The U.S. Securities and Exchange Commission recently charged a Chicago charter school operator with defrauding investors in a $37.5 million bond offering by failing to disclose transactions that presented conflicts of interest. According to the SEC’s complaint, UNO Charter School Network, Inc. (UNO) failed to disclose a multimillion-dollar construction subcontract with a company owned by a brother of UNO’s Chief Operations Officer, as well as the potential impact of this transaction on UNO’s ability to repay its bond obligations. This announcement is notable both in itself and for what may be forthcoming: SEC officials have stated that the agency may bring charges against individuals in the ongoing investigation.

UNO has settled the complaint without admitting to or denying the charges. The settlement can be instructive for issuers and underwriters determining whether to self-report under the SEC’s Municipalities Continuing Disclosure Cooperation Initiative (MCDC).

In 2010 and 2011, according to the complaint, UNO entered into two grant agreements totaling $78 million with the Illinois Department of Commerce and Economic Opportunity to build three charter schools. Both agreements contained a lengthy conflict of interest policy. The policy required UNO to certify that no conflicts of interest exist and immediately notify the Department of “any actual or potential conflicts of interest, as well as any actions that create or which appear to create a conflict of interest.” If UNO breached this provision, the Department was entitled to suspend any future grant payments as well as recover grant funds already paid to UNO.

According to the SEC, in 2011, UNO contracted with two companies owned by its COO’s brothers, agreeing to pay one company approximately $4 million to supply and install windows at the schools it was constructing and the other approximately $500,000 to serve as UNO’s representative during construction. Although both transactions qualified as conflicts of interest under the grant agreements, UNO allegedly failed to disclose them to the Department.

UNO subsequently conducted a $37.5 million bond offering in October 2011 to finance the construction of the three charter schools. The bonds were to be repaid using the revenues UNO received from the Chicago Public School system for operating the charter schools. In connection with the offering, UNO issued an Official Statement to investors that devoted an entire section to UNO’s “Conflicts Policy.” In addition to affirming to investors that UNO followed a policy that was more robust than required for nonprofit organizations, UNO also disclosed that it had engaged a company owned by its COO’s brother to serve as UNO’s construction representative.

Nevertheless, the SEC alleged that the disclosures in the Official Statement were deficient due to UNO’s failure to disclose that UNO had entered into a $4 million window installation contract with a company owned by another of its COO’s brothers, and that UNO was in breach of the conflict of interest provisions in the grant agreements due to its failure to disclose the conflicted transactions. Most egregiously, according to the SEC, UNO failed to disclose that due to its breach, the Department was entitled to suspend and/or recoup all the grant funds. Because the bonds were to be repaid with funds UNO received from the Chicago Public School system for operating the charter schools, a breach of the conflicts policy and resulting potential repayment of the grants could have put the primary source of repayment funds at risk. 

The SEC alleged that UNO’s negligence violated Section 17(a)(2) of the Securities Act of 1933. Without any admission of wrongdoing, UNO agreed to settle the SEC’s charges by undertaking measures to improve its internal procedures and training. Among those measures is the appointment of an independent monitor for one year, at a cost of $100,000 to UNO, with the authority to prohibit UNO from expending significant funds or engaging in any transaction deemed to be a conflict of interest.

The complaint notably does not include any charges against UNO’s CEO, who allegedly approved the conflicted transactions, signed the Official Statement, and allegedly falsely stated, on an investor call, that the grants did not subject UNO to any guidelines on conflicted transactions. Peter K. M. Chan, assistant regional director of the SEC’s Chicago Regional Office, stated, however, that the SEC is “not finished” with its investigation and intends to “look into all parties and individuals who contributed to UNO’s violations.” This further review is consistent with the SEC’s recent focus on pursuing individuals responsible for securities law violations, a primary focus of SEC Chair Mary Jo White’s enforcement agenda.

The MCDC, spearheaded and publicized by the Chicago Regional Office, allows issuers and underwriters to voluntarily report materially inaccurate statements made in offering documents regarding prior continuing disclosure obligations in exchange for lesser sanctions. When determining whether to self-report, however, an issuer or underwriter must determine whether its prior disclosure lapses were material—a determination that can be difficult to make, particularly in a realm involving mostly settled actions.

In announcing its charges against UNO, however, the Chicago Regional Office demonstrated that there is a category of disclosures that it considers material—those relating to the issuer’s ability to repay the bonds. As the SEC noted, “[i]nvestors had a right to know that UNO’s transactions with related persons jeopardized its ability to pay its bonds because they placed the grant money that was primarily funding the projects at risk.” Determinations of whether to self-report under to the MCDC still must be made on a case-by-case basis, but this case may provide a guidepost regarding the SEC’s view on materiality.

Ballard Spahr’s Municipal Securities Regulation and Enforcement Group helps municipal market participants navigate a rapidly evolving regulatory, investigative, and enforcement environment, enabling them to anticipate and address compliance issues and respond effectively to investigations when necessary. For more information, please contact John C. Grugan at 215.864.8226 or 

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