Junk bonds fuel a building spree, but schools are more crowded, insiders are taking fees, and state regulators can't do much about it.
St. Croix Preparatory School's Executive Director Jon Gutierrez prepared to cut the ribbon that ceremonially opened the school's new building on Stagecoach Trail North in Stillwater in September. To the left of him is school board member Carroll Davis-Johnson.
Minnesota's charter school movement, which sparked a national rethinking of public schooling nearly two decades ago, has been infected by an out-of-control financing system fueled by junk bonds, insider fees and lax oversight.
State law prohibits charter schools from owning property, but consultants have found a legal loophole, allowing proponents to use millions of dollars in public money to build schools even though the properties remain in the hands of private nonprofit corporations.
The key to making it all work is the state's lease aid program, which was created 11 years ago to help spur competition in public education by offering rental assistance to groups promoting alternatives to district schools. In the beginning, many charters were located in dumpy strip malls and received no real-estate grants.
But the once-obscure program has snowballed into one of the fastest growing expenses in the state, with building projects receiving little of the vetting that typically accompanies other public works. One school project was being led by a convicted sex offender until this month, when the Star Tribune exposed his past.
In the past decade, 18 charter schools have been built with $178 million in junk bonds, with financing costs on some projects chewing up nearly a quarter of the funds raised. Twelve more charter schools have taken steps to buy or build facilities, and the state projects annual spending on lease aid to reach $54 million in 2013, up from just $1.1 million in 1998.
To lure the investors they need for new buildings, some educators are abandoning the intimate campuses their founders envisioned and are building large schools that look more like the conventional institutions that some families are fleeing. Some charter school advocates say the build-your-own trend could undermine an education movement built on small class size and parental inolvement.
"It destroys the intent and initial purpose behind all of it,'' said Paul Simone, director of the Math and Science Academy charter school in Woodbury, a National Blue Ribbon award winner under the No Child Left Behind Act.
State lawmakers are frustrated by the building boom. Since 2000, at least 64 public school buildings in the metro area closed because of declining enrollment. Charter schools are responsible for recruiting away some of those students.
"When district schools are closing, should we allow charter schools to build new buildings?" said Rep. Jim Abeler, R-Anoka, who was cleared in 2001 of legislative ethics charges for voting to boost lease aid even though he personally received the funds from a charter school he helped start. "These are being built with 100 percent state moneys, but who is minding the store on using that money well?"
Fees for insiders
For major construction projects at district schools, elected school board members must win approval from voters for the money, but self-appointed charter school officials have been able to plan projects in relative privacy. Until recently, the state had virtually no veto power.
Legislators changed some of the rules this year. A charter school must now operate in a rented facility for at least eight years before building a school, and proponents must explain to the state Education Department why they want a new facility.
But Deputy Education Commissioner Chas Anderson and key lawmakers say broader steps are needed.
Unlike 26 other states that have imposed caps on charter school expansion, Minnesota has no limits on the size of its program or on state support. There's nothing in the new law that would return the facilities to the state once they are paid for -- even if the school were to fail. In fact, school backers can continue to obtain lease aid even after construction bonds are paid off. And while the state's top education official must now sign off on new projects, few schools are ever halted because of state interference.
Taxpayer approval also remains unnecessary. A charter school simply needs to find a municipality willing to lend its name to a deal, even if that community is far removed from the school.
That is how it worked two years ago, when the Otsego City Council balked at financing a charter school. Undeterred, school promoters went 35 miles down the road to Falcon Heights, where officials were persuaded to authorize the bond issue in exchange for a $45,000 "processing fee." As is standard in such deals, the city of Falcon Heights was indemnified against default, merely acting as a "conduit" to give the bonds tax-exempt status.
The elementary school was built in Otsego, and Falcon Heights banked the money for a new firetruck.
Such discretionary fees are not uncommon in charter school projects.
At St. Croix Preparatory Academy, a K-12 charter school that opened in new space this year near Stillwater, three insiders rewarded themselves with $140,000 in fees related to the $21.7 million bond deal that financed the facility, records show. Former computer software salesman Jon Gutierrez, who co-founded St. Croix Prep and serves as its executive director, took $25,000 in fees, on top of his annual salary of $110,000. His wife, Kelly Gutierrez, the school's chief financial officer, received $15,000.
But the biggest chunk went to Carroll Davis-Johnson, chairperson of the school's building company, who received $100,000. She served as a project manager on the new school even though the project's architect told school officials the expense was "unnecessary," records show.
Architect Ed Kodet, who earned about $1 million on the school, was one of several construction experts overseeing the project. The general contractor had a full-time supervisor at the job site, and the school had a four-person facilities committee to evaluate progress.
Davis-Johnson, who also served on the school's board of directors, said she and the Gutierrezes deserved the money "based on the huge number of hours" they worked on the project.
By comparison, the directors of two other charter schools received no fees for handling construction management chores at their facilities.
In an interview, Gutierrez said he had "no idea" how he received his management fee, even though he was at board meetings when it was authorized and approved. He abstained from the vote, which Davis-Johnson approved. Similarly, Davis-Johnson abstained from the vote on her bonus, which was approved by Gutierrez's wife.
Jim Markoe, a board member of both St. Croix Prep and the building company, said the insider payments were cleared by bond lawyers involved in the deal.
"Everybody has done everything morally, ethically and legally, and I'll stand by that until the day I die,'' Markoe said.
Sen. Kathy Saltzman, D-Woodbury, chair of the Minnesota Senate Subcommittee on Charter Schools, said lawmakers had no idea charter school insiders were taking such large fees on building projects.
"If they have enough lease aid to do bond deals that pay salaries or one-time bonuses to insiders, obviously they are getting more lease aid than they need,'' Saltzman said.
Like some of its charter school peers, St. Croix Prep has struggled with financial issues. In three consecutive financial reports by the school's independent auditor, the school was knocked for letting the same people with access to school money handle deals and record transactions, a "material weakness." In 2007, the auditor found a $16,000 accounting error and blamed it on a lack of financial controls.
The situation was worse at Kaleidoscope Charter School in Otsego, where top administrator Michelle Strait was charged with forging $72,000 in fraudulent checks on a school account while spearheading an $8.6 million junk bond deal to build a school in 2008. Strait wrote some of those checks to herself and others to a company owned by the husband of her best friend, who installed computers at the school without a contract.
Strait, who was fired after auditors discovered the irregularities, was charged in June with forging checks and theft by swindling. She is scheduled for a court hearing in early December and has not yet entered a plea. Strait's attorney declined to comment and Strait could not be reached.
In a regular public school system, Strait may never have survived a background check by elected school board members, because she had a personal bankruptcy in her past. That also could have been a red flag to investors, but the bond underwriter failed to catch it.
Matthew Patterson, who succeeded Strait as chair of Kaleidoscope's building company, said in-depth background checks were not conducted on any of the principals in the bond deal, including himself. "I believe someone asked me for my Social Security number,'' Patterson said.
Charles P. Schumacher also slipped through the cracks.
Although he was convicted on two counts of criminal sexual conduct in 1995, Schumacher, 40, wound up on the board of North Lakes Academy in Forest Lake. He also served as chairman of the school's affiliated building company.
Schumacher, who taught at Lourdes High School in Rochester 15 years ago, pleaded guilty to groping two of his students. The girls also accused Schumacher of forcing them to touch his groin.
A court evaluation said Schumacher was a "high risk to re-offend,'' and he was sentenced to register as a sex offender, obtain treatment and spend 90 days in jail.
North Lakes announced his resignation two days after the Star Tribune exposed his criminal convictions to the Education Department, which immediately said it would seek to remove him from the school board. Under North Lakes' agreement with the state, school officials are required to run criminal background checks on all prospective board members. State officials are investigating what went wrong. Schumacher did not return calls.
Until he left North Lakes, Schumacher was leading the effort to build an $8.2 million facility for the charter school, but those plans are now on hold. Records show Schumacher filed for personal bankruptcy in 2006, but neither his bankruptcy nor his criminal history were included in a preliminary disclosure statement put out by the school's bond underwriters this year.
Pioneers in Choice
Minnesota was the first state in the nation to pass a charter school law, giving rise nearly 20 years ago to an education choice movement that now includes 4,600 charter schools and 1.4 million students in 40 states and the District of Columbia. In Minnesota, 150 charter schools enroll more than 39,500 students, a figure that has doubled since 2004 but still represents only 4 percent of Minnesota's total public school enrollment.
Charter school advocates say they are preserving public education by making it more efficient and affordable. School districts complain that niche-minded charter schools are draining scarce resources from regular schools charged with educating the masses.
Originally, charter school funding in Minnesota offered no extra money for facilities, just general aid payments per student.
Former state Sen. Ember Reichgott Junge, who wrote the 1991 law, said the intent was to keep charter schools focused on education and out of the real estate business. Junge said support for a lease aid program crystallized in 1998, after lawmakers discovered many start-ups were operating in cheap retail storefronts that were unfit for young children.
The first school built with lease aid money was Minnesota New Country School in Henderson, which originally occupied three abandoned storefronts, including a defunct bar. With guidance from an analyst with the state Education Department, school promoters skirted the state ban on ownership by forming an affiliated building company, which borrowed $1.4 million from a bank for the project. Like subsequent projects, the loan is being repaid with lease aid funds. Unlike subsequent deals, however, there were no fees or underwriting expenses on the Henderson school.
School adviser Dee Thomas said Henderson residents cherish the small school, which has about 120 students. "It's made a big difference in this town and we couldn't have done it without lease aid,'' Thomas said.
Wall Street soon caught on, and charter school advocates discovered they no longer had to deal with ill-suited rental properties if they were willing to create building companies and use junk bonds -- high-cost debt issued by borrowers considered to be at greater risk for default -- for construction. The bonds are repaid with lease aid money, which is capped at 90 percent of property costs or $1,200 per student, whichever is lower. This year, Minnesota will distribute an estimated $42.4 million in lease aid, a figure that has doubled in just four years.
On average, it costs more to own than to rent. Charter schools built or bought with junk bonds cost taxpayers an average of $13.50 a foot, or 17 percent more in lease aid payments than all charter facilities, according to Education Department records.
"This lease aid is out of control,'' Saltzman said. "It's like all you do is put your paperwork in and you get money and you can build a new school."
It's not cheap to build a school with junk bonds. Consider two recent projects.
Prairie Seeds Charter School in Brooklyn Park and the Faribault Public School District each raised about $15 million through the sale of tax-exempt bonds in March. But after paying underwriting expenses and other costs, the charter school project was left with only 78 percent of the proceeds; the public school retained 96 percent.
Over the next 30 years, taxpayers will pay $32.4 million in lease aid to cover interest payments at Prairie Seeds, where the interest rate on most of the bonds is a whopping 9.25 percent. That's five times more than the interest expense in Faribault Public Schools. Records show the Prairie Seeds project generated $928,000 in fees and other underwriting costs, with $630,800 going to Dougherty & Co., the sales agent for the bonds. The Faribault deal generated $200,000 in fees.
State Education Department officials said lawmakers should either forbid such junk-bond deals or sharply regulate them. "It's legal under the law, but it was never the underlying intent'' for charter schools to build their own schools, Anderson said.
Consultant Mark Beltz, who has been involved in more than a dozen of these deals, agreed that junk bonds are an expensive way to finance building schools.
"We can save a ton of money here. Let's sit down and talk about it,'' said Beltz, former business manager in Farmington Public Schools. "If we went with public bonds, the state could cut its lease aid appropriation in half, and schools could still afford the payments.''
Pressure to recruit
With state support capped at $1,200 per student, charter school advocates have discovered that small schools don't work if they want new digs. That's why 16 schools built with junk bonds enroll an average of 411 students, versus 200 at a typical charter campus. St. Croix Prep, the state's largest charter school built with junk bonds, has nearly 900 students. That is larger than half the school districts in Minnesota.
The pressure begins early in the process. In private meetings in the offices of Dougherty & Co., Kaleidoscope's founders were told they would have to push enrollment if they wanted a new school, according to one board member who attended.
School officials originally hoped to keep enrollment at a maximum of 195, in keeping with their philosophy of small class sizes. But Dougherty representatives said they would need a minimum of 325 to 350 students if Kaleidoscope wanted a "decent building," according to school board minutes. Enrollment reached 420 this year. To cover the bond payments, the school added four classes, and each classroom has about two more students than originally desired, said Patterson, chairman of the school's affiliated building company.
At Woodbury's Math and Science Academy, one of the first charter schools built with junk bonds, the classrooms are even more crowded. Enrollment now stands at 300, about 15 percent higher than original projections, while student-teachers ratios have increased from a desired 17-1 to 21-1, and could eventually reach 24-1.
Simone, the school's director, said adding students was a financial necessity, but he worries it reduces the school's ability "to enforce the rigor that we've come to expect from our students.'' And while the school is already larger than he wanted, Simone said school officials are considering a second facility to generate more per-pupil revenue from the state.
"The only way you can meet your bills is to take in more kids,'' Simone said.
Some parents have already bailed out. Sarah Lilja, of Maplewood, whose son attended Math and Science Academy until last year, said the school went from a "cozy" campus with lots of individual support to a place with fewer choices, overcrowded rooms and less stimulating classes.
"There's a need for small schools with a focus on individual success,'' Lilja said. "If it becomes just another Woodbury High School, what do we have?''
Some charter schools refuse to play by Wall Street's rules. Kevin Byrne, who runs Minnesota Internship Center Charter School, said his board formed a building company four years ago to consider building a new high school with junk bonds. The idea was floated by a lawyer for the school who stood to earn more than $40,000 in fees if the deal was completed.
Byrne said the pitch was tempting, because it would free him from the hassle of finding decent rental space. But he said he and other administrators were turned off when bond advocates explained the school would need 250 to 300 students to "make the numbers work." Byrne said his school, which caters to dropouts and the disadvantaged, would become dysfunctional with that many students.
"I like keeping enrollment down around 100,'' Byrne said. "It's a better setting for the kids.''
Staff writers Paul McEnroe and Patrick Kennedy contributed to this report.