The Securities and Exchange Commission charged William A. Batchelor and John M. Zukoski with misleading investors who bought $25.54 million in bonds issued for Tri-Valley Learning Corp., a California public charter school operator that went on to collapse.
Batchelor, the chief executive officer of Tri-Valley, and Zukoski, the director of finance, agreed to a settlement in which they will pay $20,000 and $15,000 respectively, according to the complaint filed Monday in U.S. District Court in the northern district of California.
Tri-Valley, which had more than $60 million in conduit bond financing, filed for bankruptcy in November 2016 and defaulted on the bonds in 2017. Its four charter schools in Stockton and Livermore, California, have closed.
“Municipal bond investors depend on issuers providing full and accurate information about the issuer’s ability to repay the bonds. In this case, we allege the defendants misled investors about Tri-Valley’s dire financial condition,” said LeeAnn Gaunt, chief of the enforcement division’s public finance abuse unit.
The SEC case involves bonds issued in May 2015 through conduit issuer California Statewide Communities Development Authority after the charter school operator had already begun to have financial problems,
The pair were charged with violating the antifraud provision of Section 17(a)(3) of the Securities Act of 1933. Without admitting or denying the allegations in the complaint, Batchelor and Zukoski agreed, in addition to the fines, to be enjoined from future violations of the charged provision and from participating in future municipal debt offerings.
The settlements are subject to court approval.
"The amount of the fines were low when compared to the magnitude of the disruption created by TVLC's scheme; $20,000 is unlikely to get anyone's attention," said Paul Mansfield, a parent whose children attended Tri-Valley's Livermore school. "This may just be the beginning of the legal proceedings related to this bond deal."
Calls seeking comment from Batchelor’s attorneys at law firm Murphy Pearson Bradley & Feeney and to Zukoski’s attorney, Steven F. Gruel, were not returned.
Tri-Valley Learning Corp. filed for Chapter 11 bankruptcy to reorganize its debts in November 2016 and converted that bankruptcy to Chapter 7
Orrick, Herrington & Sutcliffe, bond counsel and disclosure on the Tri-Valley bonds, also settled a lawsuit that arose out of the bankruptcy that claimed Orrick was negligent as bond and disclosure counsel in a deal for a northern California charter school.
The suit by bond trustee UMB bank was "about matters unrelated to Orrick's opinions," John Sullivan, a partner with Long & Levit LLP, the firm that represented Orrick told the Bond Buyer
In May 2015, Batchelor and Zukoski helped prepare and signed a bond offering document for $25.54 million to fund the purchase and renovation of a building to house two public charter schools, according to the SEC complaint.
The SEC alleges that Batchelor and Zukoski were aware that Tri-Valley was experiencing serious cash flow problems that affected its ability to make debt service payments on the bonds, was delinquent on payments owed to vendors, had incurred additional debt in the form of a private term loan that was overdue by nearly one year, and had drawn a bank line of credit to its limit just prior to the bond sale.
The offering document failed to disclose that Tri-Valley was in serious financial distress at the time the bonds were sold and contained misleading financial projections, according to the SEC complaint. Additionally, the complaint alleges that, despite knowing the true state of Tri-Valley's financial condition, Batchelor and Zukoski signed separate certifications that the information in the offering document contained no material misrepresentations or omissions.
Batchelor and Zukoski helped prepare the offering memorandum, signed the document, and also signed separate certifications to the underwriter, according to the filing.
Debt service on the bonds was to be paid through lease payments from Tri-Valley and California Preparatory Academies, a private high school that Batchelor founded and managed, that shared space in the building funded by the bonds.
“Tri-Valley’s financial ability to make lease payments was the primary factor relied upon by the underwriter and investors concerning the ability to repay the debt, because they were aware that Batchelor’s private high school was not yet operating at the time the bonds were sold,” according to the complaint. “In fact, unbeknownst to investors, Tri-Valley was in such dire financial condition at the time of the offering that it was not able to make even a single lease payment under the arrangement.”
The complaint alleges that the pair knew that Tri-Valley was suffering from severe cash flow problems that resulted in hundreds of thousands of dollars in delinquent debts owed to vendors; that the charter school operator had opened a new line of credit that had been drawn to its limit two months prior to the bond sale; and that it had received millions of dollars from another non-profit controlled by Batchelor to make payroll and pay other operational expenses.
In addition, the LOM contained a table showing financial projections for fiscal years 2015 through 2018 that was materially inaccurate, according to the filing.
After the bonds were sold, Tri-Valley was unable to make any of bond payments due to its continuing financial struggles. Instead, payments were made solely by Cal Prep from funds Batchelor had raised from foreign sources, according to the filing.
The school officials may have gotten a lesser fine because they weren’t charged with a high level of fraud, said Kathleen Marcus, a shareholder at the Stradling law firm who is not involved in the case.
SEC Rule 10b-5 is the highest and most severe sanction for fraud.
Rule 10b-5 of the Exchange Act prohibits in connection with the purchase or sale of a security, the making of any untrue statement of material fact or omitting to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
The two officials were charged with SEC Rule 17a-3, which requires negligence but does not burden the SEC to prove knowledge of wrongdoing, Marcus said.
“It is interesting that there are some significant disclosure concerns that are set forth in the complaint that appear to be misleading and problematic,” Marcus said. “But there is no disgorgement in the matter, which suggests that these individuals were not personally enriched through the bond proceeds in any way."
Marcus said charging SEC Rule 17a-3 means that SEC staff felt that the officials were not enriching themselves such as drawing salaries or diverting bond proceeds into their own pockets and were also waiting on state money.
The complaint, according to Marcus, said the state was delaying making its funding payments to all charter schools, so Tri-Valley was months behind on needed cash.
"If you google, "charter school scandal," you can find stories all over the country where charter school operators are finding some way of directing funds away from the goal of student achievement and toward the goal of private benefit," Mansfield said. "Districts need better mechanisms to put a halt to bad operators."
This case has been investigated for years, but Peter Chan, a partner at Baker McKenzie, said it was the kind of case that will be happening more as municipalities grapple with coronavirus woes.
“The expectation is that a lot of municipalities are financially stressed and will try to tap the municipal bond market to get public financing," Chan said. "The [SEC] staff will be very focused on issuers who may not disclose as fully the level of financial stress that they are experiencing.”
Chan called the case a “timely reminder.”
Tri-Valley had also issued $42.5 million in debt in 2012 to build a campus for its Livermore Valley Charter School. Those bonds were not included in the SEC case.
