By Joan Berkes, Policy & Federal Relations Staff

Early this year, the Department of Education (ED) initiated negotiated rulemaking primarily to establish a new federal standard and process for determining whether a borrower has a defense to repayment on a loan based on an act or omission of a school. The Notice of Proposed Rulemaking (NPRM) released by ED also includes proposed revisions to the financial responsibility standards and additional disclosure requirements for schools.

This article is the fourth and final one in a series that describes the proposed rules. It addresses proposed changes to the financial responsibility rules that in part determine institutional eligibility to participate in the Title IV programs. The other articles, which can all be found on our Notice of Proposed Rulemaking - 2016 page, addressed the following issues: 

• First article: proposed borrower defenses that may result in loan discharge.
• Second article: proposed rules related to arbitration agreements.
• Third article: new repayment rate and disclosure requirement.

The deadline for commenting on all of these proposed rules is August 1.

Current Financial Responsibility Rules
To be eligible for participation in the Title IV student financial aid programs, an institution must demonstrate both administrative capability and financial responsibility. Violation of the standards under either area can cause an institution to lose its eligibility. This NPRM proposes changes to only the financial responsibility standards.

Currently, financial responsibility for a private non-profit or for-profit institution is based on four metrics:

• A weighted composite financial health score based on equity, primary reserve, and net income ratios defined in regulation (668.172);
• Sufficient cash reserves to make required refunds (668.173);
• Current in debt payments [668.171(b)(3)]; 
• Meeting all of its financial obligations, including but not limited to refunds to withdrawn students and repayments for debts and liabilities arising from the institution’s participation in the Title IV programs [668.171(b)(4)].

An institution that fails to meet all of the financial responsibility standards may qualify to participate under an alternative standard if certain conditions are met. Alternative standards may involve:

• Letters of credit or financial guarantees;
• Closer financial monitoring and oversight, including more restrictions on drawing down federal funds, for limited periods and only if the institution’s composite score falls into a defined zone;
• Provisional certification;
• Agreements regarding liabilities.

Public institutions are financially responsible essentially by virtue of their state backing.

In addition, ED can consider any institution to fail the financial responsibility requirement due to certain past performance issues of the institution or certain persons affiliated with the institution.

Proposed Changes to Financial Responsibility Standards

ED states that it is proposing new requirements because it “seeks to identify, and take action regarding, material actions and events that are likely to have an adverse impact on the financial condition or operations of an institution.” The proposed rules would give ED authority to determine at the time a material action or event (a “trigger”) occurs that the institution is not financially responsible, rather than wait to see an institution’s annual audited financial statements. ED also notes that the current regulations did not serve to provide financial protection to either borrowers or ED for the effects of recent school closures. ED wants to “develop more effective ways to identify events or conditions that signal impending financial problems and secure financial protection while the institution has resources sufficient to provide that protection either by a letter of credit, or, by arranging a set-aside from current payables of Federal funds that could defray losses that may arise.”

ED is not proposing changes to the composite score requirements, the refund reserve, or past performance rules. However, it does propose a substantial list of triggers that would result in an institution being considered unable to meet its financial or administrative obligations. Some factors that were previously listed as a general standard of financial responsibility would now be a triggering event that would necessitate immediate action. The institution would be required to notify ED of the occurrence of a triggering event within 10 days, but could show that certain actions or events are not material, or that those actions are resolved. Briefly (more detail is in the NPRM preamble), triggers would encompass:

• Certain lawsuits and other actions:
• Claims and actions related to a Federal loan or educational services: An audit, investigation or similar action based on claims related to the making of a Federal loan or the provision of educational services, initiated by a State, Federal, or other oversight entity, results in required payment or liability of, or settlement for, an amount that exceeds the lesser of the threshold amount for which an audit is required (currently $750,000), or 10 percent of its current assets. This trigger applies if the payment was required within the past three award years, or if the institution is currently being sued by an oversight agency for such an amount.
• Claims of any kind: The institution is currently being sued by one or more State, Federal, or other oversight entities based on claims of any kind that are not related to a Federal loan or educational services, and the potential monetary sanctions or damages from that suit or suits are in an amount that exceeds 10 percent of its current assets.
• False claims and suits by private parties: The institution is currently being sued in a lawsuit filed under the False Claims Act seeking relief or resulting in settlement or liability for an amount that exceeds 10 percent of the institution’s current assets, if certain other conditions are met.
• Repayments to the Secretary: ED requires repayment for losses from borrower defense claims in an amount that, for a given year, exceeds the lesser of the threshold amount for which an audit is required (currently $750,000), or 10 percent of the institution’s current assets.
• Accrediting agency actions: The institution’s primary accrediting agency:
• Required the institution to submit a teach-out plan; or
• Placed the institution on probation, show-cause, or similar status for failing to meet one or more of the agency’s standards, unless the action is withdrawn as a result of subsequent compliance within 6 months.
• Loan agreements and obligations: With regard to the creditor with the largest secured extension of credit:
• The institution violated a provision or requirement in a loan agreement with that creditor;
• The institution failed to make a payment in accordance with its debt obligations with that creditor for more than 120 days; or
• As provided under the terms of the security or loan agreement, a default or delinquency event occurs or other events occur that trigger, or enable the creditor to require or impose, a sanction penalty or fee.
• Non-title IV revenue: For its most recently completed fiscal year, a proprietary institution did not derive at least 10 percent of its revenue from sources other than Title IV funds (i.e., did not meet the “90/10” requirement currently in regulation).
• Publicly traded institutions
• The Securities and Exchange Commission (SEC) warns the institution or its corporate parent that it may suspend trading on the institution’s stock, or the institution’s stock is delisted involuntarily from the exchange on which the stock was traded;
• A judicial or administrative proceeding stemming from a complaint filed by a person or entity that is not part of a State or Federal action was disclosed in a report filed with the SEC;
• The institution failed to file timely a required annual or quarterly report with the SEC; or
• The exchange on which the institution’s stock is traded notifies the institution that it is not in compliance with exchange requirements.
• Gainful employment (GE): The number of students enrolled in GE programs that are failing or in the zone under the debt-to-earnings rates is more than 50 percent of the total number of Title IV recipients enrolled in all the GE programs at the institution, unless fewer than 50 percent of students enrolled at the institution who receive Title IV funds are enrolled in GE programs.
• Withdrawal of owner’s equity: For an institution whose composite score is less than 1.5, any withdrawal of owner’s equity from the institution by any means, including by declaring a dividend.
• Cohort default rates: The institution’s two most recent official cohort default rates are 30 percent or greater, unless a challenge/adjustment/ appeal reduces its default rate below 30 percent, or results in no loss of eligibility or provisional certification.
• Other events or conditions: ED determines that an event or condition is reasonably likely to have an adverse impact on the financial condition, business, or results of operations of the institution. The proposed rule includes a list of examples.

Proposed Changes to Financial Responsibility Alternatives

The proposed rules would also amend the current regulations regarding alternatives to the standard measures of financial responsibility.

The zone alternative would continue to be available only when an institution is not financially responsible solely because its composite score is less than 1.5, as long as it is not less than 1.0. (The composite score is meant to represent the strength of an institution’s margin against adversity and resources necessary to meet its operating needs.) Institutions under the zone alternative would be subject to most of the same requirements as under the current rules, such as disbursement under the heightened cash monitoring or reimbursement methods. However, some of the conditions that could affect an institution’s continuing permission to participate in the Title IV programs under this alternative would be moved into the list of triggers that would automatically negate the institution’s designation as financially responsible to begin with, and require permit more immediate action by ED. Institutions that fall afoul of those factors would not have the zone alternative available at all, but could fall under the provisional certification alternative.

The provisional certification alternative would continue to be available to institutions that are not financially responsible because they do not satisfy the general standards, because of an audit opinion, or because of a past performance issue. In addition, it would be available if one of the proposed new triggers applies.

In lieu of a letter of credit requirement under the alternatives as financial protection for ED, the proposed rules would allow an institution to provide cash or to agree to a set-aside from reimbursement claims payable to the institution. The amount of the financial protection that an institution must provide to ED under the provisional certification alternative would be tied to the trigger that the institution tripped.

Financial Protection Disclosures

An institution would have to disclose that is required to provide financial protection to ED, and why, to enrolled and prospective students in the same manner as would be prescribed for student warnings about low loan repayment rates.

Severability of the Regulatory Provisions

The proposed rules also include a declaration by ED that if any provision of the financial responsibility subpart of the regulations or its application to any person, act, or practice is held invalid (e.g., by a court), the remainder of the subpart or the application of its provisions to any person, act, or practice would not be affected.

This is the final article in a series of four articles describing the proposed rules. The other articles in the series can be found on our Notice of Proposed Rulemaking - 2016 page.

Publication Date: 7/27/2016

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