. Pabst was rejected because
he lacked the proper experience, HUD could not confirm his references, and Mr.
Pabst did not respond to HUD’s questions concerning the project’s deficiencies.
Also, HUD told the president that the compensation for Mr. Pabst, combined with
the salary of the resident manager, was not a reasonable expense for on-site man-
agement. HUD informed the VSC board that they would be held personally re-
sponsible for any payments made to Pabst using project funds. Despite HUD’s
warning, the president has made monthly payments of $5,000 to Mr. Pabst begin-
ning on May 15, 1997. The president labels Mr. Pabst’s position as “project ad-
ministrator.”

EFFECTS

The unnecessary and unsupported uses of project funds had significant effects on
the low-income housing project.

                      During the period of CPM’s management, the project had
Cash Shortages
                      serious cash problems. The December 31, 1995 financial
audit shows that the project had a cash deficit of $6,322 and a surplus cash1 defi-
ciency of $57,864. The project often had little or no cash while there were signifi-
cant accounts payable. Based on reports submitted to HUD between December
1994 and August 1996, the project had an average accounts payable balance of
$49,588. From February 1993 to August 1996 the operating account had deficits
twenty-one times. This forced the project to take funds from other project ac-
counts, including the tenant security deposit accounts. The poor financial status of
the project increased the possibility that the project may default on its mortgage
payments, thus increasing HUD’s risk.

                                        The VSC tenant security deposit account
    Reports submitted to HUD
                                        was not maintained at a level to cover the
    misrepresented the balance of       liability as required by the regulatory
    security deposits held in trust     agreement. The account is to contain
    for residents.                      funds held in trust for the project’s ten-
ants. Monthly reports submitted to HUD showed that the balances in the security
deposit accounts were at the level of the liability until September 1996, after the
agent left. However, contrary to these reports, security deposit bank statements
showed that the balance was below the liability between May 1993 and February
1997. The deficit in the account ran over $11,000 before CPM concluded its man-
agement. This deficit occurred because security deposit funds were being trans-
ferred to the VSC operating accounts and directly to CPM. Due to the poor fi-


1
  HUD defines surplus cash as the amount of cash in excess of that necessary to be on hand for
project operations. For non-profit owners such as VSC, surplus cash is to be deposited in a re-
stricted project account.



                                                                                            17
                                                                     98-SF-212-1001


nancial condition of the project, the shortage could not be restored to the account
until February 1997.

                                          Operating account deficiencies caused by
Depleted Replacement Reserves
                                          improper project disbursements also ap-
pear to have led to the misuse of the replacement reserve. The project withdrew a
total of $6,527 from the replacement reserve account for transfers to the operating
account for non-existent expenses.

The regulatory agreement states that the owner shall establish and maintain a re-
serve fund for replacements in a separate account with the mortgagee. Disburse-
ments from the fund may be made only after receiving written consent from HUD.
Handbook 4350.1 REV-1, Multifamily Asset Management and Project Servicing,
details the requirements for requesting withdrawals from the reserve fund. All re-
quests to HUD are to be in writing and provide a detailed description of work
done or to be done. If the withdrawal request is a reimbursement for work that
has been done, a copy of the invoices should accompany the request.

The project requested permission to withdraw $3,484 for a water softener pur-
chased with check 1214, dated September 10, 1993, by submitting an invoice and
the check stub to HUD indicating payment. Based on this documentation, HUD
approved the withdrawal from the reserve on September 30, 1993. However, the
check was subsequently voided. There was no subsequent payment to the vendor
to substitute for the voided check, and we found no evidence that a water softener
was purchased subsequently. CPM provided no response to our inquiries con-
cerning the withdrawal.

In addition, between 1995 and 1996 VSC made two requests to withdraw a total
of $27,705 for landscaping performed by Reyna’s Lawn Care. The first request
included a payment of $6,125 on check 2004, dated October 6, 1995. The second
request included payments of: $3,000 on check 2054, dated November 1, 1995;
$3,000 on check 2031, dated October 24, 1995; $3,000 on check 2167 dated Feb-
ruary 1, 1996; $500 on check 2168, dated February 1, 1996; and $12,080 on
check 2215, dated March 10, 1996. HUD approved the requests based on the in-
voices and check stubs submitted. However, the accounting reports showed that
VSC only paid $24,662 to Reyna’s Lawn Care between 1995 and 1996, $3,043
less than the amount withdrawn from the reserve. The difference occurred be-
cause checks 2004 and 2215 were voided. New checks were then issued for
smaller amounts.

Attached to the requests to withdraw funds from the reserve account were certifi-
cations stating that any overpayment of funds resulting from errors in calculations
or for any ineligible reserve for replacement items will be promptly returned.
These certifications were signed either by the project’s resident manager or the
management agent.



                                                                                18
                                                                      98-SF-212-1001




                            The improper uses of project funds were at the ex-
Deferred Maintenance
                            pense of adequate project maintenance. By the end of
the management term of CPM, the project’s physical condition had deteriorated to
an unacceptable level. The unsatisfactory condition of the project continued under
Pabst’s management.

A physical inspection performed by HUD in August 1993 found the cost to bring
the project into satisfactory condition was $417,500. The report identified defi-
ciencies with the boilers, playground area, roofs, driveways, walkways, landscap-
ing, sprinklers, exterior lighting, and exterior painting. In 1995, an owner-
commissioned study concluded that the cost of fixing the project was $731,150.

                                           Another HUD physical inspection on
Deferred maintenance more
                                           March 18, 1997 gave VSC an unsatisfac-
than doubled to one million                tory rating. Due to continued deferred
dollars in less than four years.           maintenance, the estimated cost to bring
the project into proper condition had increased to $1,019,838. The inspection re-
port required the owner to immediately respond to the poor living conditions of
the tenants. The report blamed poor maintenance and management for the condi-
tion of the project, including inadequate preventive maintenance, unqualified per-
sonnel, and lack of maintenance supplies. The deficiencies cited in the 1993 report
remained. In addition, the report listed new problems with the plumbing, periodic
flooding, heating, asbestos, electrical fixtures, doors, windows, poor floor cover-
ing, ceiling stains, exhaust fans, splash-blocks, patio fences, decks, and refrigera-
tors.

The project’s poor condition continued under Pabst’s management. The mortga-
gee’s October 1997 inspection noted deferred maintenance and rated the overall
condition of the property as “unsatisfactory.” HUD offered to provide funds to fix
the project, but the owner has withdrawn its application for these funds. The
owner proposed to use the money from the project’s reserve for replacements, but
HUD believed this was only a fraction of what is needed.

                     While CPM was managing VSC, the project experienced
Unit Vacancies
                     prolonged vacancy periods of some of its housing units. Ac-
cording to the project’s occupancy reports from June 1995 and August 1996, units
would remain vacant for an average of forty days, even though there was a waiting
list for new tenants. Nine units were vacant sixty days or more. Since CPM
stopped managing VSC, the vacancy period has improved but remained high,
dropping to an average vacancy of thirty days. According to HUD, units should
not remain vacant for more than two weeks. The long vacancies caused the proj-
ect to incur unnecessary rent losses. Lost rental income between June 1995 and
March 1997 was approximately $28,000 (or to the extent of any vacancy claims
for these units under the section 8 contract, HUD paid additional subsidies.) The



                                                                                  19
                                                                                98-SF-212-1001


president of CPM and the VSC staff blamed the financial deficiencies of the project
for the vacancy problems and the deferred maintenance. The project could not buy
materials to make needed repairs in advance or in bulk due to the project’s cash
flow problems and poor credit history.

We requested maintenance reports for 15 of the long-vacant units. The project
administrative staff could not locate these documents. While the resident manager
found some documentation, he was unable to produce repair schedules or work
orders. The documentation provided consisted of brief lists of repairs performed
on all but two of the units. The reports did not show dates items were repaired or
replaced, who performed the repairs, a list of supplies used, or indication of man-
agement review. Thus, the available reports were insufficient to determine
whether or when the needed work had been performed or whether there had been
proper supervision over the work.

CAUSES

There were several reasons why there were unnecessary and unsupported uses of
project assets: poor accounting records, the bypassing of VSC management policy,
poor oversight by the VSC board of directors, and management’s disregard of
HUD requirements.

                                    The agent did not maintain proper accounting
Poor Accounting Records
                                    records. Invoices and bills were missing from
the project’s files. Some canceled checks and most transfer notices were not avail-
able at the project or the agent’s office. General ledger reports were either missing
or had not been prepared. There were no general ledger reports prepared for 1996
through August 1996 when CPM stopped managing the project, nor were any pre-
pared after Benno Pabst of U.S. Prime Property Management began managing the
project. The W-2 employee payroll reports for 1993 and 1994 were not available.
Personnel files were not available and CPM did not provide payroll documentation
to the project. The lack of documentation made it difficult for project staff to de-
termine the eligibility of disbursements. Thus, records were not in condition for an
efficient audit. In many instances, we had to contact vendors directly to confirm
the legitimacy of transactions. Also, since no general ledger statement was pre-
pared for the year ended December 31, 1996, the owner had not submitted audited
financial statements that were due by March 1, 1997.2



2
  The 1996 audited financial statements were issued in January 1998. The public accountant’s
report gave a disclaimer of opinion on the financial statements because $157,405 of project ex-
penditures recorded for the year could not be adequately accounted for. This was because of poor
oversight by the board of directors and the lack of an effective system of control. The audit was
also significantly restricted because there was no access to records controlled by former manage-
ment agent CPM.



                                                                                              20
                                                                      98-SF-212-1001


The agent was not able to produce his own accounting records to support amounts
he had collected from the project, other than his monthly management fee and
most payroll costs. CPM did not maintain invoices or bills for expenses suppos-
edly paid directly on the project’s behalf. CPM did not maintain accounting re-
ports or ledgers separate from the project’s. This made it impractical for the agent
to support the propriety of many collections from the project’s accounts.

                             The agent had the ability to transfer or pay amounts
Bypassing VSC Policy
                             from the project’s accounts without obtaining the
proper concurrence of project officials. VSC policy required the signature of both
a CPM representative and the project’s resident manager to make disbursements
from project accounts. However, the agent was able to make transfers from the
project accounts with only his authorization. In addition, the bank accepted
checks from project accounts with the signatures of the agent and his wife alone.
The resident manager stated that CPM often did not provide him with documenta-
tion to support the disbursements that he was approving. The agent’s ability to
disburse project funds to himself and vendors, without proper review by VSC staff,
was a significant control weakness that resulted in improper disbursements.

                     The VSC board of directors was not sufficiently involved in
Poor Oversight
                     the project’s financial affairs. VSC policy states that all pur-
chases over $1,000, with the exception of the normal recurring monthly expenses,
were to be approved by the treasurer or president of the board in writing. Project
staff could not provide documentation to support board approval for purchases
over $1,000. Management stated that the president of the board would approve
items orally; but the president stated that he often did not have time to approve
expenses, that he was left out of the decision making process, and that he was not
aware of the agent’s activities. Nevertheless, the owner is responsible for the
agent’s actions.

                                         The owner largely ignored HUD Office
Disregard of HUD Requirements
                                         of Housing demands to return ineligible
withdrawals to the project, correct physical deficiencies, obtain proper manage-
ment, and provide explanations for inconsistencies and findings. The owner be-
lieved that through hard work it had made the project “a model in the Nation” (de-
spite that both HUD and mortgagee considered the project’s physical condition to
be unsatisfactory), and the owner continually rejected HUD’s demands to obtain
proper management. Further, the improper disbursements from the operating, se-
curity deposit, and replacement reserve accounts demonstrated a glaring disregard
by owner and agent of HUD requirements, directives, and agreements.

AUDITEE COMMENTS & OIG EVALUATION

The board president, Victor Camacho, provided a written response (contained in
Appendix 2) to our preliminary audit conclusions. We subsequently discussed the


                                                                                  21
                                                                     98-SF-212-1001


audit’s conclusions and the president’s response on January 26, 1998 with the
board president, project administrator Mr. Pabst, and the project’s public account-
ant Dennis Lorette. The former management agent, CPM, did not respond to our
requests for comments. The board president told us that CPM advised that it did
not intend to respond.

The response from VSC indicates general concurrence with the audit’s conclusions
except for the matters of the appraisal and payments to Mr. Pabst.

                          The board plans to seek recovery of project funds mis-
Recovery from CPM
                          appropriated by CPM and to address management con-
trol weaknesses.

                      While agreeing that greater board oversight of the project is
Board Oversight
                      needed, the board president believed that HUD did not want
the board involved in the project’s daily operations. As a result, the board was not
aware of the former agent’s improprieties.

While HUD may not have wanted the board involved in every aspect of the proj-
ect’s daily operations, we note that HUD did not approve CPM agent until CPM
and VSC showed that their policy called for the board to approve all expenses over
$1,000 in writing, except for normally recurring monthly expenses. In addition,
CPM was to provide the board with monthly accounting reports, rent rolls, bank
reconciliations, and budgets. Thus, HUD was relying on the board to fulfill its re-
sponsibilities and oversee the agent’s activities. If the board had been performing
this function, then much of the inappropriate activity should have been identified
and corrected much earlier. Whether or not the board knew of the inappropriate
activity, it was still responsible for their agent’s misuse of project funds.

                       The president indicated that HUD is responsible for im-
Selection of CPM
                       posing an inferior agent to manage the project.

HUD wanted the project to obtain professional management because it considered
the project to be poorly run without it. While CPM was only one of the available
approvable management agents, the board selected CPM because it had acted as
the agent on another HUD-insured project, Villa San Pedro, the president had been
previously involved with. Still, HUD initially rejected the board’s request to hire
CPM. HUD wanted an agent that had more experience managing projects similar
to VSC. However, due to owner and CPM persistence, HUD eventually approved
the agent.

                                    In his written response, the president said
Unsupported CPM Back Fees
                                    that the board had not been aware of the
back-fees paid to CPM for the period of October 1992 to January 1993. This re-
sponse is inconsistent with an April 26, 1993 letter from the president to HUD



                                                                                 22
                                                                      98-SF-212-1001


stating that the project would compensate the agent for back-management fees
from October 1992 on. The president did not explain this inconsistency when we
brought this to his attention.

              In the board’s written response, the board president stated that the
Appraisal
              project appraisal was an allowable expense to assess the project’s
condition. The purpose of the appraisal was to obtain a bank loan to put the proj-
ect into proper physical condition.

We believe there was no need to obtain a bank loan to fund project repairs. HUD
had offered to provide flexible subsidy funds to rehabilitate the project, but the
former agent had not completed all actions necessary for the funds’ release. In ad-
dition, the cost of the appraisal appeared to be excessive since the project had ob-
tained a detailed assessment of the project’s physical and financial condition the
year before at half the cost.

Further, documents we obtained during the audit only speak of the appraisal in the
context of loan refinancing. No copy of the appraisal was available to show that
the appraisal’s purpose and results were to identify repair and replacement needs.
At the meeting, the president told us that the appraisal has never been received.
When we advised him that in this case the project received no benefit from the
$10,000 appraisal fee and that the appraisal would be useless now, the president
said that he intended to obtain a refund.

                           The president contends that Mr. Benno Pabst is actu-
Project Administrator
                           ally the project’s administrator, not a management
agent, thus making amounts paid to him allowable.

Nevertheless, HUD Office of Housing has determined that Mr. Pabst was not ap-
provable as management agent and that the costs of additional on-site management
were not reasonable.

RECOMMENDATIONS

We recommend that the Office of Housing take the following actions.

A.     Assure that acceptable and competent management is in place to run the
       project.

B.     Obtain compensation from the owner and agent as provided under statute
       and take appropriate administrative action for their misuse of project as-
       sets. Determine what portion of the compensation may be turned over to
       the project.

C.     Assure that the physical deficiencies of the project are corrected.


                                                                                 23
                                                                    98-SF-212-1001




D.     Require that misused funds be restored to the VSC replacement reserve.

E.     Require the owner to establish proper accounting records and procedures
       for the retention of records and to submit audited financial statements on a
       timely basis.

F.     Require the owner to judiciously oversee project operations and establish
       procedures to document the board’s involvement.

G.     Require the owner to maintain adequate records on the maintenance needs
       and on the repairs and replacements done for individual housing units and
       common facilities.

We request that action not be taken on these recommendations until you have first
consulted with us.




                                                                                24
                                                                     98-SF-212-1001



Finding 2
Other Poor Management Practices Were Noted

In addition to deficient management practices noted in finding 1, we found
that procurement practices were inadequate and employee time records ap-
peared to be unreliable. These occurred because of insufficient oversight by
the VSC board and the poor management practices by the agent, including
violation of the VSC written procedures. These poor practices reduce assur-
ance that the project is operated in a cost effective manner.


The regulatory agreement requires the owner to ensure that project funds are to be
used only for reasonable and necessary expenses and repairs. Payments for mate-
rials and services are not to exceed amounts ordinarily paid.

The management certification, signed by the management agent, requires the agent
to assure that all expenses of the project are reasonable and necessary; exert rea-
sonable efforts to maximize project income; take advantage of all discounts, re-
bates, and money saving techniques; obtain the necessary verbal or written cost
estimates and document the reasons for not accepting other than the lowest bid;
and maintain copies of such documentation. The agent also agreed to establish
and maintain the project’s accounts, books and records in accordance with HUD’s
administrative requirements, generally accepted accounting principles, and in a
condition that will facilitate audit, and to comply with the project’s regulatory
agreement, HUD handbooks or notices, and HUD requirements.

                                        Time and attendance records supporting
Time and Attendance Records
                                        time worked and on leave cannot be relied
upon because procedures for the preparation and review of employee time cards
were not followed. Employee time cards were supposed to be prepared by the
employees, reviewed by the resident manager, and then reviewed by the agent be-
fore processing the payroll. However, we found that the resident manager was
preparing the time sheets rather than the employees and there was no evidence that
the employees had reviewed them. Also, there was no evidence that the agent re-
viewed the time cards.

Also, a significant number of time cards were unaccounted for. Time cards pre-
pared before April 1996 could not be located by project staff. Time cards after
August 1996, when Benno Pabst managed the project, were not maintained in
readily-accessible and organized files in the project’s administration office files.
The resident manager had to search for these documents even though they had
only recently been prepared. The poor retention and organization of these files



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also resulted in the misplacement of time cards for the period between February 6,
1997 and March 5, 1997, which could not be located.

In addition, it appears that not all leave was recorded. For the period reviewed
(June 1993 to August 1996), little leave was recorded. The leave that was re-
corded was largely attributed to only one employee. Also, there was no sick leave
recorded between April 1996 and April 1997 on the employee time cards.

As a result of these deficient practices, there is little assurance that employees take
no more leave than is due them and that they are properly compensated for leave
not taken.

                              The agent did not follow proper procurement proce-
Procurement Practices
                              dures. VSC and CPM procurement policy stated
that all purchases or contracts over $5,000 required three bids to be obtained in
writing. If the lowest bid was not chosen, then the reason was to be given in writ-
ing. However, the agent and project staff could not provide such documentation
for any purchases and contracts over $5,000 between 1993 and 1996 except for
one.

These procurement procedures had been adopted to resolve recommendation 2C
contained in a HUD Inspector General audit of VSC issued February 18, 1993.
The recommendation called for the project management to establish and implement
a procurement policy that requires obtaining necessary services and supplies at a
fair and reasonable price. Based on the board’s adoption of these procurement
procedures on August 16, 1993, HUD closed the recommendation.

The only procurement documentation available at the project was for the 1993 fi-
nancial audit. Three bids were obtained for the audit. However, the lowest bidder
was not selected, and there was no documentation giving the reason for not ac-
cepting the lowest bidder.

One of the significant procurements was for the services of a handyman. During
the period reviewed (January 1996 to February 1997) the project paid over
$13,000 to the handyman. Although no contract was prepared, the handyman was
treated as an independent contractor. The project did not obtain competitive bids
for his services. The contractor told us that he was a personal friend of the board
president. It appears the handyman was chosen based on this relationship.

AUDITEE COMMENTS

Board president Camacho and project administrator Pabst indicated that action
was being taken to correct the above situations




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                                                                  98-SF-212-1001



RECOMMENDATION

A. We recommend that the Office of Housing require the owner to establish and
   follow proper procedures for employee time cards and leave records.

Also, we are reopening recommendation 2C of HUD Inspector General audit
report 93-SF-212-1006 calling for HUD to ensure that the project’s management
establishes and implements a proper procurement policy that requires obtaining
necessary services and supplies at a fair and reasonable price.




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                                                                   98-SF-212-1001




Management Control
                            In planning and performing our audit, we considered
Controls Considered
                            the management control systems used at Villa San
Carlos Garden Apartments to determine our audit procedures and not to provide
assurance on management control. Management control is the process effected by
an entity’s board of directors, management, and other personnel, designed to pro-
vide reasonable assurance for the achievement of objectives for:

              •   Program operations,
              •   Validity and reliability of data,
              •   Compliance with applicable laws and regulations, and
              •   Safeguarding resources.

We determined that the following systems were relevant to our review objectives.

              •   Expenses and disbursements
              •   Revenues and receipts

                                   We obtained an understanding of the control
Weak Control Environment
                                   structure pertinent to the above systems and
determined the risk exposure to design our audit procedures. We did not assess
control design or determine whether the policies and procedures had been placed
in operation. We did not make a complete assessment because of the weak control
environment (in that the systems could not be relied upon) and the limited objec-
tives of the audit. Thus, our conclusions did not rely on the control systems.

A significant weakness exists if management control does not give reasonable as-
surance that all four control objectives are met. We identified weaknesses con-
cerning uses of project assets as discussed in the report’s findings.




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Prior Audit Findings
                           The HUD Office of the Inspector General previously
Similar Issues Noted
                           audited Villa San Carlos Garden Apartments for the
period of January 1, 1991 to September 30, 1992 (report number 93-SF-212-
1006). The audit report was issued on February 18, 1993. For the period covered
by that audit, the project was self-managed so there was no management agent.
That audit raised some issues that are similar to those discussed in findings 1 and 2
of the report in-hand.

       •   Services and materials were not obtained using competitive procure-
           ment and bidding procedures.

       •   The owner’s board of directors was not sufficiently involved in the
           project’s financial activities.

                    The prior audit’s principal recommendation was to transfer
Owner Capacity
                    project ownership to a proficient non-profit entity since the
owner was considered incapable of operating the project. Part of this conclusion
was based on the presumption that an appropriate board of directors did not exist.
Subsequently, the owner showed HUD that the board composition was legal. The
above issues were resolved upon the hiring of outside management (Creative
Property Management) and the establishment of new procurement procedures.




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                                                                  98-SF-212-1001




Appendices
Appendix 1

Schedule of Unnecessary, Unreasonable, and
Unsupported Amounts


                      Issue                    Unneces-    Unsupported
                 (from finding 1)            sary/Unreaso   Amounts
                                                 nable
                                               Amounts
      Management fees                              $32,933     $29,747
      Payroll                                      117,187      51,944
      Security deposit transfers                    13,000
      Workers compensation insurance                23,917       4,867
      Miscellaneous disbursements                    1,766      11,819
      Disbursements by owner                        15,000
                      Totals                      $203,803     $98,377


Unnecessary/unreasonable amounts represent project assets that were not used for
necessary or reasonable project operations, thus violating the regulatory agree-
ment.

Unsupported amounts represent project assets where documentation was not
available to show that their use conformed with the regulatory agreement. None-
theless, federal law (12 USC §1715z-4a) states that inadequately documented use
of project assets constitutes a violation of the regulatory agreement.




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                                                                98-SF-212-1001



Appendix 3

Distribution

Director, Multifamily Housing Division, California State Office, HUD
Chief, Multifamily Asset Management Branch, California State Office, HUD
Director, Office of Housing, California State Office, HUD
Assistant General Counsel, California State Office, HUD
Secretary’s Representative, California State Office, HUD
Director, Accounting Division, California State Office, HUD
Director, Administrative Service Center, Colorado State Office, HUD
Office of Comptroller, Texas State Office, HUD
Deputy Secretary, HUD
Assistant Secretary for Housing, HUD
Assistant Secretary for Congressional and intergovernmental Relations, HUD
Chief of Staff, HUD
Assistant General Counsel, HUD
Deputy Assistant Secretary for Public Affairs, HUD
Counselor to the Secretary, HUD
Senior Advisor to the Secretary for Communications and Policy, HUD
Assistant to the Secretary for Labor Relations, HUD
General Counsel, HUD
Housing-FHA Comptroller, HUD
Director, Participation and Compliance Division, HUD
Director, Housing Finance Analysis Division, HUD
Assistant to the Deputy Secretary for Field Management, HUD
Chief Financial Office, HUD
Deputy Chief Financial Officer for Finance, HUD
Acquisition Librarian, HUD
Committee on Governmental Affairs, U.S. Senate
Government Reform and Oversight Committee, U.S. House of Representatives
Subcommittee on General Oversight and Investigations, U.S. House of Represen-
       tatives
Director, Housing and Community Development Issue Area, U.S. General Ac-
       counting Office
Board President, Villa San Carlos, Inc.
President, Creative Property Management
Dennis L. Lorette & Associates




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