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
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)