NEW YORK — The government is moving forward with its crackdown on the country’s for-profit schools, aiming to protect students from taking on too much debt to attend schools that do nothing for their job prospects.
But student advocates protest that the final version of the Department of Education’s “gainful employment” rule, released Thursday, is way too soft. Meanwhile, schools and industry lobbyists rail that the Education Department has no legal standing to even impose the rule at all.
Only investors appeared happy with the outcome Thursday. Shares of for-profit school companies soared as investors viewed the scope of the Education Department’s new regulations as having a much less dire impact on the sector than they had feared. Analysts say the rule is more lenient than they and most shareholders had expected — “meaningfully watered down,” said R.W. Baird’s Amy Junker.
Corinthian Colleges Inc., one of the schools considered most at risk of having to shut down programs or make a significant overhaul to its business to comply with the rule, jumped nearly 27 percent. Shares of the nation’s largest chain, Apollo Group Inc., which owns the University of Phoenix, rose 11 percent. DeVry gained nearly 15 percent and the Washington Post Co., which owns the Kaplan school chain, rose more than 5 percent. Education Management Corp. rose 22 percent.
Former Maine Gov. John McKernan is chairman of the board of directors of Education Management Corp.
Earlier this year, the Justice Department joined an employee whistle-blower suit against Education Management Corp. The suit alleges that Pittsburgh-based Education Management Corp., 40 percent owned by Goldman Sachs funds, illegally paid recruiters based on the number of students they enrolled, the company said in a Securities and Exchange Commission filing. The government, in most cases, forbids such incentive compensation for colleges accepting federal aid because of concern the practice will encourage companies to enroll unqualified students.
McKernan was CEO of the company from September 2003 until 2007. He first joined the company in 1999 as vice chairman and a member of the board, according to the company.
The company, which enrolls more than 148,000 students, operates the Art Institute chain, Argosy University, Brown Mackie College and South University. Analysts project the company will report revenue of $2.89 billion in the year ending in June, according to the average of estimates compiled by Bloomberg News.
The Justice Department action Education Management Corp. against in federal court in Pittsburgh followed scrutiny by Congress and the federal Education Department of sales practices, student-loan defaults and job placement claims at for-profit colleges, which can receive as much as 90 percent of their revenue from federal financial aid.
Because most students at career colleges and vocational schools pay tuition with federal financial aid dollars, taxpayers are left on the hook if students can’t find good jobs and default on their loans. And they are defaulting in large numbers. Students at for-profit institutions such as technical programs and culinary schools represent just 12 percent of all higher education students but 46 percent of all student loan dollars in default. The average student earning an associate degree at a for-profit school carries $14,000 in federal loan debt versus the $0 debt burden of most community college students.
So the Education Department has set criteria that for-profit schools must meet in order to maintain access to federal financial aid. If graduates owe too much relative to their income, or too few former students are paying back their tuition loans on time, schools stand to lose access to Pell grants and federal student aid. Such a loss would seriously crimp schools’ ability to attract students and make money.
Under final terms of the law, schools will only be able to receive federal-paid tuition if at least 35 percent of its former students are repaying their loans. Or, the estimated annual loan payment of a typical graduate must not be bigger than 30 percent of his or her discretionary income, or 12 percent of his or her total earnings.
The agency drew up the gainful employment rule in 2010, but delayed putting it into effect as it faced heavy lobbying from schools and politicians. For the past 18 months, the Education Department has been negotiating the scope of gainful employment with industry representatives and advocates. Last summer, the Education Department released a draft of the regulation and the tough proposed stance spurred a sell-off in education shares. Companies fought hard against it. The Education Department received more than 90,000 comments about the rule. Corinthian alone has spent more than $1 million since the beginning of last year on lobbying.
The lobbying appears to have worked. Under the rule’s original terms, programs that failed to meet the criteria would have lost federal loan eligibility immediately and enrollment would have been frozen at any school in danger of failing. But the rule now gives schools multiple chances over a four-year period to improve their stats. That means no school will be in danger of losing funding for a program until 2015, rather than next year. After “three strikes,” a school will lose eligibility for three years.
Education Secretary Arne Duncan said the final version is “more thoughtful and more sophisticated” than the first draft, incorporating feedback from “hundreds of conversations” and “tons and tons of meetings.” The Education Department said it expects 18 percent of for-profit schools’ programs to fail its tests at some point, and 5 percent of programs to lose eligibility under the new law.
“We’re focusing on improving [for-profit programs] rather than closing them. Students would be better off if their programs were stronger rather than closed down,” said James Kvaal, a Education Department official, during a conference call with reporters.
But student advocates who favor regulation were frustrated by the more forgiving tone.
“Under the new regulations, many of the most toxic career education programs will continue to operate — largely at taxpayer expense — for three years with no requirements to improve,” added Jose Cruz, a vice president of Education Trust.
“It’s a limited first step to make sure taxpayer dollars aren’t being wasted,” said Pauline Abernathy of the Institute for College Access & Success, an education advocacy group that favors more industry regulation.
Others, including the National Black Chamber of Commerce and the Hispanic Leadership Fund, have said the new federal rule in its original form could hurt minority and low-income students by eliminating important funding options and therefore reducing the number of schools they can afford to attend.
And some question the Education Department’s authority to set such a rule at all.
Harris Miller, the president of Association of Private Sector Colleges and Universities, an industry group, said the rule has “fundamental legal flaws” because the DOE is “engaging in a form of price fixing.” Corinthian spokesman Kent Jenkins said the school has “serious reservations about the integrity of the [Education Departmen]’s regulatory process and its legal authority to take this action.” And Sen. Mike Enzi, R-Wyo., ranking member of the Senate’s education committee, has asked the Securities and Exchange Commission to investigate interaction between education policymakers and short-sellers who were betting against the school stocks.
There’s a lot at stake for the schools and their investors, who had benefited from the surge in for-profit programs hitting the market in the last decade. The country’s largest chain, Apollo Group, saw revenue and net income grow about eightfold since 2000. Even accounting for the hit that the sector’s stocks have taken from increased regulatory scrutiny, Apollo’s stock has more than quadrupled in that time.
But BMO Capital Markets analyst Jeff Silber has said the new regulations could cause profits to decline or stagnate at most for-profit schools over the next few years. New enrollments have dropped sharply after years of double-digit growth as the schools adjusted their businesses to accommodate the government’s stricter oversight.
Some schools have been trying to get out in front of the new laws and adapt their business models to the new reality even before the rule was made final. Apollo’s University of Phoenix, for example, now offers a free, three-week orientation that helps weed out unprepared students without charging them. The Washington Post Co.’s Kaplan education division has also put in place a free trial period so students can see if they really want to commit to school. Career Education Corp. is making new online undergraduate students pass a college prep course if they haven’t attended college before — if they can’t do the work, they can drop out without paying tuition.
Spokespeople from the University of Phoenix, Kaplan and DeVry declined to comment on the new rule.