Alternative Research Services, Inc.

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1 Alternative Research Services, Inc. Robert MacArthur w c September 17, 2014 For-profit Education Industry Timeline -- History of Fraud In the late 1980 s and early 1990 s, the US Department of Education started to crack down on schools they deemed to be operating illegitimate businesses taking advantage of federal loan programs. Many schools were closed because of high student default rates, often in excess of 40%. In that time, the DOE implemented regulations to prevent schools from paying commission to enrollment counsellors. Rightly so, they were concerned about the quality of students that would be recruited under any type of quota system. In the mid-to-late 1990 s, the Department of Education had serious concerns about one of the country s largest schools, Computer Learning Centers (CLC). With nearly two dozen locations nationwide, CLC had grown rapidly through its use of federal loan money. At that time, schools were limited to deriving 85% of revenue from federal student aid Title IV programs. Later, the ratio changed to 90/10 in the early 2000 s, as for-profit schools lobbied for access to more federal funds. In early 1998, the Illinois Attorney General filed a fraud lawsuit against CLC, which prompted a program review of the company s main campus and several branch schools in the Washington, DC area. WJLA TV in Washington, DC went into the school with hidden cameras, obtaining footage of enrollment counsellors violating federal laws. CLC was caught shredding documents the night before federal investigators arrived. In 1999, the US Department of Justice raided 10 ITT Education schools, arresting the CEO and seizing several cases of documentation that outlined the company s use of incentive compensation. Approximately two years later, the DOJ let ITT Education go, without explanation. ITT and a large shareholder were rumoured to have strong political ties. Around 2000 or 2001, the Department of Education published a Final Determination Letter concluding that all of CLC s enrollment counselors were being paid commission based on the number of students they enrolled (i.e. a quota system.) As a result, the US Department of Education demanded that all Title IV monies received by CLC be returned to the federal government. This amounted to approximately $185 million dollars. That action put CLC into bankruptcy. CLC s stock went from $40 to zero from 1998 to Several other up and coming for-profit schools watched, concerned about their own recruiting practices, as many of them were already using incentive compensation schemes. Robert MacArthur Alternative Research Services, Inc. September 17, 2014

2 During October of 2002, Bill Hansen, then deputy secretary of education, effectively re-wrote the way the incentive compensation ban would be enforced. In a memo dated October 30 th 2002, Hansen wrote: After further analysis, I have concluded that the preferable approach is to view a violation of the incentive compensation prohibition as not resulting in monetary loss to the Department. Improper recruiting does not tender a recruited student ineligible to receive student aid funds for attendance at the institution on whose behalf the recruiting was conducted. Accordingly, the Department should treat a violation of the law as a compliance matter for which remedial or punitive sanctions should be considered.[h]owever, much more commonly, the appropriate sanction to consider will be the imposition of a fine. Hansen left the Department in 2003 to go work for ACS a subcontractor of Apollo s, where he served as managing director. After that, in 2005, Hansen joined Apollo s lobbying firm, the Chartwell Group. Also in 2002, the industry sought clarification of the ban on incentive comp. It was then that the so called Safe Harbor provisions went into effect. Those regulations inserted the word solely into the language of the regulations banning incentive compensation, in an effort to soften the ban. Under the new provisions, incentive compensation was deemed legal, so long as an enrollment counselor s income wasn t solely derived from a quota system. The Safe Harbor provisions were regulations that were supposed to explain the ban on incentive compensation, not create a loophole around it. Instead, the Safe Harbor provisions which the industry had lobbied hard for effectively reversed the intent of the regulation. This opened the floodgates. The publicly-traded for-profit schools began exploit this loophole by saying, in name only, that they did not have enrollment counselors earning income solely based on a quota system. In several court cases and government reports, particularly in the Hendow qui tam suit versus Apollo Group, as well as the McKinney suit filed against Apollo, it was proven that the company had intentionally sought to circumvent the incentive compensation ban (i.e. showing how enrollment counselors were paid based on factors other than enrolment quotas). 1 In August of 2003, DOE conducted a program review of the University of Phoenix. In that report, it was shown by the department that UOP s systems were designed to fly under the radar (quoted from the DOE report) of government regulations. The school took the position that as long as they could prove that even 1% of compensation was being paid based on non-quota factors, they considered themselves to be compliant with the Safe Harbors. Apollo Group received the final program review document in February That document was kept hidden from the public for six months. During the period between when the Department conducted its review in August of 2003 and Apollo Group s receipt of the final document in February 2004, senior management sold several million shares of stock, and then sold even more stock after the receipt of the final 1 Hendow vs University of Phoenix, et al, Eastern District of California, case number 2:03-cv-00457; McKinney vs Apollo Group et al, Southern District California, case number 3:07-cv

3 program review docs in February of The Securities & Exchange Commission failed to investigate Apollo Group for insider trading, despite that it appeared that they were in possession of material non-public information, given the findings of the program review. Apollo Group s then CEO Todd Nelson later claimed that they failed to make the final program review document public because the company s management believed that it did not contain anything that would have been important to shareholders. During 2004, the Department of Education regional office in San Francisco that was in charge of overseeing Apollo was in the process levying a fine on Apollo for illegally obtained federal funds, since Apollo was found to be in violation of the ban on incentive compensation. In September of 2004, Apollo announced a $9.8 million dollar settlement related to the program review. This settlement amount was determined not by the regional office that had jurisdiction over the group, but from senior officials in Washington. Had it gone through proper channels, the fine would have been several hundred millions dollars. In February 2004, CEO Todd Nelson wrote a letter to the Secretary of Education, Rod Paige, attempting to have the San Francisco investigator fired for trying to apply the ban on incentive compensation to Apollo as it had been applied to CLC (letter was an exhibit in Hendow). By November of 2004, Rod Paige became a lobbyist for Apollo at the Chartwell Group, shortly thereafter. Also in the timeframe, another for-profit education company, Career Education ( CEC ), ran into trouble, this time with an accreditor. Following the CLC fiasco, the State of California Office of the Attorney General developed an office specifically to address for-profit education fraud. Career Education had acquired small for-profit companies, opening many schools over a short period of time. Some of them were in California. CEC quickly developed a bad reputation in the industry for its recruiting efforts. However, they were able to show growth. From 2000 to 2004 the company s stock price went from $5 to $75, turning the CEO into a billionaire. However in the latter half of 2004, CEC ran into trouble with the law and regulators. Several lawsuits were filed against the company across the country, by students, employees, etc. The California Attorney General, in particular, went after CEC aggressively after receiving many complaints from students. Amongst other things, this later prompted the company s accreditor to suspend CEC s ability to recruit students for its online division. So, the company simply set up shop in another part of country and got a different and less restrictive accreditor; however, that took a year to complete, causing the stock to drop from $75 back to $25. Having made their money, senior management quit. 60 Minutes went to CEC s schools undercover, and like WJLA, in the case of CLC, found CEC violating federal laws. The House Post-Secondary Education Sub- Committee held a hearing shortly thereafter. However, the committee was chaired by Congressmen Boehner and McKeon, both Republicans with little interest in pursuing the issue. On May 26, 2005, John Higgins, the Inspector General from the ED, testified in Congress on the dangers of for-profit education: Violations of this requirement occur 3

4 when refunds are not paid timely, when incorrect calculations result in returning insufficient funds, and when institutions fail to pay refunds at all, which is a criminal offense under the HEA. Higgins declared, Historically, fraud and abuse predominantly involves proprietary schools. In fact, over the last six completed fiscal years the majority approximately 74 percent of our institutional fraud cases involved proprietary schools. From 2004 to 2008, the information flow, press, etc, quieted down while industry growth took off. During this period, several lawsuits were filed across the industry, as the companies started to expand. In December of 2005 and January 2008, the Office of Inspector General at the DOE conducted two audits of Apollo, showing in detail that UOP has computerized systems in place that were designed to defraud the federal government by rounding up students time in class in a manner such that the school did not have to return any federal funds when the student dropped out in the early stages of a class. It was never clear that the company changed those systems, as they were a repeat offender for some of the findings in the 2003 program review, the 2 audits, and then in a 2009 program review. For example, untimely refunds, incorrect refunds, and incorrect last dates of attendance issues persisted. The Securities and Exchange Commission began an investigation of Apollo in 2009 regarding the financial impact of these practices on reported earnings and financial statements. Several lawsuits were filed across the industry, eventually providing a clear pattern of systematic abuse of government programs. Accreditors and state Attorneys General started to take notice. The Hendow qui tam was proceeding, providing incriminating evidence and documents about UOP s internal system. A stock options backdating case provided further information about Apollo. A particularly nasty shareholder suit, Taubenfeld, was filed against Career Education, containing dozens of interviews with former enrollment counselors and other staff, who provided detailed information about fraudulent business practices. The suit was dismissed. Meanwhile, Corinthian Colleges was offering degrees in nursing in states where they had no accreditation, meaning graduates could not get jobs at local hospitals because their degrees were not recognized by employers and governing medical bodies. The fraudulent practices mushroomed during , as former senior managers left Apollo Group for greener pastures, taking up the lead at other unscrupulous schools that came public: Education Management Corporation, Grand Canyon University, and Bridgepoint Education. Essentially, they transferred and implemented their knowledge of exploiting the Safe Harbors loophole, spawning massive and suspicious growth. Some of these schools were already under investigation by regulators when they came public. Several government reports from DOE started to show cracks in the industry, such as low graduation rates and default rates that were climbing much faster than at non-for-profit schools. In a hearing before the House Post-Secondary Education Committee, the OIG at the DOE testified that there is significantly fraud among the big for-profit schools. 4

5 The industry really started to become aggressive and ugly once they figured out that it would be to their benefit if a high number of students dropped out. They figured out that they could exploit the Pell Grant program and book revenue even if they recruited students with no chance to success. Aggressive enrollment counsellors started recruiting students from low income housing projects, drug rehabs, the pool of single mothers on welfare, etc. Many of these people figured out, too, that if they signed up for online education, they could steal the Pell money and never attend classes. The schools could book revenue, and no one would know; there is no law against recruiting unqualified students. In late 2008, Sallie Mae issued a report saying they would no longer provide loans to sub-prime borrowers at for-profit schools, a term which carried a lot of meaning at that time. They specifically mentioned the high default rates from Corinthian College, although all of the large public for-profits were largely blind-sided, as SLM had been active in providing funding to their students; however, the defaults caused SLM to write-off an excessive amount of bad loans from the for-profit industry. Following this, the schools started to make loans to students directly, effectively buying their own revenue, only having to write-off massive amounts of bad debt in the months that followed. The industry then lobbied for and received an increase in the maximum amount of Title IV loans that can be borrowed by students. In 2009, with the Obama administration in place, the environment changed substantially. The Obama administration immediately hired Bob Shireman as deputy undersecretary at the DOE; Shireman had formerly been at the DOE under President Clinton. In his early weeks, Shireman immediately set into motion the negotiatedrulemaking (NegReg) process, offering three open microphone forums in which the DOE would hear complaints, followed by several hearings with industry executives and insiders. The first issue to be addressed was the revocation of the Safe Harbors, which would effectively render incentive compensation illegal again, though one could openly argue that it was ever supposed to be made legal by the Safe Harbor provisions in the first place. The repeal of the Safe Harbors has devastated the industry since. Shireman deserves all the credit for pressuring the industry into near bankruptcy where they belong. Senator Harkin held a series of hearings to uncover the true magnitude of the fraud being perpetuated by the industry. The GAO conducted an undercover investigation, finding massive fraud across the industry. It was discovered that the industry was manipulating a regulatory loophole in the 2-year loan default calculation, so the Department and Harkin sought a so called 3 rd year default rate calculation, as well as overall loan repayment rates. It was found that many for-profit schools had drop-out rates in excess of 50%, default rates in excess of 50% and repayment rates less than 50%. The massive growth of the industry and its predatory recruiting has caused a wave of student loan defaults that ultimately, the taxpayer must shoulder. For example, in the University of Phoenix received $657 million in Pell Grants. By 2010, that number was $1.2 billion. At $5,000 per Pell Grant, roughly 50% of Apollo s 5

6 students were receiving Pell Grants. The graduation rates at for-profit schools are half the average for post-secondary education at large. Shireman subsequently developed the Gainful Employment rule, which was an attempt to implement fairly aggressive restrictions on the industry by using, for example, limits on the amount of money students could borrow in relation to the expected salary they would earn. The industry lobbied hard against the regulation, and achieved its goal of pushing out Gainful Employment s implementation, while hoping for a Republican presidential victory in 2012 that would provide a more industry-friendly regulatory environment. If implemented, the Gainful Employment regulation will most likely cause tuition prices to come down. If the government doesn t act, the industry may recover under a new Administration, unless the Republicans seize the opportunity left by the Democrats, attacking the for-profit schools by exposing their fraud and waste of government resources. Wanting to expand the opportunity for minorities to attend college is one thing, but to allow federal student aid programs to be turned into social welfare is something else. The taxpayer must be protected by better oversight, and enforcement against the financial aid fraud being perpetuated by for-profit schools, that have a greater incentive to obtain revenue than to provide an education. 6