TO HEAR THE REACTION OF SOME PUNDITS to the controversy swirling around the student loan industry, the most surprising thing about it is that it has taken so long to surface. We should be clear up front that the actions of a few individuals do not and should not sully the reputations of the thousands of dedicated financial aid professionals throughout the country. But we should be equally clear that parts of the student loan industry have become entangled in some practices that are both unethical and illegal.
With the relatively low borrowing limits on federally guaranteed loans, many students and their families are increasingly turning to private lenders to finance their education. Student loan requests have increased an average of 27 percent in each of the last six years, while students struggle to pay tuition and often graduate with enormous debt.
"With the student loan issue, the federal government has hit students and their families with a real one-two punch," said New York Attorney General Andrew Cuomo in testimony before the Senate Banking Committee last month. "First, federal student aid has not even come close to keeping pace with rising costs of attending college, essentially forcing students and families to enter the costly private loan market. Second, the federal government failsto police that marketplace by ensuring these lenders are operating legally and not at the cost of unsuspecting borrowers."
Students must almost always find extra cash to pay for college, and loans are the easiest way to achieve that. Private lenders know this, of course, and some will go out of their way to be placed on a school's preferred lender list. Why? Because students, who are already dazed and confused by the myriad forms and requirements just to get accepted into school, usually defer to the names on the preferred lender list. In fact, according to one study, 90 percent of students take loans from those on their institutions' preferred lender lists.
To be sure, preferred lenders most often earn that distinction with good reason. They offer competitive rates and a level of service with which schools and students are generally satisfied. Financial aid directors contacted for this story say they haven't had negative reactions to the news of the New York attorney general's investigation. Bryan Terry, associate vice president for Enrollment Services at Seton Hall University (N.J.), says, "The school has yet to find a family that has called our office concerned about whether or not we are acting in their best interest."
"We use a very popular lending institution that offers extremely competitive rates, so that may be why I'm not hearing any complaints," Terry explains. "However, I've heard that many of my colleagues are monitoring the same kind of activities. For now, until we get a final ruling, we will continue to work with families with the student's best interest at heart."
But what if a lending company wants to get more of those students to choose it over another lender? That company might try to offer some sort of incentive to the school's financial aid director to get placed at the top of the list.
Unethical, surely, but illegal? Perhaps. The Department of Education does not regulate private loans per se. However, it does administer the Federal Family Education Loan Program, a public private partnership that administers guaranteed education loans for students and families.
Testifying before the U.S. House of Representatives Committee on Education and Labor, Cuomo said his investigation found numerous violations within the regulations of FFELP, but much of what was uncovered falls under the realm of consumer fraud.
"Under the business and consumer protection laws of the state of New York, it is illegal to have deceptive business practices. In our opinion, some of these business practices are deceptive. When you are getting a kickback-which is the term we are using-for a loan that was undisclosed, you have deceptive business practices."
Cuomo said his rationale for jurisdiction in schools in other states is that his department protects New York consumers wherever they are. But was there an active attempt to deceive students? Yes, Cuomo charged. Some schools had an economic incentive in recommending a lender and never disclosed that self-interest. In fact, he said, they represented the opposite. "You never told me you were getting a commission on the business transaction," Cuomo said. "I consider that deceptive."
In addition, financial aid administrators who own stock in private lending companies may be violating their institution's code of ethics, and possibly criminal laws as well, he said.
But wait, there's more. Cuomo's investigation also uncovered evidence of revenue-sharing agreements between schools and lenders, university financial aid call centers staff ed by lender employees, and perks such as trips and gifts from lenders to a school's financial aid directors.
The whispers of impropriety have been around for years. Student advocacy groups and Democratic lawmakers have long been asking for more oversight into the student loan industry and how lenders conduct business with institutions.
For example, a proposal for stricter regulation of the private lenders drawn up by Department of Education officials in the last days of President Clinton's term was apparently ignored by the incoming Bush administration in 2001. That proposal read, inpart, "We are particularly concerned with allegations that some lenders and guaranty agencies have attempted to hide or disguise an impermissible offer."
Two years later, Jon Oberg, then with the Institute of Education Sciences within the DOE, wrote a memo that raised questions about private lending to low-income students. Oberg's research also showed that some lenders had overcharged the government for subsidies on loans. Rather than act on his findings, Oberg's supervisors told him to end his research and concentrate on other work. Oberg was transferred to another department tasked with overseeing grants and contracts, a move he believes was perpetrated to keep his research from continuing or from being made public. "The Education Department is controlled very heavily from the top," he says, "so the way they chose to minimize the risk of unwelcome research coming out of IES was to prohibit its researchers from doing any."
And then there was MyRichUncle, a three-year-old private lender that said it was being shut out of competition by the stranglehold that other lenders had on the loan market. In a wideranging ad campaign last summer, MyRichUncle denounced the "cozy" relationship between private lenders and financial aid offices.
"Our goal was to inform consumers they have choice, and in doing so, to provide student loans directly to students and their parents," says Raza Khan, president and cofounder of the lender. "The campaign developed into providing information that we offer our loans free of the conflicts-of-interest that have plagued student lending."
Within the financial aid community, the ads were met with outrage. Financial aid administrators denied the claims, and lenders such as Sallie Mae attacked both the ads and the company on television and in print. But, to paraphrase Shakespeare, the lender doth protest too much.
"We were genuinely surprised by the reactions of financial aid administrators," says Khan. "The questions we asked were very simple, yet not one financial aid administrator would answer them," he says. "With the revelations of the recent investigations, it is interesting to see that some of the most vocal critics of MyRichUncle were also guilty of engaging in the alliances that the investigations uncovered."
Congressional Democrats have pointed to the Bush administration's laissez-faire style as one reason the situation has gotten as bad as it has. Rep. George Miller (D- Calif.) and Sen. Edward Kennedy (D-Mass.) are among those who have joined Cuomo-the former HUD secretary under President Clinton-in charging the administration with being "asleep at the switch" as the loan industry spun out of control. "The practices we have uncovered were not undiscoverable until now. Rather, the entity charged with maintaining the integrity of the student loan market failed," Cuomo said. "The failure of the Department [of Education] to pass adequate regulations is disappointing and irresponsible."
The law at the heart of the controversy is the Higher Education Act, which, though intended to be renewed every five years, has languished in Congress since 1998.
The HEA itself set the stage for many of the improprieties that have come to light. For example, the law permits private lenders to provide free software that can be installed in a university's financial aid system, presumably to help the institution defray the cost of building its own applications. On the surface there seems to be nothing wrong with this arrangement-financial aid administrators are not software developers after all-but it has the potential of giving the lender unfair access to student information for marketing purposes. And, over time, the software can become entrenched in the rest of the school's enterprise system, making it difficult to get rid of, should the school want to change systems.
The HEA also says a lender can own the company charged with keeping a student from defaulting on a loan, but it can also own the company that collects on the debt if the student defaults. These companies can then add fees and penalties that may be more lucrative for them than if the borrower did not default.
Finally, HEA allows lenders to loan money to schools to loan to students. Then the schools sell the loans back to the lender and the school gets to keep part of the profits.
When Andrew Cuomo took office in January of this year, he wasted no time launching his probe, which was instigated by an unnamed whistleblower. Now, instead of faceless corporations, there were schools and people involved. The attorney general sent letters to 60 public and private institutions in 18 states, requesting information about the arrangements they had with various lenders, including how they chose what companies made it to their preferred lender lists.
One school on the receiving end was The University of Texas at Austin, which launched its own investigation into the actions of Associate Vice President of Student Financial Services Lawrence Burt, says Don Hale, vice president for Public Affairs. "When the attorney general contacted us, we immediately conducted an investigation. At the end of that investigation we acted and fired Larry Burt, a move that drew the praise of Andrew Cuomo and Sen. Edward Kennedy and some press."
To its credit, leaders at The UT System were forthcoming about the results of its investigation, which shed light on an often-confusing subject. Administrators released a detailed 134-page report, which included 100 pages of e-mails and communications, documenting questionable and inappropriate actions, including expensive dinners, after-work happy hours, ice cream carts, and goodie buckets from lenders.
Burt, who was appointed by Education Secretary Margaret Spellings to serve on the Advisory Committee on Student Financial Assistance in 2006, owned 2,300 shares in Education Lending Group, the former parent company of Student Loan Xpress. That includes 1,500 shares he bought from a friend shortly before adding the company to the preferred lender list, according to an internal investigation by the UT System. The investigation found no direct evidence that the stock was tied to the rise of Student Loan Xpress to the list, but the timing and the reality of the company's performance "raises suspicion and, at least, creates the appearance of impropriety."
"The statistical information compiled by the Office of Student Financial Services regarding Student Loan Xpress does not seem to justify a first ranking," according to the report, "and no employee of OSFS interviewed, including Dr. Burt, was able to articulate a compelling case for Student Loan Xpress being first on any lender list."
In the end, though, it was the fact that Burt did not disclose his stock purchases to the university-a violation of the Regents' Rules and Regulations and The University of Texas at Austin's standard of conduct-that led to his dismissal.
"We're now moving forward to restore the credibility of that office," Hale says. The school has appointed Charles A. Sorber, a former senior administrator in The University of Texas System, as acting director of Student Financial Services.
"I don't think we were tarnished as the result of the actions of one individual," Hale comments. "Any institution is going to have crises and problems, and they are judged on the way that they address those crises and problems, and in this regard I think we acted with speed and addressed the issue."
Burt's dismissal was soon followed by swift action at other institutions. Columbia University's (N.Y.) financial aid director, David Charlow, lost his job after an internal investigation found evidence of kickbacks from Student Loan Xpress, which Cuomo later called "among the most flagrant."
"In addition to promptly alerting the attorney general, Columbia placed Charlow on leave in April, pending a full review, and removed Student Loan Xpress from the list of preferred lenders," says Robert Hornsby, director of media relations at Columbia. "In May, Charlow was dismissed. Despite his actions in violation of the university's conflict of interest policy, we believe that there has been no harm to students and their families."
Johns Hopkins University (Md.) then announced that Financial Aid Director Ellen Frishberg-who was a frequent advisor to the federal government on rules for officials dealing with the student loan industry- had resigned after a probe revealed she had received at least $133,695 in unreported consulting fees from eight private lending firms.
In June, Catherine Thomas, financial aid director for the University of Southern California, resigned amid controversy over her dealings with a lender. Cuomo's investigation charged that Thomas had acquired and sold about $14,000 worth of stock in Education Lending Group.
"The university noted that Ms. Thomas' actions in connection with the student loan company Student Loan Xpress were inconsistent with USC's conflict-of-interest policy," the university said in a statement. Soon after, the for-profit, online institution Capella University dismissed its financial aid director, Timothy Lehmann, after an investigation revealed he had received $12,400 in consulting fees from Student Loan Xpress, as well as additional money for speaking at loan industry events without university approval.
Finally, Widener University (Pa.) last month announced the early retirement of Assistant Vice President for Finance Walter Cathie, after Cuomo's investigation alleged that Cathie ran a company that accepted $80,000 from Student Loan Xpress to sponsor a conference.
Although the firings and resignations made headlines for a few days, it appears that the investigations by Cuomo and Congress have only scratched the surface of a larger problem. Paul Wrubel, a college funding expert and cofounder of TuitionCoach, put it succinctly in a recent editorial: "As one of the last bastions of unregulated conduct proves that it does, in fact, need to be regulated, it becomes clear that we are not talking about a few bad apples spoiling a good barrel. Maybe removing them is simply treating a symptom. Maybe the real cause is not what's in the barrel but the barrel itself."
Early last month, the National Association of Financial Aid Administrators signaled that it agreed with that assessment. NASFAA announced it would adopt a new "Code of Conduct for Institutional Financial Aid Professionals." The code, which mirrors Cuomo's "College Loan Code of Conduct" (see sidebar on page 52), gives advice on "ensuring transparency in the administration of the student financial aid programs, and to avoid the harm that may arise from actual, potential, or perceived conflicts of interest."
The move represents a turnaround for the organization, which earlier had been critical of Cuomo's investigation. "When he began the investigation, I had written a letter to the attorney general on behalf of the Association because I was a little bothered about him questioning the integrity of all of my members," said NASFAA President Dallas Martin. "I believe that they are very hardworking, dedicated individuals, and I was fairly defensive and critical of the attorney general at that time. We didn't have all of the facts. There were things occurring that we didn't know about."
As Cuomo continues his investigation- now joined by attorneys general in other states-it will likely turn up other things we didn't know about.