Rebecca Batts
Director,
Rural Housing/Natural Resources Division
Office of Inspector General, USDA
Washington, D.C.
Addressing the National Association of Home Builders:
The evaluation report that was issued in February contains three primary areas. We actually started the project as a comparison between HUD’s legislative authority and the legislative authority the RHS has. In looking at the differences, there were things HUD had that would be helpful for RHS. We also came up with some other legislative proposals and suggestions to RHS for things they should propose that came came from our audit and investigative history. We have quite an extensive history in the last five years with 84 audits in this area, an identification of $94 million in Federal funds that were misused. So we used those findings to develop some other legislative proposals. Finally, we proposed some other administrative changes where we did not feel that legislative change would be necessary.
Equity Skimming
The first area where we felt HUD legislation could be beneficial to the RHS program was the area of equity skimming. In HUD, they have equity skimming legislation that said the willful misuse of project assets — the rents, the laundry receipts, whatever assets there are — will be a criminal offense if the note isn’t current and you’re in a non-surplus cash condition. Or, you can have double damages as the penalty if everything is paid up and you have the cash there, but you’ve misused the project. In OIG, we’ve had some difficulty in getting the US Attorneys to take cases even when we felt that quite clearly projects assets had been misused. The reason for that is the US Attorney felt that the crime, if you will, was against the project, not against the government. But, since the cash flows and the income to the project feed directly into the rent and Rental Assistance, higher expenses, more cost to the Government, we felt that this was an appropriate way to move toward getting a way to prosecute persons actually stealing from the government by stealing from the project. That’s the first of the proposals.
Auditable Records
The second area is also based on HUD legislation. HUD’s legislative authority requires auditable records. The requirement for auditable records in RHS is really just sort of implied in the regulations and in the policies, but there’s nothing actually in the law that says the records must be auditable or in a certain condition or anything that really talks about what type of bookkeeping system or accounting system has to be maintained. We believe that adapting a document that HUD has requiring an auditable system of records and includes a civil penalty for noncompliance — if the auditor shows up, and we’re completely unable to determine where certain expense items came from, where money went, what accounts things went into, and out of what project — we think this would also strengthen the ability of RHS to manage its program.
Reserve Interest
We think that we’ve identified over the years in our audits one thing we felt that a legislative change could help us with is the investment of the Reserve Account funds. As the tax laws currently stand, there’s some real disincentives to the investment of the Reserve Account because the interest income may flow through to the Limited Partners. As we understand it, the IRS has not been willing to grant any kind of waiver or any kind of administrative relief on this issue. So, we are recommending to RHS in their legislative proposals to get some kind of relief from this issue so that projects could have some incentive to invest that money. It all goes back to cost to the government, because higher project income in the form of interest income would be cash into the project and ultimately affect the rents. As an interim measure, what we’ve talked with RHS about is, short of doing it legislatively, requesting that they would be invested in tax-free municipals or some sort of tax-free investment.
Section 8
Another one of the issues that we address in our report is the idea of transferring the HUD Section 8 assistance to RHS since subsidy computation for HUD is fixed by law; it almost always exceeds what’s necessary for the project. And, the transfer would decrease the Rental Assistance to the level needed for project expenses.
Identity of Interest
OMB has considered the Rural Housing multi-family program to be one of it’s most high risk programs for several years. Over the years in our audits, we have repeatedly identified problems in Identity of Interest companies which are paper, shell-type companies that don’t add value to the services that they provide. They simply mark up the cost of doing business for a project, and increase Rental Assistance cost to the government. In our evaluation report we concluded that the problems involved in the Identity of Interest companies are so severe that there’s really not a good way to control them administratively. That there’s really not a way to do that. And we recommended that Identity of Interest companies not be permitted to purchase goods for projects and not be permitted to procure services, unless an outside vendor was completely unavailable.
The other items that we talked about — not a difficult sale to RHS. Identity of Interest is one they have definitely not bought into. What they provided us is a counter-proposal that we’re looking at. The heart of the matter is really how you can put controls on this Identity of Interest issue so that you’re not allowing really exorbitant profits — they’re really clearly stealing is just really almost the only way you can look at it. Eliminate that and yet still allow the idea that there could be a legitimate Identity of Interest that could add value for services to the project. How do you make that distinction?
One of the things that I want to cover is a little bit of the back and forth we are doing with RHS. RHS has come back to us; they agreed with our other proposals and have come back to us on this one with some proposals for regulatory change that they think will strengthen their ability to deal with Identity of Interest.
Management Agent Responsibility
One of the first things they are proposing to do is to clearly define or standardize what a Managing Agent responsibility is. One of the things that over the years we’ve always talked about in our audits is why are we getting charged for the Xerox machine when obviously (to the auditor) Xeroxing is a Management Agent responsibility. So one of the first things RHS is agreeing to do is trying to get a little clearer handle on what exactly a Management Agent is responsible for and what would be a legitimate extra. The second area is kind of related — standardizing project administration types of responsibilities. The first two are really going to help all of us because it is going to be much clearer as to what is allowable, what isn’t allowable, and if you do this, can it be an add-on to the management fee kind of thing. This would be most important when the Management Agent is an Identity of Interest company. These would apply across the board.
Standardized Record Keeping
The next area would be standardizing record keeping systems. They’re proposing to standardize the basic requirements of the the project and the management company record keeping systems. When we’ve gone out to do our audit on the management company and the project, we often find that the records are not in very good shape. Sometimes we get a shoe box full of receipts or scribbled notes or whatever and there’s just really nothing.
Approval of Identity of Interest Company
For the Identity of Interest firm, in order for the Identity of Interest (and remember this is the RHS proposal) firm to do business with the project, they would have to request a special designation and meet a number of criteria to get this special designation. It would be necessary, before they could do business and before they could charge any profit or any kind of mark-up (and, to get that, first there would have to be full disclosure of any Identity of Interest relationship. Again, when we do our audits, we often find there is an undisclosed Identity of Interest relationship). Second, the Identity of Interest firm would provide an initial list of charges for all the transactions and comparison costs with at least two other third parties in that same market area. They would do some work to show they would add value to the project. And by doing that, to demonstrate that the Identity of Interest company is not just a shell or a pass-through or an artificial method of profit, things like licenses, IRS tax ID numbers will be required as well as a resume of experience and a list of actual employees that would be doing work. Of course, the idea here, is to identify (and it will be hard for RHS to track) and catch the situation where, in one of our audits where we looked at Management Agents: there were $252,000 in fees we found that this Identity of Interest firm had subcontracted with another company for $159,000. There was $113,000 just plain fat or profit — there was no value added; nothing extra had been done; it was simply an additional shell. This is to get at those types of shell companies. Presumably, the RHS review of employees and resumes would identify situations where there really weren’t folks on the payroll and it wasn’t really a company.
There would be, before the charges would be allowable, a full review of the company’s bookkeeping system, and by that the Identity of Interest company’s bookkeeping system, including a maintenance work order and purchase order system to make sure there would be reasonable books available for audit purposes. Again, we’ve often gone out and found we have an Identity of Interest laundry company and there is no bookkeeping system whatsoever.
One of the things we’ve talked about is that we’re concerned about RHS having the staffing to actually do this. The idea is that before they’d get the designation, these are prerequisites to getting the designation. We are concerned that RHS will be able to get all this done before they can designate someone as Identity of Interest firm. This is their counter-proposal of what they’re suggesting back to us. It certainly would be an aid to us and also an aid to RHS in managing the program if they did know that where they had an Identity of Interest situation, they could go in and determine what was going on.
Special Audit Requirements
A prerequisite for designation for a business with an Identity of Interest would be agreeing to some special audit requirements for all of the projects in which they do business and for the Identity of Interest company. An RHS proposal is that these would initially be done annually and then if things were okay after two or three years, these audits could be done at longer and longer intervals. The audit would not be necessary before it could be approved, but agreement to the audit. In going back and forth with RHS on this, I’m not entirely certain that what they’re thinking about is a GAGAS audit.
They’re thinking of agreed to procedures. In other words, this is what we want to check and this is how we want to check it. We would work with RHS to come up with those practices and procedures, and have that locked in so everyone would understand this is how we’re going to apply this.
What RHS is saying is they want a number of things: a determination that costs are reasonable through spot checking; financial records that meet Agency requirement and are auditable; that the costs the Identity of Interest firm is charging are allowable and supportable; a determination (I don’t know how they’re going to do this) that the company actually performed work at the project and added value. This is going to be a little bit tough but that’s what they’re really looking for — it all comes down to: was this a real service, was this a real company, or was this a shell. The next part is an annual budget approval where there’s an Identity of Interest company, they would annually provide updated cost-comparisons, and updated copies of contracts as well as updated comparables at budget approval time. Next would be an annual physical inspection so that there could be a comparison of what was charged for and the actual physical condition of the project; the annual physical inspection would involve interviews with both site employees and tenants to confirm work was performed. And, finally, RHS is telling us that they would be much more open to pursue criminal or administrative actions. Once they had all these other things, once you’ve got all this other stuff, and then you find a problem, it’s hard for it to be a misunderstanding or whatever.
Other RHS Proposals
Other things that they are proposing are objective Housing Quality Standards; these standards will be published in the Federal Register and set a minimum level of maintenance to be maintained at all times. There’d be an annual inspection and if the standards weren’t complied with, there’d be an immediate loan servicing action. A five year Capital Improvement and Maintenance Plan; this would be updated annually. An outline of the way the Reserve Account is going to be used, and also deal with an investment strategy for the Reserve Account funds. They would approve management of the property. A revised audit policy that would include a standardized format for submitting financial information to the Agency. They’re committing to additional training of Agency personnel on understanding that format. That includes not just seeing that there’s a number, but understanding what it means and knowing what to do with it when you get that number. They’re also proposing requiring a financial audit only, which would lower the cost of the audit services to the project, and would allow them to require audits of projects with 13 or more units, which would bring some more projects into the fold. Further, the audit would be completed by a non-Identity of Interest CPA.
CPA Audit Cost
[A comment is made from the floor to the effect that you can make a pizza so cheap no one will eat it, which is to say that RHS isn’t willing to permit realistic CPA audit costs, forcing Borrowers to go to lesser, cheaper, inadequate CPA firms].
That’s a very good point. We’ve had discussions with the Agency on that. We keep hammering them on that. That’s part of the reason we’re at where we are today with a lot of suggestions for changing and a lot of oversight. A lot of these problems have been out there; they haven’t gotten to the surface where they can be dealt with. And, part of that is that the Agency hasn’t been willing to make sure we get a good quality audit. I think, as we work through this and revise the audit program, we’ll have those kinds of discussions with the Agency and try to get a more realistic view of what that should cost.
Supervisory Visit/Performance Evaluation
The next area is the Supervisory Visit/Performance Evaluation. They’re looking at setting up a very specific way that RHS will come out to do the reviews at the various projects. They’re looking at moving to more immediate loan servicing actions when projects haven’t been maintained. Part of this idea is moving the Agency from property management into more of an enforcement/monitoring type role. The key change there is moving into immediate loan servicing action rather than working and doing more cajoling. At some point these Performance Evaluations would have a result in moving to loan servicing actions.
Management Fee/Costs
They are talking about developing a management fee methodology that can be compared to conventional property management fees with add-ons for any additional requirements. Have the State Office come up with what a fair management fee is, and that would help them in dealing the Identity of Interest type management companies. This would be done with a comparison of conventional property management and then other subsidized properties. They’d do spot checks of their operations and maintenance data bases — that would be with things like Accu-pro and also with other institutional knowledge about what’s out there. Here they’re looking to see that costs for Identity of Interest firms are reasonable. They would require competitive bidding for all Reserve requests over $5,000 when there is an Identity of Interest company, and specific plans and specifications.
That’s what their proposal back to us was in response to our recommendation that they eliminate Identity of Interest. So that’s where we are. Our position is that there’s no way this can be reasonably controlled, and they’ve come back with this kind of basket full of controls that they believe will allow them to get at the Identity of Interest firms.
Administrative changes we proposed, more for further thought, included the non-recourse nature of the loan itself. In trying to do some research where that non-recourse against the General Partner provision came into place, we were not able to identify the source of that particular thing other than it was in HUD and has happened however many years back. There is a suggestion to look at the idea of should these loans include some recourse provisions.
Some other things that RHS is proposing is fidelity bond coverage for any company or any individuals that have access to project assets. That would be like laundry companies and site managers, etc. The next area is fidelity bond coverage for the General Partner and included the recommendation that RHS look to see if this could be obtained. In other words, would it be possible to get bonding to bond the General Partner against himself.
And the third one was limiting preapplications. Since there are some costs in developing preapplications, perhaps RHS should look at the situation where a developer goes in and just blankets the country with preapplications, with the tremendous amount of costs there that have to be recovered.
Responses to Several Questions
The requirements for audits, the reviews, the forms, the record keeping requirements are absolutely not working with respect to the Identity of Interest firms. That’s the reason for the proposal to eliminate them. You combine that with the lack of a penalty, because the U.S. Attorney has not been willing to take action in some of the most horrific cases you would want to talk about. We don’t catch them very well; we don’t identify the problem very well; and, when we do, not much happens.
We know that we’re coming from a position where we’ve documented any number of cases that have been harmful to the program. And that’s the danger that you well know: if more of these keep coming to the surface, then the whole program is in danger. We’re also coming from the position of the Agency responding to us, saying that they were not willing to do anything — two years ago, a year ago. Telling us to go away. That they were not going to touch that. The Hill won’t do anything about it. We keep hammering and hammering. We’re coming from a position of: get rid of everything. Maybe, in the middle, there’s a compromise there that will work. Better auditing procedures. Full disclosure. If we can get some of these criminal things taken care of. I think it will go a long way toward bringing some better order to the process.