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May 7, 1992

COMMITTEE FOR FAIRNESS, et al., Plaintiffs,
JACK F. KEMP, Secretary of Housing and Urban Development, Defendant.


The opinion of the court was delivered by: HAROLD H. GREENE

A number of public housing authorities from around the nation brought suit against the Secretary of Housing and Urban Development (HUD) for his implementation of a new method for calculating their operating subsidies and for doing so retroactively, in violation of the Administrative Procedure Act. Plaintiffs seek a declaratory ruling that these changes are invalid, and an injunction to prohibit HUD from recapturing some $ 68 million from the public housing authorities. *fn1" Pending before the Court are cross-motions for summary judgment. *fn2" Numerous briefs, affidavits, and exhibits have been submitted, and the Court has heard oral argument.


 General Background

 The factual backdrop of this suit is as follows. Plaintiffs, a collection of local public housing authorities (PHAs) in various states, *fn3" operate federally-assisted low-rent public housing pursuant to the Housing Act of 1937, 50 Stat. 888 as amended, 42 U.S.C. § 1401 et seq. Defendant HUD, in accordance with a 1974 amendment to the Act, provides the PHAs with annual operating subsidies to make up the difference between the amount of rent these entities may charge their tenants *fn4" and the PHA operating costs. Housing and Community Development Act of 1974, 88 Stat. 633, 752, 42 U.S.C. § 1437g(a)(1).

 The 1974 amendment directed the Secretary of HUD to establish standards for determining the appropriate operating subsidy to be paid to each PHA. According to the statute, the implementing regulations were to

 establish standards for costs of operation and reasonable projections of income, taking into account the character and location of the project and characteristic of the families served, or the costs of providing comparable services as determined in accordance with criteria or a formula representing the operations of a prototype well-managed project.

 42 U.S.C. § 1437g(a). Pursuant to this statutory direction, and following notice and comment rulemaking procedures, HUD in 1976 established by regulation the "Performance Funding System" (PFS) as the method for such determinations. See 24 C.F.R. Part 990.

 The PFS in effect for the fiscal years between 1976 and April 1, 1986 *fn5" provided that, in general, the operating subsidy to be awarded was the difference between a PHA's allowable expense level and its projected income as approved by HUD. See 24 C.F.R. § 990.101. Under this system, projected income consisted of three components: dwelling rental income, investment income, and "other" income. *fn6" Under the PFS regulation, the local PHA was to calculate dwelling rental income projections based on a precise formula -- that is, the rent roll for a particular month divided by the number of dwelling units then occupied. See 24 C.F.R. § 990.109(b). In contrast, projections of both investment income and "other" income were to be "based on the judgment of the PHA which will reflect past experience and a future projection for the Requested Budget Year . . . ." 24 C.F.R. § 990.109(e).

 Once the local PHA estimated its projected income for the following fiscal year, the projection was submitted to a HUD field office for approval. In reviewing the projections, the HUD field office could use a limited operating budget review procedure or it could request additional information as part of the review. *fn7" Following approval, the operating subsidies were distributed to the PHAs in advance of the period for which the funds were needed, on a monthly, quarterly, or yearly basis. 24 C.F.R. § 990.113(a).

 Pursuant to regulation, HUD retained the power to initiate adjustments in the subsidies. However, the responsible official has stated that HUD considered the operating subsidies under the PFS to be "firm commitments . . . not generally subject to revision." *fn8" The funding was accordingly approved and distributed on a forward-looking basis. What this meant is that if a PHA earned more income than it had projected, it could use the additional funds for eligible expenses not covered by the allowable expense level, or it could deposit the excess money in a reserve account. This system also meant, however, that if the PHA earned less than the projected income figure, it had to absorb the loss. *fn9"


 Changes with Regard to Investment Income

 Although the Performance Funding System had been in effect since 1976, beginning in the early 1980s the system of calculating the investment income portion of the PHA subsidy summarized above was considered by some HUD officials to be unsatisfactory. *fn10" HUD therefore implemented two changes in the method for calculating and assessing the investment income portion of the PHA's operating subsidies.

 First. According to the section of the original regulation that dealt with investment income, a PHA was able to use its own judgment and experience to estimate both the amount of funds it would have available for investment, and the interest rate it would be able to secure in the coming fiscal year. See 24 C.F.R. § 990.109(e). In place of this standard, HUD established a new set of criteria in 1982 for evaluating investment income estimates, known as the Target Investment Income program (TII). According to HUD, the program was intended to "provide an incentive procedure for improved cash management." *fn11"

 The TII program replaced the old judgment-and-experience-based standard with a precise mathematical formula. Under that formula, the central office of HUD dictated the amount of funds a PHA would be deemed to have available for investment, as well as the interest rate it would be deemed capable of securing in the upcoming fiscal year. *fn12"

 Although this new standard ultimately became the subject of notice and comment rulemaking (see infra), it was implemented as early as August of 1982 for application to PHA fiscal years beginning on January 1, 1982, on the basis of a mere change in HUD's Handbook for local income housing financial management issued in November of 1981. *fn13"

 The program quickly generated both criticism and some confusion. *fn14" In response to various protests and comments, Assistant Secretary Winn issued a memorandum on December 10, 1982, which sought to clarify the program and in which he promised that revisions in the PFS regulation would soon be promulgated. The following month the year-end reconciliations were to go into effect, but HUD had still failed to promulgate new regulations by that time, and complaints continued to be made.

 Second. HUD developed a related program, called the Retroactive Recapture Program, which applied the new investment income formula established by the TII plan retroactively to expenditures in past budget years notwithstanding that such expenditures had long been approved and closed under the former, prospective-oriented subsidy evaluation system.

 The new program was developed through a series of internal memoranda, beginning with a memorandum from Assistant Secretary Abrams on December 10, 1982, entitled "Guideline for the Closing of Findings relating to Investment Income Earned in Excess of Estimates," in which it was acknowledged that the "applicable procedures did not call for a year-end resettlement of subsidy payments." *fn15" The Abrams memorandum proposed to proceed with recaptures of the "overpayments," and it noted that, due to the lack of applicable procedures, the recaptures would be limited to the two most recent fiscal years.

 There was significant confusion and dissension about this program as well, and for that reason it was initially not implemented. However, on April 11, 1984, Assistant Secretary Lindquist directed by way of an internal memorandum that the new criteria of the TII income program were to be applied to all past fiscal years for PHAs with 500 or more units. *fn16"

 Like the TII system, the Retroactive Recapture Program was the subject of notice and comment rulemaking in 1984 and 1985, and it was made effective through a rule for PHA fiscal years beginning April 1, 1986.

 Plaintiffs do not challenge the rules adopted through this procedure. However, they do maintain that the changes and the financial consequences flowing therefrom in the fiscal years between 1982 and April 1, 1986, are invalid as they were implemented without the benefit of rulemaking procedures or publication in the Federal Register. Plaintiffs also claim that the changes are the product of unlawful agency action which was arbitrary and capricious, an abuse of discretion, and inconsistent with the Housing Act and the regulations issued thereunder.

 Plaintiffs estimate that the retroactive application of the two programs to the five budget years between 1982 and April 1986 has resulted in a deduction of approximately $ 68 million from the subsidies the PHAs would have received under the old Performance Funding System. As of the date of the hearing herein, plaintiffs ...

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