oversight

Sundial Care Center, Modesto, California, Used $659,746 in Project Funds for Ineligible and Undocumented Costs and Was Unable to Account for Revenue Totaling $407,454

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-05-18.

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

                                                                   Issue Date
                                                                        May 18, 2006
                                                                   Audit Report Number
                                                                        2006-LA-1011




TO:         Janet L. Browder, Director, San Francisco Multifamily Housing Hub, 9AHMLA
            Margarita Maisonet, Director, Departmental Enforcement Center, CV
            R. Faye Austin, Regional Counsel, 9AC



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

SUBJECT: Sundial Care Center, Modesto, California, Used $659,746 in Project Funds for
           Ineligible and Undocumented Costs and Was Unable to Account for Revenue
           Totaling $407,454


                                    HIGHLIGHTS

 What We Audited and Why

             We reviewed the books and records of Sundial Care Center (project), a 68-bed
             assisted living facility. We initiated the audit in response to a request for audit
             from the San Francisco Multifamily Housing Hub of the U.S. Department of
             Housing and Urban Development (HUD) due to its concerns about the owner’s
             use of project funds. Our objective was to determine whether the owner used
             project funds in compliance with the regulatory agreement and HUD’s
             requirements.

 What We Found


             The owner, Sundial Care Center, Inc., used $659,746 in project funds for
             nonproject (ineligible) purposes or lacked supporting documentation and could
             not account for $407,454 in project revenue receipts, both of which occurred
             while the project had no surplus cash and/or was in default on its HUD-insured
           mortgage. The ineligible uses included $244,370 for payments on unauthorized
           loans, $89,000 for an inappropriate lease, $22,000 for nonproject legal fees,
           $8,654 in excessive management fees, and $1,771 for other miscellaneous
           nonproject expenses. The owner lacked documentation to support additional
           disbursements of $293,951 for insurance expenses, consulting expenses, and other
           costs.

What We Recommend


           We recommend that the director of HUD’s San Francisco Multifamily Housing
           Hub ensure that the owner reimburses HUD’s Federal Housing Administration
           insurance fund for the ineligible disbursements and provides documentation for
           the unsupported payments and revenue receipts or reimburses those amounts that
           cannot be adequately supported to HUD’s Federal Housing Administration
           insurance fund. We also recommend that HUD’s Regional Counsel, in
           conjunction with the director of HUD’s San Francisco Multifamily Housing Hub
           and HUD’s Office of Inspector General, pursue double damages remedies for the
           misuse of project funds and inappropriate collection of project revenue in
           violation of the regulatory agreement.

           We recommend that the director of HUD’s Departmental Enforcement Center
           take administrative actions against the owner and its principals/officer for their
           part in the regulatory violations. We also recommend that the director impose
           civil money penalties against the owner and its principals.

           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 on April 13, 2006. We
           attempted to hold an exit conference on the scheduled date of April 21, 2006, but
           the auditee failed to attend. The owner provided written comments on April 28,
           2006. The owner generally disagreed with our report findings.

           The complete text of the auditee’s written 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 Project’s Owner Improperly Used or Lacked Supporting         5
      Documentation for the Use of $659,746 in Project Funds
      Finding 2: The Project’s Owner Could Not Account for $407,454 in Project   10
      Revenue

Scope and Methodology                                                            13

Internal Controls                                                                14

Appendixes
   A. Schedule of Questioned Costs                                               15
   B. Auditee Comments and OIG’s Evaluation                                      16
   C. Federal Requirements                                                       26




                                            3
                      BACKGROUND AND OBJECTIVES

Sundial Care Center (project) is a 68-bed assisted living facility located in Modesto, California.
The project was insured under section 232 of the National Housing Act, and its regulatory
agreement was executed on March 1, 2000. The project’s owner is Sundial Care Center, Inc.
(owner). The president of the owner (president), who is also the majority shareholder, has
control over all project operations.

The project was never in a surplus cash position. The owner defaulted on its U.S. Department of
Housing and Urban Development (HUD)-insured mortgage on May 2, 2004. The owner’s
mortgage note was assigned to HUD on October 8, 2004. At the note sale on March 16, 2005,
HUD suffered a $3.6 million loss from the sale of the mortgage note. The final closing of the
note sale occurred on March 31, 2005.

We initiated the review based on a request from HUD’s San Francisco Multifamily Housing Hub
due to its concerns about the owner’s improper use of project funds.

Our objective was to determine whether the owner used project funds in compliance with the
regulatory agreement and HUD’s requirements.




                                                 4
                                 RESULTS OF AUDIT

Finding 1: The Project’s Owner Improperly Used or Lacked Supporting
           Documentation for the Use of $659,746 in Project Funds
The project’s owner violated the terms of the project’s regulatory agreement by using $659,746 in
project funds for nonproject (ineligible) purposes during a period when the project did not have
surplus cash available for distribution and/or was in default on its HUD-insured mortgage. The
ineligible uses included $244,370 for payments on unauthorized loans, $89,000 for an inappropriate
lease, $22,000 for nonproject legal fees, $8,654 in excessive management fees, and $1,771 for other
miscellaneous nonproject expenses. The owner also lacked documentation to support additional
disbursements of $293,951 for insurance expenses, consulting expenses, transfers, and other costs.
The problems occurred because the owner failed to follow the project’s accounting procedures and
disregarded the project’s regulatory agreement with HUD. As a result, the project’s funds available
for debt service were reduced, contributing to the default on its $7.2 million HUD-insured mortgage
and eventual $3.6 million loss to HUD.




 The Project Paid $244,370 for
 Unauthorized Loans

               Project funds totaling $244,370 was used for ineligible loan repayments and interest
               payments as follows:

               •   From July 2003 to October 2004, operating funds totaling $138,000 were
                   disbursed to two identity-of-interest companies, San Francisco Care Center and
                   Van Ness Care Center, to repay advances the owner’s president obtained for the
                   project’s operations. Using her authority as managing general partner of the two
                   identity-of-interest companies, the president had advanced $867,200 to the
                   project from these two identity-of-interest companies. The repayments occurred
                   while there was no surplus cash available for distribution, and $78,000 (57
                   percent) was disbursed while the project was in default of its mortgage. The
                   return of these funds directly benefited the owner’s affiliated companies to the
                   project’s detriment.

               •   In October 2002, project funds were used to make principal payments of
                   $100,025 on a loan derived from a Bank of America line of credit that belonged
                   to the sister-in-law of the owner’s president. The owner’s president claimed the
                   funds from this line of credit were advanced to the project for its operations in
                   February 2001. However, there is no evidence that any of the funds loaned to




                                                 5
               the project were deposited into the project’s bank account. From October 2003
               to February 2005, $6,345 in project operating funds was used to pay the interest
               on another Bank of America line of credit that belonged to the brother of the
               owner’s president. There is no evidence that the funds withdrawn from this
               credit line were used for project operations.

            According to HUD Handbook 4370.2, REV-1, owner advances made for reasonable
            and necessary operating expenses may only be repaid from surplus cash or with
            HUD approval.


The Project Inappropriately
Disbursed $89,000 to the
Owner’s President for a
Parking Lot Lease

            In March 2005, the project inappropriately paid a lump sum of $89,000 to the
            owner’s president, which the owner later identified as a parking lot lease payment.
            The owner purchased the parking lot in a separate transaction when it acquired the
            project with HUD insurance. HUD did not include the parking lot as part of the
            original mortgaged property because it was not necessary for the operation of the
            project. Since the residents of the assisted living facility don’t drive, and the
            project provided their transportation, the 27 parking spaces available on the
            project premises were sufficient for visitors. Therefore, leasing of the parking lot
            would not be a necessary and reasonable project expense.

            However, the owner’s president claimed the project leased the parking lot from
            her from April 2000 to March 2004. The president signed the lease agreement as
            both the owner of the parking lot and as the project’s agent. Although the lease
            terms required a monthly rent payment, the project did not make any monthly
            payments, and no such liability was accrued in the project’s accounting records
            for four years. In addition, although HUD Handbook 4370.2, REV-1, requires
            identity-of-interest activity to be disclosed in the project’s audited financial
            statements, neither the lease nor a liability was identified in the project’s audited
            financial statements submitted to HUD.

            A year after the lease term ended, on March 21, 2005, a lump-sum disbursement
            of $89,000 was made to the owner’s president. The project’s general ledger and
            the bank’s withdrawal memorandum used to withdraw the funds did not identify
            the purpose of this payment. These funds were moved from the project’s bank
            accounts five days after the note sale, while the project remained in default. The
            terms of the regulatory agreement were still in effect until the note sale was final
            on March 31, 2005; the payment, therefore, represents an ineligible disbursement
            to the owner.




                                              6
Project Funds Totaling $22,000
Were Used for Nonproject
Legal Fees


            Between August 2002 and January 2005, $22,000 in project operating funds were
            used to pay nonproject legal fees. In July 2002, a former management agent filed
            a lawsuit against the owner, the owner’s president, and an individual unrelated to
            the project. Although the project was not a named party in the lawsuit, the owner
            used project funds to pay legal expenses incurred in connection with the case.
            Legal services provided in the case were not for the operation of the project. It is
            unreasonable for the project to bear the cost of legal services provided to the
            owner, the owner’s president, and an unrelated third party.


The Project Paid $8,654 in
Excessive Management Fees

            For the period between June 2001 and February 2002, the project paid $8,654 in
            excessive management fees to Eskaton Properties, Inc. (Eskaton). The owner and
            Eskaton certified to HUD that the project would pay Eskaton a management fee
            that was 5 percent of the monthly operating revenue. However, the project paid
            Eskaton a minimum monthly management fee, which for seven months during
            Eskaton’s tenure as the management agent, was more than the amount that was
            certified to HUD.

Project Funds Were Used for
$1,771 in Other Miscellaneous
Nonproject Expenses


            The project paid $1,771 for other miscellaneous nonproject expenses. These
            ineligible expenses included a $500 cash gift to a project employee, $716 in travel
            reimbursements to an identity-of-interest company’s employee, and a $555
            reimbursement to a project employee for a catered staff dinner. These expenses
            are not considered reasonable and necessary to the operation of the project;
            therefore, they are prohibited by the regulatory agreement.


More Than $293,951 in
Disbursements Were Not
Supported


            The project lacked documentation to support $293,951 in disbursements. In
            accordance with paragraph 9(c) of the regulatory agreement, books and records



                                              7
             must be maintained at all times in reasonable condition for proper audit and be
             available for inspection by HUD. The unsupported expenses included $163,357
             in insurance expense, $43,638 in consulting fees, and $74,785 in other costs such
             as reimbursement charges to Eskaton, a refund to a nonresident, nonpayroll
             disbursements to employees, phone charges, supplies, etc. The project disbursed
             an additional $12,171 in project funds to unknown entities. The owner could not
             explain who received the project funds and for what reasons.

Conclusion



             The owner used $659,746 in project funds to pay ineligible and unsupported
             expenses. Despite knowledge of HUD requirements and a December 2004
             warning from HUD the owner’s continued to use of funds in an unauthorized
             manner and misused project assets in violation of its regulatory agreement. The
             improper use of project funds significantly contributed to the owner’s default on
             its $7.2 million HUD-insured mortgage. Further, the improper use of project
             funds makes the owner subject to criminal and civil money penalties, including
             the equity skimming statutes set out in Title 12, United States Code, sections
             1715z-19 and 1715z-4a.


Recommendations


             We recommend that the director of HUD’s San Francisco Multifamily Housing
             Hub require the owner to

             1A. Reimburse HUD’s Federal Housing Administration insurance fund
                 $365,795 for the ineligible disbursements cited in this report.

             1B. Provide documentation to support the $293,951 in undocumented
                 disbursements cited in this report or reimburse the Federal Housing
                 Administration insurance fund for the applicable portion.

             We also recommend that HUD’s Regional Counsel in conjunction with HUD’s
             director of the San Francisco Multifamily Housing Hub and HUD’s Office of
             Inspector General

             1C. Pursue double damages remedies against the responsible parties for all
                 violations of the project’s regulatory agreement mentioned in this audit
                 report.




                                              8
We also recommend that the director of HUD’s Departmental
Enforcement Center

1D. Pursue appropriate administrative sanctions and impose civil money
    penalties against the owner and/or its principals for their part in the
    regulatory violations cited in this audit report.




                             9
                            RESULTS OF AUDIT

Finding 2: The Project’s Owner Could Not Account for $407,454
           in Project Revenue
The owner did not ensure the project collected and accounted for $407,454 in rental
revenue. This uncollected revenue included $67,592 in unconfirmed revenue deposits,
$15,460 in outstanding accounts receivable that were at least a year old, and $324,402 in
outstanding accounts receivable that had accumulated for less than a year. These
problems occurred because management failed to follow its own accounting procedures
and ignored HUD rules and regulations, including its HUD regulatory agreement. As a
result, less revenue was available for project operations and debt service, which
contributed to the default on the $7.2 million HUD-insured mortgage and the $3.6 million
loss to HUD.




 The Owner Was Unable to
 Confirm $67,592 in Revenue
 Deposits

              Of the total revenue the owner claimed the project collected in 2002,
              rental receipts totaling $67,592 were unconfirmed deposits. All rents and
              other project receipts must be deposited into the project’s bank account as
              required by paragraph 9(g) of the regulatory agreement. However, the
              owner could not produce the supporting documentation necessary to
              confirm rental receipts recorded in the project’s accounting records were
              deposited into the project’s bank account. As a result, there is no evidence
              that $67,592 in tenant rent payments were deposited into the project’s
              bank account as required by the regulatory agreement.


 The Project Left $15,460 in
 Accounts Receivable
 Outstanding for More Than a
 Year

              The project had $15,460 in outstanding accounts receivable balances that
              were at least a year old. These accounts receivable had been left
              outstanding since 2002, 2003, and 2004. The project made no effort to
              collect these accounts when they came due, violating the project’s
              accounts receivable policies for collecting delinquent accounts. As a



                                           10
             result, the outstanding balances could not be considered bad debt
             writeoffs. Further, the owner could not provide any reasonable
             explanation why these balances still existed and had not been sought for
             collection.

The Owner Failed to Document
Whether the Project Collected
$324,402 in Revenue


             The project’s general ledger showed additional outstanding tenant
             accounts receivable of $324,402 accruing between December 2004 and
             March 31, 2005. In the past, the owner ensured the accountant routinely
             reconciled the project’s accounting records quarterly. However, beginning
             in December 2004, the owner did not give the accountant permission to
             update the general ledger, including recording rental receipts. As a result,
             many tenant invoices remained open and potentially uncollected through
             March 2005. Supporting documentation was not available to show these
             open invoices were paid and that funds were deposited into the project’s
             bank account. In accordance with paragraph 2-3 of HUD Handbook
             4370.2, REV-1, books and accounts must be complete, accurate, and kept
             current at all times; and postings to the general ledger must be made at
             least monthly. However, the project’s accounting records for the first
             quarter of 2005 remained unreconciled as of December 2005. The owner
             failed to maintain the project’s accounting records in an auditable
             condition to show whether the project collected and deposited $324,402 in
             revenue.

Conclusion



             The owner failed to maintain proper accounting records to ensure the
             project collected and deposited $407,454 in rental revenue. Despite
             knowledge of HUD requirements, the owner continued to not update or
             reconcile the project’s accounting records for a year in violation of its
             regulatory agreement with HUD. Therefore, it is uncertain whether the
             project received any of the revenue earned. The unconfirmed deposits and
             uncollected revenue have significantly contributed to the owner’s default
             on its $7.2 million HUD-insured mortgage and the $3.6 million loss to
             HUD. Further, diversion of project revenue makes the owner subject to
             criminal and civil money penalties, including the equity skimming statutes
             set out in Title 12, United States Code, sections 1715z-19 and 1715z-4a.




                                          11
Recommendations


          We recommend that the director of HUD’s San Francisco Multifamily
          Housing Hub require the owner to

          2A. Provide documentation to support that the $407,454 in uncollected
              revenue cited in this report was deposited into the project bank
              account before HUD’s note sale or reimburse the Federal Housing
              Administration insurance fund for the applicable portion.




                                     12
                     SCOPE AND METHODOLOGY

We performed the review at HUD’s San Francisco regional office and the project site in
Modesto, California, from September 2005 through March 2006. To accomplish our
objective, we interviewed officials of the San Francisco HUD Multifamily Housing Hub;
HUD Headquarters Asset Sales Office; Sundial Care Center, Inc., the project’s owner and
management; Mok, Shen & Company, the project’s accountant; Eskaton Properties, Inc., a
former management agent; and Paradigm Senior Living, a former management consultant.

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 articles of incorporation and bylaws;
   •   The owner’s mortgage documents;
   •   The owner’s board minutes;
   •   The owner’s settlement agreement with a former management agent;
   •   The project’s audited financial statements;
   •   The project’s financial records such as bank statements, canceled checks, and
       general ledgers;
   •   The project’s contract with a former management agent; and
   •   The former management agent’s certification.

Our review generally covered the period from June 1, 2001, through March 31, 2005. This
period was adjusted as necessary. We performed our review in accordance with generally
accepted government auditing standards.




                                            13
                          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 items are significant
               weaknesses:

               •      The project owner circumvented the project’s procedures for
                      procurements, disbursements, receipts and collections, and ignored
                      controls that would reasonably ensure project funds were used in
                      compliance with the regulatory agreement and HUD requirements
                      (see finding 1 and 2).



                                             14
                               APPENDIXES

Appendix A

             SCHEDULE OF QUESTIONED COSTS

                 Recommendation               Ineligible 1/   Unsupported 2/
                     number
                        1A                      $365,795
                        1B                                         $293,951
                        2A                                         $407,454

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.

2/   Unsupported costs are those costs charged to a HUD-financed or HUD-insured
     program or activity when we cannot determine eligibility at the time of audit.
     Unsupported costs require a decision by HUD program officials. This decision, in
     addition to obtaining supporting documentation, might involve a legal
     interpretation or clarification of departmental policies and procedures.




                                         15
                        Appendix B

     AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation        Auditee Comments




Comment 1




                            16
Comment 2




Comment 3



Comment 4



Comment 5




Comment 6




Comment 7




            17
Comment 8




Comment 9


Comment 10

Comment 11


Comment 12




             18
Comment 13


Comment 14

Comment 15

Comment 16



Comment 17



Comment 18




Comment 19


Comment 20




             Names have been redacted for privacy




                             19
Comment 21




Comment 22




Comment 23




             20
                       OIG Evaluation of Auditee Comments

Comment 1     During the audit, the owner asserted that one of the disbursements to the
              identity-of-interest companies was made to correct a transfer error. She
              explained the project disbursed $12,000 to an identity-of-interest company
              in October 2004 to correct a transfer error made in December 2003.
              However, this explanation is not reasonable given the long period of time,
              ten months, before the claimed reimbursement was made. The project
              accountant would have caught such a transfer error and notified the owner
              when she performed the project’s bank reconciliations at the end of the
              quarter in which the original disbursement occurred. Further, the bank
              statement shows the accountant’s handwritten note labeling the December
              2003 transfer into the project account as a loan from the identity-of-
              interest company. There is no evidence to substantiate the owner’s claim
              that the transfer in December 2003 was an error and the disbursement in
              October 2004 was a correction.

              According to the regulatory agreement, owner advances may only be
              repaid from surplus cash or with HUD approval. Further, HUD Handbook
              4370.2, REV-1, prohibits the repayment of owner advances when the
              project is in default.

Comment 2     The line of credit was not for the project. Instead, the line of credit was
              for the brother of the owner’s president. There is no evidence that funds
              from this line of credit were used for the project’s operating expenses.

Comment 3     California Fire Code, Part 3, Article 9, Section 902, Fire Department
              Access, specifies that fire apparatus access roads must have an
              unobstructed width of not less than 20 feet. However, the California Fire
              Code did not require the project to lease or purchase additional space to
              ensure the fire apparatus access road is free from obstruction.

Comment 4     The City of Modesto does not have specific requirements for dumpster
              placement as long as the dumpster does not block the street right-of-way,
              per Modesto Municipal Code, Title 5, chapter 5. Furthermore, the
              Modesto City Planning Division agreed that the project with the number
              of parking spaces available on its premises can be self-contained. The
              facility did not need the parking lot adjacent to the project to operate.

Comments 5 The leasing of the parking lot was an unnecessary and unreasonable
           expense. The owner’s president should not have obligated the project for
           this expense. The owner could have used the $89,000 to pay the
           mortgage, which was in default. Instead, the owner chose to pay the
           owner’s president for an ineligible expense.




                                           21
Comments 6 A schedule of ineligible and unsupported costs was previously provided to
           the owner to assist the owner in identifying the specific questionable
           payments found in the audit.

Comments 7 The Project Owner’s/Management Agent Certification submitted to HUD
           states that Eskaton would receive a management fee equal to 5% of
           residential income collected. It further states that no special fee would be
           charged. The certification does not state that a minimum fee would be
           charged if the calculated management fee fell below a certain dollar
           amount.

Comments 8 While these expenses may be common practices for uninsured properties,
           the $1,771 in expenses were not reasonable and necessary under the terms
           of the regulatory agreement

Comment 9     The owner stated that $65,851 was paid to Andreini & Company for the
              project’s property and liability insurance. However, the owner could not
              provide any insurance policy purchased from Andreini & Company for
              our review. While supporting documentation given to the auditors
              included invoices, copies of canceled checks, and a promise-to-pay letter,
              none of the information indicates the project purchased property and
              liability insurance from Andreini & Company. Instead, the promise-to-
              pay letter shows the owner’s president agreed to repay Andreini &
              Company for funds advanced to pay workers compensation insurance.
              However, neither the owner nor Andreini & Company could provide the
              workers compensation insurance policy to support the $65,851 in
              disbursements.

Comment 10 The invoice provided by the owner supported only a portion on the
           payment. The remainder of the disbursement included $4,957 in manual
           adjustments and a $100 overpayment that the owner could not explain.

Comment 11 Imperial Premium Finance, Inc. is not an insurance provider. It provides
           insurance premium financing. Contrary to her statement, the owner could
           not provide any insurance policies related to payments made to Imperial
           Premium Finance, Inc. The owner also could not provide invoices for 10
           out of 19 payments. Of the invoices that were provided, none of them
           contained sufficient information to show what the project was being billed
           for.

Comment 12 The owner could not provide an insurance policy to support these
           disbursements. Instead, the owner provided a workers compensation
           insurance policy rate sheet that covered the period from July 27, 2004, to
           July 27, 2005, as proof of insurance coverage. While the rate sheet may
           be acceptable support for payments made during the covered period, it




                                          22
              cannot be used to support disbursements made in October 2002 and
              September 2003 totaling $14,264.

Comment 13 Documentation provided to support three payments totaling $7,291
           consisted of only copies of the face of canceled checks. Canceled checks
           by themselves are insufficient information to document the eligibility of
           these disbursements.

Comment 14 The Nurse Consultant’s contract specified that she would be compensated
           based on the number of hours worked. Since the number of hours the
           Nurse Consultant worked fluctuated from week to week, a timecard was
           used to track her work hours. A timecard was not available to support five
           out of seven payments made. No other evidence was available to show the
           $3,581 paid to the Nurse Consultant was appropriate.

Comment 15 The project did not have a contract with this consultant. Accordingly, it
           could not be determined what type of work the consultant performed, the
           number of hours worked, and the rate charged. Canceled checks by
           themselves are insufficient information to prove the disbursements were
           appropriate project expenses.

Comment 16 The project did not have a contract with Paradigm Senior Living to
           provide any type of service. Further, the owner could not provide any
           supporting documentations relating to eight of the nine payments made to
           the company. A copy of the face of a canceled check and an invoice were
           provided for one payment. The invoice requested payment for an
           individual’s time for five days and reimbursement for his travel and meal
           costs. Since there was no contract to establish a scope of work and
           compensation, it is unclear what services were provided, if any, and why
           travel and meal expenses were reimbursed.

Comment 17 In addition to its management fee, Eskaton charged the project for other
           items. Invoices provided by the owner lacked sufficient information to
           demonstrate these other charges, totaling $65,053, were eligible project
           expenses. These other charges included postage, general stores, workers
           compensation for an Administrator, an Administrator’s salary and FICA,
           and other unidentified expenses purportedly paid by Eskaton. None of
           these charges were supported by documentation evidencing that Eskaton
           incurred/paid for these expenses or that they were related to the project.

              The owner gave the auditors permission to remove records from the
              project. Per the owner’s instruction, project staff inspected and
              inventoried the documents before the auditors left the project premises.
              All documents were subsequently returned and signed for by the owner
              upon receipt.




                                          23
Comment 18 Information provided by the owner for these expenses was insufficient.
           The $9,732 consisted of 11 disbursements. Five of the disbursements
           were for vendor payments without supporting invoices and three were
           reimbursements to employees without supporting receipts. The owner
           could not offer a logical explanation supporting the eligibility of the other
           three payments. During the review, the owner claimed one of these three
           payments was a refund to the daughter of a resident who passed away.

              However, the check request merely stated it was a second request and
              made no reference to a refund. Also, there was no evidence that either of
              the two names that appeared on the canceled check was affiliated with a
              resident of the project. As such, the owner’s claim was unsupported. The
              owner claimed another payment was a stipend paid to an employee.
              However, the personnel file did not show the employee was entitled to a
              stipend. The only documentation provided to support this payment was a
              copy of the face of a canceled check. The third payment was made to
              another employee. The owner could not explain why the disbursement
              was made because supporting documentation, including the canceled
              check, could not be located.

Comment 19 Although these two checks and the related support were subpoenaed, they
           were not delivered to us as part of the owner’s December 9, 2005,
           response to our subpoena. The owner could not provide any information
           to show the payments were for reasonable project operating expenses.
           Therefore, these disbursements remained unsupported.

Comment 20 While the owner did email Paradigm Senior Living to request information
           related to the three disbursements (which was not provided), it is the
           owner’s responsibility to maintain the project’s books and records in a
           reasonable condition for proper audit. The owner is responsible to
           maintain all documentation related to the project’s operations and make it
           available for HUD’s inspection.

Comment 21 We reviewed the documents submitted by the owner. However, the
           documents submitted to us did not include the information needed to
           confirm reported revenue received from tenants was deposited in the
           project’s bank account. Although numerous requests were made to the
           owner asking for the missing information (e.g. copies of checks, daily
           receipt reports, deposit slips, and bank receipts), the owner could not
           provide any new information or documents confirming the deposit of such
           revenue in the project’s bank account.

Comment 22 On December 14, 2005, we emailed the owner a list of all outstanding
           resident balances, including those that were more than a year old. In the
           email, we asked the owner to confirm whether any of the outstanding
           accounts receivables were collected. The owner did not respond. On



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              December 20, 2005, we met with her in person and again asked for
              information on the $15,460 in accounts receivables that were reported as
              being uncollected for more than a year. The owner responded that she did
              not know why these account balances remained outstanding and why they
              were not collected.

Comment 23 The owner’s February 19, 2006, email only explained an error for the
           month of December 2004, where the accounting system recorded two
           billings for every resident. The owner explained that the first set of
           billings recorded only the basic rate, while the second set billed each
           resident for the basic rate plus any additional ancillary charges. We
           accepted the owner’s explanation for the double-billing error and took it
           into account in our reconciliations. The amount of the double-billing was
           removed from the initial outstanding receivables balance of $427,051 to
           arrive at the final outstanding receivables balance of $324,402 at the end
           of March 2005. The owner could not explain why the outstanding
           receivable balance of $324,402 remained on the project’s books or
           whether it was valid.

              The owner hired an accounting firm to perform bank reconciliations and
              reconcile the project’s accounting records. In the past, usually at the end
              of a quarter, the owner arranged for the accountant to carry out these
              accounting functions at the project’s corporate office in San Francisco.
              However, the accountant did not have the owner’s permission to perform
              any project work for 2005. Therefore, the project accounting records for
              2005 were not reconciled or kept up-to-date. When asked why the project
              accounting records were not properly maintained for 2005, the owner held
              the accountant liable for not taking care of her bookkeeping
              responsibilities. However, as set out in the regulatory agreement, it is the
              owner’s responsibility to make certain that the project’s books and
              accounts are kept current and up-to-date.




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Appendix C

                      FEDERAL REQUIREMENTS

Regulatory Agreement

Important provisions of Sundial Care Center, Inc.’s regulatory agreement include the
following:

   •   Paragraph 6(b) mandates that the owner may not, without the 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 from
       surplus cash, except for reasonable operating expenses and necessary repairs.

   •   Paragraph 6(e) prohibits the project owner from making or receiving and retaining
       any distribution of assets or any income of any kind of the project except surplus
       cash unless HUD has given prior written approval.

   •   Paragraph 6(f) forbids the owner from incurring any liability or obligation not in
       connection with the project without first obtaining written approval from HUD.

   •   Paragraph 9(b) states that payment for services, supplies, or materials shall not
       exceed the amount ordinarily paid for such services, supplies, or materials in the
       area where the services are rendered or the supplies or materials furnished.

   •   Paragraph 9(c) requires that the mortgaged property, equipment, buildings, plans,
       offices, apparatus, devices, books, contracts, records, documents, and other papers
       relating thereto shall at all times be maintained in reasonable condition for proper
       audit. The owner shall keep copies of all written contracts or other instruments
       which affect the mortgage property. All or any of these documents and records
       may be subject to inspection and examination by the secretary of HUD or his duly
       authorized agents.

   •   Paragraph 9(d) requires the books and accounts of the operations of the mortgage
       property and of the project to be kept in accordance with the requirements of the
       secretary of HUD.

   •   Paragraph 9(f) requires that at the request of the secretary of HUD, his agents,
       employees, or attorneys, the owner shall furnish monthly occupancy reports and
       shall give specific answers to questions upon which information is desired from
       time to time relative to income, assets, liabilities, contracts, operation, and
       condition of the property and the status of the insured mortgage.




                                           26
   •   Paragraph 9(g) stipulates that all rents and other receipts of the project shall be
       deposited in the name of the project in a bank and that such funds shall be
       withdrawn only in accordance with the provisions of the agreement for expenses
       of the project. Any owner receiving funds of the project shall immediately
       deposit such funds in the project’s bank account and, failing to do so in violation
       of the agreement, shall hold such funds in trust. At such time as the owner shall
       have lost control and/or possession of the project, all funds held in trust shall be
       delivered to the lender to the extent that the mortgage indebtedness has not been
       satisfied.

   •   Paragraph 12 stipulates that upon default, the owner is not permitted to collect and
       retain any rents due or collected thereafter.

   •   Paragraph 17 stipulates that the project owner, Sundial Care Center, Inc., remains
       liable under the agreement “a) for funds or property of the project coming into
       their hands which, by the provisions hereof, they are not entitled to retain; and b)
       for their own acts and deeds or acts and deeds of others which they have
       authorized in violation of the provisions hereof.”

Applicable Handbook Requirements

HUD Handbook 4350.1, REV-1, “Multifamily Asset Management and Project
Servicing,” paragraphs 8-11 and 8-12, authorize HUD to impose civil and criminal
penalties to enforce program requirements.

HUD Handbook 4370.1, REV-2, “Reviewing Annual and Monthly Financial
Reports,” paragraph 1-3, states that a monetary penalty may be imposed for any
violation of the regulatory agreement, including failure to maintain books and accounts of
the project according to requirements prescribed by the secretary of HUD.

In the same handbook, paragraph 2-21, Compliance with HUD Requirements, states that
owners’ advances made for reasonable and necessary operating expenses may be paid
from surplus cash at the end of the annual or semiannual period. Repayment is generally
not considered an owner distribution. Repayment of owner advances when the project is
in a non-surplus-cash position may subject the owner to criminal and civil money
penalties.

In the same handbook, paragraph 2-22, Potential Diversions of Project Assets, stipulates
that use of project assets (e.g., cash, security deposits, equipment, supplies, etc.) for other
than necessary and reasonable operation of the project or for payment of authorized
distributions to owners constitutes a violation of the regulatory agreement. Such
diversions of project assets can cause defaults in mortgage payments and may also be
violations of federal law.




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HUD Handbook 4370.2, REV-1, “Financial Operations and Accounting Procedures
for Insured Multifamily Projects,” paragraph 2-3, “Maintenance of Books and
Accounts,” states that books and accounts must be complete and accurate. The books of
original entry must be kept current at all times, and postings must be made at least
monthly to ledger accounts. Standard journal entries may be established for recurring
items and posted monthly.

In the same handbook, paragraph 2-6, Regular Operating Account, stipulates that project
funds should only be used to make mortgage payments, make required deposits to the
reserve for replacements account, pay reasonable expenses necessary for the operation
and maintenance of the project, pay distributions of surplus cash permitted, and repay
owner advances authorized by HUD.

In the same handbook, paragraph 2-11, Repayment of Owner Advances, states that
advances made for reasonable and necessary operating expenses may be paid from
surplus cash at the end of the annual or semiannual period. Such repayment is not
considered an owner distribution. It is considered a repayment of advances. Repayment
of owner advances when the project is in a non-surplus-cash position will subject the
owner to criminal and civil monetary penalties.

In the same handbook, paragraph 3-4, Preparation of Financial Reports, requires business
activities conducted with identity-of-interest entities to be disclosed in the audited
financial statements if payments for services performed for the project totaled $1,000
during the operating period.

In the same handbook, paragraph 4-4, Manual of Accounts, distinguishes mortgagor/
corporate expenses from expenses necessary and reasonable for the operation of the
project. The handbook states that owners may only charge these expenses against the
project’s operations with the prior written approval of HUD.

Equity Skimming and Civil Remedies Statutes

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

Title 12, United States Code, section 1715z-19, Equity Skimming Penalty, authorizes a
fine of not more than $500,000 and/or imprisonment of not more than five years for any
owner, agent, or manager who willfully uses or authorizes the use of any part of the rents,
assets, proceeds, income, or other funds derived from the property for any purpose other
than to meet reasonable and necessary expenses in a period during which the mortgage
note is in default or the project is in a non-surplus-cash position as defined by the
regulatory agreement.




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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 of a property with five or more living units
and a HUD-insured mortgage. A penalty may be imposed on that mortgagor, on a general
partner of a partnership mortgagor, or on any officer or director of a corporate mortgagor for
any knowing and material violation of the regulatory agreement, such as paying out any
funds for expenses that were not reasonable and necessary project operating expenses,
failing to maintain the books and accounts of the operations of project, failing to make
promptly all payments due under the note when there is adequate project income available
to make such payments, or making distributions to owners while the project is in a non-
surplus-cash position.




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