Since 1998, private nonprofit and for-profit colleges and universities have had to show that they are not at risk of precip-itous closure, using a financial responsibility calculation, based on three ratios that produce a composite score. Depending on the score, schools fall into one of the following categories: (1) financially responsible; (2) zone alternative, subject to additional oversight; and (3) failing, which would make institutions subject to provisional certification, in addition to requiring them to post a letter of credit in order to continue to participate in the Title IV programs.
In conjunction with its effort to revise rules promulgated last year under the Obama administration, the Department of Education (ED) recently announced that it will convene a formal subcommittee to consider revisions to the financial responsibility standards.
Government Seeks Accountability
One of the Obama-era regulations being revisited by the Trump administration is the borrower defense to repayment rule, which targets abuses in the for-profit sector, but impacts all higher education institutions and their students. It was spurred by the large number of former Corinthian College students seeking loan relief after the for-profit chain’s demise.
To address these claims—among others—this rule focuses on how and when ED should forgive federal loans to students who have been misled or defrauded by their institution or if the institution closes, as well as how ED can hold colleges and universities accountable for their losses.
Also included in these rules are significant changes to the financial responsibility requirements for independent nonprofit and for-profit institutions that participate in the federal student aid programs; these rules were finalized in November 2016, and scheduled to take effect in July.
However, under the Trump administration, on June 16, the Department of Education indefinitely postponed implementation, citing a lawsuit filed by the California Association of Private Postsecondary Schools challenging the rules. At the same time, ED announced its intention to consider revisions to the borrower defense to repayment regulations. Impending rulemaking negotiations will address issues related to the financial responsibility standards and administrative practices that impact student borrowing.
NACUBO Urges Revision
At a public hearing in July, NACUBO and several other associations called on ED to revise the financial responsibility standards, noting long-standing concerns with the rules, recent changes to accounting standards for nonprofit entities, and the new triggering events that were added to the financial responsibility standards as part of the borrower defense rules.
NACUBO also requested the establishment of a dedicated committee to focus specifically on these issues, with representatives from institutions, accounting firms, and others with expertise in both financial accounting and ED’s standards.
Responding positively to the testimony, in an August 30 announcement of the negotiated rulemaking effort, ED specifically sought, for the subcommittee, the nominations of individuals to represent private nonprofit and for-profit institutions, accrediting agencies, chief financial officers, auditors, and organizations that provide accounting standards. The department also asked for chief financial officers and experienced business officers to serve on the main negotiating committee focused on borrower defense rules.
Each group will meet three times over the course of several months, beginning in November, in Washington, D.C.
History of the Rules
ED originally issued regulations in 1998, establishing the current methodology for determining the financial stability of institutions participating in the Title IV federal student financial assistance programs. The system is based on three ratios: primary reserve, equity, and net income. An institution’s ratio results are multiplied by strength factors and combined into a composite score.
After the 2008 economic downturn, several flaws in the administration of the financial responsibility standards became apparent. In 2012, a task force organized by the National Association of Independent Colleges and Universities (NAICU) issued a report raising several concerns about how ED treats key elements of the ratio calculations. However, those recommendations went unanswered for years.
During last year’s rulemaking process, NACUBO and NAICU argued that the financial responsibility rules should not be expanded until ED fixed existing problems. Further, NACUBO is concerned that composite score calculations will be complicated by recently released changes to nonprofit accounting standards.
Understanding the Triggers
The new rules reflect an effort to recoup from institutions the cost to the federal government of student loan forgiveness. The borrower defense rules created two categories of events—automatic and discretionary triggers—that would lead to the re-evaluation of an institution’s financial standing and determine whether it needed to provide additional surety to the Department of Education. These new triggers were to apply to nonprofit and for-profit institutions; several additional triggers related only to for-profit schools.
Automatic triggers included borrower defense–related lawsuits and accrediting agency actions requiring a teach-out plan when an institution, including any branches or additional locations—is closing. ED would then determine the potential loss to the institution to estimate the possible impact to the institution’s score. As an example, for potential program, branch, or institutional closures, ED would presume both loss of revenue in the amount of corresponding Title IV funds and lower expenses.
The regulations also include a list of other factors or events that may cause an institution to be judged unable to meet its financial or administrative obligations, if ED demonstrates that it is “reasonably likely to have a material adverse effect on the financial condition, business, or results of operations of the institution.”
The list is open-ended, but includes such discretionary triggers as:
- Significant fluctuation from year-to-year in the amount of Pell and/or direct loan funds received by the institution.
- Citation by state licensing or authorizing agency for failing requirements.
- Failing a financial stress test devised or adopted by ED (no such test has been developed or designated to date).
- High annual dropout rates.
- Placed on probation, show-cause order, or similar accreditation status.
- Violation of a provision or requirement in a loan agreement that enables the creditor to increase collateral.
- Pending claims for borrower relief discharge.
- Significant borrower defense claims expected due to a lawsuit, settlement, judgment, or finding.
This trigger regime is also on hold and will be revisited during the upcoming negotiations.
It is very difficult to predict where a negotiated rulemaking process will end. Under the protocols for negotiated rulemaking, consensus is defined as the absence of dissent. If the negotiated rulemaking committee reaches consensus, ED is bound to propose the rules as agreed upon by the committees. If not, ED is free to draft proposed rules on its own. The department usually honors compromises on issues where agreement was reached, but is not legally bound to do so.
The master calendar provisions in the Higher Education Act require final rules to be promulgated no later than November 1, to take effect the following July. Regardless of whether the committee comes to a consensus, in all likelihood institutions will see new financial responsibility rules issued next year, with a new implementation date of July 1, 2019. ED has discretion to allow for voluntary early implementation.