When a struggling college closes without warning, students’ lives are thrown into turmoil, and many are left with few options and nothing to show for months or years of work. Precipitous closures also result in enormous costs to taxpayers, who are left to foot the bill for federal student loans that the government forgives. Recent years have seen a rash of sudden college closures, including hundreds of campuses operated by giant for-profit conglomerates such as Corinthian Colleges, ITT Tech, Education Corporation of America (“ECA”), Vatterott, and the formerly for-profit schools operated by the Dream Center. The abrupt closure of these and other schools has disrupted the educations of tens of thousands of students and resulted in hundreds of millions of dollars in costs to taxpayers.
The U.S. Department of Education has an array of financial oversight tools intended to identify financially unstable schools in time for the department to take steps to protect against such losses. Unfortunately, the department’s oversight tools have proven ineffective at identifying at-risk schools and inadequate to protect taxpayers from the fallout of precipitous school closures. The department’s upcoming regulation-drafting process, known as negotiated rulemaking, provides an opportunity for the department to tear down the existing oversight structure and replace it with one that better protects taxpayers and students. To create a functional financial oversight system, the department must, at minimum:
- replace the single-number financial fitness test with a multi-factor, nuanced, and comprehensive diagnostic model;
- require more frequent financial reporting from high-risk schools;
- strengthen existing financial fitness standards and create additional bright-line rules;
- prevent schools from escaping accountability to taxpayers and students through receivership; and
- hold for-profit college owners and executives personally liable for liabilities to taxpayers.
Replacing the Single-Number Financial Fitness Test
The Department of Education’s primary tool for financial oversight of colleges is the financial composite score, a single number that is intended to represent a school’s financial health. Although the financial composite score is the department’s chief measure of financial fitness, the composite score has proved highly ineffective at predicting precipitous closures—only half of abrupt school closures are predicted by the composite score. This failure stems, in part, from the difficulty of boiling down a complex, multifaceted financial picture into a single number.
The composite score is derived from ratios intended to measure schools’ liquidity, ability to borrow, and profitability, which are combined into a single number between –1 and 3. Schools “pass” with scores above 1.5, “fail” with scores below 1, and fall within a warning “zone” with scores between 1 and 1.5. Passing schools qualify to receive federal funds without restrictions. “Zone” schools remain eligible for federal funding but are subject to restrictions on fund disbursement methods. Schools with failing scores can continue to receive federal funds by providing a letter of credit, which ensures partial repayment of obligations to the Department of Education in the event of sudden closure. Failing schools may also be required to enter into a provisional agreement with the department, which may impose additional requirements and which makes it easier for the department to terminate the school’s participation in federal financial aid programs.
The composite score attempts to combine multiple complex financial factors into a single number. Combining multiple indicators in this way can mask problems where strengths in one metric masks weaknesses in others. In addition, the composite score fails to consider year-over-year financial changes and trends such as enrollment decreases or increases that can serve as important “red flags” signaling financial risk.
A more effective way to evaluate schools’ financial fitness would be to base fitness evaluations on analysis by independent financial experts. Using experts would enable a more nuanced, flexible, and comprehensive analysis of schools’ financial fitness. Experts could use their judgment to evaluate whether strengths in one financial area mitigate risks in other areas. In addition, analysis by independent experts would permit evaluation of year-over-year changes in a schools’ financial health and consideration of trends such as enrollment changes.
Analysis by independent experts would also decrease opportunities for manipulation of scores by schools. The current composite score system is highly susceptible to manipulation—one for-profit school, for example, reportedly took out a multi-million dollar loan in multiple years immediately before the end of its fiscal year and paid it back a few days later, enabling it to receive a passing score.
Requiring More Frequent Financial Reporting from High-Risk Schools
The composite score is also ineffective at predicting precipitous closures because it is based on highly outdated data. The scores are calculated using information from annual audited financial statements that are submitted as late as six months after the end of the schools’ fiscal year. This time lag, combined with the additional time it takes the Department of Education to generate the composite score, renders the data nearly useless for evaluating a school’s current financial health. For example, almost two years into the pandemic, the department is relying on composite scores that are based on 2018 and 2019 data, and thus do not reflect any of the economic impacts of the pandemic.
Existing regulations require schools to provide updated financial data to the Department of Education after certain events that trigger a recalculation of the composite score. Schools with low financial scores are also required to notify the department of certain changes in financial circumstances, such as unusual losses. These reporting requirements are a good start, but they must be expanded and strengthened. For example, all schools should be required to submit updated financial data to the department when there is any significant change in the schools’ financial circumstances. In addition, schools that are designated high risk should be required to report on financial changes on a quarterly basis.
Strengthening Financial Fitness Standards and Creating Additional Bright-Line Rules
In recent years, the Department of Education’s attempts to protect taxpayers from the costs of precipitous closure have come much too late. When the department waits until a school is already struggling financially to take action, restrictions such as slowing the flow of federal dollars can trigger a catastrophic closure. Part of the reason for the delay in the department’s action is that the department is under constant political pressure to keep struggling Title IV schools afloat. To combat this pressure, the department’s discretion should be eliminated in favor of hard and fast rules. For example, all at-risk schools (that is, schools with “zone” or “failing” composite scores) should be required to enter into provisional certification agreements that impose significant collateral requirements and funding disbursement restrictions.
In addition, the Department of Education should increase the minimum collateral requirements for all at-risk schools. Current regulations require certain at-risk schools to post a letter of credit equal to 10 percent or more of the prior year’s Title IV receipts. This minimum should be increased and should be tied to a percentage of all potential liabilities, including those arising from loans discharged through the Borrower Defense process. The department should also enact a bright-line rule that prevents struggling schools from continuing to receive Title IV funds despite failing to improve their financial health over multiple years.
Preventing Schools from Escaping Accountability through Receivership
In recent years, three financially troubled schools have exploited a statutory loophole that permits schools to remain eligible for Title IV funding while in receivership status. A receivership is a legal status that occurs when a creditor or other outside entity requests that a court appoint an individual—the “receiver”—to control the school’s assets while a dispute involving the school is pending before the court. The receiver oversees a process that is similar to a bankruptcy reorganization, in which the company can settle or discharge debts or seek a purchaser or merger agreement. Because schools that reorganize in bankruptcy are statutorily prohibited from eligibility for Title IV funds, schools enter receiverships, rather than entering bankruptcy, to attempt to reorganize while continuing to qualify for Title IV funding.
Receiverships raise the risk that schools on the brink of collapse will continue to collect federal funds and enroll new students in the run-up to closure, increasing the magnitude of harm to students and taxpayers. In addition, in a traditional receivership, as in a bankruptcy proceeding, the interests of secured creditors are prioritized over the interests of taxpayers and students. Accordingly, without additional safeguards, students and taxpayers are unlikely to obtain relief for their losses through the vehicle of a receivership. Students and taxpayers can even lose their rights to seek relief in other venues: in a recent case, a receiver for a collapsed school chain successfully sought a court order shielding school executives from facing student lawsuits alleging deceptive practices. Schools and school executives should not be able to use receivership to escape accountability for misconduct.
In light of these risks, the Department of Education should close the loophole that permits schools to maintain Title IV eligibility after entering receivership, except where (a) the department requests appointment of a receiver, and (b) the receivership is established by a court for the express purpose of maximizing and preserving assets for relief to taxpayers and students and with the express instruction that taxpayer and student claims be prioritized.
Holding For-Profit College Owners and Executives Personally Liable
The abrupt closures of Corithina, ITT, ECA, Dream Center, and others all occurred after the schools, as well as school owners and executives, profited from receiving millions, or even billions, in federal aid. In each case, owners and executives have walked away with their profits without facing any personal liability for taxpayers’ losses.
As explained in a recent report by Student Defense, the Department of Education has explicit statutory authority to hold school owners and officials personally liable for financial losses to the department resulting from precipitous school closures. No new regulations are required for the department to take action to recover from these individuals. However, the department should consider enacting regulations or issuing guidance that describes procedural mechanisms the department may use to demand and/or collect payments from individuals. This would set the stage for aggressive action by the department and could also have a deterrent effect on school officials, who would be more likely to heed financial warnings and avoid choosing the kinds of actions, such as continuing to increase enrollment despite signs of an imminent financial collapse, that increase taxpayer losses.