Cuyahoga County Agency of Inspector General Follow-up Review – Department of Development Loan Funds June 30, 2017 Inspector General Mark D. Griffin Cuyahoga County InspectorGeneral.CuyahogaCounty.us Together We Thrive Table of Contents I. EXECUTIVE SUMMARY ............................................................................................. 1 II. BACKGROUND ............................................................................................................ 4 A. Summary of Prior Investigations ............................................................................ 4 1. The AIG Has Issued Six Prior Reports with Recommendations ................. 4 2. This June 30 Draft Incorporates or Responds to DoD’s Comments Regarding the Draft Report Issued February 3, 2017 ..................................... 4 3. This June 30 Draft Recognizes the County’s Recent Efforts to Improve DoD’s Processes ...................................................................................................... 5 B. Summary and Status of Prior Recommendations .............................................. 5 C. Information Requested and Reviewed................................................................. 11 III. FINDINGS .................................................................................................................... 14 A. DoD’s Records Have Been Inaccurate and Incomplete .................................. 14 B. Origins of Dysfunction: DoD’s Flawed Practices Began Under the Prior County Commissioner System of Government ................................................ 15 C. Year-End 2016 Data Regarding The DoD’s Loan Portfolio Indicated Problems That Must Be Addressed ..................................................................... 17 1. In 2016, 46.59% of DoD Loans were Past Due or Delinquent ..................... 17 2. In 2016, the County was Owed $8.5 Million in Uncollected Principal and Interest ...................................................................................................................... 18 3. In 2016, the Balances on Past Due Loans Represented 46.56% of All Outstanding Balances .......................................................................................... 20 D. DoD Did Not Comply with Federal, State and County Guidelines ............... 21 1. Compliance with Federal and State Guidelines ............................................. 21 2. Nearly $1 Million In Purported Write-Offs Without Policies, Procedures, Limits or Approval of the County Executive .................................................. 23 ii DoD’s Records Should be Corrected in Order to Facilitate Improved Management, Internal Controls and Decision Making .................................... 25 E. 1. DoD’s Loan Database Has Been Incomplete and Inaccurate .................... 25 2. The County Has Lacked Basic Information Regarding its Loan Portfolio 26 3. Inaccurate Job Creation Data ............................................................................. 27 4. Overdue Tracking Reports .................................................................................. 27 5. Incomplete Descriptions of Receipts in FAMIS Impedes the Tracking and Monitoring of Loans .............................................................................................. 28 DoD’s Services Should be Improved ................................................................... 28 F. 1. DoD Has Failed to Provide Basic Monitoring of Loans ............................... 28 2. Loan Servicing Letters are Incomplete and Inaccurate ............................... 30 3. High Risk Loans Should be Tied to Tangible Collateral or Personal Guarantees............................................................................................................... 31 G. DoD Has Failed to Comply with County Code Sections 501.23 and 701.07 Requiring Public Disclosure of All Outstanding Loans.................................. 31 H. DoD’s Past Practices Exposed the County to Unnecessary Risks ............. 32 1. Unnecessary Risk Factors .................................................................................. 32 2. The AIG Recommended That DoD Adopt Written Policies to Improve Internal Controls..................................................................................................... 33 3. The County Should Require Background Checks for DoD Borrowers and Review Past Loans as Necessary...................................................................... 34 I. J. IV. Other Jurisdictions Manage Their Development Loans with Effective Policies and Procedures ......................................................................................... 35 1. Franklin County ...................................................................................................... 35 2. Hamilton County..................................................................................................... 36 3. Summit County ....................................................................................................... 37 4. Lorain County ......................................................................................................... 37 5. Other Jurisdictions – U.S. Virgin Islands ........................................................ 38 The County Should Out-Source the Servicing and Monitoring of Development Loans.................................................................................................. 38 CONCLUSION ............................................................................................................. 39 iii I. EXECUTIVE SUMMARY The Cuyahoga County Department of Development (“DoD”) plays a central role in county government. When the voters and taxpayers of Cuyahoga County chose to replace the County Commissioner form of government with a County Executive and County Council, the very first sentence of the new charter declared: We, the people of Cuyahoga County, Ohio, desire a reformed County Government to significantly improve the County's economic competitiveness. The second sentence declared: With it, the taxpayers of Cuyahoga County can have: . . . (2) job creation and economic growth as a fundamental government purpose, thereby helping the County do a better job of creating and retaining jobs and ensuring necessary and essential health and human services; Our community declared economic growth to be a fundamental government purpose. Cuyahoga County is the only county in Ohio which states in its charter that economic development is a primary goal. However, the reorganization of County government did not automatically replace past practices with new ones. The issuance of loans to promote economic growth is an important and effective tool. However, since its creation, DoD has never had written policies or procedures to monitor and protect the taxpayers’ dollars that are disbursed as development loans. From 2004 to 2005, DoD dramatically increased its loan activity ten-fold -- primarily targeting high risk loans. Despite its exponential expansion in lending activity, DoD had: • • • • • No written policies and procedures for the servicing and monitoring of loans; No comprehensive list of all outstanding development loans; No accurate accounting of all of its outstanding development loans; No written policies and procedures for the collection of past due loans; and Ineffective internal controls. These deficiencies were long-standing. By the end of 2016, over $8.5 million in loans had gone uncollected. Further, approximately 46% of DoD’s outstanding balances were associated with loans that were either past due or in default. The deficiencies identified in this report occurred at all levels of government. First, and most importantly, DoD had – and still has – a continuing obligation to monitor and protect the taxpayers’ dollars. DoD staff recognize that its monitoring has been inadequate. Second, these inadequacies should have been identified by oversight entities including the previous County Commissioners, County Auditor, prior administrations and other authorities at the federal, state and county levels. 1 DoD’s mission is to create jobs and to spur economic growth in our community. It cannot do so without effective policies and accurate data. DoD cannot make good decisions regarding the targeting or management of its resources if its own data is flawed. Similarly, without strong internal controls and policies, DoD cannot deter waste, fraud and abuse. Every dollar wasted is a dollar which cannot be used to invest in our people and our companies. In 2016, in response to prior AIG reports, the County issued an RFQ for an independent consultant to review DoD’s loan portfolio. Later that year, the County contracted with Douglass & Associates for the collection of delinquent loans. In December, County Executive Budish instructed DoD to provide him with a complete and accurate list of outstanding loans. The AIG circulated an initial draft of this report on February 3, 2017. County Executive Budish and DoD Director Carter reviewed the February 3 Draft and have moved forward to adopt its recommendations. Additionally, as a result of the RFQ issued in 2016, Ernst & Young was engaged in January 2017 to provide an independent review of DoD and to identify best practices. Ernst & Young’s findings are consistent with the findings in this report. On June 22, 2017, DoD provided an update regarding its corrective action steps. This report includes findings from Ernst & Young as well as DoD’s recent updates. Briefly, as of the February 3 Draft of this report, DoD had not corrected its data, had not implemented internal policies or controls, and had not modified its practices. Moreover, DoD had not complied with federal and state guidelines requiring DoD to adopt clear, effective written policies for the servicing, monitoring and writing off of loans.1 Because DoD lacked policies, procedures and effective internal controls, its underlying data has been incomplete and inaccurate. DoD’s loans had been tracked in a variety of separate locations. The primary database is Portfol – a loan servicing and monitoring program. However, many loans were not entered into Portfol. Some were tracked on Microsoft Excel (“MS Excel”) spreadsheets by individual program officers. Because the loans were tracked in different places, by different employees, using different systems, the County did not have a complete and accurate source for fundamental data including: the total number of unpaid loans, the balances of these unpaid loans and other financial data. At the end of 2016, DoD’s Portfol database included records for 264 economic development loans with loan balances totaling $50,077,688. Of these loans, 123 were past due by more than 90 days. The balances on these past due loans totaled $23,313,754. Accordingly, 46.59% of DoD’s recorded loans (measured by the number 1 See OMB Circular A-133, Part 6 (applies to loans issued prior to Dec. 26, 2014; 2 C.F.R. 200 et seq applies to loans issued after Dec. 26, 2014); Ohio Admin. Code § 117-02-01 et seq. 2 of loans) and 46.56% of the County’s outstanding balances (measured by the dollar value of those balances) associated with DoD loans were past-due, at-risk of default, or already in default. The uncertainty in the data was compounded by DoD’s failure to have a “hard close” on its books. The absence of a “hard close” allowed retroactive changes to be made to the data without the typical accounting procedure of a written adjustment and explanation that are independently approved and recorded. DoD had, in fact, made retroactive changes. These retroactive changes may need to be reviewed to determine if a restatement must be made to the Comprehensive Annual Financial Report (“CAFR”) or a report should be provided to County Council. Due to the lack of confidence in the data, DoD has not yet implemented Portfol’s automatic function to generate monthly invoices to borrowers. The prior lack of invoicing has led to repeated failures. Recently, one borrower, CFRC Water and Energy Solutions, failed to make a balloon payment of over $103,000 due January 1, 2017. Because DoD failed to send timely invoices, DoD decided to waive the contractually required $4,919 in late fees and also waived the default interest.2 The AIG reviewed the practices in other jurisdictions. Franklin County, Hamilton County, Summit County and Lorain County all have written or adopted standard procedures. They also invoice borrowers monthly and review the status of loans in regular committee meetings. Summit County and Lorain County use private financial institutions to manage their portfolios. Based upon the AIG’s recommendation, the County has decided to outsource the servicing and monitoring of its loans. The County has begun to correct these problems. Since February 3, 2017 the County has: • • • • • • • • Adopted a policy manual for DoD loans which establishes written procedures and internal controls for the first time; Identified all DoD loans approved since 2007; Reviewed and regularized files for all loans approved since 2015; Referred 87 loans to collection by a private firm; Issued an RFP to out-source loan servicing and monitoring; Initiated the identification, review and analysis of all outstanding DoD loans; Worked with a forensic accountant to review specific loans; and Engaged Ernst & Young to review DoD’s loan portfolio and recommend best practices going forward. 2 DoD has used its failure to invoice or notify borrowers as a reason to waive late fees owed to the County’s taxpayers. See Portfol Log/History Note, Kovez LLC (Sept. 14, 2016) ("Removed late fees as borrower has excellent payment history. Borrower missed 1 payment and was not notified in a timely manner. T”). Having missed one payment, DoD still used the same rationale of “excellent payment history” to forgive another missed payment by the same borrower. See Portfol Log/History Note, Kovez LLC (Feb. 9, 2017) (“"Removed late fees as borrower has excellent payment history. Borrower missed 1 payment and was not notified in a timely manner. This resul [sic])”). 3 The progress is real, it is substantial – and it is not yet complete. DoD’s problems are well-entrenched, significant and systemic. These problems will take time to correct. However, the AIG recognizes that, for the first time, the County is now working to fix problems that took root decades ago. The AIG will continue to review DoD’s efforts. II. BACKGROUND A. Summary of Prior Investigations 1. The AIG Has Issued Six Prior Reports with Recommendations On October 26, 2012, the AIG initiated a review of the collections process for the New Product Loan Program based on a complaint received from a borrower. On January 22, 2015, the AIG issued a report (AIG Report 12-0057-I) indicating DoD’s efforts to collect delinquent loan balances were inadequate and the AIG requested DoD respond to the recommendations by March 16, 2015. DoD failed to provide the AIG with a response. Subsequently, the AIG issued the following reports: AIG Report 15-0013-I, AIG Report 15-0019-I, AIG Report 15-0025-I, AIG Report 16-0023-I, AIG Report 16-0024-I (collectively incorporated by reference). Broadly, these reports found that DoD’s loan records were incomplete, inaccurate, and that DoD had failed to collect outstanding loans. The AIG made recommendations to improve the completeness and accuracy of DoD’s financial information. The AIG also made recommendations to improve the servicing, monitoring and collection of these loans. As a result, some steps were taken to begin the process of reviewing DoD’s operations. In 2016, Director Carter initiated an RFP to engage outside consultants to evaluate DoD’s loan programs. On December 7, 2016, County Executive Budish met with staff from DoD and the AIG. During this meeting, County Executive Budish directed DoD to produce a comprehensive and accurate list of all DoD loans. 2. This June 30 Draft Incorporates or Responds to DoD’s Comments Regarding the Draft Report Issued February 3, 2017 The AIG provided an initial draft of this report to DoD on February 3, 2017. The AIG’s goal was to provide DoD an opportunity to respond, to correct any errors identified by DoD in the February Draft, and to allow the County time to take corrective action. DoD provided its initial response on June 22, 2017 and a revised response on June 26, 2017. The present draft of this AIG report includes DoD’s responses in the text, and where deemed appropriate provides the AIG’s position. 4 3. This June 30 Draft Recognizes the County’s Recent Efforts to Improve DoD’s Processes In its entire history, DoD has never had written policies, never had a comprehensive and accurate list of its loans, and has never been required by oversight entities to implement changes. Since February 3, the County has initiated important steps to analyze and correct the deficiencies in DoD’s loan process. These steps were taken at the direction of County Executive Budish and Director Carter. First, the County engaged Ernst & Young LLP to review DoD’s loan processes. Ernst & Young reviewed the AIG’s February 3 Draft, met with AIG and DoD staff, conducted its own independent investigation and issued its own report. Ernst & Young’s findings are consistent with the AIG’s findings. In addition, Ernst & Young’s scope of work was substantially larger than the work performed to date by the AIG. Beyond solely identifying current issues in DoD, Ernst & Young also provided analysis regarding best practices in the industry, recommendations for organizing DoD, and recommendations for optimizing development strategy on a going-forward basis. Second, the County organized an inter-departmental project team led by Ms. Heather Reffett from the Office of Innovation to correct the problems identified in DoD. Ms. Reffett has been supported by as many as 11 additional staff and interns. Third, the County had Mr. George Hillow, a forensic accountant, review the County’s loans. Fourth, Executive Budish held weekly meetings to personally monitor and drive the necessary changes. As a result, for the first time, the County has made substantial and important progress in identifying and reconciling DoD loans, and establishing procedures to protect taxpayers’ funds in the future. As noted below, the task is not complete. However, the County has made significant and notable improvements. DoD is moving in the right direction. B. Summary and Status of Prior Recommendations This section discusses the status of recommendations from the prior AIG reports listed above and identified in the February 3 Draft. The AIG recognizes and appreciates the significant efforts made since February to address these problems. Where appropriate, the updated status is included in the discussion below. 5 Through the investigations listed above, the AIG identified the following major deficiencies: • Lack of Written Policies and Procedures Recommendation: DoD should also draft policies and a formal system for collection and repayment oversight of DoD loans.3 Status (February 3, 2017): Not Implemented. DoD has requested the Department of Law, the County Fiscal Office and/or the AIG to draft DoD’s policies. DoD’s Response (June 26, 2017): As of June 30, 2017, the County has issued for the first time a Loan Portfolio Policy Manual. DoD received input from the Law Department, the members of the Cuyahoga County Community Improvement Corporation (CCCIC), Ernst & Young, Mr. George Hillow, external stakeholders and DoD staff. This manual will be used as a performance-management tool to guide performance expectations in the conduct and execution of our Loans from origination to underwriting to collections. Though the manual will be refined and updated periodically, staff will be expected to have a full understanding of performance expectations as outlined by the policy. A senior member of the DoD staff will be charged, by the Director, with ensuring policy compliance. As the DoD continues to refine its economic development program, updates to the Policy Manual, as well as the development of detailed operating procedures, will be used to further support consistent and standardized quality practices. • Inaccurate and Incomplete Records Recommendation: DoD should prepare an inventory of all DoD loans, then review and audit these loans for accuracy. All loans should be included in Portfol, DoD’s loan monitoring software.4 See also EY, p.12 (“There are no consistent written or followed policies and procedures for disbursing funds or servicing loans. Currently, the loan originators are expected to service and disburse the loans. This is directly contrary to leading practice in well-run economic development organizations as well as private sector loan issuers, such as banks.”) 3 Consistent with this finding, Ernst & Young wrote that: “EY believes the Department will not be able to move forward until each historic loan is properly accounted for and documented. The Department should devote all necessary resources to ensure the entire loan pool has been entered into Portfol, the Department’s economic development loan tracking system. Portfol provides features to assist with job tracking and reporting, accounting for different funding sources and generating reports. During the research phase of the project EY was unable to confirm certain key facts including the number of the outstanding loans and the outstanding loan balances due to gaps in the Department’s current data collection processes and the scope of EY’s initial evaluation, which called for a sampling of loans rather than an exhaustive review of the entire portfolio. These facts and figures must be made available, both on a historical and go-forward basis, in order to provide both transparency and accountability.” EY, p. 3. 4 6 Status (February 3, 2017): Partially initiated. DoD did not respond to the AIG’s recommendations. However, the County Executive has similarly requested that DoD prepare such an inventory. DoD’s Response (June 26, 2017): For the first time, the DoD has created an inventory of all loans approved since 2007 by reviewing approved legislative resolutions and financial disbursement records. DoD staff are collecting loan documents to associate with the inventoried list of borrowers. Work in progress includes: documenting all loans originating between 2007 and 2017, as well as validating that the loan terms are structured correctly and financial records accurately reflect within the database (Portfol). Policies, as outlined above are in place to maintain good practices long-term. • No Monthly Invoicing Or Reports Recommendation: Activate and use the existing automatic invoicing function of the Portfol software.5 Status (February 3, 2017): Not Implemented. Recommendation: Send out monthly statements for all loans where payment is due. Status (February 3, 2017): Not Implemented. DoD’s Response (June 26, 2017): Due to lack of confidence in the Portfol data, this has not yet been implemented. Development recognizes the importance of invoicing and equally the importance of maintaining communication with borrowers, especially those identified as high risk. Since the beginning of the Budish Administration, the Department has minimized the approval of what might be considered high-risk loans with a few exceptions. As a general matter, loans from January 2015 forward, have required collateral and or personal guarantees – this will continue to be the Department’s policy. Additionally, the DoD has worked closely with the Office of Procurement and Diversity to release a Request for Qualifications (RFQ) for loan servicing\portfolio management. The RFQ was released Friday, June 16, 2017. Via the RFQ process, the DoD will have the opportunity to evaluate potential vendors for their ability to effectively manage the servicing of the economic development loans. Additionally, the Department has received budget approval to hire a Loan Portfolio See also EY, p. 13 (“Upon review and demonstration, EY has come to the conclusion that Portfol seems to be an effective tool for tracking economic development projects. However, individual staff members are not diligent at properly inputting the loan information on a timely basis. This is due to both a lack of clarity regarding who is responsible and, in some cases, lack of timely access to the information needed to fully document. Additionally, it appears the tool is not being maximized efficiently. Certain potentially, useful functionalities, such as the system’s ability to generate invoices and notices on a periodic basis, are not being utilized.”) 5 7 Manager to oversee all loan management efforts. This position will report directly to the Director. The position will be posted for hire in July. • No Adequate System for Collections Recommendation: DoD should designate a responsible person and create written policies and procedures that establishes a loan servicing process for delinquent and defaulted borrowers and outlines procedures for loans requiring collection action.6 DoD employees and managers should acknowledge the policies and responsibility for upholding the policies.7 Status (February 3, 2017): Not Implemented. Recommendation: The Department of Law should designate one or more persons to pursue collections. If appropriate, the County should consider engaging outside legal counsel to pursue these collections on a contingent-fee basis. Status (February 3, 2017): The Department of Law has entered into a collection agreement with the State of Ohio and has designated at least one attorney to serve as a liaison for collection matters. The Department of Law has also engaged outside counsel to evaluate and pursue outstanding debts. DoD’s Response (June 26, 2017): With regards to collections, the DoD engaged Douglass & Associates in September of 2016 to collect on its delinquent loans. An updated list and an additional list has been submitted to Douglass. DoD has issued a new Loan Policy Manual. The Director received input from the Law Department, the Cuyahoga County Community Improvement Corporation (CCCIC), Ernst & Young, external stakeholders and DoD staff. The Manual includes language to address accounts that have past due payments. This will also be the joint responsibility of the Loan Portfolio Manager and the 3 rd party outsourcing firm that will be selected as part of an RFQ process. • Poor Response to Requests by Borrowers for Pay-Off Numbers Recommendation: The County should designate separate individuals who can promptly review and provide payoff numbers and settle claims.8 6 This will likely require the coordination of efforts with the Department of Law and other County entities. Ultimately, this may require guidance of the County Executive and/or County Council. As a matter of good policy and effective internal controls, the County’s Department of Internal Audit recommends when conducting an audit that employees acknowledge the department-specific policy and procedure manuals by signing a form when hired or when policies change. 7 See also EY, p. 13 (“Staff have not been able to identify all of the outstanding loans because the information was not properly entered into Portfol and the files may be located in archives. EY identified at least one instance where a loan was mistakenly archived while still active, leading to subsequent delays and errors by the Department when the borrower sought to pay off the balance and the records were not readily available. This example illustrates the urgent need to correct and update the system including all 8 8 Status (February 3, 2017): Not Implemented. DoD’s Response (June 26, 2017): The Executive office has directed DoD to include both the Fiscal Department and Law Department in its calculation of loan balances (payoff numbers) to assist the collections agency with settling claims. • Failure To Disclose Loan Information in Accordance with County Code Sections 501.23 and 701.07 Recommendation: DoD should use Portfol to post on its website all loan information required by the County Code in a searchable MS Excel spreadsheet or other format. Status (February 3, 2017): Not Implemented. DoD’s Response (June 26, 2017): On an annual basis, DoD provides a list of all loans to the Fiscal office for inclusion in the CAFR report, and routinely DoD has provided a list of loans to the Office of Management and Budget in efforts to comply with the County Code public disclosure requirement.9 Going forward, Development would expect to use Portfol as the source of information once the data is confirmed as complete and accurate. Once the Portfol data is validated, DoD will adhere to a procedure for providing routine data to the Fiscal office to assist in populating an Excel spreadsheet that informs the public of all borrowers who received loans, as well as providing an annual list of outstanding loans. • Extremely Limited Access to Loan Information Recommendation: Train and/or request vendor training for multiple DoD staff members to learn how to properly use the Portfol software, including the use of automated loan delinquency alerts, and create a set schedule to review and monitor loans for defaults or delinquencies and outline time-sensitive procedures to address any defaults or delinquencies. Status (February 3, 2017): DoD initiated training sessions for staff. DoD has not followed the recommendation to implement automated delinquency alerts or set a schedule for the regular monitoring of loans because it does not yet have confidence in the Portfol data. Recommendation: It is imperative that accurate and up-to-date loan information is immediately accessible and able to be retrieved in a reasonable amount of time current loans. Also, policies and procedures need to be in place to ensure timely input of data going forward.”) 9 The data provided for the CAFR has typically only included loans that DoD determined were current. In the past, DoD has excluded loans that were delinquent, forgivable or not included in Portfol’s incomplete database. 9 upon request. This access should be made available to persons outside of DoD, including Law, Fiscal, Internal Audit and the AIG. Status (February 3, 2017): DoD has provided limited access to Portfol to the AIG. DoD’s Response (June 26, 2017): In March 2017, three DoD staff attended a 2day, in-person Portfol training course. In addition, a 2-hour introductory webinar on Portfol was provided to DoD staff, fiscal staff and members of the Improvement Team, including EY. Fiscal staff included not only DoD employees but staff members from the Office of Budget and Management. In May, 3 members of OBM were provided access to Portfol. Future plans include hosting an in-house 2-day Portfol training for needed staff and continuing our relationship with OBM for guidance and oversight on financial data related to ED loans. As part of the Policy Manual - all loan officers and fiscal staff are required to attend Portfol training and be proficient in its use. A senior member of the DoD leadership team will be charged with ensuring compliance. • Borrowers Can Default on More Than One Loan From the County Recommendation: The AIG should perform debarment reviews on any entities and/or principals that failed to demonstrate a good faith effort to repay County loans. Borrowers who have defaulted on prior loans should be prohibited from future County loans. Status (February 3, 2017): After reviewing DoD’s Portfol data, the AIG initiated Notices of Potential Debarment to delinquent borrowers. Working with the Department of Law, the AIG has met individually with borrowers to discuss repayment plans. Some borrowers have resumed payments and even paid off past due balances. DoD’s Response (June 26, 2017): Certainly, it is at the discretion of the AIG if it will pursue debarment reviews on any entities and/or principles that failed to demonstrate a good faith effort or repay County loans. It would be most beneficial for the AIG and DoD to partner in the future, if appropriate, to create a procedure that streamlines the sharing of information, documentation and or process steps, enabling a collections effort that integrates and effectively engages our borrowers to achieve the intended result. As, DoD now has a working policy on how to address delinquencies, DoD will build upon that policy. • Uncollected Loans Recommendation: Work with the Department of Law to pursue judgments against delinquent New Product Loan Program borrowers using the original, signed cognovit contained in the borrower loan agreements. 10 Status (February 3, 2017): The Department of Law has reduced many cognovit notes to judgment. However, prior outside counsel declined to participate in numerous cases due at least in part to the unreliability of DoD data. The County has engaged new collections counsel that is evaluating the outstanding debts. DoD’s Response (June 26, 2017): As of September 2016, the DoD has partnered with the Department of Law in pursuing collection efforts and hired Douglass and Associates to provide 3rd party collections services. Additionally, DoD has steadily worked to document each of its economic development loans, which includes the NPD loans. DoD has initiated work with the County’s Fiscal Office and a Forensic Accountant to assess the supposedly written-off loans. C. Information Requested and Reviewed 1. Documents Reviewed • • • • • • • • • • • • • • • • • • Portfol Loan Portfolio Snapshot Report as of Jan. 6, 2016; Portfol Loan History Statements as of Feb. 17, 2016; Portfol Outstanding Payment Due Report as of Mar. 8, 2016; Portfol Received Checks and Amounts Due Report as Mar. 1, 2016; Portfol Payoff Statements as of Jan. 6, 2015; Portfol Loan Condition Statements as of Feb. 17, 2016; Portfol Notes & Tickler Files; Portfol Loan Correspondence Files; DoD Loan files; DoD Written-Off Loan Memos to County Fiscal Office – Sept. 13, 2013 and Mar. 20, 2015; DoD Responses to AIG Questionnaire, received on May 9, 2016; BoxCast hard copy files and related Portfol files on Apr. 29,2016 to June 6, 2016; Revenue Receipts for four select New Product Development Fund loans from Feb. 2016 to Jan. 2013; Revenue Receipt Summaries, Bank Statements or Cash Worksheets for four select New Product Development Fund loans from Feb. 2016 to Jan. 2013; Amortization Schedules for four select New Product Development Fund loans; Loan Agreements and Cognovit Notes for New Product Development loans; FAMIS Revenue Receipts for four select New Product Development Fund loans from Feb. 2016 to Jan. 2011; Survey Responses from the departments of development in Franklin, Hamilton, Lorain and Summit counties. 11 2. Interviews Conducted • • • • • • • • • • 3. Robert Flauto, DoD Senior Development Finance Analyst – Feb. 10, 2016 and various other dates; Michael May, Development Administrator Economic Development – Mar. 1, 2016 and Mar. 17, 2016; Jennifer Bigadza, Business Service Manager – various dates; Hongloan Nguyen, Financial Reporting, on Mar. 2, 2016; Harry Conard, Compliance Officer of DoD, on Mar. 17, 2016 and various dates; Jerry Butterfield, Manager of Accounts Payable, on Feb. 18, 2016; James Fischer, Process Center Manager, on Feb. 17, 2016; Rebecca Ruffing, Assistant Investment and Cash Management Officer, on various dates; Edward Long, owner of HomeTech HealthCare on Mar. 2, 2016; and Anthony Lockhart, owner of M.O.M Tools on Mar. 10, 2016. Requested Items Not Received As noted above, DoD has issued a policy manual regarding the servicing and monitoring of loans. However, prior to February 3, 2017, the AIG received no response or an insufficient response to the following requests: • Written Policies and Procedures: The AIG requested all written policies and procedures. At the time, DoD management indicated that it did not have any formal written policies. However, they contended that there were unwritten practices and procedures in place regarding loan servicing. DoD did not provide any written procedures to the AIG. A written manual was provided in June 2017. • Written Policies Regarding Loan Reconciliation: The AIG requested all written policies regarding the reconciliation of accounts. According to DoD employees, they did not have a policy regarding the reconciliation of accounts. DoD employees stated that the department performs an annual reconciliation of “active accounts” for the County’s CAFR report. However, they declined to identify the person responsible for reconciling the accounts. A written manual was provided in June 2017. • Review of Reconciliations: DoD employees told investigators that “various Fiscal, OBM and Development staff review the CAFR and the report and files are audited annually by the County’s Internal Audit Department and/or State of Ohio Auditor.” Per the former Director of Internal Audit, Valerie Harry (“Harry”), the Internal Audit Department does not perform any reviews or any reconciliations for the DoD and is 12 not a part of DoD reconciliation process. Harry also confirmed that the Ohio Auditor of State (“AoS”) is not a part of the DoD reconciliation process. DoD’s files have not been audited by the Internal Audit Department. Similarly, the AIG interviewed Amy Himmelein (“Himmelein”), Controller for Cuyahoga County Fiscal Office and Angela Rich (“Rich”), Assistant Finance Officer for Cuyahoga County. Himmelein and Rich both stated they are not a part of the DoD reconciliation process. The County Fiscal Office does scan the prior year ending loan balances (for the CAFR) and compare them to the current year loan beginning balances for consistency in the financial reporting. Maggie Keenan, Director of the Office of Budget and Management (“OBM”), stated that OBM is not a part of the DoD reconciliation process. • Identification of Persons Posting Transactions to the Portfol System: DoD employees stated that “payments are posted into the Portfol database by various development and fiscal staff (in DoD). In years past, individual loan officers maintained records on separate spread sheets and serviced the loans from the cradle to the grave. Over the decades as the individual loan portfolio grew it became both necessary and wise to create a separation of duties as well as invest in software that would systemize the growing portfolio. With the purchase of the Portfol software, by default the effort to combine the active loans into one database became the responsibility of one staffer. This was the beginning of loan servicing department with Development. Recently we have further separated duties by transferring some of the loan servicing posting responsibilities to the fiscal staff.” Again, DoD declined to identify the individuals in the department who performed these tasks or who had access to the data. • No Monthly Closing Procedures: AIG investigators asked DoD employees to explain the monthly close procedures for the loan accounts in Portfol or other records system. DoD employees stated that there were no monthly close procedures. These are not best practices consistent with generally accepted accounting or business standards. • No Review of Payoff Letters: AIG requested that DoD should provide the name of “each person who is responsible for verifying and approving “payoff” letters to borrowers.” Rather than identify the appropriate employee, DoD management responded only that “Payoff amounts are dictated by terms of the loan documents.” • No Identification of Person Responsible for Approving Deferment of Payments Required By Contract: Despite the request, DoD failed 13 to name any person who was responsible for approving loan deferrals. Moreover, the AIG was unable to locate any documents approving the deferment of payments that are required by contract. III. • No Identification of Person Responsible for Approving Late Fee Waivers: Although requested to do so, the DoD did not identify the person responsible for waiving late fees that are required by contract. • No Identification of Person Responsible for Approving Adjustments to Loans: DoD declined to identify a person responsible for adjustments to loans, answering instead that “various Development and Fiscal staff have made adjustments to loan accounts. The Portfol software captures and records the creator of all transactions, time and date stamps all activities within each client loan case.” DoD failed to name the employee(s) responsible for reviewing and approving any adjustments or modifications to County loan contracts. DoD should not depart from any contractual requirements without seeking an opinion from the County Department of Law. FINDINGS A. DoD’s Records Have Been Inaccurate and Incomplete This report analyzes DoD’s policies, practices and the state of the DoD loan portfolio. However, this analysis comes with a cautionary note: DoD’s records remain incomplete and inaccurate. Furthermore, DoD does not “close” its books. As a result, historical data can be changed retroactively in Portfol – and, in fact, has been changed retroactively – without proper documentation. These retroactive changes result in the original data being overwritten. Thus, this AIG report relies on Portfol – the best available data – which is itself deeply flawed. For example, identical reports for balances as of the exact same day should show the same results, even if the reports for the same day are generated at different times. DoD’s records have failed this test of reliability. For example, on March 11, 2016 in a report printed that same day the “Portfol Snapshot Report for Close of Business on 3/11/16” showed that BoxCast LLC owed $125,000 on loan no. 193-01-01.10 This entry was not correct. DoD later retroactively corrected these records. The exact same “Portfol Snapshot Report for Close of Business on 3/11/16” that was generated ten months later on January 18, 2017 shows that it was fully paid and indicates “Open – Zero Balance.”11 Because DoD can – and did – change its records retroactively, it shows different results for the same day. 10 See Portfol Snapshot Report for Close of Business March 11, 2016 generated Mar. 11, 2016, p. 32. 11 See Portfol Snapshot Report for Close of Business March 11, 2016, generated Jan. 18, 2017, p. 33. 14 Under proper procedures, the County’s books should have been fully closed with no retroactive changes permitted. Any changes or adjustments should have been noted, reviewed and approved after the fact and indicated separately. The ability to retroactively change data can be an invitation to fraud because it prevents the finalization of records and hinders the disclosure and oversight of changes. DoD notes that to address inaccurate records, the County has put in place an improvement team to assist Development with identifying all of its loans (between 2007 and 2017), record loan documentation, restructure its loan database (Portfol) and confirm the status of each identified loan. This work is expected to be complete by Monday, July 31, 2017, with a two-week closeout period lasting until mid-August. Ernst & Young is assisting with this effort. The AIG’s analysis below is based upon records generated from DoD’s Portfol system. Because this data is inconsistent, it is difficult to reconcile reports generated on different dates. Following this analysis is a more detailed discussion of the data inadequacies. B. Origins of Dysfunction: DoD’s Flawed Practices Began Under the Prior County Commissioner System of Government The AIG has found no record of DoD ever having written policies or procedures for the servicing, accounting, monitoring, and collection of economic development loans. Instead, for the entirety of its history, DoD when it issued loans relied upon individual employees and implied understandings to administer such loans on an informal ad hoc basis. The failure to institute -- at the very beginning of a loan program -- written policies for the control and care of taxpayers’ dollars is never a good idea or an acceptable practice. The lack of standards permits loans to go uncollected and for funds to be misused. Moreover, the failure to monitor and review loans prevented the County from evaluating the effectiveness of its programs and restricted its ability to correct, expand or eliminate these programs. Without such basic accurate information, the County cannot improve its efforts. The County’s ad hoc approach to loan monitoring was inadvisable from the start – but became worse when the County greatly increased the number of loans it approved in the early 2000s. The chart below shows the growth in DoD loans. From 2001 to 2004, the County approved on average only 2 loans per year. But the following year, the number of approved loans exploded ten-fold to 29 loans approved in 2005. 15 Table 1: Past Due Loans 2001 to 201612 Year Total No. of Loans Approved & Disbursed 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total Principal of Number of Loans Approved Loans Past Due or Delinquent 2 1 3 2 29 29 24 12 25 15 12 13 12 9 10 9 $242,926.49 $500,000.00 $887,432.00 $315,200.00 $5,257,219.87 $4,017,602.86 $2,135,774.97 $2,687,636.58 $3,670,228.26 $1,478,104.56 $3,471,107.70 $8,781,001.76 $10,318,357.97 $3,153,261.93 $10,225,000.00 $8,932,092.00 0 0 1 0 19 20 15 8 14 7 4 5 3 1 3 2 In 2005, the County initiated the New Product Development Loan Fund (“NPDLF”) which was intended to create new jobs by funding early-stage product development. The value of loans approved by the County Commissioners increased from $315,200 in 2004 to $5,257,219.87 in 2005. As discussed in other AIG reports, these loans were expected to be high-risk. Other loan funds (e.g. the North Coast Opportunities Technology Fund) were also high-risk. Considering the acknowledged strategy of issuing high risk loans, it would have been particularly important for the County to adopt effective policies for loan monitoring and support. Despite the fact that the County exponentially increased its lending, and targeted higher-risk loans, the County still did not adopt any written policies for servicing, monitoring or collecting these loans. According to Portfol data, 82% of the loans that were past due or delinquent as of December 31, 2016 were approved by the County 12 As noted above, this data is based upon Portfol Snapshot Reports (exported to MS Excel) that are subject to retroactive change. Thus, these numbers may not be consistent with similar reports generated on different days. Moreover, this report excludes loans that were approved, but not yet disbursed. Thus, some loans approved in 2015 and 2016 have been excluded because, among other reasons, they had not been disbursed or had not yet been entered into Portfol. For example, in 2015, the County approved $4.5 million in two loans to the City of Euclid. Those loans are not listed because, although they have been approved, no funds have been disbursed, and thus, no debt has been created. 16 Commissioners. Approximately, 18% of the past due or delinquent loans were approved after the County re-organization. As part of understanding the historical context of the problem, it is important to recognize that failures occurred at every level. Fundamentally, it was DoD’s responsibility to properly monitor and account for the loans that it issued. DoD’s failure to do so is the origin of a series of cascading failures. Indeed, other entities were also charged with the oversight of these loans. For unknown reasons, the County Commissioners, the County Auditor, the County Treasurer as well as state and federal authorities, permitted DoD to operate a million-dollar lending operations with no written policies and inaccurate records. The systemic problems addressed in this report were created during the County Commissioners’ era. However, they also continued after the County’s re-organization. Until now, these deficiencies have not been addressed. C. Year-End 2016 Data Regarding The DoD’s Loan Portfolio Indicated Problems That Must Be Addressed 1. In 2016, 46.59% of DoD Loans were Past Due or Delinquent The AIG sought to determine whether the number of delinquent loans was merely a problem of the past.13 Table 2 below indicates the records as of December 31, 2016. In sequence from left to right, the columns indicate: the name of each fund, the number of loans in each fund, the amount that was initially authorized for the loans in the fund and the outstanding balances of each fund. The final two columns indicate the number of loans in each fund that are more than 90 days past due, and then calculates this number as a percentage of all loans that were authorized during the history of the fund. Table 2 includes all loans recorded in Portfol as of December 31, 2016. Thus, this data includes loans that were approved before 2007 and is not limited to the last ten years. DoD has objected to the AIG’s use of the term “delinquent” for loans that are identified as “past due” by Portfol, but which may not necessarily be “delinquent” as that term may be defined by the applicable loan agreement. DoD’s point is well-taken. Accordingly, this report attempts to clarify that it includes loans that are past due, but that some past due loans may not yet be technically delinquent. Further, DoD has also asserted that loans should not be considered “delinquent” until they are officially written-off by the County Executive. The AIG does not agree with this position. See also EY, p. 13 (“There is a disparity in the reported default rates on County loans because different individuals are using different methodologies. If only official write-offs are counted, the default rate will be lower as claimed by some County staff members, whereas if all loans in arrears are counted, it will be much higher. It will not be possible to reconcile this disparity and arrive at an agreed conclusion until records in Portfol are reconciled. Then the default rate can be determined based on an agreed methodology, the corrected data and a confirmed list of active versus non-performing loans. This task has been targeted, both by the AIG and the County Executive, as a high priority action that requires immediate attention.”) 13 17 Table 2: Past Due Loans (Dec. 31, 2016) Fund 2 General Fund 3 CDGB 4 HUD 108 7 New Product Development 8 North Coast Opp. Fund 9 Storefront 10 Community Assessment Initiative 11 Brownfield Redevelopment 12 USEPA Brownfield Revolving Loan Fund 13 Micro Loan Program 14 Miscellaneous 15 Casino Revenue 100 CC Western Reserve Fund 101 CC Western Reserve Fund Forgivable Totals # of All Loans 19 17 11 104 41 20 Loan Balance as of Amount 12/31/2016 $6,228,140 $2,177,107 $5,116,030 $1,531,281 $9,419,560 $6,473,700 $4,280,781 $2,502,537 $3,994,275 $3,090,690 $820,963 $89,658 # of Past % of Past Due Due Loans Loans 7 36.84% 2 11.76% 4 36.36% 67 64.42% 14 34.15% 8 40.00% 6 4 $0 $2,318,044 $0 $1,235,045 0 1 0.00% 25.00% 2 4 1 3 24 $1,500,000 $93,458 $350,000 $5,000,000 $25,476,201 $988,602 $84,462 $262,500 $4,915,923 $23,622,985 2 4 1 1 9 100.00% 100.00% 100.00% 33.33% 37.50% 8 264 $4,728,000 $69,325,453 $3,103,197 $50,077,688 3 123 37.50% 46.59% Table 2 indicates that at the end of 2016, there were 123 loans that were past due. This suggests that 46.59% of all DoD loans were past due.14 2. In 2016, the County was Owed $8.5 Million in Uncollected Principal and Interest By itself, the number of past due loans does not fully describe the County’s actual financial risk from its development loans. This inquiry asks “How much money should the County have already collected, but is outstanding?” This number would provide further information – beyond the gross number of bad loans – regarding the County’s financial management. The AIG reviewed the value of past due payments as of December 31, 2016. This includes payments for principal and interest that are at least 90 days past due. Table 3 14 Generally, regarding the status of loans as reported in Portfol, DoD wrote in response to the February 3 draft: An incomplete and inaccurate database does not allow one to reach any meaningful conclusions, make comparisons or report findings. Until every loan is identified properly, accurately documented and then structured correctly within Portfol, the data is not available for analysis. DoD would like to revisit this finding with the AIG, once this effort is complete. (original emphasis). 18 below indicates for each loan fund: the name of the loan fund, the balance of outstanding loans for each fund and the value of missing payments that are at least 90 days past due. The last column expresses the amount of late payments of principal and interest as a percentage of the total outstanding balances that are due to the county. Table 3: Past Due Payments of Principal and Interest (Dec. 31, 2016) Fund 2 General Fund Loan Balance Past Due Principal & 12/31/2016 Interest Payments $2,177,107 $534,710 Past Due Payments as % of Balance 24.56% 3 CDGB $1,531,281 $349 0.02% 4 HUD 108 7 New Product Development 8 North Coast Opportunities Tech Fund $6,473,700 $1,561,648 24.12% $2,502,537 $2,025,758 80.95% $3,090,690 $1,199,767 38.82% $89,658 $31,437 35.06% $0 $0.00 0.00% $1,235,045 $177,766 14.39% $988,602 $94,193 9.53% $84,462 $81,382 96.35% $262,500 $262,500 100.00% $4,915,923 $51,254 1.04% $23,622,985 $904,542 3.83% $3,103,197 $1,630,205 52.53% $50,077,688 $8,555,517 17.08% 9 Storefront 10 Community Assessment Initiative 11 Brownfield Redevelopment Fund 12 USEPA Brownfield Revolving Loan Fund 13 Micro Loan Program 14 Miscellaneous 15 Casino Revenue 100 CC Western Reserve Fund 101 CC Western Reserve Fund Forgivable Totals At the end of 2016, borrowers owed the County $8,555,517 in past due principal and interest. The AIG concludes that – when measured by the value of delinquent payments - the County has a substantial amount of unpaid principal and interest on DoD loans. This statistic only represents the value of principal and interest that is already past due – without accelerating the payment or balance on past due loans. Another measure of the County’s risk is to examine the total outstanding balance on past due loans. 19 3. In 2016, the Balances on Past Due Loans Represented 46.56% of All Outstanding Balances The AIG sought to determine the continuing risk to the County from loans that are past due. The fact that a borrower has failed to make timely payments is a marker that the loan itself is at risk of falling into default. Thus, the AIG reviewed the balances of loans that are at risk of default (i.e. 90 days past due). Table 4 below shows: the name of each fund, the outstanding balance of all loans in that fund, and the outstanding balances of only the at-risk loans. The final column expresses the percentage of all loan balances that are from at-risk loans. Table 4 – At-Risk Loan Balances (Dec. 31, 2016) Balance of all Loans 12/31/2016 $2,177,107 Balances of Loans With Past Due Payments 12/31/2016 $845,185 Loan Amount % of At Risk Loans 12/31/2016 38.82% 3 CDGB $1,531,281 $370,106 24.17% 4 HUD 108 $6,473,700 $6,214,972 96.00% 7 New Product Development 8 North Coast Opportunities Tech Fund $2,502,537 $2,393,480 95.64% $3,090,690 $1,326,668 42.92% $89,658 $76,238 85.03% $0 $0.00 0.00% $1,235,045 $171,966 13.92% $988,602 $988,601 100.00% $84,462 $84,462 100.00% $262,500 $262,500 100.00% $4,915,923 $1,500,000 30.51% $23,622,985 $7,412,982 31.38% $3,103,197 $1,666,590 53.71% $50,077,688 $23,313,754 46.56% Fund 2 General Fund 9 Storefront 10 Community Assessment Initiative 11 Brownfield Redevelopment Fund 12 USEPA Brownfield Revolving Loan Fund 13 Micro Loan Program 14 Miscellaneous 15 Casino Revenue 100 CC Western Reserve Fund 101 CC Western Reserve Fund Forgivable Totals 20 At the end of 2016, DoD indicated that that balances on loans with past-due payments equaled $23,313,754. Thus, when measured by the dollar value of disbursed loans (rather than simply the total number of loans), approximately 46.56% of DoD loans are at risk. The AIG concludes that $23,313,754 in at-risk balances should be of concern to DoD. The fact that nearly half of DoD’s outstanding balances are at-risk suggests that DoD should aggressively monitor its portfolio. Overall, the County continues to experience a problem with the servicing and monitoring of loans. D. DoD Did Not Comply with Federal, State and County Guidelines 1. Compliance with Federal and State Guidelines DoD is required to comply with state and federal regulations. As a recipient of federal funds, DoD should have followed the guidelines set forth in OMB Circular A-133 which require appropriate internal controls for federal loans.15 This rule provides, among other things, that: • transactions must be properly recorded and accounted for; • operating policies and procedures must be clearly written and communicated; • duties must be adequately segregated between performance, review, and recordkeeping of a task; and • computer and program controls should include data entry controls, e.g., edit checks, exception reporting, access controls; and reviews of input and output data.16 The AIG’s review of DoD indicates that DoD does not comply with these requirements.17 Policies were not written, duties were not segregated, transactions were not properly recorded, and computer controls were not implemented. 15 OMB Circular A-133, Part 6 governs loans issued before December 26, 2014. Loans issued after December 26, 2014 are governed by 2 C.F.R. § 200 et seq and the “Uniform Guidance” set forth in “Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards.” 16 OMB Circular A-133, Part 6 (emphasis added). 17 DoD Response: The only federal loans which the Department of Development has participated in are a series of “Section 108 loans” the County has utilized these loans to participate in community Development projects, DoD is required to enter into loan agreements with HUD ; they are reviewed by HUD frequently to ensure that the loans meet HUD’s eligibility and administrative requirements. To date, the office is unaware of any written or oral concerns that have been expressed by a federal or State agency regarding our non-compliance with State or Federal guidelines, with respect to our federal loan portfolio. Having said that, DoD is undergoing an in-depth review of its economic development loan program and working with the Executive office, the Law Department and the Fiscal 21 Similarly, Ohio Administrative Code § 117-02-01 provides that “all public officials are responsible for the design and operation of a system of internal control that is adequate to provide reasonable assurance regarding the achievement of objectives for their respective public offices in certain categories.” These internal controls should be sufficient to: (1) Ensure that all transactions are properly authorized in accordance with management's policies. (2) Ensure that accounting records are properly designed. (3) Ensure adequate security of assets and records. (4) Plan for adequate segregation of duties or compensating controls. (5) Verify the existence and valuation of assets and liabilities and periodically reconcile them to the accounting records. (6) Perform analytical procedures to determine the reasonableness of financial data. (7) Ensure the collection and compilation of the data needed for the timely preparation of financial statements. (8) Monitor activities performed by service organizations.18 At the most basic level, DoD was out of compliance with federal and state guidelines because DoD had no written policies regarding the management of $50 million of taxpayers’ dollars. During the AIG’s review, we also noted that there was no written evidence in the Portfol system documenting management’s supervisory approval of changes or adjustments to the installment loan accounts. Similarly, there was no segregation of duties between “performance, review, and recordkeeping” of loan account data entry. 19 For example, Department to ensure that moving forward, comprehensive policies and procedures are in place, internal controls are established and inter-agency oversight is instituted. 18 Ohio Administrative Code § 117-02-01 et seq. See also EY, p.12 (“An immediate solution would be to segregate functions into front office (loan originators responsible for identifying loan prospects and completing initial structuring and evaluation of the loan applicant), in-house processing (administrative staff trained to align the prospective project with written guidelines and established procedures (which, in turn, should be shared both internally and externally to eliminate confusion and lack of knowledge about eligibility criteria), and servicing personnel (if the County decides to conduct in-house servicing), whose function is to process and monitor payments and ensure disbursed loans continue to comply with all required terms and conditions. Should a loan be deemed out of compliance, the responsibility for determining next steps should follow a specific decision 19 22 we noted that the same employees would receive checks from the payor; were authorized to execute installment loan receipt transactions; and would record the transactions in the Portfol System without any required evidence of review or approval by management.20 The Portfol System is never closed. This could have allowed employees to change data retroactively without independent oversight and without noting the reason for an adjustment to the books.21 Additionally, we noted that DoD’s internal control processes were not formalized in writing and there was no evidence of how DoD communicates their internal control processes to staff and management. 2. Nearly $1 Million In Purported Write-Offs Without Policies, Procedures, Limits or Approval of the County Executive DoD had not established formal written policies or procedures for writing off loans. Instead, DoD purportedly wrote off loans inconsistently and at times without proper approval. The AIG reviewed the following write-off memos: Date of Memo: March 20, 2015 September 13, 2013 Loan Amounts: $1,125,972.43 $2,460,145.60 Loan Balance Due: $ 993,364.64 $1,649,406.64 The September 13, 2013 Write-Off Memo was approved by the former Cuyahoga County Executive.22 In contrast, the AIG found no evidence that the March 20, 2015 Write-Off Memo was provided to or approved by the current Cuyahoga County Executive.23 Instead, the 2015 Write-Off Memo was allegedly sent by the former DoD director to his internal staff without disclosure to the appropriate oversight authority. 24 workflow and should not be the responsibility of the individual who initially managed the loan application. This will minimize conflicts of interest and promote fairness and consistency in portfolio management.”) Portfol provides a “history/log” function which indicates the individual whose password was used to make changes to Portfol. Portfol has a function for an “audit stamp.” This function has never been used. Portfol also has a “control code” function which is rarely used. 20 21 The AIG reviewed its access to the functions in Portfol. AIG investigators found they were unable to access the loan servicing and systemwide administration functions. These functions include a computer history log which tracks individuals in the system and any changes they made in the Portfol. Because DoD did not perform a “hard close” on any loan account, the activity log should be reviewed. DoD should provide complete “read only” Portfol access reviewers outside of DoD to conduct an independent inquiry of the loan transactions. We also recommend that DoD use Portfol’s hard close function to require a hard close on the loan records each month and at the close of each year. Additionally, all Portfol loan account modifications should be approved in writing, with explanations, by a supervisor and/or the Director of DoD. 22 Memorandum, Subject: 2013 Loan Write-Offs (Sept. 13, 2013). 23 Memorandum, Subject: 2014 Loan Write-Offs (Mar. 20, 2015). The AIG also notes that the 2015 WriteOff memo limits oversight and disclosure because it does not include as an addressee any person outside of DoD. Moreover, the AIG’s investigation never found a signed, original of this document. Also of note, this memo is dated March 20, 2015. The DoD Director’s last day was shortly thereafter on April 10, 2015. 24 DoD Response: The September 2013 write off memo referenced, was approved by the former County Executive Fitzgerald. The Backup documentation for those write- offs apparently included a detailed list of 23 The AIG’s review of the loan files did not indicate that DoD had conducted the due diligence needed to assess the collectability of these loans. Moreover, there are no emails or other documents indicating that the prior county executive approved the writeoffs or that an out-going county executive has authority to write off loans during the elected term of his successor. There is a sharp contrast between the documented approval for the 2013 write-offs and the undocumented 2015 attempted write offs. Finally, the lack of due diligence is evidenced by the fact that several of the borrowers on the 2015 write off volunteered to resume payments and asserted that they had not been contacted by DoD regarding delinquencies. The AIG is deeply concerned that DoD could seek to write off $993,363.64 without independent oversight and approval by the current county executive. It is unclear whether DoD had any limit or cap on its asserted ability to write off County debt. AIG is unaware of any authority which authorized – or limited – these write offs. Written policies, procedures and limits are essential. This attempted write-off – done without standards or policies – stands in sharp contrast to the County’s rigorous controls on expenditures. By purportedly writing these loans off without sufficient attempts at collection, DoD allowed the County to cease collecting on defaulted loans even where collection was still possible.25 Separately, in other instances, late fees were unilaterally removed or forgiven “due to borrowers good payment history - database courtesy."26 Such waivers were made without a record of a controller’s code, audit stamp or other approval. Nor are there any rules indicating when County staff can forgive fees for one set of borrowers, but not others. As noted in previous reports, the AIG is unaware of the legal authority for waiving such fees or modifying contracts which have been approved by the Board of Control. We recommended that DoD establish formal written policies and procedures relating to the write-off process for all delinquent loans. This has now been done. In response to NDP loans, delinquencies or defaults as, which was implied in the design of the program structure. It is our understanding that the former Chief Fiscal officer and the former Executive received this list, which became the predicate for the 2nd list of write offs memo in March 2015. Currently, all of the loans that were included in the referenced September 2013 and March 2015 memos have been referred to a collections agency to pursue repayment. DoD has engaged Ernst & Young to review and share best practice write-off guidelines. 25 After receiving debarment letters from the AIG, nine (9) of the borrowers contacted the AIG and expressed a desire to work out a repayment plan. 26 See e.g. Portfol Log/History Note, Archer Realty, (Oct. 27, 2015). Other waivers indicated that a late fee was “due to borrowers good payment history - database courtesy. Will need to send warning letter next time." See Portfol Log/History Note, Cleveland Whiskey (Nov. 20, 2015). 24 the AIG reports, DoD has developed a process for writing off loans in consultation with the County Fiscal Office, County Department of Law and the County Board of Control. E. DoD’s Records Should be Corrected in Order to Facilitate Improved Management, Internal Controls and Decision Making 1. DoD’s Loan Database Has Been Incomplete and Inaccurate27 Portfol is a computerized loan account case management and accounting system implemented to track DoD loans. Portfol’s loan portfolio should include all documents relating to: Community Development Block Grant Loans; Housing & Urban Development Section 108 Loans; New Product Development Fund Loans; North Coast Opportunities Technology Fund Loans; Storefront Loans; Community Assessment Initiative; Brownfield Redevelopment Fund Loans; Micro Loan Program; Miscellaneous Loans; Casino Revenue Loans; Cuyahoga County Western Reserve Fund Loans; and the Cuyahoga County Western Reserve Fund Forgivable Loans.28 Among other deficiencies, the Portfol database did not include all the loan file documents. AIG reviews found that some loan files were missing loan agreements, cognovit notes, amortization schedule, past due notices, letters of deferment and other important documents. DoD did not store the entire loan file in one location. The following portions of the loan files were filed separately; loan agreement file; payment file (copies of checks paid), other loan correspondence and cognovit note file; one electronic file on Portfol and one file in the fire proof safe in which the original loan agreements and cognovit notes are kept. Filing the records in multiple locations prevented DoD from performing loan account reviews without physically retrieving a loan file. This created built-in inefficiencies which included an increased risk of missing or misfiled documents. Finally, DoD had not entered all loans into the Portfol database. For example, forgivable loans are not consistently recorded and reported in Portfol or on the CAFR. 27 DoD Response: DoD acknowledges the accuracy of this statement. In recent weeks, DoD has engaged in an extensive process to document all loans within the database and to use the official documentation to validate the accuracy of each borrower profile within Portfol. This work is on-going and expected to be completed by Friday, July 31, 2017. Separately, DoD’s electronic and paper loan files are incomplete because they do not always include all the loan file documents. Many of the files reviewed were missing loan agreements, cognovit notes, amortization schedules, past due notices, letters of deferment and other important documents. 28 25 2. The County Has Lacked Basic Information Regarding its Loan Portfolio29 DoD is responsible for maintaining accurate records of its loan portfolio. Accurate records are necessary to manage the loan portfolio. However, the following deficiencies were found: • • • • • No accurate record of the total amount of loans outstanding (including loans deemed “active” and “inactive”); No accurate record of the total number or individual balances of loans outstanding; No accurate record of the total number or balances of loans which are delinquent; No accurate record of the expected payments during the next period; and No accurate record of troubled loans or loans likely to default; The County runs a multi-million dollar loan portfolio. Unfortunately, DoD records provided to the AIG reflected outstanding loan balances varying by hundreds of thousands of dollars. The AIG recommended that the DoD establish written policies and procedures regarding DoD loan processes which include but are not limited to the following: • • • • • • • • Loan application and approval process; Accounting and recording to loan accounts; The issuing of monthly invoices for all accounts;30 The timely review of the loan accounts; The monthly and annual reporting process; The review of the delinquent accounts and the follow up process;31 The processes of the Loan Service Department and the collection methods uses; The authorization of loan deferments; 29 DoD Response: DoD acknowledges the accuracy of this statement. In recent weeks, DoD has actively worked to document all loans and to reconcile the status of each loan based upon loan documentation. It is expected that DoD will be able to report by Friday, July 31, 2017, with full accuracy, the status of each of the loans approved between 2007 and 2017. EY concurred, noting: “Invoicing: copies of borrower invoices were not available for any of the 12 files reviewed. In discussions with the Department personnel, it was stated that monthly invoices are not sent for all loans as most borrowers pay monthly. As a best practice, if the servicing is kept in-house, invoices should be generated monthly for all loans and include the total payment required, any late fees assessed, and due date for the payment. Additionally, the contact number and mailing address for the servicing department (inhouse or outsourced) should be included in the invoice to the borrower.” EY, p. 27 30 31 As a loan progresses in the 30-60-90 day delinquent categories, collateral should be reviewed, delinquent letters should be mailed to the clients. DoD should then contact the borrowers in an attempt to return the account to the agreed payment schedule or to renegotiate the terms of time and payment schedule of the loan. 26 • • • The process for handling delinquent accounts;32 The correction of errors; and Checklist for each loan file. In response to these recommendations, DoD has adopted written policies and procedures. 3. Inaccurate Job Creation Data33 One of the primary purposes of DoD is to create jobs in Cuyahoga County. However, DoD had not implemented an effective system to monitor jobs created by its efforts. According to Portfol, since 1985, DoD had issued 56 loans for $11.7 million dollars and purportedly created zero new jobs, retained only one job, and affected only five jobs. This data reflected DoD’s inadequate record-keeping and monitoring. Because DoD’s Portfol database has been fundamentally flawed, the data is insufficient to reach a reliable conclusion regarding the actual number of jobs retained, created or affected. The County cannot effectively manage its job creation efforts without accurate data. The AIG recommended that DoD update and correct its records. DoD has acknowledged this recommendation and is implementing changes. As part of this process it should require updated employment reports from borrowers who made job commitments. If appropriate, DoD should evaluate whether to seek “clawbacks” from borrowers who have not fulfilled their job creation commitments. This is underway. 4. Overdue Tracking Reports34 DoD requires certain borrowers to report on the progress of the activities that are funded with taxpayer dollars. According to Portfol records, as of December 31, 2016, the County had 264 outstanding loans. Of these loans, 131 had overdue tracking reports. Notably, a substantial number of these overdue tracking reports are associated with delinquent borrowers. These delinquent borrowers are unlikely to ever submit a See also, EY, p. 27 (“Collections: the loan origination documents provided include standard language in regard to referral to collections or legal counsel. However, as observed there is not a documented policy for referral to collections and the engagement of the third-party collections vendor was not initiated until 2016. As a best practice, the Department should document and implement a clear policy for referral to collections (e.g., 120 days from first date of delinquency)”). 32 33 DoD Response: DoD acknowledges the accuracy of this statement and is working to create internal capacity to improve our assessment of ROI and loan performance. In 2016, DoD reassigned a longstanding team member to begin this work. At this time, DoD has secured a Fellow with a one-year commitment and has temporary assistance from two seasonal Fellows and a data analyst. Their primary purpose is to improve our job data collection methodology, produce a 2015 and 2016 jobs report, and put into place policies and procedures to institute long-term program changes. 34 DoD Response: The most recent efforts from DoD has focused on the lenders who are not current on their repayments. However, DoD launched a working group on June 15 th to focus on loan performance. This team is comprised of a Development manager, three Fellows and a data analyst. The first priority is to develop the 2015 and 2016 jobs data programs. The next item on their agenda is an assessment of the loans types. 27 tracking report. However, there were 28 borrowers listed as “current” which nonetheless had overdue tracking reports.35 5. Incomplete Descriptions of Receipts in FAMIS Impedes the Tracking and Monitoring of Loans36 During the AIG’s review of loan payments as recorded in the FAMIS accounting system, the AIG noted at least 16 occasions when the receipt description did not include the vendor’s name, there was no payee listed, the payee’s name was misspelled, or there was no description at all for the receipt. These errors make it difficult to trace or search for payees.37 The AIG reviewed FAMIS entries for New Product Development Fund in February and March of 2016 and noted numerous entries in which the FAMIS receipts did not include names of payors or payees. At a minimum, DoD should work cooperatively with the County Fiscal Office to ensure that all FAMIS entries always include complete names in the descriptions. F. DoD’s Services Should be Improved 1. DoD Has Failed to Provide Basic Monitoring of Loans38 DoD Management and staff have a responsibility to address borrower requests for loan information including: the outstanding loan balances, details on obtaining a repayment 35 See Portfol List of Tracking Reports Now Overdue, generated December 8, 2016. 36 DoD Response: As the AIG is aware, the Department of Development has not entered data into FAMIS. However, the core of the finding is a request that DoD work closely with the Fiscal office to ensure that information on each loan and/or borrower and every financial transaction is as detailed and accurate as possible. To this end, DoD continues to work with the Fiscal Office and has recently improved its working relationship to include: 1) a Fiscal staff member participating in the Executive’s improvement team; 2) OMB receiving access to Portfol and base level training; 3) OMB being included in the calculation of loan balances for delinquent loans sent to our collections agency; 4) direct guidance from the County Fiscal Officer on DoD’s submission for the annual financial audit; and 5) direct involvement from the County’s Fiscal Officer on the assessment of historical financial transactions. As part of our policy revisions, the Office will have stronger procedural and operational connectivity to the Fiscal office, i.e., our fiscal unit will be more aligned and integrate with the County Fiscal division with respect to Loan portfolio budgeting, management, to how loan receivables and payables are accounted for and recorded The AIG also identified four (4) instances in which revenue receipts had the wrong vendor’s check attached to them. AIG investigators were required to search through the month revenue receipts to find the correct check that should have been attached to the revenue receipt. 37 38 DoD Response: This finding is accurate and has been supported by an in-depth assessment conducted by EY of the economic development program. Additionally, improvement efforts put in place by the County Executive has arrived at the same conclusion. Hence, DoD worked closely with the Office of Procurement and Diversity to release an RFQ for loan servicing on Friday, June 16 th. The DoD has received budget authority to hire a Loan Portfolio Manager to oversee the loan portfolio. This position will be posted to initiate the hiring process in early-July. This is a new position, which will report directly to the Director. 28 plan, questions on restructuring of the current loan agreement, and concerns on the handling and monitoring of the loan accounts. During the investigation, the AIG received numerous complaints about DoD’s inability to answer/respond to borrower requests and/or questions in a timely manner. These borrowers reported that DoD ignored requests for pay-off numbers and/or promised to provide invoice, repayment plans or coupon books but failed to follow through. Several borrowers complained that the lack of regular invoicing and DoD’s inability to provide accurate information made it difficult to understand the required payments amounts. For example, on January 24, 2017 DoD chose to waive late fees and delay the higher rate of default interest on an overdue loan to CFRC Water & Energy Solutions. DoD wrote: “We realize that you have not been billed for the balloon payment due on this loan as of today. My manager, Michael May, has agreed to reverse the late fee assessed due to us not getting you a statement sooner. However, please note that the terms of this loan carry a default interest rate of 10% that will commence after February 15th.” The DoD’s initial failure to timely invoice the CFRC loan led to DoD waiving $4,919 in contractually-required late fees. Failure to monitor past due and delinquent loan accounts on a monthly basis potentially contributed to the loss of County funds which would have allowed DoD to support other economic development projects. The AIG recommended that DoD perform a cost/benefit analysis regarding the effectiveness of out-sourcing the loan servicing and monitoring function. In the event that DoD retains responsibility for servicing and monitoring its loan portfolio, we recommended that DoD: • Designate a responsible person to create written policies and procedures that establish a loan servicing process for delinquent and defaulted borrowers; • Outline procedures for loans requiring collection action; • Issue monthly statements on all loan accounts; • Implement monthly monitoring of all loan accounts (current, past due and delinquent); and • Address borrower requests and questions in a timely manner and provide training to management and the staff regarding the Portfol invoicing for current and past due loan account functions.39 39 Once the data in Portfol is confirmed, these Portfol functions should be turned on and utilized monthly to keep borrowers updated on their loan accounts, outstanding balance, monthly payment, past due amounts and late fees being charged. Staff and management should be required to put all communications with the loan borrowers in Portfol (emails, notes on telephone conversations, and any U.S. Mail correspondence). 29 DoD has decided to follow our recommendations and outsource the loan servicing function. 2. Loan Servicing Letters are Incomplete and Inaccurate40 Communications with the public and with borrowers of DoD loans should be clear, concise and accurate. Correspondence should contain basic information including the name and title of the author of the letter in order to enable the recipient to contact the author with questions or disputes. DoD has not provided monthly invoices to borrowers on a consistent basis. Even when DoD has sent invoices, those invoices were frequently incomplete and inaccurate. During the review of the loan files, AIG noted numerous letters in the loan account files signed by the “Loan Servicing Department.” A review of the DoD’s organizational chart and records did not evidence any employee in Cuyahoga County with this title or classification. A review of DoD employee job titles similarly noted that no employees held that title or classification.41 Indeed, there is no “Loan Servicing Department.” Furthermore, DoD employees told investigators that the DoD does not service loans or have a loan servicing division. The AIG recommends that all loan servicing letters be signed by a DoD employee. This will create personal accountability within DoD and will allow the borrower to address questions to the person responsible for the communication. Additionally, all loan servicing letters should include, at a minimum, the following information: • • • • The total amount of the loan that is past due on each loan; The current outstanding loan balance on each loan; The current amount of late fees accrued; and The outstanding balance of late fees charged and uncollected. 40 DoD Response: The Director of DoD has directed all staff to appropriately sign each of their letters and provide their full contact information. This directive is also covered in the June 26, 2017 Policy Manual. 41 See Department of Development Organizational Chart (Jan. 2017). 30 3. High Risk Loans Should be Tied to Tangible Collateral or Personal Guarantees42 The County has created loan programs to encourage the development and manufacturing of new products within the County. Some of these loans were “secured” solely or primarily by intellectual property or other non-tangible assets for which there was minimal collectable value. The New Product Loan program disbursed over $4,000,000.00 in loan funds since 2005. The majority of these loans were not collateralized against tangible assets in the case of default. Other loan funds had similar flaws. These weaknesses directly contributed to DoD’s 2013 and 2015 write-offs of $2,642,771.28 in loan balances. There is no evidence that the 2015 write-offs were approved by the County Executive. We recommend DoD require all borrowers to collateralize their loans against tangible assets or personal guarantees in the case of default unless an alternative high risk loan policy is developed. G. DoD Has Failed to Comply with County Code Sections 501.23 and 701.07 Requiring Public Disclosure of All Outstanding Loans43 County Code § 501.23 states that the “County Executive shall develop, maintain, and post on the county's website a grants and loans database, which shall include two separate parts, which shall contain descriptions of . . . all grants and loans provided, searchable by purpose, recipient, funding source, department, date provided, and other relevant factors.” Similarly, County Code §701.07 requires an annual “list of outstanding loans made by the County.” There are numerous “outstanding loans” made by DoD which have not been disclosed. We recommend that DoD review all of its grants and loans and ensure that they are posted on the County’s website per County Code requirements.44 Although the County 42 DoD Response: We agree with this finding. Currently, DoD is working closely with EY to restructure its existing loan program to minimize variance in loan terms and to better articulate to stakeholders projected ROI, as a result of the underwriting process. Our new loan policy specifically addresses collateral requirements that Borrowers will be expected to provide before receiving a County loan. DoD maintains a critical role in the lending market for small business that may not qualify for lending through traditional commercial avenues and is committed to putting in place measures that mitigate its risk. DoD continues to evaluate which loan programs are most impactful in the marketplace. DoD is planning on procuring a loan-servicing vendor in place, as well as improved borrower interactions and business development support that increases the likelihood that borrowers will have to repay their loans. 43 DoD Response: On an annual basis, DoD provides a list of all loans to the Fiscal office for inclusion in the CAFR report, and routinely DoD has provided a list of loans to the Office of Management and Budget in efforts to comply with the County Code public disclosure requirement. Most recently, in April, a list of loans in collections was published by the Plain Dealer newspaper, a form of public disclosure. See also, EY, p. 3 (“In accordance with leading practices, the Department should maintain an accessible list of all loans that have been paid in full, or defaulted on (i.e., inactive or terminated loans) either in Portfol or on the shared drive available to staff. Information on each loan should include, at minimum, the payoff request, date of payoff, point of contact for the borrower and County, dates of key actions, and a list of the specific decisions and County approvals taken with respect to each loan.”) 44 31 is currently in the process of transitioning to an Electronic Resource Planning (“ERP”) system, this should not preclude the County from posting data from sources such as the defaulted loans, grants and current loans on the County website. In the interim, posting a PDF file or spreadsheet containing the information outlined in the County Code is advisable. All grants and loans posted to the website should be traceable and reconciled to County records. DoD should request a legal opinion from the Department of Law requesting how to handle written-off loans for financial reporting purposes only. Loans not forgiven by the County should be recorded on the County’s website as debts that are still owed. H. DoD’s Past Practices Exposed the County to Unnecessary Risks45 1. Unnecessary Risk Factors DoD’s internal controls should be structured to avoid even the appearance of opportunity for inappropriate conduct. The U.S. Department of Defense’s Office of Inspector General has identified specific factors as “General Fraud Indicators.”46 These indicators are not evidence of wrong-doing, but signal that opportunities exist for misfeasance. According to the U.S. Department of Defense these “General Fraud Indicators” are: General Fraud Indicators • Management override of key controls. • Inadequate or weak internal controls. • No written policies and procedures. • Overly complex organizational structure. • Key employee never taking leave or vacation. • High turnover rate, reassignment, firing of key personnel. • Missing electronic or hard copy documents that materialize later in the review. • Lost or destroyed electronic or hard copy records. • Photocopied documents instead of originals. Copies are poor quality or illegible. • “Unofficial” electronic files or records instead of “archived” or “official” files or records. • Revisions to electronic or hard copy documents with no explanation or support. 45 DoD Response: Some risk is inherent in the department achieving its mission of job creation, business formation and community development, which entails, by necessity, taking prudent risks and making judgments with regard to companies and or non-profits to support based on quantitative and qualitative factors, which will be outlined in the Department’s policy manual. This is a balance-beam approach – achieve results, while ensuring the return of public monies and assuring that they have been spent appropriately. 46 www.dodig.mil/resources/fraud/pdfs/IndicatorsOnly.pdf 32 • Use of means of alteration to data files. • Computer-generated dates for modifications to electronic files that do not fit the appropriate time line for when they were created. • Missing signatures of approval or discrepancies in signature/handwriting. • Computer report totals that are not supported by source documentation. • Lengthy unexplained delays in producing requested documentation. The County should manage all of its departments – particularly those charged with the investment of taxpayer dollars – so as to eliminate any indicators or opportunities for fraud. 2. The AIG Recommended That DoD Adopt Written Policies to Improve Internal Controls47 As a general matter, the absence of written policies and lack of strong internal controls can increase the risk of occupational fraud. The consulting firm KPMG recently issued a report entitled “Global Profiles of The Fraudster: Technology Enables And Weak Controls Fuel The Fraud.” In KPMG’s survey, one “key finding is that weak internal controls remain a major contributing factor for the frauds, up from 54 percent in 2013 to 61 percent in the recent survey.” Thus, the County should adopt written policies to improve its internal controls. These policies should consider recent fraud research. KPMG also identified characteristics of the “typical fraudster.” KPMG reported that, among other characteristics, a typical fraudster has worked for the organization for at least six years and holds an executive or director level positions.48 Other analysts have looked for behavioral red flags of fraudsters. According to the Association of Certified Fraud Examiners, fraudsters often display the following characteristics:49 • • • • Control issues; unwillingness to share duties (18%) “Wheeler-dealer” attitude (15%) Irritability, suspiciousness or defensiveness (13%) Refusal to take vacations (7%) 47 DoD Response: The DoD Director has issued a new Loan Policy Manual. The Manual has had input from the Law Department, the CCCIC, EY, Mr. George Hillow, external stakeholders and DoD staff. Additional attention will be given to staff to ensure that there is a full understanding of performance expectations now outlined in the policy. As the DoD continues to refine its economic development program, updates to the Policy Manual, as well as detailed standard operating procedures, will be developed to further support consistent and standardized quality practices. 48 KPMG, https://home.kpmg.com/xx/en/home/insights/2016/05/global-profiles-of-the-fraudster.html Association of Certified Fraud Examiners, “The Profile of a Fraudster: Who is Most Likely to Commit Occupational Fraud?” 49 33 Additionally, the lack of internal controls or even a deviation from established internal controls creates an increased risk of fraud from external sources. Thus, based upon these observations, the AIG recommended that the County adopt written policies which, among other things, include assuring that multiple staff members have access to, and control over, loan data, that staff who control loan data are rotated on a regular basis, and that there is both an adequate segregation of duties and effective independent oversight. In response to our recommendations, DoD has adopted a new policy manual. 3. The County Should Require Background Checks for DoD Borrowers and Review Past Loans as Necessary Prior to the reorganization of the County in 2010, borrowers were not required to undergo background checks. DoD staff have taken the position that, unlike other County contractors, DoD borrowers are not required to disclose their principals or undergo background checks. This decision should be changed. Past loans should be reviewed. The AIG has reviewed a limited number of the loans issued by the County Commissioners. To date, the AIG has identified three loans to borrowers associated with individuals allegedly involved in the County corruption scandal. In 2007, the County Commissioners created a “Commercial Redevelopment Fund” (“CRF”) that was financed by the issuance of industrial revenue bonds. The CRF issued $ 10,569,956 in partially-forgivable loans. It appears as though the majority of these CRF loans were repaid within 5 years. One exception is an $800,000 loan to 1170 Ivanhoe LLC, a company affiliated with Steve Pumper.50 The CRF was closed by the Fitzgerald Administration. Most of the paper files were destroyed on March 24, 2014. The destroyed records were never entered into Portfol. The AIG believes that forgivable loans were generally not recorded by DoD in Portfol or on the CAFR. In 2008, the County approved two loans totaling $1 million to 1170 Ivanhoe LLC. One loan for $800,000 was funded through CRF. A second loan for $200,000 was funded as a brownfields loan. Neither loan appears to have been repaid. At the time, the $800,000 loan was personally guaranteed by: John A. Pumper, Daniel Pumper, John D. Pumper and Daniel Troxell. Based on the available records, there is in excess of 50 Steven W. Pumper was sentenced to 97 months in prison by U.S. District Judge Sara Lioi. Pumper previously pleaded guilty to a nine-count information for charges including conspiracy to commit bribery of programs receiving federal funds, obstruction of justice, bribery, mail fraud, structuring, and mail fraud. Pumper, the former president and CEO of DAS Construction, admitted to paying bribes to public officials in return for official actions on his behalf. For example, Pumper provided $33,000 in cash to thenCuyahoga County Commissioner Jimmy Dimora and also provided free improvements to Dimora’s home worth tens of thousands of dollars. These actions were done in return for Dimora’s support on several projects in which Pumper was involved, including securing funding for development projects. https://archives.fbi.gov/archives/cleveland/press-releases/2013/construction-executive-steven-pumpersentenced-to-eight-years-in-prison-for-paying-bribes-to-public-officials 34 $1.4 million in unpaid principal and interest owed to the County on this loan. After being notified of this loan, DoD referred it to Douglass & Associates for collection. A separate loan authorized by the County Commissioners, in the amount of $350,000, was approved in 2006 to Deep Three Partners LLC. Deep Three Partners was allegedly affiliated with Michael Forlani.51 DoD’s records indicate that this loan was fully repaid in 2017. The AIG has not completed its review of loans but recommends that background reviews be conducted for DoD borrowers. A thorough review will not be possible until the County completes its current efforts to verify and validate its outstanding loan documents and data. I. Other Jurisdictions Manage Their Development Loans with Effective Policies and Procedures 1. Franklin County The Franklin County development department works in cooperation with the Economic & Community Development Institute (“ECDI”). ECDI follows written policies and procedures regarding its development loans. ECDI tracks and monitors accounts using a software system called Down Home Loan Manager. All funds are acknowledged within that system and each client account is updated as payments are made. Bills are automatically produced from the system. Reporting functions within the system allow for ECDI to easily identify which loans are from Franklin County general funds versus other funding sources. Franklin County maintains copies of all checks in the loan files. Franklin County reconciles its records on a monthly basis by comparing the records of the Down Home Loan Manager with their accounting system, Financial Edge, as well as the county bank accounts to ensure that all payments are recorded appropriately. If there is an error, the staff member making the loan payment enters the information and should the need for adjustment occur, the transaction line within the software system must be reviewed, approved and unlocked by a supervisor within the system before that transaction may be edited. Thus, any adjustments or corrections are independently reviewed and approved before changes are made to the loan accounts. 51 Cleveland-area businessman Michael Forlani was sentenced to more than eight years in prison after previously pleading guilty to RICO conspiracy and other crimes related to bribes Forlani paid to public officials in exchange for help getting contracts for companies he owned or controlled. U.S. District Judge Sara Lioi sentenced Forlani, of Gates Mills, to 97 months in prison. Forlani pleaded guilty to RICO conspiracy, Hobbs Act violations, conspiracy to commit wire fraud and honest services wire fraud, and other charges. Forlani was the sole owner of Deep Three Partners, LLC, according to court documents. See: https://www.justice.gov/usao-ndoh/pr/businessman-michael-forlani-sentenced-eight-years-prison 35 Franklin County software system will only allow the administrator to make such changes. Franklin County sends out monthly statements on all loans. It assesses a late fee of 5% of the installment due. They also age past due installment loans. Supervisors are required to monitor the accounts on a monthly basis. Franklin County brings together every month its portfolio managers, management staff and legal in a meeting where all delinquent accounts are reviewed. As a loan progresses in the 30 60 - 90 day categories, collateral is reviewed, letters are mailed to the clients and the project managers work with clients as much as they can to return the account to paying as agreed. Flexible payments are allowed to return a client to a normal payment schedule and are discussed internally at this monthly meeting. Franklin County also has written policies regarding the write-offs and delinquency of any loans. All accounts within the portfolio are treated equally. As an account continues in its delinquency, there is a series of escalating attempts to collect and return the account back to an “on time” status. Should a loan reach 120 days, the loan will be charged off internally. However, collection efforts will continue and any funds recovered either through the payment or repossession of collateral will be tracked through a recovery account. 52 2. Hamilton County The Hamilton County Department of Development has written policies and procedures regarding its loans. However, these written policies have not been revised recently and are in need of updating. Hamilton County uses a software system called FoxPro which holds all development loans in a portfolio. FoxPro indicates when an account is past due according to a 30, 60, and 90 day protocol. Each month the staff at the Department of Development prepares invoices for each of the loan accounts. These invoices note the amount of each loan account payment, the current amount of the outstanding loan, and includes a return envelope. Late or past-due loan accounts are telephoned by the Department of Development staff prior to a second mailing of the past-due notice to the loan account. A phone call is made because the majority of the home repair borrowers are elderly and may have misplaced or forgotten to make the payments. All loans are invoiced on a monthly basis. These loans are aged. Loan accounts and payments are monitored on a monthly basis. Loan records are reconciled on a monthly basis. If there are any errors or corrections required, there is an adjusting journal entry made to the loan account. Any adjustments or corrections are independently reviewed by both the accountant and a senior staffer. 52 Telephone interviews and emails from Mar. 25, 2016 to Apr. 12, 2016 with Mark Paxson, Grant Administrator, Franklin County Economic Development and Planning Department. 36 3. Summit County Summit County has established written policies and procedures regarding its Economic Development loan process. Servicing and monitoring is handled by Cascade Capital. Cascade Capital handles the receipting process and loan servicing process. Cascade Capital also handles the invoicing of past due accounts, tracks them, and provides a monthly report. Statements invoiced to borrowers include the past due amount, the outstanding balance of the loan as of that date, and the current amount of the monthly payment. Cascade Capital charges Summit County $1,250 per file for loan servicing. Cascade Capital also provides aging of past-due loan accounts. It sends out monthly statements to all loan accounts. Summit County uses “Banner” accounting software to reconcile on a monthly basis the statements received from Cascade Capital regarding receipts and expenditures. Every loan account is monitored at a minimum on a monthly basis. Adjustments and correction of errors are accounted for by confirmation through the fiscal officer. If Summit County’s Fiscal Office discovers an error, the Department of Development will recheck the support and accounts to ensure that there are no mispostings. 53 4. Lorain County The Lorain County Department of Development operates a revolving Loan Fund for CDBG funds. This fund is monitored by the Ohio Department of Development and requires that the Lorain County Department of Development adopt and follow the State’s written policies and guidelines. The loan accounts are serviced by an independent bank. The bank handles receipts, accounting processing, and collections. Lorain County deposits its development funds into an interest-bearing account. The bank charges Lorain County $275/month ($3,300/year) to service the loans in the account. The bank sends the Lorain Department of Development monthly bank statements. Then, the Lorain Department of Development posts to their internal records and reviews the receipts on the County Auditors monthly reports. The County Treasurer processes the revenue receipts. After one staff member posts the receipt or expenditure transaction, a different employee will check or verify the posting to the source documents as an internal control. If there are any adjustments or corrections, they are reviewed and approved by at least two people. Supervisors are required to monitor the accounts on at least a monthly basis. 54 53 Telephone interviews and emails from Mar. 25, 2016 to Mar. 30, 2016 with Holly Miller, Senior Administrator & Certified Home Specialist Department of Community Economic Development, Summit County. 54 Telephone interviews and emails from Mar. 24, 2016 to Apr. 4, 2016 with Jason McDonald, Lorain County, Department of Development, Community Development Senior Financial Analyst. 37 5. Other Jurisdictions – U.S. Virgin Islands The AIG also performed a cursory review of practices in jurisdictions outside of Ohio. The AIG found, for example, in the U.S. Virgin Islands: “The draft loan servicing manual procedures requires the implementation of the following steps by collection officers to proactively manage the portfolio and minimize losses. For a loan: • 15 days past due, a telephone call is to be made to the borrower requesting payment. • 30 days past due, a standard letter is to be mailed to the borrower requesting payment within 15 days to bring the loan current. • 60 days past due, a standard letter is to be mailed to the borrower requiring payment within 15 days and informing the borrower that the matter will be referred to legal counsel if payment is not received. • 90 days past due, “senior staff…confer with legal counsel and issue a right to cure, which could include a new payment agreement.” If necessary, further legal steps are taken to protect the portfolio. • The loan/collection officer is required to immediately identify loans that are 120 days and over past due and bring them to the attention of the supervisor.”55 The AIG is confident that Cuyahoga County can be as diligent as these other jurisdictions in monitoring its development loans. J. The County Should Out-Source the Servicing and Monitoring of Development Loans56 The DoD’s process for servicing and monitoring its loan portfolio has been inadequate to protect the taxpayers’ interests or comply with Federal, State and County law. Under prior leadership, DoD did not adopt any written policies, implement independent reviews, invoice borrowers on a regular basis, or use the automatic functions of its portfolio management software. Other counties have written policies, regular invoicing, independent controls, and monthly reviews. Cuyahoga did not. 55 www.viig.org/wp-content/uploads/2015/09/AR-01-EDA-13.pdf 56 DoD Response: The DoD has worked closely with the Office of Procurement and Diversity to release a Request for Qualifications (RFQ) for loan servicing and portfolio management. The RFQ was released on Friday, June 16, 2017. Via the RFQ process, the DoD will have the opportunity to evaluate potential vendors for their ability to effectively manage the servicing of the economic development loans. 38 The County has decided to outsource the servicing, monitoring and collection of its loan procedures. Both Summit County and Lorain County use third-party financial institutions to service their loans. Cuyahoga County will likely benefit from similar outsourcing. IV. CONCLUSION The County has struggled with the servicing and monitoring of its development loans. The lack of written policies and procedures contributed to the inaccuracy of data used to manage the County’s development programs. In the last five months, DoD has made real and substantial progress in improving its operations. However, the task is not yet complete. With good data, effective controls and strong leadership, DoD will greatly improve its stewardship of taxpayer dollars. 39