Karen Newton Cole, chief of human resources at the U.S. Department of Housing and Urban Development, said HUD started the review after receiving a tip from a PHA employee in early spring. The whistle-blower claimed that Audrey Lim was receiving preferential treatment as a result of a relationship with Kelly.
HUD, which took direct control of PHA in March 2011, oversaw the investigation. It was carried out by PHA's chief internal investigator, Kelvin Jeremiah, appointed Friday as Kelly's temporary replacement.
The review determined that there were no illegal payments and that the relationship was consensual, but that there was an "indiscretion," said Jereon Brown, a HUD spokesman who joined Newton Cole in an interview.
When confronted by investigators, Kelly acknowledged the affair, Brown said.
"We explained the circumstances to Michael . . . that it was an improper relationship and it would be hard to correct," Brown said.
Brown said the affair would set "a bad example for the rest of PHA."
HUD informed Kelly of the review results in May and he submitted his resignation two weeks ago. Newton Cole formally accepted his resignation at Friday's PHA board meeting.
Kelly was hired Monday in Washington as head of that city's housing and community development office. He said he told his new employer why he left PHA.
Lim, of Singapore, who was director of special projects and earned $125,000, resigned June 1. She could not be reached for comment.
Kelly said the relationship had "absolutely" ended. "I recognized the wrongness of that long ago," he said.
In an interview with The Inquirer on May 30, Kelly shared PHA's new ethics policy. It specifically forbids managers from being romantically involved with subordinates.
Kelly noted that the new rules only took effect last Friday. In Tuesday's phone interview, he said, "I was setting a standard that I couldn't hold myself."
"That was the basis for my resignation."
Jeremiah said it was painful for him to investigate Kelly, who had recruited him from New York City's office of investigations, where he was responsible for ferreting out corruption at the city's housing authority.
"It's disheartening when somebody you love and respect and look up to disappoints you. It's a colossal lapse in judgment," he said.
As part of his review of Kelly's actions, Jeremiah inspected credit-card statements, travel records, schedules, and bonuses, and interviewed employees, including Kelly.
Jeremiah said there was no evidence of any cover-up or any payment of hush money to conceal the affair.
He credited Kelly with helping to rebuild PHA after Greene was fired.
"We've done a lot," he said. "The system is working. We've put in place rigorous internal controls.
Jeremiah said that before Kelly, the agency was suffering from "a complete breakdown" in internal controls over the agency.
"At the end of the day, we hold people responsible for the good things they do, as well as the bad things they do," he said. "This case highlights that."
When Kelly's resignation was first announced, he gave no other reason for quitting other than saying he was going home to Washington for "personal reasons."
HUD had hoped to return the agency to local control three months ago but decided to stay on until next year. Before Kelly resigned, the main stumbling block appeared to have been the legislature's approving new rules governing a replacement board for PHA.
Newton Cole was replaced as PHA's sole board member on Friday as part of a HUD rotation. Estelle Richman, a senior adviser to the HUD secretary, has been appointed to take her place.
Contact staff writer Jennifer Lin at 215-854-5659 or firstname.lastname@example.org, or on Twitter @j_linq.