As students prepare to go back to school, a long-simmering dispute between government regulators and the for-profit college industry has boiled over, with a lawsuit charging that one of the major players engaged in a giant fraud.
Last Monday, the Department of Justice filed a complaint against Education Management Corp. (EDMC), marking the first time the federal government has gotten involved in one of many cases against such for-profit colleges.
The move represents an escalation in a battle against for-profit colleges, which have been targeted because they are funded largely by students with federal loans, who are far more likely to default than students at non-profit colleges and universities.
The complaint against EDMC, which operates schools in 105 locations under the names such as Art Institute, Argosy University, Brown Mackie College and South University, alleges the company paid its recruiters based on how many students they enrolled.
Because commission-based recruiting violates federal law, the Justice Department contends that EDMC was not eligible for the $11 billion in state and federal aid it received from July 2003 to June 2011. Attorneys general from Illinois, Florida, California and Indiana have also joined the lawsuit. The company says the legal action is "flat-out wrong."
Not the first tangle
The Obama administration has tangled with the for-profit college industry before. In June, the Education Department tightened regulation of the industry, requiring these institutions to meet new benchmarks or risk losing federal funding. The industry lobbied heavily against the new rules and won enough leeway to ensure that colleges are unlikely to be forcibly closed.
Students who attend for-profit colleges default at an alarming rate — about 15 percent in fiscal year 2009, up from 11 percent just two years earlier, according to a Moody's report released in July. Default rates for students at public colleges and universities rose to seven from six percent in the same time period.
But these high default rates aren't necessarily indicative of any wrongdoing, said Mark Kantrowitz, publisher of financial aid websites FinAid and Fastweb. To a large extent, for-profit schools have higher default rates because of the demographics of populations they serve, which tend to be minority and lower-income, he said.
"Some think they want to go to college, but they drop out," he said. "Someone who drops out is more likely to default than someone who completes their education."
Recognizing this trend, the Obama administration instituted new "gainful employment" regulations for any higher-education institutions to qualify for federal aid.
The first phase addressedregulations about misleading marketing practices. Under a second phase, set to go into effect in July 2012, qualifying programs must meet at least one of three requirements: At least 35 percent of former students are repaying their loans, the estimated annual loan payment of a typical graduate cannot exceed 30 percent of their discretionary income or the estimated payments cannot exceed 12 percent of their total earnings.
For-profit colleges are unhappy about the regulations, said Brian Moran, interim CEO and president of the Association of Private Sector Colleges and Universities.
"Gainful employment has been in law for 45 years and Congress has not redefined it or suggested that it needed additional definition," hesaid. "Yet now, the DOE comes along and decides to define it in such a way that generates 500 pages of convoluted, complicated measures that we think are experimental. In this economy, this is no time to experiment with students and education."
Because of these new regulations, Kantrowitz said that the case against EDMC seems like "water under the bridge." Since the company wasn’t held responsible for following these new laws during the time period it’s being scrutinized for, there seems to be no real opportunity to set a precedent with this case, he said.
But the government lawsuit contends that EDMC violated the False Claims of 1986, which bans fraudulent claims for government funds.
A sales culture
"EDMC has created a 'boiler room' style sales culture and has made recruiting and enrolling new students the sole focus of its compensation system," the government says in its 122-page complaint.
Recruiters were told to enroll applicants "regardless of their qualifications, including applicants who are unable to write coherently, applicants who appear to ADAs to be under the influence of drugs, and applicants for EDMC’s online program who do not own computers," the complaint contends.
Bonnie Campbell, a former Iowa state attorney general who is advising the company, said EDMC's compensation plan for recruiters was legal.
“Federal regulations issued in 2002 permitted companies to consider enrollments in admission officer compensation, so long as enrollments were not the sole factor considered," she said. She added that the company is proud of the quality of its programs, including its offering of "career-focused academic degrees to its students, many of whom would not otherwise attend college."
EDMC stock is down about 14 percent since the lawsuit was announced.
Settled out of court
In the past, similar cases brought against for-profit college chains have been settled out of court, said Stephen Burd of the New America Foundation, who lists some examples on his Higher Ed Watch blog.
"By never taking them all the way, there's never been any conclusion as to whether the college has done something wrong or not," he said. The EDMC case is important "because a number of the largest publicly traded for profit corporations were basically skirting the rules."
The case is also significant because the government has stepped in to what was originally a lawsuit brought by whistle-blowers, said David Hawkins, the director public policy and research at the National Association for College Admission Counseling.
"The government is sending a clear signal, that whether in past, present or future, it will not sit on the sidelines when it feels that the industry has run afoul of the law," he said. "Even if they aren't attempting to enforce the law as it's currently enforced, they're trying to send a message to the industry — that it will be watching."
© 2013 msnbc.com. Reprints