oversight

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)

                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.




                                            2
                           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


                                             31
            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