Is Education the New Subprime?

Stop me if you’ve heard this one before: Publicly traded corporations accused of wrongdoing countering critics by saying they are helping low-income Americans achieve the American dream.

No, this isn’t the subprime loan debacle all over again.  It’s the for-profit higher education industry, which is currently reeling from plummeting stock prices and shareholder unrest due to a government investigation that found potentially fraudulent practices and a need for new regulations.

Indeed, on August 3, 2010, the U.S. Government Accountability Office (GAO) issued a report which concluded that for-profit educational institutions had “encouraged fraudulent practices” designed to recruit students. The GAO investigated for-profit colleges in Arizona, California, Florida, Illinois, Pennsylvania, Texas and Washington, D.C. Recruiters at all 15 colleges studied by the GAO were found to have, “made some type of deceptive or otherwise questionable statement to undercover applicants, such as misrepresenting the applicant’s likely salary after graduation and not providing clear information about the college’s graduation rate. Other times our undercover applicants were provided accurate or helpful information by campus admissions and financial aid representatives.”

Zamansky & Associates has been investigating a number of these publicly held corporations purporting to offer accredited higher education including: The Apollo Group (APOL), Corinthian College (COCO), ITT Education Services Inc. (ESI), among more than a dozen others.  A full list of corporations our investigation is focusing on can be viewed here.  These corporations’ recruitment practices call into question whether they engaged in false and/or misleading statements and failed to disclose information to investors such as their accurate growth prospects and true financial results.

The actions of these companies has been detrimental to shareholders, but, like the subprime scandal before it, there is a human toll as well.  On June 24, 2010 Yasmine Issa, a 25 year-old single mother of 3 year-old twins, testified at a Senate hearing that she paid $32,000 to learn to become an ultrasound technician, believing she would receive marketable skills and job placement services.  Instead, after exhausting her savings, and taking on $20,000 of debt, she couldn’t find a job, and the so called placement services were of no help.  Unfortunately, this sad story is a common one.

Supposedly, lawmakers are going to step-in and change the laws that govern how for-profit education corporations operate.  The Department of Education, for example, plans to enact a “gainful employment” rule that threatens to cut off federal student loan money to schools that allowed their students, after having lost their jobs during the recession,  to take on more debt than they could afford.

Just like lending institutions such as Countrywide Financial, who argued they were helping low-income families achieve the American Dream when in reality the company was bleeding them dry, for-profit education companies are on the offensive.  They have reportedly hired expensive lobbyists and consultants to sway government rule makers, while also taking out full-page ads at their shareholders’ expense.  Corinthian Colleges, Inc.’s “1,000,000 students don’t count?” campaign and its website www.mycareercounts.com is a prime example.

Wall Street made a fortune selling loans to people who couldn’t pay them back.  For-profit education companies similarly paid their executives millions, while making empty promises to students looking to better themselves.  And while there are many similarities between the two scandals, the for-profit education industry differs in one very important way: it’s not too late for regulators to act.

The SEC Needs a Win Against Mozilo

As a New York Times story suggested earlier this week, Federal Judges are no longer rubber stamping the SEC’s settlements with Wall Street. This has put the SEC in an almost impossible situation: drive harder bargains and risk facing off in court against Wall Street’s limitless legal resources or bow to their wishes and risk more rejected settlements.

It all started with Judge Jed S. Rakoff’s denouncement of the SEC’s settlement with Bank of America for allegedly misleading shareholders about losses pending at Merrill Lynch, which at the time was in the process of being acquired. Judge Ellen Segal Huvelle then refused to accept a settlement with Citigroup, which also was accused of misleading shareholders about tens of billions of dollars in potential losses.

Judges are frustrated that the SEC’s settlement patterns harm shareholders who actually bear the brunt of the fines. They also want the SEC to negotiate stiffer penalties holding executives personally liable for fraudulent acts.

There are many reasons why large Wall Street firms are able to negotiate such generous terms with the SEC. One reason is the so-called “revolving door,” where former SEC officials representing Wall Street sit across from their past colleagues who themselves might be eying lucrative Wall Street jobs. But another is that Wall Street knows that the SEC is at a disadvantage if push comes to shove and a trial is scheduled.

The SEC rarely argues cases in a courtroom and even more rarely prevails against large Wall Street banks. With a track record like that, Wall Street’s legal representatives have the leverage they need to protect senior management and continue practices that exploit investors.

But that could all change in October when the trial against former Countrywide Financial CEO Angelo Mozilo is scheduled to begin.

A settlement agreement has yet to be struck between the SEC and senior executives of mortgage giant Countrywide Financial, including Mr. Mozilo. The SEC has accused them of misleading investors about their lending standards. It’s conceivable that an agreement may prevent a trial or that a judge could dismiss the charges, but considering the judicial scrutiny of late, the terms of a settlement would not be favorable to Mr. Mozilo and his former colleagues. Thus, it certainly looks like a civil fraud trial will get started this October.

The symbolic importance of the trial has been noted by several experts including former SEC chairman Harvey Pitt, who said that the case is “significant because it is a reflection of the SEC’s commitment to go after people who have been involved in the financial meltdown.”

I agree with Chairman Pitt, and I’d take it a step further: a win for the SEC would provide its enforcement team with the leverage they need to negotiate stiffer terms for settlements. Future settlements could and should include admissions of liability, as well as personal financial liability of the wrongdoer and his or her manager if applicable.

For the SEC, this is a “bet the farm” lawsuit and one that could lay the groundwork for the future of enforcement on Wall Street.