SEC Settles Bond Case Centered on Construction of Charter Schools

by Dorsey & Whitney LLP

The Commission continues to focus on the municipal bond market, filing a settled action against two state grant recipients who were supposed to construct charter schools. The action, alleging fraud in connection with the sale of municipal bonds, centers on undisclosed conflicts with could jeopardize the ability to repay the bonds. SEC v. United Neighborhood Organization of Chicago, Civil Action No. 1:14-cv-04044 (N.D. Ill. Filed June 2, 2014).

Defendant United Neighborhood or UNOC is a not-for-profit corporation founded as a Hispanic community organization. It is an affiliate of, and provides management services for, Defendant UNO Charter School Network, Inc. or UCSN, also a not-for-profit. UCSN is the largest operator of charter schools in the State of Illinois.

The Defendants became involved with charter schools in the late 1990s. Subsequently, they lobbied the State of Illinois for grants to construct charter schools. In 2010 the Defendants entered into a grant agreement with the Illinois Department of Commerce and Economic Opportunity or IDCEO. The next year a second grant agreement was executed. The grants were for the construction of three schools and totaled $88 million.

Each grant agreement contained a provision regarding conflicts involving the officers and directors of the firms and their family members. In part the provisions prohibited conflicts which might give the appearance of “being motivated by a desire for private gain . . . for themselves or others, particularly those with whom they have family business . . .” Each agreement also stipulated that there were no existing conflicts and that IDCEO would be notified by the Defendants if one arose. Each concluded by prviding that if there was a violation of the conflict provisions, the Agreements were suspended and the grant funds could be recovered in which case there would be no other source of funds for the construction. The Defendants executed the agreements.

At the time the agreements were executed, however, the Defendants had engaged one company, and approved the engagement of another, for services. Each company was owned by a brother of the then Senior Vice President /Chief Operating Officer of UNOC. Additional agreements were subsequently reached with the two firm. In sum, the Defendants contracted to pay one company about $11 million for windows and the other about $1.9 million to serve as an owner’s representative during the construction.

In October 2011 Charter School Refunding and Improvement Revenue Bonds were issued in the principal amount of approximately $37.5 million. The Defendants issued an Official Statement that informed investors about their “Conflicts Policy.” That policy, investors were told, was more robust than required. The conflict regarding the owner’s representative agreement was disclosed. The agreement regarding the windows was not. Investors also were not told that IDCEO had not been advised about the agreements. Nor were they told that IDCEO could recoup the grant money,, effectively ending the construction and any ability to repay the bonds.

In February 2013 the Chicago Sun-Times published an article concerning the use of state grant funds by the Defendants. That article alleged violations of the conflict provisions of the grant agreements. When subsequently asked about the allegation by IDCEO, the Defendants denied the conflicts but noted that the COO would be terminated, that the contract with the owner’s representative would be suspended and that an independent audit and review would be conducted.

Two months later IDCEO send the Defendants a letter stating that the grant agreements would be temporarily suspended and that additional payments would be withheld until further notice. The action was taken in view of the failure of the Defendants to identify and report the appearance of a conflict of interest based on the agreements with family members. At the time just less than half of the grant money had been paid out. The Defendants were subsequently unable to make timely payments to construction contractors. Liens were placed on one of the schools. The Commission’s complaint alleges violations of Securities Act Section 17(a)(2).

Defendants resolved the proceeding with each Defendant agreeing to undertakings to improve their internal procedures and training. An independent monitor will also be appointed.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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