Nationwide Student Loan Investigation Continues to Expand

The high-profile consumer fraud investigation of the $85 billion student loan industry first initiated by New York State Attorney General Andrew Cuomo shows no sign of abating. Initially focused on loan companies, the investigation has expanded to include educational institutions—from elite universities to for-profit and online schools—and, most recently, alumni associations. Moreover, the investigation is now a nationwide inquiry. Attorneys general from more than 40 states are coordinating strategy, and several states have launched separate investigations. This update summarizes the current status of the investigation and the practices that have come under scrutiny.

New York Investigation Uncovers Problematic Practices

In November 2006, then New York State Attorney General Eliot Spitzer began a preliminary inquiry into potential conflicts of interest and financial dealings between universities and loan providers. Spitzer became well known as an activist attorney general, leading industry-wide investigations into Wall Street investment research, improper insurance practices and excessive consumer fees. Spitzer’s successor as attorney general, Andrew Cuomo, wasted no time in picking up where Spitzer left off, launching his own industry-wide investigation. While loan companies were the initial targets, including industry leaders Education Finance Partners, Sallie Mae and CIT (Student Loan Xpress), Cuomo quickly expanded the student loan investigation to include public and private post-secondary educational institutions throughout the United States. In February 2007, more than 60 schools received civil investigative demand letters and subpoenas requesting information concerning the standards used by schools to place providers on so-called “preferred lender” lists. According to Cuomo, the probe has revealed that some student loan companies provided financial and other incentives to schools and financial aid officers in exchange for those schools and officers directing borrowers (students) to the lenders.

Schools theoretically have enormous power to influence their students’ choices of a lender simply by providing a list of companies interested in doing business. It is estimated that 90% of students seeking loans obtain financing from companies on these lender lists. In this context, a conflict of interest may arise when a school has an undisclosed motivation for listing a lender. This conflict becomes acute when the lender does not offer borrowers the most competitive rates. In addition to institutional conflicts of interest, the investigation has also revealed individual conflicts involving school financial aid administrators compounded by lax university oversight over these officials. Among the purportedly improper practices uncovered by the investigation are:

• Revenue-sharing arrangements whereby schools received payments from preferred lenders based on the percentage of loans generated; schools designating particular companies as “exclusive” providers purportedly received a larger share of revenue;
• Contributions from lenders to scholarship funds, donations such as computer systems and printing costs, and the establishment of lines of credit in exchange for preferred lender status;
• Improper relationships between lenders and financial aid officers, including administrators holding stock in a lender, serving on lender advisory boards and accepting gifts of all-expense-paid trips and tickets to sporting and other entertainment events; and
• The practice of loan companies establishing and staffing school information call centers without disclosure to students.

Fallout From the Investigation

The investigation has implicated schools in a dozen states, from the Ivy League (the University of Pennsylvania and Columbia University) to vocational and online institutes (DeVry University and Capella University). The fallout has been extensive. In recent weeks, financial aid directors at Columbia University, Johns Hopkins University and the University of Texas, as well as several department of education officials, have resigned or been dismissed. Loan providers Student Loan Xpress, Sallie Mae and Education Finance Partners along with more than 16 universities and schools have entered into settlement agreements. Under the settlement agreements, the loan companies are required to pay millions into a fund established to educate students regarding loan options, while eight schools have agreed to reimburse students for the costs of revenue-sharing arrangements. All the implicated institutions have also agreed to sign a model College Loan Code of Conduct. Signaling his seriousness of purpose, Cuomo filed a notice of intent in April to sue Drexel University for its failure to provide the proper level of cooperation with the investigation.

The most serious sanctions to date, levied as part of a settlement agreement with Columbia University announced on May 31, resulted from Columbia's lack of oversight over its financial aid director, who was personally benefiting from a relationship with a lender. While Cuomo praised Columbia's efforts to assist in the investigation, Columbia's failure to know what was going on in its own financial aid office came at the price of damaging publicity and a $1.1 million settlement payment into the student loan education fund.

Additional schools and lenders are likely to come under investigation with the announcement last week that the probe is now focusing on alumni associations that allegedly steered former students to preferred loan consolidation companies. Moreover, state attorneys general in Arizona, California, Connecticut, Illinois, Missouri and Wisconsin have launched their own investigations, issuing civil investigative demand letters and subpoenas, again focusing on preferred lender lists, revenue-sharing agreements and financial dealings between lenders and administrators. Finally, on May 31, the Federal Trade Commission announced that it had begun an investigation into anticompetitive relationships between universities and lenders.

Legal Liability: Potential Violation of Consumer Protection Laws

Although only a single civil prosecution has been announced to date, the conduct described above may run afoul of state consumer protection laws. These laws vary among the states; however, they generally prohibit deceptive and fraudulent practices, misrepresentation, concealment or the omission of any material fact in connection with the sale or advertisement of any merchandise. The use of preferred lender lists (the term has been broadly interpreted to include any list of lenders provided to current and prospective students regardless of any other endorsement by a school) without disclosing the criteria used to confer preferred lender status may be interpreted as a violation of consumer protection laws where schools have revenue sharing agreements or officials have accepted gifts from or hold stock in the lender. This is particularly true where preferred lenders do not offer borrowers the best rates available.

Recommendations

• Post-secondary educational institutions, financial institutions and student loan companies should carefully examine their current practices, especially with respect to lender lists and revenue-sharing arrangements, in light of the concerns and problems revealed by the nationwide attorneys general investigation.
• Schools and financial institutions may also want to take the affirmative step of conducting an internal investigation into their relationships with lending institutions and the relationships between their financial aid officers and those institutions.
• If you receive a civil investigative demand, take immediate steps to preserve both electronic and hard copies of all potentially relevant documents and consider initiating a thorough review of procedures and practices that might be relevant.
• With the assistance of competent counsel, consider whether to make an affirmative disclosure to the relevant state attorney general.