Screw U: a Random Walk Through the Diploma Mill “This Is An

Screw U: A Random Walk Through The Diploma Mill

“This is an industry that is ripe for, begging for, regulation.” -Senator Tom Harkin, Chairman of the Senate Committee on Health, Education, Labor and Pensions (HELP)

As of last year, the for-profit education sector accounted for 13 percent of postsecondary students; however, they account for about 50 percent of all student loan defaults.1 One of the main causes of this disproportion is because the majority of students who attend for-profit schools never graduate; at the University of Phoenix, the flagship university of this sector, only about 9% of students graduate within six years (Only 5% graduate in their online program, which houses 175,200 students as of 2008).2 To exacerbate this problem, schools like University of Phoenix charge about four times the tuition of a typical non-profit institution.3 These schools prey on the vulnerable and disadvantaged, for they have the best access to federal aid and zero clue of what they are signing up for. In the past, we have seen multiple industries operate in the manner; notably the banking sector with sub-prime borrowers. In that case and in this one, employees are deluding the uneducated, and selling them the American Dream on borrowed money. As we know now, defaulted loans will dry up credit; with default rates growing exponentially, the federal credit line is about to stop.

1 U.S. Department of Education, IPEDS 12-month enrollment for 2011-12 and FY 2010 three-year CDRs. 2 The Education Trust, Subprime Opportunity: The unfulfilled promise of for-profit colleges and universities, November 2010. 3 For-Profit Higher Education: The failure to Safeguard the Federal Investment and Ensure Student Success, United States Senate Health, Education, Labor and Pensions (HELP) Committee.

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Predatory Lending

Predatory lending is legally described as any type of unscrupulous lending practice where a lender takes advantage of a borrower; if this sounds familiar, it’s because it is. This illegal practice is what led to the greatest financial crisis since the great depression: The Sub-Prime Mortgage Collapse. Akin to this crisis, for-profit institutions rely on predatory lending to entice ‘sub- prime’ students into their programs. Like the mortgage brokers of the last decade, recruiters from these institutions target the most vulnerable class of Americans: the bottom quintile of earners, also known as the lower class.

For these institutions, lower class citizens made the ideal students: 1) They did not understand the education system, and 2) They had the highest probability of obtaining a government loan. Knowing this, it’s not surprising that approximately ninety percent of revenues in this industry stem from the federal government. 4

The fundamental concept behind this fraudulent behavior in regards to for-profit universities pertains to the manipulative and deceptive recruitment techniques imposed by the industry.5

According to a Senate report in 20126, recruiting materials indicate that at some for- profit colleges, admission representatives were trained to locate and push on the pain in students’ lives. They were also trained to “overcome objections” of prospective students in order to secure enrollments. Additionally, companies trained recruiters to create a false sense of urgency to enroll and inflate the prestige of the college. (Appendix 1)

4 The Future of Children, Journal Issue: Postsecondary Education in the United States Volume 23 Number 1 Spring 2013, For Profit Colleges, David J. Deming, Claudia Goldin, and Lawrence F. Katz 5 National Association for College Admission Counseling, Federal Student Aid Program Integrity. 6 For-Profit Higher Education: The failure to Safeguard the Federal Investment and Ensure Student Success, United States Senate Health, Education, Labor and Pension (HELP) Committee.

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The picture below was taken from a training manual from the Apollo Education Group, the parent company of the infamous University of Phoenix, the largest for- profit college in the country.7

As you can see, these accusations are not unfounded; recruiters deliberately delude prospective students and use aggressive ‘boiler room’ like tactics to pressure the uneducated and gullible.

The low-income demographic is not the only one being taken advantage of by these tactics; military veterans have also been heavily targeted. In a study from the HELP committee, about 41 percent of the entire GI Bill ($1.7 billion) went to for- profit colleges. The epitome of “unscrupulous marketing”, as noted in the legal definition for predatory lending, can be found in the case of QuinnStreet, an internet marketing company. The company was forced to pay the government $2.5 million after they

7 For-Profit Higher Education: The Failure to Safeguard the Federal Investment and Ensure Student Success, United States Senate Health, Education, Labor and Pension (HELP) Committee.

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registered GIBill.com and used the apparently official website to generate leads for for-profit colleges. 8

Legal action is not new to this industry, according to court records, the University of Phoenix agreed to pay the United States $67.5 million to resolve allegation that its student recruitment policies violated the False Claims act. The Phoenix-based University also agreed to pay an additional $9.8 million on similar charges without admitting any wrongdoing.9

Education

The underlying problem with for-profit education is the current disconnect between tuition prices and education quality; unlike most things in life, you simply do not get what you pay for in this industry. As evidenced in SEC filings from all major players in this space, relatively small amount revenue goes towards instruction.10

According to a study by federal investigators, the University of Phoenix received close to 90 percent of revenues from the government; of that revenue, only about 17 percent went to actually educating the students. The majority of revenues from corporations like the University of Phoenix go towards marketing and recruiting efforts.11

On average, the cost to recruit the average new student at a large national chain is around $4,000, or about 25 percent of the average annual tuition.12 Unfortunately, only one-in-three of those students recruited will actually graduate. As for the 32 percent of students who actually graduate, they are now facing a grim outlook on future employment. Over the past several years, a negative stigma has attached itself to for-profit college degrees. As evidenced by employers past with for-profit college graduates, students in these institutions are simply not learning what they should be.

8 United States Securities And Exchange Commission, Form 10-Q, QuinStreet, Inc., Commission File No. 001-34628 9 United States of America ex rel. Mary Hendow and Julie Albertson v. University of Phoenix, case number 03-cv-00457, in the U.S. District Court for the Easter District of California. 10 For-Profit Higher Education: The Failure to Safeguard the Federal Investment and Ensure Student Success, United States Senate Health, Education, Labor and Pension (HELP) Committee. 11 U.S. Government Accountability Office, For-Profit Colleges: Undercover Testing Finds Colleges Encouraged Fraud and Engaged in Deceptive and Questionable Marketing Practices. 12 See ‘10’.

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Here is an excerpt from a professor of NTI, a subsidiary of Universal Technical Institute Corporation:

“Every day that I come to work, I hear students tell me that they have encountered employers that point blank tell them that they do not hire NTI students because of consistent poor performance… [W]e at NTI are being told to pass students who should fail because we are ‘training every level technician who paid for their certificates like everybody else’… We have been reduced to merely ‘selling’ diplomas for $30,000”13 In 2005, an economist by the name of Raghuram Rajan of the International Monetary Fund presented his paper in Jackson Hole, Wyoming at annual gathering of high-powered economist. His paper, “Has Financial Development Made The World Riskier?” found that everyone in the mortgage industry had an incentive to bring in more loans because the risk would be transferred out. Come to find out, he was absolutely right. This same philosophy is ingrained in the for-profit college model, everyone from the recruiters to the CEOs have incentive to increase enrollment, because the risk is then transferred to the taxpayers. This theory explains the sub-par instruction in this industry; the teachers are part-time employees, not tenure professors like they are in traditional schools. With this, the only job that instructors are held accountable for is passing students. In an investigation by the GAO, a Career Point teacher told an undercover agent this after failing a few assignments:

Those assignments you did not pass, I’ve opened them up so you can retake them. They are open book so there should not be any failure. All answers are right in the back of the book and there is no time limit. In addition to the lack of education, studies have also found that instructors do not hold students accountable for academic honesty and rarely check for plagiarism. In the same GAO investigation, an undercover deliberately submitted plagiarized work and received this response from the teacher: It appears that you copied and pasted from the website. By doing so you put a lot of extra information that I didn’t need. Next time I would prefer if you would read the information and only include what is needed. I

13 Universal Technical Institute Internal Email, August 2008, re: FW: (UTI-C-000491, at UTI-C-000492) Senate Health, Employment, Labor, and Pensions (HELP) Committee – Universal Technical Institute Inc.

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know that this was a hard assignment though. Everyone struggled with it [sic].14

Even after this act of plagiarism, the student still received a 24.5 out of 30 points for the assignment. As evidenced in the report and many others, it is obvious that these institutions are nothing short of a diploma mill. Practices such as the ones noted are the reason employers have attached such a negative stigma to these diplomas; they were bought, not earned. In addition to these unethical practices, we are also seeing state regulators investigate the credentials of the instructors. Case in point, in a suit filed by Department of Justice – Western District of Texas, Kaplan University agreed to pay a $1.3 million settlement after being accused of knowingly employing unqualified instructors to teach Medical Assistant courses at their San Antonio campuses.15

Default

One of the most alarming statistics regarding proprietary colleges is the debt and default ratios, despite only accounting for about 10 percent of total students in postsecondary education, they account for about half of the total defaulted debt.16 According to the Federal Education Budget Project, as of FY 2014 Q3, there is about $100 billion in defaulted federal student loan debt.17 So, basically, for-profit college students, about 10 percent of all college students, account for $50 billion of that; and out of the roughly 3.5 million for-profit students that defaulted on that debt, almost 2.4 million of them don’t even have a degree to show for it. (Appendix 2)

In regards to default rates in the education system, everything is measured by what is known as Cohort Default Rates or CDRs.18 This measurement is the percentage of

14 The United States Government Accountability Office, GAO-12-150, For-Profit Schools: Experiences of Undercover Students Enrolled in Online Classes at Selected Colleges, October 2011. 15 United States ex rel. Leslie Coleman v. Kaplan, Inc., The Washington Post Company, Kaplan Higher Education Corporation, Kaplan College – San Antonio (San Pedro) and Kaplan College – San Antonio (Ingram), no. SA:12-cv-0459-FB 16 U.S. Department of Education, IPEDS 12-month enrollment for 2011-12 and FY 2010 three-year CDRs. 17 National Student Loan Data System (NSLDS), Servicer Portfolio by Loan Status – Includes Direct Loans and ED-owned Federal Family Education Loans, September 30, 2014. 18 Federal Student Aid, Default Management, Three-year Official Cohort Default Rates for Schools, Federal Regulations 34 CFR 668.217 and Appendix A within that section.

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federal loan borrowers that entered repayment during a given federal fiscal year and defaulted before the end of the next fiscal year.

This instrument only measures defaults over a two-year period directly after a cohort of students enter repayment. Thus, it primarily captures borrowers who never begin making payments on the loan or who default within the first years after entering repayment.

According to filings by DeVry Education Corp., the average debt held by a for-profit school student is around $31,200 versus that of $7,960 for a student at a public school.19 The difference between that debts alone should explain the default rate, however, it’s only the beginning. Aside from for-profit debt being three times that of non-profit debt, the bigger story is that 50 percent of debt holders from for-profit schools are already living in a low- income household. This fact of course exacerbates the problem, for most debt holders, it will be almost impossible to pay the debt off. If you think the risk of default couldn’t get worse, it very well can. According to the Bipartisan Student Loan Certainty Act of 2013 (Sponsored by Rep. John Kline, the major contributor to his campaign is the Apollo Education Group, owner of the University of Phoenix), they revise how interest rates are determined on typical federal loans such as the Stafford and Plus loans20. As of now, they are tied to 10- year treasuries; however, interest rates can raise almost 50 percent from the current rate. Thus, these provisions could increase the lifetime cost of a University of Phoenix degree by over $33,000, even if tuition and fees remain flat. So, they have three times the debt level, a 50 percent chance of being in a low- income family, and there is a chance that their loan amount could almost double, how could it get worse? Easy, underemployment.

In a recent paper by Patrick Denice, a doctoral student in sociology at the University of Washington, says:

Those who graduated with associate degrees from for-profit colleges earned, on average, $425 per week, which is statistically

19 Senate HELP Committee staff analysis of fiscal year 2009 and 2010 Securities and Exchange Commission annual proxy filings. 20 Library of Congress, H.R. 1911 – Bipartisan Student Loan Certainty Act of 2013, House – Budget; Education and the Workforce Committee, Became Public Law No: 113-28 on 08/09/13.

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indistinguishable from the $388 earned weekly by those who held only high-school diplomas. 21

Like the sub-prime mortgage bubble, the question isn’t if they will default, the question is when.

Competition

Like WebTV and the Microsoft SPOT smart watch, some technologies come to market simply before their time. Although distance education is not on this list, that was the fear for non-profit colleges and universities. As we see now, online courses fueled the engine for proprietary institutions. However, like anything else, with great innovation comes great competition. After seeing the success of this model, non-profits are beginning to enter the on-line space. Now, the negative stigma of going to school on-line can be erased; we are even seeing notable institutions such as Georgetown and Texas A&M University offering degrees online.22

As you can imagine, the for-profit colleges offering similar degrees in this space will simply no longer be able to compete. The epitome of this can be seen in graduate education, such as Masters in Business Administration and STEM programs. Along with non-profit colleges entering this space, we are also seeing an increase in non-profit companies such as Kahn Learning Academy offering a free alternative for self-learners. This type of autodidacticism could transform not only the way people learn, but also how employers hire. As the millennial generation grew up with the Internet, they also developed skills in self-teaching. For the curious, the Internet has offered a cost-free way of learning about any subject imaginable. Non-profits such as Codecademy and Code.org have begun offering courses on computer programming and software engineering for free. As this type of learning continues to innovate, students will no longer pay for something they can learn for free: computer programming, languages, culinary arts, and countless others.

21 Denice, Patrick. “Does it pay to attend a for-profit college? Horizontal stratification in higher education” University of Washington, Department of Sociology. 22 Texas A&M University Instructional Technology Services, Distance Education (DE) degrees and certificates .

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In order to diversify their interest, companies have focused on investing in developing countries like Brazil and India. Unfortunately, numerous others are attempting to do the same. With this, as paralleled with the increase in medical and technological course offerings, the increased competition will inevitably have a negative effect on tuition rates. As noted, with enrollment already declining, the larger companies can no longer afford a decrease in tuition. As you can see in the table, for-profit institutions have disproportionate share of the online market, as normalization occurs, for-profits will be pressured to decrease tuition rates to lower price points to remain competitive. However, unlike traditional schools, proprietary universities will continue to have to pay taxes and increase marketing expenses. When, not if normalization occurs, these companies will have to find other avenues to attract students.

As normalization slowly deteriorates for-profit institutions market share in the online space, they will most likely enter into new categories that have yet to be tapped in the typical education model. We predict the educational service industry will begin to concentrate on shorter courses like “bootcamps” and nano-courses; however, these types produce only a fraction of the operating margin that degree- seeking students produce. In addition to increased competition for degree-seeking students, we are also seeing an overwhelming amount of people educating themselves in non-traditional formats. For example, Harvard, MIT, and Berkeley, have launched free online classes

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in every subject imaginable.23 Also, Yale has began posting entire classes on Youtube; notably, Nobel Laureate Robert Shiller’s freshman economic course.24

The largest amount of competition comes from a newly developed spaced called Massive Open Online Courses (MOOCs). In 2012 two computer science professors named Andrew Ng and Daphne Koller from Stanford University launched a for- profit education company called Coursera, and pioneered MOOCs.

Coursera is on the path of becoming a major competitor in this sector, as they are currently testing the fee-paying “signature track” which will allow students to put course completion on resumes.25 Unlike proprietary institutions, Coursera developed a keystroke biometric system which analyses keystroke dynamics during typing and webcam images to confirm the identity of fee-paying students during test and quizzes.

This platform partners with major research universities (e.g. Princeton, Stanford, and the University of Pennsylvania) to make some of their courses available online, and offers courses in subjects like physics, engineering, humanities, business, and other subjects. As of October 2014, Coursera has 1- million users in 839 courses from 114 institutions. As the information age continues to evolve, the traditional students at for-profit colleges will be introduced to better, more efficient alternatives.

Strengthening Economy

Proprietary colleges, or the for-profit education industry, are well known as being counter-cyclical to the overall economy. Therefore, when the economy strengthens, this industry will weaken. The chart below tells this tale, in the past several years of economic growth, this sector has suffered dramatically. As the negative correlation shows, people simply do not value the potential long-term goals of education over the immediate availability of jobs. Conversely, when no opportunities are present, see 2008, people feel that

23 EdX is a massive open online course (MOOC) provider and online learning platform. EdX differs from other MOOC platforms, such Coursera and Udacity, in that it is nonprofit and runs on an open source software platform. 24 Open Yale Courses, Financial Markets, YouTube. 25 https://www.coursera.org/about/

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postsecondary education can provide shelter for the financial storm In some instances, the strengthening economy can be a double-bladed sword to this industry. In regards to Universal Technical Institute, Inc, a for-profit college that focuses on automotive technicians, they have not only been hit from the growing economy but the indirect effect of increased auto sales. In the chart below you can see how New Auto Sales have negatively effected this profession.

This negative correlation stems from a basic economic principal known as opportunity cost. Students enrolled during economic prosperity are missing the opportunity to earn good wages; conversely, during economic down turns there is little opportunity, hence the increase in demand. This correlation is not limited to solely for-profit colleges, we can find a similar scenario if we look at the legal education in our country. In regards to the thesis surrounding the potential student-debt bubble, we do not have to search far to find our first casualty: law school. Legal education is a microcosm of the overall education bubble, for most students, it is the middle-class version of for-profit education: an exponentially high tuition, students have little opportunity elsewhere, colleges cover-up actual employment statistics, and of course, students believe they are on the path to guaranteed financial prosperity. Akin to proprietary colleges, colleges and universities began opening up law schools everywhere to access this profitable market. To get accredited, they did the same thing as for-profit colleges, bought small unsuccessful law schools and increased the enrollment. To get a better grasp on what was going on, take a look at the two graphs based on overall acceptance and attendance rate:

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The underlying fundamental problem in the legal sector is that too many unqualified applicants were entering the profession; the students who were qualified no longer saw the economic benefits of law school. We are now seeing the same scenario unfold in the medical and technological industries, an industry where the majority of proprietary institutions have invested heavily in. Here is a recent interview with the president of DeVry Education:

“U.S. Nursing colleges are turning away over 50,000 qualified applicants (a year),” Hamburger said. “It’s not because people don’t want to be nurses. The reason is there is not enough capacity.” DeVry plans to pen two new campuses for its Chamberlain College of Nursing in January, bringing its total to 16. “What’s driving growth in the private education sector is that shortage of capacity.” Hamburger said.26

Despite Hamburger’s biased optimism on ‘qualified’ students, his argument on the capacity shortage amongst prospective medical students is unambiguously meritless, as evidenced by the default rate and debt burdens provided by DeVry’s two Caribbean-based medical schools.27 Naturally, in a industry full up of manipulation, even though DeVry’s medical schools are based in the Dominican and are not accredited by the body that approves programs in the United States, their medical students are still eligible for loans issued by the United States Department of Education. “These schools are taking advantage of an offshore loophole that allows federal funding to be released to students attending a medical school that is not accredited in the U.S… Until Congress acts, these schools will stop at nothing to keep the American taxpayer dollars flowing.” – Senator Dick Durbin Students at DeVry’s medical schools – Ross University and American University of the Caribbean – often leave with hundreds of thousands of dollars in debt and no means to pay it back. Relative to the domestic average, Ross University has about six times the class size and about seven times the dropout rate. The alarming statistics are rather unsurprising, considering that the vast majority of these students were denied admission to U.S. based medical schools. If the majority

26 Business Wire, DeVry CEO Discusses Issues in Higher Education at Forum Hosted by Senator Dick Durbin, August 31, 2010. 27 DeVry Education Group, William Blair Growth Stock Conference, Daniel Hamburger President and CEO. June 11, 2014.

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of these students went on to be practicing physicians then this would not be an issue; however, that is obviously not the case.28

“I don’t feel that these schools are very selective all the time and will potentially take students whose failures could be predicted based on their academic record… There are a lot of important ethical issues here” –Jessica Freedman29

We highlight this issue as it pertains to the overall strategy at DeVry, and the majority of corporations in this industry as well. As the economy strengthens and overall enrollment declines across universities in this sector, companies will be looking for new markets and higher profit margins, the medical industry is their only logical option. However, unlike the commoditized programs instructed by these corporations in the past, such as automobile maintenance, the medical field will have stricter rules on licensing and the non-profit sector will add increased competition, leaving small margins and even higher default rates for proprietary college students. Hamburger is correct, a capacity shortage the main factor driving growth; however, that is only because a glut of students are applying to these programs, just because someone meets the credentials does not mean they are ‘qualified’. Like the issue with NTI and the negative stigma attached to the degree, the same problem will eventually occur in the medical industry. However, not all proprietary institutions have made the mistake of investing in these areas. In a study conducted by Harvard and Columbia University, for-profits appear to be at their with well-defined programs of short duration that prepare students for a specific occupation. But for-profit completion rates, default rates, and labor market outcomes for students seeking associate’s or higher degrees compare unfavorable with those of public postsecondary institutions. As we move forward with the second half of this decade, a new generation will enter the workforce, a generation that was too young to understand the last financial crisis, and will naturally start building the next one.

28 Per Company presentation, students at these universities have a high residency placement rate. This is true, because DeVry pays for the placement via hospital slot contracts. This statistic is purchased directly by the university, and is thus academically irrelevant. 29 Dr. Jessica Freedman is employed by MedEdits, a medical school admissions firm, she is a graduate of Temple University School of Medicine.

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Government

As noted previously, the vast majority of revenues for proprietary colleges stem from federal loans from the United States government. Therefore, federal legislation can make or break one of these institutions. At the beginning of 2015, President Obama unveiled his new proposal, America’s College Promise: Tuition-Free Community College for Responsible Students. In essence, this bill will indirectly destroy several corporations currently operating in this space. According to a press release from the White House, this bill aims at helping two separate categories of students: students who plan on attending a four-year college, and those students who are looking to learn a trade; notably in the technological industry.30 A core philosophy behind this bill is to expand the technical training for middle- class jobs; as evidenced by the similar program in Tennessee.31 Furthermore, they will be providing ‘Job-Driven Training Grants’ to prepare workers in-demand in their regional economies; think energy related careers in Texas.

Along with the program will come a ‘College Rating Program’, which will be part of the Department of Education, and rate colleges on affordability and employment prospects. Based on the criteria stipulated by the Obama administration, schools like ITT Technical Institute will not make the grade.

Therefore, corporations whom focus on associates degrees and specific job training programs will be hit drastically. The troubling reality is that the government can put more red tape around specific careers such as plumbing that could eventually require certificates via this program. This program, however, is far from being passed. However, there are regulations that have either been passed, or in the process of. In July 2015, a new regulation coined “gainful employment” will be beginning.32 The framework of this regulation intends to hold certain career-oriented programs all institutions accountable for whether their students find jobs earn a living wage after graduation.

30 The White House – Office of the Press Secretary, “FACT SHEET – White House Unveils America’s College Promise Proposal: Tuition-Free Community College for Responsible Students” January 9, 2015. 31 Known as the “Tennessee Promise” Governor Haslam has launched the Drive to 55 Alliance – the Drive to get 55 percent of Tenesseans equipped with a college degree or certificate by the year 2025. 32 American Council on Education, Summary of 2014 Gainful Employment Regulation Proposed by the U.S. Department of Education.

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This type of regulation has not come without a long legal battle; namely via opposition from the for-profit sector. Despite increasing accountability, this bill was relatively weak. A key measure in draft regulations released last March – cohort student loan default rates for different programs – has disappeared from the final draft, largely after institutions lobbied against this requirement. According to US News, under the final regulations, which will take effect July 1, about 1,400 programs (99 percent of which are housed at for-profit colleges) serving 840,000 students would not currently pass. 33

The reason behind the ‘weakness’ of the regulation comes from the way the department changed the way it calculates cohort default rates, they now leave out the borrowers who defaulted on a loan but had one or more other loans in repayment, deferment or forbearance that had not defaulted during the monitoring period. Rory O’Sullivan, deputy director of Young Invincibles (A youth advocacy group) said the administration “caved to industry pressure”, here is an excerpt from his interview:

“By failing to include a default rate standard, the administration ignores the most vulnerable students: those who withdraw from failing

33 U.S. News and World Report, “Education Department’s Gainful Employment Rules Rebuffed – The regulations will hurt thousands of students enrolled in failing programs, opponents say.”

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programs with debt but no degree… This rule legs dropout factories off the hook at the expense of students and their financial security.”34

Although it cannot be speculated on for certain, it can be assumed that a change in this regulation would cripple this for-profit sector, as their student profile epitomizes the people left out of this legislation and thus needs help the most. Additional regulation comes in the form of what is known as the “90/10 Rule” which states that for-profit colleges cannot derive 90 percent of their operating revenue from federal student aid money.35

According to thousand plus page study by the federal government36, of the publicly traded for-profit colleges, on average, they derive about 86 percent of their revenues from federal student aid. As shown in the study, if these institutions had to count the GI Bill as federal aid, every college within the study would exceed the 90 percent threshold. With revenues only a few percentage points away from destroying the company, it a more than a mere convince that these companies are able to maximize profit to such an extent. According to lawsuits, nearly every publicly traded company in this sector has either lost legal battles or paid fines in regards to student aid fraud and questionable loan practices. In filings from the Department of Education, the University of Phoenix, Kaplan University, and Everest University are among the schools that were under investigation by the department for delaying cohort student loan defaults in an effort to retain their student loan eligibility. The universities are believed to use aggressive manipulation, encouraging students to put their loans in forbearance in order to delay defaults past the three-year period that the Department of Education measures when determining cohort default rates. In light of these investigations, as of May 2013, the University of Phoenix was placed on “notice” status with its accreditation agency, the Higher Learning Commission; they now have to submit reports to the agency on a regular basis.

Despite this slap on the wrist, in many cases, the accreditation agencies, like the rating agencies in the credit crisis, are meaningless. The vast majority of

34 Rory O’Sullivan, Deputy Director of Young Invincibles, Young Invincibles’ Statement on the Obama Administration’s Gainful Employment Rule. October 30, 2014. 35 The Institute for College Access & Success, The Project on Student Debt: Q&A on the For-Profit College “90-10 Rule” February 22, 2012. 36 For-Profit Higher Education: The Failure to Safeguard the Federal Investment and Ensure Student Success, United States Senate Health, Education, Labor and Pension (HELP) Committee.

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commissioners within these accreditation agencies is from the proprietary sector, and is still on the payroll. That being said, non-governmental bodies like the Accrediting Council for Independent Colleges and Schools (ACICS) have representatives on their board that oversees the representative’s college, inevitably influencing the approval process and oversight of their company.37 When regulations change, these accreditation bodies will be the first out; this is the epitome of conflict-of-interest. Without their representatives influencing the approval process, it likely that the majority of proprietary institutions will lose their and accreditation and in turn, their Title IV funding (86% of revenue).

Unlike other corporations who rely on federal funding, like Boeing and Northrop Grumman, proprietary institutions spend the majority of their government revenue on marketing, which helps them achieve astronomical profit margins; companies in this sector like ITT Educational Services has better profit margins than Apple.38 The key reason we believe institutions like ITT have not been regulated, is because of the outcry of students that will be negatively affected by the closing.39 Unlike traditional schools, students at for-profit colleges are unable to transfer credit to another institution. Therefore, leaving thousands of students with debt and no chance of obtaining a degree. However, sooner or later, the spending has to stop.

37 Meet our Commissioners, Accrediting Council For Independent Colleges and Schools (ACICS). 38 Per Company Filings with the United States Securities and Exchange Commission, Gross Profit Margins can be calculated by subtracting Cost of Goods Sold from the revenue and diving that product by revenue. 39 A political debate ensued after the closing of Corinthian College, after declining enrollment and regulatory concerns.

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Corporations

The educational services sector has experienced exponential growth in the past decade, and in turn, countless new companies have emerged. In this segment, we will look at the extremities, and understand why some of the companies will fail, and why some of these companies will be able to weather the storm. The Apollo Education Group Inc. is based out of Phoenix, Arizona and is known as the pioneer of the for-profit education industry. The group’s flagship university, University of Phoenix, is the largest postsecondary college in the country with an expected 250,000 students in 2015, down from 600,000 just five years ago. In a recent conference call, Apollo Education Group’s CEO, Greg Cappelli blames the “bad economy” on the decreasing enrollment. Although, the corporations stock was at an all-time high during the Great Recession, which alludes that there are larger problems with their current business model. Fundamentally, the cause of the falling enrollment is our growing economy and less expensive alternatives.

With virtually of their revenues stemming from federal aid, there is only one metric to look at the value this company: enrollment. In 2010 when the corporation was had 600,000 students enrolled, the stock price was around $60 per share; now in 2015, with about 250,000 students, the stock price is around $25 per share. During the last earnings report, executives continued to cover to greater problems with blaming the falling enrollment and revenue per student (RPS) on distance education malfunctions and macroeconomic trends. In order to diversify their interest, I assume they will spends massive amounts of capital in developing nations and shorter more job-specific programs.

As evidenced by similar companies using this strategy, it often ends in unbelievable failure. Anecdotally, Career Education Corp and their investment in ‘Le Cordon Bleu’ culinary school used a similar strategy with campuses around the world, they are currently attempting a divestiture. Companies in this industry can simply not afford to be in a segment that can’t be funded via federal aid. Like the case with NTI, the negative stigma has already been attached to programs such as these, and it is doubtful that the stigma will ever be forgotten.

Over the past five years, the quarterly year-over-year revenue growth has went from 27.5% all the way to -15.2% currently. Per company filings to the SEC, the revenue growth is projected to only get worse, as they their net income dropped an astounding 66 percent as enrollment continues to drop.

We believe shares are overvalued by close to 45%, our price target is around the $17 mark, close to the 10-year low reached in March of 2013.

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ITT Educational Services, Inc. is headquarted in Carmel, Indiana; they enrolled about 88,000 students as of fall 2010 and own Daniel Webster and ITT Technical Institute. In our analysis, this company tops the list in most likely to fail. Several contrarian investors believe this company is set for a short squeeze; unfortunately, they are wrong.

About 85% of students enrolled in ITT are in associate degree programs, costing students about 4 times the tuition amount from a comparable community college. With enrollment falling every year and increased competition in the medical and technological space, it seems highly doubtful that this corporation will do anything but get closer to its inevitable bankruptcy. (The graph on the right depicts enrollment trends over the last 5 years)

In the same 2012 investigation led by Sen. Tom Harkin (D-Iowa) citied previously, ITT was singled out amongst the entire industry as employing “some of the most disturbing recruiting tactics among the companies examined.” Undercover probes found manuals for ‘recruiters’, within this manual was called a “pain funnel”, in which admissions officers would ask students increasingly propping questions about how they got to this point, and why their lives were so bad. As noted in article on this matter by Mother Jones, a former employee said the probing questions would “bring a prospect to their inner child, an emotional place intended to have the prospect say, “Yes, I will enroll.”

According the United States District Court, the Consumer Financial Protection Bureau filed a complaint for injunctive relief and damages for countless violations. After researching almost every publicly traded company in this industry, ITT Tech is by far the most immoral and perverse corporation in this sector.

Aside from the exorable lawsuits, this specific company is most susceptible to the increased level of competition from both public and private sectors. In regards to the public sector, community colleges will have to focus on short-term job specific classes, which in turn, force them to be indirect competition with ITT Tech. As stated in a study from Teachers College at Columbia University, it is clear that for-profit institutions are their best when focusing on short job-specific courses; eventually, the larger proprietary institutions will resort to entering this market. Soon a perfect storm will pass over this corporation, expenses will increase and revenue will decrease. ITT Tech will be the first corporation to drop in this industry

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purely based on the negative stigma that they have created, the government and competition will just exacerbate the their problems.

According to company filings, eighty-percent of revenues came from Federal taxpayers in the fiscal year 2009, which allows them to comply with the 90/10 rule by a few percentage points. However, that is not the entire story; for the remaining fourteen percent, ITT partnered with a Wall Street investment bank that advised them on what is known as ITT PEAKS, a complex financial loophole allowing them to consider the remaining fourteen percent of revenues “private”. (Appendix 3)

Conclusion

Ironically, yet quite typical, the companies that Main Street sees as malicious and fraudulent are seen as promising and lucrative to Wall Street. The Apollo Education Group epitomizes this disconnect; eventually, like Countrywide and Enron, their fraud will be uncovered and the American public will rally against them. With the GOP gaining share in Washington, it is doubtful that this industry will be regulated anytime soon. This industry will continue to pay lobbyist, continue to buy seats at accreditation groups, and most importantly, continue to steal the taxpayer’s money. Despite the circumstances, even the pro-business republicans cannot turn their back on the massive default rates. Akin to the recent financial crisis, a similar conundrum will occur as lawmakers grapple with this question: Although we know that these companies have committed fraud, is it worth letting these companies fail and millions of students lose their credits? Or, do we let them continue and keep the peace for the time being?

Although the negative stigma is there, the people vulnerable enough to sign up for these problems are rarely educated enough to understand the stigma, which exemplifies the core issue to this entire problem. Corporations in this sector have not gone unaffected with the recent drop in enrollment and regulatory scrutiny; however, they still have a long way to fall. The unsatisfactory education this industry delivers will not hurt them, the share of defaulted student debt will not hurt them, and the percentage of federal related revenue will most likely not kill them either; although, there is a chance the misleading recruitment practices can actually hold in court.

Numerous lawsuits of been filed under the federal False Claims Act, mostly by former employees, charging that the conduct of these corporations defrauded the federal government. After the verdicts come out, it won’t be the “University of Phoenix – Thinking Ahead” commercial we will be seeing daily, it will be “If you

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worked for, or attended a for-profit college between the years of 2001-2014, call Attorney ______, you could be entitled to compensation.”

In May 2010 a prominent hedge-fund manager named Steve Eisman, notoriously known for his accurate prediction on the sub-prime mortgage crisis, presented a speech at the Ira Sohn Conference titled “Subprime Goes to College”. Here is an excerpt from his speech:

“Until recently, I thought that there would never again e an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry. I was wrong. The for-profit education industry has proven equal to the task.”40 Turns out, like his previous bearish prediction, he was exactly right. Two of the corporations that he called out, Corinthian Colleges and Educational Management (Goldman Sachs owned a 41.8% stake), have since turned into penny stocks. The additional corporations listed in his presentation, Apollo Education Group and ITT Education, have fallen as well.

In addition to the similarities between proprietary institutions and the sub-prime lenders of the last decade, another parallel can be drawn from another morally abrasive industry and the collapse that proceeded: The Savings & Loan Sector. In the three separate, but abnormally similar cases, each industry flourished and experienced exponential growth as waves of deregulation brought in new ways to cover-up fraudulent business practices and bring in new income; manipulating those Americans who can not understand nor afford the financial obligations they were making. As in the Savings & Loan crisis, the fraud that these companies were partaking in was made available by buying everyone in Washington; from lobbyist groups, to congressmen, and even the lawyers who previously fought against them. However, what separates for-profit colleges from the other ‘morally bankrupt’ industries of our past, is that proprietary institutions receive virtually all of their income from the federal government; thus, they are fighting the government with the governments money. Despite this fight for deregulation, many corporations in this industry have already faltered; and when the negative stigma begins its saturation on the largest for-profit universities, the corporations will no be able to afford to fund Washington. Not if, but when the student-debt bubble begins to pop, the educational industry will be the first one targeted when the government and the public are looking for

40 Any Kroll (27 May 2010). “Steve Eisman’s Next Big Short: For-Profit Colleges” Mother Jones.

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someone to blame. Unfortunately, before this happens, hundred of billions of taxpayer dollars will be wasted and the lives of countless veterans and lower-class citizens will be made even harder.

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APPENDIX

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