oversight

The Middlesex Health Care Center, Middletown, CT, Was Not Always Operated According to Its Regulatory Agreement and HUD Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-06-29.

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

          Middlesex Health Care Center,
                Middletown, CT
                            Section 232 Program




Office of Audit, Region 1              Audit Report Number: 2018-BO-1004
Boston, MA                                                   June 29, 2018
To:            Timothy Gruenes
               Director, Asset Management and Lender Relations, HP
               //signed//
From:          Ann Marie Henry
               Regional Inspector General for Audit, Boston Region, 1AGA
Subject:       The Middlesex Health Care Center, Middletown, CT, Was Not Always Operated
               According to Its Regulatory Agreement and HUD Requirements


Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our audit of the Middlesex Health Care Center.

HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.

The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its
publicly available reports on the OIG website. Accordingly, this report will be posted at
http://www.hudoig.gov.

If you have any questions or comments about this report, please do not hesitate to call me at
617-994-8345.
                     Audit Report Number: 2018-BO-1004
                     Date: June 29, 2018

                     The Middlesex Health Care Center, Middletown, CT, Was Not Always
                     Operated According to Its Regulatory Agreement and HUD Requirements



Highlights

What We Audited and Why
We audited the Federal Housing Administration-insured nursing home, Middlesex Health Care
Center in Middletown, CT, because we identified profitability and solvency issues during
ongoing work with the Section 232 program. Additionally, the U.S. Department of Housing and
Urban Development (HUD) identified the project as potentially troubled as of November 2017.
Our audit objective was to determine whether the project was operated according to its regulatory
agreement and HUD requirements.

What We Found
Although the owner, Athena Middlesex LLC, generally complied with the regulatory
requirements tested, it did not operate according to its regulatory agreement and HUD
requirements when it transferred or distributed funds from the project to affiliated healthcare
facilities, and while the project was not in a surplus-cash position. The owner’s regulatory
agreement, sections 6(b) and 6(e), state that owners shall not 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, and that owners
shall not make or receive and retain any distribution of assets or any income of any kind of the
project except from surplus cash. This condition occurred because the owner treated the project
the same as its other affiliated healthcare facilities that were covered under a master lease, which
allowed available funds to be transferred between each facility. However, the master lease did
not include the project. As a result, more than $1.1 million in project transfers or distributions
made did not comply with the regulatory agreement and were not available to the project for
necessary and reasonable expenses.

What We Recommend
We recommend that HUD’s Director of Asset Management and Lender Relations require the
owner to (1) repay the project the more than $1.1 million in ineligible distributions made to
affiliated healthcare facilities and (2) implement controls to ensure that project distributions are
made from surplus cash and comply with the regulatory agreement and HUD requirements.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................4
         Finding 1: The Project Was Not Always Operated According to Its Regulatory
         Agreement and HUD Requirements ............................................................................... 4

Scope and Methodology ...........................................................................................6

Internal Controls ......................................................................................................8

Appendixes ................................................................................................................9
         A. Schedule of Questioned Costs .................................................................................... 9

         B. Auditee Comments and OIG’s Evaluation ............................................................. 10




                                                              2
Background and Objective
Section 232 of the National Housing Act authorizes the Federal Housing Administration (FHA)
to insure mortgages made by private lenders to finance nursing homes and other eligible
facilities. The Office of Residential Care Facilities, under the U.S. Department of Housing and
Urban Development (HUD), Office of Healthcare Programs, manages the Section 232 program.
Federal regulations at 24 CFR (Code of Federal Regulations) 200.105(a) require HUD to
regulate FHA-insured borrowers by means of a regulatory agreement, providing terms,
conditions, and standards established by HUD.

The Middlesex Health Care Center in Middletown, CT, is a 150-bed for-profit nursing home
facility that is owned by Athena Middlesex LLC and managed by Athena Health Care Systems.
The project’s owner and the management agent, as well as the 44 other healthcare facilities
managed by the management agent, are all affiliated and share a majority stakeholder. The
owner is licensed by the Connecticut Department of Public Health and participates in the
Medicare and Medicaid programs. The mortgage was refinanced in 2011 under section
223(a)(7) of the National Housing Act of 1937 with a principal balance of more than $8 million.
As of November 1, 2017, the mortgage was current and had an unpaid principal balance of more
than $7.2 million.

The project had profitability concerns during our audit period. It reported a net loss of more than
$1.2 million in fiscal year 2015 and a net income of $686,376 in fiscal year 2016. However, to
meet its debt service requirement, affiliated healthcare facilities advanced the project more than
$1.8 million over the 2-year period. Although the project reported net income in 2016, more
than $1.4 million in advances had been forgiven by an affiliated healthcare facility, and the
management agent had stopped charging a management fee. If the healthcare facility had not
forgiven the advances and the management agent had charged a management fee, the project
would have reported a net loss of around $1 million in 2016.

Our audit objective was to determine whether the project was operated according to its regulatory
agreement and HUD requirements.




                                                 3
Results of Audit

Finding 1: The Project Was Not Always Operated According to Its
Regulatory Agreement and HUD Requirements
Although the owner generally complied with the regulatory requirements tested, it did not
operate according to its regulatory agreement and HUD requirements when it transferred or
distributed funds from the project to affiliated healthcare facilities, and while the project was not
in a surplus-cash position. This condition occurred because the owner treated the project the
same as its other affiliated healthcare facilities that were covered under a master lease which
allowed available funds to be transferred between each facility. However, the master lease did
not include the project. As a result, more than $1.1 million in project transfers or distributions
made did not comply with the regulatory agreement and were not available to the project to
distribute for necessary and reasonable expenses.

The Project Owner Generally Complied With the Regulatory Requirements Tested
We reviewed $725,119 of more than $29.5 million in project disbursements during fiscal years
2015 and 2016 and determined that the costs were generally eligible, necessary, and supported.
The mortgage was current, and the project and its systems appeared to be in good, serviceable
condition. However, we found one area of noncompliance in which the owner did not operate
the project in accordance with its regulatory agreement and HUD requirements.

The Owner Transferred or Distributed Funds From the Project While It Was Not in a
Surplus-Cash Position
The owner transferred or distributed more than $1.1 million from the project to affiliated
healthcare facilities while the project was not in a surplus-cash position. The owner’s regulatory
agreement, sections 6(b) and 6(e), state that owners shall not 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, and that owners
shall not make or receive and retain any distribution of assets or any income of any kind of the
project except from surplus cash. Management agent officials explained that funds were
transferred weekly as needed between the project and other affiliated healthcare facilities to
cover costs. The funds were transferred dependent on each healthcare facility’s negative or
positive cash flow. The funds were transferred from the project as if it were covered under a
master lease. 1 Although some of the other healthcare facilities were covered under a master
lease, the project was not. As a result, more than $1.1 million in project transfers or distributions




1
 Section 13.1 of HUD Handbook 4232.1 states that a master lease requires a facility operator to allow available
funds from one facility to be used for any other facility in the master lease portfolio that is unable to generate
adequate cash flow. The project was not part of the master lease that was executed between the other affiliated
healthcare facilities.



                                                           4
made did not comply with the regulatory agreement and were not available to the project to
distribute for necessary and reasonable expenses.

A similar finding was identified in the project’s draft financial statements for the year ending
December 31, 2017, prepared by an independent public auditor. The finding identified that the
project paid legal fees of $108,284 on behalf of affiliated healthcare facilities, which violated the
regulatory agreement because the project was prohibited from making loans or advances without
having available or sufficient surplus cash. As a result of the finding, the affiliated healthcare
facilities agreed to repay the legal fees paid by the project, and the management agent agreed to
implement a control policy whereby all distributions are made only from available and sufficient
surplus cash.

Conclusion
The project was not always operated in accordance with its regulatory agreement and HUD
requirements. The deficiency occurred because the owner treated the project the same as its
other affiliated healthcare facilities that were covered under a master lease which allowed
available funds to be transferred between each facility. However, the master lease did not
include the project, and as a result, more than $1.1 million in project transfers or distributions
made did not comply with the regulatory agreement and were not available to the project to
distribute for necessary and reasonable expenses.

Recommendations
We recommend that HUD’s Director of Asset Management and Lender Relations require the
owner to

       1A.     Repay the project the $1,168,000 in ineligible distributions made to affiliated
               healthcare facilities during fiscal years 2015 and 2016.

       1B.     Implement controls to ensure that project distributions are made from surplus cash
               and comply with the regulatory agreement and HUD requirements.




                                                  5
Scope and Methodology
We performed our audit work from December 2017 through April 2018 at the project located at
100 Randolph Road, Middletown, CT, and at the management agent located at 135 South Road,
Farmington, CT. Our audit generally covered the period January 1, 2015, through December 31,
2016, and was adjusted when necessary to meet our objective. To accomplish our objective, we
performed the following:

   •   Reviewed the Code of Federal Regulations, HUD handbooks, and the project’s policies
       and procedures.
   •   Reviewed key documents for the project, including the regulatory agreement, the
       management agent agreement, and the mortgage.
   •   Interviewed key personnel to determine financial and operational controls.
   •   Reviewed independent public auditor reports for the project.
   •   Reviewed HUD and U.S. Department of Health and Human Services monitoring reports
       to determine areas on which to focus our review.
   •   Reviewed the mortgage statement to determine whether the mortgage was current.
   •   Reviewed bank statements to identify unusual transactions.
   •   Reviewed the reserve for replacement account to determine whether deposits were made
       and expenditures were authorized by HUD.
   •   Reviewed owner distributions and determined whether the project was in a surplus-cash
       position.
   •   Reviewed any loans made with project funds.
   •   Identified related entities and reviewed contracts and invoices for cost reasonableness.
   •   Reviewed 100 percent of the more than $1.1 million in project distributions made to the
       affiliated healthcare facilities to determine whether the distributions were eligible and
       supported.
   •   Selected a sample of 20 disbursements totaling $725,119 from a universe of 3,207
       disbursements totaling more than $29.5 million to determine whether the costs were
       eligible, necessary, and supported. The sample was chosen based on large dollar
       disbursements and disbursements that appeared unusual to the project. A sample was
       chosen rather than reviewing 100 percent of the universe because the universe was too
       large. We did not perform a statistical sample, so our results were not projected.

To achieve our objective, we relied in part on the project’s computer-processed data. We used
the data to select samples to determine whether disbursements were eligible, necessary, and
supported. For our disbursement tests, we traced automated data to source documents. Although
we did not perform a detailed assessment of the reliability of the data, we performed a minimal
level of testing and found the data to be adequate for our purposes.

We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate


                                                6
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                7
Internal Controls
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to

•   effectiveness and efficiency of operations,

•   reliability of financial reporting, and

•   compliance with applicable laws and regulations.

Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.

Relevant Internal Controls
We determined that the following internal controls were relevant to our audit objective:

•   Program operations – Policies and procedures that management has implemented to
    reasonably ensure that a program meets its objectives.

•   Compliance with laws and regulations – Policies and procedures that management has
    implemented to reasonably ensure that the use of resources is consistent with laws and
    regulations.

We assessed the relevant controls identified above.

A deficiency in internal control exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned functions, the
reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or
efficiency of operations, (2) misstatements in financial or performance information, or (3)
violations of laws and regulations on a timely basis.

Significant Deficiency
Based on our review, we believe that the following item is a significant deficiency:

    •   The owner did not establish and implement adequate controls to ensure compliance with
        regulatory requirements for project distributions (finding 1).




                                                  8
Appendixes

Appendix A


                             Schedule of Questioned Costs
                           Recommendation
                                               Ineligible 1/
                               number
                                   1A.           $1,168,000

                                 Totals           1,168,000



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.




                                             9
Appendix B
                 Auditee Comments and OIG’s Evaluation



Ref to OIG
Evaluation         Auditee Comments




             June 1, 2018


             Ann Marie Henry
             Regional Inspector General for Audit
             Region 1 Boston
             U.S. Department of Housing and Urban Development
             Office of Inspector General
             10 Causeway Drive, Room 370
             Boston, MA 02222-1092

             Dear Ms. Henry:


             In response to the HUD OIG summary finding regarding Athena Middlesex LLC
Comment 1    ("Middlesex"), Middlesex disagrees with the audit finding that it violated its HUD
             regulatory agreement and disagrees that certain disbursements were termed as
             distributions subject to surplus cash restrictions.

             Middlesex agrees with the HUD OIG's assessment that Middlesex is not an
             affiliated entity covered under a master lease. As noted in the report, such master
             lease would allow covered facilities to transfer funds between them. Middlesex,
Comment 2    however, was a party to a HUD approved line of credit amendment dated February
             2015. Middlesex argues that the majority of the activity in the intercompany
             accounts reflects internal cash re-allocations to the line of credit borrowings
             between Middlesex and the 13 other facilities (" Athena 14"). All of the terms and
             conditions of the lines of credit including the addition of Middlesex to the Athena
             14 were approved by HUD.

               100 Randolph Road • Middletown, CT 06457 • Tel: 860.344.0353 • Fax: 860.346.1932
                                          athenanh.com/middlesex

                                    Managed by Athena Health Care Systems


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                 Auditee Comments and OIG’s Evaluation



Ref to OIG
                     Auditee Comments
Evaluation

             As explained during the audit and exit interview, cash flow for each facility is
             assessed at least weekly at each of the Athena 14. Excesses are then transferred
             to one of the other Athena 14 as necessary to cover any shortfalls. Instead of one
             facility paying down the line and another borrowing, these transactions were
Comment 2    recorded in an intercompany account at each of the Athena 14. In Middlesex's
             case they have received over $2.2 million through 12/31/16 in cumulative funds
             from the other Athena 14 to fund cash shortfall issues at Middlesex. Most of the
             $2.2 million could have been eligible for distributions to the owners at those
Comment 3    other facilities but due to our commitment to HUD and our facilities the decision
             was made to forgo distribution and support Middlesex.

             Although Middlesex has received over $2.2 million from other Athena 14
             facilities, the issue is when Middlesex in a particular week had excess cash flow
             and that excess was needed at another Athena 14 facility. Middlesex argues that
             it could have paid those excess funds toward the HUD approved credit line. This
Comment 2    would now create availability in the line which would now be available to another
             Athena 14 facility to borrow it. The whole purpose of a multifacility line of credit.
             What the Athena 14 did instead of paying and borrowing on the line was to
             simplify the process. Athena 14 facilities simply transferred the cash internally
             through its operating accounts to avoid all the banking transactions and delays
             involved with transferring through the line of credit. This reduces the cost and
             time involved for these transactions to meet the cash flow needs which are
             usually immediate (cover payroll, rent, supplies, etc}. This has the exact same
             effect as paying and borrowing on the credit line but simply eliminated the extra
             steps.

             In addition to the above, the audit lists all intercompany transactions paid to
Comment 4    other facilities during the audit period totaling $1,168,000. However, the audit
             findings do not include the $1,841,000 that was contributed in during that same
             period. The audit also suggests that surplus cash was transferred to facilities
             outside the Athena 14 by Middlesex during the audit period. That amount was
Comment 2    $250,000. However, the amounts contributed to Middlesex by these facilities
             totaled $451,000 during that same period. Contributions exceeded distributions
             by $201,000.

             To further assist Middlesex with cash flow, Athena Health Care Associates, Inc.
Comment 4    ("Athena"}, the project manager, amended its management contract to remove
             the amount of the management fee beginning June 1, 2016 to further assist
             Middlesex with cash flow. This amendment is not a HUD requirement however



                                          11
                 Auditee Comments and OIG’s Evaluation




Ref to OIG          Auditee Comments
Evaluation
             Athena felt it was necessary for Middlesex at the time. To date, the cash flow
             savings to Middlesex for the management fee is approximately $1.2 million.

             In summary, Middlesex disagrees with the finding that it violated its regulatory
             agreement for the reasons noted above. In fact, Middlesex was supported
             through its line of credit and the removal of management fees to the extent of
Comment 4    over $3.4 million. Such support is not a requirement of Middlesex's regulatory
             agreement. In addition, although the audit process may not take this into account
             Middlesex's intent should be considered. The intent of the transfers was not in
             any way to move "surplus plus" cash funds from Middlesex to other facilities. The
Comment 2    intent was simply our attempt to move monies as allowed through the line of
             credit. We may have simplified that approach by moving the monies directly
             instead of through the line but the ending result either way would have been the
             same.

             We believe that our decision to support Middlesex during this time was our
             commitment to HUD and Middlesex. As we have noted during the audit and exit
Comment 3    conference, Middlesex is financially turning around to become successful once
             again.




                                         12
                         OIG Evaluation of Auditee Comments


Comment 1   Project officials disagreed with the finding that they violated the HUD regulatory
            agreement and they disagreed that certain disbursements were termed as
            distributions subject to surplus-cash restrictions.

            We disagree that certain disbursements should not be termed as distributions
            subject to surplus-cash restrictions. As stated in the audit report, more than $1.1
            million was distributed to affiliated healthcare facilities while the project was not
            in a surplus-cash positon. Section 13(g) of the project’s regulatory agreement
            defines a distribution as any withdrawal or taking of cash or any assets of the
            project, including the segregation of cash or assets for subsequent withdrawal
            within the limitations of paragraph 6(e) hereof, and excluding payment for
            reasonable expenses incident to the operation and maintenance of the project.
            Section 6(e) states that owners shall not without the prior written approval of the
            Secretary, make or receive and retain any distribution of assets or any income of
            any kind of the project except surplus cash. Since the questioned distributions
            were not for reasonable expenses of the project, and the project was not in a
            surplus-cash position, the distributions violated the regulatory agreement and
            were ineligible.
Comment 2   Project officials agreed that the project was not covered under a master lease.
            They stated that the project was, however, a party to a HUD approved line of
            credit amendment, dated February 2015, along with 13 other affiliated healthcare
            facilities (Athena 14). Project officials stated that cash flow for each of the 14
            facilities was assessed at least weekly and excesses from one facility were
            transferred to another facility as necessary to cover any shortfalls. They stated
            that instead of one facility paying down the line of credit and another one
            borrowing from the line of credit, the transactions were recorded in an
            intercompany account at each of the facilities. They argued that they could have
            paid any excess funds toward the HUD approved line of credit thereby creating
            availability in the line for use by one of the affiliated healthcare facilities. They
            stated this has the same effect as paying and borrowing on the line of credit, but
            simply eliminated the extra steps. Project officials also acknowledged $250,000
            was transferred by the project to facilities outside of the Athena 14. However,
            they stated that the amounts contributed to the project by these facilities totaled
            $451,000 during the same period and that contributions exceeded distributions by
            $201,000.

            We agree that the project was added to the HUD approved line of credit in
            February 2015. However, project officials chose not to use the HUD approved
            line of credit. Instead they chose to distribute funds from the project while it was
            not in a surplus-cash position in violation of the regulatory agreement. We


                                               13
            audited the transactions that occurred and not the transactions that could have
            occurred if the line of credit was used. As stated in the audit report, this occurred
            because the owner treated the project the same as its other affiliated healthcare
            facilities that were covered under a master lease which allowed available funds to
            be transferred between each facility. During the exit conference, project officials
            acknowledged that they treated the project as if it were part of the master lease
            and discussed working with HUD to add the project to the master lease in the
            future. We offer no comment regarding the contributions made by other facilities
            to the project because we did not audit any of those facilities.
Comment 3   Project officials stated that the project received over $2.2 million through
            December 31, 2016 in cumulative funds from the other affiliated healthcare
            facilities to fund cash shortfall issues at the project. They stated that most of the
            $2.2 million could have been eligible for distributions to the owners at those other
            facilities but due to their commitment to HUD and their facilities, the decision
            was made to forgo distribution and support the project. They also stated that, as
            noted during the exit conference, that the project is financially turning around to
            become successful once again.

            We acknowledge the commitment shown by project officials. We offer no
            comment on whether or not the $2.2 million received by the project could have
            been eligible for distributions to the owners at the other affiliated healthcare
            facilities because we did audit any of those facilities.
Comment 4   Project officials stated that the audit finding discussed the more than $1.1 million
            paid by the project to other affiliated healthcare facilities, but it did not include
            the more than $1.8 million that was contributed to the project from affiliated
            healthcare facilities. They also stated that the management agent amended the
            management agreement to stop paying a management fee as of June 2016.
            Project officials believe the intent regarding the distributions should be
            considered. They stated that the intent of the distributions was not to move
            surplus cash from the project to affiliated healthcare facilities, but instead to
            simplify the approach of moving the money.

            In the background section of the report we acknowledged that affiliated healthcare
            facilities advanced the project more than $1.8 million and that more than $1.4
            million was forgiven. We also acknowledged that the management agent stopped
            charging a management fee. That information or the intent of the distributions
            does not change the fact that distributions were made from the project while the
            project was not in a surplus-cash position. We stand by our conclusion that the
            distributions violated the regulatory agreement and were ineligible.




                                               14