oversight

The Owner of Century Mission Oaks, San Antonio, Texas, Violated Its Regulatory Agreement with HUD

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-03-21.

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

                                                                Issue Date
                                                                             March 21, 2008
                                                                Audit Report Number
                                                                             2008-FW-1008




TO:         Gretchen Marchand
            Director, Multifamily Housing Division, 6JHMLAX

            William J. Daley, Regional Counsel, 6AC

            Henry S. Czauski, Acting Director of Departmental Enforcement Center, CV


FROM:       Gerald R. Kirkland
            Regional Inspector General for Audit, Fort Worth Region, 6AGA

SUBJECT: The Owner of Century Mission Oaks, San Antonio, Texas, Violated Its
         Regulatory Agreement with HUD

                                  HIGHLIGHTS

 What We Audited and Why

             As part of the Office of Inspector General’s (OIG) annual audit plan, we audited
             Century Mission Oaks (project). Our objectives were to determine whether the
             project’s owner-manager, Century Mission Oaks GEAC, LLC (owner), complied
             with the regulatory agreement with the U. S. Department of Housing and Urban
             Development (HUD) during fiscal years 2005 and 2006. Specifically, we wanted
             to determine whether the owner (1) adequately supported and documented that
             project expenditures were reasonable and necessary, (2) obtained HUD approval
             for any distributed funds, and (3) maintained the books and records to properly
             account for revenues and expenses.

 What We Found


             The owner did not support and document that project expenditures were
             reasonable and necessary because it ignored HUD requirements, lacked the
             expertise and knowledge to operate a HUD-insured project, and displayed poor
             cash management skills. As a result, the owner could not support more than $2.9
           million in expenses, incurred $65,524 in ineligible expenses, and improperly
           transferred $197,000 in project funds to an affiliate. As a result, fewer project
           funds were available for mortgage payments, and the risk to the Federal Housing
           Administration insurance fund was unnecessarily increased.

           Further, the owner did not ensure that the project’s books and records were
           properly maintained. Financial records were missing; general ledger entries were
           incomplete, misclassified, and/or unsupported with revenues and payroll expenses
           overstated; and there were conflicting records. As a result, HUD and other
           stakeholders could not accurately assess the financial condition of the project.

What We Recommend


           We recommend that the Director, San Antonio Multifamily Program Center,
           require the owner to (1) provide support for or make necessary adjustments to its
           financial records to remove $2.7 million in unsupported expenses and expense
           accruals recorded in its books, (2) provide support for or reimburse $272,753 in
           unsupported costs, (3) deposit $262,524 for the ineligible disbursements and
           unauthorized transfers, into the project’s reserve for replacement account (4)
           correct and accurately maintain its accounting records, and (5) implement
           procedures and controls to ensure that future disbursements for project expenses
           comply with requirements. We also recommend that HUD’s Regional Counsel in
           coordination with the Director of the San Antonio Multifamily Program Center
           and the OIG pursue double damages remedies against the responsible parties for
           the ineligible disbursements and unauthorized transfers. Further, the Acting
           Director of HUD’s Departmental Enforcement Center should pursue civil money
           penalties and administrative sanctions, as appropriate, against the owner for its
           part in the regulatory violations cited in this report.

           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 draft report to the owner on January 31, 2008, and held an exit
           conference with project officials on February 15, 2008. We requested a written
           response by February 19, 2008, and extended the due date to February 25, 2008.
           The owner generally disagreed with the findings. The owner’s response included
           almost 700 pages of documents and data; thus, we only included the summary of
           the comments and our evaluation in Appendix B. The additional information is
           available upon request.




                                            2
                          TABLE OF CONTENTS

Background and Objectives                                                        4

Results of Audit
      Finding 1: The Owner Incurred More Than $3 Million in Questionable Expenses 5
      Finding 2: The Owner Improperly Transferred $197,000 in Project Funds       10
                 without HUD Approval
      Finding 3: The Financial Condition of the Project Could Not Be Reasonably   12
                 Assessed

Scope and Methodology                                                            15

Internal Controls                                                                17

Appendixes
   A. Schedule of Questioned Costs                                               18
   B. Auditee Comments and OIG’s Evaluation                                      19




                                          3
                     BACKGROUND AND OBJECTIVES

Century Mission Oaks (project) is a 150-bed skilled nursing facility specializing in the treatment
of geri-psychiatry care, located at 3030 South Roosevelt in San Antonio, Texas. The project’s
mortgage is insured by the Federal Housing Administration (FHA) under Section 223(f) of the
National Housing Act. Governmental and Education Assistance Corporation (GEAC) created
Century Mission Oaks GEAC, LLC, which is the project owner.

Early in 2004, the U.S. Department of Housing and Urban Development’s (HUD) Departmental
Enforcement Center reviewed five HUD-insured projects (including Century Mission Oaks)
affiliated with GEAC. It found that for fiscal years 2001 through 2003, GEAC violated the terms
of the regulatory agreements for all five HUD-insured projects by (1) transferring funds between
projects without prior written authorization, (2) disbursing residual receipts which were based on
an erroneous computation of surplus cash, and (3) paying excessive management agent fees and
unauthorized consultant fees. As a result of the review, the management agent was terminated,
effective December 31, 2004. Since then, GEAC has not been able to contract with a suitable
management agent. The project became owner operated on April 1, 2005. Two off-site
employee-managers ran the day-to-day operations. The owner contracted with a firm to provide
bookkeeping services.

Our objective was to determine whether the owner complied with its regulatory agreement with
HUD during fiscal years 2005 and 2006, July 1, 2004, through June 30, 2006. Specifically, we
wanted to determine whether the project’s owner (1) adequately supported and documented that
project expenditures were reasonable and necessary, (2) obtained HUD approval for any
distributed funds, and (3) maintained the books and records to properly account for revenues and
expenses.




                                                4
                                       RESULTS OF AUDIT

Finding 1: The Owner Incurred More Than $3 Million in Questionable
           Expenses
During the project’s fiscal years 2005 and 2006, the owner incurred more than $3 million in
ineligible and unsupported expenses because it ignored HUD requirements, lacked the expertise
and knowledge to operate a HUD-insured project, and displayed poor cash management skills.
As a result, fewer project funds were available for mortgage payments, and the risk to the FHA
insurance fund was unnecessarily increased.



    Ineligible Expenses Totaled
    $65,524

                  The owner incurred ineligible expenses totaling $65,524. 1 These expenses
                  included payments for consulting contracts that were not approved by HUD, late
                  fees, parties for project employees, excessive payroll processing fees, and
                  overpayments to a software contractor.

                  The on-site project administrator and the owner entered into and paid $36,581 for
                  two consulting contracts without HUD’s approval. Further, they did not solicit
                  bids as required 2 for one of the contracts, the cost of which was greater than
                  $10,000.

                  The purpose of the two contracts was to increase reimbursements from Medicare
                  and the state of Texas. HUD believes that an owner-managed project, such as this
                  one, should have the capacity to provide these services. Further, the regulatory
                  agreement prohibits entering into any contract for such services without HUD
                  approval. In addition, the owner could not provide a copy of one of the contracts.
                  Finally, the Departmental Enforcement Center reminded GEAC in 2004 that
                  HUD approval was required before entering into consulting contracts and required
                  it to reimburse the project for those consulting fees incurred without HUD’s
                  approval. Since the owner ignored HUD’s requirement and did not get approval
                  or properly procure the services, the payments of $36,581 were ineligible
                  expenses.

                  The owner paid late fees of $10,392 for overdue mortgage payments because it
                  made most of the fiscal year 2006 (July 1, 2005, to June 30, 2006) mortgage
                  payments about 60 days late. The owner claimed that the late fees for mortgage
                  and utility expenses are reasonable and necessary expenses given that reduced
                  Medicaid reimbursements created cash flow problems. However, from June 21,
1
       Paragraph 9(c) of the regulatory agreement requires that expenses be reasonably necessary for the operation
       of the project and not exceed the amount ordinarily paid for such expenses.
2
       HUD Handbook 4381.5, REV-2, paragraph 6.50(a).
                                                         5
            2005, to November 30, 2005, the owner inappropriately transferred a total of
            $197,000 to an affiliate (Finding 2). Thus, the funds were not available to make
            the mortgage payments in a timely manner. For example, the owner
            inappropriately transferred $42,000 to the affiliate between June 21 and June 29,
            2005. This $42,000 could have been used to substantially pay the July 1, 2005,
            mortgage payment of $52,621. However, the payment was not made until
            August 31, 2005.

            The utility companies assessed another $1,501 in late fees, and the owner
            admitted to having received cutoff notices. The owner blamed the late water and
            electricity payments on cash flow problems. If the owner had not made the
            inappropriate transfers, the funds would have been available to make the
            mortgage and utility payments in a timelier manner. Since the funds were not
            available because of the owner’s actions, the late fees were not ordinary and
            reasonable expenses, as claimed by the owner, and the payments were ineligible.

            The owner also paid $13,651 for employee parties and $2,376 in excessive payroll
            fees because it did not exercise good cash management procedures. The payroll
            servicer charged the same base fees each time it processed checks regardless of
            whether there was one check or many checks. The owner allowed the payroll
            servicer to process the two managers’ checks separately from those of other
            project employees. In addition, when the owner took over management of the
            project, the servicer processed one or two employees’ pay separately from the rest
            of the project’s employees for several pay periods. Paying for employee parties
            and extra processing fees to process payroll checks separately are not reasonable
            and necessary expenses.

            Further, the software company that the project used for tracking Medicare and
            Medicaid revenue overbilled the owner by $1,023. The owner paid the ineligible
            excess cost because it did not realize that it was overbilled.

            The table below summarizes the ineligible expenses.

                                           Ineligible expenses
                              Description of expense           Ineligible amount
                      Unapproved consulting contract fees                  36,581
                      Late fees                                            11,893
                      Employee parties                                     13,651
                      Excessive payroll processing fees                     2,376
                      Overpayments to software contractor                   1,023
                      Total ineligible expenses                           $65,524

Unsupported Expenses Totaled
More Than $3 Million

            The owner could not properly support expenses totaling more than $3 million.
            These expenses included paid expenses and expense accruals for payroll, legal
                                           6
               fees, a contract for duplicative management services, the manager’s payroll, other
               general expenses, and audit fees.

               Payroll disbursements were overstated due to $2.4 million in expense accruals.
               The payroll disbursements recorded in the general ledger were $2.4 million
               greater than the payroll disbursements identified by the project’s payroll bank
               account. The excess payroll disbursements were unsupported. 3

               Legal expenses totaling $351,013 were unsupported. Of this amount, $296,352
               were accrued expenses. The owner did not provide evidence that the legal
               services were received. The remaining $54,661 appears to have been paid. The
               owner provided support for $776 of this amount, but its allocation plan was not
               reasonable, and the actual allocations did not follow the allocation plan. The
               regulatory agreement prohibits the owner from making payments for any services
               unless such services were actually rendered and are reasonably necessary for the
               project’s operation. Further, the Departmental Enforcement Center cited GEAC
               during 2004 for unsupported legal fees and reminded it that such fees require
               support. Since the owner did not show that the services were actually rendered
               and necessary, the $351,013 in legal expenses was unsupported.

               The owner paid a contractor $137,149 to provide project management functions at
               the same time that it was owner managed and should have had the capacity to
               provide any required management services. In addition, the owner did not solicit
               bids as required by HUD; thus, it could not assure HUD that the project paid the
               best price for the service. Therefore, the payments to the contractor were
               unsupported.

               The owner paid salaries totaling $54,864 for two employees to manage the project
               and make decisions on its behalf. However, the owner did not show support for
               their employment with job descriptions, employment contracts, performance
               appraisals, timesheets, or any other method for determining how much time they
               worked for the project. Thus, the $54,864 was unsupported.

               In addition, the owner incurred $25,008 in miscellaneous expenses that it could
               not support. These miscellaneous expenses included $5,618 in payments through
               six checks, professional fees accounts of $8,391, minor equipment lease accounts
               of $4,301, trade accounts payable of $2,563, a miscellaneous expense of $4,062,
               and a waste service payment of $73.

               Other unsupported costs included $3,537 more in accrued audit fees than the
               amount invoiced during the review period and payments totaling $1,071 to the on-
               site project administrator and the maintenance supervisor.




3
    The overstated expenses are further explained in finding 3 of this report.
                                                        7
             The table below summarizes the unsupported expenses:

                                         Unsupported expenses
                                               Unsupported Unsupported                   Total
                   Description of expense       expenses      expenses
                                                   paid       accrued
              Excessive payroll expenses                       $2,451,323              $2,451,323
              Legal expenses                        $ 54,661      296,352                 351,013
              Payments for management               137,149                               137,149
              services
              Salary payments                         54,864                               54,864
              Unsupported general expenses            25,008                               25,008
              Unsupported audit fees                                3,537                   3,537
              Project employee payments                1,071                                1,071
                Total unsupported expenses         $272,753    $2,751,212              $3,023,965

Conclusion


             The owner incurred the ineligible costs of $65,524 and unsupported costs of more
             than $3 million when it ignored HUD requirements, lacked the expertise and
             knowledge to operate a HUD-insured project, and displayed poor cash
             management skills. Specifically, the owner (1) ignored requirements that HUD
             approve consulting contracts; (2) entered into management contracts for services
             that should have been performed by the owner and did not solicit bids to ensure
             that it received the services at a competitive price; (3) did not keep sufficient
             records to support legal costs, payments, and payroll; and (4) did not pay bills in a
             timely manner, thus incurring unnecessary late fees.




                                               8
Recommendations


          We recommend HUD’s Director, San Antonio Multifamily Program Center,
          require the owner to

          1A. Deposit $65,524 for the ineligible/inappropriate disbursements cited in this
              report, into the project’s reserve for replacement or a restricted capital account
              that requires HUD approval for the releases of the funds.

          1B. Provide documentation to support the $272,753 in unsupported disbursements
              cited in this report or reimburse the project’s reserve for replacement or
              restricted capital account that requires HUD approval for the release of the
              funds for the applicable portion.

          1C. Provide documentation to support the $2,751,212 in unsupported expenses
              recorded in the general ledger or make adjusting entries to the financial records
              to reflect the true financial position of the project.

          1D. Implement procedures and controls to ensure that future disbursements for
              project expenses comply with the regulatory agreement and HUD’s
              requirements.

          We also recommend HUD’s Regional Counsel, in coordination with HUD’s
          Director, San Antonio Multifamily Program Center, and HUD’s Office of
          Inspector General,

          1E.     Pursue double damages remedies against the responsible parties for the
                  ineligible/inappropriate disbursements that were used in violation of the
                  project’s regulatory agreement.

          We also recommend that HUD’s Director of the Departmental Enforcement
          Center,

          1F.     Pursue civil money penalties and administrative sanctions, as appropriate,
                  against the owner, operator, and/or their principals/owners for their part in
                  the regulatory violations cited in this report.




                                            9
Finding 2: The Owner Improperly Transferred $197,000 in Project
           Funds without HUD Approval
                 The owner inappropriately transferred $197,000 in project funds to an affiliate
                 when it ignored HUD prohibitions against such transfers. As a result, fewer
                 project funds were available for mortgage payments, and the risk to the FHA
                 insurance fund was unnecessarily increased.




    The Owner Ignored HUD
    Instructions and the Regulatory
    Agreement

                 The owner transferred $197,000 to Ebony Lake, another HUD-insured project, in
                 violation of previous HUD instructions and the regulatory agreement. 4 The
                 Departmental Enforcement Center identified other unauthorized transfers in 2004
                 and notified GEAC that it had to repay the projects and obtain HUD approval
                 before making fund transfers between projects. The owner ignored the
                 instructions and continued to transfer funds between projects to meet operational
                 needs.

                 The owner made the transfers without notifying its contracted bookkeeping firm.
                 Representatives of the bookkeeping firm discovered the transfers in August 2006
                 when they could not balance the accounts. The owner may have then attempted
                 to conceal the transfers when it instructed them to record the transfers in accounts
                 payable rather than an interfund transfer account.

                 By making the unauthorized transfers, the owner reduced the amount of the
                 project’s operating funds available and increased the risk that the project would
                 not have sufficient funds to pay its mortgage premiums, thus placing the FHA
                 insurance fund at increased risk.




4
      Paragraph 4(b) of the regulatory agreement states that without prior HUD approval, the owner shall not
      assign, transfer, dispose of, or encumber any personal property of the project, including rents, and shall not
      disburse or pay out any funds except for usual operating expenses and necessary repairs.
                                                         10
Recommendations



          We recommend that the Director, San Antonio Multifamily Program Center,

          2A.     Require the owner to reimburse the project $197,000 from nonfederal
                  funds.

          We also recommend HUD’s Regional Counsel, in coordination with HUD’s
          Director, San Antonio Multifamily Program Center, and HUD’s Office of
          Inspector General,

          2B.     Pursue double damages remedies against the responsible parties for the
                  unauthorized transfers under Title 12 U.S.C., section 1715z-4a, for
                  knowingly disregarding the regulatory agreement and previous HUD
                  instructions.




                                          11
Finding 3: The Financial Condition of the Project Could Not Be
           Reasonably Assessed
The owner did not maintain complete and accurate books and records as required by the
regulatory agreement and other HUD requirements. 5 This condition occurred because the owner
lacked the expertise to properly account for operations of a HUD-insured project. As a result,
the project’s financial data were unreliable, its accounting records did not support its financial
statements, and HUD could not reasonably assess the financial condition of the project.



    The General Ledger Account
    Balances Conflicted with Other
    Financial Records


                  The project’s general ledger balances were unverifiable for fiscal years 2005 and
                  2006 because they conflicted with financial statement balances. The general
                  ledger and cash disbursements journal also showed overstated revenue and payroll
                  disbursements when compared to third-party sources, such as bank statements and
                  Medicare and Medicaid funding documents.

                  Conflicting Balances
                  General ledger accounts and financial statement account balances for assets,
                  liabilities, and expenses did not agree. For example, the general ledger accounts
                  receivable for patient care for fiscal year 2006 reported a $267,685 balance, while
                  the financial statement reported a $657,099 balance for the same account. The
                  $389,414 difference was unsupported. Also, in fiscal year 2006, the general
                  ledger cash account reported a $67,171 balance, while the financial statement
                  reported a $49,609 deficit 6 for the same account. The $116,780 difference was
                  unsupported. There were other smaller unsupported differences between the
                  general ledger and the financial statements.

                  Overstated Revenue and Payroll Disbursements
                  Our review of the project’s bank statements and other third-party documents
                  found that revenues and payroll disbursements were overstated on the general
                  ledger accounts and cash disbursements journal. The general ledger reported
                  more than $1.1 million more in Medicare and Medicaid revenue for fiscal years
                  2005 and 2006 than funding reported by Medicare and Medicaid providers. The
                  excess revenue did not reconcile to deposits in the bank accounts. The
                  independent auditors did not discover the excess revenue in their annual audits
                  because they did not trace cash receipts reported in the general ledger and annual
                  financial statements back to supporting documentation. Instead, they used
                  analytics to determine the veracity of reported receipts. In addition, the project’s
                  payroll cash account recorded salary and benefit payments totaling more than $6.7

5
       HUD Handbook 4370.2, chapter 2, paragraph 2-3(B)
6
       Since the balance was a deficit, it was reported in the financial statements as a bank overdraft.
                                                          12
                 million, while the payroll bank account records showed a little more than $4.3
                 million. The bookkeeper did not provide any support to completely reconcile the
                 difference.

    The Owner Ignored Adjusting
    Entries and Misclassified
    Expenses

                 The owner ignored reclassification adjusting entries made by the independent
                 auditors to prepare 2005 and 2006 financial statements. The project’s fiscal year
                 2006 accounting records resumed with fiscal year 2005 balances as though the
                 reclassification entries had not occurred. As a result, the general ledgers for both
                 years did not support the audited financial statements. The independent auditors
                 did not respond to inquiries regarding the reclassifications.

                 Further, the owner misclassified at least 28 accounts on the annual financial
                 statements. For example, security expenses were classified under the category for
                 exterminating supplies, vehicle expenses were classified under the category for
                 miscellaneous administrative expenses, and telephone expenses were classified
                 under the category for office supplies. HUD provided specific accounts for all of
                 these expenses in its chart of accounts. 7

    The Accounting System
    Contained Conflicting Data

                 The project’s accounting system contained conflicting data and could not generate
                 a complete and accurate check register. For example, the system generated two
                 check listings for the same period. The total dollar value of the checks was the
                 same, but the check numbers, check amounts, and check payees were different.
                 The owner could not explain the discrepancy.

    The Owner Could Not Provide
    Records in a Timely Manner

                 During our review, we continuously had difficulty obtaining records despite
                 repeated requests over a six-month period and issuing a subpoena in August 2007
                 to obtain complete records for our review period. For example, the owner did not
                 provide financial records for the period July 1 through December 31, 2004, until
                 after we completed our fieldwork in November 2007. Further, the only record
                 provided for the period was the general ledger. While the general ledger might
                 account for some of the unsupported costs, without the supporting documents, we



7
       HUD Handbook 4370.2, Financial Operations and Accounting Procedures for Insured Multifamily Projects,
       chapter 4.
                                                     13
             could not assure ourselves of its accuracy; thus, we did not review it. We will
             provide these records to HUD.

             Delays in obtaining information also occurred because in violation of
             requirements, the owner required the contracted bookkeeper to submit documents
             to it for review before they were provided to us.


Conclusion


             The conflicting account balances, overstated revenues and payroll disbursements,
             unrecorded adjusting entries, misclassified expenses, and inadequate accounting
             system are all indications that the owner lacked the capacity to account for a
             HUD-insured project. Further, they prevented HUD and other stakeholders from
             assessing the project’s true financial condition. Although the owner contracted
             with a bookkeeping firm, the owner was responsible for ensuring that the books
             and records were maintained in accordance with requirements.

Recommendations

             We recommend that the Director, San Antonio Multifamily Program Center,
             require the owner to

             3A. Correct and maintain accounting records in accordance with requirements.




                                             14
                        SCOPE AND METHODOLOGY

Our objective was to determine whether the owner complied with the regulatory agreement with
the U.S. Department of Housing and Urban Development (HUD) during fiscal years 2005 and
2006. To accomplish our objective, we

   •   Interviewed HUD management and staff.
   •   Interviewed the owner’s employee-managers.
   •   Reviewed applicable regulations, handbooks, and the regulatory agreement.
   •   Reviewed previous Departmental Enforcement Center evaluations of the project.
   •   Reviewed the independent auditor’s reports for the years ending June 30, 2005 and 2006.
   •   Reviewed the San Antonio, Texas, Office of Multifamily Housing files for the project,
       including monthly accounting reports.

We also

   •   Selected a sample of 60 cancelled checks for review, using ACL statistical software, a 95
       percent confidence level with a plus or minus 5 percent precision, and an expected error
       rate of 0 percent, to determine whether the disbursements were properly approved,
       supported, and recorded. However, since we did not have a complete universe for the
       review period and we concluded that the financial data were unreliable, we did not
       project our results to the universe of disbursements.
   •   Reviewed the general ledger accounts with significant changes (between the two years in
       our scope); identified transactions (in those accounts) over $1,000 that were not self-
       explanatory in the description, payments to employees, and payments to contracted firms
       that did not appear ordinary; and reviewed the supporting documentation provided by the
       project.
   •   Used computer-assisted auditing techniques and compared the trial balances in the
       general ledger to the balances reported in the annual financial statements, compared the
       Medicare and Medicaid revenue reported in the annual financial statements to the
       amounts reported by the Center for Medicare and Medicaid Services and the Department
       of Aging and Disability Services, compared the check registers provided to the cash
       disbursements journals, and determined that the computer-processed data were
       significantly unreliable.
   •   Used the project bank statements to identify and trace all fund transfers.
   •   Compared the bank statements from the payroll account to the payroll cash disbursements
       journal.

We conducted the audit between June 8 and November 30, 2007, at the HUD San Antonio field
office. The owner’s representatives provided the records and documentation via mail, e-mail,
and fax. Our audit covered the period July 1, 2004, through June 30, 2006. However, the audit
was under a scope limitation because the project’s owner did not provide any financial records
for the period July 1 through December 31, 2004, until we had completed our field work. To
complete our review in a timely manner, we did not review these records. We will provide these
records to HUD. In addition, the owner restricted our access to project employees and
documents. Finally, the owner, its bookkeeper, and its auditors did not respond to many of our
                                              15
requests for information throughout the audit. They responded only after they received the draft
report and after we held an exit conference to obtain their input.

We extended the deadline for the owner’s written response at its request. Along with its
response, the owner submitted 699 pages of documents. We reviewed all of the documents and
made appropriate changes to the audit report. The owner submitted several more documents
after the deadline that we were unable to fully analyze. We will forward them to HUD for
further review and resolution.

We performed our review in accordance with generally accepted government auditing standards.




                                               16
                             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, and
   •   Compliance with applicable laws and regulations.

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:

              •       Controls over compliance with laws and regulations;
              •       Controls over cash management, including accounts payable and accounts
                      receivable; and
              •       Controls over financial reporting.

              We assessed 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.

 Significant Weaknesses


              Based on our review, we believe the following items are significant weaknesses:

              •       Controls to prevent the owner from overriding HUD regulations did not
                      exist.
              •       Controls to ensure that books and records were maintained in accordance
                      with requirements did not exist.
              •       Controls over cash management were poor.




                                               17
                                   APPENDIXES

Appendix A

                SCHEDULE OF QUESTIONED COSTS

        Recommendation              Ineligible 1/              Unsupported 2/
            number
               1A                    $ 65,524
               1B                                                 $272,753
               1C                                                $2,751,212
               2A                      197,000                   ________

              Totals                 $262,524                    $3,023,965




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.

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.




                                             18
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




Comment 2




                         19
20
Comment 3




            21
Comment 4




Comment 5




            22
Comment 6




            23
Comment 7




            24
Comment 5




Comment 8

Comment 9




Comment 10




Comment 11




Comment 12


Comment 13




             25
Comment 14




Comment 15

Comment 16


Comment 17


Comment 18




             26
Comment 19




Comment 20

Comment 10




             27
28
                             OIG Evaluation of Auditee Comments

Comment 1 The owner stated that the language in the draft report is sharp and pejorative, and
reads as if Mission Oaks "looted" the project for a $3.8 million monetary gain, and requested that
the OIG modify the language of the final report. The OIG disagrees with the owner's assertion.
The report identified ineligible and unsupported expenditures, and discrepancies between the
owner's accounting records and reports. The regulatory agreement requires project funds be used
for reasonable and necessary expenses, and that the books and records be maintained in
reasonable condition for proper audit. The report findings are directly related to these regulatory
requirements. However, we revised some of the language in the report.

Comment 2 The owner stated that there were significant communication problems underlying
the OIG conclusions. As stated in the report, the owner, its bookkeeper, and its auditors did not
respond to many of our requests for information throughout the audit. In addition, the owner
restricted our access to project employees, and documents.

Comment 3 The owner's comment does not address the findings in the report because the
findings are related to unsupported payroll disbursements recorded in the general ledger and
excessive payroll processing fees.

Comment 4 HUD's knowledge of the management arrangement does not excuse the owner
from complying with the regulatory agreement. There is no evidence that HUD waived any of
the regulatory agreement requirements regarding reasonable and necessary expenditures.

Comment 5 The owner claimed that the late fees for mortgage and utility expenses are
reasonable and necessary expenses given that reduced Medicaid reimbursements created cash
flow problems. The OIG maintains its position that the expenses are ineligible. Paragraph 1 of
the regulatory agreement requires the owner to promptly make all mortgage payments due. The
owner paid late fees of $10,392 for overdue mortgage payments because it made most of the
fiscal year 2006 mortgage payments about 60 days late. During about this same time period, the
owner inappropriately transferred $197,000 to an affiliate. If the owner had not made the
inappropriate transfers, the funds would have been available to make the mortgage and utility
payments in a timelier manner and improve cash flow. Since the funds were not available
because of the owner’s actions, the late fees were not ordinary and reasonable expenses and the
payments were ineligible. We revised the finding to clarify that the late fees were incurred
because the owner made inappropriate transfers to an affiliate.

Comment 6 The owner stated that it does not understand the OIG's recommendations to
reimburse accrued amounts. In the recommendations, the OIG did not intend for the owner to
reimburse the project for accrued amounts. We clarified the language in the report.

Comment 7 While the owner agreed with the finding that it did not obtain HUD approval prior
to entering into the consulting contracts, it believes that one of those contracts resulted in a net
increase to revenue, and the other contract cost was minimal. The regulatory agreement
prohibits entering into any contract for such services without HUD approval. The Departmental
Enforcement Center reminded GEAC in 2004 that HUD approval is required before entering into

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consulting contracts. Since the owner did not obtain HUD approval or properly procure the
services, the payments of $36,581 were ineligible expenses.

Comment 8 The owner claimed that the employee parties were actually for resident activities
and to pay a $44,210 payable that it could not immediately pay to a food vendor. However, the
owner was not able to explain why the expenses were posted to the account for "food purchases -
employee health and welfare", or the nature of the resident activities. In addition, we noted on
one of the receipts that at least $22 was paid for dog supplies, including a collar, leash, food, and
treats. Further, the contracted bookkeeper told us that the account is used for food purchased for
facility employees for recognition and employee parties. There is another account in the chart of
accounts that is specifically used to record expenses for food purchased for resident activities.
The OIG maintains its position that the expenses were for employee parties.

Comment 9 The owner claimed that the additional processing fees occurred because the
project had to pay employees whose time was not reported to the payroll processor on time or
due to special circumstances. Each time one or two employee payrolls were processed separate
from the rest of the project employees, the payroll processor charged the project all of the base
processing fees again (in addition to the per employee fees). Understandably, there will be
circumstances that may warrant special processing of payroll checks; however, Mission Oaks did
not change payroll processors during the audit and no additional processing fees occurred until
the project became owner-managed. Thus, it seems that either Mission Oaks did not require
special payroll processing, or it was not assessed additional fees for processing these payrolls.
The OIG maintains its position that the additional processing fees were excessive and ineligible.

Comment 10 The owner disagreed that payroll expenses recorded in the general ledger were
$2.4 million greater than recorded in the payroll bank account. After the exit conference, the
owner provided additional documentation and claimed that all but $71,895 of the $2.4 million
was attributable to accrual, reversing, and adjusting entries in the payroll general ledger. The
additional documentation contains numerous adjustments including amounts that may be
unrelated to payroll expenditures and needs further review and analysis. The owner’s failure to
provide the documents in a timely manner, despite several requests, led to our determination that
the $2.4 million was unsupported. We will provide the documentation to HUD for review. Until
HUD has completed its review, the OIG maintains its position that the $2.4 million is
unsupported.

Comment 11 After the exit conference, the owner provided support for $730,260 in accrued
accounts payable; thus, we removed this issue from the report.

Comment 12 The owner disagreed that there were unsupported legal expenses totaling
$450,610. The owner provided a copy of an ongoing lawsuit regarding medical negligence to
the OIG on December 13, 2007, after our field work was complete. This ongoing litigation was
not disclosed in the notes to the financial statements, which is a violation of the Accounting
Standards Board Financial Reporting Standard 12. Further, the owner told us on November 19,
2007, that there were no pending legal claims during our review period.

The owner accrued $18,750 per month for legal expenses and reported it under its account for
insurance incident claims. The accrual basis described in the owner's response does not provide
a reasonable basis for the accrued amount because it did not provide any actuarial or insurance
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information that was used to determine the amounts. The OIG maintains its position that the
owner should provide further support for its accrued amount of $126,178, or reverse the accrual.

Based on our review of additional support provided by the owner, we changed the total
unsupported legal expenses to $351,013. Of this amount, $296,352 was accrued expenses, and
$54,661 was actually paid.

The owner stated in its response that it will remove the double booked expenses and over
accrued expenses. In addition, the owner admitted to miscoding some of the expenses. The
owner also claimed that $53,180 of legal expenses is the result of a loading balance as of
December 31, 2004, provided by the previous management agent. The owner did not provide
any supporting documentation showing that the expenses were removed, reversed, reclassified or
justified. The owner should provide support to HUD. The OIG maintains its position that these
expenses are unsupported.

Comment 13 The owner disagreed that the $128,149 paid for a management contract was
inappropriate because HUD’s lack of response to its disclosure implied approval for the contract.
The OIG maintains its position that the contract is unsupported because the owner did not solicit
bids prior to entering into the contract. Therefore, the owner cannot assure HUD that it obtained
the services at the best possible price. Also, the documentation provided with the owner’s
response for other questioned costs revealed an additional $9,000 paid to the contractor. We
adjusted the report accordingly.

Comment 14 Regardless of HUD's knowledge of the employment arrangement, the OIG
maintains its position that the salary is not supported. There were no job descriptions,
employment contracts, performance appraisals, timesheets, or any other method for determining
how much time the employees worked for the project.

Comment 15 The owner disagreed that miscellaneous expenses of $43,008 are unsupported,
and provided additional documentation. We reviewed the documentation, and reduced the
questioned amount by $18,000.

Comment 16 The owner disagreed that the audit fees were over accrued. However, there was
no logical basis for the accrual. Further, the contracted bookkeeper agreed with our conclusions
on February 20, 2008, and stated that an adjustment to the over accrual should be made to the
financial records.

Comment 17 The owner did not provide any documentation supporting that the $1,071 paid to
the on-site project administrator and maintenance supervisor is reasonable and necessary.

Comment 18 The owner admitted that $197,000 in unauthorized transfers were made and
claimed that they were the result of reimbursement to another HUD insured project for
unauthorized loans made during our review period. The owner also stated that the transfers were
done in order to maintain operations at the project. The OIG reviewed the documentation
provided, and maintains its position that the owner improperly transferred $197,000 in project
funds without HUD approval. It is irrelevant whether the funds were transferred to pay a loan to
another project.

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Comment 19 Contrary to the owner’s statement the OIG and the contracted bookkeeper did not
resolve the issues regarding the conflicting balances between the general ledger accounts and the
financial statement balances. Neither the owner nor the contracted bookkeeper provided any
documentation that resolved the issue. Thus, we maintain our position that the general ledger
accounts and financial statement balances did not agree.

Comment 20 The owner disagreed that the Mission Oaks revenues are overstated. The owner
provided numerous documents reconciling the accounting records to the general ledger. On
February 29, 2008, after the exit conference, the owner provided additional documentation,
including numerous schedules with detailed calculations. Again, due to repeated delays by the
owner in providing documentation, we were unable to review the information without further
delaying the audit. We will provide the documentation to HUD. Pending review and analysis by
HUD, we maintain our position that the $1.1 million in Medicare and Medicaid revenues was
excessive.




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