Nonprofits Serving For-Profit Interests: The Slippery Slope of Too Close Contracting

Free Rent [citation needed]” by Matt Mechtley

September 13, 2017; Pittsburgh Post-Gazette

When a nonprofit hands over too much of its judgment to a for-profit, profit motives may win out, and that is the case so much in the field of charter schools that a number of states have banned for-profit involvement. NPQ has often written about situations where boards agree to questionable relationships with for-profits that lead to complexity, obfuscation, and malfeasance. Looking at how this happens should provide a warning to other nonprofit boards to throw up red flags when they spot conflicts.

The Pittsburgh Post-Gazette recently examined how charters in Pennsylvania are taking advantage of state law and using their independence and invisibility to shift funds designed for facilities to the bank accounts of other, separately incorporated businesses they control. Pennsylvania requires charter schools to be incorporated as nonprofit organizations. However, their board members and other leaders are not barred from establishing additional corporations that can provide services to the charter schools they lead, opening a tempting loophole for abusive business practices.

Pennsylvania offsets the cost of providing school facilities by allocating funds beyond the per-pupil education funding they require local districts to provide charter schools serving students from their catchment area. Seeing this as an opportunity for creative financial management, the leadership of the multi-school Propel Schools charter network formed a separate nonprofit real estate management corporation, School Facilities Development (SFD).

According to the Post-Gazette, “SFD has spent $32.6 million buying a portfolio of seven schools, comprising most of Propel’s 11 locations. With no employees and just a few volunteers and part-time consultants, the nonprofit receives $3 million in annual lease payments from Propel schools, and after debt payments runs annual six-figure surpluses.”

The lease arrangements allow Propel Schools to receive hundreds of thousands of dollars in rent subsidies from the state, which are used to pay rent to the real estate company they control. SFS has generated surplus funds from those rentals. This effectively transfers revenue from the Propel schools to another organization that may or may not use them for the benefit of Propel’s students.

From the prospective of Propel/SFD, this is just good management, allowing the schools to meet facility contingencies that might not be funded by ongoing public education funds. SFD’s CFO notes, “a healthy balance sheet…enables SFD to make the necessary capital investments and improvements and to reduce outstanding debt.”

On the other hand, Pennsylvania’s Auditor General Eugene DePasquale, sees it as problematic. He told the Post-Gazette,

You’ve created this nonprofit and sort of in a sense, you control it. You’re getting a lease reimbursement for renting to yourself…the outsourcing of charter school functions to special-purpose nonprofits is still a problem…because the organizations sometimes claim to be outside of the scope of laws governing open records and state auditing…When they say, “we’re a private business,” I somewhat chuckle at that…because some of them have been set up simply to get the management of the charter schools out of the public view.

A recent study of Arizona’s charter schools by the Grand Canyon Institute found that similar practices are taking place. The independence given charters from public oversight has led to rampant self-dealing. “In 2013-14, 48 percent of Arizona’s charter school expenditures for contracts, leases and rents were owed (committed) to for-profit companies that employed or were owned by the charter holder or a related party. These commitments amounted to $497.5 million annually. That figure would be higher if administrative and teacher salaries and benefits to related parties were included.” Perhaps this is a way of saving money, but the lack of transparency makes that conclusion difficult to document.

A lack of “public view” is more than a cosmetic issue. While state laws governing the operations of nonprofits vary, the complex interlinking of closely controlled organizations and self-dealing relationships provides an avenue for abuse. At its worst, it creates the opportunity for public harm.

Nonprofit boards have a critical responsibility to ensure that the benefits that can come from these practices are realized and the potential harms are avoided. Again, self-dealing does not bar an honest, arm’s-length transaction that benefits the nonprofit and does not unduly favor the trustee or officer over others. In the Summer 2017 edition of the Nonprofit Quarterly, Herrington Bryce advised, “These types of transactions should always be approached with very careful legal and ethical scrutiny and within the scope of a carefully crafted and existing policy. Discussions involving the questioning of the involved parties—as well as decisions—and the supporting or exculpatory information should always be retained.”

Even when there is no mismanagement or fraud, it can create a complex and invisible system that keeps the public in the dark and out of the loop and weakens the connection between community and school.—Martin Levine