oversight

Lakewood Care Center; Milwaukee, WI; Multifamily Equity Skimming of More Than $1 Million in Project Funds

Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-12-22.

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

           AUDIT REPORT




         LAKEWOOD CARE CENTER
       MULTIFAMILY EQUITY SKIMMING

          MILWAUKEE, WISCONSIN

                2005-CH-1004

            DECEMBER 22, 2004




           OFFICE OF AUDIT, REGION V
               CHICAGO, ILLINOIS



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                                                                  Issue Date
                                                                        December 22, 2004
                                                                  Audit Report Number
                                                                           2005-CH-1004




TO:          Howard Goldman, Director of Minneapolis Multifamily Housing Hub,
               5KHMLA
             Margarita Maisonet, Director of Departmental Enforcement Center, CV


FROM:        Heath Wolfe, Regional Inspector General for Audit, 5AGA

SUBJECT: Lakewood Care Center; Milwaukee, WI; Multifamily Equity Skimming of More
           Than $1 Million in Project Funds

                                    HIGHLIGHTS

 What We Audited and Why


              We reviewed the books and records of the Lakewood Care Center (Project), a
              196-bed skilled nursing facility in Milwaukee, WI. The review was part of our
              efforts to combat multifamily equity skimming. The review was also part of our
              nationwide reviews of nursing homes due to the increasingly high default rate and
              number of Federal Housing Administration (FHA) insurance claims being paid
              under the Section 232 program. We chose the Project due to its default status and
              more than $1 million dollar write-off of bad debt reported in its fiscal year 2002
              audited financial statements.

              Our review objective was to determine whether the owner/management agent
              used Project funds in compliance with the Regulatory Agreement and the
              Department of Housing and Urban Development’s (HUD) requirements.

 What We Found


              The owner of the Project, 2115 Woodstock Place, LLC (Woodstock Place),
              inappropriately disposed of $1,021,056 in Project assets on December 31, 2002,
              without obtaining HUD approval and in violation of its Regulatory Agreement.



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           The Project was in a non-surplus cash position and in default of its FHA-insured
           loan at the time of the disposition.

           Woodstock Place also inappropriately loaned $612,500 of Project funds to
           Summit Health Care, Incorporated, the identity of interest operator of the Project.
           The Project was in a non-surplus cash position and/or in default at the time
           Woodstock Place made the loans.

What We Recommend


           We recommend that HUD’s Director of Multifamily Housing Hub, Minneapolis
           Field Office, ensure that Woodstock Place reimburse the Project’s Reserve for
           Replacement and/or HUD’s FHA insurance fund $1,021,056 for the inappropriate
           disposition of Project assets. We also recommend that HUD’s Director of
           Multifamily Housing Hub, in conjunction with HUD’s Office of Inspector
           General, pursue double damages remedies if Woodstock Place does not reimburse
           the Project’s Reserve for Replacement and/or the FHA insurance fund for the
           inappropriate disposition of Project assets.

           We also recommend that HUD’s Director of Departmental Enforcement Center
           impose civil money penalties and pursue administrative sanctions against
           Woodstock Place and its Managing Member.

           For each recommendation without a management decision, please respond and
           provide status reports in accordance with HUD Handbook 2000.06, REV-3.
           Please furnish us copies of any correspondence or directives issued because of the
           audit.

Auditee’s Response


           We provided our discussion draft audit finding to Woodstock Place’s Managing
           Member and HUD’s staff during the review. We held an exit conference with the
           Managing Member and HUD’s staff on June 7, 2004.

           Woodstock Place’s Managing Member did not disagree with our finding that
           Woodstock Place disposed of and loaned the Project’s assets. However, the
           Managing Member did not agree with our recommendations due to either HUD’s
           knowledge and/or approval of Woodstock Place’s disposition and/or loaning of
           the Project’s assets. We included the complete text of the Managing Member’s
           comments in appendix B of this report.




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Background and Objectives                                                           4

Results of Audit

      Finding 1: Woodstock Place Inappropriately Disposed of More Than $1 Million   5
                 in Project Funds

Scope and Methodology                                                               8

Internal Controls                                                                   9

Appendixes
   A. Schedule of Ineligible Costs                                                  11
   B. Auditee Comments and OIG’s Evaluation                                         12
   C. Federal Requirements                                                          26




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                      BACKGROUND AND OBJECTIVE

Lakewood Care Center (Project) is a 196-bed skilled nursing facility in Milwaukee, WI. The
Project was insured under Section 232 of the National Housing Act and its Regulatory
Agreement was executed on September 1, 1999. The Project’s owner was 2115 Woodstock
Place, LLC (Woodstock Place). The Managing Member of Woodstock Place was also the
President of Summit Health Care, Incorporated (Summit), the identity of interest operator of the
Project. The Project was in a non-surplus cash position as of September 1999 and Woodstock
Place was in default of its U.S. Department of Housing and Urban Development (HUD)-insured
mortgage as of June 2002. Woodstock Place sold the Project on August 28, 2003, through a
Transfer of Physical Assets.

The review was part of our efforts to combat multifamily equity skimming. The review was also
part of our nationwide reviews of nursing homes due to the increasingly high default rate and
number of FHA insurance claims being paid under the Section 232 program. We chose the
Project due to its default status and more than $1 million dollar write-off of bad debt reported in
its fiscal year 2002 audited financial statements.

Our review objective was to determine whether the owner/management agent used Project funds
in compliance with the Regulatory Agreement and HUD’s requirements.




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                                 RESULTS OF AUDIT

  Finding: Woodstock Place Inappropriately Disposed of More than $1
                      Million in Project Funds
The owner of the Project, 2115 Woodstock Place, LLC (Woodstock Place), inappropriately
disposed of $1,021,056 in Project assets on December 31, 2002, without obtaining HUD
approval and in violation of its Regulatory Agreement. The Project was in a non-surplus cash
position and in default at the time of the disposition. The inappropriate disposition included
$509,778 in loans and $511,278 in delinquent lease payments. Contrary to the Regulatory
Agreement, Woodstock Place loaned $612,500 of Project funds to Summit, the identity of
interest operator of the Project. Further, Woodstock Place reclassified the payment of $147,478
in 1998 real estate taxes as a loan to Summit in its fiscal year 1999 audited financial statements.
Summit repaid $250,200 of the loans as of December 2002. However, Summit failed to make
$511,278 in lease payments to Woodstock Place from April 2001 through December 2002. The
problems occurred because Woodstock Place did not follow its Regulatory Agreement and
lacked effective procedures and controls to assure Project funds were used appropriately. As a
result, fewer funds were available for debt service, and Project funds were not used efficiently
and effectively.



 Woodstock Place
 Inappropriately Disposed of
 More than $1 Million in Project
 Funds


               Woodstock Place inappropriately wrote-off $1,021,056 in Project assets as bad debt
               on December 31, 2002. The Project was in a non-surplus cash position at the time
               of the disposition. Further, Woodstock Place had been in default of its mortgage
               since June 2002. Woodstock Place failed to obtain HUD approval for the
               disposition of the Project assets.

               The inappropriate disposition included $509,778 in loans and $511,278 in
               delinquent lease payments. Woodstock Place’s Managing Member said he was not
               aware the Regulatory Agreement required him to obtain HUD’s approval before
               disposing of Project assets.




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Woodstock Place
Inappropriately Loaned Project
Funds to Summit


           Contrary to the Regulatory Agreement, Woodstock Place loaned $612,500 of
           Project funds to Summit, the identity of interest operator of the Project.
           Woodstock Place loaned $594,500 from October through December 1999.
           Woodstock Place loaned the remaining $18,000 to Summit in October 2002. The
           loans occurred while the Project was in a non-surplus cash position. The October
           2002 loan also occurred while the Project was in default. Woodstock Place failed
           to obtain HUD approval for the loans. Further, Woodstock Place reclassified the
           payment of $147,478 in 1998 real estate taxes as a loan to Summit in its fiscal
           year 1999 audited financial statements. Summit repaid $250,200 of the loans
           between November 1999 and September 2000.

           Woodstock Place’s Managing Member, who was also the President of Summit,
           said Woodstock Place’s former Accountant transferred the Project funds for the
           1999 loans without informing him. The Managing Member also said he first
           found out about the loans during the preparation of the 1999 audited financial
           statements. The former Accountant said she would have informed the Managing
           Member of any transfer of funds from the Project’s account.

           The Managing Member signed the check from Woodstock Place to Summit for
           the $18,000 loan. The Managing Member said he was not aware that HUD
           approval was required for a loan of Project funds while the Project is in a non-
           surplus cash position.

 Summit Failed To Make Lease
 Payments to Woodstock Place



           Summit failed to make $511,278 in lease payments to Woodstock Place from
           April 2001 through December 2002. Woodstock Place’s Amended and Restated
           Lease with Summit, dated September 1, 1999, required Summit to make monthly
           lease payments of $92,338. The lease payments were for the Project’s mortgage
           payment, real estate taxes, and property insurance.

           Summit paid its President, who was also Woodstock Place’s Managing Member,
           and/or his wife more than $1.2 million in salaries and distributions from
           September 1999 through August 2002. Therefore, Summit had ample funds to
           make the lease payments instead of paying the Managing Member and/or his wife
           the salaries and distributions. We believe these salaries and benefits of more than
           $1.2 million were an undue enrichment to the Managing Member and/or his wife
           at the expense of the Project’s financial position.



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The Project’s Reserve Was
Reduced by 92 Percent



          Woodstock Place had $1,021,056 less in Project funds to make mortgage and
          Reserve Fund for Replacement payments due to the inappropriate disbursements.
          HUD was not aware Woodstock Place made the loans to Summit or that
          Woodstock Place disposed of the Project’s assets. HUD approved Woodstock
          Place’s use of $526,754 from its Reserve account to bring its mortgage up to date.
          HUD’s Director of the Milwaukee Field Office of Multifamily Housing Program
          Center said HUD would not have approved the use of the Project’s Reserve if it
          had known about the loans and disposition of assets. Woodstock Place sold the
          Project on August 28, 2003, through a Transfer of Physical Assets. As a result,
          the Project’s reserve at the time of the sale was $48,811, $49,189 below HUD’s
          minimum requirement of $98,000 for the Project. Further, the Project’s reserve
          would have been $621,931 if Project funds had been available to make the
          mortgage and reserve payments.


Recommendations


          We recommend that HUD’s Director of Multifamily Housing Hub, Minneapolis
          Field Office, ensure that Woodstock Place

          1A. Reimburse the Project’s Reserve for Replacement and/or HUD’s FHA
              insurance fund $1,021,056 for the inappropriate disposition of Project assets.

          We also recommend that HUD’s Director of Multifamily Housing Hub,
          Minneapolis Field Office, in conjunction with HUD’s Office of Inspector General
          (OIG)

          1B. Pursue double damages remedies if Woodstock Place does not reimburse the
              Project’s Reserve for Replacement and/or the FHA insurance fund for the
              inappropriate disposition of Project assets.

          We also recommend that HUD’s Director of Departmental Enforcement Center

          1C. Impose civil money penalties against Woodstock Place and its Managing
              Member for the inappropriate loans and disposition of Project assets cited in
              this report that violated the Project’s Regulatory Agreement.

          1D. Pursue administrative sanctions against Woodstock Place and its Managing
              Member for the inappropriate disposition of Project assets cited in this report.




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                         SCOPE AND METHODOLOGY

We performed the review at HUD’s Milwaukee Field Office and the Project from October 2003
through June 2004. To accomplish our audit objectives, we interviewed: HUD’s staff; the
Project’s employees; Woodstock Place’s Managing Member and Summit’s President; employees
from BDO Seidman, LLP, the independent public accountant who audited Woodstock Place; and
the Executive Vice-President of Capital Funding Group, Inc., with whom Woodstock Place
entered into the HUD-insured mortgage for the Project.

To determine whether the owner/management agent used Project funds in compliance with the
Regulatory Agreement and HUD’s requirements, we reviewed:

   •   The Regulatory Agreements among HUD, Woodstock Place, and/or Summit;
   •   HUD’s project files and correspondence related to the Project;
   •   HUD’s Real Estate Management System information related to the Project;
   •   Woodstock Place’s Amended and Restated Operating Agreement, Articles of Organization,
       Mortgage and Security Agreement with Capital Funding Group, Inc., and Amended and
       Restated Lease with Summit;
   •   Woodstock Place’s and Summit’s financial records;
   •   Woodstock Place’s audited financial statements for the years ending December 31, 1999,
       2000, 2001, and 2002; and
   •   The Articles of Incorporation for Summit and other identity of interest companies.

We also reviewed Title 12, United States Code, sections 1715 and 1735; Title 31, United States
Code, section 3801; 24 Code of Federal Regulations parts 24 and 232; and HUD Handbooks
2000.06, REV-3; 4350.1, REV-1; 4370.2, REV-1; and 4381.5, REV-2.

The review covered the period September 1, 2001, to August 31, 2003. This period was adjusted
as necessary. We performed our review in accordance with Generally Accepted Government
Auditing Standards.




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                             INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

   •   Effectiveness and efficiency of operations;
   •   Reliability of financial reporting; and
   •   Compliance with applicable laws and regulations

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals and objectives. Internal controls include the processes and procedures for
planning, organizing, directing and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls


              We determined the following internal controls were relevant to our review
              objectives:

                  •   Program Operations – Policies and procedures that management has
                      implemented to reasonably ensure that a program meets its objectives.

                  •   Validity and Reliability of Data – Policies and procedures that management
                      has implemented to reasonably ensure that valid and reliable data are
                      obtained, maintained, and fairly disclosed in reports.

                  •   Compliance with Laws and Regulations – Policies and procedures that
                      management implemented to reasonably ensure that resource use is
                      consistent with laws and regulations.

                  •   Safeguarding Resources – Policies and procedures that management
                      implemented to reasonably ensure that resources are safeguarded against
                      waste, loss, and misuse.

              We assessed the relevant controls identified above. However, our assessment of the
              controls was limited since Woodstock Place no longer owned the Project as of
              August 28, 2003.

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



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Significant Weaknesses


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

               •   Program Operations – Woodstock Place did not operate the Project
                   according to its Regulatory Agreement. Specifically, Woodstock Place
                   disposed of assets while in a non-surplus cash position and without approval
                   from HUD (see Finding).

               •   Safeguarding Resources – Woodstock Place inappropriately wrote-off
                   $1,021,056 of Project assets as bad debt and loaned $612,500 of Project
                   funds to Summit while in a non-surplus cash position and without
                   approval from HUD (see Finding).




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                                 Appendixes
Appendix A

                  SCHEDULE OF INELIGIBLE COSTS

                             Recommendation
                                 Number            Ineligible 1/
                                   1A              $1,021,056
                                  Total            $1,021,056

1/    Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity
      that the auditor believes are not allowable by law; contract; or Federal, State, or local
      policies or regulations.




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Appendix B

        AUDITEE COMMENTS AND OIG'S EVALUATION


Ref to OIG Evaluation   Auditee Comments




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Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




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Ref to OIG Evaluation   Auditee Comments




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Ref to OIG Evaluation   Auditee Comments




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Ref to OIG Evaluation   Auditee Comments




Comment 3

Comment 4




Comment 3




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Ref to OIG Evaluation   Auditee Comments




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Ref to OIG Evaluation   Auditee Comments




Comment 2




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Ref to OIG Evaluation   Auditee Comments




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Ref to OIG Evaluation   Auditee Comments




Comment 2


Comment 2




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Ref to OIG Evaluation   Auditee Comments




Comment 2




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Ref to OIG Evaluation   Auditee Comments




Comment 2
Comment 3
Comment 5




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Ref to OIG Evaluation   Auditee Comments




Comment 2




Comment 2
Comment 6




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Ref to OIG Evaluation   Auditee Comments




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                         OIG Evaluation of Auditee Comments


Comment 1   We granted Woodstock Place an extension of 30 days to respond to the draft audit
            finding.

            HUD did not have possession of the Project’s documentation during the 45 days
            Woodstock Place had to respond to the draft audit finding.

Comment 2   HUD’s receipt of annual financial statements does not constitute approval and/or
            knowledge of the Project’s financial position and actions. Further, HUD does not
            approve annual financial statements.

Comment 3   HUD was not, and would not be expected to be, aware that Woodstock Place
            loaned Project funds to Summit prior to obtaining its HUD-insured mortgage.

Comment 4   Woodstock Place loaned $612,500 of Project funds to Summit while the Project
            was in a non-surplus cash position. Woodstock Place’s Regulatory Agreement
            did not allow the loaning of Project funds while the Project was in a non-surplus
            cash position.

Comment 5   Woodstock Place’s audited financial statements for the year ending December 31,
            1999 submitted to HUD referred to Woodstock Place’s loans of Project funds to
            Summit as related party receivables. Therefore, HUD was not aware the related
            party receivables were loans to Summit.

Comment 6   Woodstock Place loaned $594,500 of Project funds to Summit from October 1999
            through December 1999. Woodstock Place loaned an additional $18,000 to
            Summit in October 2002. Woodstock Place wrote-off $1,021,056 in Project
            assets as bad debt on December 31, 2002. HUD approved Woodstock Place’s use
            of $526,754 from its Reserve account to bring its mortgage current. HUD’s
            approvals occurred from June 2001 through August 2003. Therefore, HUD’s
            approvals did not occur prior to Woodstock Place’s inappropriate disposition of
            Project assets.




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Appendix C

                           FEDERAL REQUIREMENTS


Woodstock Place’s Regulatory Agreement, paragraph 6, mandated that the owner may not,
without the prior written approval of the Secretary, (b) assign, transfer, dispose of, or encumber
any personal property of the project, including rents, or pay out any funds except from surplus
cash, except for reasonable operating expenses and necessary repairs; and (e) make or receive
and retain any distribution of assets or any income of any kind of the project except surplus cash.

Paragraph 13(g) of the Regulatory Agreement defines distribution as any withdrawal or taking of
cash or any assets of the project, excluding payment for reasonable expenses incident to the
operation and maintenance of the project.

Paragraph 3 of Woodstock Place’s LLC Rider to Note, Mortgage, and Regulatory Agreement
requires all signatories to the Rider to be liable for a) funds or property of the Project coming
into their hands that they are not entitled to retain and b) their own acts and deeds or acts and
deeds of others, which they have authorized, in violation of the provisions.
HUD Handbook 4370.2, REV-1, CHG-1, “Financial Operations and Accounting Procedures for
Insured Multifamily Projects,” paragraph 2-10, section A, states that if the owner takes
distributions when the project is in default or when the project is in a non-surplus cash position,
the owner is subject to criminal and/or civil penalties.

According to 24 Code of Federal Regulations, part 24.110, HUD is permitted to take administrative
sanctions against employees or recipients under HUD assistance agreements that violate HUD’s
requirements. The sanctions include debarment, suspension, or limited denial of participation
and are authorized by 24 Code of Federal Regulations, parts 24.300, 24.400, or 24.700,
respectively. HUD may impose administrative sanctions based upon the following conditions:

   •   Failure to honor contractual obligations or to proceed in accordance with contract
       specifications or HUD regulations (limited denial of participation);

   •   Deficiencies in ongoing construction projects (limited denial of participation);

   •   Violation of any law, regulation, or procedure relating to the application for financial
       assistance, insurance, or guarantee or to the performance of obligations incurred pursuant to
       a grant of financial assistance or pursuant to a conditional or final commitment to insure or
       guarantee (limited denial of participation);

   •   Violation of the terms of a public agreement or transaction so serious as to affect the
       integrity of an agency program such as a history of failure to perform or unsatisfactory
       performance of one or more public agreements or transactions (debarment);

   •   Any other cause so serious or compelling in nature that it affects the present responsibility of
       a person (debarment); or



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   •   Material violation of a statutory or regulatory provision or program requirements
       applicable to a public agreement or transaction, including applications for grants,
       financial assistance, insurance, or guarantees, or to the performance of requirements
       under a grant, assistance award, or conditional or final commitment to insure or guarantee
       (debarment).

Title 12, United States Code, section 1715z-4a, “Double Damages Remedy for Unauthorized
Use of Multifamily Housing Project Assets and Income,” allows the Attorney General to recover
double the value of any project assets or income that was used in violation of the Regulatory
Agreement or any applicable regulation, plus all cost relating to the action, including but not
limited to reasonable attorney and auditing fees.

Title 12, United States Code, section 1735f-15, “Civil Money Penalties against Multifamily
Mortgagors,” allows the Secretary to impose a civil money penalty of up to $25,000 per violation
against a mortgagor with five or more living units and a HUD-insured mortgage. A penalty may
be imposed for any knowing and material violation of the Regulatory Agreement by the
mortgagor, such as paying out any funds for expenses that were not reasonable and necessary
project operating expenses or making distributions to owners while the project is in a non-surplus
cash position.




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