Last month, the U.S. Department of Education announced that it will hold the owners of certain private colleges financially liable if the institutions defraud students or close without warning — a move that will largely affect for-profit schools.
The policy means the Ed Department may require any firm that has at least a 50% stake in a private college to join college officials in signing the institution's program participation agreement, or PPA, which is a pledge to follow federal standards. Typically, only a college's chief executive or other official signs these agreements.
If the college defrauds students or closes unexpectedly, the Ed Department can forgive the loans of its students and recoup those losses through the terms outlined in the PPA.
The for-profit sector has expressed concerns with the announcement. In a statement last month, the president of Career Education Colleges and Universities, which lobbies on behalf of for-profit institutions, urged the Ed Department to closely consider the circumstances of institutional closures before "piercing the corporate veil" of limited liability to claw back money to cover taxpayer losses.
A month later, the sector worries about what the policy could mean for its ability to raise money.
"When investors are nervous, they don't invest capital quite as much, and there tends to be less innovation and competition in higher education — which I think is ultimately bad for students," said John Huston, CECU's vice president for legislative and regulatory affairs.
To be sure, the Ed Department announcement formalized a shift in policy. But the agency had already taken steps to ask a private college's owner to be financially responsible for wrongdoing before it codified its procedures. Moreover, the announced policy may be weaker than what's allowed under federal regulations, and some groups have urged the department to go a step further and hold business executives personally liable.
The policy change is likely to make owning for-profit colleges less desirable for private equity firms, which could be concerned it will make it more expensive to own these institutions, said Trace Urdan, managing director at Tyton Partners, an investment banking firm.
But the development isn't an entirely new framework. Rather, it's another step in a regulatory environment that has been growing more difficult for for-profit colleges.
"It's not a sea change," Urdan said. "It's an incremental change."
Florida Coastal School of Law provides precedent
The Ed Department has already asked a private equity firm to sign a for-profit college's PPA in at least one high-profile case. The Florida Coastal School of Law was a proprietary school that ceased operations in 2021 after the Ed Department yanked its access to federal student aid, which had provided about 80% of its revenue.
But before the school shuttered, the Ed Department asked Sterling Capital Partners — a private equity firm that had a 98.6% stake in Florida Coastal's parent company — to sign the institution's provisional PPA. The department said the signature was necessary after Florida Coastal failed to meet financial responsibility standards.
School officials resisted, and Sterling Capital's general counsel said it wasn't involved in Florida Coastal's day-to-day operations and that it was in the process of terminating its investment fund that owned the institution. Florida Coastal's provisional PPA lapsed at the end of March 2021, and Sterling Capital told the Ed Department the next month that it had given up its entire stake in the college's parent company.
The Ed Department refused to restore Florida Coastal's federal financial aid, and the institution collapsed several months later. It has since sued the department over the decision, and the case is still pending.
Other situations may not be as dire. The Ed Department said it will ask the owners of private colleges to sign the agreements when their campuses have not met financial responsibility requirements, when they are only provisionally certified to participate in federal aid programs or when they have significant liabilities stemming from defrauding students.
Huston contended that these are overly broad criteria that may affect financially strong institutions. He argued the department should instead take a case-by-case approach.
If institutions have failed financial responsibility requirements, they've typically been asked to instead post a letter of credit, a type of financial collateral that usually ranges from 10% to 50% of the Title IV federal student aid that an institution received in a prior year. It's also been standard practice for the department to require institutions to post letters of credit when they've been sold to new owners, Urdan said.
But that practice may be expanding as an alternative to the new PPA requirements. The department's policy says some ownership groups may not be required to sign PPAs if a school has alternative protections, such as letters of credit.
"If I read between the lines, it looks like it will become a standard practice of PPA renewal," Urdan said. "So basically, instead of something that just gets imposed initially upon change of control, it looks like it's going to be required every time that a PPA comes up for consideration."
PPAs last up to six years, according to the Ed Department's website.
Huston agreed that letters of credit will likely still be on the table as an alternative to having owners sign the PPA.
"But, you know, not all institutions are going to be in a situation like that, where they have the capability to do that," Huston said. "Some owners are going to sign, and some will decide to post larger letters of credit."
Advocates want even stricter policies
Some policy advocates and lawmakers have been clamoring for the Ed Department to hold company executives personally liable for wrongdoing by for-profit colleges.
In October 2020, the National Student Legal Defense Network, an advocacy organization, called on the next presidential administration to hold executives responsible within its first 100 days. The group also called letters of credit "woefully insufficient" to protect against taxpayer losses.
Rep. Bobby Scott, a Virginia Democrat who chairs the House Committee on Education and Labor, in August 2021 wrote Education Secretary Miguel Cardona urging the department to take legal action against executives of for-profit colleges found to have defrauded students. And Richard Cordray, who heads the Ed Department's student aid office, signaled his support for such moves during a congressional hearing last year.
Others took issue with the fact that the new Ed Department policy only affects organizations with at least a 50% stake in a private college. Meanwhile, federal regulations consider entities to have "substantial control" over institutions if they have at least a 25% ownership.
Aaron Ament, president of the National Student Legal Defense Network, said in an emailed statement that it's critical the department doesn't water down its authority "to hold corporate owners with smaller shares accountable" or back down from Cordray's commitment to hold individuals personally liable.
"This will not only deter abusive conduct but give future investors and insurers pause before backing companies with predatory behavior," Ament said.