SEC says for-profit ITT college executives engaged in fraud

The U.S. Securities and Exchange Commission levied fraud allegations Tuesday against a major for-profit college company, accusing ITT Educational Services Inc. of hiding the “extraordinary failure” of two student loan programs from investors.

When the high-risk loan programs collapsed under the weight of mass defaults, ITT executives engaged in “a series of deceptive acts” to hide the losses, according to the SEC. The company had guaranteed the loans for private lenders, leaving investors on the hook for tens of millions of dollars in bad debt.

ITT employed accounting tricks to hide the losses, in some cases making small payments for student borrowers — temporarily delaying defaults, but masking the company’s ballooning obligations, according to the SEC complaint. In one example cited in October 2012, ITT paid $2.4 million on delinquent student loans to avoid having to pay $30 million if those loans defaulted.

The SEC complaint is the latest in a string of scandals in the for-profit college industry, which has struggled with declining student enrollment and heightened regulation. Last week, Santa Ana-based Corinthian Colleges Inc. filed for bankruptcy protection after closing more than two dozen of its remaining campuses, following a U.S. Department of Education crackdown involving allegations of bogus job placement rates.

Two other for-profit college giants, Education Management Corp. and Career Education Corp., also announced a series of school closures last week.

Although for-profit colleges have faced intense government scrutiny for more than five years, with federal and state investigators probing misleading sales tactics and poor student performance, the last year has been especially tumultuous. Experts and industry analysts said a variety of factors — growing consumer awareness, more regulations and an improving job market — have forced a reckoning for some of the largest players.

“The bad actors are essentially getting weeded out,” said Michael Tarkan, a research analyst and senior vice president with Compass Point who follows the industry.

For publicly traded companies in particular, the pressure to satisfy Wall Street led some in the industry to enroll as many students as possible — without regard for their academic potential or ability to repay debts.

“You have a motivation to drive growth and profitability for your shareholders,” Tarkan said. “That can lead you down a path that may not be the best path for students.”

The ITT case centers on two private student lending programs that the company set up in 2009 and 2010 to comply with federal regulations. ITT, like many for-profit colleges, relies heavily on federal student aid because such schools tend to enroll many low-income students.

But federal regulations require for-profit schools to earn at least 10% of revenue from non-federal money. ITT struggled to come up with the required 10% of private money during the Great Recession, according to the SEC’s case, so it set up two private funds to generate the needed cash for students.

When the loan programs went south, ITT understated the total amount owed in presentations to investors, according to the complaint, leading analysts to believe that the company was in much stronger financial shape.

By 2014, however, the program started to unravel as ITT began to disclose more to anxious investors. Last fall, the company restated much of its 2013 earnings to reflect its true exposure to the private loan defaults. One of those amended reports disclosed that the company would have to pay $159 million to the private lenders in 2014 — representing 77% of the company’s available cash, according to the complaint.

Since January 2014, the company’s stock price has plunged nearly 95%, from more than $45 to $2.27, where it closed Tuesday.

In a statement, ITT said it was “deeply disappointed” with the SEC’s “mistaken” decision to bring the case. The company said it had conferred with outside experts on the accounting issues to ensure that its methods were “reasonable and appropriate.”

ITT operates more than 130 campuses under the ITT Technical Institute and Daniel Webster College brands. Fifteen of those are in California, including eight in the Southland.

The U.S. Consumer Financial Protection Bureau sued ITT last year over problems involving the same private lending programs, alleging that the company paid incentives to financial aid employees based on how many students they could steer into the loans.

Corinthian Colleges had created a similar private lending program, which was also the subject of a Consumer Financial Protection Bureau lawsuit last year.

David Bergeron, a former assistant secretary at the Education Department who crafted some of the for-profit college regulations, said private loan programs such as the ones created by ITT and Corinthian were destined to fail because the schools had such high price tags.

“We’ve learned that this was a disastrous strategy,” said Bergeron, now a vice president at the left-leaning Center for American Progress in Washington. “In the short run it created the appearance that other money was coming into the institution, but it wasn’t a sustainable model. It harms students, it harms the institutions, it harms the shareholders.”

Although the for-profit college industry saw its boom years during the recession, Bergeron said the improving economy will continue to work against the industry over the next few years.

“The for-profits who fed off the bottom of the economic cycle are now paying the consequences of that business model,” he said.

Other advocates urged the Education Department to protect students who are still eligible to enroll at ITT.

“We give the government such powerful tools to protect investors,” said Pauline Abernathy, vice president of the Institute for College Access & Success, “but the government should have similarly strong tools to protect students.”

Twitter: @c_kirkham