Recent Developments Related to Regulation and Litigation Involving the Education Sector (May 2017)

May 1, 2017

This is the latest update of significant developments relating to regulatory, administrative, or legal actions involving schools, especially private-sector schools.  This past quarter, there were several noteworthy developments in False Claims Act ("FCA") cases involving schools and further uncertainty over what the Trump administration will mean for private-sector schools.  These developments, and others, are discussed below. 

A.     Another Win for Kaplan (and the Sector) Plus a Positive Trend in FCA Law

On March 22, 2017, the U.S. Court of Appeals for the Ninth Circuit affirmed summary judgment in a long-running FCA case, U.S. ex rel. Jajdelski v. Kaplan, Inc.*  A former admissions representative filed the lawsuit back in 2005, alleging that a private-sector school in Las Vegas knowingly received federal financial aid on behalf of "phantom students" who either never attended the school or had previously withdrawn.  The United States District Court of Nevada had dismissed the case at the pleadings stage in 2011.  But in 2013, the Ninth Circuit reversed in a 2-1 unpublished decision that provoked a vigorous dissent.  517 F. App’x 534 (9th Cir. 2013).

After completing discovery, Gibson Dunn and Kaplan successfully moved for summary judgment, arguing, among other things, that Jajdelski lacked sufficient evidence of a false claim.  2015 WL 1034055 (D. Nev. Mar. 9, 2015).  Jajdelski then appealed again to the Ninth Circuit.  A Ninth Circuit panel consisting of Circuit Judges McKeown and Bybee, and Senior District Judge Mollway (sitting by designation), unanimously affirmed last month because Jajdelski had failed to provide adequate evidence "of a false claim."  No. 15-15668, 2017 WL 1075428, at *1 (9th Cir. Mar. 22, 2017).  Although the Ninth Circuit’s opinion is unpublished, this back-to-basics decision that reiterates the obvious–an FCA case requires evidence of an actual false claim–should prove helpful to other schools facing lawsuits that "describe[] a generalized scheme to defraud" but lack actual proof.  Id. 

Kaplan’s win in the Ninth Circuit on summary judgment further illustrates that schools continue to prevail at the "’put up or shut up’ moment in a lawsuit," even if the school was unsuccessful at the pleadings stage.  Johnson v. Cambridge Indus., Inc., 325 F.3d 892, 901 (7th Cir. 2003).  Such a record of success once there is actual evidence before the reviewing court is obviously a good sign that many of these cases remain unfounded.

B.     The Circuit Courts Continue to Interpret Escobar  

The tide may also be turning back to a more reasonable approach in FCA cases, and even at the pleadings stage.  Since the Supreme Court’s decision in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), the courts have applied a much more "rigorous" standard for materiality, taking to heart the Supreme Court’s admonition that the "materiality standard is demanding."  Id. at 2003.  The Ninth Circuit has done so at the summary judgment stage in U.S. ex rel. Kelly v. Serco, Inc., 846 F.3d 325 (2017), in which the court affirmed summary judgment because the evidence showed that the Government could not have possibly considered the alleged violations material given that the Government knew about them and yet still chose to pay.  Id. at 334.  And the First Circuit recently applied a robust interpretation of the materiality element at the motion to dismiss stage.  D’Agostino v. ev3, Inc., 845 F.3d 1, 7 (2016).  If this trend continues, as we expect given Escobar‘s clear mandate, schools may no longer have to spend considerable resources to make it to the "’put up or shut up’ moment in a lawsuit," in order to prevail against meritless claims and may again begin obtaining more victories at the pleadings stage.

C.     How Damages Are Calculated in FCA Cases Remains Uncertain, Driving up the Cost of Settlements

This past quarter saw the conclusion of a lawsuit brought by the federal government against the now-defunct for-profit college, FastTrain College, and its CEO, for allegedly submitting fraudulent documents on behalf of FastTrain students to secure millions in federal financial aid in violation of the FCA.  On February 15, 2017, the court granted the government’s motion for summary judgment and entered final judgment for the United States, ordering approximately $24 million in damages.  See U.S. v. FastTrain II Corp., No. 12-21431-MGC, Dkt. Nos. 226, 227 (S.D. Fla. Feb. 15, 2017). 

In conducting its damages analysis, the court followed what it claimed to be the Eleventh Circuit’s "general rule" that "’the measure [of damages for an FCA claim] is the difference between what the government actually paid on the fraudulent claim and what it would have paid had’ it known of the false statements."  Id., Dkt. No. 226, at *15 (quoting United States v. Anghaie, 633 F. App’x. 514, 516 (11th Cir. 2015)).  The court then noted that it believed the "proper measure of damages [to be] the full amount the United States paid out" to FastTrain, which was approximately $25.2 million from 2010-2012.  Id. at *15-16.  But, interestingly, the government requested that the court "limit the measure of damages to the more modest amount of federal student aid FastTrain actually stole through its false claims and false certifications," which was $4.1 million, an amount the court found "to be reasonable, if not a conservative, estimate of the United States’ loss."  Id. at *16.  The court then held that FastTrain was liable for $4.1 million, trebled, and also imposed the maximum civil penalty of $11,000 for each false claim allegedly submitted–here, 924 false claims.  Id. at *16-17. 

The judgment in this case simply highlights the discrepancy in how courts analyze damages.  For example, in U.S. ex rel. Christiansen v. Everglades College, Inc., No. 12-60185-CV, 2014 WL 5139301 (S.D. Fla. Aug. 14, 2014), a court in the same district as FastTrain explained that it should calculate damages by first determining the amount the government paid because of defendant’s false claims and then subtract the value the government nonetheless received from the defendant.  Id. at *9.  Under that approach, the court stated that the government suffered no damages.  The court did not reach that conclusion for the reason we expected (and believe to be correct)–i.e., that the students had received the education for which the government paid and therefore, the government suffered no damages.  Id. at *11.  Instead, the court found there were no damages because it found the government would not have withdrawn the funding or sought reimbursement had it known about the alleged false claims.  This rationale sounds less like a damages analysis and more like a materiality analysis consistent with Escobar‘s demanding standard. 

Due to the uncertainty regarding how damages are calculated with regard to the typical  FCA claims involving schools, if a school is not able to defeat the claims at summary judgment, there remains a great deal of risk at trial, even with regard to what might be viewed as weak claims on the merits.  Moreover, if the school is found liable after trial, the school is on the hook for statutory attorneys’ fees, which often increase dramatically as the case continues.  This may have been recently exemplified by Career Education Corporation’s settlement in U.S. ex rel. Powell v. Am. InterContinental University, Inc., No. 8-cv-02277 (N.D. Ga.).  On February 15, 2017, less than a month before trial was set to begin and after one of the claims was able to get by a motion for summary judgment, Career Education Corporation and American InterContinental University agreed to settle the case, paying $22 million in attorneys’ fees to the attorneys representing the relators.  The school only paid $10 million to the United States, the party supposedly injured, and did not admit to any wrongdoing.

D.     Gainful Employment Regulation: A Data Error and a Surprising Trump Administration Defense

As many expected, the "gainful employment" regulation has hit more than a few snags, but at least for now, appears to have not yet sunk.  Just before President Trump’s inauguration, the Department revealed that a coding error in its College Scorecard program had substantially inflated colleges’ student loan repayment rates, perhaps by as much as 20 percentage points for some colleges.  The Department reported that over 90% of colleges were not affected and scrambled to fix the error.  Approximately 200 colleges have appealed the Department’s calculation of their gainful employment data, and the Department announced earlier this month that it will give colleges more time to submit appeals. 

Critics of the rule were optimistic that the Trump Administration would move quickly to revise or repeal the gainful employment rule.  So far that has not been the case.  And the Trump Justice Department surprised many with a recent defense of the rule in a case filed by the American Association of Cosmetology Schools.  The suit alleges that the Department substantially underestimates the earnings of cosmetology graduates, who often make a large percentage of their income in tips, and challenges the regulation as arbitrary and capricious as applied to cosmetology programs.  In a recent brief, however, Justice Department attorneys argued that the rule protected students "because it could prevent them from taking on debt that they will not be able to repay, and they could more reasonably evaluate whether they would prefer to enroll in programs that have been more successful in enabling their students to find employment that would allow them to repay their loans." 

The Department under Betsy DeVos has announced a delay of the deadline by which programs must disclose additional information under the gainful employment rule until July 1.  Senate Democrats, led by Richard Durbin of Illinois, Patty Murray of Washington, and Elizabeth Warren of Massachusetts, wrote to Secretary DeVos asking that she explain the decision.  They may have to wait some time for a response.  The Senators are still waiting for Secretary DeVos’s reply to a February 23, 2017 letter, asking for more information on the announced federal education task force to be led by Jerry Falwell Jr., president of Liberty University.  Quoted by The Washington Post as stating that "there’s too much intrusion into the operation of universities and colleges," Mr. Falwell seems likely to help carry out the anti-regulation priorities of the Trump administration. 

E.     More Developments from the Trump Administration

The appointment of the Falwell task force and the delayed implementation of the gainful employment rule are just two of many developments signaling the new direction of the Trump administration.  Since our last update, the Senate confirmed Betsy DeVos as the new Secretary of Education.  When asked about gainful employment rules during her confirmation hearing, Ms. DeVos stated "I will review that rule and see that it is actually achieving what the intentions are.  The last thing any of us want is to unnecessarily close down important programs."  Ms. DeVos has already hired Robert Eitel and Taylor Hanson, two experts who are well known to, and understand the significant value provided by, schools in the sector. 

On February 24, President Trump signed an executive order establishing a "regulatory reform task force" charged with reviewing agencies’ existing regulations in search of rules to repeal or change.  Several groups have already challenged the order in court, although it is not clear they will have standing to sue until a regulation is repealed by the task force. 

Congress wants in on the de-regulation activity, too.  Rep. Virginia Foxx (R-NC), the new chair of the House Committee on Education and the Workforce, has vowed to "do everything we can" to roll back Obama-era regulations.  In 2015, Foxx introduced the Supporting Academic Freedom through Regulatory Relief Act, which was assigned to committee this past February.  The bill would repeal the gainful employment rule, the credit hour regulation, prohibit teacher preparation regulations, and clarify that incentive compensation provisions allow tuition sharing agreements between third-party service providers and colleges.  And just last month, the House Financial Services Committee’s Oversight and Investigations Subcommittee heard testimony on the constitutionality of the Consumer Financial Protection Bureau (CFPB).  Three of four experts called to testify, including Gibson Dunn’s Ted Olson, argued that the CFPB–which is headed by a single director who serves a minimum five-year term, wields expansive powers, and can only be removed for cause–is an unconstitutional limitation on the president’s executive power. 

The U.S. Court of Appeals for the District of Columbia Circuit is also currently rehearing (en banc) several questions relating to the CFPB’s constitutionality and powers, including whether the president can fire the CFPB director at will.*  The petitioners, represented by Gibson Dunn, argue that the CFPB is unconstitutionally structured and should be struck down in its entirety.  The United States has filed an amicus brief arguing that the CFPB’s structure violates the separation of powers, and that the D.C. Circuit should strike down the statutory provision purporting to limit the president to removing the CFPB director for cause. 

Despite these promising changes, certain state attorneys general are likely to persist in their enforcement actions involving the sector.  A group of 18 state AGs, led by Illinois Attorney General Lisa Madigan, wrote to Betsy DeVos in February, asking her not to declare "open season" on students by rolling back regulations governing for-profit colleges.  The letter was harshly critical of the sector, concluding "In short, the entire for-profit education system was failing students and taxpayers."

F.     One For-Profit School Goes Public, One Private, and Two Nonprofit

On February 1, 2017, Laureate Education Inc., the world’s largest for-profit network of colleges, went public on the Nasdaq Stock Exchange, pricing 35 million shares at $14 each.  Laureate primarily operates schools outside the United States, which has allowed it to distance itself from its American-focused peers, which have endured heightened scrutiny under the Obama Administration.   

Going in the opposite direction that same month, the Apollo Education Group, the publicly traded owner of University of Phoenix, announced it completed a deal to be taken private by a consortium of investors, including Vistria, a private-equity firm run by former president Barack Obama’s friend Marty Nesbitt and former deputy education secretary Tony Miller.  The $1.1 billion sale took nearly a year to close as Apollo waited for the Education Department and the Higher Learning Commission, a college accreditation agency, to sign off.  In late January, the Higher Learning Commission voted in favor of allowing the Apollo-owned schools to retain their accreditation post-sale, nearly a month after the Education Department had signed off on the sale pursuant to certain conditions, including the requirement of a letter of credit from a bank assuring the availability of 25 percent of the federal loans and grants the schools receive, approximately $385 million.

Education Management Corp. took a third path, announcing in March that it was abandoning its for-profit business model and was selling its operating schools to the Dream Center Foundation, a Los Angeles-based nonprofit that funds programs across the country for the underprivileged.  Notably, the sale will require the Education Department’s approval, as well as the sign-off of accreditors, before it is finalized.  The Dream Center has previously focused on GED programs and a private school to help children who have trouble adjusting to a public education, and was reported to be particularly interested in the medical and health programs at South University and the psychology and mental health counseling programs at Argosy University.  The EDMC universities will be managed by Dream Center Education Holdings, which was created specifically for purposes of the acquisition.  Brent Richardson, formerly the chief executive officer at Grand Canyon University, a large Christian for-profit institution, will serve as the nonprofit’s chief executive officer and co-chairman.   

Finally, just last week, Kaplan announced its acquisition by public, Indiana-based Purdue University, which plans to transform Kaplan’s 15 campus locations and online programs into a public school under the Purdue name. Purdue president and former Republican governor of Indiana, Mitch Daniels, explained, "We cannot honor our land-grant mission in the 21st century without reaching out to the 36 million working adults, 750,000 of them in our state, who started but did not complete a college degree, and to the 56 million Americans with no college credit at all."  Graham Holdings, which owns Kaplan, will continue to operate Kaplan under a 30-year contract. The deal will require Department of Education and Higher Learning Commission approval.               

G.     Bridgepoint Wins Another Round in Securities Case

On April 5, 2017, the United States District Court for the Southern District of California dismissed again a putative securities class action filed in 2015 against Bridgepoint Education.  The allegations in the case center on whether the school recorded tuition revenue in conformity with generally accepted accounting principles.  The court held that even if the school did not, the case still must be dismissed because the allegations did not lead "to a strong inference of scienter that is at least as compelling as an inference of nonfraudulent conduct."  Zamir v. Bridgepoint Education Inc., No. 3:15-cv-00408, slip op. Dkt. No. 64, at 18 (S.D. Cal. Apr. 5, 2017).  The court, however, did give the plaintiffs another chance to sufficiently plead their allegations, despite its "doubts concerning Lead Plaintiffs’ ability to adequately re-plead scienter." 

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As always, we will continue to monitor all of these developments, and you can look forward to updates in our next report.

[*] The asterisks indicate matters in which Gibson Dunn is involved.