K12 Inc.: California Virtual Academies’ operator exploits charter, charity laws for money, records show

K12 Inc.: California Virtual Academies’ operator exploits charter, charity laws for money, records show

By Jessica Calefati, jcalefati@bayareanewsgroup.com© Copyright 2016, Bay Area News Group

Posted:
 
04/18/2016 04:48:09 AM PDT

Frustrated with the quality of their neighborhood schools, parents, teachers and civic leaders have founded hundreds of California charter schools, combining locally sourced ingenuity with the public funding that state law allows them to command.

California’s largest network of online academies is different: Although the schools are set up like typical charters, records show they’re established and run by Virginia-based K12 Inc., whose claims of parental involvement and independent oversight appear to be a veneer for the moneymaking enterprise.

The company — the subject of a two-part investigative series by this newspaper — says the schools operate independently and are locally controlled. But the academies’ contracts, tax records and other financial information suggest something entirely different: K12 calls the shots, operating the schools to make money by taking advantage of laws governing charter schools and nonprofit organizations.

“What this company has done may make sense from a business perspective, but to me, it’s a sham,” said Renee Nash, a business and tax attorney and a member of the Eureka Union School District’s Board of Trustees.

“K12 is clearly taking advantage of the laws in California,” she said, “and the Legislature needs to put a stop to it.”

California law is silent on whether for-profit firms are even allowed to run charter schools. So before applying 14 years ago to open the state’s first online academies, K12 treaded cautiously into a new market, creating a series of nonprofit organizations whose names match those of the schools.

That means each California Virtual Academy is considered by the IRS to be a charitable organization that need not pay taxes, even though K12 effectively controls the schools by providing them with all academic services.

The structure, accounting experts say, makes it tough to tell where the nonprofit ends and where the company begins.

Mike Kraft, K12’s vice president for finance and communication, disputes that characterization. He said the nature of the relationship between the company and the schools is articulated clearly in documents.

“The contracts between K12 and each (academy) outline the parties’ obligations and expressly provide that the governing body of the school retains final decision-making authority and full control,” he said. Still, Kraft acknowledged that K12 personnel “may at times provide newly forming boards that lack any staff with administrative assistance on the organizational documents.”

Tax and education records show that K12 employees started each of more than a dozen online academies in California, even though the applications they filed to open the schools described the founders as a “group of parents,” none of whom were named. For several years, company employees even signed the nonprofit schools’ tax filings.

‘The law is clear’

Federal tax law prohibits charitable organizations from operating to benefit a person or company. And to that end, the online academies’ articles of incorporation vow that the schools’ money won’t be used to enrich “any shareholder or individual.”

“The law is clear: Charities may not use their resources to promote a business, even if that business’ services are helpful,” Eric Gorovitz, a San Francisco attorney who specializes in nonprofit tax law, said, speaking generally about charitable organizations. “And if the violation is bad enough, a charity could lose its exemption.”

According to the nonprofit’s application for tax-exempt status, California Virtual Academy at San Mateo has a board of directors whose members should be willing to cut ties with the company if they feel the school is getting a raw deal. Indeed, the application specifies that all agreements between K12 and the school are the result of “arm’s-length” negotiations.

But a review of minutes from the 2014-15 school year’s board meetings and records of the board’s relationship to administrators hand-picked by K12 suggest the board has little or no independence from the company. A K12 employee led the board meetings, and all 35 resolutions she encouraged the board to endorse won unanimous approval.

The board’s open public meetings are held during the workday in a conference room or around an administrator’s desk in the Daly City-based Jefferson Elementary School District, which authorized the academy’s charter. And board members rarely attend the meetings in person. They usually just call in from home.

All told, the board spent an average of 13 minutes in each meeting.

The board has four members. Two of them, President Don Burbulys, a resident of Soquel, in Santa Cruz County, and Stephen Warren, the board’s secretary, who lives in Riverside County, are related to high-ranking school administrators, who, under K12’s contract with the academy, are selected by the company.

Burbulys is married to Laura Terrazas, dean of student services, and Warren is related to Academic Administrator April Warren, according to a brief filed by teachers. Terrazas and April Warren on Sunday did not return calls or emails seeking comment. Burbulys, Stephen Warren and the board’s other two members have also declined requests for comment.

When K12 sought approval in 2009 to open a charter school for Contra Costa County students that featured a mix of online schooling and traditional classes in a brick-and-mortar setting, Mt. Diablo Unified School District denied the application, citing concerns about the company’s role in running the proposed school day to day.

“Not only does the charter school delegate all charter school-related operations, management and administrative functions to K12 California, but it inappropriately gives K12 California control over areas that should be the responsibility of school site staff and the charter school’s governing board,” the Mt. Diablo school board wrote in a report.

But Contra Costa County, as well as Alameda County residents, can still enroll in a K12 school because there’s a California Virtual Academy in San Joaquin County, and the state allows online students from adjoining counties to enroll.

A close look at the contract between California Virtual Academy at San Mateo and K12 raises questions about why a truly independent board of directors would ever agree to the terms, said Luis Huerta, a Columbia University expert on online schools.

Under the contract, which Huerta reviewed for this newspaper, K12 handles almost every aspect of the public school’s operations. It’s responsible for writing curricula, hiring principals, recruiting students and much more. In exchange, the company is entitled to compensation that can amount to as much as 75 percent of the school’s public funding.

Jefferson Elementary school trustees and administrators are tasked with reviewing the contract, but no state agency is required to examine it.

The school’s application for tax-exempt status states “the charter school determined that it paid no more than fair market rate for the services.” Yet in a bizarre twist, the rates outlined in the contract routinely exceed what the school can afford — by more than 25 percent.

K12 requires all its California academies to pay only what they can without going into debt. The company then issues “credits” to cover the balance.

California Virtual Academy at San Mateo, for example, hasn’t been able to pay its bill in full in a decade. So since 2007, K12 has given the school $8 million in credits. Over the past 10 years, the company has doled out more than $130 million in credits to all the California schools it operates.

Unique arrangement

Accountants and financial analysts interviewed by this newspaper, including several who specialize in school finance, say they’ve never seen anything quite like the arrangement between K12 and the public online academies.

“If the schools can’t cover their expenses and need K12 credits every year to balance their budgets, then the contingent liability to K12 just keeps growing,” said Charlene Podlipna, an accountant who works for Freeman & Mills, a Los Angeles-based litigation consulting firm.

Writing down the operating losses of the schools it manages in California and across the country has allowed K12 to reduce its taxable income by $179.5 million over the past three years, according to the company’s most recent annual report. That raises questions about why K12 consistently charges more than the schools can pay.

Kraft insisted the company doesn’t receive a tax deduction for forgiving the debts of the schools it operates. But when the newspaper presented Kraft with K12’s most recent Securities and Exchange Commission filing and asked him to explain whether K12 wrote off the losses, his answer was hardly straightforward: “A company’s tax provision is based on its net income. A component of net income is the revenue that a company records. Anything that increases or decreases revenue, and ultimately impacts net income, would therefore impact the taxes owed by that company. K12 is no different than any other company in this respect.”

Katrina Abston, K12’s senior head of schools for the academies, defended the credits, saying they “provide a high level of protection” for the schools against financial uncertainties.

Huerta, however, said taxpayers could lose out in the end.

Typically, he said, any extra taxpayer funding on hand when a charter school shuts its doors is returned to the state’s general fund. But tucked away on one of the final pages of the K12 contracts is a clause that requires a school that’s closing to repay the company with any money it has left — meaning it’s highly unlikely the state would recoup anything.

“These companies are exploiting the gray in the law and using clever legal teams to skirt public accountability,” Huerta said. “Taxpayers and policymakers should be alarmed.”

To address some of the thorny problems that can crop up when for-profit companies run nonprofit public schools, the Legislature last year approved Assembly Bill 787, authored by Assemblyman Roger Hernández, D-West Covina, that would have banned the practice.

But Gov. Jerry Brown rejected it, writing in his veto message: “I don’t believe the case has been made to eliminate for-profit charter schools in California.”

Read Part 1 of the investigation: Is online charter school network cashing in on failure?

Contact Jessica Calefati at 916-441-2101. Follow her at Twitter.com/calefati.

What our investigation found

  • Teachers employed by K12 Inc.’s charter schools may be asked to inflate attendance and enrollment records used to determine taxpayer funding.
  • Fewer than half of the students who start the online high schools earn diplomas, and almost none of them are qualified to attend the state’s public universities.
  • K12’s heavily marketed online model has helped the company reap more than $310 million in state funding over the past 12 years.
  • Students who spend as little as one minute during a school day logged in to K12’s school software may be counted as present in records used to calculate the amount of funding the schools get from the state.
  • About half of the schools’ students are not proficient in reading, and only a third are proficient in math — levels that fall far below statewide averages.
  • School districts that are supposed to oversee the company’s schools have a strong financial incentive to turn a blind eye to problems: They get a cut of the academies’ revenue, which largely comes from state coffers.
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