Council for Affordable and Rural Housing Panel Discussion:
RHS’s New Enforcement Tools
Remarks by:
Harry J. Kelly, Esq.
Nixon Peabody LLP
Washington, D.C.
202.585.8712
It’s Déja Vu All Over Again
John brought you up to date on the history of the emergence of these
issues. I want to go into a little bit of detail about the recent RHS
Enforcement Statute because I think it’s important.
The Statute was passed in December 2000, in the waning days of
the Congress. Legislation can be a lot like making sausage, and I think some
things sneak in under the radar, without a lot of thought or a lot of attention.
The new Statute covers several matters. It extends and sort of deepens
the powers of the Agency with respect to Equity Skimming. It adds Civil
Monetary Penalties for a series of operating misconduct activities the Agency
has identified. It extends certain Criminal Sanctions that we’ll talk about
shortly.
The reason I entitled this part of the program “It’s Déja Vu All Over
Again” (the title Yogi Berra gave to his new book) is that for those of us
who have participated in HUD Enforcement proceedings through the years, this
all looks very familiar—troublingly familiar. What Congress just gave to RHS
is very similar to the powers HUD has been able to exercise over the last
five or six years, and HUD has done a terrific job of antagonizing and
scaring and provoking many of its owners. I don’t know what all of you did to
upset these people so very much — you all look very innocent! Obviously,
someone thinks you’re very bad people because of the nature of the laws they
enacted.
The “American Homeownership and Economic Opportunity Act of 2000” must
be understood in the who, what, where, and, now, the how much of the
Enforcement mechanism. The first part, Section 543, consists of the Criminal
provisions. Let’s examine it clause by clause.
As John pointed out, there has been an Equity Skimming Statute on the
books since 1996. This Section does extend and deepen the equity skimming
rules. It says:
CRIMINAL PENALTY - Whoever, as an owner, agent, employee, or manager, or is
otherwise in custody, control, or possession of a property. . . .
I don’t know of anyone here that isn’t in this group. If you’re not, you
can go to another session now. You can look at this and see the extensiveness
of the statute — it is extraordinary in its comprehensiveness:
. . . [who] willfully uses, or authorizes the use, of any part of the rents,
assets, proceeds, income, or other funds derived from such property, . . . .
This is significant because the term “willful” has criminal meaning and
generally speaks to a knowing and intentional violation of the law. This may
be the saving grace for many people; it’s hard sometimes to document that
somebody intentionally did the kinds of things here. On the other hand, the
term “willful” can also be interpreted to refer to those kinds of things
that are not “unwillful,” like snoring in your sleep. So, the word
“willful” does have some protection, and it is important, because it helps
to explain the differences between the Criminal sanctions in the first part
of the law and the Civil provisions in the second.
. . . for any purpose other than to meet actual, reasonable, and necessary
expenses of the property, or for any other purpose not authorized by this
title or the regulations adopted pursuant to this title. . . .
Again, this is extremely broad. Essentially, if as a result of an Audit,
money is going out without a reason (even if it doesn’t necessarily come into your pocket), that may be sufficient to come under this part of the Statute.
We have had situations where owners have not been able to document expenses,
such as John talked about, and we have seen threats of Equity Skimming. Not
necessarily Criminal Equity Skimming, because I don’t think they could
demonstrate the willful component. The fact is, they were showing payments
for various checks without having the documentation to support them. That’s
where you begin to get in trouble, and that’s when the Agency will begin to
raise these issues.
. . . shall be fined under title 18, United States Code, or imprisoned not
more than 5 years, or both.
These Title 18 fines are the multi-hundred-thousand-dollar fines that the
Criminal statute permits. In my experience, I have not seen anyone actually
threatened with a jail term, but I have seen the Criminal statute used for
very large fines.
The Civil provisions have a somewhat narrower, but still expansive, scope
in what they cover:
An entity or individual who as an owner, operator, employee, or manager, or
who acts as an agent for a property. . . .
Again, I think this would cover most of the people in this room. And this
covers the issues of the misuse of project funds:
. . . that is security for a loan made or guaranteed under this title where
any part of the rents, assets, proceeds, income, or other funds derived from
such property are used for any purpose other than to meet actual, reasonable,
and necessary expenses of the property, or for any other purpose not
authorized by this title or the regulations adopted pursuant to this title,
shall be subject to a fine of not more than $25,000 per violation. The
sanctions provided in this paragraph may be imposed in addition to any other
civil sanctions or civil monetary penalties authorized by law.
I’m going to take you through the provisions one by one. And then I’ll make
some comments about what they mean. I do want to point the language out so
you will have a number of issues floating in the air.
Question from the floor: Is it important that the civil penalties are not
“willful?”
Kelly: This is very meaningful. This means an accidental failure to keep
your records properly or a false receipt. If they find that you’re not
properly keeping your books and records, that may be sufficient for these purposes to trigger the Equity Skimming statute. If they find evidence of
willfulness in your conduct, that is when they will seek Criminal
prosecution. If they don’t find willfulness, they will still get you on the
Civil provisions.
The next big section of the statute is in some respects even more
troubling. This is the Civil Monetary Penalties. Significantly, they do give
you an option for a Notice and Hearing. That is important; John and I agree
that the National Appeals Division (NAD) for USDA, at least right now, is the
entity that will be dealing with this. It isn’t yet clear that they will do
this.
The Section states:
The Secretary may, after notice and opportunity for a hearing, impose a civil
monetary penalty in accordance with this subsection against any individual or
entity, including its owners, officers, directors, general partners, limited
partners, or employees . . . .
I don’t know if any of you are actually Limited Partners. I assume many
of you are Management Agents or General Partners. This is really rather
extraordinary, to find a statute which confers liability on Limited Partners.
Presumably the reason people become Limited Partners is to avoid the kind of
liability this kind of statute wants to thrust upon them. If I were a Limited
Partner, I would be very concerned about this because of the next part of the
sentence:
. . . who knowingly and materially violate, or participate in the violation
of, the provisions of this title, the regulations issued by the Secretary
pursuant to this title, or agreements made in accordance with this title,
by— . . . .
Well, that’s fine. But let me ask what it means to “participate in the
violation” of the failure to do something? I realize that you’re not
lawyers, but even for those of us that do this every day, our head begins to
spin, when we begin to think about a knowing participation in a failure to
act. I’m not exactly sure what that means logically.
I’m afraid that what it means, for example, is that if you are a Limited
Partner and you get a Financial Statement or some other information from your
General Partner on the finances of the property, and there is an item which
doesn’t make sense or it looks like there is money going to the wrong place
or improperly accounted for, you may have participated in the violation of
this statute. You are now aware of something. You now have knowledge, even
though you are a Limited Partner.
I think it is a very unfair burden to put on Limited Partners because
what do you do then? You’re a Limited Partner, you don’t have control of the
partnership, you really don’t an ability to act, unless you call up the U.S.
Attorney and tell him that your General Partner is bad. I suppose you could
begin proceedings to remove the General Partner.
You can see where there is a lot of uncertainty and ambiguity in this
statute and a lot of matters which will take some time to resolve. If I were
a Limited Partner, I would be very concerned about the potential liabilities
this imposes upon me. Consequently, if I were a General Partner, I would also
be concerned because I might get calls and further scrutiny from the Limited
Partners because they don’t want to be caught up in the statute.
What strikes me about the list of bad things Civil Monetary Penalties can
be used to sanction is that some of them are very scary:
• (A) submitting information to the Secretary that is false;
The information submitted might not necessarily be fraudulent, but simply
false. If you say my property is in very good condition, thank you very much
and give me my next Rental Assistance check, and it really isn’t in that
condition, that’s a false statement. That is an untrue statement. And
you’ll have just violated this law.
• (B) providing the Secretary with false certifications;
This is the same sort of thing.
• (C) failing to submit information requested by the Secretary in a timely
manner;
We don’t know what “information” this is. We don’t know what “timely” means
under this statute. But presumably there is a tremendous amount of
information to share with the Agency, and if you violate deadlines, fall
behind or you’re not “timely” (whatever that means — is that a day, week,
overnight, instantaneously by E-mail?), you may be violating the statute.
• (D) failing to maintain the property subject to loans made or guaranteed
under this title in good repair and condition, as determined by the Secretary;
Is that a crack in the sidewalk? A crack in the window? A chip in the
paint on the window sill? Whatever the Agency determines it to be? These are
all matters which I think are explosive. I don’t know what to tell you. I
don’t know what the Agency will do with this, but it gives the Agency an
enormous amount of leverage and latitude. I am concerned that so far the
Courts have not been too sympathetic to owners in these situations. The
Courts have said, essentially, we’ll let the Agency figure this out because
they are the experts and they know what their law says.
The penalties are significant:
• (A) IN GENERAL- The amount of a civil monetary penalty imposed under this
subsection shall not exceed the greater of—
(i) twice the damages the Department of Agriculture, the guaranteed lender,
or the project that is secured for a loan under this section suffered or
would have suffered as a result of the violation; or
(ii) $50,000 per violation.
Trying to figure out exactly how to work through these things is somewhat
difficult. Presumably, if money isn’t where it is supposed to be, it is twice
the amount of money that OIG finds. There is another consideration you need
to be aware of that can be used to determine the amount of penalty. It
appears that these can be used to reduce the amount of the penalty so you may
not have to pay as much if you fall on the right side:
• (B) DETERMINATION - In determining the amount of a civil monetary penalty
under this subsection, the Secretary shall take into consideration—
(i) the gravity of the offense;
(ii) any history of prior offenses by the violator (including offenses
occurring prior to the enactment of this section);
(iii) the ability of the violator to pay the penalty;
(iv) any injury to tenants;
(v) any injury to the public;
(vi) any benefits received by the violator as a result of the violation;
(vii) deterrence of future violations; and
(viii) such other factors as the Secretary may establish by regulation.
Some of these are clearly things that — if the Agency acts as HUD has —
will only be used to say “here’s our justification for going to the mat,”
such as to deter future violations, injury to public, injury to tenants. They
may conclude any failure to be diligent is a violation constituting injury to
the public. If you don’t turn over necessary information, you restrict their
ability to audit things, and that’s going to be support for the harsh
penalties they can impose.
The “Remedies for Non-Compliance” section in the statute are significant
in two respects. This is the point, where according to the statute:
• (A) JUDICIAL INTERVENTION - If a person or entity fails to comply with a
final determination by the Secretary imposing a civil monetary penalty under
this subsection, the Secretary may request the Attorney General of the United
States to bring an action in an appropriate United States district court to
obtain a monetary judgment against such individual or entity and such other
relief as may be available. The monetary judgment may, in the court's
discretion, include the attorney's fees and other expenses incurred by the
United States in connection with the action.
In other words, all the rest of this is presumably done through an
administrative hearing. If you fail to comply with a final determination, but
from the statute it isn’t clear what this final determination is, then it can
be referred to the U.S. Attorney for action. This is a little bit different
from the Equity Skimming Statute in HUD cases because the Department of
Justice has original jurisdiction there. I don’t know whether failure to
comply means you didn’t pay or you didn’t respond to whatever they allege
the misconduct was. I think it could be both, and you need to be aware of
that.
The real catch is the following paragraph, and this is a real
extraordinary piece of language:
• (B) REVIEWABILITY OF DETERMINATION - In an action under this paragraph, the
validity and appropriateness of a determination by the Secretary imposing the
penalty shall not be subject to review. . . .
Presumably, the “action” is the action the Department of Justice will bring
to enforce the penalty. This “not subject to review” is the deprivation of
your ability to challenge the Agency determination. There are very few times
Congress has ever said to the Courts, “Hands off, you may not address this.”
That’s what Congress did in this statute. There’s no legislative history and
very little explanation. I find it really extraordinary. There are scholars
that think Congress can basically define jurisdiction of the U.S. District
Courts any way it wishes to. But it is extraordinary because very rarely
does Congress ever say something is off limits.
There is something you can do in a situation like this. This withdrawal
of jurisdiction applies to the Civil action brought by the Department of
Justice. What that means is that before the matter is sent to Justice, you’d
better have your attorney on the phone and tell him to file an action under
the Administrative Procedures Act. As far as I can see, this was not intended
to withdraw the Administrative Procedures Act. These are two separate
matters. In other words, you can’t defend, once you get into District Court,
that the action was invalid. I would argue that this new language does not
terminate the Administrative Procedures Act and that you still have the right
to go to court, but you’d better go to court before the Agency does.
As additional arm-twisting, RHS may now condition extension of the Rental
Assistance contract on the agreement to comply with the terms. There are
additional Criminal amendments made such that the Equity Skimming provisions
are now included in the Money Laundering statute and subject to the penalties
there. And it is also now a violation of the Criminal law to obstruct audits
related to a property.
Let me make a suggestion to those of you who do not have current audits.
You may want to go to an attorney and have the attorney call up an accountant
to perhaps run through your books and records at the attorney’s request and
under the attorney’s supervision. You want the accountant to see whether
there are problems with your books and records. The accountant is not
necessarily to do an audit, but just to find if your records are in an
auditable condition because it is now a criminal penalty if your records
could be deemed to in such bad condition as to obstruct a Federal audit. It
may be a good thing to hire an accountant just to make sure that if the OIG
ever comes, they can do what they need to do. It is possible that if all this
stuff is thrown in — they don’t just get you for Equity Skimming, they get
you for Equity Skimming and a Civil monetary penalty and obstruction of the
audit — you’d at least like to be in a position where you know that if
someone does come in, your records are in good condition. Do it through your
attorney because the report prepared by the accountant will be subject to
attorney-client privilege and will not be producible in any subsequent
proceeding.
These provisions parallel what HUD has done in the past. The idea is
that, on the one hand, the Equity Skimming statute focuses on income; on the
other hand, the Civil Penalties statute focuses on conduct. If they can’t get
you on conduct, if you haven’t done one of the bad things listed in the
statute, but you nevertheless have done something they don’t like, they can
probably get you for having received money, for having paid money, or for
having spent money outside of what the Loan Agreement or Instructions allow
you to do. It’s kind of like Al Capone — they didn’t get him for running
gin or killing people, they got him for tax evasion. So if they can’t get you
on conduct, they’ll get you on the money.
The idea is to follow the money. That’s why this is sort of a two-way
street.
Why is this similar to what we’ve seen with HUD? Basically, the Agency
knows you don’t have the resources it has. It can devote more effort to
penalizing you. Even if you think you’re right and even if you think you have
good defenses, they can wear you down. Most owners, rather than go to the mat
and actually defend and go all the way through the proceeding and risk the
consequence of being found wrong, would rather settle things on an early
basis. I don’t deny the efficacy of that. If you can get out with your nose
relatively clean, you’d better do it.
As to the HUD experience, Courts have given the Agency a great deal of
latitude. Even though we believe the HUD Enforcement Center operates in a way
which begins to violate the constitutional and administrative rights of
owners, the Courts have not been receptive to these arguments. They let the
Agency interpret the statutes wrongly and have not found that the
administrative mechanisms violate the law or constitutional rights.
It seems as though RHS program staff and OIG staff are fairly cooperative
in working together. But in the HUD experience, we have seen tremendous
antagonism and rivalry between the program side and OIG side, with the
consequence that each side tries to prove it’s tougher than the other. It is
the owners, of course, who get it in the neck. I’m not sure that OIG and the
RHS staff will not develop the same kind of antagonism. They seem right now
to be cordial to one another and trying to be cooperative, but I think they’ll
get to the same point and try to demonstrate who can be toughest.
Are there any saving graces? So far, we know that RHS has established an
Enforcement Team. This is a small team of only eight or ten people according
to the Agency. But it is intended to centralize, formalize and
professionalize the enforcement mechanism. Right now its role is to support
field offices in their enforcement actions.
On the HUD side, we’ve seen this become a real enforcement monster. It
develops charges, investigates, and prosecutes, and one of the attorneys
there serves as the hearing officer to adjudicate. If you can imagine, very
seldom will that hearing officer not agree with the charges his colleagues
bring. It may be that, because USDA has the National Appeals Division with the
adjudicatory function separate from the Agency enforcement function, you may
have a better chance of avoiding the worst consequences of what HUD does now.
Again, this RHS enforcement role is growing and since they don’t like
having a neutral adjudicator get in the way of enforcement actions, it
wouldn’t surprise me if at some point in the future RHS also tries to bring
enforcement adjudication inside its own enforcement center.
I hope this gives you a chance to learn a little bit about the statute
and be more prepared when OIG comes to call.
Question: Is there a particular area of enforcement that RHS will be going
after? Is there something on the table that they’re concerned about? I’ve
heard things about fee splitting being an issue. I know it is an issue on the
HUD side.
Kelly: I haven’t seen their cheat sheet of what they’re going to look for.
They’re probably going to be looking for evidence of Equity Skimming. I think
they’re going to be looking for evidence of fee splitting. They’re going to
be trying to see if there is any other way they can try and shoehorn your
conduct into something in the statute that violates the law. If as a result
of their visit, the worst they conclude is that you’re perhaps you’re not
fitting the neediest families into the largest apartments, consider yourself
lucky. But they do have axes to grind and I think what I would expect to see
is evidence of fee splitting, evidence of undocumented use of cash, and other
evidence that in their mind constitutes equity skimming. Those are the things
that are high on their list.
Meyers: I agree. I think most immediate is the physical condition of your
projects, Classification D. Identity of Interest will be co-equal. I would
especially raise a warning if you are Identity of Interest over several
states and if you’re a mid-size borrower, say 30 and up projects. Fee
splitting is not really on the horizon — it surfaced one time with the IG at
USDA, and it will come back. I don’t think they’ve figured out what to do
about it, and I think it’s going to be a mixed bag. I’d say fee splitting
won’t be another issue for probably 18 months.
Kelly: So you have time to get your records in order.
Question: I’ve been involved in discussions or debates on what may be
considered fee splitting. A lot of the arguments are presented by
certain Management Agents or Borrowers who take the position of “Why can
someone tell me what to do with my profits?” Is there a distinct difference
between fee splitting and profit splitting?
Meyers: Nixon Peabody has probably done more litigation on fee splitting and
is state of the art on the HUD side.
Kelly: I think the problem you get into, and I assume everyone knows what
we’re talking about with fee splitting. No? Well, that’s the problem: I
don’t think the Agency does either, but they think that they do.
Meyers: A quick example: I’m a GP and I want out. I offer my General Partner
interest for sale. Someone offers me twice management fees because, of
course, with the GP interest you get to name the Management Agent. That’s
Part One. Part Two is that you say it’ll be a three pay or four pay. I think
that you have all the elements of fee splitting right there.
Kelly: It could come up in any number of contexts. We have had people who
have entered into contracts with third parties to provide a service and get
a discount: If you sign up for this particular service for umpteen number of
properties, we’ll give a discount. Whose pocket that discount shows up in is
a different matter. That discount can be deemed to be a way of improperly
giving a contract to a third party which does not provide the maximum benefit
to the property, but arguably may go to provide more income or shelter some
income for the Management Agent or for the GP. The Agency is going to come by
and say that on that contract, you split the fee — you got essentially some
sort of a kickback for giving that contract to a third party. That’s where
the statute’s Equity Skimming language kicks in:
. . . where any part of the rents, assets, proceeds, income, or other funds
derived from such property are used for any purpose other than to meet
actual, reasonable, and necessary expenses of the property. . . .
You fall into some trouble there. And, obviously, with respect to the
certifications and the other bad things the Civil Monetary Penalties are
intended to catch, they can shoehorn the fee splitting into those matters as
well. I thinks it’s a serious problem just because the law is so vague. There
is a Fraud Alert which was put out about two years ago by the HUD OIG in the
form of a Federal Register Notice on May 4, 1999. It’s essentially a warning
to the regulated public. It says if we catch you doing this, we’re going to
consider these sort of kickback arrangements (whether they are or are not
kickbacks, I’m going to use the term) as a form of fee splitting and we’re
going to hold you liable. The idea was to put everyone on notice. Those of
you who aren’t familiar with it need to look at it. I think they have the
ammunition from a regulatory enforcement point of view to go after this.
Whether it’s 18 months from now or two months from now, the point is it will
be out there. You need to be aware of it.
Thank you very much. We hope if you have any questions, call John or
me. These are important matters and you’ll be doing yourself, your tenants,
and anyone you work for a lot of good if you raise your awareness of these
things and act proactively to avoid the kind of consequences so many people
are suffering from.