oversight

Dutchtown Care Center, Review of Project Disbursements, St. Louis, MO

Published by the Department of Housing and Urban Development, Office of Inspector General on 2002-03-29.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

           AUDIT REPORT




    DUTCHTOWN CARE CENTER
REVIEW OF PROJECT DISBURSEMENTS

            ST. LOUIS, MISSOURI

                    2002-KC-1001

                    March 29, 2002



         OFFICE OF AUDIT, GREAT PLAINS
             KANSAS CITY, KANSAS



Table of Contents
                                                                 Issue Date
                                                                         March 29, 2002
                                                                Audit Case Number
                                                                         2002-KC-1001




TO: Herman Ransom, Director, Office of Multifamily Housing, Kansas City Hub, 7AHM



FROM: Roger E. Niesen, District Inspector General for Audit, 7AGA

SUBJECT:       Dutchtown Care Center - #085-43066-NC-PM
               St. Louis, Missouri

We have completed an audit of Dutchtown Care Center’s use of project funds to determine if the
owners complied with the terms of their Regulatory Agreement. Dutchtown is a Section 232
insured nursing home located in St. Louis, MO.

Our report contains three findings with recommendations requiring action by your office. The three
findings address misuse of project funds totaling $844,771 between March 1997 and May 2000.
Dutchtown improperly used $484,253 in project funds to repay owner advances when the project
did not have surplus cash. Dutchtown also paid $308,559 in project funds to provide a salary to one
of the owners. Dutchtown did not have HUD’s consent to make these distributions. In addition,
project funds totaling $51,959 were paid for other ineligible or unsupported purposes. Although
Dutchtown generated surplus cash in 2001, it did not have any surplus cash during the periods it
made the unauthorized distributions and inappropriate expenditures.

Within 60 days please give us, for each recommendation in this report, a status report on: (1) the
corrective action taken; (2) the proposed corrective action and the date to be completed; or (3) why
action is considered unnecessary. Also, please furnish us copies of any correspondence or
directives issued because of the audit.

Should you or your staff have any questions, please contact me at (913) 551-5870.




              Table of Contents
Executive Summary
We have completed an audit of Dutchtown Care Center. The objective of our audit was to
determine whether the owners of Dutchtown Care Center complied with the terms of the
Regulatory Agreement, as well as all applicable statutes, regulations, handbooks and other
requirements of HUD. We decided to conduct an audit of Dutchtown because its financial
statements had indications of equity skimming.

We found that Dutchtown improperly used $484,253 in project funds to repay owner advances
when the project did not have surplus cash. Dutchtown also paid $308,559 in project funds to
provide a salary to one of the owners. Salary paid to an owner is prohibited unless HUD has
approved the salary as essential to project operations. In addition, project funds totaling $51,959
were paid for other ineligible or unsupported purposes.

These actions violated Dutchtown’s Regulatory Agreement and increased the risk to HUD’s
mortgage insurance fund. The requirement to generate surplus cash before distributions are made
provides assurance to HUD that owners efficiently and effectively operate and properly maintain
projects.



                                      The owners of Dutchtown Care Center inappropriately paid
 Distributions to Owners              $484,253 from project funds to themselves and their affiliates
                                      between March 1997 and February 2000. The owners
                                      disregarded HUD’s requirements and advice from their own
                                      cost certification auditors that distributions other than from
                                      surplus cash were improper. The owners made these
                                      distributions in order to repay funds that the owners had
                                      advanced to the nursing home between November 1994 and
                                      July 1997. When a project is in a non-surplus cash position,
                                      HUD guidelines prohibit repayment of owner advances unless
                                      prior approval is obtained. When the owners took these
                                      distributions, Dutchtown had never had surplus cash. The
                                      improper distributions increased the risk to the HUD mortgage
                                      insurance fund.

                                      Dutchtown’s operating funds were inappropriately used to
 Salary to Owner                      pay a salary to one of the owners to serve as the
                                      administrator and subsequently assistant administrator. The
                                      duties of the administrator and assistant administrator are the
                                      same and are similar to those required of the identity-of-
                                      interest management agent. These payments were made
                                      during a period when the same owner was paid over
                                      $500,000 for services rendered as the management agent.
                                      The project paid the salary even though HUD had notified
                                      the owners that using project operating funds to pay a salary
                                      to the project’s principals was prohibited. Under HUD

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Executive Summary


                                   guidelines, owner salaries other than approved management
                                   fees are considered distributions that can only be paid out
                                   of surplus cash. The improper payments increase the risk
                                   to the HUD insurance fund and could set an undesirable
                                   precedent for other project owners.

                                   The owners of Dutchtown Care Center used project funds
 Ineligible Expenses               to pay $51,959 for purchases that were not supported to be
                                   reasonable or necessary project expenses. These expenses
                                   included car payments for vehicles driven by the owners,
                                   sports team season tickets, former nursing home legal
                                   expenses, credit card purchases of food, gas, auto parts and
                                   repairs, rental cars, department store shopping, and other
                                   purposes that could not be shown to be project related. The
                                   owners said they believed the purchases were eligible
                                   project expenses, even though they could not produce
                                   documentation to support how the purchases were
                                   reasonable and necessary operating expenses. Dutchtown’s
                                   Regulatory Agreement requires all project funds be used for
                                   reasonable and necessary operating and maintenance
                                   expenses of the project, with the exception that
                                   distributions from surplus cash can be used for any
                                   purpose. Using project funds for other than reasonable and
                                   necessary expenses increases the risk to HUD’s mortgage
                                   insurance fund.

                                   We recommend that the Director, Office of Multifamily
                                   Housing, Kansas City Hub, takes all appropriate action to
                                   correct these deficiencies and to prevent them from occurring
                                   in the future. At a minimum, the Director should require
                                   Dutchtown to obtain HUD’s approval before making any
                                   surplus cash distributions for the next three years. During
                                   this period, HUD should also review all project expenditures
                                   to ensure there are no ineligible payments before granting
                                   approval for surplus cash distributions. If ineligible expenses
                                   are found, distributions should be denied and appropriate
                                   administrative or civil actions taken. HUD should also
                                   require the owners to develop and implement procedures to
                                   ensure they abide by Dutchtown’s Regulatory Agreement
                                   and HUD’s guidelines regarding: future distributions of
                                   project funds; payment of expenses from project funds; and
                                   maintenance of documentation to support the amount and
                                   eligibility of expenses.




2002-KC-1001                           Page iii

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Table of Contents

Management Memorandum                                                      i



Executive Summary                                                     ii



Introduction                                                           1



Findings

1.     The Owners Took Distributions When the Project Had Negative
       Surplus Cash                                                    2


2.     Dutchtown Improperly Paid $308,559 To An Owner                  6

3.     The Owners Made Purchases that Were Not Reasonable or
       Necessary                                                     10



Management Controls                                                  14



Follow Up On Prior Audits                                            15



Appendices
     A. Audit Comments                                               16


     B. Distribution                                                 20




                              Page iv                       2002-KC-1001
Introduction
The Department of Housing and Urban Development insured, under the 232 program, a $4,221,500
mortgage to construct Dutchtown Care & Rehabilitation Center. The owner of Dutchtown Care &
Rehabilitation Center is A.F.T., Inc., a corporation registered in the State of Missouri. The officers
and sole shareholders of A.F.T. are a married couple.

Dutchtown Care Center was built to replace another nursing home that formerly occupied the same
site. The initial closing for the loan to construct Dutchtown Care Center took place on December 7,
1995. On that date, the owner signed a Regulatory Agreement with HUD. Residents first occupied
the new nursing home on March 12, 1997. Final Endorsement of the mortgage took place on
September 21, 1998.

Dutchtown Care Center has 120 beds and is located in the city of St. Louis. The nursing home had
a net loss of $81,102 in its fiscal year ending March 31, 2000. Its net income for the fiscal year
ending March 31, 2001 was $440,211.



                                       The overall audit objective was to determine whether the
 Audit Objectives                      owners of Dutchtown Care Center have complied with the
                                       terms of the Regulatory Agreement, as well as all applicable
                                       statutes, regulations, handbooks and other requirements of
                                       HUD.

                                       To achieve our objective, we reviewed the project’s bank
 Audit Scope and                       statements, canceled checks, general ledgers, invoices,
 Methodology                           management agreement, and financial statements. We also
                                       interviewed the owners, the controller, and the financial
                                       statement auditors.

                                       We performed our audit work from June 2000 through
                                       August 2000. The audit covered the period March 12, 1997
                                       through April 30, 2000. We extended the review, where
                                       appropriate, to include other periods. The Audit was
                                       conducted in accordance with generally accepted government
                                       auditing standards. In August 2000 after we completed our
                                       audit work, we provided our conclusions to HUD’s attorneys
                                       for a legal review. Subsequently, we provided draft findings
                                       to the owners of Dutchtown on February 11, 2002 and
                                       received the owners’ responses to our findings on March 6,
                                       2002. After receiving the owner’s comments, we revised our
                                       recommendations to allow HUD maximum flexibility in
                                       resolving the deficiencies we identified. We provided a
                                       copy of this final report to the owners of Dutchtown Care
                                       Center.

                                            Page 1                                      2002-KC-1001

              Table of Contents
                                                                                          Finding 1


      The Owners Took Distributions When the
         Project Had Negative Surplus Cash
The owners of Dutchtown Care Center inappropriately paid $484,253 from project funds to themselves
and their affiliates between March 1997 and February 2000. The owners disregarded HUD’s
requirements and advice from their own cost certification auditors that distributions other than from
surplus cash were improper. The owners made these payments in order to repay funds the owners had
advanced to the nursing home between November 1994 and February 1997. When a project is in a non-
surplus cash position, HUD guidelines prohibit repayment of owner advances unless prior approval is
obtained. When the owners took these distributions, Dutchtown did not have nor ever had surplus cash.
The improper distributions increased the risk to the HUD mortgage insurance fund.



                                      Dutchtown Care Center is governed by a Regulatory
 Program Requirements                 Agreement that says except for payments made from surplus
                                      cash, all payments must be for reasonable operating expenses
                                      and necessary repairs. Payments from surplus cash may be
                                      used for any purpose, but only after the amount of surplus
                                      cash is calculated at the end of a fiscal period.

                                      HUD Handbook 4370.2 says owner advances made for
                                      reasonable and necessary operating expenses may be repaid
                                      from surplus cash at the end of the annual or semi-annual
                                      period. Repayment of owner advances when the project is in
                                      a non-surplus cash position will subject the owner to criminal
                                      and civil monetary penalties.

                                      Handbook 4370.2 also says that to encourage owners to
                                      make advances to projects in critical situations, the
                                      Department may approve on a case-by-case basis requests to
                                      make advances and for repayment of such advances. Prior
                                      HUD approval is required for an owner to receive repayment
                                      on a monthly basis.

                                      The owners and two of their affiliates made advances to
The Owner’s Made                      Dutchtown from 1994 through 1997. The owners did not
Advances And Repaid                   disclose these advances to HUD in documents related to their
Themselves                            September 30, 1998 final endorsement of the mortgage.

                                      Dutchtown used project funds to repay these advances from
                                      April 1997 through February 2000. This was done by
                                      making payments from project accounts directly to the

                                           Page 2                                      2002-KC-1001

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Finding 1


                                   owners, their affiliates, and to third parties on the owners’
                                   behalf. The amounts of these payments were then deducted
                                   from the balance of advances shown as having been made to
                                   Dutchtown. This process continued until these advances
                                   were fully repaid in February 2000.

                                   At the time the repayments were made, Dutchtown did not
                                   have surplus cash. Dutchtown’s financial statement auditors
                                   calculated surplus cash at March 31, 1998, 1999, and 2000,
                                   and in each case it was a negative amount. Additionally, in a
                                   November 18, 1997 note to the owners, the cost certification
                                   auditors informed the owners that advances could only be
                                   repaid from surplus cash.

                                   The payments made to reimburse these advances were
                                   ineligible distributions of operating funds that violated
                                   Dutchtown’s      Regulatory Agreement        and    HUD’s
                                   requirements. These payments increased the risk to HUD’s
                                   mortgage insurance fund. The requirement to generate
                                   surplus cash before distributions can be made helps ensure
                                   HUD owners efficiently and effectively operate and properly
                                   maintain projects.

                                   After our audit field work was completed, the owners
  The Current Surplus Cash         indicated that the improper distributions were not a concern
  Position Is Not                  since they had positive surplus cash as of March 31, 2001.
  Guaranteed                       However, we believe the fact that Dutchtown generated
                                   surplus cash in 2001 does not ensure the project is operating
                                   efficiently and effectively or will continue to do so. It also
                                   does not dismiss the fact that the owner’s knowingly violated
                                   their Regulatory Agreement over a four-year period.

                                   We examined the conditions that led to Dutchtown’s March
                                   31, 2001 positive surplus cash totaling $679,859 and found
                                   69 percent ($471,346) of the surplus cash was the result of
                                   non-recurring income that Dutchtown received in fiscal year
                                   2001. This non-recurring revenue was from a settlement
                                   reached with a contractor, reimbursement from Medicaid for
                                   a prior period, and a special nursing home distribution from
                                   the State legislature.

                                   Surplus cash in one year does not guarantee Dutchtown is
                                   operating effectively or will sustain this level of operation in
                                   future years. We believe HUD should monitor Dutchtown’s
                                   expenditures and require Dutchtown to obtain HUD’s

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                                                                                   Finding 1


                              permission prior to making surplus cash distributions for a
                              specified period in the future to ensure Dutchtown is
                              operating effectively and in accordance with its Regulatory
                              Agreement.



Auditee Comments              Excerpts from Dutchtown’s comments on our draft finding
                              follow. Appendix A, page 19, contains the complete text of
                              the comments.

                              Dutchtown acknowledges the owner took distributions when
                              the project had negative surplus cash. However, Dutchtown
                              believes it is a timing issue since they currently have surplus
                              cash. Also, Dutchtown asserted that contrary to our findings,
                              the owner was required by Gershman Investment
                              Corporation and HUD to make advances during the
                              construction period to cover change orders and construction
                              and lease up overruns in excess of $400,000. Further,
                              Dutchtown explained that surplus cash had been calculated
                              incorrectly for three years, and the correct surplus cash
                              figures were less negative than the original figures.
                              Dutchtown says that our comment that $471,346 of the
                              surplus cash was the result of non-recurring income is
                              absolutely wrong. The Nursing Home Reimbursement Act
                              and the Nursing Facility Acceptance Corporation have been
                              around since the mid-1990’s. The facility has received the
                              funds every year since it opened.


OIG Evaluation of             Dutchtown is correct in stating that if it would not have
Auditee Comments              violated its Regulatory Agreement, it would have had the
                              opportunity to generate positive surplus cash at the end of the
                              period following its ineligible distributions. However, since
                              it did violate the regulations, it did not have positive surplus
                              cash. Thus HUD’s risk was increased during the period
                              when distributions were taken with no assurance a positive
                              surplus cash position would be reached. The statement that
                              the owners were required to make the advances is not
                              relevant. We did not take issue with why the owners made
                              the advances. Our finding deals with the manner in which
                              the advances were repaid when there was no confirmation
                              that the project had surplus cash or had received HUD’s prior
                              permission to repay the advances. Also, even though surplus
                              cash had been incorrectly calculated, the corrected the figures

                                   Page 4                                       2002-KC-1001

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Finding 1


                                   were negative. Finally, our treatment of the Nursing Home
                                   Reimbursement payments as non-recurring was consistent
                                   with information we received from Dutchtown’s financial
                                   statement auditor and the Missouri Department of Social
                                   Services. We revised our draft recommendations to allow
                                   HUD maximum flexibility in resolving this issue.



Recommendations                    We recommend the Director, Office of Multifamily Housing,
                                   Kansas City Hub:

                                   1A.     Takes all appropriate actions to correct the ineligible
                                           distributions and to prevent them form occurring in
                                           the future. At a minimum, the Director should:

                                           (1) For the next three years, require Dutchtown to
                                           obtain HUD’s approval before distributing surplus
                                           cash.

                                           (2) Prior to approving any distributions, review
                                           Dutchtown’s expenditures for ineligible items and
                                           deny the distribution of surplus cash and take
                                           appropriate administrative or civil action if ineligible
                                           distributions are found.




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               Table of Contents
                                                                                       Finding 2




   Dutchtown Improperly Paid $308,559 To An
                   Owner
Dutchtown’s operating funds were inappropriately used to pay a salary to one of the owners to
serve as the administrator and subsequently as the assistant administrator. The duties of the
administrator and assistant administrator are the same and are similar to those required of the
identity-of-interest management agent. These payments were made during a period when the same
owner was paid over $500,000 for services rendered as the management agent. The owners paid
the salary even though HUD had notified them that using project operating expenses to pay a
salary to the project’s principals was prohibited. Under HUD guidelines, owner salaries other
than approved management fees are considered distributions that can only be paid out of surplus
cash. The improper payments increase the risk to the HUD insurance fund and could set an
undesirable precedent for other project owners.



                                    Dutchtown Care Center’s Regulatory Agreement requires
 Program Requirements
                                    all distributions be limited to the extent of surplus cash
                                    available as of and after the end of an annual or semiannual
                                    fiscal period. Although Dutchtown was permitted to
                                    compute surplus cash semiannually, it only calculated
                                    surplus cash annually.

                                    HUD Handbook 4370.2 says a distribution is any
                                    withdrawal or taking of cash or any assets of a project other
                                    than for the payment of reasonable expenses necessary to
                                    the operation and maintenance of the project. The term
                                    distributions includes, for example, supervisory fees paid to
                                    general partners and any salaries or other fees paid to the
                                    sponsor or mortgagor, unless those salaries or fees have
                                    been approved by HUD as essential to the operation of a
                                    project (e.g., a management fee approved by HUD and paid
                                    on an Owner-Managed project).

                                    A husband and wife team owns the corporation that
 Owner Salary                       controls Dutchtown. Dutchtown’s husband-owner served
                                    as the paid administrator for Dutchtown from March 1997
                                    through May 1998. After a full-time administrator was
                                    hired in June 1998, the husband-owner held the position of
                                    assistant administrator. The owner was paid a salary of
                                    approximately $100,000 as administrator and continued to
                                    receive this same amount as assistant administrator, while

                                         Page 6                                     2002-KC-1001

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Finding 2


                                   the new administrator earned about $67,000.

                                   The job descriptions for the administrator and assistant
                                   administrator are identical.       Additionally, the duties
                                   included in their job descriptions are similar to those of the
                                   management agent. The management agent is an identity-
                                   of-interest corporation also under control of the husband
                                   and wife team. The husband signed the management
                                   contract for the management agent and received $539,231
                                   for management agent services provided over the same
                                   period he was paid $308,559 as administrator and assistant
                                   administrator. HUD guidelines prohibit the owner from
                                   receiving any salary or fee unless specifically approved.

                                   HUD notified the owners prior to these payments being
                                   made that owner salaries were prohibited. HUD sent a
                                   letter to the mortgagee and the identity-of-interest owner
                                   entity in June 1997, that denied their request to use working
                                   capital escrows to pay a salary to the owner. The letter
                                   says, “HUD’s guidelines prohibit including in the project
                                   operating expenses any salary paid to the project’s
                                   principals.”

                                   Dutchtown did not have surplus cash at any time during the
                                   period these salary payments were made. Dutchtown’s
                                   financial statement auditors calculated surplus cash at March
                                   31, 1998, 1999, and 2000, and found, in each case, that
                                   surplus cash was a negative amount. As a result, the salary
                                   paid to the owner as administrator and assistant
                                   administrator is contrary to HUD’s instructions and
                                   guidelines, and constitutes a diversion of project funds.



Auditee Comments                   Excerpts from Dutchtown’s comments on our draft finding
                                   follow. Appendix A, page 19, contains the complete text of
                                   the comments.

                                   Dutchtown indicated that our finding is based on the
                                   erroneous conclusion that the administrator and management
                                   agent perform the same functions. All nursing homes are
                                   required by law to have a state licensed administrator, whose
                                   license is posted on the wall, who is responsible for day to
                                   day running of the nursing home. The management company
                                   has the authority and responsibility for the management and

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               Table of Contents
                                                                                   Finding 2


                              over all operation of the facility. These are separate and
                              distinct responsibilities. Who better to act as administrator to
                              help in the initial lease up of the facility than someone with a
                              vested interest in attracting good residents for the long term
                              benefit of the project than the owner? Also, Dutchtown said
                              the Auditors must have thought they were auditing a
                              multifamily housing project, not a nursing home. Further,
                              Dutchtown said HUD’s refusal to use working capital
                              escrows for the administrator’s salary is not unusual during
                              the lease up period and does not necessarily prove anything.



OIG Evaluation of             Our finding is based on the fact that salary payments to
Auditee Comments              owners are prohibited except with prior HUD approval such
                              as when a project is self managed and the owner is not
                              paying a fee to a management agent. In this case, the owner
                              was the identity of interest management agent, so he was
                              already being paid a fee to manage the project. Additionally,
                              the owner did not request HUD’s approval to receive a
                              salary. If the owner chooses to act as administrator because
                              he feels he is best suited to run the nursing home, he should
                              not draw a salary. The owner can reimburse himself for his
                              efforts using surplus cash distribution procedures. These
                              procedures were designed to encourage owners with a vested
                              interest in a project to run it more effectively. The HUD-
                              OIG Auditor used the Regulatory Agreement and HUD
                              Handbook 4370.2 as criteria to audit Dutchtown. Both are
                              applicable to insured, Section 232 nursing home projects.
                              Finally, in a letter to Dutchtown regarding the use of working
                              capital escrows to pay the owner an administrator salary,
                              HUD said salary payments to an owner are also prohibited
                              from operating expenses.            We revised our draft
                              recommendations to allow HUD maximum flexibility in
                              resolving this issue.



Recommendations               We recommend the Director, Office of Multifamily Housing,
                              Kansas City Hub:

                              2A.     Takes all appropriate actions to correct the ineligible
                                      distributions and to prevent them from occurring in
                                      the future. At a minimum, the Director should:


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Finding 2


                                      (1) Require Dutchtown to cease paying a salary to
                                      the owner, and restrict future payments to owners to
                                      the amount of available surplus cash following an
                                      annual or semiannual calculation.




2002-KC-1001                       Page 9

               Table of Contents
                                                                                         Finding 3


    The Owners Made Purchases that Were Not
           Reasonable or Necessary
The owners of Dutchtown Care Center used project funds to pay $51,959 for purchases that were
not supported to be reasonable or necessary project expenses. These expenses included car
payments for vehicles driven by the owners, sports team season tickets, former nursing home legal
expenses, credit card purchases of food, gas, auto parts and repairs, rental cars, department store
shopping, and other purposes which could not be shown to be project related. The owners said they
believed the purchases were eligible project expenses, even though they could not produce
documentation to support how the purchases were reasonable and necessary operating expenses.
Dutchtown’s Regulatory Agreement requires all project funds be used for reasonable and necessary
operating and maintenance expenses of the project, with the exception that distributions from
surplus cash can be used for any purpose. Using project funds for other than reasonable and
necessary expenses increases the risk to HUD’s mortgage insurance fund.



                                      The Regulatory Agreement says that project funds must be
 Program Requirements                 used to pay amounts required by the mortgage, make
                                      required reserve deposits, pay reasonable expenses necessary
                                      to the operation and maintenance of the project, and repay
                                      owner advances authorized by the Secretary’s administrative
                                      procedures and approved by the mortgagee. Any other
                                      distributions can only be paid out of surplus cash that exists
                                      as of the end of a semi-annual or annual fiscal period.
                                      Dutchtown opted to only calculate surplus cash at the close
                                      of each annual fiscal period.

                                      The owners of Dutchtown used project funds: to make car
 Unallowable Purchases                payments for vehicles driven by the owners; for sports team
                                      season tickets; to pay former nursing home legal expenses;
                                      to pay credit card purchases of food, gas, auto parts and
                                      repairs; and to pay for rental cars, department store
                                      shopping, and other purposes that could not be shown to be
                                      reasonable and necessary operating or maintenance
                                      expenses.

                                      Acting as management agent, the owners used project funds
 The Project Paid Costs               to pay for vehicles leased for their use. From March 1998
 That Were a Management               through May 2000, the project paid $5,753 for these
 Agent Responsibility                 vehicles. In addition, during this same period the project
                                      paid car-related expenses, such as gas and repairs, totaling
                                      $8,214. The management contract says that Dutchtown is

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Finding 3


                                   to pay a management fee, but Dutchtown will not pay
                                   expenses of the management company unless specified in
                                   the contract. The contract does not state the project will
                                   provide transportation for the management company. The
                                   contract states that the management agent will supply, at its
                                   sole cost, all equipment, tools, materials, and supplies
                                   necessary or appropriate to perform its duties. Therefore,
                                   vehicle expenses should have been paid out of management
                                   fees, not project funds.

                                   Between October 1998 and April 2000, the project paid
  The Project Paid Costs           $15,545 for tickets to various St. Louis sporting events.
  That Were Not                    The Controller said the tickets were used as an employee
  Reasonable Or Necessary          fringe benefit. The owners offered them to employees who
                                   had done exceptional work. The owners said these tickets
                                   were also offered to patients and responsible parties of
                                   patients.

                                   The owners also used project funds to pay $3,472 in legal
                                   expenses for a nursing home that was formerly located on
                                   the site. In addition, Dutchtown paid for the same expenses
                                   twice. Dutchtown paid a credit card company $945 for
                                   purchases made on behalf of Dutchtown and then
                                   reimbursed an owner for the same expenses. Further, the
                                   owners used their credit cards to purchase food, items from
                                   department stores and other miscellaneous purchases
                                   totaling $5,334 and used project funds to pay their credit
                                   card bills. Although Dutchtown had in its files the credit
                                   card statements listing the transactions, it did not have
                                   receipts documenting how these purchases were legitimate
                                   project expenses.

                                   Dutchtown wrote checks totaling $11,418 to various
                                   payees, but did not have documentation such as invoices
                                   and receipts to support that the payments were project-
                                   related. Among these payments were checks payable to
                                   members of the owners’ family, cash, and sports
                                   organizations.   HUD requires that all payments be
                                   adequately supported with documentation.

                                   The Regulatory Agreement’s spending requirements are in
                                   place to protect the Department’s interest. Not following or
                                   improperly applying the requirements increases the risk to
                                   the HUD mortgage insurance fund. The following table
                                   itemizes the unallowable purchases:

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                                                                                    Finding 3



                              Unallowable Purchases                      Amount
                              Vehicles                                     $5,753
                              Vehicle gas, stereo, repair                  $8,214
                              Sports                                      $15,545
                              Relates to another project                   $3,472
                              Payments to owners                           $1,367
                              Restaurants                                  $4,060
                              Miscellaneous (includes shopping)            $1,780
                              Unsupported                                 $11,418
                              Donation                                       $350
                                    TOTAL                                 $51,959


Auditee Comments
                              Excerpts from Dutchtown’s comments on our draft finding
                              follow. Appendix A, page 19, contains the complete text of
                              the comments.

                              Dutchtown disagrees with our conclusion that purchases of
                              $51,959 were not reasonable or necessary expenses, except
                              for the $945 paid twice which was a mistake. Dutchtown
                              claims that HUD and the OIG should not be micro managing
                              a successful project. If the expenses were disallowed, then
                              the owners claim they would have an even larger surplus
                              cash amount to be distributed to the owners. The owners are
                              expending funds that they feel will provide long term
                              benefits to the facility. The owners said that although certain
                              items may appear to be questionable, the best authority for
                              what are ordinary and necessary expenses are the owners,
                              since ultimately monies expended are just reducing their
                              surplus cash distributions, and the proof is in the profitability
                              of the project.



OIG Evaluation of             We believe that HUD should hold all insured projects to the
Auditee Comments              requirements set forth in the Regulatory Agreement. The
                              Regulatory Agreement limits the type of expense that can be
                              made from project operating funds and requires a surplus
                              cash computation before distributions can be made. We
                              commend Dutchtown on attaining surplus cash in March
                              2001, but emphasize that past performance is not a guarantee
                              of continued future success. That is why these requirements

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Finding 3


                                   exist. The regulatory agreement is structured to protect
                                   tenants and reduce HUD’s risk from a non-recourse loan.
                                   We revised our draft recommendations to allow HUD
                                   maximum flexibility in resolving this issue.



Recommendations                    We recommend the Director, Office of Multifamily Housing,
                                   Kansas City Hub:

                                   3A.      Takes all appropriate actions to correct the ineligible
                                            distributions and to prevent them from occurring in
                                            the future. At a minimum, the Director should
                                            require Dutchtown to:

                                            (1) Stop paying non-project type expenses from
                                            project funds.

                                            (2) Develop and implement procedures that ensure
                                            only eligible expenses are paid from project funds,
                                            and that documentation is maintained to support the
                                            eligibility and the amount of operating funds
                                            expended.




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Management Controls
In planning and performing our audit, we considered the management controls of Dutchtown Care
Center to determine our auditing procedures, not to provide assurance on the controls. Management
controls include the plan of organization, methods and procedures adopted by management to ensure
that its goals are met. Management controls include the processes for planning, organizing,
directing, and controlling program operations. They include the systems for measuring, reporting,
and monitoring program performance.



                                    We determined the following management controls were
 Relevant Management                relevant to our audit objectives:
 Controls
                                        ·   Assuring safeguarding of resources.
                                        ·   Assuring compliance with laws and regulations.

                                    We assessed the relevant controls identified above.

                                    It is a significant weakness if management controls do not
                                    provide reasonable assurance that the process for planning,
                                    organizing, directing, and controlling program operations will
                                    meet an organization’s objectives.

                                    Based on our review, we believe the following items are
 Significant Weaknesses             significant weaknesses:

                                    The owners took distributions, in violation of Dutchtown’s
                                    Regulatory Agreement, when the project did not have surplus
                                    cash (see Finding 1).

                                    Dutchtown paid $308,559 to an owner for a salary that was
                                    duplicative and violated HUD’s instructions (see Finding 2).

                                    The owners made purchases that were not reasonable or
                                    necessary expenses of the project (see Finding 3).




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Follow Up On Prior Audits
This is the first audit of Dutchtown Care Center performed by the Office of Inspector General.




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                                                                                Appendix A

Auditee Comments
The letter responding to our findings is printed below. Exhibits attached to this letter are
excluded since they are not necessary for understanding the comments.




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Appendix A




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                              Appendix A




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Appendix A




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                                                                                   Appendix B

Distribution Outside of HUD
Ranking Member, Committee on Governmental Affairs, 340 Dirksen Senate Office Building,
  United States Senate, Washington, DC 20510
Chairman, Committee on Governmental Affairs, 706 Hart Senate Office Building,
  United States Senate, Washington, DC 20510
Chairman, Committee on Government Reform, 2185 Rayburn Building, House of
  Representatives, Washington, DC 20515
Ranking Member, Committee on Government Reform, 2204 Rayburn Building
  House of Representatives, Washington DC 20515
Director, Housing and Telecommunications Issues, United States General Accounting
  Office, 441 G Street NW, Room 2T23, Washington DC 20548
Senior Advisor, Subcommittee on Criminal Justice, Drug Policy & Human
  Resources, B373 Rayburn House Office Building, Washington, DC 20515
Chief, Housing Branch, Office of Management & Budget, 725 17th Street, NW, Room 9226,
  New Executive Office Building, Washington, DC 20503
Assistant Inspector General for Health Care Financing Audits, N2-25-26, North Bldg., 7500
  Security Blvd., Baltimore, MD 21244-1850
House Committee on Financial Services, 2129 Rayburn H.O.B., Washington, DC 20515
Senior Counsel, Committee on Financial Services, United States House of Representatives,
  B303 Rayburn H.O.B., Washington, DC 20515




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