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         Return to FAA/Educators |
Illegal Inducements and Preferred Lender Lists
This article discusses federal laws and regulations concerning
preferred lender lists, with special focus on the illegal inducements
rules.
Preferred Lender Lists
A preferred lender list is a selective list of lenders recommended by
a college. The list may be ranked, unranked (alphabetical) or
randomized. Although there is no legal requirement to have a preferred
lender list, many colleges provide one in order to direct borrowers to
lenders that, in the financial aid administrator's opinion, offer the
best loans. The primary selection criterion is almost always low cost,
but other criteria also play a role. These criteria can include the
quality of customer service, responsiveness to complaints, lender
reputation, local vs national lenders, accuracy of lender marketing
materials, and the quality of loan
counseling and financial literacy programs offered by the lender.
A secondary benefit of preferred lender lists is they help limit the
number of lenders that a college must routinely deal with. While there
are now many standard loan origination interfaces, such as Commonline,
there are always differences in the loan certification process at each
lender. Many schools have their own administrative systems, and
interfacing with a lender's systems is far from seamless. College
financial aid offices also have limited staff available to evaluate
the hundreds of lenders and offerings that may change many times a
year. This creates some resistance to adding new lenders to the
preferred lender lists. Lenders that offer
a school administrative assistance are more likely to overcome these
barriers.
FinAid conducted a survey of college preferred lender lists in October
2005, reviewing the preferred lender lists published on 88 college web
sites. The median number of lenders on a preferred lender list was
six. The range was 2 to 24, with three quarters of the colleges having
between 4 and 10 lenders. (In contrast, the FinAid site lists more
than 300 education lenders.)
The financial rewards to a lender for appearing on a college's
preferred lender list are great. The first lender on a preferred
lender list often gets 75% to 95% of the college's student loan
volume, which can represent tens or even hundreds of millions of
dollars of education loans per year. As a result, there is a lot of competition
among lenders in the school relations channel as they try to
convince the colleges to add them to the college's preferred lender
list.
Rules Affecting Preferred Lender Lists
Lenders will attempt to influence college financial aid administrators
in every way possible in order to be included on the college's
preferred lender list. In order to ensure that the decision making
process is focused primarily on the benefits to the students and not
on external factors, there are a variety of federal rules and
regulations that limit acceptable practices by colleges and
lenders. Chief among these are the rules concerning illegal
inducements, also referred to as "prohibited inducements".
There is no statutory or regulatory requirement to have a preferred
lender list, but the US Department of Education has indicated
that if a college has a preferred lender list, it must include at
least three different lenders.
Colleges may not discriminate against any lender or require families
to borrow only from lenders on the preferred lender list. Students and
parents may choose to borrow from any lender, not just the college's
preferred lenders. Colleges may not have unreasonable delays in
certifying a loan from a lender that is not on the preferred lender
lists.
These rules affect School as Lender colleges in addition to other FFEL
schools. Direct Loan schools,
however, may refuse to certify loans from FFEL lenders. One of the
primary attractions of the Direct Loan program is that it limits the
number of lenders a college must interact with to just one, the
federal government.
Nondiscrimination Against Lenders
The rules that prohibit discrimination against lenders come from the
loan certification regulations. Before a lender may disburse a federal
education loan, the college must certify the loan, per sections 428H(b)
and 454(a)(1)(C)
of the Higher Education Act of 1965, verifying the student's
eligibility for a federal education loan and that the loan amount does not
exceed the applicable annual and aggregate loan limits, including the
requirement that the loan amount does not
exceed the cost of attendance when combined with all other financial aid
received by the student.
Section 479A(c) of the Higher Education Act of 1965 gives colleges the
authority to refuse to certify loans or certify a loan for a lower
amount on a case by case basis:
Illegal Inducements
The Higher Education Act of 1965 has three separate definitions of
illegal inducements for lenders, guarantee agencies and colleges.
There are subtle differences in the legislative language used for each.
The illegal inducements rules have several key elements:
The emphasis on quid pro quo relationships weakens enforcement of the
regulations, as such relationships are more difficult to demonstrate. This
is especially true when a relationship is established by a wink and a
nod or "coincidence" and not documented in writing. An arrangement may
be unethical and illegal, but having to prove that it violates the quid
pro quo requirement gives lenders a pass.
Purpose of Illegal Inducements Rules
The purpose of the prohibition against illegal inducements is partly
to ensure program integrity and partly to ensure that colleges remain
objective in the advice they provide to their students and
parents. Dear Colleague Letter DCL-95-G-278 (DCL-95-L-178) elaborates
on these ideas:
Illegal Inducements - Lenders
The illegal inducements rules for lenders appear in section 435(d)(5)
of the Higher Education Act:
The corresponding regulations appear in the definition of "Lender" in
34 CFR 682.200(b)"Lender"(5):
Illegal Inducements - Guarantee Agencies
The illegal inducements rules for guarantee agencies appear in section
428(b)(3) of the Higher Education Act:
The corresponding regulations appear in 34 CFR 682.401(e):
Illegal Inducements - Schools
Colleges are likewise prohibited from paying lenders to offer loans to
the college's students and parents.
These restrictions appear in the regulations at 34 CFR 682.212,
paragraphs (a) and (b):
(b) The following are examples of transactions that, if entered into for
the purposes described in paragraph (a) of this section, are prohibited:
In addition, the Higher Education Act contains restrictions on the way
a college may compensate its employees and contractors in section
487(a)(20):
The regulations at 34 CFR 668.14(b)(22) provide a list of safe
harbors, including exclusions for compensation based on student
completion of educational programs and non-cash token gifts to
students or alumni (limit one gift per year) worth not more than
$100. The former is why some lenders offer loan discounts in the form
of a "graduation gift" to the borrower. They assume that this safe
harbor would also apply to lenders.
Examples of Illegal Inducements
Dear Colleague Letter DCL 89-L-129 gave several examples of illegal
inducements. These include:
The lawsuit SLMA v. Riley 112 F. Supp. 2d 38 (D.D.C. 2000)
is often
misinterpreted as indicating that the restrictions against illegal
inducements are unenforcable. In reality, this court case was focused
on whether a School as Lender program loan purchase agreement was
an illegal inducement. Much of the decision rested on three factors:
The Ohio Ethics Commission issued an advisory opinion on December 17,
2003, that prohibited Ohio public college employees from accepting
gifts and entertainment or other benefits from an education lender, or
from paid service on a lender advisory board.
Examples of Permissible Activities
Dear Colleague Letter DCL 89-L-129 gives several examples of
activities that do not represent illegal inducements:
These examples in effect establish several safe harbors, including:
Are Preferred Lender Lists Allowed?
Dan Madzelan and Jeff Baker of the US Department of Education have
frequently stated in public forums that preferred lender lists are not
illegal inducements, so long as the preferred lender lists includes at
least three different lenders. Examples include talks given at the
following conferences:
Besides stating that "Preferred Lenders Lists are OK", they also noted
several requirements:
At the Federal Update session at the NASFAA National Conference on
July 9, 2007, Jeff Baker said that the US Department of Education had
sent letters to a total of 921 colleges where a single lender received
80% or more of the loan volume. The Chronicle of Higher Education,
however, reported that data from Student Marketmeasure Inc. shows that
1,412 colleges had a single lender with more than 80% of federal loan
volume, and 521 colleges had a single lender with 100% of the loan
volume. On October 24, 2007, the Department sent a follow-up letter
requesting more detailed information from
55 colleges (some with
multiple campuses) with $10 million or more in FFELP loan volume and
many with 95% or more of their loan volume with a single lender. A
similar letter was sent to 23 lenders.
For additional information concerning US Department of Education
policy concerning prohibited inducements and preferred lender lists,
see
US Department of Education Regulations below.
Questionable Preferred Lender List Practices
Some current federal education lender practices may cross the line of what is
appropriate:
The current practice of providing a random drawing for a prize such as
a DVD Player, LCD TV, MP3 Player, PDA or fruit basket is also questionable. Some
lenders hand-select the winners of the supposedly random drawing,
which is clearly inappropriate. Some conferences now require vendor
drawings to be performed in a public forum to prevent this
practice. Others limit the number of prizes per attendee to one per
year. Many conferences encourage vendors to provide prizes in the form
of a scholarship for a student at the winner's college.
While some of these practices may not be illegal or influence college
personnel, one has to be concerned not just with actual problems, but
also with appearances.
Some colleges, especially public colleges, already have policies that
prohibit accepting any benefit from a vendor, including meals.
Acceptable Preferred Lender List Practices
Some practices that do not represent illegal inducements include:
In addition, lenders that do not participate in the FFEL program, such
as lenders that offer only private student loans, are not subject to
the illegal inducement rules.
Criticisms of Preferred Lender Lists
There are several potential criticisms of preferred lender lists. Some
of the following criticisms have been raised by public policy
advocates, lender advertisements in newspapers and magazines, and
legislators:
The School as Lender program has also been criticized as circumventing
the intent of the illegal inducements rules, by allowing payments for
loans as opposed to loan applications. But School as Lender schools
are now required to use the proceeds for reducing loan costs and for
need-based grants.
Defenses Against the Criticisms
Clearly, the ultimate defense against criticisms of preferred lender
lists is to not have a preferred lender list. There is no statutory or
regulatory requirement to have a preferred lender list.
But many financial aid administrators feel that it is important to
safeguard students and their families from harm. Lenders often have a
strong profit motive, which may mean that an individual lender may
focus more on its financial interests than on what's in the student's
best interest. For example, some lenders have encouraged student to
include Perkins loans in a consolidation loan and most lenders
encourage borrowers to chose a longer loan term despite the increase
in interest paid over the lifetime of the loan.
By providing a preferred lender list, the colleges can
guide families to the best loans.
A guiding question should always be: Do the borrowers benefit?
NASFAA has published an excellent de facto industry standard in their
Guide to Developing a Preferred Lender List (Monograph 15, May 2005).
Every college should read and follow this guide's recommendations.
Some of the criteria established by the NASFAA Monograph include: loan
cost, quality of customer service, problem resolution (responsiveness
to complaints), lender default rates and lender default aversion
efforts (including early intervention), ease of loan certification
process, 24/7/365 availability to borrowers, disbursement flexibility,
loan products offered (Stafford Loan, Parent PLUS Loan, Grad PLUS Loan, Private
Student Loan, Consolidation Loan), borrower preferences for national
and local lenders, life of loan servicing, entrance and exit
counseling, financial literacy and debt management counseling,
clarity and accuracy of lender marketing materials and web site, protection of
borrower privacy, response time for processing loan applications, and
quality of lender toll free telephone numbers and call centers (e.g.,
hold times and complexity of phone menus).
NASFAA is currently revising the monograph to take into account recent
changes in the rules concerning preferred lender lists. In the
interim, NASFAA has issued a short article for NASFAA members entitled
Requesting Lender Information: What You Need to Know about RFIs.
In addition to the NASFAA Monograph's recommendations, every college
should include several clear and conspicuous disclosures together with
any publication of the preferred lender list:
Colleges should ensure that they certify loans from lenders that are
not on the preferred lender list without any artificial
delays. Maintaining an audit trail of school actions can help
establish when delays are caused by problems with the lender's
systems. Ideally, the school should certify all loans in a
lender-blind manner.
Inclusion on the preferred lender list should be reviewed annually
with a formal RFP. Many lenders change their discounts at least once a
year, before the start of the peak loan season, so an annual review is
necessary. If the school wants to limit the number of lenders it will
have to consider, it should publish minimal standards for
consideration, such as minimum loan discounts and a minimum lender
default rate.
Colleges should use objective criteria for selecting the lenders on
the preferred lender list. Subjective criteria, such as the quality of
customer service and the borrower complaint record, should be
quantified in a clearly defined scale as much as possible.
Since evaluating loan discounts is complicated, colleges should
require lenders to disclose the actual value of their discounts. This
could include:
Colleges that participate in revenue sharing agreements with lenders
(e.g., School as Lender schools and some private student loan
programs) should ensure that the loans are competitive with the best
loans available from other lenders. The colleges should also take
steps to ensure that the funds generated by these agreements accrue
to the students whose loans enabled them (e.g., via loan discounts,
such as interest rate and principal reductions).
Colleges should also include at least three lenders on their preferred
lender lists, to ensure that borrowers are given a meaningful choice.
Ideally these lenders should not all have forward purchase agreements
or be owned by the same secondary market, since the loan discounts and
the quality of customer service are often dictated by the lender that
ultimately holds the loans, not the lender that originates the loans.
Conferences should establish rules concerning vendor prize drawings,
such as requiring winners to be selected via a public random drawing
and publicly disclosing the list of winners on the conference web
site.
Colleges should establish and enforce institutional policies governing
the acceptance of gifts and other compensation from vendors, including
education lenders.
Non-College Lender Lists
Aside from college preferred lender lists, there are several other
companies that provide lists of lenders. These include FinAid.org,
eStudentLoan.com, SimpleTuition.com and CollegeLenderList.com. Most of
these sites receive a financial benefit from including a lender on
their list, and so their selection criteria are based on pay for
placement. Often these lists will be paid a percentage of each funded
loan or a fee per loan lead or loan application. These non-college
lender lists are not subject to federal regulations and do not
necessarily disclose the criteria they use to compile their lender
lists. (FinAid's lists
of lenders are intended to be comprehensive. FinAid does not charge
lenders for inclusion in the list.)
Nuanced Ethical Choices
Some of the choices faced by financial aid administrators are not
black and white, but fall into more of a gray area, making it more
difficult to make the right choice. For example, when a lender offers
opportunity loans, donates scholarships to the school or provides a
revenue share which is used soley for need-based student aid, one
could ask "where's the harm to consumers?". After all, doesn't this
parallel the practice of charging higher tuition in order to fund
need-based grants to low income students?
There are, however, several key differences. While students in general
may benefit from such deals, the benefits are not necessarily accruing
to the individual borrower whose loans enabled the benefit. When a
financial aid administrator is advising a student concerning education
loans, his or her responsibility is to the individual student, not
students in general. The financial aid administrator must focus solely
on that student's best interests, offering advice that is adapted to
that student's specific financial situation. The student is also
seeking a service from a third party, and it is an abuse of the
special trust the student places in the college to exploit that
relationship for financial gain.
When a lender offers such deals, it distorts the marketplace, shifting
attention away from the merits of the product. If it weren't for these
special deals, prices would be lower for borrowers. For example, when
a lender pays a 2% referral fee to a school, that's 2% that could have
been paid to the borrower, or about $500 per borrower. Moreover, these
deals serve to impede competition on price, letting lenders compete on
the marketing of auxiliary services and not on the fundamental merits
of their products. This lends support for higher prices throughout
the education lending marketplace by diluting the competitive pressure
on the lenders. There is no valid baseline for comparison in such an
environment, since the baseline itself is subject to distortion.
Also, money is fungible. When a college receives payments, services or
other material benefits from a lender, it reduces pressure on its
budget. So even when the money is used for need-based student aid, it
is difficult to demonstrate that this money is supplementing and not
supplanting existing institutional funds.
It is important that college financial aid administrators distance
themselves from education lenders so that they can provide
independent, objective and disinterested advice. All of the special
deals and trinkets offered by lenders, while they may be
well-intentioned, have a tendency to blur the ethical
boundaries. Since the appearance of a conflict of interest is almost
as bad as an actual conflict of interest, colleges must take steps to
ensure that lender relationships do not call their integrity into
question.
Loan Industry Guidelines
On April 24, 2007, the Education Finance Council (EFC) and National
Council for Higher Education Loan Programs (NCHELP), two education
lending trade groups, endorsed a set of
Student Loan Business Practices
for their members. The principles include encouraging families to
borrow only what they need, "fairly and accurately" disclosing all
loan terms and conditions, "plainly" disclosing all borrower benefit
eligibility conditions (but do not say that lenders should disclose
the percentage of borrowers qualifying for the benefits), complying
with "all applicable federal and state laws" that restrict the use of
nonpublic personal information for purposes unrelated to education
loans (e.g., permitting uses that comply with the law),
The principles also call for lenders to refrain from "taking
action that would cause a school employee to have a conflict of interest"
and say that the lenders "should not offer gifts, meals or tickets to
entertainment events" if it would "create the appearance of
impropriety on the part of the school employee". The principles use
the word "should" and not "must" and are not necessarily binding on
lenders.
The principles also
make reference to the
Guidelines for FFELP Industry Practices
which were endorsed by CBA, EFC and NCHELP in November 2004.
Those guidelines permit philanthropic activities so long as there is
no quid pro quo business relationship ("condictioned on the existence
of, or the expectation of, an FFEL business relationship between the
industry participant and the institution"), permit colleges to have a
single preferred FFEL lender, prohibit tying of private loan products to a
dollar amount or percentage of a college's FFEL loan volume or an
exclusive relationship, prohibit paying or offering referral or
marketing fees to colleges for FFELP loan applications, and permit
reimbursement of travel, lodging, meal and entertainment expenses
associated with service on a lender's advisory board provided that the
value is not "greater than what would be offered in a normal business setting".
The guidelines also
said that borrowers have the right to choose any lender. These
guidelines are not necessarily binding on lenders.
On May 25, 2007, the Consumer Bankers Association (CBA) issued an
Education Loan Customer Commitment
which is nonbinding on its members and weaker than the New York
Attorney General's code of conduct, albeit somewhat more specific than
the EFC/NCHELP "Student Loan Business Practices". It was prepared by
the Washington Partners LLC public relations firm.
Both documents say that lenders will "encourage" borrowers to borrow
no more than what they need, "fairly and accurately" disclose loan
terms and conditions (including whether the loan may be sold and how
the sale would affect borrower benefits and other terms of the loans),
and refrain from taking actions that cause school employees to have a
conflict of interest or the appearance of a conflict of interest. Both
encourage lenders to not give gifts or other benefits if "the value of
the item would create the appearance of a conflict".
The CBA document also encourages borrowers to maximize use of
scholarships and federal student aid before private student loans. It
encourages lenders to inform borrowers of their "right to choose a
student loan provider regardless of school preferred lender lists" and
to not identify themselves as school employees when
interacting with students, parents and borrowers. It continues an
emphasis on quid pro quo, stating that lenders should not give
"anything of value to a school, school employee or school affiliate or
provide private loan products in exchange for a commitment of any kind
relating to FFELP loans".
It adds that college
preferred lender lists should be based on "the best interests of
borrowers" and that the criteria used to create the lists "should be
fully disclosed".
Lender Actions
On June 1, 2007, the Chronicle of Higher Education reported that
three Student Loan Xpress executives had been fired: Michael Shaut
(CEO), Fabrizio "Breeze" Balestri (President) and Robert deRose (Vice
Chairman). All three had been placed on leave in April in connection
with the student loan conflict of interest scandal. CIT Group, the
parent company of Student Loan Xpress, had settled with the New York
Attorney General in early May, agreeing to pay $3 million to the
education fund. Four financial aid administrators who received stock
or payments from the company have been fired, retired or resigned. A
US Department of Education official who received stock remains on paid
leave.
New York Attorney General
New York Attorney General Andrew M. Cuomo has been conducting an
investigation into preferred lender lists and lender-school
relationships since late 2006. On March 15, 2007 the attorney general
sent a
letter to college presidents
that included a sample
Student Lending Brochure
and issued a
press release
concerning the investigation. The letter called for colleges to end or
fully disclose potential conflicts of interest in their relationships
with education lenders. The letter noted several problematic
practices, including:
On March 22, 2007, Attorney General Andrew Cuomo announced
a lawsuit against a private lender, Education Finance Partners (EFP),
alleging deceptive business practices, focusing on allegedly
inadequate disclosure of revenue sharing arrangements between EFP and
school partners. Education Finance Partners issued a
press release in response to
the attorney general's statement of intent to sue.
On April 2, 2007, Attorney General Andrew Cuomo announced
settlements
with several colleges who had received payments for loan
volume. The settlements require colleges to reimburse borrowers on a
pro-rata basis for the money the colleges received from the
lenders. The settlements also require the colleges to adhere to a
college code of conduct intended to prevent potential conflicts of interest.
(Citi also agreed to adopt the code of conduct and to donate $2
million to a national fund to educate students and parents about their
borrowing options.)
Key
aspects of the code of conduct include:
Generally, this code of conduct ensures that the advice colleges
provide to students and parents is based on the best interests of the
students and parents and not on the college's financial self-interest.
It also prohibits certain practices (e.g., revenue sharing,
opportunity pools) even when the colleges use the proceeds for student
aid, partly because of the potential conflict of interest, partly
because of inadequate disclosure to borrowers, and partly because the
benefit was not accruing to the borrowers whose loans enabled the benefit.
All colleges should review the code of conduct and consider whether to
adopt some or all of the provisions, especially the disclosure rules,
as best practices.
On April 11, 2007, the New York Attorney General announced a
settlement with Sallie Mae,
where Sallie Mae agreed to contribute $2 million to a national fund for
educating high school seniors about their loan options. This is the
same amount as Citi had previously agreed to pay to the fund in
its settlement with the attorney general. Sallie Mae
also agreed to
adhere to a student loan code of conduct
and to:
On April 16, 2007, the New York Attorney General announced a
settlement with Education Finance Partners,
in which Education Finance Partners agreed to adhere to the student
loan code of conduct, to review existing revenue sharing agreements
with colleges and to not enter into any new revenue sharing
agreements,
and to contribute $2.5 million to the education fund. The attorney
general also expanded the ongoing investigation to include 13 more
education lenders.
On April 19, 2007, the New York Attorney General announced settlements
with several more colleges and a
threatened lawsuit against Drexel University
for an alleged revenue sharing agreement with Education Finance Partners.
On April 20, 2007, the Nebraska Attorney General announced a
settlement with Nelnet Inc., an education lender. Nelnet agreed to pay
$1 million to an education fund and to adhere to a
code of conduct
similar to the one established by the New York Attorney General. It
prohibits revenue sharing, opportunity loans,
gifts and trips to higher education employees, and paid advisory board
service. In some regards it is stronger than the New York Attorney
General's code of conduct. For example, Nelnet also agreed to provide borrowers with the better of
the direct-to-consumer channel or school channel rates regardless of
how the prospective borrower reached Nelnet. Nelnet also supports
requiring a minimum of three lenders on preferred lender lists, at
least two of which are unaffiliated. In other ways it is weaker. For
example, the restriction on paid service on advisory boards is limited
to financial aid administrators who are involved with student
lending. The prohibition on staffing financial aid offices merely
requires proper disclosure and transparency. Nelnet agreed to adopt
this code of conduct nationally by August 15, 2007.
On April 25, 2007, the New York Attorney General announced
settlements with Bank of America and JP Morgan Chase,
where both lenders agreed to adopt the attorney general's code of conduct.
Johns Hopkins University announced that it was adopting
the Code of Conduct and that it was dropping all preferred lender
lists. The University of Texas system had also previously dropped all
preferred lender lists.
On April 30, 2007, the New York Attorney General announced
settlments with six more colleges
and on May 3, 2007
with another college.
On May 3, 2007, the New York Attorney General announced that he was
expanding his probe to include the relationships between
education lenders and college alumni associations.
Some lenders had entered into arrangements with college alumni
associations to pay the colleges to market consolidation loans to
their alumni. These deals involved the rights to use the college's
name and logo, a flat annual payment, plus a payment per
funded consolidation loan.
On May 10, 2007, the New York Attorney General announced
a settlement with CIT Group Inc.
CIT Group is the parent company of Student Loan Xpress. CIT Group
agreed to contribute $3 million to the education fund and to adopt the
code of conduct. CIT Group has agreed to assist the New York Attorney
General in his ongoing investigation. The agreement with CIT Group
does not prevent the attorney general from taking action against
current and former Student Loan Xpress employees.
On May 15, 2007,
two more colleges settled with the
New York Attorney General, including Drexel University. Drexel
University had previously said that it would defend itself against the
attorney general's threatened lawsuit. Both colleges agreed to adopt
the attorney general's code of conduct. Drexel also agreement to
refund approximately $250,000 in revenue share fees to borrowers.
On May 24, 2007, the New York Attorney General launched his education
initiative and presented a Student Bill of Rights and Smart Tip
Sheets. The Student Bill of Rights includes the following nine rights:
On May 29, 2007, the New York Attorney General announced an agreement with
Wells Fargo, an education lender. Wells Fargo has agreed to adopt
the attorney general's code of conduct.
On May 31, 2007, the New York Attorney General announced
an agreement with Columbia University
in which the college agreed to pay $1.125 million to the education
fund, to adopt the college code of conduct, and to submit to
oversight by the office of the New York Attorney
General. Columbia University agreed to centralize its financial aid
operations, implement more robust conflict of interest screening for
financial aid office employees, submit preferred lender lists to
committee review and review by the office of the university president,
and issue an annual report for the next five years concerning student
loan policies and violations of the college code of conduct.
Columbia University had previously fired
its director of financial aid.
The attorney general also announced
an agreement with NASFAA.
On June 14, 2007, the New York Attorney General announced
an agreement with
Johns Hopkins University
in which the college agreed to pay $1.125 million to education
funds set up by the New York and Maryland attorneys general ($562,500
to each), to adopt the college code of conduct, and to submit to
oversight by the office of the New York and Maryland Attorneys
General. The university also agreed to centralize oversight of its
financial aid offices, require annual conflict of interest disclosures
by college financial aid administrators and annual conflict of
interest training, submit preferred lender lists to
committee review and review by the office of the university president,
and issue an annual report for the next five years concerning student
loan policies and violations of the college code of conduct.
The code of conduct includes a new provision explicitly prohibiting
the college financial aid administrators from owning stock or holding
other financial interests in an education lender, although ownership
through publicly traded mutual funds is ok.
On June 20, 2007, the New York Attorney General announced agreements
with National City Bank, Regions Financial Corporation, and Wachovia
Education Finance. All have agreed to adopt the code of conduct.
On July 20, 2007, the New York Attorney General announced an agreement
with
College Loan Corporation (CLC),
where CLC agreed to contribute $500,000 to the national education fund
and to adopt the code of conduct. The attorney general alleged that
CLC had used school exit and entrance loan counseling sessions to
market their loan products, among other activities. The settlement
includes a few interesting provisions, including an agreement to
disclose to colleges, upon request, the interest rates charged to
borrowers and the number of borrowers obtaining each rate during the
previous year as well as default rate information. It also includes
the usual prohibition on gifts, paid advisory board service and
opportunity loans, and the requirement to ensure persistence of
repayment benefits. CLC's code of conduct
emphasizes that it did not participate in some of the more eggregious
practices by using language like "has not and will not", such as
revenue sharing agreements and opportunity loan pools, but otherwise
reflects the settlement with the New York Attorney General.
On July 18, 2007, Nelnet published a summary of findings to date with
regard to an
ongoing review of its marketing practices,
announcing, among other measures, that it was
terminating its referral fee relationship with approximately 120
college and university alumni associations.
On July 31, 2007, the New York Attorney General announced an agreement
with Nelnet
in which Nelnet agreed to contribute $2 million to the national
education fund and to adopt the code of conduct. Nelnet also agreed to
stop paying alumni associations for loan referrals. This settlement is
in addition to the $1 million settlement with the Nebraska Attorney
General. However, the New York Times
reported on August 1, 2007 that Nebraska Attorney General Jon Bruning
has decided to forgive Nelnet's $1 million settlement with Nebraska in
light of the $2 million settlement with New York.
Higher Ed Watch
criticized this lender forgiveness, noting campaign contributions from
Nelnet to the Nebraska Attorney General. This may represent a
violation
of the
Nebraska Rules of Professional Conduct.
On August 10, 2007, Nebraska Attorney General Jon Bruning announced
that Nelnet has agreed to pay the original $1 million settlement after
all.
The Associated Press reported that the Attorney General approached
Nelnet about reinstating the settlement in order to avoid creating the
"perception of a conflict of interest".
On August 1, 2007, the New York Attorney General announced that he was
expanding his investigation to include
deals between education lenders and college athletic departments.
As part of the expanded investigation, the attorney general served
subpoenas and document requests on
Student Financial Services (dba University Financial Services)
and 40 colleges
concerning the relationships between the lender
and the college athletic departments.
On October 11, 2007, the New York Attorney General announced that he
was expanding his investigation to include
direct
marketing companies, issuing subpoenas to 33 marketers and
lenders. Some of the practices under investigation include:
It is worth noting that the settlement agreement criticizes the use of
phrases such as "save money" to imply that consolidating loans
decreases the cost of the loans. While using extended repayment may
decrease the size of the monthly payment, it does not save money. For
example, increasing the loan term on a
Stafford loan from 10 years to 20 years may reduce the size of the
monthly payment by 34%, it does so at a cost of increasing the total
interest paid over the life of the loan by a factor of 2.18. So rather
than saving money, consolidating with extended repayment costs money.
(Borrowers with variable rate loans can potentially save money by
using consolidation to lock in the current interest rate on their
loans. Consolidating fixed rate loans, on the other hand, generally
does not save any money except for when PLUS loans are consolidated by themselves.)
The settlement defines "clear and conspicuous" as follows:
The statement, representation or term being disclosed is of such size,
color, contrast and/or audibility and is so presented as to be readily
noticed and understood by the person to whom it is being disclosed. If
such statement is necessary as a modification, explanation or
clarification to other information with which it is presented, it must
be presented in close proximity to the information it modifies, in a
manner so as to be readily noticed and understood. In addition to the
foregoing, in interactive media, the disclosure shall also be
unavoidable (i.e., no click-through required to access it), and shall
be presented prior to the consumer incurring any financial obligation.
Also on December 11, 2007, the New York Attorney General released a
Direct Marketing Code of Conduct.
The new code of conduct bans a variety of direct marketing tactics,
including:
On September 4, 2008, the New York Times reported
that the New York attorney general was preparing a lawsuit against
Goal Financial, alleging violations of federal and state laws. The
allegations include providing borrowers with gifts as an inducement to
apply for federal loans and "incentives for students who persuaded
their classmates to apply". The article also discusses misleading
advertising about the comparison of private student loans with federal
loans and about allegedly inadequate disclosures concerning
eStudentLoan.com, a Goal Financial subsidiary. The
newspaper also reported that the New York attorney general is nearing
settlements with about a dozen loan companies about appropriate
marketing methods.
On September 9, 2008, the New York Attorney General
announced
a $1.4 million dollar combined settlement with seven
direct-to-consumer (DTC) education lenders concerning their marketing
practices. The lenders were identified as Campus Door, EduCap, GMAC
Bank, Graduate Loan Associates, Nelnet, NextStudent and Xanthus
Financial Services. The lenders are adopting a code of conduct that
bans a variety of marketing practices, such as using logos or seals
that look like federal emblems, providing incentives to induce
students to borrow from the lender (e.g., gift cards, iPods, prizes
and sweepstakes), providing false rebate checks, paying students
referral fees to encourage friends to borrow, advertising interest
rates and discounts that few borrowers will realize (including using
such rates and loan terms in repayment examples and examples
illustrating loan costs), misrepresenting the advantages of private
loans over federal loans. The new code of conduct requires the
lenders and marketers to encourage families to exhaust federal
borrowing options before turning to private student loans. An eighth
lender, MyRichUncle, agreed to adopt the code of conduct
voluntarily. MyRichUncle was not a target of the New York Attorney
General's investigation and was not involved in the financial
settlement.
On November 2, 2008, the
New York Times
reported that the New York
Attorney General reached a $350,000 settlement with Goal
Financial. Goal Financial also agreed to adopt a code of conduct
regarding its marketing practices.
Other State Attorneys General
The Attorney Generals in several other states, including
Arizona,
California,
Connecticut,
Florida,
Illinois,
Kansas,
Maryland,
Massachusetts,
Michigan,
Minnesota,
Missouri,
New Jersey,
Ohio
and
Tennessee
have also opened investigations into school-lender relationships.
On June 19, 2007, a total of 32 state attorneys general sent a
joint
letter to the US Senate urging passage of the Student Loan Sunshine Act.
On June 20, 2007, the Missouri Attorney General announced that
eleven
public and private colleges in Missouri have agreed to a code of
conduct. Another school had previously agreed to the code of conduct in
April. The code of conduct is similar to the one promulgated by the
New York Attorney General, prohibiting revenue sharing, gifts and paid
advisory board service, and requiring
preferred lender list disclosures. One novel feature is a requirement that
lenders must agree to a code of conduct in order to appear on the
college's preferred lender lists.
On August 27, 2007, the Connecticut Attorney General
announced a settlement with the
Connecticut Conference of Independent Colleges (CCIC)
and the Connecticut State University System
concerning student loan conflicts of interest. All schools agreed to a
code of conduct. The attorney general
also reached financial settlements with three colleges that had placed the
College Board on their preferred lender lists in exchange for
discounts on financial aid software and services (e.g., Financial Aid
Strategy Tool, Institutional Documentation Service, Descriptor PLUS
Geodemographic Data Service, Student Search Service and PowerFAIDS).
Such activities would be a violation of previous US Department of
Education guidance which explicitly
cites providing software at below market cost as a prohibited inducement.
(The College Board announced on August 22, 2007 that it was exiting
the student loan business.)
On September 4, 2007, the New Jersey Attorney General issued a
code of conduct for
state colleges and universities. It bans revenue sharing, printing
costs or services, and computer hardware at below market price. It
also bans student loan disbursement software unless that software can handle
disbursements from all education lenders. It bans remuneration (more
than a nominal amount) from
lenders to any college employee, including a ban on payment or
reimbursement of lodging, meals and travel to conferences and training
seminars and a ban on paid advisory board service. It requires
preferred lender lists to contain at least three unaffiliated
lenders and to be updated at least annually. Preferred lender lists
must also disclose forward purchase agreements and must require
lenders to give assurances that advertised loan discounts will
continue even if the loans are sold. It bans lender staffing and
opportunity loans. Overall, the code of conduct seems like a blend of
the New York code of conduct with the pending regulations from the US
Department of Education.
On September 6, 2007, the Maryland Attorney General issued a
press release
announcing that all of Maryland's public and private colleges had
agreed to adopt a College Loan Code of Conduct.
The code of conduct bans revenue sharing, payment for appearance on a
college's preferred lender lists, gifts and trips for college
employees in connection with their financial aid work, and paid advisory
board service.
Preferred lender lists must be based solely on the borrower's best
interest, must disclose the criteria and process used to select
lenders for the list, and must inform borrowers that they can choose
any lender (not just those on the list). Lenders included on a
preferred lender list must disclose forward purchase agreements and
other agreements to sell the loans to another lender. Lender employees
and agents are banned from identifying themselves as college
employees.
On December 5, 2007, the Florida Attorney General issued a
press release
announcing a proposed
code of conduct
which was subsequently adopted on December 6, 2007
by the Florida Board of Governors of the State University System for
implementation at all Florida public colleges and universities. It
bans college employees from receiving gifts of more than nominal value
from lenders, including cash, stock, entertainment, travel, lodging
and meals. It also bans paid lender advisory board service. It bans
lender staffing of financial aid offices, revenue-sharing agreements with
lenders, opportunity loans, lender-paid printing costs, computer
hardware and software, and lender use of the school's name, logo and
mascot. It also mandates certain disclosures with regard
to preferred lender lists. However, the code of conduct includes
numerous loopholes, making it much weaker overall than the New York
Attorney General's code of conduct or the final regulations published
by the US Department of Education on November 1, 2007. (The only areas
in which it is stricter involve restricting board membership to
tax-exempt organizations and some aspects that apply to all college
employees and not just financial aid administrators.) Some of the
loopholes include:
On February 14, 2008, New Jersey Attorney General Anne Milgram
announced a settlement with the
New Jersey Higher Education Student Assistance Authority (HESAA)
in which HESAA has agreed to adopt a code of conduct. The agreement
also requires a state-appointed independent monitor to ensure HESAA's
compliance for one year.
41 public and private colleges in the state also agreed to adopt a
code of conduct. The attorney general launched its probe into HESAA
after newspaper reports revealed a seven-year $2.2 million marketing
and services agreement between HESAA and Sallie Mae. The contract,
which involved a fee paid based on loan volume (i.e., revenue sharing), was
cancelled in April 2007. HESAA has agreed to use the remaining revenue
from the agreement only for the direct benefit of student lona
borrowers (e.g., reducing interest rates or default fees, providing
scholarships, providing loan forgiveness).
The code of conduct bans HESAA from accepting anything of value from a
lender in exchange for providing the lender with any advantage that
may prejudice actual or potential borrowers or other lenders. It also
bans revenue sharing (with lenders or colleges), providing gifts to
any college or college employee, paying college employees for advisory
board service (including the reimbursement of expenses except as
permitted by New Jersey law), providing staff support to colleges
(except for "occasional, short-term exigent basis", in which case the
NESAA staff should be fully and conspicuously identified as a HESAA
employee). Any HESAA staff support is prohibited from a variety of
activities including the awarding, packaging and disbursing of
financial aid, verification, certifying loans or participating in the
selection of preferred lenders. It bans HESAA from providing benefits
to one college and not to all colleges in the state. It also requires HESAA to
maintain certain disclosures on its web site in connection with its
lists of lenders for which HESAA provides a guarantee. The code of
conduct also requires HESAA to adopt a best practices manual and to
appoint a chief compliance officer.
On June 19, 2008, Nevada attorney general Catherine Cortez Masto
announced
that the Nevada System of Higher Education adopted the Nevada Student Loan
Code of Conduct.
Financial Settlements
These settlement figures include amounts refunded to borrowers.
State Legislatures On April 16, 2007, the New York Attorney General also announced a legislative initiative to encode the code of conduct into New York law. The Student Lending Accountability, Transparency and Enforcement (SLATE) Act of 2007 (S.4524, A.7950) will apply to all New York colleges. It passed the New York State Senate on April 25, 2007 and the Assembly on May 7, 2007. It was signed into law by Governor Spitzer on May 30, 2007. The law goes into effect in 180 days (November 26, 2007). The New York legislation bans gifts from education lenders and guarantee agencies to colleges and their employees, revenue sharing, paid advisory board service, lender staffing of financial aid offices, opportunity pools (in exchange for "concessions or promises to the lending institution that may prejudice other borrowers or potential borrowers"), and online promissory notes and loan agreements that prefill the lender name/code in an uneditable fashion. The term "gift" includes anything of more than nominal value, including money, loans, stock, discounts, entertainment, hospitality, meals, lodging, registration fees and travel expenses. It also includes printing costs or services and below-market cost computer hardware. It excludes loan brochures and promotional literature, and also excludes food and informational material as part of a professional development training session. The New York law also sets standards for preferred lender lists, requiring disclosure of the criteria used create the list (and the relative importance of the criteria) and disclosure that borrowers may choose any lender including those not recommended by the school without penalty. The inclusion of a lender in the preferred lender list and the order in which lenders appear on the list must be based solely on the best interests of the borrowers without regard to the pecuniary interests of the college. Colleges are also required to disclose the availability of federal education loans and their terms before providing a private education loan to a borrower. The college must review and update the preferred lender list at least annually. Lenders must provide assurance that the advertised benefits will continue to be provided to the borrower regardless of whether the lender's loans are sold. If a lender has an agreement to sell its loans to another lender, this must be disclosed in the preferred lender list. Lenders cannot trade off improved benefits on one loan for more favorable placement in the preferred lender list for another loan. In addition, colleges may not direct prospective borrowers to promissory notes or loan agreements that restrict the borrower's choice of lender. Private education lenders must disclose to each college the various rates of interest charged to borrowers at the college during the previous year and the number of borrowers obtaining each rate of interest. Financial aid administrators are required to disclose all financial interests related to any education lender. The law establishes civil penalties of up to $50,000 per college or lender and up to $7,500 per employee. Other states that are considering similar legislation include Texas and Massachusetts. State Loan Agencies The Pennsylvania Higher Education Assistance Agency (PHEAA) announced on April 20, 2007 that it was adopting a code of ethics for its lending practices that is similar to the New York Attorney General's code of ethics. It prohibits revenue sharing, gifts and trips to college financial aid administrators and officials, and paid advisory board service. PHEAA was not a target of the New York probe, but had been subject to recent criticism over lavish spending on board members and employees, resulting in a new travel and expense reimbursement policy for the state agency. On May 7, 2007, the Rhode Island Student Loan Authority (RISLA) voted to terminate a contract with Nelnet, an education lender, to operate RISLA's College Planning Center. The change was intended to avoid "the appearance of impropriety" after articles concerning the arrangement appeared in the Chronicle of Higher Education and national media. The board also adopted a code of ethics and voted to have the director of the College Planning Center report directly to the board instead of to RISLA. The concern is that the College Planning Center might otherwise have a financial incentive to direct borrowers to RISLA loans, to Nelnet's private student loans or to increase borrowing. The board took these steps to ensure that the College Planning Center is an objective source of advice to Rhode Island students. The board also added a set of questions to ask about preferred lender lists to its web site. On October 2, 2007, RISLA announced that it had ended all ties with Nelnet effective September 27, 2007. Nelnet had previously paid $8 million for the rights to RISLA Stafford loans over a ten-year period. RISLA returned $4.1 million to Nelnet and terminated the contract six years early. RISLA will now again offer its own federal education loans. On May 15, 2007, the Iowa Student Loan Liquidity Corporation decided to stop reimbursing colleges for their out-of-pocket expenses for administering their loans. These payments were seen as equivalent to revenue sharing agreements criticized by the New York attorney general, presenting the colleges with a conflict of interest. US Department of Education Higher Education Watch, a blog by the New America Foundation (a public policy institute), reported on April 5, 2007 that Matteo Fontana, the US Department of Education official in charge of the NSLDS database and the financial partners program, had held more than $100,000 in stock in an education lender. Mr. Fontana was put on paid leave pending internal investigations by the inspector general and the office of the general counsel at the US Department of Education. On April 18, 2007, the US Department of Education temporarily suspended lender access to the National Student Loan Data System (NSLDS) for a security audit and to implement improved security measures. A key concern was whether lenders may have been trolling the database for prospective borrowers. The suspension of access to NSLDS prevents lenders from consolidating loans, since lenders use NSLDS to confirm borrower payoff totals. On April 27, 2007, the Department announced that it was restoring access for guarantee agencies and would phase-in restoration of access to other lenders. The new security measures include a display of distorted lenders and numbers, intended to distinguish human access to the site from machine access. On May 9, 2007, the US Department of Education announced that Theresa S. Shaw was resigning as chief operating office of the Office of Federal Student Aid at the US Department of Education effective June 1. The Department said that Ms. Shaw had been planning on leaving "to pursue other career opportunities" since February, and that her departure was unrelated to the student loan conflict of interest scandal. Critics of the Department, including New York Attorney General Andrew Cuomo and Michael Dannenberg of the New America Foundation, point to lax enforcement by the Department of the prohibited inducement rules as contributing to the current student loan scandal. The Department has also had a pattern of rulings favorable to the industry and individual lenders, including Sallie Mae. Ms. Shaw had previously worked for Sallie Mae for almost 20 years before her five-year stint at the US Department of Education.
US Department of Education Regulations
In March 2007 the US Department of Education released new proposed regulatory
language as part of negotiated rulemaking on
prohibited inducements and
preferred lender
lists. These draft regulations would enhance borrower protections,
including:
To a large extent these draft regulations would encode existing
guidance from Dear Colleague Letters
DCL-95-G-278 (DCL-95-L-178)
and especially DCL 89-L-129
concerning acceptable and unacceptable practices.
The statutory basis for the authority to regulate preferred lender
lists derives from section 432(a)(1) of the Higher Education Act,
which grants the US Department of Education the authority to
"establish minimum standards with respect to sound management
and accountability of programs under this part" and section 432(a)(3),
which grants authority to modify loan insurance contracts "if
necessary to protect the United States from the risk of unreasonable loss".
A revised version of these proposed regulations
was provided to the Federal Register on May 31, 2007 and published
June 12, 2007 (Federal Register 72(112):32410-32447, June 12, 2007). A 60 day
public comment period will follow publication. It is unclear when
these regulations will become effective, but the most likely date is
July 1, 2008. The Secretary of the US Department of Education does
have the option of implementing an earlier effective date for the
rules concerning prohibited inducements and preferred lender
lists. (The master calendar provisions in section 482(c) of the Higher
Education Act would require implementation on
or after July 1, 2008. Any earlier implementation of the regulations
would have to be voluntary. However, the US Department of Education
could potentially enforce earlier implementation under section
432(a)(3) of the Higher Education Act on the grounds that it is
"necessary to protect the United States from the risk of unreasonable loss". )
Discussion of the proposed regulations for prohibited inducements
appears on pages 60-85 and 139-141
and discussion of the rules for preferred lender lists appear on pages
92-103 and 137-139.
The need for regulatory action is discussed on pages 107-110. The
actual regulations for prohibited inducements appear on pages 164-170
(34 CFR 682.200(b)(1)(5) as part of the definition of eligible
lender) and pages 181-187 (34 CFR 682.401(e) for guaratee agencies).
The regulations for preferred lender lists appear on pages 177-179 (34
CFR 682.212(h)) and pages 206-207 (34 CFR 682.603(f) loan certification).
The regulations are given teeth on page 197 (34 CFR 682.406(d)
insurance claim payments on federal loans), page 199 (34 CFR 682.413 remedial
actions), pages 210-211 (34 CFR 682.705 suspension proceedings) and
page 211 (34 CFR 682.706 limitation or termination proceedings)
The major changes from the previous draft include:
The proposed regulations clarify that the safe harbor for providing
the same kind of assistance as provided by Direct Lending is limited
to the list of activities previously published in the Federal Register
in the
Notice of Proposed Rulemaking on August 10, 1999 (64 FR 43428, 43429-43430).
The examples include counseling (exit and entrance counseling and
general debt counseling, online counseling tools), outreach, computer
support (software, technical support and training related to
administration of student loans, but not hardware), and training
related to student loans. Note that the language emphasized that the
lender's participation in counseling activities must "reinforce the
student's right to choose a lender" and that the lender "may not pay
expenses incurred by school staff for the training".
The new regulations are a bit confusing with regard to provision of
meals and transportation. In the definition of "eligible lender"
at 34 CFR 682.200(b)(5)(i)(A)(7) the regulations prohibit entertainment
expenses which are defined to include meals and transportation.
(iv) Meals, refreshments and receptions that are scheduled in
conjunction with training, meeting, or conference events if those
meals, refreshments, or receptions are open to all training, meeting,
or conference attendees;
(iv) Travel and lodging costs that are reasonable as to cost,
location, and duration to facilitate the attendance of school staff in
training or service facility tours that they would otherwise not be
able to undertake, or to participate in the activities of an agency's
governing board, a standing official advisory committee, or in support
of other official activities of the agency;
At the Federal Update session at the NASFAA National Conference on
July 9, 2007, Jeff Baker clarified that forward purchase agreements
would be treated as an affiliate relationship with regard to the three
lender minimum. This means that preferred lender lists must include at
least three lenders who are not affiliated with each other by any
means including ownership, control or forward purchase agreement.
On August 9, 2007,
Secretary Margaret Spellings
issued a letter to colleges and lenders noting that the
final regulations
will not take effect until July 1, 2008, but asking them to
immediately adopt the regulations on a voluntarily basis.
On November 1, 2007,
the
final regulations were published in the
Federal Register 72(211):61959-62011. As noted previously, the
regulations are effective July 1, 2008, but the Department encourages
schools and lenders to adopt them sooner. The regulations clarify that
where there is a conflict between the federal regulations and state
law, the federal regulations will prevail. However, where state law
does not conflict with the federal regulations it may continue to
apply. In other words, the federal regulations as a whole are not a
substitute for state law, but rather only supersede state law where
there is a specific conflict. The new regulations do
not supplant the New York SLATE legislation.
The major changes to the regulations
concerning prohibited inducements and preferred lender lists include:
On May 9, 2008, the US Department of Education issued
Dear Colleague Letter GEN-08-06
to relax and clarify the requirement that the preferred lender list include at
least three lenders in certain situations, in light of the recent
turmoil in the student loan marketplace.
Congress
On March 21, 2007, Senator Edward M. Kennedy sent a
letter to sixteen education lenders
requesting information on their financial dealings with colleges and
universities. Senator Kennedy is chairman of the Senate Committee on
Health, Education, Labor and Pensions.
Senator Kennedy introduced the
Student Loan Sunshine Act (S.486)
on February 1, 2007
to mandate annual lender and college disclosures in connection with
preferred lender lists and in connection with private education loan
arrangements, to impose restrictions on preferred lender lists, and to
ban gifts from lenders to college employees.
On June 14, 2007 Senator Kennedy released a preliminary 50-page
report,
Report on Marketing Practices in the Federal Family Education Loan Program,
on the results of his investigation into inappropriate marketing
practices in the student loan industry. See also the
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