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ED Establishes New Financial Accountability Rules for Private Institutions

November 15, 2016

On November 1, the Department of Education published final rules providing student loan borrowers a more transparent process when filing borrower defense-to-repayment claims. 

The same regulatory package also introduced onerous new financial responsibility requirements for independent nonprofit and for-profit institutions that participate in the federal student aid programs. The final rules will take effect on July 1, 2017. Public institutions backed by the full faith and credit of their states are not held to the current or new standards of financial responsibility.

The department undertook the rulemaking following the closure of Corinthian Colleges, when ED received an influx of borrower defense claims from former Corinthian students. ED received more than 10,000 comments on the proposed regulations.

In its comment letter, NACUBO argued that this rulemaking process was not the appropriate venue to address and improve upon the current financial responsibility rules. However, ED disagreed, and ultimately included the changes as part of a final effort by the Obama administration to protect student loan borrowers and promote greater institutional accountability.

Borrower Defense

NACUBO supported ED’s goal to establish borrower defense standards and define the evidence former and current students must provide to show that a college’s misconduct warrants debt relief, but expressed some concerns with certain borrower defense rules and limitations. Ultimately, the department made few changes between the draft and the final regulations. 

The new regulations create a standard for making debt relief available to students when there is:

  1. A breach of contractual promises between a school and its students;
  2. A state or federal court judgment against a school related to the loan or the educational services for which the loan was made; or
  3. Substantial misrepresentation by the school about the nature of the educational program, the nature of financial charges, or the employability of graduates.  

NACUBO understands ED’s desire to regulate false and misleading marketing but remains concerned that “the vastly broadened view of misrepresentation will result in a booming business for lawyers and will tie-up institutions in governmental red tape.” ED argued the fallout from Corinthian’s closure is what necessitated expanding on the previous definition.The final regulations state that there is no statute of limitation for discharge of borrowers’ loan balances still owed or relief based on state or federal court judgments. 

The statute of limitation for borrower claims to recover payments that have already been made on loans originated on or after July 1, 2017, is six years for claims based on misrepresentation and breach of contract.  

The final regulations also establish a process to make it easier for the department to provide relief to groups of borrowers. NACUBO supported this plan in its comment letter.

ED also established a number of additional new protections, many of which are covered in its summary of major provisions.

Institutional Accountability and Financial Responsibility

For 20 years, private nonprofit and for-profit colleges and institutions have had to show they are not at risk of precipitous closure using a financial responsibility calculation based on three ratios that produce a composite score. Depending on the score, some schools are deemed financially responsible, some fall into the “zone alternative” and are subject to additional oversight, and schools with failing scores are subject to provisional certification and must post a letter of credit in order to continue to participate in the Title IV programs.

Using the borrower defense-to-repayment rulemaking process, ED has introduced a regime of “triggers”–conditions that could force a recalculation of financial responsibility composite scores, requirements to provide financial surety to ED, and public disclosure. Institutions experiencing a triggering event will be required to notify ED, in most cases, within 10 days. 

NACUBO and others have found that ED, under the existing rules, often fails to calculate financial responsibility ratios for nonprofit institutions correctly—and has been doing so for years. ED is imposing this new financial responsibility structure before taking steps to resolve the problems inherent in its current practice. This process will be further complicated by recently released changes to nonprofit accounting standards.

A summary of the final rules follows. NACUBO will provide additional resources for its membership following further analysis of the new rules.

Automatic Triggers

For nonprofit colleges and universities, a triggering event in one of four major categories results in the recalculation of the institution’s most recent composite score, unless the institution demonstrates to the satisfaction of the education secretary that the event or condition has had or will have no effect on the assets and liabilities of the institution. In addition, any school whose cohort default rates for the two most recent years are 30 percent or higher will be judged unable to meet its financial or administrative obligations. There are several additional triggers that only apply to for-profit schools.

ED will use actual or potential losses associated with the actions or events to recalculate the institution’s most recent composite score.  “Automatic triggers” that would result in a recalculated composite score include:

  1. Debts and borrower defense-related lawsuits.
  2. Other litigation.
  3. Accrediting agency actions requiring teach-out plans for closing institutions, branches, or locations.
  4. Gainful employment program(s) that may become ineligible for the next award year based on final debt-to-earnings ratios.

See Table 1 below for additional details.

NACUBO is particularly concerned about new composite score recalculations resulting from borrower defense-related lawsuits and other litigation. As explained in the final rules, ED’s formula will increase total expenses and distort both the primary reserve ratio and net income ratio in the composite score calculation.

Under the formulas used to recalculate composite scores as a result of accrediting agency actions (teach-out plans) and failing gainful employment programs, potential losses will reduce revenue and only the net income ratio will be impacted.

Discretionary Triggers

The final rules also lay out a number of “discretionary triggers” that may lead the secretary to determine an institution is not financially responsible. These include such indicators as fluctuations in federal grant or loan utilization rates, high dropout rates, citations by state agencies, or violations of agreements with creditors. These triggers do not compel recalculation of the composite score, but are considered on their own.  Institutions might be required to participate in Title IV student aid programs under the zone or provisional certification alternatives and to post a letter of credit or other surety. 

See Table 2 below for additional details.

Reporting and Disclosure of Information 

In the draft regulations, ED proposed to require any school that is required to provide financial protection to disclose that fact to current and prospective students and on the homepage of its website. NACUBO objected strenuously to this provision, concerned that such a warning will drive away students and alarm potential donors.

In response to the concerns expressed by NACUBO, the department stated:

“We understand the concern regarding the potential for the financial protection disclosures that were initially proposed, as well as the financial protection disclosures in these final regulations, to damage an institution’s reputation. However, we do not believe that the possibility of harm to an institution’s reputation is reason enough to withhold from students, who in many cases have borrowed heavily to finance their educations, information on the financial viability of the institutions they attend.”

The final rule backed away from the full disclosure requirements but states that, through consumer testing, the Department will determine which triggers require a disclosure that is meaningful to students. It is unclear exactly how ED will proceed with consumer testing at this time.

The revised financial responsibility standards appear on pages 76073-76078 of the Federal Register notice.


Table 1. AUTOMATIC TRIGGERING ACTIONS*
*for nonprofit institutions

AUTOMATIC
TRIGGERING ACTIONS
for Nonprofit Institutions
Related to
Calculation
Reporting Requirement
Debts and Borrower Defense-Related Lawsuits (A) The institution is required to pay any debt or incur any liability arising from a final judgment in a judicial proceeding or from an administrative proceeding or determination, or from a settlement; or
(B)  The institution is being sued in an action brought on or after July 1, 2017 by a Federal or State authority for financial relief on claims related to the making of the Direct Loan for enrollment at the school or the provision of educational services and the suit has been pending for 120 days.

Amount of loss is--
(A)  The amount of debt;
(B)  For a suit, the amount set by a court ruling, or, in the absence of a court ruling--
(1)  The amount of relief claimed in the complaint;  
(2)  If the complaint demands no specific amount of relief, the amount stated in any final written demand issued by the agency to the institution prior to the suit or a lesser amount that the agency offers to accept in settlement of any financial demand in the suit; or
(3)  If the agency stated no specific demand in the complaint, in a pre-filing demand, or in a written offer of settlement, the amount of tuition and fees received by the institution during the period, and for the program or location, described in the allegations in the complaint.  

Institution must notify the Secretary of any of the following actions or events no later than-

(A)  For lawsuits, 10 days after the institution is served with the complaint and 10 days after the suit has been pending for 120 days; and
(B)  For debts arising from lawsuits and for other actions or events, 10 days after a payment was required or a liability was incurred.
Other Litigation The institution is being sued in an action brought on or after July 1, 2017 that is not described in paragraph (c)(1)(i)(B) of this section and--
(A)  The institution has filed a motion for summary judgment or summary disposition and that motion has been denied or the court has issued an order reserving judgment on the motion;
(B)  The institution has not filed a motion for summary judgment or summary disposition by the deadline set for such motions by the court or agreement of the parties; or
(C)  If the court did not set a deadline for filing a motion for summary judgment and the institution did not file such a motion, the court has set a pretrial conference date or trial date and the case is pending on the earlier of those two dates.

The amount of loss is the amount set by a court ruling, or, in the absence of a court ruling--
(A)  The amount of relief claimed in the complaint;
(B)  If the complaint demands no specific amount of relief, the amount stated in any final written demand by the claimant to the institution prior to the suit or a lesser amount that the plaintiff offers to accept in settlement of any financial demand in the suit; or
(C)  If the complainant stated no specific demand in the complaint, in a pre-filing demand, or in a written offer of settlement, the amount of the claim as stated in a response to a discovery request, including an expert witness report.

(A)  Ten days after the institution is served with the complaint;
(B)  Ten days after the court sets the dates for the earliest of the events described in paragraph (c)(1)(ii) of this section, provided that, if the deadline is set by procedural rules, notice of the applicable deadline must be included with notice of the service of the complaint; and
(C)  Ten days after the earliest of the applicable events occurs;

Accrediting Agency Actions The institution was required by its accrediting agency to submit a teach-out plan, for a reason described in §602.24(c)(1), that covers the closing of the institution or any of its branches or additional locations. The amount of loss is the amount of title IV, HEA program funds the institution received in its most recently completed fiscal year for that location or institution, or for those GE programs. 10 days after the institution is notified by its accrediting agency that it must submit a teach-out plan;
Gainful Employment As determined annually by the Secretary, the institution has gainful employment programs that, under §668.403, could become ineligible based on their final D/E rates for the next award year. The amount of loss is the amount of title IV, HEA program funds the institution received in its most recently completed fiscal year for that location or institution, or for those GE programs.

Table 2. Discretionary Factors or Events

The Secretary has the discretion to determine an institution to be not financially responsible if—

Discretionary Factor/Event Definition Reporting Requirement
Direct Loan or Pell Grant Fluctuation There is a significant fluctuation between consecutive award years, or a period of award years, in the amount of Direct Loan or Pell Grant funds, or a combination of those funds, received by the institution that cannot be accounted for by changes in those programs; n/a
State Licensing or Authorizing Agency Citation The institution is cited by a state licensing or authorizing agency for failing state or agency requirements; Institution must notify the Secretary no later than10 days after the institution is cited for violating a state or agency requirement;
Financial Stress Test The institution fails a financial stress test developed or adopted by the Secretary to evaluate whether the institution has sufficient capital to absorb losses that may be incurred as a result of adverse conditions and continue to meet its financial obligations to the Secretary and students; n/a
Dropout Rates As calculated by the Secretary, the institution has high annual dropout rates; n/a
Accreditation Status The institution is or was placed on probation or issued a show-cause order, or placed on an accreditation status that poses an equivalent or greater risk to its accreditation, by its accrediting agency for failing to meet one or more of the agency's standards; Institution must notify the Secretary no later than 10 days after the institution's accrediting agency places the institution on that status; 
Loan Agreement Violation The institution violated a provision or requirement in a loan agreement; and
(ii)  As provided under the terms of a security or loan agreement between the institution and the creditor, a monetary or nonmonetary default or delinquency event occurs, or other events occur, that trigger, or enable the creditor to require or impose on the institution, an increase in collateral, a change in contractual obligations, an increase in interest rates or payments, or other sanctions, penalties, or fees;
Institution must notify the Secretary no later than 10 days after a loan violation occurs, the creditor waives the violation, or the creditor imposes sanctions or penalties in exchange or as a result of the waiver.
Borrower Discharge Claims The institution has pending claims for borrower relief discharge under §685.206 or §685.222; n/a
Borrower Discharge Lawsuits and Settlements The Secretary expects to receive a significant number of claims for borrower relief discharge under §685.206 or §685.222 as a result of a lawsuit, settlement, judgement, or finding from a State or Federal administrative proceeding. n/a

Contact

Liz Clark
Director, Federal Affairs
202.861.2553
E-mail

Anne Gross
Vice President, Regulatory Affairs
202.861.2544
E-mail