Update, 10/1/2019: The Department of Education issued a final rule on Sept. 23, 2019. A revised NACUBO advisory report will be published in the coming weeks following further analysis.
On August 30, 2019, the Department of Education announced its intention to promulgate new, final regulations for relieving student borrowers of their federal debt if their schools have closed or misled them. Although ED publicly shared this newest iteration of the borrower defense rules on its website, the regulations are not yet official. Because the rules have not been published in the Federal Register, they remain preliminary and subject to change. Read on for an overview of the regulations and register for our September 19 Legislative Lunchcast to learn more.
The preliminary regulations, which ED recently shared on its website, include a mix of provisions from the 2016 Obama-era rules and the Trump administration’s 2018 regulatory proposal. Most notably, the preliminary version of the borrower defense rules contain revised financial responsibility terminology and definitions for calculating composite score ratios. They also remove many of the more controversial provisions from the 2018 Trump administration proposal, such as limiting who can file a defense against repayment claim exclusively to students who have already defaulted on their loans.
Like previous iterations of the borrower defense rules, the preliminary regulations contain guidance on the following topics:
- Borrower Defense-to-Repayment
- Triggering Events
- Financial Responsibility
If ED finalizes these preliminary rules in the next two months, the regulations related to borrower defense will take effect July 1, 2020. However, the regulations relating to financial responsibility will be available for immediate implementation as soon as the rules are published in the Federal Register.
The preliminary rules blend provisions from the Trump administration’s 2018 proposal and the Obama-era regulations that are currently in effect. Notably, the unofficial new rules preserve some key Obama-era provisions that ED controversially cut in its 2018 proposal. For example, under the new regulations ED will continue to accept both affirmative and defensive claims, meaning that debt relief will not be limited to borrowers who have already defaulted on their loans. In addition, ED will continue to uphold a preponderance of the evidence standard for borrower defense claims.
ED also will continue to allow students to choose between a teach-out plan or a closed school loan discharge during an orderly school closure. However, borrowers will now have to submit an application for a closed school discharge. The process will no longer be automatic.
Although the preliminary rules maintain several important provisions from the Obama-era regulations, they also adopt a number of significant changes featured in the 2018 proposal. For example, the preliminary new regulations will establish a uniform federal standard for a borrower’s defense-to-repayment, replacing the state law-based standard currently in effect. While this approach will streamline claims, it is expected to provide weaker protections to students in most states.
Keeping with the 2018 proposal, the preliminary new rules will only consider individual claims, even when there is evidence that entire groups of borrowers were misled. The new provisions will also allow institutions to include mandatory pre-dispute arbitration agreements and class-action waivers as a condition of enrollment as long as schools explain these legal agreements in plain language. Similarly, schools will be allowed to deny transcripts to students with successful defense-to-repayment claims. In addition, when filing a claim, borrowers must specify the financial harm that resulted from a school’s misrepresentation. ED will not consider nonmonetary losses and the department will presume against full relief.
Crucially, the preliminary rules also provide a new definition of “misrepresentation,” which is similar but not identical to the definition from the 2018 proposal. Under the new provision, “misrepresentation” is defined as: “a statement, act, or omission by an eligible school to a borrower that is (a) false, misleading, or deceptive, (b) that was made with knowledge of its false, misleading, or deceptive nature or with a reckless disregard for the truth, and (c) that directly and clearly relates to either 1) enrollment or continuing enrollment at the institution; or 2) the provision of educational services for which the loan was made.”
Lastly, the preliminary rules establish new procedures for processing a borrower defense-to-repayment claim. Notably, schools will be allowed to view the claimant’s application and supporting materials and then will have the opportunity to respond. ED will issue a written decision after the borrower has a chance to reply to the institution’s rebuttal. All decisions will be final and neither the borrower nor the school will be allowed to appeal. Borrowers will have three years from the time they leave an institution to file a borrower defense claim.
Regarding triggering events, those events that may call into question an institution’s financial responsibility, the preliminary new rules have fewer triggers overall compared to the 2016 rules. Like ED’s proposed rules from 2018, these preliminary regulations organize triggering events into two categories: mandatory and discretionary.
Generally, the mandatory triggers aim to include only actions or events with immediate and quantifiable ramifications. While there are four potential mandatory triggering events under the final regulation, only two are applicable to nonprofit institutions:
- Liabilities arising from a settlement, final judgment from a court, or final determination arising from an administrative action or proceeding initiated by a federal or state entity.
- Two or more unresolved discretionary triggering events in the fiscal year reported.
When a school incurs monetary liabilities stemming from incidents outlined in the first bullet point above, ED will recalculate the institution’s composite score and consider a “failing recalculated score (less than 1.0) as evidence of an adverse material effect.”
Like the mandatory events, some of the newly proposed discretionary triggering events will only affect proprietary institutions. Unlike the mandatory events that would render a clear determination that an institution is no longer financially responsible, the discretionary triggers would prompt ED to work with an institution to look more holistically at the nature and outcome of the triggering events to determine whether the violation has or could have material financial consequences before determining whether the institution is financially responsible. Discretionary triggering events include:
- Actions taken against an institution by an accrediting agency, including unsatisfied show-cause orders that could lead to the withdrawal, revocation, or suspension of institutional accreditation.
- Violation of security or loan agreements with creditors.
- Citations by state licensing or authorizing agencies for violations of state or agency agreements that may prompt the withdrawal or termination of licensure or authorization.
- When an institution’s two most recent cohort default rates are 30 percent or greater.
- High annual dropout rates, as calculated by ED.
Schools must notify ED no later than 10 days after any of these mandatory or discretionary triggering events occur. ED will consider in its review any additional information provided by the institution at the time it reports an event. For discretionary triggers, this affords an institution the opportunity to explain why the event is either already resolved or will fail to adversely materially impact the institution.
The preliminary new rules also feature substantial changes to financial responsibility standards. To accommodate significant Financial Accounting Standards Board updates on leases (FASB ASU 2016-02) and not-for-profit (NFP) reporting (FASB ASU 2016-14), the preliminary version of the borrower defense rules contain revised financial responsibility terminology and definitions for calculating composite score ratios. Additionally, institutions will need to include a supplemental schedule in their single audit financial statement package that provides the inputs used to calculate each ratio. Citations between supplemental schedule details and financial statements and notes must also be provided. The objective is to ensure that all attributes used to calculate ratios have been audited and are easily identified in the financial statements.
Although the implementation date noted in the preliminary rule is July 1, 2020 (FY21 for most independent NFP institutions), new terminology and definitions can be applied immediately for FY19 financial statements, because all NFP institutions will implement ASU 2016-14, Presentation of Financial Statements for Not-for-Profit Entities, in FY19. However, NACUBO recommends that institutions hold off on EZ-Audit submissions to allow time for a more complete analysis by NACUBO and subsequent guidance.
Under ASU 2016-02, Leases, reporting entities will capitalize and either amortize or expense a right-of-use asset over the lease term. One of the significant accounting and reporting changes for ratio calculations allows institutions to “grandfather” their lease accounting—meaning, institutions can choose to retain operating lease accounting treatment for assets leased prior to implementing ASU 2016-02. This allowance is intended to circumvent negative impact to an institution’s equity ratio for leasing business decisions made years ago.
Another grandfathered provision in the preliminary regulation concerns the treatment of long-term debt when calculating expendable net assets in the primary reserve ratio. Grandfathering allows long-term debt to be included (up to the amount of net property, plant, and equipment, or PP&E) when calculating expendable net assets – for debt and net PP&E reported prior to the July 1, 2020 implementation date of the new regulation (FY21 for most institutions). After July 1, 2020, only long-term debt obtained for the construction, acquisition, or improvement of long-term capital assets will be allowed. Disclosures and separate information for these two tranches of long-term debt will need to be included in the notes to the financial statements and the supplemental schedule.
While borrower defense rules have been in effect since 1995, they were rarely used prior to the sudden closure of Corinthian Colleges in 2015, which left thousands of students with federal student debt for degrees they could no longer complete. In response to the resulting surge in claims, the Obama administration promulgated new borrower defense regulations in 2016, with the aim of improving protections for defrauded students and better identifying financially unstable institutions.
After President Donald Trump took office, ED began efforts to revise the Obama-era regulations, proposing a package of rule changes that ED released in the summer of 2018. Under the master calendar provision of the Higher Education Act of 1965 (HEA), ED has until November 1 to finalize new rules for them to go into effect by July 1 of the next calendar year. In 2018, ED did not meet this deadline for publishing final borrower defense rules in the Federal Register.
The Road Ahead
Although ED has shared these preliminary rules on its public website, it is important to remember that they are not yet official and, as such, remain subject to change. ED has until November 1, 2019, to finalize the regulations for them to go into effect on July 1, 2020. However, the rules relating to financial responsibility will be available for immediate implementation as soon as the regulations are published in the Federal Register. NACUBO will update its advisory report on financial responsibility after final rules have been published.