AUDIT REPORT
PETERSEN HEALTH CENTER
MULTIFAMILY EQUITY SKIMMING
RHINELANDER, WI
The Operator Improperly Used Funds Required to Be Used for
the Project
2005-CH-1016
SEPTEMER 16, 2005
OFFICE OF AUDIT, REGION V
CHICAGO, ILLINOIS
Issue Date
September 16, 2005
Audit Report Number
2005-CH-1016
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: The Operator Improperly Used Funds Required to Be Used for Petersen Health
Center, Rhinelander, Wisconsin
HIGHLIGHTS
What We Audited and Why
We reviewed the books and records of Petersen Health Center (project). The
project consists of three skilled nursing home facilities, Friendly Village,
Horizons Unlimited, and Taylor Park, totaling 327 beds in Rhinelander,
Wisconsin. The review was part of our efforts to combat multifamily equity
skimming on the U.S. Department of Housing and Urban Development’s (HUD)
Federal Housing Administration insurance fund. We chose the project based
upon its negative surplus-cash position since 1999, its default status, and
indicators of diverted project funds/assets. Our objective was to determine
whether the owner/operator used project funds in compliance with the regulatory
agreement and HUD’s requirements.
What We Found
Petersen Health Care of Wisconsin, Inc. (operator), the project’s identity of
interest operator, improperly used $728,801 in funds required to be used for
project expenses from January 2003 through April 2005 when the project was in a
non-surplus-cash position and/or in default of its HUD-insured loan. The
inappropriate disbursements included $594,830 to P.P.F. Enterprises II, another
identity of interest company, to pay estimated taxes of the partners of P.P.F.
Enterprises (owner), the owner of the project; $80,385 in prepaid legal services;
$47,890 for legal services not related to the project’s operations; $3,000 for
scholarships; $2,096 for Christmas presents; and $600 related to charitable
activities. We provided the owner and operator schedules of the improper
disbursements.
What We Recommend
We recommend that HUD’s director of the Minneapolis Multifamily Housing
Hub ensure that the owner and/or operator reimburse HUD’s Federal Housing
Administration insurance fund $728,801 for the inappropriate disbursements and
implement procedures and controls to ensure funds required to be used for project
expenses are used according to the regulatory agreement. We also recommend
that HUD’s director, in conjunction with HUD’s Office of Inspector General,
pursue double damages remedies if the owner and/or operator do not reimburse
the insurance fund for the inappropriate disbursements.
We recommend that HUD’s director of the Departmental Enforcement Center
impose civil money penalties and pursue administrative sanctions against the
owner, operator, and/or their principals/owners for the payment of inappropriate
disbursements that violated the project’s regulatory agreement.
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 report to the owner’s managing general
partner and HUD’s staff during the audit. We held an exit conference with the
managing general partner on August 10, 2005.
We asked the managing general partner to provide comments on our discussion draft
audit report by September 13, 2005. The managing general partner provided written
comments dated September 13, 2005. The managing general partner disagreed that
the operator improperly used $728,801 in funds required to be used for project
expenses. The complete text of the written comments, along with our evaluation of
those comments, can be found in appendix B of this report.
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TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding: The Operator Inappropriately Used More Than $725,000 in Funds 5
Required to Be Used for Project Expenses
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 33
3
BACKGROUND AND OBJECTIVES
Petersen Health Center (project) consists of three skilled nursing home facilities, Friendly
Village, Horizons Unlimited, and Taylor Park, with 327 beds in Rhinelander, Wisconsin. The
project was insured under section 232 of the National Housing Act, and its regulatory agreement
was executed on May 24, 1995. The project’s owner is P.P.F. Enterprises (owner). Petersen
Health Care of Wisconsin, Inc. (operator) is the project’s identity of interest operator. The
project was in a non-surplus-cash position as of January 1999, and the owner defaulted on its
U.S. Department of Housing and Urban Development (HUD)-insured mortgage as of July 2004.
The owner’s mortgage note was assigned to HUD on December 8, 2004, and HUD paid
Cambridge Realty Capital LTD of Illinois $13,177,858 for the mortgage. HUD plans to sell the
note through a note auction in November 2005.
The review was part of our efforts to combat multifamily equity skimming on HUD’s Federal
Housing Administration insurance fund. We chose the project based upon its negative surplus-
cash position since 1999, its default status, and indicators of diverted project funds/assets.
Our objective was to determine whether the owner/operator used project funds in compliance
with the regulatory agreement and HUD’s requirements.
4
RESULTS OF AUDIT
Finding: The Operator Inappropriately Used More Than $725,000 in
Funds Required to Be Used for Project Expenses
The operator improperly used $728,801 in funds required to be used for project expenses from
January 2003 through April 2005 when the project was in a non-surplus-cash position. The
inappropriate disbursements included $594,830 to P.P.F. Enterprises II, an identity of interest
company, to pay estimated taxes of the owner’s partners; $80,385 in prepaid legal services;
$47,890 for legal services not related to the project’s operations; $3,000 for scholarships; $2,096
for Christmas presents; and $600 related to charitable activities. The owner was also in default
of its HUD-insured mortgage as of July 2004. The inappropriate disbursements occurred
because the owner and operator lacked effective procedures and controls over the use of funds
required to be used for project expenses. As a result, less funding was available for debt service,
and funds were not used efficiently and effectively. Further, the owner’s mortgage note was
assigned to HUD on December 8, 2004, and HUD paid Cambridge Realty Capital LTD of
Illinois $13,177,858 for the mortgage.
The Operator Improperly
Distributed Nearly $600,000 in
Dividends
The operator inappropriately disbursed $594,830 in dividend distributions to
P.P.F. Enterprises II on July 14, 2004. P.P.F. Enterprises II then used the funds to
pay the Wisconsin Department of Revenue and the U.S. Department of the
Treasury for estimated taxes of the owner’s partners. The State of Wisconsin
provided the funds to the operator through Medicaid payments for expenses
associated with the closing of Horizons Unlimited. The project was in a non-
surplus-cash position and in default of its HUD-insured mortgage at the time of
the disbursement. Further, the owner defaulted on its mortgage in July 2004.
The operator’s controller said he thought the State of Wisconsin provided the
funds to the operator to use for taxes the owner’s partners would owe due to the
owner discontinuing business. At the time of the disbursement, he was unaware
the operator’s lease with the owner bound the operator to the terms and conditions
of the owner’s regulatory agreement with HUD.
5
The Operator Inappropriately
Used More Than $130,000 for
Non-project Expenses
The operator inappropriately disbursed $133,971 in funds required to be used for
project expenses from January 2003 through April 2005 that were not reasonable
and necessary operating expenses of the project. The project was in a non-
surplus-cash position and/or in default of its HUD-insured mortgage at the time of
the disbursements. The following schedule summarizes the inappropriate
disbursements.
Inappropriate disbursements Amount
Prepaid legal services $80,385
Non-project legal services 47,890
Scholarships 3,000
Christmas presents to doctors 2,096
Charitable campaign cash prizes 500
Charitable donation 100
Total $133,971
The non-project legal services were for property refinancing and analysis of
HUD’s regulations. The disbursements occurred because the operator’s controller
said he believed the expenses were necessary and reasonable for the operation of
the project.
HUD Assumed the Owner’s
Mortgage
The operator failed to make $2,043,401 in lease payments to the owner from July
2003 through December 2004. However, the owner did not pursue collection of
the delinquent lease payments. The owner’s lease agreement with the operator,
dated June 2, 1995, required the operator to make lease payments sufficient for
the owner to pay the project’s mortgage payment, mortgage insurance premium,
replacement reserves, real estate and personal property taxes, and property
insurance. HUD approved the use of $1,082,194 from the project’s reserve fund
for replacement and sinking fund accounts to make mortgage payments from July
2003 through May 2004. HUD also authorized the suspension of the owner’s
payments into the reserve and sinking fund accounts from April 2001 through
December 2004. Therefore, since the operator improperly used $728,801 in funds
required to be used for project expenses from January 2003 through April 2005,
the owner had $728,801 less in project funds to make mortgage, reserve fund for
replacement, and sinking fund payments. HUD’s staff at the Milwaukee Field
Office of the Multifamily Housing Program Center were not aware of the
inappropriate disbursements.
6
The owner’s mortgage note was assigned to HUD on December 8, 2004, and
HUD paid Cambridge Realty Capital LTD of Illinois $13,177,858 for the
mortgage. The unpaid principal balance on the mortgage was $13,116,636.
As a result, the project’s reserve at the time of HUD’s assumption was $3,159,
$160,341 below HUD’s minimum requirement of $163,500 for the project. The
project’s reserve would have been more than $1 million if project funds had been
available to make the mortgage, reserve, and sinking fund payments. HUD plans
to sell the note through a note auction in November 2005.
Recommendations
We recommend that HUD’s director of the Minneapolis Multifamily Housing Hub
require the owner and/or the operator to
1A. Reimburse HUD’s Federal Housing Administration insurance fund $728,801
for the inappropriate disbursements cited in this report.
1B. Implement procedures and controls to ensure funds required to be used for
project expenses are used according to the regulatory agreement.
We also recommend that HUD’s director of the Minneapolis Multifamily Housing
Hub in conjuction with HUD’s Office of Inspector General
1C. Pursue double damages remedies if the owner and/or operator do not
reimburse the Federal Housing Administration insurance fund for the
inappropriate disbursements.
We also recommend that HUD’s director of the Departmental Enforcement Center
1D. Impose civil money penalties against the owner, the operator, and/or their
principals/owners for the payment of inappropriate disbursements that violated
the project’s regulatory agreement.
1E. Pursue administrative sanctions against the owner, the operator, and/or their
principals/owners for the inappropriate disbursements.
7
SCOPE AND METHODOLOGY
We performed the review at HUD’s Milwaukee Field Office, the owner’s/operator’s offices, and
the project from February through June 2005. To accomplish our objectives, we interviewed
HUD’s staff; employees from the project and the owner; the owner’s managing general partner,
who is also the operator’s president; an employee from Ginoli and Company LTD, the
independent public accountant who audited the project; the vice-president of Cambridge Realty
Capital LTD of Illinois, with whom the owner entered into the HUD-insured mortgage for the
project; and the chief, Nursing Home Section, Bureau of Fee-for-Service Health Care Benefits,
Division of Health Care Financing, State of Wisconsin Department of Health and Family
Services.
To determine whether the owner/operator used project funds in compliance with the regulatory
agreement and HUD’s requirements, we reviewed
• The regulatory agreements among HUD, the owner, and/or the operator;
• HUD’s files and correspondence related to the project;
• HUD’s Real Estate Management System and Financial Assessment Subsystem
information related to the project;
• The owner’s partnership agreement and modification;
• The owner’s lease with the operator;
• The owner’s mortgage and security agreements with Cambridge Realty Capital LTD of
Illinois;
• The owner’s and the operator’s financial records;
• The owner’s audited financial statements for the years ending December 31, 1999, 2000,
2001, 2002, 2003, and 2004;
• The operator’s records of organization; and
• P.P.F. Enterprises II’s partnership agreement.
We also reviewed Title 12, United States Code, sections 1715 and 1735; Title 31, United States
Code, section 3801; 24 CFR [Code of Federal Regulations] 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 from January 1, 2003, through December 31, 2004. This period
was adjusted as necessary. We performed our review in accordance with generally accepted
government auditing standards.
8
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,
• Compliance with applicable laws and regulations, and
• Safeguarding resources.
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 audit 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 has implemented to reasonably ensure that resource use is
consistent with laws and regulations.
• Safeguarding resources – Policies and procedures that management has
implemented to reasonably ensure that resources are safeguarded against
waste, loss, and misuse.
We assessed all of the relevant controls identified above.
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.
9
Significant Weaknesses
Based on our review, we believe the following items are significant weaknesses:
• The owner and operator lacked effective procedures and controls over the
use of funds required to be used for project expenses.
10
APPENDIXES
Appendix A
SCHEDULE OF INELIGIBLE COSTS
Recommendation
number Ineligible 1/
1A $728,801
Total $728,801
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
polices or regulations.
11
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
12
Ref to OIG Evaluation Auditee Comments
13
Ref to OIG Evaluation Auditee Comments
14
Ref to OIG Evaluation Auditee Comments
15
Ref to OIG Evaluation Auditee Comments
16
Ref to OIG Evaluation Auditee Comments
17
Ref to OIG Evaluation Auditee Comments
Comment 1
Comment 2
18
Ref to OIG Evaluation Auditee Comments
19
Ref to OIG Evaluation Auditee Comments
20
Ref to OIG Evaluation Auditee Comments
21
Ref to OIG Evaluation Auditee Comments
Comment 2
Comment 1
22
Ref to OIG Evaluation Auditee Comments
Comment 1
Comment 3
23
Ref to OIG Evaluation Auditee Comments
Comment 3
Comment 4
24
Ref to OIG Evaluation Auditee Comments
Comment 4
25
Ref to OIG Evaluation Auditee Comments
Comment 4
26
Ref to OIG Evaluation Auditee Comments
Comment 4
Comment 4
27
Ref to OIG Evaluation Auditee Comments
Comment 4
Comment 4
28
Ref to OIG Evaluation Auditee Comments
Comment 5
Comment 6
29
Ref to OIG Evaluation Auditee Comments
OIG Evaluation of Auditee Comments
Comment 6
Comment 7
30
OIG Evaluation of Auditee Comments
Comment 1 The owner is ultimately responsible for the project. The owner entered into a
lease with the operator that states the operator agrees to be bound by all terms and
conditions of the owner’s regulatory agreement with HUD. Therefore, it is the
owner’s responsibility to ensure the operator properly used funds required to be
used for project expenses. HUD was not a party to the lease between the owner
and operator.
Comment 2 The State of Wisconsin provided the funds to the operator through Medicaid
payments for expenses associated with the closing of Horizons Unlimited. The
owner entered into a lease with the operator that states the operator agrees to be
bound by all terms and conditions of the owner’s regulatory agreement with
HUD. Therefore, the funds were required to be used for project expenses.
Comment 3 The project was in a non-surplus-cash position and/or in default of its HUD-
insured mortgage at the time of the disbursements. Further, the operator
inappropriately disbursed funds required to be used for project expenses for non-
project legal services. Therefore, prepaid legal services totaling $80,385 were not
necessary and reasonable expenses of the project.
Comment 4 We do not dispute that the cited cases, Thompson v. United States, 408 F.2d 1075
(8th Cir. 1969) and United States v. Frank, 587 F.2d 924 (8th Cir. 1978), stand for
the basic proposition that permissible operating expenses under the regulatory
agreement are expenses that primarily benefit the project as opposed to its
owners. However, in the context of the instant audit, the basic proposition does
not resolve the relevant issues. Rather, it is necessary to evaluate what types of
legal expenses benefit the project as opposed to its owner.
Generally, legal expenses may be reasonable and necessary to the operation of the
project within the meaning of the regulatory agreement if they are expended to
collect rent, evict tenants, or defend lawsuits growing out of the operation of the
project. See United States v. Mansion House Center North Redevelopment Co.,
419 F. Supp. 85 (E.D. Mo. 1976). On the other hand, legal expenses to alter the
financing of a project—through bankruptcy—or otherwise, defend against
foreclosure, etc. are not considered to benefit a project or be necessary to its
operation; rather, this sort of re-financing expense is considered to be for the
benefit of the ownership entity and is not allowable under the Regulatory
Agreement. See, e.g., United States v. Harvey, 68 F. Supp. 2d (S.D. Ind. 1998);
United States v. Berk & Berk, 767 F. Supp. 593 (D. N.J. 1991); In re EES
Lambert Assoc., 63 Bankr. 174 (N.D. Ill. 1986).
Comment 5 The disbursements for scholarships, Christmas presents to doctors, charitable
campaign cash prizes, and charitable donations were not necessary and reasonable
for the operation of the project.
Comment 6 HUD’s approval of the use of the project’s reserve fund for replacement and
sinking fund accounts to make mortgage payments did not reduce the operator’s
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obligation to make lease payments sufficient for the owner to pay the project’s
mortgage payment.
Comment 7 We did not imply that HUD would not have approved the use of the project’s
reserve fund for replacement and sinking fund accounts to make mortgage
payments if HUD would have known about the inappropriate disbursements. We
made statements of fact regarding the project and reported that HUD was not
aware of the inappropriate disbursements.
32
Appendix C
FEDERAL REQUIREMENTS
The operator’s lease with the owner, article II, section 2.1, paragraph E, states the operator
agrees to be bound by all terms and conditions of the owner’s regulatory agreement with HUD.
The owner’s regulatory agreement, paragraph 6, mandates that the owner shall not, without prior
written approval of the secretary of HUD, assign, transfer, dispose of, or encumber any personal
property of the project, including rents, or pay out any funds except for surplus cash, except for
reasonable operating expenses and necessary repairs, and 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.
HUD Handbook 4370.2, REV-1, CHG-1, page 2-6, requires that all disbursements be used to
make mortgage payments and required deposits, pay reasonable expenses necessary for the
operations and maintenance of the project, and pay distributions of surplus cash. Page 2-10
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. Page 4-33 of
the Handbook permits legal expenses necessary and reasonable to the operation of the project.
However, page 4-40 states legal expenses applicable to the corporation or mortgagor entity may
be charged against project operations only with the prior written approval of HUD.
According to 24 CFR [Code of Federal Regulations] 24.100, HUD is permitted to take
administrative sanctions against employees of recipients under HUD assistance agreements that
violate HUD’s requirements. The sanctions include debarment, suspension, or limited denial of
participation and are authorized by 24.800, 24.700, or 24.1105, 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);
• 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); or
• Any other cause so serious or compelling in nature that it affects the present
responsibility of a person (debarment).
Title 12, United States Code, section 1715z-4a, “Double Damages Remedy for Unauthorized
Use of Multifamily Housing Project Assets and Income,” allows the U.S. attorney general to
33
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 of HUD 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.
34
The Operator Improperly Used Funds Required to Be Used for Petersen Health Center, Rhinelander, Wisconsin
Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-16.
Below is a raw (and likely hideous) rendition of the original report. (PDF)