Recent Developments Related to Regulation and Litigation Involving the Education Sector (November 2016)

November 7, 2016

This is the latest update of significant developments relating to regulatory, administrative, or legal actions involving schools, especially private-sector schools.  During the last quarter, one of the larger schools in the sector, ITT Educational Services, Inc., filed for bankruptcy as a direct result of adverse action by the Department of Education ("ED"); investigative and regulatory activity relating to the private-sector remained active; and the courts continued to grapple with the implications of the Supreme Court’s ruling in the False Claims Act ("FCA") case of Universal Health Services v. U.S. ex rel. Escobar, 136 S. Ct. 1989 (2016).  These developments, and others, are discussed below. 

A.    ITT Files for Bankruptcy* 

On September 16, 2016, ITT Educational Services, Inc. filed for bankruptcy and began liquidation proceedings in an Indianapolis bankruptcy court.  This came on the heels of the 50-year-old school announcing it would be closing its 136 schools that were providing education to over 35,000 students and employing over 8,000 people.  The action was a direct consequence of ED’s refusal to provide federal financial aid for new students enrolled at ITT. 

In our view, the demise of ITT is the latest example of politically motivated regulatory scrutiny gone awry.  Based upon unproven allegations, ED required ITT to post a letter of credit.  Based on that letter of credit and the same unproven allegations, ITT’s accreditor ACICS (facing scrutiny from ED on its own and now disbarred by ED from providing federally-approved accreditation) placed ITT on show-cause status.  And based upon ACICS’s show-cause status (which was based upon ED’s own actions), ED increased ITT’s letter of credit and prohibited any new students enrolled at ITT from receiving federal financial aid–the deathblow to any educational institution.  It is important to reiterate that this was done based upon unproven allegations–none of which was ever found by a judge, jury, or even an administrative judge to have merit and none of which ITT was able to challenge by having its day in court.  Instead, ED and others took efforts to effectively shut down ITT–leaving thousands of students and employees in the lurch–based upon innuendo and unconfirmed complaints.  These actions should be a source of significant concern to every other educational institution, for-profit or otherwise, especially in light of the recent DTR regulation put forward by ED, which will allow ED to take similar actions against any other school against which allegations have been made.        

B.    Department Cuts Off Access to Student Aid, Resulting in the Closures of Other For-Profit Schools

In other actions by ED, on July 26, 2016, ED announced it was cutting off federal student financial aid to three Medtech College campuses in Falls Church, Virginia; Silver Springs, Maryland; and Washington, D.C.  The decision followed an investigation by the Federal Student Aid’s Program Compliance and Enforcement Units alleging that Medtech overstated job placement rates to its accreditor and others.  In addition, ED alleged that to verify its job placement rates, Medtech used an outside contractor that did not adhere to federal standards and did not disclose this fact to ED. 

Additionally, ED increased the letter of credit for the remaining Medtech campuses, requiring the remaining campuses to either post an 80 percent letter of credit, worth $36.6 million, to receive full certification or a 40 percent letter of credit, worth $18.3 million, to be provisionally certified by October.  Previously, the remaining campuses were required to post a $9.8 million letter of credit to continue participating in federal financial aid. 

A few weeks later, in August, Medtech closed its Falls Church, Silver Springs, and Washington, D.C. campuses, citing the loss of access to federal student aid.   

C.    ED Denies Request by the Center for Excellence in Higher Education to Maintain Its Non-Profit Status and Faces a Lawsuit Alleging ED’s Actions Are Politically Motivated

In August 2016, ED rejected a proposal by the Center for Excellence in Higher Education ("CEHE"), which currently operates four schools, to maintain its non-profit status.  CEHE was founded in 2006 by a group of philanthropists and operated as a public charity until 2012.  In that year, it merged with four for-profit colleges, including Stevens-Henager College.  CEHE then requested that the IRS approve its status as a non-profit, which the IRS did in 2013.  ED, however, denied CEHE’s request to operate as a non-profit school, citing the alleged fact that the former owner of the for-profit schools (the Carl Barney Living Trust) still had some control and benefited from the school’s receipt of federal funding. 

Following ED’s decision, CEHE filed a federal lawsuit against ED in Utah, claiming ED’s decision and other actions were "arbitrary and capricious" and that ED is acting with "improper motives and/or bad faith."  The action alleges, among other things, that ED’s actions "indicate an intentional effort to close . . . formerly for-profit institutions."  That lawsuit is in its very early stages, and no responsive pleading has been filed.      

D.    DeVry University Reaches Settlement with ED on Marketing Claims

On October 13, 2016, ED announced a settlement agreement with DeVry University, a subsidiary of DeVry Education Group Inc., that concluded a year-long investigation and resolved a charge that DeVry’s job placement claims in recruitment and advertising materials were unsubstantiated. 

Last August, ED opened an investigation into DeVry’s claim that since 1975, 90 percent of DeVry graduates were employed in their field of study within six months of graduation.  The new Enforcement Unit, the formation of which we discussed in an earlier update, played a role in this investigation.  After reviewing the information DeVry provided, the Federal Student Aid office concluded that DeVry did not provide sufficient evidence to substantiate that "Since 1975 Representation."

As part of the settlement, DeVry agreed to immediately cease publishing and/or using marketing claims that include the "Since 1975 Representation," and prominently disclose, for two years, a notice on its online home page regarding its failure to substantiate its "Since 1975 Representations" as well as include the same language in new enrollment agreements for five years.  DeVry is also required to cease making any representations about post-graduation employment rates without possessing and maintaining (1) the graduate-specific data substantiating such claims, and (2) documentation of the methodology used to calculate such claims.  In addition, for a period of six years, DeVry will be required to engage a qualified, independent, third party to review the records and information relating to DeVry graduates, and put together a summary report of DeVry’s compliance. 

The settlement also requires DeVry to post a five-year letter of credit of no less than $68.4 million, which represents approximately 10 percent of DeVry University’s total Title IV aid revenue for the 2014-2015 award year.  Additionally, DeVry University has been placed on Heightened Cash Monitoring 1, a form of oversight that will require DeVry to provide documentation of qualifying federal aid expenses before accessing Title IV funds. 

Notably, the Federal Trade Commission continues to pursue a lawsuit against DeVry regarding the same job placement claim resolved by this lawsuit, as well as other allegedly deceptive advertisements regarding job placement rates.

E.    Other Investigations into For-Profit Schools Continue

The regulatory activity did not stop there.  DeVry Education Group announced that in July 2016 it received a second Civil Investigative Demand ("CID") from the Office of the Attorney General of the Commonwealth of Massachusetts, one of the most aggressive critics of the for-profit educational sector.  This CID requests information regarding advertising, admissions materials, placement rates, and credit/transferability agreements. 

In June 2016, Career Education Corporation ("CEC") received a request for documents and information from the Denver Regional Office of the Securities and Exchange Commission.  The request relates to CEC’s fourth quarter 2014 classification of the company’s Le Cordon Bleu Culinary Arts campuses as "held for sale" when campus operations were discontinued, as well as subsequent sales processes and other related public disclosures.

And on September 12, 2016, Bridgepoint Education, Inc. announced that it had executed a settlement agreement with the Consumer Financial Protection Bureau ("CFPB") pursuant to which Bridgepoint consented to the issuance of a Consent Order by the CFPB that resolved the agency’s allegations stemming from CIDs issued in 2015.  As part of the Consent Order, Bridgepoint will pay $8 million in penalties to the CFPB, of which $5 million will be used for restitution to students who incurred debt from private student loans issued by Bridgepoint and its educational institutions.  In addition, Bridgepoint will forgive approximately $19 million of outstanding institutional loan debt, require certain students to utilize the CFPB’s Electronic Financial Impact Platform prior to enrollment, implement a compliance plan designed to ensure that its institutional loan program complies with the terms of the Consent Order, and submit reports to the CFPB describing its compliance with the Consent Order.  Bridgepoint had discontinued its institutional loan programs prior to the start of the CFPB’s investigation.

F.    Escobar Continues to Reverberate Through the Courts  

When we said last quarter that the Supreme Court’s decision in Escobar may be the most important FCA decision for schools ever, we were not being hyperbolic.  In Escobar, the Supreme Court adopted the implied certification theory for the first time, but did so only in narrow circumstances where silence would amount to a "half-truth."  Universal Health Servs. v. U.S. ex rel. Escobar, 136 S. Ct. 1989, 2000 (2016).  And, perhaps more importantly for the education sector, the Court demanded that lower courts vigorously enforce the FCA’s standard for "materiality," explaining that the FCA’s requirement that only "material" violations can constitute the basis for an FCA case is "demanding" and "rigorous."  Id. at 2003-04 & n.6.  The Court said:  an alleged violation of the law may be actionable under the FCA only if it was "material" to the government’s payment decision.  Id.  How these holdings would filter down to the lower courts was hard to predict.  We now have our first three indications, and the results are mixed.

First, in a positive development, the Seventh Circuit again affirmed summary judgment in favor of Sanford-Brown College in an FCA case alleging violations of various Title IV requirements, including the so-called incentive compensation provision and rules relating to accreditation.  In 2015, the Seventh Circuit rejected the relator’s express false certification claim–i.e., that the school had falsely "agreed to comply with all Title IV regulations" when it entered into a program participation agreement ("PPA") with the government–because there was no showing of "bad faith" or false intent at the time of signing the PPA.  U.S. ex rel. Nelson v. Sanford-Brown Ltd., 788 F.3d 696, 708-09 (7th Cir. 2015).  The Seventh Circuit at the time also rejected the relator’s implied certification theory–i.e., that a school continues to "impliedly certify" compliance with the PPA throughout the PPA’s term such that "an institution must remain in compliance with all of the PPA’s conditions in order to remain lawfully eligible to continue receiving federal subsidies."  Id.  The Seventh Circuit called that theory "unreasonable."  Id. at 711.

Of course, this latter ruling could not stand entirely in light of the Supreme Court’s ruling in Escobar.  However, on October 24, 2016, the Seventh Circuit found that while its language had to change, the result after Escobar did not–the Seventh Circuit found that the case before it still did not fit the narrow circumstances for a viable implied certification claim that the Supreme Court had identified.  U.S. ex rel. Nelson v. Sanford-Brown Ltd., No. 14-2506, slip op. at 2 (7th Cir. Oct. 24, 2016).  Specifically, the Seventh Circuit found that there were no representations "at all in connection with [the school’s] claims for payment [during the term of the PPAs], much less false or misleading" ones, and thus no half-truths.  Id.  The Seventh Circuit also explained that after Escobar the school is "entitled to summary judgment because [the relator] failed to establish the [separate,] independent element of materiality."  Id. at 3.  The Seventh Circuit held that "at most," the relator had shown the school’s "supposed noncompliance and misrepresentations would have entitled the government to decline payment."  Id. (emphasis added).  But that is not enough under Escobar.  Id.  Instead, the panel explained, the relator needed evidence that "the government’s decision to pay [the school] would likely or actually have been different had it known of SBC’s alleged noncompliance with Title IV regulations."  Id. (emphasis added).  This was evidence the relator did not have.  Nelson is a very good case for schools to rely upon in the future. 

Second, and in contrast, the Eighth Circuit recently took essentially the opposite approach in U.S. ex rel. Miller v. Weston Educational, Inc., reinstating its troubling 2015 decision and largely ignoring Escobar.  In 2015, the Eighth Circuit had allowed an FCA case to proceed premised on an alleged violation of a school’s record keeping requirement.  U.S. ex rel. Miller v. Weston Educational, Inc., 784 F.3d 1198, 1208 (8th Cir. 2015).  Disagreeing with the trial court, the Court of Appeals reasoned that the record keeping requirement must be "material" under the FCA because it was in:  (1) the PPA that all schools must sign, (2) the statute governing participation in federal financial aid (20 U.S.C. § 1094), and (3) the applicable regulation (34 C.F.R. § 668.14).  Id. The problem with this ruling, however, is that it potentially could apply to any of the thousands of regulations referenced in the PPA and statute.  And that was exactly the kind of thinking that the Supreme Court rejected in Escobar by adopting a "demanding" and "rigorous" materiality standard.  Escobar, 136 S. Ct. at 2003. 

Earlier this quarter, without even acknowledging the lessons of Escobar, the Eighth Circuit issued a new decision in Miller that again relies almost exclusively on the same "three ways" the government imposed the record keeping requirement.  U.S. ex rel. Miller v. Weston Educational, Inc., No. 14-1760, slip op. at 12-13 (8th Cir. Oct. 19, 2016).  Indeed, in one of the few passages the court altered from its 2015 opinion, the panel doubles down on its reasoning, pointing to the text of the same exact statute to conclude "[a] reasonable person would attach importance to it."  Id. at 13.  The court then goes on to explain that ED "relies on school-maintained records to monitor regulatory compliance," and cites to two administrative findings of regulatory noncompliance issued by ED.  Id. 

Third, the United States District Court for the Northern District of California issued a decision this quarter that interpreted the impact of Escobar in an FCA case filed against Stephens Institutes (a.k.a. Academy of Art University).  Unlike the Eighth Circuit, the California district court did acknowledge that the Supreme Court now requires "a ‘rigorous’ showing that the defendant’s failure to disclose noncompliance was material to the government’s payment decision."  Rose v. Stephens Inst., No. 09-05966-PJH, ECF No. 208 at 4 (N.D. Cal. Sept. 20, 2016).  And contrary to the United States’ arguments that the materiality standard was essentially unchanged and "flexible" (ECF No. 202 at 8-9), the court correctly explained that materiality "’look[s] to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation,’" and courts cannot assume "’statutory, regulatory, and contractual requirements are . . . automatically material.’"  ECF No. 208 at 4 (quoting Escobar, 136 S. Ct. at 2002). 

Yet, despite articulating the correct standard, the district court nevertheless held that there was a triable issue of fact regarding whether Stephens Institute’s alleged violations of the incentive compensation provision were material to the government’s payment decisions.  Id. at 11.  To come to that conclusion, the court relied on two facts.  First, the court reasoned that ED must consider the incentive compensation provision material because it "took corrective actions against schools, issued fines, and entered into settlement agreements" in cases.  Id.  Those actions, however, reflect precisely the type of administrative actions related to "garden-variety . . . regulatory violations" that the FCA is not intended to enforce.  Escobar, 136 S. Ct. at 2003.  Second, the court adopted the argument presented by the United States that ED’s rescission of the Hansen Memorandum in 2015, which stated that incentive compensation violations should be handled by a fine rather than loss of student or institution eligibility, provides further support for a finding of materiality.  Stephens Inst., No. 09-05966-PJH, ECF No. 208 at 11.  But that rescission came years after the relevant time period at issue in the Stephens Institute case.  During the relevant time period, the policy and the practice of ED was to consider violations as a regulatory violation, not something that affected ED’s payment decision.  This decision from the District Court is therefore puzzling, to say the least. 

On September 20, 2016, the Stephens Institute filed a motion to certify the District Court’s summary judgment order for interlocutory appeal, and to stay the case pending appeal.  On October 28, 2016, the District Court granted the motion, finding three questions appropriate for interlocutory appeal pursuant to 28 U.S.C. § 1292(b):  (1) must the "two conditions" identified by the Supreme Court in Escobar always be satisfied for implied false certification liability under the FCA, or does the test for implied false certification set forth in Ebeid ex rel. U.S. v. Lungwitz, 616 F.3d 993 (9th Cir. 2010), remain good law; (2) does an educational institution automatically lose its institutional eligibility if it fails to comply with the incentive compensation ban; and (3) does the holding in U.S. ex rel. Hendow v. University of Phoenix that the incentive compensation ban is material under the FCA remain good law after Escobar?  Rose v. Stephens Inst., No. 09-05966-PJH, ECF No. 219 at 7 (N.D. Cal. Oct. 28, 2016).  We will keep you posted on further developments. 

Finally, the debate over Escobar is currently pending before the United States District Court for the District of New Jersey in a case against Premier Education Groups, U.S. ex rel. LaPorte v. Premier Educ. Grp., No. 11-3523 (RBK/AMD) (D.N.J.).  As we reported last quarter, the court sua sponte called for supplemental briefing on the impact of Escobar on the court’s previous decision to grant the school’s motion to dismiss in part.  As part of that briefing, the United States filed a statement of interest that makes arguments very similar to the ones it presented in the Stephens Institute case.  Specifically, the United States again attempts to argue that Escobar "confirm[ed] the ‘natural tendency’ test" and makes no mention of the fact the Court labeled the materiality inquiry "demanding" and "rigorous."  ECF No. 130 at 5.  The government also, again, argues that the fact the "Department of Education officially rescinded" the Hansen Memorandum means "that the Department does in fact consider violations of the incentive compensation ban to be material."  Id. at 7-8.  But it remains entirely unclear how a rescission in 2015 could possibly mean that ED considered the incentive compensation provision material before it took that action.     

G.    Settlements by a For-Profit and Non-Profit School with the United States

There were also two settlements in FCA cases brought by the United States.  First, the United States Attorney for the Central District of California announced it had settled an FCA lawsuit brought against the now-closed Marinello Schools of Beauty, by agreeing to an $11 million settlement with the school’s insurer.  As we reported last quarter, Marinello closed 56 of its campuses after ED denied recertification of their eligibility to participate in the federal student aid programs.  Marinello’s insurer then intervened in the FCA case pending in California, and settled the case without admitting any wrongdoing by the school.  The school maintains that the allegations in the case were false.

 Second, the United States Attorney for the Southern District of New York announced in July that Columbia University had agreed to pay $9.5 million to settle allegations under the FCA that it impermissibly applied its "on-campus," rather than lower "off-campus," indirect cost rates to 423 federal grants which were primarily performed off campus.  This serves as a further reminder that all schools–not just for-profit institutions–can be ensnared by the FCA.

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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.