oversight

The Owners of The Avenue, San Francisco, California, Misused More Than $32,000 in Project Funds

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-12-07.

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

                                                               Issue Date
                                                                    December 7, 2005
                                                               Audit Report Number
                                                                    2006-LA-1003




TO:        Janet L. Browder, Director, San Francisco Multifamily HUB, 9AHMLA



FROM:      Joan S. Hobbs, Regional Inspector General for Audit, Region IX, 9DGA

SUBJECT: Owners of The Avenue, San Francisco, California, Misused More Than $32,000
           in Project Funds

                                   HIGHLIGHTS

 What We Audited and Why

             We audited The Avenue (project), a Section 232 assisted living facility. We
             initiated the audit in response to a request for audit from the Department of
             Housing and Urban Development’s (HUD) San Francisco Office of Multifamily
             Housing. Our objectives were to assess HUD’s concerns and determine whether
             project funds were administered in compliance with the regulatory agreement and
             HUD requirements.

 What We Found


             San Francisco Care Center, L.P. (owner) improperly used $32,851 in project
             funds from February through July 2005. The questionable disbursements
             included $31,051 in excessive payments to Legacy Management Systems for a
             food service contract and $1,800 to Eagle Wong for ineligible Feng Shui
             consulting services. The inappropriate disbursements reduced the funds available
             for necessary expenses and, therefore, increased the risk of mortgage default.
             They occurred because the owner/management ignored HUD requirements and
             failed to ensure adequate controls over procurement and disbursements were in
             place.
What We Recommend
           We recommend that the director of HUD’s San Francisco Multifamily HUB
           require The Avenue’s owner/management to implement contracting and
           disbursement procedures in accordance with HUD requirements. We also
           recommend that HUD require the owner, San Francisco Care Center, L.P., to
           repay The Avenue from nonproject funds $31,051 for the excessive contract
           payments for the food service contract and $1,800 for the ineligible Feng Shui
           consulting expense.

           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 general partner on
           October 21, 2005, and held an exit conference on October 28, 2005. The owner’s
           general partner provided written comments on November 7, 2005. The owner
           generally disagreed with our report findings.

           The owner also submitted revised purchasing and disbursement procedures with
           the response. We reviewed the revised procedures and determined they meet
           HUD requirements.

           The complete text of the auditee’s response, along with our evaluation of that
           response, can be found in appendix B of this report.




                                            2
                           TABLE OF CONTENTS

Background and Objectives                                                   4

Results of Audit
      Finding 1: The Avenue Overpaid $31,051 for a Food Service Contract    5
      Finding 2: The Avenue Paid $1,800 for Ineligible Project Expense      7

Scope and Methodology                                                       9

Internal Controls                                                          10

Appendixes
   A. Schedule of Questioned Costs                                         11
   B. Auditee Comments and OIG’s Evaluation                                12




                                            3
                     BACKGROUND AND OBJECTIVES

The Avenue is a 145-bed assisted living facility constructed in 2004. The project is owned by
San Francisco Care Center, L.P., the general partner of which is Van Ness Care Center, Inc.
Two of San Francisco Care Center’s limited partners are also owners and agents of the general
partner and, together, control the ownership entity and the project’s operations. In June 2002,
the owner obtained a $23,108,000 HUD-insured mortgage loan from Pacific Commonwealth
Mortgage Company for the construction of the project. In June 2005, the owner submitted to
HUD the project’s cost certification, prepared by a certified public accounting firm, which
included construction and operating costs through December 31, 2004.

In the request for audit, dated April 29, 2005, HUD expressed concerns over the owner’s misuse
of project funds. Therefore, our objectives were to determine whether concerns raised by HUD
have merit and to assess whether project funds were administered in compliance with the
regulatory agreement and HUD requirements.

In May 2005, the owner hired a third party management agent as required by HUD. During our
review, the owner’s managing general partner (management) continued to make all decisions for
the project’s daily operations.

Although The Avenue began operations in November 2004, it has been unable to generate
sufficient cash flow to cover its mortgage payment and operating expenses. As of
September 30, 2005, the most recent five mortgage payments were paid using the project’s
operating deficit escrow. The remaining balance of the operating deficit escrow can support
three mortgage payments. However, the project’s property taxes and insurance, due in
November 2005, will exhaust the operating deficit escrow unless the owner pays these expenses
with additional contributions. Further, it appears the owner must contribute additional funds to
keep the mortgage current for subsequent months because the project cannot afford the mortgage
at its current occupancy level.




                                                4
                                  RESULTS OF AUDIT

Finding 1: The Avenue Overpaid $31,051 for a Food Service Contract
The Avenue overpaid $31,051 to Legacy Management Systems (Legacy) for a food service contract
for the period of December 2004 through June 2005. Excessive payments were made because
management did not consider obtaining project services at a reasonable cost a priority and
disregarded HUD’s procurement requirements. While management did eventually remedy the
situation by obtaining a lower-priced contract, the excessive costs left less funding available for debt
service and increased the risk of mortgage default.




 The Avenue Entered into an
 Unreasonable Food Service
 Contract

                The Avenue paid Legacy $135,844 for food services provided between
                December 16, 2004, and June 30, 2005. The owner/management admitted to
                contracting with Legacy on November 15, 2004, without soliciting quotes from
                other potential contractors to ensure the contract price was reasonable. The owner
                disregarded HUD Handbook 4381.5, REV-2, section 6.50, which requires the owner
                to solicit written cost estimates from at least three contractors for any contract
                expected to exceed $10,000 per year. Instead, the owner relied on the
                recommendation of its former management consulting firm, Paradigm Senior
                Living.

                Furthermore, the owner stated she knew the contract price was unreasonable as early
                as December 2004 but chose not to take any action to remedy the situation for seven
                months. The Avenue’s regulatory agreement dictates that payments for services
                must not exceed the amount ordinarily paid in the area where the services are
                rendered. It was unreasonable for the owner to enter into this contract and then
                allow the contract to continue, knowing it was excessive, without taking immediate
                steps to remedy the situation.

                Finally, in July 2005, the owner/management renegotiated with Legacy for a lower
                price contract and was granted a $30,000 credit on the unpaid balance. In the new
                contract, Legacy agreed to charge 48 percent less for the fixed portion of the
                semimonthly charge based on serving 20 residents ($8,061 versus $15,469) and 54
                percent less for each additional resident day ($5.60 versus $12.10). The original
                contract was unreasonable because the minimum semimonthly charge for serving up




                                                   5
          to seven residents was $9,904 and it also allowed extra payments for additional
          residents served, while the new contract amount charged less ($8,061) yet allowed
          services for as many as 20 residents.

          After applying the $30,000 credit, The Avenue paid $135,844 to Legacy for the
          fixed and variable portion of the contract for food services provided between
          December 16, 2004, and June 30, 2005 under the initial contract terms. However,
          the project would have only been obligated to pay $104,793 over the same six-and-
          a-half-month period ($8,061 semimonthly charge for up to 20 residents for six and a
          half months) under the new contract terms even without the benefit of graduated
          payments based on lower occupancy. The difference of $31,051 represents an
          overpayment of project funds for services, which could have been avoided if the
          owner had followed proper procurement procedures from the outset.

          These actions show the owner did not place a proper priority on ensuring project
          services were obtained at a reasonable cost. The excessive payments were made
          because the project did not have any procurement policies and procedures when it
          entered into the initial contract. The excessive cost of the contract reduced funds
          available for project operations and debt service, therefore, increasing the risk of
          mortgage default.

          Along with its written comments to our draft report, the owner submitted revised
          purchasing procedures to include procurement procedures. We reviewed these
          procedures and determined they meet HUD procurement requirements.



Recommendations


          We recommend that the director of HUD’s San Francisco Multifamily HUB
          require

          1A. The owner/management to implement the written procurement policies and
          procedures submitted with the comments in accordance with HUD requirements.

          1B. The owner to repay The Avenue $31,051 from nonproject funds for the
          excessive contract payments for the food service contract.




                                             6
                               RESULTS OF AUDIT

Finding 2: The Avenue Paid $1,800 for Ineligible Project Expense
The Avenue improperly used $1,800 for Feng Shui consulting services not necessary for the
project’s operations. We attribute this inappropriate disbursement to the owner’s/management’s
disregard for HUD requirements and inadequate controls to ensure only necessary and
reasonable project expenses with proper support were paid. The project, consequently, had less
funding available for its operations.




 The Avenue Paid $1,800 for
 Feng Shui Consulting Services

              The Avenue paid $1,800 to Eagle Wong for Feng Shui consulting services on
              March 17, 2005. The owner/management hired the Feng Shui consultant based
              on a personal belief that Feng Shui could help create a harmonious atmosphere
              and better living environment for the staff and residents. The owner/management
              attempted to justify the Feng Shui consulting services for the project with a design
              award the project received from a magazine. However, the owner/management
              could not provide anything to show that the Feng Shui consulting services
              expense was necessary and reasonable for the operations of a senior assisted
              living facility, as required by HUD Handbook 4370.2, REV-1, chapter 2-6,
              paragraph E. The owner/management also could not produce a supporting
              invoice for the disbursement, as required by the handbook. The ineligible
              expense was paid due to the lack of effective procedures and controls over project
              disbursements. As a result, the project had less funding available to pay for its
              reasonable and necessary expenses.

              Along with its written comments the owner subsequently revised the purchasing
              procedures to ensure only authorized project expenses with proper supporting
              documentation are paid. We determined the revised procedures meet HUD
              requirements.



 Recommendations


              We recommend that the director of HUD’s San Francisco Multifamily HUB
              require




                                               7
2A. The owner/management to implement the revised written disbursement
policies and procedures to ensure the project only pays for necessary and reasonable
project expenses with proper supporting documents.

2B. The owner repay The Avenue $1,800 from nonproject funds for the ineligible
Feng Shui consulting expense.




                                  8
                        SCOPE AND METHODOLOGY

We performed the review at HUD’s San Francisco regional office and the project site from June
through September 2005. To accomplish our objectives, we interviewed officials of the San
Francisco HUD Multifamily HUB; San Francisco Care Center, L.P., the project’s owner and
management; Mok, Shen & Company, an identity-of-interest firm that provides bookkeeping
services to the project; Paradigm Senior Living, a former management consultant; Michel
Augsburger & Cluney Stagg, the project’s HUD-approved management agent; Pacific
Commonwealth Mortgage Company, the lender; and Legacy Management Systems.

To determine whether the owner/management used project funds in compliance with the regulatory
agreement and HUD requirements, we reviewed

   •   The project’s regulatory agreement,
   •   HUD handbook requirements,
   •   HUD files and correspondence related to the project,
   •   HUD’s Real Estate Management System information related to the project,
   •   The owner’s partnership agreement,
   •   The owner’s mortgage documents with Pacific Commonwealth Mortgage Company,
   •   The owner’s financial records such as bank statements, canceled checks, and general
       ledgers,
   •   The project’s cost certification,
   •   The project’s financial records such as bank statements, canceled checks, and general
       ledgers,
   •   The project’s contract with the management agent, and
   •   The management agent’s certification.

Our review generally covered the period from January 1, 2003, through June 30, 2005. This period
was adjusted as necessary. We performed our review in accordance with generally accepted
government auditing standards.




                                                9
                             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 control was relevant to our audit objectives:

              •       Policies and procedures that management has in place to reasonably ensure
                      the HUD-insured assisted living project was administered in accordance with
                      the regulatory agreement and HUD requirements.

              We assessed the relevant control 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.


 Significant Weaknesses


              Based on our review, we believe the following item is a significant weakness:

              •       The Avenue lacked effective procurement and disbursement procedures and
                      controls to reasonably ensure project funds were used in compliance with the
                      regulatory agreement and HUD requirements (see findings 1 and 2).




                                               10
                                       APPENDIXES

Appendix A

                    SCHEDULE OF QUESTIONED COSTS

                                   Recommendation         Ineligible 1/
                                       number
                                           1B                 $31,051
                                           2B                  $1,800

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.




                                                 11
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1

Comment 2
Comment 3



Comment 4




Comment 5




                         12
Comment 6
Comment 7



Comment 8


Comment 9




            13
                         OIG Evaluation of Auditee Comments

Comment 1   The owner subsequently revised The Avenue’s purchasing procedures to include
            procurement policies that meet HUD requirements. Our recommendation in the
            audit report has been revised accordingly.

Comment 2   Since the owner could not provide the invoices to support the payments, we
            obtained the invoices for the payments in question from Legacy. After further
            review, we determined the amount paid for the food service contract was actually
            $135,844 and the excessive amount was $31,051. The audit report and
            recommendation have been revised accordingly.

Comment 3   We recognized The Avenue received a $30,000 credit from Legacy. The credit
            has already been accounted for in determining the ineligible amount. However,
            the credit was not given for services not used due to a difference between
            expected and actual occupancy. Legacy always billed The Avenue based on
            actual occupancy. In our interview with Legacy’s President, he told us Legacy
            was forced to give The Avenue a $30,000 credit to avoid contract termination and
            to collect half of their unpaid balance totaling more than $60,000.

Comment 4   The original contract and the new contract require essentially the same level of
            service from Legacy. Under both the old and new contract terms, Legacy would
            not provide any services unrelated to preparing and serving meals once occupancy
            reached 20 residents. According to Legacy’s President, when the old contract was
            in effect, residents’ rooms were cleaned once a week by the dishwashers. The
            cleaning service was an immaterial part of the overall food service contract. As a
            result, the renegotiated semi-monthly rate of $8,061 was sufficient for the
            contractor to provide food services for up to 20 residents, and is therefore
            applicable to the period in question. This rate would have been available to the
            project from the onset if the owner had followed competitive bidding
            requirements.

Comment 5   The owner is required to follow HUD requirements whether or not the owner
            chooses to hire a consultant. The owner was unable to show they complied with
            HUD’s procurement requirements. They could not show us evidence that they
            obtained price quotes from a minimum of three contractors.

Comment 6   The owner subsequently revised The Avenue’s purchasing procedure to ensure
            only authorized project expenses with proper supporting documentation are paid.
            Our recommendation in the audit report has been revised accordingly.

Comment 7   The owner submitted a receipt for payment, not an invoice. The receipt is
            evidence that the Feng Shui consultant received payment from The Avenue.




                                            14
Comment 8   Feng Shui consulting is not a necessary and reasonable expense for the operation
            of a HUD-insured assisted living facility.

Comment 9   The owner submitted additional invoices on November 8, 2005 supporting
            payment for computer services received from Sirius Analytical Sciences. The
            original finding on this issue and related recommendation have been removed
            from the audit report.




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