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MONTHLY NEWSLETTER:  AUGUST 2008 ISSUE

LOOKING FOR CONFLICTS OF INTEREST
BY BRENT VAN ALFEN
PROVIDENCE FINANCIAL CO., LLC



There is a story about a mafia don who thought he had found the perfect bookkeeper because he was deaf. What could be better for a mafia figure than a bookkeeper who could not hear what was being discussed around him? As the years passed by, the don heard that the bookkeeper was embezzling money from him. He determined to confront the bookkeeper in a forceful manner to get the truth, so he brought his attorney, who knew sign language, to talk to the bookkeeper. They entered the bookkeeper’s office, walked up to his desk, and the don demanded to know if the bookkeeper had been stealing money. The attorney dutifully interpreted the question in sign language. The bookkeeper responded by denying that he had even thought of doing such a thing to his boss, which the attorney translated to the don. The don was not satisfied with the answer, so he pulled out his automatic weapon, released the safety, and pointed it directly at the bookkeeper’s forehead, and repeated the question. The attorney again translated the message into sign language. The terrified bookkeeper broke, then admitted that he had hidden a little over two million dollars in a box that was buried behind his cousin Vinnie’s garage in Brooklyn. The attorney then turned to the don and calmly told him that the bookkeeper said he didn’t think the don had the guts to pull the trigger!

The moral of the story is that all of us, even mafia dons, are subject to being taken advantage of by those we work with who may have conflicts of interest. In the charter school world, where administrators and directors are managing public funds, their fiduciary duty requires that they make every effort to make sure the schools get the best possible goods and services available. There are “war stories” that abound in the area of charter school facility development and finance where school boards have been victimized by those who had ulterior motives. Since my experience is concentrated in the financing of facilities, I will use some examples I am aware of.

Bond underwriters are subject to conflicts of interest because they must create a financial instrument that investors will buy while structuring a loan that the charter school will accept. Many underwriters will claim that they can represent the interests of the school (borrower) while also satisfying the demands of investors. If one thinks about this, it is counter-intuitive as the financing for any charter school is a “zero-sum” game. What the investor gains, the school loses---and vice-versa. How can the underwriter represent equally and fairly the interests of both investor and borrower? Keep in mind also that underwriters have long-standing relationships with investors, and they will likely deal with a charter school only one time.

There are “war stories” that abound in the area of charter school facility finance where school boards have been victimized by those who had ulterior motives.

For example, one of the primary functions of an underwriter is to secure the best possible pricing for the bonds (lowest interest rate). This is done by expending a lot of energy and effort to bring as many investors as possible to the project and thus get the maximum number of buyers for the bonds. The effect of this situation is an auction for the available bonds which results in the best possible pricing for the borrower. Without proper oversight by the borrower, some underwriters avoid all of this work and effort by placing the bonds with one friendly investor. This makes their job much easier, but it can cost the borrower a great deal of money over the life of a financing in the form of a higher interest rate on their bonds.

Here is another example of conflicts of interest. An underwriter in a charter friendly state convinces some schools to enter into a pooling arrangement with other schools for their financing. In today’s market there are questionable advantages for the schools to do this, but many disadvantages. They are stuck in the pool; they assume liability for other schools; they cannot get out of the pool without significant penalties; they cannot refund their debt unless it is with the underwriter who put them into the pool; they cannot borrow additional funds; etc. In short, the situation is very restrictive for the school; but the benefits are obvious for the underwriter and investors. The school’s management and directors are simply not experienced enough in finance to know what their options are and to determine what is best for the school.

I could fill several pages with more examples of conflicts of interest on the part of professionals who work with charter schools in their facility development and financing. As your financial advisor, I guarantee that Providence Financial will only represent the interests of the school and no one else. We get no reward or compensation from any money sources. Many underwriters and attorneys would rather not have us involved because we require accountability from everyone involved and we make sure all transactions are in the school’s best interest. Further, there are many situations in which we recommend a completely different financing vehicle that would not involve an underwriter.?

For information contact Brent Van Alfen, Providence Financial Co., Inc.
Phone: 801-556-2290
Email: brent @ providencefinancialco.com