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Troubles encountered by the charter school operator, Magnolia Public Schools (MPS), at two of its eight charters in the LA Unified School District highlight a murky governance issue that legislatures in California and elsewhere have been slow to address.

Should a parent company operate its charter school network as a single entity, as MPS does with its 11 California charters? Or should each school be run independently, with separate budgets and governance?

LA Unified last month closed two MPS schools, saying financial problems at the parent company rose to the “level of fiscal mismanagement.”  But by scrutinizing the financial health of the overall charter management organization, the district has tread into uncharted territory for an authorizer.

“This is an emerging issue, and my guess is a lot of legislatures will have to address this in the near future,” says Kathy Christie of the Education Commission of the States, which compiles research on charter school practices nationally.

The school closures followed a District audit that not only examined Magnolia Science Academy 6 and Academy 7, both high-performing schools, but also MPS as the parent group. The audit found among other things that MPS met the IRS definition of being “insolvent” as of June 2013, that it owed millions of dollars to the schools it oversees and that it transferred money between schools. It also found that it paid millions of dollars to a third party non-profit, Accord, for educational services with little accountability.

All that, the audit said, “not only raises significant questions about the governance and overall health of the organization but . . . of its future likelihood of success.”

As a result, LA Unified is expanding its investigation into the district’s other MPS schools, Superintendent John Deasy told LA School Report last week.

MPS disputes the findings of the audit and denies any fiscal malfeasance. (MPS is in court today, asking a judge to block the district’s effort to close the two science academies. See story here.)

One of the central questions for the district is the structure of governance: the Magnolia network runs its 11 schools under an “umbrella model,” using a single, tax-exempt non-profit status, under section 501(c)(3) of the Internal Revenue Code, and one governing board.

And even as California continues to strengthen laws that govern the accountability of individual charter schools, the effort does not extend to the parent organizations, which answer to the IRS, not to the school districts. Thus, contracts between the parent company and third parties, as well as money transferred between the parent and the schools, is hard to track and not necessarily in the purview of the local school district.

Kim Onisko an accounting consultant for MPS defends the umbrella practice, saying it is perfectly legal and vastly more efficient for the schools. “Otherwise, you would need a board for every school,” he told LA School Report.

While other charter operators use the same approach, many do not. One of the largest networks in LA Unified, the Alliance for College-Ready Schools, applies a different model. Says CFO David Hyun, “We don’t want to run the risk of jeopardizing the whole network for one school. Let’s say you have a catastrophe at one school, you don’t want it to circulate through the whole system.”

For the Alliance, which operates 22 high-performing charters serving high-needs students in Los Angeles, separating each school’s operations makes good business sense, Hyun said. Each school is run as an individual non-profit, with a separate governance structure and separate programmatic and financial accountability.

That model is gaining favor in some states. Colorado, for example, passed a law last year that requires each individual charter school to be organized as a nonprofit corporation, separate from its management organization, so that the schools are more accountable to the district.

But in California, short of an operator electing to run its networks that way, the relationship between a school’s finances and the finances of its parent company remains undefined.

In fact, there is even confusion over whether a district can require a charter applicant to provide any information about its parent organization, according to Alice Miller of the California Charter School Association, which is helping MPS protest the closures.

“That’s not covered by charter law,” she said. “A [Charter Management Organization] has the option of providing, or not providing the information. The law has never been expanded to include that requirement. It may never have occurred to anyone when charter law was created.”

Previous Posts: Magnolia going into court to keep 2 of its charters open; Magnolia charter troubles having an impact beyond LA Unified; JUST IN: LAUSD expands probe into Magnolia charter schools; oanaokcn