Breaking Down Borrower Defense Regs: ED Issues New Set of Financial Responsibility Standards

By Jill Desjean, NASFAA Policy & Federal Relations Staff

On August 30, the Department of Education (ED) released an unofficial draft of its Institutional Accountability regulations, which include borrower defense to repayment claims, pre-dispute arbitration agreements, and institutional financial responsibility standards. The rule becomes effective July 1, 2020. This is the first in a series of three articles analyzing the rule, and will focus on changes to the financial responsibility standards, primarily located in sections 668.171 and 668.175 of the General Provisions regulations.

For background, these issues were previously negotiated under the Obama administration and a final rule was issued in 2016. That rule became effective in 2018 after a court declared invalid two delays issued by ED prior to the rule’s original effective date of July 1, 2017. The newly-issued rule is the result of negotiated rulemaking sessions held in 2017-18, in which negotiators failed to reach consensus, leaving ED to draft its own language. 

Background

Institutions must meet certain standards of financial responsibility as one condition of participation in the Title IV federal student aid programs. Institutions are considered financially responsible if: 

  • Their Equity, Primary Reserve, and Net Income ratios yield a composite score of at least 1.5 (see 668.172);

  • They have sufficient cash reserves to make required returns of unearned Title IV funds; and 

  • They are able to meet all of their financial obligations and provide the administrative resources necessary to comply with Title IV program requirements.

The 2016 rule established a system requiring private for-profit and not-for-profit institutions (publics are exempt) to provide financial protection to the federal government if the institution’s financial stability was determined to be at risk. That risk was determined through a set of triggering events that were intended to proactively identify threats to institutions’ financial stability more promptly than such threats would otherwise be revealed through the annual audit process. 

Mandatory, or automatic, triggers would immediately signal that an institution did not meet financial responsibility standards, whereas discretionary triggers were events that ED could investigate further to judge whether they indicated a failure to meet financial responsibility standards.

Institutions found to not be meeting financial responsibility standards can continue to participate in the Title IV aid programs if they meet some alternative standard, such as submitting a letter of credit to ED, or being subject to heightened cash monitoring or the reimbursement payment method and increased oversight activities.

Triggering Events

The new 2019 rule revises some triggering events, removes other triggering events altogether, moves some from mandatory to discretionary, and adds a provision that converts two or more unresolved discretionary triggers that occur in a single year to a mandatory trigger.

Mandatory triggers that have been removed include pending lawsuits, partly on the grounds that frivolous lawsuits seeking unreasonable damages could inappropriately impact an institution’s financial responsibility standing when the actual risk is unknown and/or unquantifiable. ED stated as a goal in making such changes its desire to prevent situations where requiring an institution to obtain a letter of credit led to closure when its financial position otherwise would not have led to closure.

Discretionary triggers that have been removed include significant changes to Direct Loan or Pell Grants received by the institution, as well as pending or anticipated borrower defense claims.

The final list of mandatory triggering events included in the 2019 rule are:

  • 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;

  • Withdrawal of owner’s equity from a proprietary institution with a composite score below 1.5, unless the withdrawal is a transfer to an entity included in the affiliated entity group upon whose basis the institution’s composite score was calculated;

  • For publicly traded institutions, 

    • the Securities and Exchange Commission (SEC) issues an order suspending or revoking the registration of the institution’s securities, or suspends trading of the institution’s securities on any national securities exchange, 

    • the national securities exchange on which the institution’s securities are traded notifies the institution that it is not in compliance with the exchange’s listing requirements and the institution’s securities are delisted, or 

    • the SEC is not in timely receipt of a required report and did not issue an extension to file the report; and

  • For the fiscal year reported, when an institution is subject to two or more discretionary triggering events, those events become mandatory triggering events, unless a triggering event is resolved before any subsequent event(s) occurs.

The final list of discretionary triggering events included in the 2019 rule are:

  • The institution’s accrediting agency issues an order—such as a show-cause order or similar action—that if not satisfied could result in the loss of institutional accreditation;

  • The institution violated a provision or requirement in a security or loan agreement with a creditor;

  • The institution’s state licensing or authorizing agency notified the institution that it has violated a state licensing or authorizing agency requirement and that the agency intends to withdraw or terminate the institution’s licensure or authorization, if the institution does not take the steps necessary to come into compliance;

  • The institution fails to meet the 90/10 requirement (moved from 2016 mandatory triggers);

  • As calculated by the Secretary, the institution has high annual dropout rates; and

  • The institution’s two most recent official cohort default rates are 30% or greater, unless the institution files a challenge, which results in a reduction to  below 30% for either or both of those years or precludes the rates from either or both years from resulting in a loss of eligibility or provisional certification (moved from 2016 mandatory triggers).

Composite Scores

New requirements issued by the Financial Accounting Standards Board (FASB) with respect to operating leases prompted ED to now calculate two composite scores for institutions—one that grandfathers in leases entered into prior to the new FASB rule implementation date of Dec. 15, 2018, and another that applies the new lease accounting standards to leases entered following the FASB rule implementation date. Both composite scores would need to be at least 1.5 for the institution to be considered financially responsible.

ED will also change the way it treats an institution’s long-term debt when calculating the composite score, closing a loophole created by guidance issued in 2003 that permits manipulation of the composite score through the use of long-term debt. For background, when the financial responsibility standards were first developed, only long-term debt associated with Property, Plant, and Equipment (PP&E) could be included in the numerator of the Primary Reserve Ratio for calculating the institution’s composite score. Institutions responded that it was difficult to associate a particular long-term debt amount with the acquisition of PP&E, and ED responded with Dear Colleague Letter GEN-03-08 to allow institutions to count long-term debt up to the amount of PP&E, without demonstrating that the debt is associated with a particular asset. This rule effectively repeals GEN-03-08 and reverts back to the original treatment of long-term debt. ED acknowledges that institutions may not have adequate records to associate long-term debt with PP&E because it has not been required since 2003, and will grandfather treatment of long-term debt under the old guidance based on PPE held prior to implementation date. 

Disclosures

The rule removes the financial protection disclosures that required certain financial responsibility triggers to be disclosed to students. 

Watch Today’s News for coverage of the rest of the rule in the upcoming week.

 

Publication Date: 9/6/2019


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