Mortgage Banking & Consumer Credit Alert. Lenders Beware: Congress and Regulators Target Referral Arrangements in Student Loan Transactions

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1 August 2007 Authors: Steven Kaplan Jonathan D. Jaffe Holly M. Spencer K&L Gates comprises approximately 1,400 lawyers in 22 offices located in North America, Europe and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations and public sector entities. For more information, please visit Lenders Beware: Congress and Regulators Target Referral Arrangements in Student Loan Transactions Prohibited referrals may no longer be a concern only for federal student loans. Just as the residential mortgage lending industry became a target of legislative and regulatory scrutiny in the 1970s as a result of its alleged anti-competitive referral practices, both the federal and private student lending industries are now caught in the cross hairs of the United States Congress and the United States Department of Education ( Department ) as a result of similar allegations. Alleged conflicts of interest, preferred student lender lists, and lavish gifts to financial aid personnel are the subjects of several settlement agreements and investigations recently announced by the Attorneys General in New York, New Jersey, Ohio, Arizona, and Minnesota, to name a few. 1 On the heels of these actions, Congress and the Department introduced new legislation and proposed rules to prohibit and govern some of the same practices on a nationwide basis. 2 If this legislation and the proposed rules become a reality, the industry could be looking at restrictions similar to those found in the Real Estate Settlement Procedures Act ( RESPA ), which has resulted in literally hundreds of class actions, regulatory investigations, and millions of dollars in settlements for lenders and all other players in the mortgage lending industry. With that backdrop, this Client Alert summarizes one of the most significant student lending bills introduced by Congress, House Bill 890, and the Department s proposed rules, as well as the lessons the lending industry has learned from RESPA. Notably: House Bill 890 would require educational institutions to adopt and administer a Code of Conduct, which would prohibit things of value, including gifts, educational loan arrangements, fees for services, and staffing assistance, to name a few. Lenders would be required to disclose, under House Bill 890, more favorable terms and conditions available under federal student loans and provide a model disclosure form containing relevant information about federal and private student loans. House Bill 890 would require educational institutions to provide similar disclosures on their websites and in financial aid informational materials. Both House Bill 890 and the Department s proposed rules would restrict the number of lenders an educational institution may include on a preferred lender list and require specific disclosures to accompany the lists. The Department proposes to issue a non-exhaustive list of prohibited inducements and activities applicable to lenders in the Federal Family Education Loan Program. The Department would issue an exhaustive list of permissible activities.

2 STUDENT LOAN SUNSHINE ACT The Student Loan Sunshine Act ( Act ), which was passed by the House of Representatives with an overwhelming 414 votes, 3 would amend the Higher Education Act of The legislation creates new disclosure requirements, requires institutions of higher education to develop Codes of Conduct, bars gifts and referral fee arrangements, and provides new emphasis on the availability of federally funded student loans. The Act applies to both (a) covered institutions, which includes any postsecondary educational institution and its agents (i.e., alumni associations, booster clubs, or other organizations), and (b) lenders, which includes any creditor that provides student loans under the federal student financial aid programs or through private educational loans (excepting lenders that issue credit secured by a dwelling or under an open-end credit plan). 4 While the U.S. Senate s version of the Student Loan Sunshine Act is pending before its Committee on Health, Education, Labor and Pensions, the Senate continues to introduce a variety of bills governing lending practices related to federal and private student loans. Most recently, the Senate passed the Higher Education Act of 2007, which reauthorizes certain programs under the Higher Education Act of 1965 and prescribes new disclosure, preferred lender list, and Code of Conduct requirements for student lenders and educational institutions. 5 Until the House and Senate resolve the differences in their legislation, however, the House s Act remains the most comprehensive legislation addressing student lending activities. We summarize relevant provisions of the Act in this Client Alert. Preferred Lending Arrangements The Act defines preferred lending arrangements to mean an arrangement between a lender and a covered institution whereby the lender provides educational loans 6 to the institution s students and the institution recommends, promotes, or endorses the educational loan products of the lender. 7 The Act requires lenders to certify that these arrangements are compliant in annual audits. It also requires lenders to inform students or parents of their options for federal student loans, including information on more favorable terms and conditions, before providing a private educational loan. 8 Moreover, the Act prohibits lenders in a preferred lending arrangement from using the name, emblem, mascot, or logo of the educational institution, or other words or symbols of the institution, in marketing materials that would, in any way, imply that the educational institution endorses the lender s private educational loans. 9 New York s Attorney General first drew attention to preferred lending arrangements in the state s settlement agreements with several universities. Attorney General Cuomo alleged that lenders showered universities and their financial aid personnel with gifts, trips, and other monetary payments in exchange for the university s endorsement of the lender as its preferred lender. 10 New York has claimed this resulted in students receiving educational loans with far less favorable terms and conditions than loan products available from other lenders. No effort, however, has been made, either in New York or as proposed in the Act, to ban preferred lending arrangements altogether. To a certain degree, it appears that the industry has selfregulated, as many lenders already have adopted codes of conduct to govern their student lending activities. Nevertheless, we highlight the preferred lender provision of the Act, as it could make it more difficult for lenders to advertise their presence on college campuses, and more difficult for covered institutions to promote only private educational loans. Disclosures Disclosures by Lenders Model Disclosure Form The Act attempts to increase transparency in preferred lending arrangements by requiring lenders to provide additional disclosures to the student or the student s parent concerning student loan products. The Act tasks the Secretary of the Department with developing a model disclosure form for lenders that will provide students and parents with relevant information about the terms and conditions of both federal and private educational loans. 11 The form must provide information on the applicable interest rates, associated fees, repayment terms, opportunities for deferment or forbearance, additional terms and conditions, annual percentage rates, average amount borrowed from the lender by students at the educational institution in the preceding year, average interest rate on loans provided to students during the preceding year, contact information for the lender, and any philanthropic August

3 contributions made by the lender to the educational institution. 12 This type of disclosure is reminiscent of the federal Truth in Lending Act ( TILA ) Disclosure Statement 13 required by TILA and the Settlement Costs Booklet and Good Faith Estimate ( GFE ) required by RESPA for use in residential real estate transactions. 14 While the disclosures do not necessarily require the repayment information unique to a student loan (i.e., TILA expressly exempts federal student loans), the TILA Disclosure Statement, Settlement Costs Booklet and the GFE are designed to inform borrowers about the costs incurred to obtain a mortgage loan, including applicable fees and interest rates, and to assist borrowers in comparing offers or quotes from different lenders. In light of charges by the New York Attorney General and lawmakers that students and their parents are unaware of the differences in the costs and the terms and conditions of various student loans, it appears that lenders might see TILA- and RESPA-like disclosures for student loans in the near future. TILA Disclosure In addition to the model disclosure form applicable to both federal and private student loans, the Act amends TILA to require disclosures concerning only private educational loans. Notably, the creditor will be required to provide in every application for private student loans, and together with any solicitation, marketing or advertisement of such loans, the following clear and conspicuous statements: That the borrower may qualify for federal financial assistance through a program under Title IV of the Higher Education Act in lieu of or in addition to a private student loan; That, in many cases, a federal student loan may provide the consumer with more beneficial terms and conditions than a private student loan, including a lower annual percentage rate and fewer and lower fees; That the consumer may obtain additional information concerning federal financial assistance from the consumer s institution of higher education or the Department s website; and Other information as the Board of Governors of the Federal Reserve System may require. 15 The creditor must obtain a written acknowledgment from the consumer that the consumer read and understood these disclosures. In addition, before a creditor issues any funds of $1,000 or more, the Act requires the creditor to notify the relevant university, in writing, of the proposed extension of credit. Disclosures by Covered Institutions In addition to the disclosures required of lenders, the Act requires the educational institution to provide a disclosure on its website and in financial aid informational materials that includes the following: (1) a statement that indicates that students are not limited to or required to use the lenders the institution recommends and the institution is required to process the documents required to obtain a loan from any eligible lender the student selects; (2) at a minimum, all of the information provided by the model disclosure form with respect to any lender recommended by the institution for federal or private student loans; (3) the maximum amount of federal grant and loan aid available to students, in an easy-to-understand format; and (4) the institution s cost of attendance. 16 A university that provides information to any student regarding a private educational loan also must provide a disclosure prior to or at the same time the institution provides the information on the private loan. This disclosure must inform the student or parent of eligibility for assistance under the federal financial aid programs and the terms and conditions of the private educational loan that are less favorable than the terms and conditions of other educational loans for which the student or parent is eligible, including interest rates, repayment options, and loan forgiveness. 17 The university must ensure the information regarding private educational loans is presented in a manner that is distinct from the information regarding federal educational loans. 18 Finally, an institution that maintains a preferred lender list must clearly and fully disclose on the preferred lender list: (1) why the institution has included each lender as a preferred lender; and (2) that the students attending the institution do not have to borrow from a lender on the preferred lender list. 19 The institution must ensure that there are not fewer than three lenders August

4 named on each preferred lending list (that are not affiliates of each other), specifically indicate on the preferred lender list whether the lenders are affiliates, and describe the affiliation, if applicable. 20 While a preferred lending arrangement is different from RESPA s affiliated business arrangement, that affiliated arrangement disclosure serves the same purpose as the disclosure envisioned for educational institutions above. Notably, RESPA requires an affiliated business disclosure to be provided to a borrower at the same time the borrower is referred to a mortgage lender, 21 and that notice must state that the borrower should shop around for a mortgage loan, as other lenders may be able to offer a better deal. This RESPA disclosure, however, is part of a statutory safe harbor, which, if satisfied, protects the affiliated business arrangement against certain RESPA claims. There does not appear to be any safe harbor available for preferred lender arrangements under the Act. Code of Conduct The Act takes a cue from the Codes of Conduct imposed by the New York Attorney General on universities and lenders in that state by requiring all institutions of higher education to develop, publish, and administer a Code of Conduct with respect to student loans if the institution participates in federal student loan programs or its students obtain private educational loans. 22 The Code of Conduct must prohibit the following: (1) a conflict of interest or the appearance of a conflict of interest in the responsibilities of an institution s officer, employee, or agent with respect to financial aid; (2) gifts from a lender, guarantor or servicer of educational loans; (3) fees, payments, or other financial benefit to an officer, employee or agent in the financial aid office as compensation for consulting services, serving on an advisory council, or otherwise advising a lender or affiliate; (4) educational loan arrangements where lenders pay the educational institutions that recommend the lender s loan products; (5) staffing assistance from lenders, unless otherwise permitted; (6) opportunity pools; and (7) service on advisory councils of lenders or affiliates of lenders. Prohibited Things of Value Gifts The Act prohibits lenders, guarantors, and servicers of student loans from offering any gift to an officer, employee, or agent (or their family members) of a covered institution. 23 This includes any gratuity, favor, discount, entertainment, hospitality, loan, or other item having a monetary value of more than a de minimus [sic] amount, as well as gifts of services, transportation, lodging or meals, whether provided in kind, by purchase of a ticket, payment in advance, or reimbursement after the expense has been incurred. 24 A lender, however, may provide: (1) standard informational material related to loan or financial literacy; (2) food, refreshments, training, or informational materials furnished as an integral part of a training session; (3) favorable terms, conditions, and borrower benefits on a student loan provided to a student employed by the covered institution, if such terms are comparable to those provided to all students; and (4) exit counseling services under certain conditions. 25 The Act s prohibition against offering gifts is most like RESPA s Section 8 prohibition against referral fees and other things of value, with two important distinctions. First, Section 8 explicitly prohibits referral fees and things of value (which include the gifts defined above) in exchange for the referral of business. In other words, if there is no referral of business, then any fees paid or gifts provided are not prohibited under RESPA. 26 The Act appears to establish an outright prohibition against a lender making a gift to personnel at an educational institution, regardless of whether the gift is for a referral. Second, Section 8 of RESPA prohibits the giving and receiving of referral fees or things of value. The Act, on the other hand, prohibits only the lender from giving gifts to educational institutions and does not appear to hold the educational institutions responsible for receiving the gift, other than through a Code of Conduct. 27 Lenders, therefore, should beware this prohibition could make them a prime target under the Act. Fees for Services In addition to a prohibition on gifts from lenders, the Act prohibits officers, employees, or agents employed in the financial aid offices of educational institutions from accepting from any lender or an affiliate of a lender any fee, payment, or other financial benefit, including the opportunity to purchase stock, as compensation for consulting services, serving on an advisory council, or otherwise advising such lender or affiliate. 28 Unlike the provision on gifts discussed August

5 above, this prohibition targets a university s financial aid personnel. Yet, the prohibition is limited to fees received for consulting or advisory services. Educational Loan Arrangements The Act prohibits an institution of higher education from entering into any educational loan arrangement with any lender. An educational loan arrangement is defined as an arrangement under which a lender provides or issues educational loans to students attending the institution or to parents of such students, the institution recommends the lender or the loan products of the lender, and the lender pays a fee or provides other material benefits, including profit or revenue sharing, to the institution or officers, employees, or agents of the institution. 29 Essentially, the educational loan arrangement appears to be the functional equivalent of the referral fee arrangement addressed in Section 8 of RESPA, where the fee paid by the lender is tied to the educational institution s recommendation of the lender and its student loan products. Moreover, although this section of the Act does not outright prohibit universities from receiving fees from the lenders, it does prohibit educational institutions from entering into the arrangements, which, by definition, include the payment of fees. Staffing Assistance Institutions of higher education also are prohibited from requesting or accepting from a lender any assistance with call center staffing or financial aid office staffing. 30 This, however, does not preclude an institution from requesting or accepting assistance from a lender with regard to professional development training or providing educational counseling materials, financial literacy materials, or debt management materials to borrowers. 31 Opportunity Pools The Act prohibits an institution of higher education from requesting, accepting, or considering from a lender any offer of funds to be used for private educational loans to students in exchange for the covered institution providing concessions or promises to the lender. 32 Moreover, the lender is explicitly prohibited from making the offer. Participation on Advisory Councils Finally, financial aid personnel are prohibited from serving on or otherwise participating with advisory councils of lenders or affiliates of lenders. 33 This, however, does not prohibit lenders from seeking advice from financial aid offices in order to improve their products and services for borrowers, provided there are no gifts or compensation given by lenders in connection with seeking this advice from such institutions. Compliance and Enforcement The Act ties compliance to both federal funding and civil money penalties. A covered institution or a lender that receives federal funds or assistance must comply with the Act to continue receiving federal assistance. 34 Moreover, the Act gives the Secretary of the Department the authority to investigate violations of the Act and impose a civil money penalty up to $25,000 against institutions or lenders that do not participate in federal financial aid programs. 35 If a lender does participate in federal programs, the Secretary may limit, terminate or suspend the lender s participation in the programs. 36 These penalties appear to apply to all violations of the Act, including any disclosure and things of value violations. Students and their parents have no separate right of action to pursue violations under the Act. It is important to note that the Act is not yet law. The bill has been referred to the Senate Committee on Health, Education, Labor and Pensions and requires passage from the Senate, as well as Presidential approval, to become effective. 37 And this is not the only potential piece of legislation. During the month of July, the Senate introduced and debated additional legislation regulating federal and private student loans. For example, on July 19, 2007, Senator Charles Schumer introduced the Private Student Loan Disclosure Enhancement Act of 2007, which proposes to amend TILA and improve disclosures for private student loans. 38 And as discussed above, on July 23, 2007, the Senate debated and passed by unanimous consent the Higher Education Act of With other legislation proposed and pending before Senate committees, it remains to be seen what effect these bills and recent enactments will have on the House s Student Loan Sunshine Act. August

6 Given the widespread attention student lending practices have received in New York and nationwide, lenders should be aware of the Act s restrictions and begin to evaluate their current referral or preferred lender arrangements. Congress appears to have made reform in the student loan industry a priority and this reform has tremendous support from its members. DEPARTMENT OF EDUCATION PROPOSED RULES At the same time that Congress is considering prohibitions on gifts and inducements in connection with private student loans, the Department announced earlier this summer its proposed amendments to regulations governing federal financial aid programs, including the Federal Perkins Loan Program, the Federal Family Education Loan Program, and the William D. Ford Federal Direct Loan Program. 39 While the amendments propose to alter a number of student loan-related regulations, including deferment and discharge requirements, to name a few, the proposed rules also target the Department s existing regulations on prohibited inducements and introduce new rules for preferred lender lists. The Department will accept public comments on the rules until August 13, We discuss these proposed amendments below. Prohibited Inducements While Department regulations already contain certain prohibitions on inducements to educational institutions and borrowers applicable to lenders and guaranty agencies in the Federal Family Education Loan Program ( FFEL ), 40 the proposed regulations plan to incorporate current Department interpretive guidance on prohibited inducements issued in response to private letter inquiries from program participants. Notably, the Department proposes to issue a nonexhaustive list of examples of prohibited inducements and activities, and an exhaustive list of permissible activities. The amendments provide that a lender is prohibited from offering, directly or indirectly, any points, premiums, payments, or other benefits 41 to any school or other party to secure FFEL loan applications or loan volume. These points, premiums, payments or other benefits include: Payments or other benefits, including prizes or additional financial aid funds, to a prospective borrower in exchange for applying for or accepting a FFEL loan from the lender; Payments or other benefits to a school, any schoolaffiliated organization (i.e., alumni association or athletic clubs), or to any individual in exchange for FFEL loan applications, or application referrals, or a specified volume or dollar amount of loans made, or placement on a school s list of recommended or suggested lenders; Payments or other benefits provided to a student at a school who acts as the lender s representative to secure FFEL loan applications from prospective borrowers; Payments or other benefits to a loan solicitor or sales representative of a lender who visits schools to solicit prospective borrowers; Payment of referral or processing fees to another lender or any other party; Payment of conference or training registration, transportation, and lodging costs for an employee of a school or school-affiliated organization; Payment of entertainment expenses, including expenses for private hospitality suites, tickets to shows or sporting events, meals, alcoholic beverages, and any lodging, rental, transportation, and other gratuities related to lender-sponsored activities for employees of a school or schoolaffiliated organization; Undertaking philanthropic activities, including providing scholarships, grants, restricted gifts, or financial contributions in exchange for FFEL loan applications or application referrals, or a specified volume or dollar amount of FFEL loans made, or placement on a school s list of recommended or suggested lenders; and Staffing services to a school as a third-party servicer or otherwise on more than a short-term, non-recurring, emergency basis, to assist a school with financial aid-related functions. 42 Lenders also are prohibited from: (1) conducting unsolicited mailings of FFEL application forms to a student, unless the student received a previous loan August

7 from the lender; (2) offering, directly or indirectly, a FFEL loan to a prospective borrower to induce the purchase of a policy of insurance or other product; and (3) engaging in fraudulent or misleading advertising. 43 However, in an attempt to provide better service, a lender may provide the following: Assistance to a school that is comparable to the kinds of assistance provided by the Secretary of the Department under the Direct Loan Program; Support of and participation in a school s student aid and financial literacy-related outreach activities, as long as the name of the entity that developed and paid for the materials is provided and the lender does not promote its student loan products; Meals, refreshments, and receptions that are reasonable in cost and scheduled in conjunction with training, meeting, or conference events if those meals, refreshments, or receptions are open to all training, meeting, or conference attendees; Toll-free telephone numbers for use by schools or others to obtain information about FFEL loans and free data transmission service for use by schools to electronically submit applicant loan processing information or student status confirmation data; A reduced origination fee; A reduced interest rate; Payment of federal default fees that would otherwise be paid by the borrower; Purchase of a loan made by another lender at a premium; Other benefits to a borrower under a repayment incentive program that requires, at a minimum, one or more scheduled payments to receive or retain the benefit; and Items of nominal value to schools, school-affiliated organizations, and borrowers that are offered as a form of generalized marketing or advertising, or to create good will. 44 In terms of enforcement, the proposed rules provide that once the Department determines a lender has violated the prohibited inducement provisions, there is a rebuttable presumption that the lender s activities were undertaken to secure FFEL loan applications or loan volume. 45 The regulations also incorporate the Federal Trade Commission s ( FTC ) Holder Rule as it applies to FFEL loans. 46 The most notable aspect of that rule provides that any lender holding student loans is subject to all claims and defenses that the borrower could assert against the school with respect to the loan, including claims of improper inducement. Preferred Lender Lists In addition to amendments to the Department s prohibited inducement regulations, the proposed rules would introduce, for the first time, regulations to govern a school s issuance of preferred lender lists. A school may provide a preferred lender list, provided the list (1) is not used to deny or otherwise impede a borrower s choice of lender; (2) does not contain fewer than three lenders that are not affiliated with each other and that will make loans to borrowers or students attending the school; and (3) does not include lenders that have offered, or have been solicited by the school to offer, financial or other benefits to the school in exchange for inclusion on the list or any promise that a certain number of loan applications will be sent to the lender by the school or its students. 47 A school that provides a preferred lender list must: Disclose to prospective borrowers, as part of the list, the method and criteria used in selecting the lenders on this list; Provide comparative information to prospective borrowers about interest rates and other benefits offered by the lenders; Ensure that any benefits offered to borrowers by the lenders are the same for all borrowers at the school; Include a prominent statement in any information related to the list of lenders, advising prospective borrowers that they are not required to use one of the school s recommended lenders; For first-time borrowers, not assign, through award packaging or other methods, a borrower s loan to a particular lender; and Not cause unnecessary certification delays for borrowers who use a lender that has not been recommended or suggested by the school. 48 August

8 In proposing these regulations, the Department notes that there is increasing evidence that the preferred lender lists maintained by many schools do not represent the result of unbiased research by the school to identify the lenders providing the best combination of service and benefits to borrowers. 49 In addition, the Department highlights its recent investigations regarding preferred lender lists, where the Department discovered that, in some cases, a school s selection of a preferred or recommended lender was the result of a lender s offer of prohibited inducements that took the form of direct payments or other benefits to the school, its students, or its employees The Department s reasoning and proposed regulations nearly mirror the disclosure requirements passed by the U.S. House of Representatives in the Act. As the New York Attorney General has publicized the alleged link between lender inducements to universities and the lenders appearing on a school s preferred lender list, lenders now must carefully monitor the various disclosures that may be imposed with regard to federal student loans and private educational loans. IMPLICATIONS AND LESSONS LEARNED FROM RESPA After 30 years of RESPA enforcement in the mortgage lending industry, lenders, builders, real estate brokers, and other real estate settlement service providers know that violations of anti-kickback laws and rules could result in severe consequences. Even though RESPA gives the U.S. Department of Housing and Urban Development ( HUD ) only the authority to enjoin violations of Section 8, the statute gives consumers the right to pursue violators for three times the amount of any charge paid for a settlement service. 51 As a result, mortgage lenders and other providers have been the subject of numerous class action lawsuits across the country. Moreover, despite HUD s limited remedy to enjoin violations, over the past decade HUD has collected millions of dollars in settlements from real estate service providers, including mortgage lenders, for referral fee arrangements, settlement disclosures, and affiliated business arrangements, to name a few. And this does not account for the $10,000 in civil penalties and one-year imprisonment authorized under the statute. 52 With this kind of money at stake, mortgage lenders know that the payment or receipt of any gifts, fees, or other things of value in connection with the referral of mortgage business are arrangements that catch regulators attention. While it is unclear at this early stage of the legislative process whether the Act and the Department s proposed regulations will instill the same fear among student lenders as RESPA instills in mortgage lenders, student lenders should be aware of the potential implications of the laws. First, the provision of any improper gifts, fees, or benefits to university financial aid personnel, or the failure to provide required disclosures to students, could threaten a student lender s federal assistance, subject lenders to civil penalties, and bar participation in federal financial aid programs. While the proposed law, unlike RESPA, does not provide a private right of action, lenders should not discount plaintiffs attorneys attempts to use state Unfair and Deceptive Acts and Practices ( UDAP ) laws as enforcement tools. Plaintiffs attorneys often have alleged that violations of RESPA also constitute violations of state UDAP laws, and could attempt to use the same approach to sue student loan lenders. In addition, other state laws could provide a private right of action for failure to comply with federal law, which could supply the class action threat missing from the Act. Second, despite the Act s limitation on the Department s enforcement authority, student lenders should not dismiss the threat of settlements. HUD has demonstrated that, regardless of its limited right to enjoin under RESPA, its investigative powers and threat of judicial action are sufficient to provoke settlements that often reach six-figure amounts. As the Department has proposed new regulations to govern the provision of preferred lender lists and to tighten its rules with regard to prohibited inducements, student lenders should expect that enforcement of these rules will remain a priority for the Department. Finally, although the Act does not give consumers a RESPA-like private right of action to pursue lenders for three times the amount of charges incurred, the Department has proposed to codify a borrower s right to invoke the FTC s Holder Rule with regard to FFELs. This might allow a borrower to assert claims or defenses against lenders holding the loans based on the improper actions of the university s financial aid personnel. Although it is not clear what form the final legislation and Department rules will take, student lenders should consider evaluating any current referral or preferred lender arrangements that could soon be prohibited or restricted should the Act be enacted and the Department s proposed rules made final. * * * * August

9 If you have any questions about House Bill 890 and the Department s proposed student loan regulations, or the lessons learned from RESPA enforcement against lenders, builders, real estate brokers, and other real estate settlement service providers, please contact Steve Kaplan ( / steven.kaplan@klgates. com), Jonathan Jaffe ( / jonathan.jaffe@ klgates.com), or Holly M. Spencer ( / holly.spencer@klgates.com). Endnotes 1 See Press Release, New Jersey Attorney General, Attorney General Issues Civil Subpoenas in College Loan Probe (May 4, 2007) available at nj.gov/oag/newsreleases07/pr a.html; Press Release, Minnesota Attorney General, Attorney General Swanson and New York Attorney General Cuomo Enter Settlement Agreement with Capella University Regarding Student Loan Investigation (May 15, 2007) available at CapellaUniversity.asp; Press Release, Ohio Attorney General, Student Loan Investigation Moves Forward: Attorney General Dann Demands Preferred Lender Lists from Ohio Colleges and Student Loan Companies (April 23, 2007) available at press/07/04/pr asp; Press Release, Arizona Attorney General, Terry Goddard Launches Student Loan Investigation (April 2007) available at gov/press_release/2007/apr07.html. Please also note that the Ohio Ethics Commission issued an Advisory Opinion in December 2003, which prohibited a public college employee from accepting entertainment, gifts, meals, and other things of value from a private student loan lender. See Ohio Ethics Comm., Adv. Op. No (Dec. 17, 2003) available at 2 While the United States House of Representatives passed its student loan legislation (H.B. 890) on May 9, 2007, the United States Senate, since early 2007, has introduced and continues to introduce, a number of bills that would govern student loans and certain lending practices. With the exception of the Senate s Higher Education Act of 2007 (S.B. 1642), which reauthorized certain programs under the Higher Education Act of 1965 and contained lender disclosure and Code of Conduct requirements, these Senate bills remain in committee. 3 See The Library of Congress, Summary of H.B. 890, available at HR00890:@@@L&summ2=m&. 4 See H.B. 890, 151(1), (4). 5 See The Library of Congress, Summary of S.B. 1642, available at s.01642:. Senate Bill 1642 enacts disclosures and an interest rate report for lenders involved in educational loan arrangements, which are defined to mean arrangements between a lender and educational institution (or its employees or affiliates) under which a lender provides student loans to the students attending the educational institution and the educational institution recommends or promotes the lender in return for fees or other things of value from the lender. See S.B. 1642, 113. The bill also enacts requirements for an educational institution s Code of Conduct and preferred lender lists. See id Educational loan is defined by the bill to mean any loan made, insured, or guaranteed under Title IV [of the Higher Education Act], or a private educational loan. See H.B. 890, 151(2). 7 See id. 151(3). 8 See id See Attorney General Announces Landmark Student Loan Agreements Schools to Adopt New College Code of Conduct and Repay Students, Press Release, Apr. 2, 2007 available at apr02a_07.html. 11 See H.B. 890, 153(a). 12 Note that any lender participating in a preferred lender arrangement is required to provide the information to be included on the model disclosure form to both the Secretary of the Department and the educational institution on an annual basis for each type of educational loan provided by the lender. 153(b). Similarly, a covered institution participating in a preferred lending arrangement must prepare an annual report to be filed with the Secretary of the Department. This report must include the information included on the model disclosure form for each type of educational loan provided to students and/or parents by the preferred lender at the covered institution and a detailed explanation of why the institution believes the terms and conditions of each type of loan are beneficial for students. 153(c). This report must be provided to students and parents prior to their application for educational loans. 13 TILA provides an exemption for loans made, insured, or guaranteed pursuant to a program authorized by Title IV of the Higher Education Act of C.F.R (f). 14 See 12 U.S.C See H.B. 890, See id. 153(d). 17 See id August

10 19 See H.B. 890, 3. In addition, the institution must establish and disclose a process to ensure that lenders are placed on preferred lender lists based on benefits provided to borrowers, including competitive interest rates, terms or conditions and high-quality servicing, or additional benefits beyond the standard terms and conditions. The institution also must use a duty of care and a duty of loyalty to compile the preferred lender list without prejudice, and refrain from denying or impeding the borrower s choice of a lender, even if not one recommended by the institution. 20 Note that the Secretary of the Department is charged with maintaining and updating a list of lender affiliates of all eligible lenders and providing this list to institutions to aid them in their preferred lender disclosures. 21 See 12 U.S.C. 2607(c)(4). 22 See H.B (a). 23 See id. 155(b) RESPA defines referral to include any activity that has the affirmative effect of influencing the selection of a particular service provider. 24 C.F.R (f). 27 We note, however, that H.B. 890 does not propose penalties for a lender s violation of the terms of the Code of Conduct, which the Act requires lenders to create, publish, and administer. Instead, arguably a lender could only be penalized under the Act for failing to create, publish, and administer the Code. 28 See H.B. 890, 155(c) (d). 30 See id. 155(e) See id. 155(f). 33 See H.B. 890, 155(g). 34 See id. 156(a). 35 See id. 155(b). 36 See id. 37 While House Bill 890 has been read and referred to the Senate Committee on Health, Education, Labor and Pensions, Senator Edward Kennedy has introduced Senate Bill 486, also titled the Student Loan Sunshine Act. This bill generally tracks the proposals under House Bill 890, with some differences. For instance, while House Bill 890 prohibits gifts, educational loan arrangements, staffing assistance, opportunity pools, and participation on advisory councils, Senate Bill 486 prohibits only gifts. Senate Bill 486 also has been read and referred to the Senate Committee on Health, Education, Labor and Pensions. 38 See The Library of Congress, Summary of S.B. 1831, available at s.01831:. This bill has been referred to the Senate Committee on Banking, Housing, and Urban Affairs. 39 See Federal Perkins Loan Program, Federal Family Education Loan Program, and William D. Ford Federal Direct Loan Program, 72 Fed. Reg (proposed June 12, 2007). 40 This Client Alert focuses on the proposed rules applicable only to lenders. 41 Other benefits is defined to include, but not be limited to, preferential rates for or access to the lender s other financial products, computer hardware or non-loan processing or non-financial aid-related computer software at below market rental or purchase cost, and printing and distribution of college catalogs and other materials at reduced or no cost. 72 Fed. Reg , (June 12, 2007) Fed. Reg. at As the list of prohibited inducements mirrors the items prohibited under the Act, it is no surprise that the Department reasons these prohibitions are needed because special relationships between schools and lenders have developed, jeopardizing a borrower s right to choose a FFEL lender and undermining the student financial aid administrator s role as an impartial and informed resource for students and parents working to fund postsecondary education. at See id. at See id Fed. Reg. at at See 12 U.S.C. 2607(d). 52 See id. August

11 K&L Gates Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance. For more information, please contact one of the professionals listed below. LAWYERS Boston R. Bruce Allensworth bruce.allensworth@klgates.com Irene C. Freidel irene.freidel@klgates.com Stephen E. Moore stephen.moore@klgates.com Stanley V. Ragalevsky stan.ragalevsky@klgates.com Nadya N. Fitisenko nadya.fitsenko@klgates.com Brian M. Forbes brian.forbes@klgates.com Los Angeles Thomas J. Poletti thomas.poletti@klgates.com Miami Paul F. Hancock paul.hancock@klgates.com New York Elwood F. Collins elwood.collins@klgates.com Steve H. Epstein steve.epstein@klgates.com Drew A. Malakoff drew.malakoff@klgates.com Thomas C. Russler tom.russler@klgates.com San Francisco Jonathan Jaffe jonathan.jaffe@klgates.com Erin Murphy erin.murphy@klgates.com Seattle Holly K. Towle holly.towle@klgates.com Washington, D.C. Costas A. Avrakotos costas.avrakotos@klgates.com Melanie Hibbs Brody melanie.brody@klgates.com Eric J. Edwardson eric.edwardson@klgates.com Steven M. Kaplan steven.kaplan@klgates.com Phillip John Kardis II phillip.kardis@klgates.com Rebecca H. Laird rebecca.laird@klgates.com Laurence E. Platt larry.platt@klgates.com Phillip L. Schulman phil.schulman@klgates.com H. John Steele john.steele@klgates.com Ira L. Tannenbaum ira.tannenbaum@klgates.com Nanci L. Weissgold nanci.weissgold@klgates.com David L. Beam david.beam@klgates.com Emily J. Booth emily.booth@klgates.com Krista Cooley krista.cooley@klgates.com David Keith Gaston david.gaston@klgates.com August

12 Anthony C. Green Laura A. Johnson Kris D. Kully David G. McDonough, Jr Lorna M. Neill Staci P. Newman Stephanie C. Robinson Kerri M. Smith Holly M. Spencer Erin E. Troy DIRECTOR OF LICENSING Washington, D.C. Stacey L. Riggin REGULATORY COMPLIANCE ANALYSTS Washington, D.C. Dameian L. Buncum Nancy J. Butler Teresa Diaz Jennifer Early Marguerite T. Frampton Robin L. Gieseke Angela M. Gonzalez Joann Kim Brenda R. Kittrell Dana L. Lopez Jeffrey Prost K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name Kirkpatrick & Lockhart Preston Gates Ellis LLP qualified in Delaware and maintaining offices throughout the U.S., in Berlin, and in Beijing (Kirkpatrick & Lockhart Preston Gates Ellis LLP Beijing Representative Office); a limited liability partnership (also named Kirkpatrick & Lockhart Preston Gates Ellis LLP) incorporated in England and maintaining our London office; a Taiwan general partnership (Kirkpatrick & Lockhart Preston Gates Ellis) which practices from our Taipei office; and a Hong Kong general partnership (Kirkpatrick & Lockhart Preston Gates Ellis, Solicitors) which practices from our Hong Kong office. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is available for inspection at any K&L Gates office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1998 We may contact you from time to time with information on Kirkpatrick & Lockhart Preston Gates Ellis LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please london@ klgates.com if you would prefer not to receive this information Kirkpatrick & Lockhart Preston Gates Ellis LLP. All Rights Reserved. August