July 16, 2011
States Move to Limit Spending on For-Profit Colleges While Tightening Oversight
By Armando Montaño
As a federal investigation into for-profit colleges continues, states are coming up with legislation on their own to rein in the rapidly growing sector.
Lawmakers in 23 states have introduced 54 bills this year aimed at for-profit colleges, according to the National Conference of State Legislatures.
Two-Pronged Attack Suggests a Shift in Federal Policy and
Stimulates a Rash of Securities Class Actions
By Jim Castagnera
In September 2004, as President George Bush’s reelection campaign shifted into high gear, the Chronicle of Higher Education reported that his plans for higher education in his anticipated second term included “relax[ing] certain rules that for-profit colleges must follow to participate in the federal student-aid programs.” The September 7th article added, “According to a document released by the president’s re-election campaign late Thursday night, Mr. Bush’s higher-education proposals for a second term focus on eliminating restrictions that prevent adult and part-time students from receiving federal grants and loans.”
Six years, one Great Recession, and one historic substitution of a black Democrat for a WASP Republican in the White House, and a sea change in federal policy may now be in the offing. In recent weeks, two tidal forces have surged out of Washington to whipsaw the for-profit side of our industry simultaneously.
The first of these powerful political forces is a new set of proposed regulations from the Department of Education, aimed at punishing for-profit education providers who fall short of their statutory mandate of graduating students qualified for “gainful employment.”
In a July 23rd press release announcing the new regs, DOE Secretary Arne Duncan commented, “While career colleges play a vital role in training our workforce to be globally competitive, some of them are saddling students with debt they cannot afford in exchange for degrees and certificates they cannot use. These schools --- and their investors --- benefit from billions of dollars in subsidies from taxpayers, and in return, taxpayers have a right to know that these programs are providing solid preparation for a job.”
The press release notes, “To qualify for federal aid, the law requires that career colleges and training programs prepare students for gainful employment in recognized occupations.” Under the proposed rules, “The Department would define whether a program successfully prepared students for gainful employment using a two-part test: measuring the relationship between the debt students incur and their incomes after program completion; and measuring the rate at which all enrollees, regardless of completions, repay their loans on time.”
The picture painted by the DOE press release of the results of this test isn’t pretty. “The median federal loan debt carried by students earning associate degrees at for-profit institutions in 2007-08 was $14,000 --- almost double the median debt for their peers at non-profit institutions.” By way of contrast, “while 88 percent of recent borrowers from nonprofit institutions and 80 percent of borrowers from public institutions were able to pay down the balance of their students loans in recent years, only 55 percent of borrowers attending for-profit institutions were able to pay off more than accrued interest.”
Federal student-loan aid may legally account for up to 90 percent of a for-profit’s gross revenues. In the words of staff writer James Goodman of rocnow.com, “Although fewer than 10 percent of the estimated 19 million students enrolled in institutions of higher learning take courses from for-profit colleges, these schools account for 44 percent of all defaults on federal loans.” In other words, big exposure combined with a high default rate add up to one big reason for Uncle Sam’s new interest in regulating the for-profit sector. Or, as Arne Duncan perhaps somewhat understated it, “While proprietary schools have profited and prospered thanks to federal dollars, some of their students have not. This is a disservice to students and taxpayers….”
DOE’s proposed remedies include increased transparency. If the agency has its way, “on or after July 1, 2012, unless the program has a loan repayment rate of at least 45 percent and an annual loan payment that is at least 20 percent of the discretionary income or 8 percent of average annual revenue…”, the institution must “ include a prominent warning in its promotional literature, and all other materials, including those on its Web site, and in all admissions meetings with prospective students, that is designed to alert prospective students and currently enrolled students that they may have difficulty repaying loans for attending that program….”
More onerous yet, programs failing to meet specified debt thresholds will be deemed ineligible for further federal student loans. These could include an annual loan repayment rate of at least 35 percent.
While, indeed, these proposed regs may prove onerous to some for-profit players, standing alone they might not reflect anything more than a prudent policy correction on the part of the DOE. More unusual --- and, therefore, maybe more of a signal of which direction the Obama administration is steering the ship of state --- is the recent exercise undertaken by the Government Accountability Office. The GAO engaged in what entrepreneurs, such as myself, with experience in the retail world, call “shopping.” In the convenience store industry, where my experience lies, my partners and I regularly employed professional shoppers, who made purchases at selected store locations, then reported back to our security director if the clerks failed to properly record the sales.
In the GAO’s case, “Undercover tests at 15 for-profit colleges found that 4 colleges encouraged fraudulent practices and that all 15 made deceptive or otherwise questionable statements to GAO’s undercover applicants.” The August 4th issue of GAO Highlights reported, “Four undercover applicants were encouraged by college personnel to falsify their financial aid forms to qualify for federal aid --- for example, one admissions representative told an applicant to fraudulently remove $250,000 in savings.”
On that same date, Gregory Kurtz, managing director of the GAO’s Office of Forensic Audits and Special Investigations, testified about these findings before the Senate Committee on Health, Education, Labor and Pensions.
One upshot of these revelations was a dramatic decline in the stock values of publicly traded for-profit companies. One well-known firm to take a hit was the Washington Post Company. Best known for its iconic newspaper --- made legendary by Woodward and Bernstein during the Watergate scandal--- its cash cow in these days of dying daily newspapers is subsidiary Kaplan. According to one source, writer Mark Basch at Jacksonville.com, “Kaplan accounted for $1.46 billion of Washington Post’s $2.34 billion in revenue” in the first half of this calendar year. “Kaplan had an operating profit of $166.9 million, while the company as a whole had operating income of $266.2 million.”
Coming clean on August 17th, the Post ran a story by Nick Anderson in which it confessed, “Late Friday, the Education Department released data on student loan repayment rates that showed 28 percent of Kaplan University’s former students are repaying the principal on their federal loans. That was lower than the 36 percent repayment rate posted by the for-profit sector overall….”
The story continues, “In a statement, The Post Co. said that ‘a significant number of Kaplan schools’ could be at risk of new limits on financial aid.’” The reference was to the proposed DOE regulations.
Why would the Washington Post Company come clean?
One reason might be a flurry of security class-action suits filed against other for-profit corporations in mid-August, in the wake of the GAO’s revelations and the DOE’s proposed rulemaking. Suits were filed in federal district courts against Educational Management Corporation on August 11th; American Public Education on August 12th; Lincoln Educational Services on August 13th; Apollo Group (parent of giant University of Phoenix) on August 16th, and Corinthian Colleges on September 1st.
According to Kevin M. LaCroix, Esquire, of OakBridge Insurance Services in Beachwood, Ohio --- author of the blog “The D&O Diary” [www.dandodiary.com] ---
security class actions “is a big business.” Such an avalanche of class actions happens “where in one sector everybody has the same problem.” He notes that “the same law firms are driving all these litigations.” And, indeed, a review of the complaints in four of the five actions --- against Educational Management Corp, American Public Ed, Lincoln, and Apollo --- reveals they are all signed by Attorney Kim Miller of Kahn Swick & Foti of Fifth Avenue in New York City and Attorney Lewis Kahn of that firm’s Madisonville, Louisiana office. Each of the complaints --- filed in federal courts in Pittsburgh (PA), West Virginia, New Jersey, and Phoenix (AZ), respectively --- are also signed by local counsel. (The Corinthian suit was filed by the firm of Pomerantz Haudek Grossman & Gross in the federal court for central California.)
The lead firm’s homepage asserts, “Kahn Swick & Foti represents victims of corporate wrongdoing. Consistent with our goal to lend a helping hand is our mission to only accept payment at the end of a case, only if we win. And win we do. We have recovered millions of dollars for victims of corporate greed.” [www.ksfconsel.com]
As LaCroix notes, the allegations in the complaints are all much the same. The plaintiffs assert that between specified recent timeframes, each of the defendants made “a series of false and misleading statements” in their public pronouncements --- such as registration and proxy statements, other SEC filings, press releases, and the like--- which induced investors to buy their stock, which subsequently declined in value. While emphasizing that he has “no idea of the merits” of the claims, LaCroix observes it’s “not a pretty picture.”
On his blog, LaCroix identifies yet a sixth suit, “a separate class action lawsuit against Alta College, Inc. (parent of Westwood College)… on August 11, 2010 in the District of Colorado alleging violations of the Colorado Consumer Protection Act.”
Observing “it seems safe to predict that other publicly-traded for-profit education companies could also be hit with one of these suits,” LaCroix singles out Apollo Group for special attention.
He writes, “The name Apollo Group may be familiar to many readers, as the company was the target of a prior securities class action lawsuit that has achieved a certain amount of notoriety because it is one of the few securities cases that has actually gone to trial. The trial resulted in a plaintiffs’ verdict, although the presiding judge later set the verdict aside in a response to a post-trial motion. More recently, the Ninth Circuit (Court of Appeals) reversed the trial court’s ruling and remanded the case to the district court for further proceedings, a development that has sparked significant interest and discussion.”
When I interviewed him recently, LaCroix added that Apollo Group’s “management disclosure practice has drawn a lot of attention.”
In fact, my own interest, as reflected in this magazine, has long been drawn to the case of Hendow v. University of Phoenix (see Jim Castagnera, “Unable to shake qui tam case, University of Phoenix faces reappearance of old action,” http://www.todayscampus.com/articles/load.aspx?art=762). In this case, Hendow and another former Phoenix employee claimed that the company illegally rewarded admissions officers on the basis of the number of students each enrolled. The case initially was dismissed by the federal trial court, only to be reinstated by the Ninth Circuit, which said, “This case involves allegations under the False Claims Act that the University of Phoenix… knowingly made false promises ... in order to become eligible to receive Title IV funds. Appellants, Mary Hendow and Julie Albertson (relators), two former enrollment counselors at the University, allege that the University falsely certifies each year that it is in compliance with the incentive compensation ban while intentionally and knowingly violating that requirement.” [U.S. ex rel Hendow v. University of Phoenix, 461 F3d 1166 (9th Cir. 2006).]
After the Ninth Circuit reinstated the case, the suit was finally set down for trial in March of this year. Before the case could come to trial, the university’s parent corporation, the publicly traded Apollo Group, settled with the government for $67.5 million, while also paying the relators’ lawyers $11 million in attorney fees, according to published reports.
Little wonder, in light of all this bad news, one commentator on the Daily Show’s blog (http://forums.thedailyshow.com) ranted on August 6th --- shortly after the Senate hearing --- “It is crazy how the matchbook schools now market themselves as ‘universities.’ Many are basically predators on Title IV and GI Bill funds --- basically taking taxpayer money and delivering content and certificates of dubious value…. The problem ones seduce low-income and freshly discharged military with unsupportable fantasies just to get their one precious opportunity to use public funding to better themselves. Instead they get crap.”
While with regard to the for-profit sector as a whole these allegations may be unfair, it appears that all publicly-traded players may end up being painted with the same broad brush strokes to the detriment of their stock values, as well as their reputations. If Kevin LaCroix is right in his prediction, most will wind up defending their practices and their overall performances in federal court cases, while they and all the rest of the for-profits will also have to deal with DOE’s new regulatory scheme a couple of years down the rulemakers’ road. If so, we are witnessing a sea change in this sector’s federal fortunes.