Audit of Spectrum Health Systems and Civigenics -Tax Fraud, MA Auditor, 2004

• Feb. 24, 2016 • Locations: United States of America -> Massachusetts • Topics: Corrections Audits

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The Commonwealth of Massachusetts
AUDITOR OF THE COMMONWEALTH
ONE ASHBURTON PLACE, ROOM 1819
BOSTON, MASSACHUSETTS 02108
A. JOSEPH DeNUCCI

TEL. (617) 727-6200

AUDITOR

NO. 2002-4453-3C
INDEPENDENT STATE AUDITOR’S
REPORT ON CERTAIN ACTIVITIES OF
SPECTRUM HEALTH SYSTEMS, INC.
JANUARY 1, 1992 TO DECEMBER 31, 2002

OFFICIAL AUDIT
REPORT
FEBRUARY 26, 2004

2002-4453-3C

TABLE OF CONTENTS/EXECUTIVE SUMMARY

INTRODUCTION

Spectrum Health Systems, Inc., (Spectrum) was incorporated in 1969 as a private, notfor-profit corporation. Presently, Spectrum maintains a full-time staff of 800 clinicians,
caseworkers and other professionals who serve adolescents, adults, and criminal justice
populations throughout eastern and central Massachusetts for substance abuse and
mental health and behavioral health care issues. Spectrum also provides out-of-state
services that include adolescent services in Hawaii and services for criminal justice
populations in Georgia, Illinois, North Carolina, and Rhode Island. (Appendix I of this
report further details Spectrum’s programs and service locations within the
Commonwealth.) Our audit, which covered the period January 1, 1992 to December 31,
2002, had the following objectives: (1) review, analyze, and evaluate Spectrum’s controls
over state contracts; (2) determine whether such controls are adequate to safeguard state
funds and in compliance with laws, rules, and regulations; and (3) ensure that Spectrum’s
charges to state contracts are reasonable, allowable, and applicable to contracted
program services. Our audit identified $13,689,206 in unallowable and highly
questionable payments to related parties; $995,000 in unallowable compensation paid to
the Chairman of Spectrum’s Board of Trustees; $1,550,444 in nonreimbursable expenses
funded with state program revenues; $1,151,540 in out-of-state program expenses
funded with state program revenues; and $42,695 in unallowable and questionable travel
expenses. During our audit, we found that Spectrum’s current administration has
improved the overall efficiency and effectiveness of the agency’s operations by reducing
its administrative costs and taking steps to comply with state regulations.
AUDIT RESULTS

1. SPECTRUM PAID EXCESSIVE MANAGEMENT AGENCY FEES TO ITS RELATED
PARTY, CIVIGENICS, WHICH RESULTED IN UNALLOWABLE CHARGES TO THE
COMMONWEALTH TOTALING APPROXIMATELY $10.2 MILLION

2002-4453-3C

TABLE OF CONTENTS/EXECUTIVE SUMMARY

2. SPECTRUM’S PURCHASE OF A MENTAL HEALTH FACILITY FROM ITS RELATED
PARTY, CIVIGENICS, RESULTED IN $3.3 MILLION IN UNALLOWABLE AND
HIGHLY
QUESTIONABLE
EXPENSES
BEING
CHARGED
TO
THE
COMMONWEALTH

On May 31, 2000 Spectrum purchased Boston Road Clinic, Inc., (BRC) and
CiviGenics Management Services, Inc., (CMS) from its related party, CiviGenics, for
$3,273,100. Our review of this transaction revealed that the purchase price was
unreasonable and inflated because it included $2,674,917 in goodwill for which
Spectrum received no tangible assets. As of June 30, 2003, $454,736 of this goodwill
has been charged to state contracts. Moreover, because Spectrum financed this
purchase over a 10-year period, as of December 31, 2002, Spectrum has incurred
interest expenses attributable to this goodwill totaling $233,352. Lastly, although
Spectrum has not contracted with the Commonwealth to provide mental health
services at BRC, for the two-year period ended June 30, 2002, Spectrum used
Commonwealth funds totaling $2,611,252 to cover operating losses incurred at this
clinic. Based upon state regulations, these expenses are unreasonable and nonprogram-related, and therefore represent nonreimbursable costs to the
Commonwealth.
3. SPECTRUM’S BOARD CHAIRMAN RECEIVED UNALLOWABLE COMPENSATION
TOTALING $995,000

Our audit identified that the Chairman of Spectrum’s Board of Trustees received
unallowable compensation totaling $995,000. The payments, which spanned an 11year period, resulted from a management transition agreement between Spectrum
and the Chairman dated December 24, 1991. However, contrary to state regulations,
Spectrum was unable to provide any documentation to substantiate that the
Chairman, in return for this compensation, provided services that directly benefited
Spectrum’s state-funded programs. Thus, the Chairman’s compensation represents a
nonreimbursable cost to the Commonwealth. Additionally, the Chairman received
the majority of this compensation while working and residing in Alaska and residing
in Florida. Therefore, we question how this individual was able to adequately
provide the management services for which Spectrum paid him.
4. SPECTRUM MADE UNALLOWABLE LEASE PAYMENTS TOTALING $151,532 TO A
RELATED PARTY, SPECTRUM DEVELOPMENT CORPORATION, INC.

During the three-year period ended June 30, 2002, Spectrum leased three properties
from a related party, Spectrum Development Corporation, Inc. (SDC) that Spectrum
used to house several of its Department of Public Health, Department of Social
Services, and Department of Correction residential and non-residential programs.
However, Spectrum’s lease payments exceeded by $151,532 the allowable limits
established by the OSD for payments made to related parties. Therefore, Spectrum
owes $151,532 to the Commonwealth.

2002-4453-3C

TABLE OF CONTENTS/EXECUTIVE SUMMARY

5. SPECTRUM USED STATE PROGRAM REVENUES TOTALING $1,550,444 TO FUND
BAD DEBT EXPENSES, EXCESSIVE SALARY PAYMENTS, DEPRECIATION
EXPENSES, FUNDRAISING COSTS, AND FREE CARE

Our audit identified that Spectrum utilized state program revenues totaling
$1,151,540 to fund losses incurred by its out-of-state programs. Spectrum, which
primarily serves Massachusetts residents who suffer with substance abuse and
domestic violence issues, also operates a Department of Youth Services (DYS)
program within the state of Hawaii as well as Department of Correction (DOC)
programs within the states of Georgia, North Carolina, and Rhode Island. During
fiscal years 1998 and 1999, Spectrum received funding totaling $4,405,371 for these
out-of-state programs, which was virtually limited to Non-Massachusetts State
Service Fees. However, during the same period, Spectrum incurred operating
expenses within these programs totaling $5,556,911. Consequently, for the two-year
period, Spectrum’s combined operating losses for its out-of-state programs totaled
$1,151,540.
7. SPECTRUM IMPROPERLY USED STATE PROGRAM REVENUES TO FUND
UNREASONABLE, UNALLOWABLE, AND UNDOCUMENTED TRAVEL EXPENSES
TOTALING $42,695

Our review indicated that Spectrum used state program revenues totaling $42,695 to
fund unreasonable, unallowable, and undocumented travel costs during fiscal years
2000 through 2002. These unreasonable, unallowable, and undocumented costs
resulted from Spectrum’s (a) reimbursing the Board Chairman for his commuting
costs from Alaska and Florida to attend monthly board meetings, (b) using state
funds to help cover the associated travel costs of Spectrum representatives visiting
out-of-state programs, and (c) maintaining inadequate supporting documentation for
its travel costs. Based upon state program regulations such unreasonable,
unallowable, and undocumented costs represent nonreimbursable expenses to the
Commonwealth. Consequently, Spectrum owes $42,695 to the Commonwealth.

iii

2002-4453-3C

TABLE OF CONTENTS/EXECUTIVE SUMMARY

APPENDIX I

Spectrum’s State Program Services and Service Locations
APPENDIX II

45
46

Spectrum’s President’s Recommendation to Terminate CiviGenics Management
Contract
APPENDIX III

46
47

Spectrum’s Example of CiviGenics Billing Invoice/Department of Correction
APPENDIX IV

47
48

Spectrum’s Example of Chairman’s Billing Invoice

2002-4453-3C

INTRODUCTION

INTRODUCTION
Background

Spectrum Health Systems, Inc., (Spectrum) was incorporated in 1969 as a private, not-for-profit
corporation.

Presently, Spectrum maintains a full-time staff of more than 800 clinicians,

caseworkers, and other professionals who serve adolescents, adults, and criminal justice populations
for substance abuse, and mental and behavioral health care needs. Spectrum offers these services at
numerous locations throughout central and eastern Massachusetts.

Spectrum also provides

adolescent services in Hawaii and services for criminal justice populations in Georgia, Illinois, North
Carolina, and Rhode Island. Appendix I of this report further details Spectrum’s programs and
service locations within the Commonwealth.
Spectrum’s funding primarily comes from state funds. For fiscal years 2000 through 2002, Spectrum
received the following revenues:
Spectrum Health Systems, Inc.
Summary of Revenues

Revenue -MA Government
Medicaid

Fiscal Year
2002

Fiscal Year
2001

Fiscal Year
2000

$9,388,657

$10,059,679

$8,185,208

Department of Youth Services

7,303,087

5,684,956

5,106,336

Department of Public Health

5,423,371

5,406,138

4,942,598

Department of Correction

4,026,664

3,989,579

3,643,146

Department of Social Services

1,176,593

269,068

141,571

POS Subcontract

337,613

Other MA State Agency POS

129,610

391,472

79,313

219,201

58,812

2,572

68,984

47,053

MA Government Grant
Department of Education

2002-4453-3C

INTRODUCTION

Other MA Program Revenue
Private Client 3rd-Party Offsets

$ 4,087,008

$ 4,785,105

$ 1,416,110

Private Client Fees

907,361

809,120

597,641

Local Government

515,527

488,241

964,216

MA Publicly Sponsored Client Offsets

299,609

402,900

474,043

63,405

36,664

51,439

$ 3,339,965

$ 2,894,351

$ 2,212,335

Other

720,663

96,406

160,649

Commercial Activities

240,222

135,682

5,017

Private In-Kind

127,689

55,563

45,179

58,789

64,186

Client Resources
Other Revenue
Out-of-State

Government In-Kind/Capital Budget
Investment Revenue
Contributions
Total Revenue

13,528
6,574
$38,189,031

91,023
$35,942,921

76
221,770
$28,337,385

Related-Party Relationship

During our audit period, Spectrum maintained a related-party relationship with two entities,
Spectrum Development Corporation (SDC) and CiviGenics, Inc. (CiviGenics).

The Financial

Accounting Standards Board in Statement of Financial Accounting Standards No. 57 (FASB 57)
defines such relationships as follows:
Affiliates of the enterprise; entities for which investments are accounted for by the equity method
by the enterprise; trusts for the benefit of employees, such as pension and profit-sharing trusts
that are managed by or under the trusteeship of management; principal owners of the enterprise
and its management, members of the immediate families of principal owners of the enterprise
and its management; and other parties with which the enterprise may deal if one party controls
or can significantly influence the management or operating policies of the other to the extent that
one of the transacting parties might be prevented from fully pursuing its own separate interests.
Another party also is a related party if it can significantly influence the management or operating
policies of the transacting parties or if it has an ownership interest in one of the transacting
parties and can significantly influence the other to an extent that one or more of the transacting
parties might be prevented from fully pursuing its own separate interest.

In November 1983, Spectrum, which was formerly known as Spectrum House, Inc., formed SDC as
a not-for-profit corporation under Chapter 180 of the Massachusetts General Laws. According to
its Articles of Incorporation, SDC was established for the purpose of holding title to property on
behalf of Spectrum House, Inc. Although SDC was created as an independent not-for-profit
2

2002-4453-3C

INTRODUCTION

agency, it shares a common Board of Trustees with Spectrum, and its real estate transactions are
conducted exclusively for Spectrum’s benefit. Based upon FASB 57, such common management,
common control, and exclusiveness of purpose constitute a related-party relationship.
Additionally, Spectrum maintained a related-party relationship with CiviGenics from October 1995
to June 30, 2002. CiviGenics was organized during 1995 as a for-profit corporation under Chapter
156B of the Massachusetts General Laws. According to its Articles of Organization, CiviGenics was
established for the purpose of providing management services to for-profit and not-for-profit
organizations and to provide advice and services regarding addiction rehabilitation.
In March 1995, Spectrum’s then President founded CiviGenics after expressing concerns to
Spectrum’s Board of Trustees that “without some radical departure from the present way of doing
business Spectrum can only look forward to a shrinking market-share and progressive withering
away.” In this regard, the President made a series of recommendations that the Board of Trustees
unanimously voted to authorize. Moreover, the board authorized the President to take further
action consistent with his plan of action, which is provided below as described in the Trustee’s
meeting minutes dated January 18, 1995:
•

A new for-profit corporation would be created.

•

This corporation would assume responsibility for the corrections work formerly
undertaken by Spectrum.

•

Spectrum would be a stockholder in the new corporation, the extent of its stock
ownership to be determined by an independent evaluation of its current corrections
work.

•

In addition to providing rehabilitation services at correctional facilities, and related
business activities, the new corporation will provide management assistance to
Spectrum, on a fee basis.

•

The new corporation would raise the necessary capital to take advantage of the
corrections market and otherwise expand those business activities. Hopefully, this will
benefit Spectrum by increase in value of its stock ownership in the new corporation.

•

As part of this arrangement, Spectrum would no longer participate in the corrections
rehabilitation market but its work would otherwise remain unchanged. Its Board would
remain in place and the new corporation would have a separate and independent
Board, reflecting its ownership. [Spectrum’s President] would head the new organization
and some members of the Spectrum Board would be invited to join the new venture.

2002-4453-3C
•

INTRODUCTION

The arrangement between the new corporation and Spectrum would be contractual and
the management contract between Spectrum and the new corporation would be
terminable in the discretion of the Spectrum Board.

Following the formation of CiviGenics, on May 24, 1995, Spectrum’s Board of Trustees awarded
CiviGenics a management agreement whereby it engaged CiviGenics as its sole and exclusive
managing agent and as an independent contractor to manage, operate, and conduct the business of
Spectrum. Under the terms of this agreement, CiviGenics was authorized to perform such duties as
are customary for Chief Executive Officers of state contractors comparable in size and
demographics to Spectrum, including hiring and terminating personnel, setting compensation, and
making all other management decisions consistent with the mission of Spectrum.

Moreover,

CiviGenics was required to provide full and complete supervision of all Spectrum operations, which
included coordination of direct care staff, administration of Spectrum facilities, fiscal administration,
planning and development, and personnel administration.
The management agreement took effect on October 12, 1995, at which time Spectrum’s President
resigned from Spectrum and began managing Spectrum’s operations in his new capacity as President
of CiviGenics. CiviGenics managed Spectrum’s operations until June 30, 2002, during which time
CiviGenics greatly influenced the management and operating policies of Spectrum. However,
effective July 1, 2002, Spectrum cancelled the CiviGenics management agreement, thus ending a
seven-year relationship between the two companies.
During our audit, CiviGenics’ President asserted that Spectrum and CiviGenics are not related
parties within the meaning of 808 Code of Massachusetts Regulations (CMR) 1.00. However,
Spectrum’s relationship with CiviGenics clearly represents a related-party relationship as defined by
FASB 57, as demonstrated by the following facts:
•

The terms of the CiviGenics management agreements with Spectrum for fiscal years 1996 to
2002 enabled the company to significantly influence Spectrum’s management and operating
policies.

•

For fiscal years 1996 to 2002, CiviGenics’s private accountant identified in the annual Notes
To Consolidated Financial Statements the related-party relationship between Spectrum and
CiviGenics.

•

For fiscal years 1996 to 2002, Spectrum’s private accountants identified within Spectrum’s
annual Notes To Financial Statements the related-party relationship between Spectrum and
CiviGenics.
4

2002-4453-3C

INTRODUCTION

•

Spectrum’s and CiviGenics’s Board of Trustees and Board of Directors, respectively, have
maintained at least one common board member since CiviGenics was founded in 1995. In
this regard, Spectrum’s Chairman of the Board of Trustees, who was appointed Chairman in
January 1992 and continues in that capacity today, served on CiviGenics’s Boards of
Directors from March 1995 through April 2002. Moreover, at the time CiviGenics was
founded, Spectrum’s Vice-Chairman also served on CiviGenics’ Board of Directors. The
Vice-Chairman maintained his dual leadership role until November 28,1995, at which time
he resigned from Spectrum’s Board of Trustees.

•

At the time that Spectrum’s Board of Trustees awarded CiviGenics its first management
agreement, Spectrum acquired an ownership interest in CiviGenics, investing $500 for
50,000 shares of CiviGenics common stock, which represented approximately 12.5% of the
outstanding stock of CiviGenics. Spectrum reported the value of this investment through
fiscal year 1997 using the equity accounting method, which is used to determine income
derived from a company’s investment in another company over which it exerts significant
influence.

Audit Scope, Objectives, and Methodology

The scope of our audit was to examine certain administrative and fiscal activities of Spectrum during
the period January 1, 1992 to December 31, 2002. Our audit was conducted in accordance with
applicable generally accepted government auditing standards for performance audits and included
procedures and tests considered necessary by the Office of the State Auditor (OSA) to meet these
standards.
Our objectives consisted of the following:
1. A determination of whether Spectrum has established and implemented adequate and
effective management controls, including:
•

Policies and procedures to ensure internal administrative and accounting controls over
Spectrum revenues, expenses, and fixed assets;

•

Policies and procedures to ensure that resource use is consistent with laws and
regulations; and

•

Policies and procedures to ensure those resources are safeguarded and efficiently used.

2. An assessment of Spectrum’s business practices and its compliance with applicable laws,
rules, and regulations as well as the various fiscal requirements of its state contracts.
In order to achieve our audit objectives, we first assessed the system of management controls
established and implemented by Spectrum over its operations. The purpose of this assessment was
to obtain an understanding of management’s attitude, the control environment, and the flow of
5

2002-4453-3C

INTRODUCTION

transactions through Spectrum’s accounting system. The assessment was used in planning and
performing our audit tests.

We then held discussions with Spectrum officials and reviewed

organizational charts and internal policies and procedures. We also reviewed all applicable laws,
rules, and regulations. Finally, we examined Spectrum’s financial statements, budgets, cost reports,
invoices, and other pertinent financial records to determine whether expenses incurred under
Spectrum’s state contracts were reasonable, allowable, allocable, properly authorized and recorded,
and in compliance with all applicable laws, rules, and regulations.
Our review was not made for the purpose of forming an opinion on Spectrum’s financial
statements. We also did not assess the quality and appropriateness of program services provided by
Spectrum through its contracts. Rather, our report was intended to report findings and conclusions
regarding Spectrum’s compliance with applicable laws, rules, and regulations; the adequacy of
Spectrum’s performance; and specific processes, methods, and internal controls that could be made
more efficient and effective. Additionally, due to the magnitude of the issues we identified at
Spectrum (over $17 million dollars in state resources being misused over an 11-year period), our
review of Spectrum’s financial activity was limited to the following five areas in order to provide a
timely reporting of these issues:
• Spectrum’s purchase of a mental health facility from its related party, CiviGenics
• Fiscal years 1996 through 2002 management agreements with CiviGenics
• Fiscal years 2000 through 2002 lease payments to its related party, SDC
• Payments to Spectrum’s Chairman of the Board of Trustees from January 1992 through
December 2003
• Use of state program resources to fund out-of-state program costs and other
nonreimbursable costs
Finally, the OSA is authorized under its enabling legislation, Chapter 11, Section 12, of the General
Laws, to perform audits of entities such as Spectrum that contract with the Commonwealth to
“determine compliance with the provisions and requirements of such contracts or agreements and
the laws of the commonwealth.” This statute further mandates that “the state auditor shall have
access to such accounts at reasonable times” and that the OSA “may require the production of
books, documents, vouchers, and other records relating to any matter within the scope of such
6

2002-4453-3C

INTRODUCTION

audit.” Additionally, regulations promulgated by the state’s Operational Services Division (OSD),
the agency responsible for regulating and overseeing all state contracts awarded to contracted service
providers such as Spectrum, require service providers to provide all records needed by the OSA as
well as other organizations to complete an audit of the agency. Specifically, 808 CMR 1.04 (8) states:
A Contractor shall make available for review, inspection and audit all records relating to its
operations and those of its affiliates, subsidiaries and Related Parties… to any contracting
Department, Executive Office, DPS, the Office of the State Auditor, the federal government or
their representatives.

During the conduct of our fieldwork, Spectrum provided us with most of the documentation that
we requested in a timely manner. At times, Spectrum was unable to supply us with requested
documentation because Spectrum (1) did not require its Chairman of the Board of Trustees and its
related party, CiviGenics, to provide documents that supported their billing invoices for consulting
and management agency services, respectively; (2) had difficulty retrieving some requested pre-1998
documents from its storage facility; and (3) was often unable to obtain other requested information
from CiviGenics. Therefore, our ability to perform sufficient audit testing in certain areas was
partially impaired, and the audit results and opinions expressed in this report are based solely on the
documentation that Spectrum provided to the audit team.

2002-4453-3C

AUDIT RESULTS

AUDIT RESULTS
1. SPECTRUM PAID EXCESSIVE MANAGEMENT AGENCY FEES TO ITS RELATED PARTY,
CIVIGENICS, WHICH RESULTED IN UNALLOWABLE CHARGES TO THE COMMONWEALTH
TOTALING APPROXIMATELY $10.2 MILLION

Our audit identified that Spectrum paid excessive management agency fees to its related party,
CiviGenics, which resulted in unallowable charges to the Commonwealth totaling $10,238,334.
Spectrum paid these fees through a series of contracts that it noncompetitively awarded to
CiviGenics during fiscal years 1996 through 2002. The purported intent of these contract
awards was to reduce Spectrum’s management and general operating expenses by sharing
common costs (e.g., personnel, rent, equipment lease, and office expenses) with CiviGenics.
However, from the onset, Spectrum’s Board of Directors allowed CiviGenics’ management fee
to escalate beyond limits established by the state’s Operational Services Division (OSD). This
problem persisted through fiscal year 2002, at which time Spectrum discontinued its contractual
relationship with CiviGenics and resumed control of its day-to-day administrative operations.
Through state regulation, the state’s Operational Services Division (OSD) has limited the
amount that the Commonwealth will reimburse state contractors for management agency fees.
Specifically, under 808 Code of Massachusetts Regulations (CMR) 1.05(16), OSD defines the
following management agency fees as nonreimbursable costs to the Commonwealth:
Management Agency Fee: Fees charged to the Contractor by a management agency
which exceed the costs the Contractor would have incurred had it not entered into a
management agreement.

On May 24, 1995, Spectrum signed the first in a series of management agreements with
CiviGenics whereby it engaged CiviGenics as its sole and exclusive managing agent. This first
agreement specified that CiviGenics had the authority to hire and terminate personnel, set
compensation, and make all other management decisions consistent with the mission of
Spectrum. Moreover, this agreement required CiviGenics to provide Spectrum with on-site
representatives to supervise all Spectrum operations, including (a) direct care staff coordination,
(b) planning and development, and (c) fiscal, personnel, and facilities administration. Lastly,
CiviGenics was required to fulfill its responsibilities in an efficient manner under the direction
and control of Spectrum’s Board of Trustees, committees, and officers.

2002-4453-3C

AUDIT RESULTS

In return for these services, Spectrum agreed to pay CiviGenics a management agency fee of 1%
less than the amount that Spectrum had incurred in performing these services during fiscal year
1995. Although this first agreement was signed and dated May 24, 1995, CiviGenics did not
begin managing Spectrum’s operations until October 15, 1995.
Although Spectrum intended to reduce its management and general operating expenses through
its contract with CiviGenics, our audit identified that Spectrum paid CiviGenics an excessive
amount during fiscal year 1996 that resulted in unallowable costs to the Commonwealth totaling
$763,535. In this regard, the fiscal year 1995 Uniform Financial Statements and Independent
Auditor’s Report (UFR) that Spectrum submitted to the Commonwealth identified that the
agency paid administrative management and general expenses totaling $1,203,136 for the period.
However, our review indicated that this amount included $64,897 in nonreimbursable costs and
$183,299 in legal and audit fees, working capital interest, Board of Trustee expenses, and other
expenses, which Spectrum would continue to pay during fiscal year 1996 and into the future.
Finally, as previously noted, because CiviGenics did not begin managing Spectrum’s operations
until October 15, 1995, it was entitled to only a prorated share of its fiscal year 1996
management agency fee.
Based upon these adjustments, which are detailed in the table below, Spectrum’s management
agency fee should have been limited to $676,412 for fiscal year 1996. Therefore, Spectrum’s
payments to CiviGenics of $1,439,9471 for the period included $763,535 in unallowable charges,
of which Spectrum allocated $751,902 to its state-funded programs.

This amount includes $181,863 of management and general expenses which Spectrum misclassified as direct state
program expenses on its fiscal year 1996 UFR. Spectrum made similar reporting errors on its fiscal years 1997
through 2000 UFRs totaling $1,357,200.

2002-4453-3C

AUDIT RESULTS
Allowable Management Agency Fees
Fiscal Year 1996

1995 UFR
Management and General
Expenses

Prorated
Amount**

UFR Total

Adjusted
Amount*

$578,058

$409,456

131,915

93,439

Leased Program Equipment

2,479

1,756

Temporary Help

2,355

1,668

Staff Training

1,463

1,036

Staff Mileage

37,216

26,361

3,767

2,668

Data Processing

10,917

7,733

Officers/Directors

11,619

Legal and Auditing Fees

44,629

Management Consultant

242,143

171,517

Administrative Vehicles Expenses

9,524

6,746

Working Capital Interest

2,922

Employee Compensation
Facility Expenses

Meals

Other
Subtotals
State Non-Reimbursable Expenses
Total

124,129
$ 1,203,136
(64,897)
$1,138,239

_________
$1,019,837
(64,897)
$ 954,940

_______
$722,380
(45,968)
$ 676,412

* Since CiviGenics was not responsible for paying all of Spectrum’s management and general expenses, the
excluded expenses (e.g., officers and directors, legal and audit, working capital interest, and other expenses)
needed to be adjusted in order to determine CiviGenics’s allowable management agency fee.
** During fiscal year 1996, CiviGenics managed Spectrum’s operations from October 15, 1995 to June 30,
1996. Therefore, CiviGenics was entitled to a management agency fee equal to only 70.833% (8.5
months/12 months) of Spectrum’s adjusted fiscal year 1995 management and general expenses.

Following fiscal year 1996, Spectrum agreed to increase the CiviGenics management fee in a
manner that violated state regulations and led to Spectrum’s charging the Commonwealth an
additional $9,486,432 in unallowable management agency expenses. Specifically, for the six-year
period ended June 30, 2002, Spectrum increased the CiviGenics management fees from
$1,439,947 to $3,744,040, or a 160% increase. Under normal circumstances, a reasonable person
would have expected CiviGenics to receive a modest fee increase to compensate it for actual
increases in its related management costs (e.g., cost of living raises, additional staffing, inflation).
However, increases to Spectrum’s management fee were not based upon CiviGenics’ relative
costs. Rather, Spectrum agreed to provide CiviGenics with additional fees based upon the
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2002-4453-3C

AUDIT RESULTS

annual growth in Spectrum’s program revenues. Spectrum agreed to this financial arrangement
on March 5, 1998, at which time the two parties executed a revised management agreement that
stipulated the following:
Spectrum and CiviGenics agree that the base fee for the management fee due CiviGenics
from Spectrum for each fiscal year of 1996, 1997 and 1998 shall be $1,603,920. This
base fee is defined in Article 4 of the management agreement as the sum of account
departments 900, 910, 920, and 930 for fiscal year 1995 less 1%. In addition to the said
base fee, CiviGenics shall be entitled to receive from Spectrum as an additional
management fee compensation for each fiscal year, 10% of any additional revenue
generated by Spectrum over the base revenue figure for fiscal year 1995; said base
revenue figure for fiscal year 1995 was $9,939,000.
Since fiscal year 1996 and fiscal year 1997 have passed, the exact amounts due
CiviGenics from Spectrum for management fee can be ascertained and said amounts
were due and payable by Spectrum to CiviGenics….

This financial arrangement, which remained in effect through fiscal year 2000, resulted in
Spectrum’s increasing CiviGenics’s management fees from $1,439,947 to $3,624,512 over the
four-year period.

Following fiscal year 2000, Spectrum negotiated two final management

agreements with CiviGenics whereby it agreed to pay CiviGenics $3.5 million and $3,774,040 for
services during fiscal years 2001 and 2002, respectively.
Under state regulations, Spectrum is required to maintain adequate documentation to support
the payments it made to CiviGenics for management services. In this regard, OSD promulgated
808 CMR 1.04(1), which details for state human service providers the Commonwealth’s record
keeping requirements, as follows:
Recordkeeping. The contractor and its subcontractors shall keep on file all data necessary
to satisfy applicable reporting requirements of the Commonwealth (including DPS, the
Division of Health Care Finance and Policy and Departments), and financial books,
supporting documents, statistical records, and all other records which reflect revenues
associated with and costs incurred in or allocated to any Program of services rendered
under the contract….

Despite this regulation, Spectrum did not require CiviGenics to provide detailed documentation
supporting the costs it incurred in managing Spectrum’s operations. Consequently, Spectrum
was unable to provide us with any documentation relative to the actual cost incurred by
CiviGenics in managing Spectrum’s day-to-day operations or with any cost data to justify the
annual increases to CiviGenics’s management fees. Thus, in order to reasonably determine the
extent to which Spectrum overcharged the Commonwealth for management agency costs, we
11

2002-4453-3C

AUDIT RESULTS

applied a 10% annual growth factor to CiviGenics’s adjusted base management fee to reflect
customary increases in management costs. Based upon this growth factor, we estimate that
Spectrum has overcharged the Commonwealth $10,238,334 for management agency fees, as
detailed in the table below.
Schedule of Nonreimbursable Management Agency Fees
Fiscal Years 1996 through 2002

Fiscal Year

Base
Management
Fee

Allowable
Management
Fee

Actual
Management
Fee

Nonreimbursable
Amount

Amount
Allocated to
State Programs

$ 676,412

$ 1,439,947

$ 763,535

$ 751,902

(10%) Yearly
Growth

1996
(Adjusted)
1997

$ 676,412
954,940

$ 95,494

1,050,434

2,147,309

1,096,875

1,079,688

1998

1,050,434

105,043

1,155,477

2,773,384

1,617,907

1,452,741

1999

1,155,477

115,548

1,271,025

3,342,058

2,071,033

1,859,738

2000

1,271,025

127,102

1,398,127

3,624,512

2,226,385

2,029,052

2001

1,398,127

139,813

1,537,940

3,114,170

1,576,230

1,402,845

2002
Totals

1,537,940
$8,044,355

153,794
$736,794

1,691,734
$8,781,149

3,744,040
$20,185,420

2,052,306
$11,404,271

1,662,368
$10,238,334

As previously noted, Spectrum resumed managing its day-to-day operations beginning in fiscal
year 2003. In this regard, Spectrum’s President, who was the former Chief Operating Officer of
CiviGenics, in a confidential memorandum to the Board of Trustees of Spectrum Health
Systems dated February 11, 2002 (see Appendix II), provided the board with reasons to
terminate CiviGenics’ management contract that included the following:
In the last two fiscal years, FY’00 & FY’01, CiviGenics has played no role in effecting
Spectrum’s growth. In that time, Spectrum’s revenues grew 13% and 21% respectively.
This year projects out to approximately 7% growth. However, in that same period of
time, the last three fiscal years, the management fee has grown 18%…
At this point, CiviGenics provides no management to Spectrum but rather acts as an
outsourcing company that provides accounting, Human Resource support, information
technology services and support and proposal development. All of these services could
be provided in house by Spectrum at substantially less what [sic] we currently pay
CiviGenics.
By terminating the management contract with CiviGenics, we would free up a substantial
amount of resources that could be re-invested back into services while still leaving a
healthy reserve which will be needed during the expected lean times of the next few
years.

2002-4453-3C

AUDIT RESULTS

Based upon the President’s recommendation, Spectrum’s Board of Trustees terminated
CiviGenics’s management agreement effective July 1, 2002. Moreover, since resuming full
control over its day-to-day operations, Spectrum has significantly reduced its administrative costs
as anticipated by its President. In this regard, Spectrum’s management and general costs totaled
$5,200,967 for fiscal year 2002, whereas for fiscal year 2003, Spectrum budgeted only $3,198,825
for these costs. By operating within this budget, which Spectrum has achieved through February
28, 2003, Spectrum will effectively reduce its total management and general expenses by over $2
million.
Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum the $10,238,334 in unallowable management agency fees that it has charged to
the Commonwealth since fiscal year 1996.
Auditee’s Response

In response to this audit result, Spectrum stated, in part:
We clearly recognize that in recent years, the organization was disserved by its
relationship with its related party management company, CiviGenics, Inc. Spectrum’s
Board of Trustees, on the recommendation of the CEO, decide that the agreement was
not providing any value to the organization and voted to terminate the agreement in
February 2002. Spectrum’s intent was to return to managing its own affairs internally
without outsourcing to CiviGenics and to more efficiently utilize its resources in furthering
its charitable mission. Over the period covered by the management agreement, fiscal
years 1996 through 2002, CiviGenics developed an inordinate level of excessive control
over Spectrum’s infrastructure that prevented the organization from terminating the
management agreement without duress, hardship and inordinate expense. Faced with
the loss of the revenue from Spectrum, CiviGenics made the organization’s transition
difficult and prolonged. As of this date, Spectrum and CiviGenics are in litigation
regarding matters that stem for the period of the management agreement. Potential
additional litigation is anticipated against CiviGenics. . . .
During 1995, Spectrum entered into a management agreement with CiviGenics, a related
party. As identified in the Report, fees charged to a Contractor “by a management
agency which exceed the costs the Contractor would have incurred had it not entered
into a management agreement” are non-reimbursable.
During the term of Spectrum’s management agreement with CiviGenics, repeated
requests were made of CiviGenics by Spectrum’s management (as well as by Spectrum’s
independent auditors) in an effort to obtain documentation to support the amounts billed
to Spectrum under the terms of the management agreement.
CiviGenics was
unresponsive, with the exception of providing basic supporting cost schedules for fiscal

2002-4453-3C

AUDIT RESULTS

year 1999. The information provided by CiviGenics for 1999 supported the management
fees billed. (This documentation was also provided to the Operational Services Division
(“OSD”) in November 2000.)
Also during the period of the management agreement, the Organization evaluated the
management fees being charged for quality of service and for comparison to general and
administrative charges being incurred by similar organizations.
Despite CiviGenics’ assurances and representations that the management fees were
being billed at cost, management of Spectrum became increasingly dissatisfied with
management fees charged and in fact, as documented in the Report, terminated the
management agreement effective June 30, 2002.
In assessing the reasonableness of the management fees charged, the Report provides
for a 10% increase in fees from a base year level. We maintain that such an increase is
not consistent with the rate at which Spectrum was growing during this period.
Spectrum’s revenues increased 280% from 1995 to 2002.
In the absence of Spectrum’s ability to obtain supportive cost data from CiviGenics and
the contention that a 10% growth rate does not take into account Spectrum’s significant
growth in size and administrative complexity during the period in question in this
response, an alternative methodology was applied to assess the reasonableness of
Spectrum’s management and general expenses incurred on an annual fiscal year basis
from 1996 through 2002.
The methodology proposed by Spectrum was developed as follows:
•

Determine the average percentage (on an annual basis from 1996 through
2002) of general and administrative expenses incurred in relation to total
revenue generated for similar health and human service providers (by utilizing
databases maintained by Guidestar and OSD).

•

Calculate Spectrum’s allowable general and administrative expenses by
applying these percentages to Spectrum’s total revenue for the respective
year.

•

Determine the excessive or non-reimbursable amounts
management fees for each year from 1996 through 2002.

charged

Spectrum contends that this methodology fairly reflects the amount of management fees
charged for each year from 1996 through 2002. In contrast, the methodology employed
by the State Auditor in the Report significantly understates the allowable general and
administrative percentages for these years.
As discussed above, in addition to Spectrum’s growth in revenues billed and services
performed during the period from 1996 through 2002, the Organization’s administrative
complexity was also increasing.
The following table documents the non-reimbursable amount of Spectrum’s general and
administrative (“G&A”) (including management fees) expenses during the period from
1996 through 2002:

2002-4453-3C

AUDIT RESULTS

Fiscal Year

Total Revenues

G&A % (1)

Allowable G&A

Actual G&A (2)

Non-Reimbursable
G&A

1996

$ 11,859,692

12.8%

$ 1,521,598

$ 2,119,883

$ (598,285)

1997

15,997,862

12.8%

2,052,526

2,397,944

(345,418)

1998

21,970,327

13.1%

2,886,901

3,334,946

(448,045)

1999

24,630,657

13.0%

3,192,133

3,704,092

(511,959)

2000

28,337,385

12.4%

3,525,715

4,274,346

(748,631)

2001

35,942,241

11.9%

4,281,062

4,355,332

(74,270)

2002

37,624,916

12.2%

4,578,952

5,200,967

(622,015)

$22,038,887

$25,387,510

$(3,348,623)

$176,363,080
•

Determined by using industry averages for similar health and human service
providers as reported by databases maintained by Guidestar and OSD.

•

Actual general and administrative expenses charged by Spectrum including all
management fees charged by CiviGenics (base management fee as well as
amount allocated to Department of Correction Programs . . . It is Spectrum’s
strong contention that the methodology utilized above is appropriate and
fairly illustrates Spectrum’s Allowable General and administrative expense for
a $3.7 million organization.

Auditor’s Reply

We agree with Spectrum’s statement that the agency was “disserved by its relationship” with
CiviGenics and that the reasonableness of the management fees charged by CiviGenics under its
management agreement with Spectrum were questionable and inadequately supported.
In its response, Spectrum also acknowledges the fact that the amounts billed by CiviGenics were
excessive but takes exception with the methodology used by the audit team in determining the
unallowable amounts billed by CiviGenics and reimbursed by Spectrum using state funds.
However, we do not agree with Spectrum that our methodology understates the allowable
general and administrative percentages for these years. First, as stated in our report, OSD
regulations state that any expenses that are not adequately documented are unallowable and
nonreimbursable under state contracts. By its own admission, Spectrum was not able to obtain
from CiviGenics documentation to substantiate the management fees it was charging to
Spectrum.
Consequently, since these expenses are unallowable in accordance with state regulations, we
could have reasonably recommended that the Commonwealth seek reimbursement for the entire
15

2002-4453-3C

AUDIT RESULTS

$20,185,420 in undocumented management expenses CiviGenics charged Spectrum during the
audit period. However, because we recognize that CiviGenics did provide management services
to Spectrum during the audit period, we elected to utilize a reasonable and conservative
approach to calculating the excessive amount that Spectrum paid for these services. As stated in
our report, according to state regulations, the management fees Spectrum should have paid for
these services should not exceed the costs the contractor (Spectrum) would have incurred had it
not entered into this management agreement. Given this fact, we took the actual management
costs Spectrum incurred prior to entering into its agreement with CiviGenics and then allowed
for a significant (10%) annual inflation factor for the entire audit period in order to calculate the
allowable amount Spectrum should have paid for these services. Even using this 10% inflation
rate, which far exceeded the 2%-3% actual rate of inflation during the audit period, we still
calculated that CiviGenics overcharged Spectrum a total of $10,238,334 for these management
services during the audit period.
The analysis of allowable management expenses Spectrum presents in its response is flawed for
several reasons. First, as previously noted, the amount of management fees that would be
allowable is equal to the actual costs that Spectrum itself would have incurred in providing these
services. However, Spectrum’s analysis is based not on a projection of its actual costs for
providing these services but rather on the average percentage of general and administrative
expenses to total revenue for purported similar organizations during the audit period. Since
such a percentage would vary significantly between organizations depending on a variety of
factors, including their size and the types of programs they operated, an average of these would
in no way be reflective of Spectrum’s actual service costs.
Moreover, Spectrum could have arrived at a more reasonable allowable cost percentage by
applying its methodology to the agency’s actual overhead expenses and program revenues. In
doing so, Spectrum would have arrived at an allowable administrative cost reimbursement rate
of 10.4% for fiscal year 1996 versus the 12.8% suggested within its response. The 10.4% rate is
based upon Spectrum’s fiscal year 1995 general and allowable administrative costs totaling
$1,138,239, revenues totaling $9,974,398, and factoring in CiviGenics’ contract requirement to
provide its management services during fiscal year 1996 at a rate of 1% less than what Spectrum

2002-4453-3C

AUDIT RESULTS

incurred in providing these services during fiscal year 1995 ([$1,138,239/$9,974,398] – 1% =
10.4%).
Finally, as part of its methodology, Spectrum utilized the average of total general and
administrative expenses for similar health and human service providers. However, CiviGenics’
fee constituted only a portion of Spectrum’s total general and administrative expenses. In fact,
throughout the audit period Spectrum continued to pay for overhead costs such as postage,
telephone, utilities, etc.

Therefore, Spectrum’s methodology includes cost factors that are

unrelated to CiviGenics’s management fees.
It is important to point out that the accuracy and reasonableness of the costs figures we use in
our analysis are in fact supported by Spectrum’s own budgeted figures. For example, in our
report we state that the allowable management fee costs for fiscal year 2002 was $1,691,734.
During fiscal year 2003, Spectrum assumed responsibility for providing these services from
CiviGenics and budgeted $1,653,233 to pay for them, a variance of $38,501 (approximately only
2%).
2. SPECTRUM’S PURCHASE OF A MENTAL HEALTH FACILITY FROM ITS RELATED PARTY,
CIVIGENICS, RESULTED IN $3.3 MILLION IN UNALLOWABLE AND HIGHLY
QUESTIONABLE EXPENSES BEING CHARGED TO THE COMMONWEALTH

Lastly, although

Spectrum has not contracted with the Commonwealth to provide mental health services at BRC,
for the two-year period ended June 30, 2002, Spectrum used Commonwealth funds totaling
$2,611,252 to cover operating losses incurred at this clinic. Based upon state regulations, these
expenses are unreasonable and non-program-related, and therefore represent nonreimbursable
costs to the Commonwealth.

2002-4453-3C

AUDIT RESULTS

The state’s Operational Services Division (OSD) is responsible for regulating and overseeing the
activities of all human service providers who contract with the Commonwealth. To this end,
OSD has promulgated 808 CMR 1.00, which governs contract compliance, financial reporting,
and auditing requirements with which all contracted human service providers must comply.
Under 808 CMR 1.05(1) and 1.05(12) OSD defines Unreasonable Costs and Non-Program
Expenses as follows:
(1) Unreasonable Costs. Any costs not determined to be Reimbursable Operating Costs
as defined in CMR 1.02 or any amount paid for goods or services which is greater than
either the market price or the amount paid by comparable Departments or other
governmental units within or outside of the Commonwealth.
(12) Non-Program Expenses. Expenses of the Contractor which are not directly related
to the social service Program purposes of the Contractor.

Moreover, under 808 CMR 1.00, OSD has published the Uniform Financial Report Auditor’s
Compliance Supplement, which provides further guidance for independent auditors to follow
when auditing state contractor’s financial statements.

Regarding reimbursable operating

expenses, OSD emphasizes that expenses must be “Costs Incurred in Providing the Contracted
or Mandated Services,” “Reasonable in Nature,” and “Reasonable in Amount.” In order to
satisfy these criteria, the expense must be (1) ordinary and necessary for the provisions of the
particular services that the Commonwealth has agreed to buy, (2) the kind that would be
incurred by a prudent person under the circumstances, and (3) the amount that would be
incurred by a prudent person.
According to documentation we reviewed, BRC is engaged in the business of providing clinical,
psychological, and related services, whereas CMS performs all of BRC’s management and
administrative functions. For fiscal years 2001 and 2002, BRC received the majority (66%) of its
funding, $4,720,283, through private client third-party payments and private client fees. In
addition, BRC received $1,860,704, or 26% of its operating revenue, through Medicaid and
Medicare payments. Finally, as detailed in the chart below, BRC did not receive funding through
the Commonwealth’s purchase-of-service system.

2002-4453-3C

AUDIT RESULTS
Summary of BRC Funding
Fiscal Year
2001

Funding Source
Private Client Third-Party Payments

Fiscal Year
2002

Total

$2,682,827

$1,753,747

$4,436,574

Medicaid

641,499

481,973

1,123,472

Medicare

440,351

296,881

737,232

Private Client Fees

206,446

77,263

283,709

Mass. Government Grant

183,600

95,700

279,300

82,545

182,617

265,162

24,488
$4,261,756

26,095
$2,914,276

50,583
$7,176,032

Commercial Activities
Other
Total Revenue

On May 31, 2000 Spectrum entered into an agreement with its related party, CiviGenics, to
purchase the assets of BRC and CMS. Under the terms of this agreement, Spectrum issued a 10year promissory note to CiviGenics totaling $2,896,101 that carried an annual interest rate of
6%. Spectrum also agreed to assume $377,000 of BRC’s and CMS’s outstanding liabilities, thus
raising the effective purchase price to $3,273,101. In return, as detailed in the table below,
Spectrum received BRC’s and CMS’s assets, which were valued at $598,183.
BRC and CMS
Summary of Assets
As of May 31, 2000
Assets Acquired

Amount

Accounts Receivable

$184,630

Office Equipment

159,801

Leasehold Improvements

114,151

Furniture/Fixtures

55,700

Computer Software

38,981

Cash

18,580

Due To/From CiviGenics

12,856

Prepaid Insurance

7,137

Security Deposit
Total

6,347
$598,183

During our audit, we reviewed the documentation being maintained by Spectrum relative to this
transaction and identified several problems. First, Spectrum could not document how the
purchase price for these two companies was determined. Spectrum’s President stated that
19

2002-4453-3C

AUDIT RESULTS

Spectrum through CiviGenics did not negotiate the price. Rather, CiviGenics stipulated the
purchase price based upon an offer it had received from a third party. Moreover, the President
said that the third party had previously owned BRC, sold it to CiviGenics during 1998, and had a
renewed interest in owning the clinic again. The President, however, could not provide us with
any documentation to support his assertion.
Second, we found documentation to substantiate that BRC was experiencing serious operational
problems prior to this purchase, yet Spectrum made no attempt to negotiate the purchase price
to reflect these problems. In this regard, Spectrum paid a consultant $5,000 to study the
proposed purchase and sale of BRC. The consultant concluded that BRC was a viable going
concern that could become profitable within one year and that the sale should proceed as
scheduled. However, the consultant also pointed out that BRC had not been properly managed
for a number of years, which affected the morale and confidence of the professional staff,
employees, payers, patients, and other referring providers. Also, the consultant identified that
neither management nor the clinic staff had confidence in the accuracy of the monthly financial
statements, especially the revenue numbers. However, per joint instructions from Spectrum and
CiviGenics, the consultant’s study was not to include a valuation of the purchase price or the
quality of the assets and liabilities to be transferred.
Third, and most significant, the difference between Spectrum’s effective purchase price,
$3,273,100, and the value of the assets that it received, $598,183, represents purchased goodwill
totaling $2,674,917. Although goodwill is routinely classified as an asset for accounting purposes
and financial statement presentation, the goodwill purchased by Spectrum had no real value at
the time since, as the consultant reported, BRC was not a profitable entity and had several
management and morale issues.
Presently, Spectrum is amortizing this goodwill over a 10-year period, and for fiscal years 2001
and 2002, Spectrum’s amortization expense relative to this transaction, which it charged to state
contracts, totaled $454,736. Additionally, as previously mentioned, Spectrum financed this
purchase through a 10-year promissory note with CiviGenics, which it refinanced during
December 2001. For the 30-month period ended December 31, 2002, Spectrum incurred
interest charges relative to the goodwill totaling $233,352, which Spectrum charged to state
contracts.
20

2002-4453-3C

AUDIT RESULTS

Since Spectrum did not receive any value through the purchase of this goodwill at the time, the
resulting goodwill expense, $454,736, and the relative interest costs, $233,352, are unreasonable
costs and not related to the social service purposes of Spectrum’s state-funded programs. Thus,
these costs represent nonreimbursable expenses to the Commonwealth.
It is important to note again that the consultant hired by Spectrum and CiviGenics to review this
purchase concluded that BRC could become profitable within one year. To this end, Spectrum,
after acquiring BRC, made various managerial and operational changes to improve the clinic’s
operating efficiency, including merging BRC’s Leominster and Fitchburg sites and eliminating
unnecessary mid-level managers. Yet, despite these and other changes, Spectrum has been
unable to operate BRC at a break-even point. In fact, for fiscal years 2001 and 2002, BRC
experienced losses totaling $1,388,170 and $1,223,082, respectively. Spectrum’s President stated
that he was naive in believing that BRC’s costs could be reduced quickly and efficiently enough
to make the clinic profitable within just a few years after its purchase.
Because Spectrum did not have unrestricted revenues to offset these losses, it relied upon its
surplus state revenues to cover BRC’s operating losses.

Based upon 808 CMR 1.03 (7),

surpluses may be used by contractors for any of its established charitable purposes, provided
that no portion of the surplus may be used for any nonreimbursable cost set forth in 808 CMR
1.05, including unreasonable costs and non-program-related expenses.

In addition, OSD’s

Uniform Financial Report Auditor’s Compliance Supplement emphasizes that an expense is not
reimbursable simply because it satisfies some element of its organization’s mission. Rather, the
expense must be reasonable in nature and be of the kind that “would be incurred by a prudent
person under the circumstances.”
Several factors surrounding Spectrum’s purchase and operation of BRC reveal that BRC’s losses
totaling $2,611,252 are non-program-related expenses that are unreasonable in amount and
nature, and thus represent nonreimbursable expenses to the Commonwealth.

First, as

previously stated, the Commonwealth has not contracted with Spectrum for services at its BRC
site. Consequently, the losses incurred by the clinic are not directly related to the social service
program purposes of the Commonwealth.

2002-4453-3C

AUDIT RESULTS

Second, the Commonwealth does not routinely fund losses of this magnitude in programs that
serve state clients; therefore, the Commonwealth certainly should not pay for such losses in
programs such as BRC’s that neither receive state contracts nor serve state clients. In statefunded programs such losses would reflect a contractors’ inability to operate within the confines
of an agreed-upon program budget. In BRC’s case, the losses reflect Spectrum’s failure to keep
its operating costs in line with its clinical revenue.
Third, as previously reported, Spectrum paid a $2,674,917 premium (goodwill) for BRC’s and
CMS’s assets despite BRC’s operational and financial problems. A prudent person, prior to
acquiring such an entity, would have performed adequate due diligence to ensure that the entity
could be operated, at a minimum, at a break-even rate; otherwise, the venture could be doomed
for failure. Based upon BRC’s fiscal year 2001 and 2002 operating results, either Spectrum failed
to perform adequate due diligence or BRC’s operational and financial problems were much
worse than Spectrum believed. In either case, for Spectrum to expect the Commonwealth to
pay for its business mistakes relative to a speculative business venture is unreasonable and
unjustifiable under any set of circumstances.
In conclusion, given the fact that Spectrum’s purchase of BRC and CMS from its related party,
CiviGenics, was not an arms-length transaction, the management of these companies had a
responsibility to ensure that a fair market price was independently established relative to the
transaction.

Because both companies failed to do this, they did not meet their fiduciary

responsibilities to Spectrum’s state funding agencies or to CiviGenics’ stockholders. As a result,
the purchase price paid by Spectrum was unreasonable and led to unallowable charges to the
Commonwealth totaling $3,299,340 as indicated in the table below:
Fiscal Year

Unallowable Use of
State Funds to Pay
CRC Expenses

Unallowable
Interest**

2001

$1,388,170

$122,075

$238,068

$1,748,313

2002

1,223,082

83,799

216,668

1,523,549

2003

27,478

Total

$2,611,252

$233,352

$454,736

$3,299,340

Unallowable
Goodwill*

Total

* The actual goodwill expenses incurred by Spectrum relative to this purchase totaled $534,984 or $267,492 for both
fiscal years 2001 and 2002.

2002-4453-3C

AUDIT RESULTS

** The actual interest expenses incurred by Spectrum relative to this purchase totaled $335,937 or $167,836, $126,590
and $41,511 during fiscal year 2001, 2002 and 2003 (July through December 2003) respectively.

Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum $3,299,340 in unallowable expenses related to goodwill, interest charges, and
program losses that it charged to the Commonwealth through December 31, 2002. Also,
Spectrum must continue to take appropriate steps to ensure that the Commonwealth is not
charged for similar expenses in the future.
Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
The Organization notes the following with respect to its purchase of Boston Road Clinic,
Inc. (“BRC”) from CiviGenics and BRC’s operating activities as documented in the Report:
•

Spectrum did not purchase the corporate entity Boston Road Clinic, Inc. but
rather acquired some of the assets and assumed some liabilities.

•

After operating BRC for three years, the Organization now recognizes that the
purchase price paid to CiviGenics to acquire BRC was excessive.

•

BRC generated operating losses of $2,611,252 for the two-year period ended
June 30, 2002.

•

The facility currently operates at breakeven

The Organization disputes the following items documented in the Report with respect to
BRC:
•

The Organization relied upon Commonwealth surplus revenue retention to
fund the operating losses incurred by BRC during the two-year period ended
June 30, 2002.

•

The Organization charged amortization and interest associated with the
purchase of BRC to state contracts.

The Organization has always calculated and reported to OSD the amount of
Commonwealth surplus revenue retention derived from Commonwealth of Massachusetts
purchasing agencies. Based on these restrictions and the cumulative unrestricted
surpluses generated and maintained by the Organization, Spectrum concludes that nonstate resources were available to fund the losses incurred by BRC for the two-year period
ended June 30, 2002.
Conclusion: As stated above, the mental health service currently operates at breakeven.
At no time did Spectrum utilize surplus revenue retention to cover losses at the mental
health facility.

2002-4453-3C

AUDIT RESULTS

Auditor’s Reply

In its response, Spectrum acknowledges the fact that it paid an excessive price for Boston Road
Clinic (BRC) and that BRC generated operating losses during the first two years of its operation.
Given this fact, the $2,674,917 that Spectrum paid for goodwill is unreasonable and unallowable
and the $454,736 of amortized goodwill expense that Spectrum charged against its state
contracts to date is also unallowable. Also, BRC had not operated at a break-even point as of
the end of our audit period and in fact, as stated in our report, incurred losses totaling
$1,388,170 and $1,223,082 in fiscal years 2001 and 2002, respectively.
Spectrum incorrectly contends in its response that it had sufficient non-state revenue to fund the
losses incurred by BRC during the audit period. However, as stated in our report, the only
surplus funds Spectrum had available were surplus revenues generated by state contracts, and
their use is restricted to allowable expenses in state-funded programs, only. Since BRC does not
contract with the Commonwealth, any state surplus funds used to fund BRC would be
considered a non-program-related expense and therefore unallowable in accordance 808 CMR
1.00. Specifically, under 808 CMR 1.05(1) and 1.05(12), respectively, OSD defines Unreasonable
Costs and Non-Program Expenses as follows:
Unreasonable Costs. Any costs not determined to be Reimbursable Operating Costs as
defined in CMR 1.02 or any amount paid for goods or services which is greater than
either the market price or the amount paid by comparable Departments or other
governmental units within or outside of the Commonwealth.
Non-Program Expenses. Expenses of the Contractor, which are not directly related to the
social service Program purposes of the Commonwealth.

Regarding reimbursable operating

2002-4453-3C

AUDIT RESULTS

3. SPECTRUM’S BOARD CHAIRMAN RECEIVED UNALLOWABLE COMPENSATION TOTALING
$995,000

Our audit identified that the Chairman of Spectrum’s Board of Trustees received unallowable
compensation totaling $995,000. The payments, which spanned an 11-year period, resulted from
a management transition agreement between Spectrum and the Chairman dated December 24,
1991.

However, contrary to state regulations, Spectrum was unable to provide any

documentation to substantiate that the Chairman, in return for this compensation, provided
services that directly benefited Spectrum’s state-funded programs.

Thus, the Chairman’s

compensation represents a nonreimbursable cost to the Commonwealth. Additionally, the
Chairman received the majority of this compensation while working and residing in Alaska and
residing in Florida. Therefore, we question how this individual was able to adequately provide
the management services for which Spectrum paid him.
The 808 CMR 1.05(10), (12), (18), and (26) promulgated by OSD identifies the following as
nonreimbursable costs under state contracts:
(10) Fundraising Expense. The cost of activities which have as their primary purpose the
raising of capital or obtaining contributions, including the costs associated with financial
campaigns, endowment drives, and solicitation of gifts and bequests. . . .
(12) Non-Program Expenses. Expenses of the Contractor which are not directly related to
the social service Program purposes of the Contractor.
(18) Lobbying Costs. Funds used to compensate or reward lobbyists, consultants or staff to
promote, oppose, or influence legislation, or influence the governor’s approval or veto
thereof or to influence the decision of any member of the Executive branch where such
decision concerns legislation or the adoption, defeat, or postponement of a standard, rate,
rule or regulation pursuant thereto, and any costs associated with lobbying activities. . . .
(26) Undocumented Expenses. Costs which are not adequately documented in the light of
the American Institute of Certified Public Accountants statements on auditing standards for
evidential matters.

During our audit, we found that the Chairman’s compensation, which Spectrum billed against its
state contracts, was not in compliance with these regulations.
On December 24, 1991, Spectrum entered into a Management Transition Agreement
(Agreement) whereby the Agency’s President, who had served as President for 13 years, was
elevated to the titles of Chairman of the Board of Trustees and President Emeritus. Although
this Agreement required the Chairman to relinquish his duties as President, Spectrum wanted to
25

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retain the Chairman’s services in order to effect an orderly transition of its management and to
continue benefiting from services that he “uniquely” provided. In this regard, the Agreement
specified that during the period January 2, 1992 to December 31, 1998, the Chairman would
continue as an employee of Spectrum for consulting and development services, particularly in
regard to maintaining and expanding Spectrum’s relationships with donors, contractors,
governmental bodies, and trade associations. Additionally, the Agreement provided that the
Chairman could engage in other business endeavors, whether as an employee or otherwise,
provided such endeavors did not violate an existing non-competition agreement between the
parties.

In return for his services, Spectrum agree to compensate the Chairman through

December 31, 2003 as detailed in the following table.
Schedule of Chairman’s Compensation
January 2, 1992 through December 31, 2003
Calendar
Year
1992
1993

Compensation
$

Deferred*
Compensation

Annual
Payment

99,000
168,000

$ 70,000

99,000
98,000

1994

177,000

80,000

97,000

1995

177,000

81,000

96,000

1996

177,000

82,000

95,000

1997

168,000

83,000

85,000

1998

84,000

1999

83,000

2000

82,000

2001

81,000

2002

80,000

2003
_________
________
70,000
Totals
$1,050,000
$396,000
$1,050,000**
* The Chairman’s deferred compensation for fiscal years 1992 to
1997 was paid during fiscal years 1999 to 2003.
** Spectrum officials informed us that they reduced the amount of
compensation paid to the Chairman by $55,000. Consequently the
total amount of compensation paid to the Chairman totaled
$995,000.

In addition to the compensation detailed above, Spectrum also agreed to provide the Chairman
with hospitalization and medical insurance, and disability insurance equivalent to that provided
to its full-time employees until the earlier of his death or December 31, 2003. Despite our
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AUDIT RESULTS

numerous requests, Spectrum did not provide detailed information necessary for us to ascertain
the costs associated with providing these insurance benefits, which were charged to the
Commonwealth.
During our audit, we determined that the compensation and fringe benefit package provided to
the Chairman violated state regulations and, at a minimum, resulted in unallowable charges to
the Commonwealth totaling $995,000. In this regard, we identified the following factors that
clearly demonstrate Spectrum’s flagrant violation of state regulations, as well as the Chairman’s
propensity over time to violate these same regulations for his personal gain.
•

Under the Management Transition Agreement, the Chairman was compensated $995,000
for “consulting and development services particularly in regard to maintaining and
expanding Spectrum’s relationships with donors, contractors, governmental bodies, and
trade associations.” Such services represent fundraising and lobbying activities, which
are nonreimbursable costs under state regulations.

•

In a letter dated February 13, 2003 detailing his understanding of the Management
Transition Agreement, the Chairman revealed that his compensation package included a
gratuitous payment (bonus) for past employment. Specifically, he wrote, “This
Agreement provided compensation to me in the amount of $105,000 per year for ten
years in part as bonus for past employment and for consulting and development services
to be performed, particularly in regards to maintaining and expanding Spectrum’s
relationships with donors, contractors, governmental bodies and trade associations.”
Under state regulations, such payments are considered non-program-related expenses
and thus represent nonreimbursable costs to the Commonwealth.

•

During the audit, we requested Spectrum officials to provide supporting documents to
substantiate the Chairman’s services and to support the $1,050,000 that it charged to the
Commonwealth. However, the invoices supplied by Spectrum officials included the
same vague description of services, e.g., “Consulting services for the month of July,
2002.” Moreover, each invoice contained the same stamped receipt date, March 19,
2003, which indicates that Spectrum requested this documentation after the fact and
solely in response to our audit. Under state regulations, such undocumented expenses
are considered nonreimbursable costs to the Commonwealth. (See Appendix IV for an
example of the invoices supplied to us by Spectrum.)

•

Over the past 10 years, the Chairman has worked and resided in Anchorage, Alaska and
resided in Palm Coast, Florida. Consequently, during this period, we question whether
the Chairman was able to provide services essential to Spectrum’s state-funded
programs.

Lastly, as previously mentioned, the Chairman has served as Spectrum’s President or Chairman
of the Board of Trustees for the past 25- years. During that period, a reasonable person would
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AUDIT RESULTS

expect that the Chairman would have become well-versed in state contract regulations, especially
those regulations pertaining to reimbursable program costs. Such knowledge is critical to a
service provider’s survivability, basic information to a provider’s independent auditors, and
routinely emphasized at training sessions offered by OSD.

Consequently, the Chairman’s

decision to accept compensation totaling $995,000 without providing documented, necessary,
and program-related services represents not only an abuse of position, but also a waste of
taxpayer funds.
Recommendation

In order to address our concerns relative to this matter, we recommend that Spectrum identify
the cost of insurance benefits that it provided to the Chairman over the past 11 years.
Furthermore, the Commonwealth should recover from Spectrum this amount, as well as the
$995,000, since these expenses represent nonreimbursable costs to the Commonwealth.
Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
In 1991, Spectrum entered into a management transition agreement with the Chairman
of its Board of Trustees, who also previously served as Spectrum’s Chief Executive
Officer. The total value of the agreement was $1,050,000 with payments commencing in
1992.
From 1992 to 1995, Spectrum made payments under the agreement totaling $390,000.
Beginning in 1996 and through 2002, the payments under the agreement were made by
CiviGenics.
Spectrum does not challenge the non-reimbursable nature of these costs as presented in
the Report.
However, it is Spectrum’s contention that it is obligated to the
Commonwealth for only the amounts funded by Spectrum. . . . Spectrum’s obligation is
limited to $390,000. Since this is the amount paid by Spectrum directly.
Auditor’s Reply

In its response, CiviGenics acknowledges the non-reimbursable nature of the payments to the
Chairman but contends that it should only have to reimburse the $390,000 that it directly paid to
this individual. However, although Spectrum did not directly pay this individual these fees,
subsequent to fiscal year 1995, CiviGenics used the state funds that Spectrum paid it for
management services to make payments to this individual. In order to accurately report on these
issues separately, we did not reduce the allowable management fee expenses we identified in
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AUDIT RESULTS

Audit Result No. 1 by the amount CiviGenics paid the Chairman under their agreement.
Consequently, since Spectrum used state contract funds to pay the Chairman the entire $995,000
in nonreimbursable expenses, it should remit this amount to the Commonwealth
4. SPECTRUM MADE UNALLOWABLE LEASE PAYMENTS TOTALING $151,532 TO A RELATED
PARTY, SPECTRUM DEVELOPMENT CORPORATION, INC.

However, Spectrum’s lease payments

exceeded by $151,532 the allowable limits established by the OSD for payments made to related
parties. Therefore, Spectrum owes $151,532 to the Commonwealth.
In 808 CMR 1.02, OSD has promulgated regulations that define a related party as follows:
Any person or organization satisfying the criteria for a Related Party published by the
Financial Accounting Standards Board in Statement of Financial Accounting Standards No. 57
(FASB 57).

Moreover, Financial Accounting Standards Board (FASB) Statement No. 57, Related Party
Disclosures (AC section R36.406), defines a related party as follows:
Affiliates of the enterprise; entities for which investments are accounted for by the equity
method by the enterprise; trusts for the benefit of employees, such as pension and profit
sharing trusts that are managed by or under the trusteeship of management; principal
owners of the enterprise and its management, members of the immediate families of
principal owners of the enterprise and its management; and other parties with which the
enterprise may deal if one party controls or can significantly influence the management or
operating policies of the other to the extent that one of the transacting parties might be
prevented from fully pursuing its own separate interests.
Another party also is a related party if it can significantly influence the management or
operating policies of the transacting parties or if it has an ownership interest in one of the
transacting parties and can significantly influence the other to an extent that one or more of
the transacting parties might be prevented from fully pursuing its own separate interest. . . .

In November 1983, Spectrum, which was then known as Spectrum House, Inc., formed SDC in
accordance with Chapter 180 of the Massachusetts General Laws. According to its Articles of
Incorporation, SDC was established for the purpose of holding title to property on behalf of
Spectrum House, Inc. Although SDC was created as an independent nonprofit agency, we
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AUDIT RESULTS

believe that its ongoing activities with Spectrum constitute a related-party relationship as defined
by FASB Statement No. 57 for the following reasons:
•

Spectrum reported on its fiscal year 2001 Return of Organization Exempt From Income
Tax (IRS Form 990) that it was related to SDC through common membership,
governing bodies, trustees, officers, etc.

•

Spectrum reported on its fiscal year 2001 Public Charities Report, which is filed annually
with the State Attorney General, that it leased assets from a related party..

•

A private accounting firm reported that Spectrum’s fiscal year 2001 financial statements
include the activity and balances of both Spectrum and SDC (together, the Organization)
after elimination of all material accounts and transactions between the two entities.
These entities are affiliated by virtue of common management and common control.

•

SDC conducted its activities virtually exclusively with Spectrum during the past three
fiscal years. SDC’s activities during the period were limited solely to purchasing,
renovating, and leasing properties for Spectrum’s use.

As a consequence of its related-party relationship with SDC, Spectrum must comply with
regulations promulgated by OSD regarding related-party transactions. Specifically, 808 CMR
1.05(8) defines the following costs as being unreasonable and therefore nonreimbursable under
state contracts.
Related Party Transaction Costs. Costs which are associated with a related party transaction
are reimbursable only to the extent that the costs do not exceed the lower of either the
market price or the related party’s actual cost.

During our audit we noted that Spectrum violated OSD regulations governing related-party
transactions. Specifically, for the three-year period ended June 30, 2002, Spectrum made lease
payments to SDC totaling $597,848, while SDC’s cost to own and maintain the facilities for the
same period totaled only $461,783. Additionally, SDC earned interest totaling $15,467 on
overpayments that it received during and prior to our audit period. The difference between
SDC’s total revenue of $613,315 and total expenses of $461,783 represents an unallowable cost
of $151,532 that Spectrum directly charged to the Commonwealth as an occupancy expense
under its DPH, DSS, and DOC service contracts.
overpayments to SDC during this three-year period.

The table below details Spectrum’s

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AUDIT RESULTS
Overpayment to Related Party
Allowable Expense

Fiscal Year
2001

Fiscal Year
2002

$ 19,760

$ 22,880

$ 24,960

$ 67,600

45,237

51,550

51,614

148,401

63,626
10,728
$139,351

81,393
19,918
$175,741

52,615
17,502
$146,691

197,634
48,148
$461,783

Lease Payments

$183,828

$207,010

$597,848

Interest Income
Total Revenue

7,316
$191,144

6,003
$213,013

2,148
$209,158

15,467
$613,315

Overpayment

$ 51,793

$ 37,272

$ 62,467

$151,532

Condominium Fees
Building Depreciation
Interest
Other
Total Allowable Expense

Fiscal Year
2000

Total

Revenue

Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum the $151,532 of unallowable lease payments that it made to its related party,
SDC, during fiscal years 2000 through 2002.
Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
Spectrum currently leases space for its program operations from Spectrum Development
Corporation, Inc. (“SDC”), a related nonprofit organization. Spectrum is aware that
Commonwealth regulations limit the allowable costs under such related party agreements
to the actual amounts incurred by the related party (in this case SDC).
The Report documents that during the period from 2000 to 2002, Spectrum’s lease
payments to SDC exceeded SDC’s expenses associated with the property by $200,720.
The primary cause of this disparity is due to SDC establishing Spectrum’s rent to match
SDC’s cash flow needs, specifically, its debt service requirements on an eight-year
mortgage note payable underlying the property.
However, the related allowable
expense is the building’s depreciation, which is based on a 40-year useful life.
In addition, the allowable expenses of SDC that are detailed in the Report exclude
various other costs incurred by SDC (i.e., insurance, utilities, certain professional fees,
etc.) during fiscal years 2000, 2001 and 2002 that appear allowable.
Based upon the above, it is Spectrum’s contention that the rent payments made to SDC
constitute actual (cash flow) costs of SDC and therefore constitute allowable costs in
determining Spectrum’s rent payment.

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AUDIT RESULTS

Auditor’s Reply

We do not agree with Spectrum’s assertion that the rent payments it made to SDC constitute the
actual cash flow costs of SDC and hence, are costs that are allocable to state contracts. During
our audit, we asked Spectrum officials to provide us with all the documentation relative to
SDC’s ownership and operation of facilities utilized by Spectrum’s state-funded programs. To
date, Spectrum has not provided complete detailed costs records for these facilities. Given
Spectrum’s inability to provide us with the requested documentation, we used its records to the
extent possible to identify the expenses being incurred by SDC relative to the operation of the
facilities in question. Based on our analysis, we properly determined that Spectrum made
unallowable lease payments totaling $151,532 to SDC during the period under review.
5. SPECTRUM USED STATE PROGRAM REVENUES TOTALING $1,550,444 TO FUND BAD DEBT
EXPENSES, EXCESSIVE SALARY PAYMENTS, DEPRECIATION EXPENSES, FUNDRAISING
COSTS, AND FREE CARE

Our audit identified that Spectrum used state revenues to fund various nonreimbursable
program costs totaling $1,550,444, including bad debt expenses, excessive salary payments,
depreciation expenses, fund raising costs, and free care. These payments, which occurred during
the five-year period ended June 30, 2002, violated state regulations and resulted in unnecessary
charges to the Commonwealth. Moreover, these violations resulted primarily from Spectrum’s
improper reporting of investment income on its fiscal year 2002 UFR report financial statements
that it submitted to the Commonwealth as well as a technical flaw within the OSD fiscal year
2001 UFR report.
Under 808 CMR 1.05, OSD identifies expenses that represent nonreimbursable costs to the
Commonwealth, including bad debts, certain excessive salaries of officers and managers, certain
depreciation expenses, fundraising expenses, and free care, as follows:
Bad Debts. Those amounts (whether estimated or actual) which represent the portion of
an account or note receivable that proves to be entirely uncollectible despite collection
efforts including legal action, and any related legal costs.
Salaries of Officers and Managers. Salaries of officers and managers to the extent they
exceed the rate paid to state managers in job-group M-XII, step seven.

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Certain Depreciation.
(a) Depreciation for assets to the extent that the assets have previously been
depreciated by the Contractor.
(b) Depreciation which is computed by a method other than the following: an historical
cost basis with a straight line method; using a schedule of asset service lives pursuant to
DPS policy; and charging one half of the annual depreciation expense in each of the
years of acquisition and disposal.
(c) Depreciation on idle, excess, or donated assets or on that portion of an asset’s
historical cost basis, which was paid for from Restricted Funds.
(d) Depreciation on assets acquired under a capital budget approved by a Department
and held in trust for the Commonwealth of Massachusetts or depreciation on assets
acquired under a capital budget approved by a Department to which the Contractor holds
title under the terms of a contract.
Fundraising Expense. The cost of activities which have as their primary purpose the
raising of capital or obtaining contributions, including the costs associated with financial
campaigns, endowment drives, and solicitation of gifts and bequests…
Free Care. Costs associated with free service and use.

In accordance with the provisions of 808 CMR 1.00, state human service contractors must, on a
fiscal year basis, submit a properly completed UFR, which consists of audited basic financial
statements, independent auditor’s reports, and unaudited supplemental information (schedules,
forms, and letters). To assist state contractors fulfill this yearly requirement, OSD has issued a
UFR Audit and Preparation Manual. This document, among other things, specifies that nonpublic sources of revenue such as philanthropic contributions and gifts, federated fundraising,
(e.g., United Way), interest income, and commercial revenue may be used to offset
nonreimbursable costs. However, this manual prohibits contractors from utilizing state contract
funds, state surplus revenue, third-party fees, client resources, client sliding fees, Supplemental
Security Income, food stamps, etc., for this purpose.
Moreover, OSD requires contractors to disclose nonreimbursable costs within their annual UFR
filing to the Commonwealth, as well as the existence of an appropriate level of non-public
sources of revenue to defray their nonreimbursable expenses. These procedures established by
OSD attempt to ensure that the Commonwealth does not fund any part of nonreimbursable
program expenses.

2002-4453-3C

AUDIT RESULTS

Despite these rules and regulations, for the five-year period ended June 30, 2002, Spectrum used
state surplus revenues and restricted program funds to help defray nonreimbursable costs
totaling $1,550,444. Although Spectrum disclosed these unallowable costs within its applicable
UFR filing, the agency did not have sufficient non-public funds to cover the costs.
Consequently, Spectrum used funding intended for state clients to cover bad debt expenses,
excessive salaries, fundraising costs, and other unallowable expenses. The following table details
the extent to which Spectrum used state program revenues to cover its nonreimbursable costs.
Summary of Nonreimbursable Costs*
Fiscal Years 1998 through 2002
Expense

2002

Bad Debts

$ 554,568

$ 590,361

$ 548,700

190,374

203,444

77,026

470,844

56,914

59,560

11,594

128,068

1,978

2,105

2,878

3,102

1,885

11,948

_________
$ 803,834

_________
$ 855,470

_________
$ 640,198

106,503
$ 558,882

73,811
$ 538,656

180,314
$ 3,397,040

$ (343,868)

$ (237,093)

$(401,506) $(432,924)

$ (431,205) ) $(1,846,596)

$ 618,377

$ 238,692

$ 107,451

Fundraising
Excessive Salary
Depreciation
Free Care
Total Expenses
Allowable Offset
Unallowable Costs

459,966

2001

2000

1999
$ 449,277

$ 125,958

1998
$ 462,960

Totals
$ 2,605,866

$ 1,550,444

* The nonreimbursable costs and non-public revenue attributable to Spectrum’s Boston Road Clinic and out-of-state
programs are excluded from this table, since Audit Results No. 3 and No. 4 take these nonreimbursable expenses
into account.

During this five-year period, Spectrum reported available non-public funds to the
Commonwealth that appeared to sufficiently cover its nonreimbursable costs. In this regard,
Spectrum’s UFRs detailed non-public funds totaling $4,480,290 and nonreimbursable costs
totaling only $3,397,040. Although Spectrum’s figures presented a sound financial picture to the
Commonwealth relative to this matter, our review found that Spectrum in fact had only
$1,846,596 available to cover its nonreimbursable costs. Highlighted below are the specific
problems we found relative to this matter.
•

During fiscal year 2002, Spectrum made a $2 million lump-sum payment to its related
party, CiviGenics. This payment was made relative to a promissory note that Spectrum
had issued to CiviGenics for the purchase of BRC (see Audit Result No. 3). In
consideration of the lump-sum payment, CiviGenics, as of December 27, 2001, released
Spectrum from the balance of the promissory note ($2,564,115). This transaction
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2002-4453-3C

AUDIT RESULTS

resulted in a $564,115 savings for Spectrum, which the agency improperly reported as
“other income” on its fiscal year 2002 UFR and designated as an offset to its
nonreimbursable costs for the fiscal year.
Spectrum’s reporting of this transaction was improper since the $2 million payment did
not generate additional revenue/income for the agency. Rather, the lump-sum payment
enabled Spectrum to effectively reduce the purchase price of BRC and thus reduce its
future cash outlays relative to the purchase. Therefore, Spectrum should have accounted
for this transaction by revaluing BRC’s assets and liabilities instead of artificially inflating
its program revenues.
•

During fiscal year 2001, Spectrum relied upon private client fees and private client thirdparty reimbursements totaling $559,588 to help offset its nonreimbursable costs.
However, according to OSD regulations these funds cannot be used to offset an entity’s
nonreimbursable expenses.
It should be noted that OSD’s fiscal year 2001 UFR was flawed in that OSD designated
client resources, private client fees, and private client third-party reimbursements as
allowable offsets to nonreimbursable costs. Although this flaw went undetected by OSD
and Spectrum, it does not waive Spectrum’s contractual responsibility to comply with the
provisions of 808 CMR 1.00. In this regard, 808 CMR 1.03(3) states the following:
CMR 1.00 Prohibitions. The failure of a Department or DPS [OSD] to identify
violations of 808 CMR 1.00 in determining or authorizing a price shall not be
deemed a waiver of violations of 808 CMR 1.00 which are identified later.

•

During fiscal years 2000, 1999, and 1998, Spectrum did not have sufficient non-public
funds to cover its nonreimbursable costs. As the preceding table details, Spectrum’s
nonreimbursable costs for these periods exceeded its allowable offsets by $238,692,
$125,958, and $107,451, respectively.

In each of these cases, Spectrum overbilled the Commonwealth because it did not have a
sufficient amount of non-public funds to defray its nonreimbursable costs.

Moreover,

Spectrum’s financial shortfall during this five-year period caused it to rely upon $1,550,444 of
state program revenues to fund its non-reimbursable costs.
Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum the $1,550,444 in state program revenues that it used to defray nonreimbursable
costs over the five-year period.

2002-4453-3C

AUDIT RESULTS

Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
As noted in the Report, the Organization had reported $2,605,866 of bad debt expense
in its UFRs for its fiscal years ended June 30, 1998 through 2002. The Organization has
reviewed available documentation for those periods and determined that the majority of
these adjustments were contractual allowances and not bad debts.
As detailed in the Operational Services Division’s (“OSD”) UFR Audit and Preparation
Manual, “contractors frequently are involved with contractual allowances and confuse
those allowances with bad debts. It is important to recognize the distinction between
bad debts and contractual allowances because contractual allowances are not considered
non-reimbursable items. Contractual allowances occur frequently in the purchase-ofservice (“POS”) system. For instance, when fees are charged to a third party for a
special service rendered by a contractor to an individual. Contractual allowances should
be netted with the revenue when the revenue is recorded at its gross amount and not
recorded via an allowance for doubtful accounts as bad debt.”
Based upon the above, the Organization has adjusted its UFR’s for the fiscal years ended
June 30, 1998 through 2002. . . .At no time did Spectrum utilize commonwealth funds to
apply for unallowable expenses. Mistakenly filed UFR’s do not constitute improper use of
state funds.
Auditor’s Reply

We note that in its response Spectrum does not take issue with the $791,174 in excessive salary
payments, depreciation, fundraising, and free care expenses that we cite as being unallowable in
our report. Therefore, Spectrum should remit these amounts to the appropriate state agencies.
Regarding the unallowable bad debt expense, Spectrum claims in its response that these amounts
were improperly classified and were in fact, contractual allowances and not bad debt expenses.
In its Uniform Financial Reports Audit and Preparation Manual for fiscal year 2002, OSD draws
the distinction between bad debt expenses and contractual allowances by stating the following:
Contractual allowances; are frequently recognized by the fact that they were never
considered to be a firm or good receivable that carried a legal obligation for payment.
Whereas, bad debts are recognized by the fact that there is a legal obligation for
payment associated with the bad debt.
Contractual allowances occur frequently in the purchase-of-service (POS) system. For
instance, when fees are charged to a third party, i.e., an insurance company for a
specific service rendered by a Contractor to an individual. The third party has an
agreement to pay a specific price for the service rendered. The Contractor may charge
more for that service for various reasons but will only be paid the agreed upon price by
the third party. The difference between the gross amount charged by the Contractor and
the amount agreed to for a particular service is considered a contractual allowance and
not a bad debt.

2002-4453-3C

AUDIT RESULTS

Accounting for contractual allowances: Contractual allowances should be netted with the
revenue when the revenue is recorded at its gross amount and not recorded via an
allowance for doubtful accounts as bad debts.
If a receivable is recorded that was never a good receivable, it should be adjusted by
crediting the account receivable and debiting the revenue account directly or debiting a
contractual allowance account which would be netted with the third-party revenue for
financial statement presentation.
Contractual allowances have no effect on the excess revenue over expenses for financial
statements when they are properly recorded.

As noted in our report between fiscal years 1998 and 2002, Spectrum charged a total of
$2,605,866 in bad debt expenses against its state contracts. If these were in fact contractual
allowances and not bad debt expenses, Spectrum should have complied with OSD guidelines by
netting these allowances out of the total revenue and not reporting them on its UFR. By not
doing so, Spectrum overstated its revenue by $2,605,866. Since CiviGenics management fee was
based on a percent of Spectrum’s revenue, the incorrect accounting of this revenue by Spectrum
would have resulted in CiviGenics receiving excessive compensation for management services
during these fiscal years. Further, the misrepresenting of this revenue denied state oversight
agencies the opportunity to properly monitor the activities of the agency.
Although Spectrum officials contend that these were in fact contractual allowances and not bad
debt expenses, to date it has not provided us with any documentation to substantiate this claim.
Further, we note that Spectrum made this alleged mistake each year during our audit period of
July 1, 1994 through December 2002.
Consequently, we recommend that the Commonwealth recover from Spectrum the $1,550,444
in state program revenues that it used to defray nonreimbursable costs over the five-year period.
Finally, if during the audit resolution phase Spectrum provides documents to support its claim
that bad debts were in fact contractual allowances, then the Commonwealth should make an
appropriate adjustment to the amount due from Spectrum.
6. SPECTRUM IMPROPERLY UTILIZED STATE PROGRAM REVENUES TOTALING $1,151,540
TO FUND OUT-OF-STATE PROGRAM LOSSES DURING FISCAL YEARS 1998 AND 1999

Our audit identified that Spectrum utilized state program revenues totaling $1,151,540 to fund
losses incurred by its out-of-state programs. Spectrum, which primarily serves Massachusetts
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AUDIT RESULTS

residents who suffer with substance abuse and domestic violence issues, also operates a
Department of Youth Services (DYS) program within the state of Hawaii as well as Department
of Correction (DOC) programs within the states of Georgia, North Carolina, and Rhode Island.
During fiscal years 1998 and 1999, Spectrum received funding totaling $4,405,371 for these outof-state programs, which was virtually limited to Non-Massachusetts State Service Fees.
However, during the same period, Spectrum incurred operating expenses within these programs
totaling $5,556,911. Consequently, for the two-year period, Spectrum’s combined operating
losses for its out-of-state programs totaled $1,151,540.
Our audit indicated that, to cover its operating losses, Spectrum improperly used state program
revenues, including client fees, retained state surpluses, state contract revenues, and third-party
payments. Under 808 CMR 1.00, Spectrum is required to use such resources only to serve
Massachusetts residents and to cover operating expenses within its state-funded programs. By
using state resources to finance out-of-state program losses, Spectrum displayed a continued
unwillingness to safeguard the Commonwealth’s assets against loss, waste, and misuse.
Under 808 CMR 1.00, OSD issued the Commonwealth’s UFR Audit and Preparation Manual, in
which OSD details the appropriate treatment of client fees and third-party payments:
Certain revenues such as client resources or third party payments made on behalf of a client
are commonly judged to be unrestricted revenues and available to defray non-reimbursable
costs. However, when these revenues are received in a Commonwealth program, they must
be used to defray or offset reimbursable operating costs and to reduce the amount of the
Commonwealth’s obligation for services rendered to the client (pursuant to 808 CMR 1.18,
(Effective 2\1\97 808 CMR 1.03(5) ). These revenues are commonly referred to as
Commonwealth required offsetting revenues (defined in 808 CMR 1.02) to be used for
program or invoice offsets.

Based upon Spectrum’s fiscal years 1998 and 1999 UFRs, the agency received client fees and
third-party payments totaling approximately $1.9 million and $1.5 million, respectively.
However, contrary to 808 CMR 1.00, Spectrum used $556,242, or 16%, of this amount to defray
operating expenses of its out-of-state programs. During the audit, Spectrum’s Fiscal Director
acknowledged that these client fees and third-party payments were misapplied but could not
provide a further explanation for the violation.
Additionally, during fiscal years 1998 and 1999, Spectrum received four human service contracts
from the Massachusetts Department of Public Health that totaled approximately $8.8 million.
38

2002-4453-3C

AUDIT RESULTS

Although these contracts were intended to serve Massachusetts residents with substance abuse
and domestic violence issues, Spectrum reallocated $69,057 of this amount to help fund its
programs based in Hawaii, Georgia, North Carolina, and Rhode Island. By subsidizing these
out-of-state programs with Commonwealth contract funds, Spectrum directly violated 808 CMR
1.02, which defines reimbursable operating costs as follows:
Reimbursable Operating Costs. Those costs reasonably incurred in providing the services
described in the contract . . . .Operating costs shall be considered “reasonably incurred” only
if they are reasonable and allocable using the standards contained in Federal Office of
Management and Budget Circular A-122 or A-21, or successors thereto.

Lastly, Spectrum’s fiscal years 1998 and 1999 UFRs identified “realized gains on investments”
totaling $1,102,335, of which Spectrum designated $1,039,890 as out-of-state program revenue.
The reported gain resulted from a revaluation of Spectrum’s common stock holdings, 50,000
shares, in its related party, CiviGenics. Specifically, from October 15, 1995 through June 30,
1997, Spectrum utilized the equity method to value this investment. After this date, Spectrum
changed to the fair market valuation method, which effectively increased the book value of its
holdings from $22,665 to $662,500 as of June 30, 1998 and $1,125,000 as of the close of fiscal
year 1999.
However, our audit identified that Spectrum did not actually realize a $1,102,335 cash gain on its
investment, since the 50,000 shares of common stock were not sold, but simply revalued by the
agency. Moreover, until Spectrum sells this investment and the proceeds from the sale are
designated by Spectrum’s Board of Directors to defray program costs, any change in the stocks’
computed value must be treated as an unrealized gain/loss on investment and not a source of
funds to offset any expenses.
Since unrealized gains do not effectively increase an entity’s cash flow, state contractors must
identify alternative sources of revenue to offset their program costs. In Spectrum’s case, it did
not have an allowable alternative source of revenue to help fund its out-of-state-program losses.
Consequently, Spectrum improperly used state surplus revenues to help maintain its out-of-stateprograms. By doing so, Spectrum violated 808 CMR 1.00, which indicates that state surpluses
may not be used for any nonreimbursable cost set forth in 808 CMR 1.05, including
unreasonable costs and non-program-related expenses. Since the Commonwealth does not fund
39

2002-4453-3C

AUDIT RESULTS

out-of-state programs, Spectrum’s use of state surpluses represents an unreasonable cost and a
nonreimbursable expense, as defined below.
Unreasonable Costs. Any costs not determined to be Reimbursable Operating Costs as
defined in 808 CMR 1.02 or any amount paid for goods or services which is greater than
either the market price or the amount paid by comparable Departments or other
governmental units within or outside of the Commonwealth.
Non-Program Expenses. Expenses of the Contractor which are not directly related to the
social service Program purposes of the Contractor.

In each instance, Spectrum overbilled the Commonwealth because it failed to identify an
allowable source of revenue sufficient to help fund its out-of-state program losses. The table
below details the extent to which Spectrum utilized state program resources to offset operating
losses within its out-of-state programs during fiscal years 1998 and 1999.
Summary of State Program Resources Used to Cover Out-Of-State Losses
Fiscal Years 1998 and 1999
State Resources
Client Fees
Retained Surplus Revenues
DPH Contract Revenues
Third-Party Payments
Total

Fiscal Year
1998

Fiscal Year
1999

$273,888

$280,171

$ 554,059

266,183

260,058

526,241

30,354

38,703

69,057

1,315
$571,740

868
$579,800

2,183
$1,151,540

Total

Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum the $1,151,540 in state program revenues that it used to offset costs associated
with its out-of-state programs.
Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
The Report states that $1,151,540 of losses incurred in out-of-state programs during
fiscal years 1998 and 1999 were funded by state program revenues. While the out-ofstate programs in question did in fact incur losses during the fiscal years identified, the
Organization contends that these losses were funded by its unrestricted net assets,
exclusive of Commonwealth surplus revenue retention.

2002-4453-3C

AUDIT RESULTS

At June 30, 1997, the Organization had unrestricted net assets of $2,917,565 (net of
Commonwealth surplus revenue retention of $356,518). At June 30, 1998 and 1999,
this balance increased to $4,838,276 (net of $308,000) and $6,153,213 (net of
($353,374), respectively. . . .Based upon the cumulative unrestricted surpluses generated
and maintained by the organization as a whole, prior to and during fiscal years 1998 and
1999, Spectrum concludes that non-state resources were available to fund the losses init
s out-of-state programs.
Auditor’s Reply

As stated in our report, we found that Spectrum allocated $1,151,540 in state funds to pay for its
out-of-state expenditures. In its response Spectrum contends that it had sufficient unrestricted
net assets to pay for the out-of-state program costs in question. However, our review of agency
records indicated that Spectrum did not have a sufficient amount of net assets derived from
non-Massachusetts state contracts to for these expenses. Consequently, Spectrum owes the
$1,151,540 in out-of-state program costs it improperly charged against its Massachusetts state
contracts.
7. SPECTRUM IMPROPERLY USED STATE PROGRAM REVENUES TO FUND UNREASONABLE,
UNALLOWABLE, AND UNDOCUMENTED TRAVEL EXPENSES TOTALING $42,695

Our review indicated that Spectrum used state program revenues totaling $42,695 to fund
unreasonable, unallowable, and undocumented travel costs during fiscal years 2000 through
2002. These unreasonable, unallowable, and undocumented costs resulted from Spectrum’s (a)
reimbursing the Board Chairman for his commuting costs from Alaska and Florida to attend
monthly board meetings, (b) using state funds to help cover the associated travel costs of
Spectrum representatives visiting out-of-state programs, and (c) maintaining inadequate
supporting documentation for its travel costs. Based upon state program regulations such
unreasonable, unallowable, and undocumented costs represent nonreimbursable expenses to the
Commonwealth. Consequently, Spectrum owes $42,695 to the Commonwealth.
a.

Unreasonable Travel Costs

The state’s OSD has promulgated regulations that specifically identify costs that are
nonreimbursable under state contracts. In this regard, 808 CMR 1.05(1) identifies the following
as a nonreimbursable cost:
Unreasonable Costs: Any amount paid for goods or services which is greater than either the
market price or the amount paid by comparable Departments or other governmental units
within or outside of the Commonwealth.

2002-4453-3C

AUDIT RESULTS

While this state regulation characterizes unreasonable terms of relative costs, federal guidelines,
with which Spectrum must comply, define unreasonable costs in a broader context. Specifically,
Office of Management and Budget (OMB) Circular A-122 characterizes unreasonable costs as
costs “which do not effect the actions a prudent person would take in the circumstances.”
Over the past nine years, Spectrum’s Chairman maintained residency outside of Massachusetts,
which has led to the agency’s allocating unreasonable travel costs to its state-funded programs.
In this regard, from January 1994 to December 2000, the Chairman lived and worked in
Anchorage, Alaska and subsequently relocated to Palm Coast, Florida, where he presently
resides. During our three-year audit period, the Chairman commuted to 26 Board of Trustees
meetings and incurred associated travel costs totaling $23,721. Of this amount, Spectrum
allocated $20,901 to its state programs and $2,820 to its non-state programs. The table below
details the Chairman’s travel costs from July 1, 1999 to June 30, 2002.
Spectrum Health Systems, Inc.
Summary of Chairman’s Commuting Costs
Fiscal Years 2000 through 2002
Fiscal Year

Air Fare

Meals

Hotel

Auto Rental

Misc.

Total

State
Allocation

2000`

$ 3,111

$163

$1,937

$ 780

$ 228

$ 6,219

$ 5,535

2001

7,507

180

4,229

2,271

682

14,869

13,234

2002
Total

1,496
$12,114

90
$433

106
$6,272

128
$3,179

813
$1,723

2,633
$23,721

2,132
$20,901

Had Spectrum used individuals from within the Commonwealth to serve on its board, as is the
case with the vast majority of the human service organizations that the Office of the State
Auditor has audited, it would not have incurred the $20,901 in unreasonable board-related
commuting costs. Moreover, these funds would then have been available to provide needed
services to Spectrum’s consumers.
b. Unallowable Travel Costs

In 808 CMR 1.05(12), OSD has promulgated regulations that specifically identify non-programrelated expenses as nonreimbursable costs under state contracts, as follows:
(12) Non-Program Expenses. Expenses of the Contractor which are not directly related to
social service program purposes of the Contractor.

2002-4453-3C

AUDIT RESULTS

During our audit, we found that Spectrum officials and representatives visited the agency’s outof-state programs located in Hawaii and Georgia and traveled to California, Colorado, and New
Jersey in an effort to expand the agency’s operations through program acquisitions and
corporate mergers. In total, Spectrum officials made 18 out-of-state trips during fiscal years
2000 through 2002. These trips cost $23,187, including the cost of airfares, hotels, meals, and
other miscellaneous expense. Although these trips did not benefit the Commonwealth in any
manner, Spectrum nevertheless allocated $20,523 of the total costs to its state-funded programs.
Consequently, Spectrum violated OSD’s regulations governing non-program-related expenses.
The table below details the $20,523 in non-program-related travel expenses that Spectrum
inappropriately charged to the Commonwealth during the three-year period ended June 30,
2002.
Spectrum Health Systems, Inc.
Summary of Non-Program-Related Travel Expenses
Fiscal Years 2000 through 2002

Fiscal Year

Hawaii

2000

$ 2,505

2001

7,589

2002
Total

853
$10,947

Georgia

New
Jersey

Colorado

$ 6,959

$ 550

$1,154

$11,168

$ 9,939

3,018

10,607

9,440

______
$550

______
$1,154

1,412
$23,187

1,144
$ 20,523

$559
$559

______
$9,977

Total

State
Allocation

California

Undocumented Travel Costs

OSD has promulgated regulations that specifically identify undocumented expenses as
nonreimbursable costs under state contracts.

Specifically, 808 CMR 1.05(26) defines

undocumented expenses as follows:
Undocumented Expenses. Costs which are not adequately documented in the light of the
American Institute of Certified Public Accountants statements on auditing standards for
evidential matters.

In addition to the unreasonable and unallowable travel expenses noted above, we also identified
that Spectrum, in some instances, did not maintain adequate supporting documentation for its
travel costs. Specifically, for fiscal years 2000 through 2002, Spectrum allocated $1,271 of travel
expenses to its state-funded programs for which the agency did not have any travel records on
file to substantiate the charges.
43

2002-4453-3C

AUDIT RESULTS

Recommendation

In order to address our concerns relative to this matter, the Commonwealth should recover
from Spectrum the $42,695 in unreasonable, unallowable, and undocumented travel costs that
Spectrum charged to Commonwealth programs.
Auditee’s Response

In response to this audit result, Spectrum provided the following comments:
The Report identified $42,695 of unallowable travel expenses incurred during fiscal years
2000 through 2002. Spectrum does not challenge the non-reimbursable nature of these
costs. . . .

2002-4453-3C

APPENDIX

APPENDIX I
Spectrum Health Systems, Inc.
State Program Services and Service Locations

Service
Location
Boston

Substance Abuse & Mental
Health Outpatient Services

Adolescent
Services

Women’s
Services

Correctional
Recovery
Academy

Transitional
Services

Yes

Bridgewater
Charlestown

Yes

Chelsea

Yes

Concord
Dorchester

Addiction
Center

Reintegration
Services

Yes

Assessment
Center

Family
Services

Detox. &
First Residential Rehab.
Step Services Services

Community
Resource
Center

Yes

Fitchburg

Yes

Framingham
Gardner

Yes
Yes

Yes

Hingham

Yes
Yes

Lancaster
Leominster

Yes

Lowell

Yes

Lynn

Yes

Methuen
Milford

Yes

Yes
Yes

Norfolk

Yes

Plymouth

Yes

Quincy

Yes

Roxbury
Shirley

Psych. &
Counseling
Services

Yes
Yes

Walpole

Yes

Webster

Yes

Westboro

Yes

Worcester

Yes

Yes
Yes

Yes

2002-4453-3C

APPENDIX

APPENDIX II
Spectrum Health Systems, Inc.
President’s Recommendation to Terminate CiviGenics Management Contract

Confidential Memo to the Board of Trustees of Spectrum Health Systems
Charles J. Faris, President/CEO
February 11, 2002
Spectrum entered into a management contract with CiviGenics, Inc. in May of 1995. The
intent was to provide management services for Spectrum, which included all business management
functions, quality improvement, accreditation, human resource functions, proposal development
and senior leadership. Additionally, there was a mandate to effect growth of Spectrum’s services in
both depth and breadth while assuring a positive net surplus at the end of each year. Spectrum
received a common stock equity position in CiviGenics of approximately 3.8%. The hope at the
time was that CiviGenics would grow successfully and eventually go public or be acquired and
Spectrum’s equity position would yield a substantial return that could be used as the basis for an
endowment for the organization. CiviGenics would receive 1 % less than Spectrum’s management
expenses at that time, FY’95 with provisions going forward for a percent of the gross that
exceeded the cost of management in FY’95.
The contract was amended January 1, 1996.
In the last two fiscal years, FY’00 & FY’01, CiviGenics has played no role in effecting
Spectrum’s growth. In that time, Spectrum’s revenues grew 13% and 21 respectively. This year
projects out to approximately 7% growth. However in that same period of time, the last three
fiscal years, the management fee has grown 18%.
CiviGenics, while financially healthy, has leveled off in their growth and has been stagnant.
There is no opportunity that an IPO will be offered thus, eliminating the hope that the equity
position will translate into a windfall basis for an endowment. The affiliation with CiviGenics
through the management agreement no longer brings any added value to Spectrum.
Over the last two years Spectrum has reinvested in the organization to build a management
infrastructure to guide the organization through the next several years. The expense of this
management team is over and above the management fee paid to CiviGenics. At this point,
CiviGenics provides no management to Spectrum but rather acts as an outsourcing company that
provides accounting, Human Resource support, information technology services and support and
proposal development. All of these services could be provided in house by Spectrum at substantially
less what we currently pay CiviGenics.
By terminating the management contract with CiviGenics, we would free up a substantial
amount of resources that could be re-invested back into services while-still leaving a healthy
reserve which will be needed during the expected lean times of the next few years.
46

2002-4453-3C

APPENDIX

APPENDIX III
Spectrum Health Systems, Inc.
Example of CiviGenics Billing Invoice/Department of Correction

2002-4453-3C

APPENDIX

APPENDIX IV
Spectrum Health Systems, Inc.
Example of Chairman’s Billing Invoice