Report 2014-135R Summary - May 2015

Magnolia Science Academies:

Although the Financial Condition of These Charter Schools Has Improved, Their Financial Controls Still Need to Be Strengthened

HIGHLIGHTS

Our audit of the Magnolia Educational and Research Foundation (Foundation) and the Magnolia Science Academies (academies) highlighted the following:

  • Some of the academies were insolvent at points during the past three fiscal years.
    • The Foundation facilitated loans between academies with excess funds and academies requiring funds to address their cash-flow problems.
    • The loans—all but one repaid—enabled the struggling academies to continue to serve their students and did not have a negative impact on the academies loaning funds.
  • The Foundation's financial and management processes need improvement.
    • Nearly a quarter of the 225 transactions we reviewed either did not have clear authorization or sufficient support.
    • We questioned the Foundation's relationship with one of its primary vendors.
    • The academies did not always follow the Foundations' policies and procedures when holding fundraisers, which created the potential for loss or theft of funds.
    • The academies grossly underreported truancy data to the California Department of Education.
  • The Los Angeles Unified School District (LAUSD) and other authorizing entities generally performed required site visits of the academies. However, LAUSD may have acted prematurely when it rescinded the charter renewal petitions of two academies.

Results in Brief

California offers its students the option of attending charter schools. These state-funded public schools operate independently from the standard public school system, to a degree, although they must petition authorizing entities, such as school districts, for approval of their charters. The Magnolia Educational and Research Foundation (Foundation) is a charter management organization that operates a network of 11 charter schools throughout California, called Magnolia Science Academies (academies). Although the academies generally perform well academically, a 2014 review that an outside accounting firm performed for the Los Angeles Unified School District (LAUSD)—the authorizing entity for eight of the 11 academies—raised concerns about the financial solvency of the Foundation and some of the academies. Further, this review found general fiscal mismanagement by the Foundation, citing in particular its lack of disclosures in its audited financial statements, its practice of engaging in interschool borrowing, its weak fiscal controls, and its processing of questionable or unexplained transactions. As a result of these concerns, LAUSD rescinded its conditional approval of two academies' charter petitions in June 2014 and did not renew a third academy's charter petition in November 2014. The Foundation responded by taking legal action against LAUSD to ensure that these academies remained open.

Our review confirmed that some of the academies, under certain key financial measures—including a cash reserve requirement specifically required by some of the academies' charters—were insolvent at points during the past three fiscal years, partly because of state funding delays. To offset the cash-flow problems at some academies, the Foundation facilitated loans between academies with excess funds and academies requiring funds to address their cash-flow problems and did not charge some academies its full management fee. We do not believe the academies that provided excess funds to and through the Foundation to other academies were negatively impacted and, in fact, these loans served a useful purpose because they enabled the struggling academies to continue to serve their students. As of July 2014 the Foundation and academies had repaid all but one loan—from the Foundation to one of its academies most in need of financial assistance. Further, by that date the academies had improved their financial conditions to the point that all were solvent under three key financial measures.

Although the financial condition of the academies improved, the Foundation must strengthen its financial and management processes. For example, we found that the Foundation often lacked authorization and support for its expenditures and the academies' expenditures, which led us to question whether those expenditures represented appropriate uses of public funds. Specifically, the Foundation could not provide either clear authorization or sufficient support for 52 of the 225 transactions we reviewed. In addition, we reviewed the Foundation's vendor agreements and questioned the Foundation's relationship with and method of payment for one of its primary vendors. We also found that the academies did not always follow the Foundation's policies and procedures when holding fundraisers, creating the potential for the loss or theft of fundraising proceeds. Finally, we found that academy staff grossly underreported truancy data to the California Department of Education (Education).

Additionally, we reviewed the Foundation's payments to the California Department of Justice (Justice), the U.S. Department of Homeland Security (Homeland Security), and immigration attorneys to determine their purpose. We found that the Foundation paid roughly $28,000 to Justice, $40,000 to Homeland Security, and $59,000 to immigration attorneys and consultants during the three years of our audit period. The Foundation's payments to Justice were generally for fingerprinting and background checks for all of its employees, and its payments to Homeland Security and immigration attorneys or consultants related to its hiring of employees from outside the United States. Overall, we found that the payments appeared reasonable.

Finally, we examined the oversight LAUSD and other authorizing entities provided to the academies and found that they generally performed required site visits. However, we concluded that LAUSD may have acted prematurely when it rescinded the charter renewal petitions of two academies. Specifically, LAUSD based its June 2014 decision to rescind the charter renewal petitions for two academies on a summary of an outside accounting firm's draft findings that did not provide key context about the financial situations of those academies. Further, LAUSD did not provide sufficient time for the Foundation to respond to its criticisms, nor did it share the accounting firm's findings in full with the Foundation until after it had rescinded the two academies' charter petitions. In addition, LAUSD denied a third academy's charter renewal petition several months later in part because of the accounting firm's report. In March 2015 LAUSD and the Foundation reached a settlement agreement, resulting in the renewal of all three academies' charters.

Recommendations

Consistent with their charter petition terms, the Foundation should ensure that each academy maintains the minimum required cash reserve.

To reduce the risk of misappropriation, the Foundation should ensure that it appropriately authorizes all of its expenditures and the academies' expenditures. It should also ensure that it includes sufficient supporting documentation for each expense, including documenting the purpose of each transaction.

To increase transparency and reduce the risk of misuse of funds, the Foundation should update its policies and procedures regarding vendor selection to require that it maintain independence in its relationships with vendors.

To safeguard the funds that the academies raise, the Foundation should ensure that academy staff follow the fundraising procedures in its accounting manual, especially with regards to the timeliness of bank deposits and sign-offs on cash-count forms.

To ensure their compliance with state and federal laws, the Foundation should continue to develop procedures for the academies to follow when they report truancy data to Education. The Foundation's procedures should include a process for the academies to document their calculations.

To improve its process for considering whether to rescind a charter school's conditionally renewed petition, LAUSD should develop procedures to provide charter schools with a reasonable amount of time for an appropriate response or to potentially remedy concerns.

Agency Comments

The Foundation stated that our recommendations are helpful and indicated that it has already begun implementing corresponding changes. LAUSD generally agreed to implement our recommendations but believed additional clarification regarding its past actions and future implementation of the recommendations was warranted.


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