THE FINAL GAINFUL EMPLOYMENT REGULATION: A PRELIMINARY ANALYSIS

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1 THE FINAL GAINFUL EMPLOYMENT REGULATION: A PRELIMINARY ANALYSIS By Dennis M. Cariello, David P. Lewis, Patricia V. Edelson, Jacob Frumkin and Allison L. Kierman The Department of Education has at last provided public access to its final gainful employment regulation. The GE Rule, which will likely be published on or about June 13, 2011 and becomes effective on July 1, 2012, has been over two years in the making. Originally part of the Program Integrity regulatory package, the GE Rule seeks to define the phrase gainful employment in an effort to provide a federally mandated return on investment for students attending institutions subject to the rule, or alternatively, ensure that students are making payments on their student loans at a sufficient rate. As was the case when the Department published a Notice of Proposed Rulemaking (NPRM) on July 26, 2010 about this rule (referred to herein as the Draft Version), opinions about the impact of a regulation with the size (over 430 pages) and scope of the GE Rule are likely to change as those subject to the GE Rule begin to work with it and better data becomes available. Thus, this analysis is subject to future revision. A quick summary of the GE Rule Under the GE Rule, as with the Draft Version, the Department will examine, on a program-byprogram basis for each institution: (i) the percentage of federal loans (by dollar volume) experiencing repayments for persons who attended a given program (Repayment Rate) and (ii) the annual ratio of loan payment to income experienced by graduates of a program (Debt Burden). 1 Relative to the Draft Version, there are a number of positive changes in the GE Rule: The GE Rule is simpler than the Draft Version. Programs may achieve compliance by meeting one of three standards, rather than needing to comply with multiple measures. There are multiple opportunities for remediation. Programs that fail the GE Rule must fail to achieve compliance with any of the three standards in three out of four consecutive years to lose Title IV eligibility and may not lose Title IV eligibility until The standards are less stringent than originally proposed. The GE Rule utilizes a 35 percent repayment rate, a 12 percent debt to income ratio and a 30 percent debt to discretionary income ratio, each of which was the least stringent of the standards proposed in the Draft Version. The Repayment Rate standard has been liberalized. The definition of repayment now includes repayments of principal and interest. The GE Rule also looks at repayments occurring only in the third and fourth year after leaving the institution, rather than the first four years, thus giving students more time to find employment. The Debt Burden standard has also been liberalized. The Debt Burden excludes debt incurred by students that exceeds institutional charges. The formula also amortizes debt over a 15-year period for bachelor s and master s programs and over 20 years for 1

2 doctoral and first-professional degree programs. In addition, the Debt Burden is generally measured during the third and fourth year after graduation. There are, however, a number of concerns: The GE Rule is still complicated. The released version of the GE Rule encompasses 438 pages of new rules and explanatory text, and despite efforts at simplification is still complex and confusing. The GE Rule influences institutions to act as underwriters. In general, an institution s repayment rate performance may be adversely affected if it admits a student who has previously defaulted on a student loan. This effectively creates underwriting criteria for student loans. While this may benefit taxpayers at some level, it may preclude some students from having access to programs that will permit necessary career shifts and force such students into longer-term programs not subject to the GE Rule. After a transition, the Department will use actual income data. While the Department is allowing otherwise failing programs to utilize salary data from the Bureau of Labor Statistics to calculate the debt burden from 2012 to 2014, the Department will use Social Security Administration actual salary data after The data needed to assess compliance may not be readily available to institutions. While utilizing actual earnings data poses an obvious data collection problem, additional needed data may be difficult to access as well. In addition, it remains to be seen if the Department has designed a method to accurately account for programmatic debt, especially in the case of consolidation loans and debt incurred at multiple institutions. The impact of the GE Rule on a given institution is difficult to assess. We expect many issues to arise during the transition period that expose unintended consequences. More Departmental guidance is needed. There are a number of definitions and gaps in the formulas that will require further clarification from the Department. Predictably, there are unanswered questions about the rule and its effect: The impact of utilizing data only from years three and four of repayment is unclear. While this should positively impact those programs whose students take longer to become employed or reach their full income potential, it may exacerbate compliance issues associated with students who are likely to leave the workforce. The impact on bachelor s programs may vary. The 15-year amortization term for debt service of bachelor s program graduates increases the potential that such programs will achieve regulatory compliance. If the wage stratification that naturally occurs over time between holders of different degree levels within the same program manifests itself in years three and four after graduation, institutions may opt to offer higher-level degree programs. 2

3 SUMMARY OF CHANGES BETWEEN DRAFT VERSION AND FINAL RULE Metric Draft Version GE Rule (exceptions discussed below) Repayment Rate Repayment range: below 35% / 35%- 45% / 45% or above 35% Cohort Numerator Denominator Exclusions Level of detail Debt Burden Former attendees in repayment within the last four fiscal years (1) Loans paid in full (2) Loans subject to loan forgiveness, and (3) Loans for which principal has been repaid. Original outstanding principal balance (OOPB) of all federal loans to all students who entered repayment during past four years Loans on military and in-school deferment or discharged due to disability or death Programmatic Range below 8% of actual income/ 8-12% / above 12% Range - below 20% of discretionary income/ 20-30% / above 30% Generally, former attendees who are in their 3rd and 4th years of repayment (1) Loans paid in full (2) Loans subject to loan forgiveness* (3) Loans for which the borrower has reduced the outstanding balance on the loan during the fiscal year* (4) Loans in an interest-only or income-based repayment plan that receive scheduled payments equal to or less than the accrued interest during the fiscal year subject to 3% anti-abuse limit,* and (5) Loans from graduate programs that experience payments equal to or less than accrued interest in that fiscal year* * Loan may not have ever been in default OOPB of all federal loans to all students in their third and fourth years after entering repayment; provisions made for programs with less than 30 borrowers, medical/dental programs and, in the case of consolidation loans, limited to loans taken by the student for the program being tested Loans on military and in-school deferment or discharged due to disability or death; loans that have been in default are excluded from the numerator (including consolidation loans from previously defaulted loans) Programmatic 12% or below of actual income; 30% or below of discretionary income 3

4 Cohort Actual income Discretionary income Amortization period Interest rate Debt source Prior debt Exclusions Full compliance Penalties triggered Loss of eligibility Graduates within the first three years of completion or within the second three years (years 4-6) of completion Use mean actual average income data, as reported by SSA Mean actual income, minus 150% of the poverty rate 10 years The current annual interest rate for Federal Direct Unsubsidized Loans All federal, private and institutional loans drawn by the student Excluded except for prior institutional debt and debt at institutions under common control Parent PLUS Loans Meet both of the most stringent standards If the program failed either of the most stringent measures Immediately, if a program failed to meet the 35% repayment test AND the debt service test (actual income) and the 30% debt service test (discretionary income) Generally, graduates who are in their third and fourth years of repayment In , failing programs may use data from BLS to determine actual income (conditions apply); otherwise, non-failing programs and all programs after 2014 use the higher of the mean or median actual earnings data, as reported by SSA Income data, whether BLS (as above) or the higher of the mean or median actual income (for 2015 and thereafter), minus 150% of the poverty rate 10 years certificate and associate s degree 15 years bachelor s and master s degree 20 years doctoral and professional degree The current annual interest rate for Federal Direct Unsubsidized Loans ( %) All federal, private and institutional loans drawn by the student, but capped at institutional charges (living expenses excluded) Excluded except for prior institutional debt and debt at institutions under common control Parent PLUS Loans; loans on military and in-school deferment; or loans discharged due to disability or death Meet any of the three measures Program must fail all three measures Fail all three measures in three out of four years 4

5 Other penalties If failed to meet both of the highest standards, must issue a debt warning Fail all three measures in one year, must disclose program missed threshold Effective date Cap on ineligible programs If failed to meet both of the intermediate standards ( yellow zone ), face cap on enrollment. July 1, 2012, with programs subject to losing Title IV eligibility immediately Fail all three measures in two out of three years, must disclose that debts may be unaffordable, that the program may lose eligibility and offer possible transfer options July 1, 2012, with programs subject to losing eligibility only in 2015 after a three-year transition period 5% of lowest performing programs 5% of lowest performing programs in each sector (public, nonprofit and forprofit) THE STANDARD The Higher Education Act requires that, to be eligible to receive funds administered under Title IV of the HEA, a for-profit institution must, among other requirements, provide an eligible program of training to prepare students for gainful employment in a recognized profession. 2 The GE Rule is the Department s attempt to test whether a program 3 prepares students for gainful employment. Specifically, the Department will examine, on an aggregate basis for each institutional program: (i) the percentage of federal loans (by dollar volume) experiencing repayments for persons who attended a given program (Repayment Rate) and (ii) the annual ratio of loan payment to income experienced by graduates of a program (Debt Burden) 4 (collectively, the Repayment Rate and Debt Burden are Debt Measures). In contrast to the Draft Version, the Department has abandoned the matrix in which both standards are considered jointly, in favor of requiring programs to comply with one of three standards. In addition, the Department abandoned the sliding scale approach of the Draft Version complete with Fully Eligible Restricted and Ineligible designations in favor of one standard by which to measure compliance. Accordingly, the final GE Rule merely requires that a program meet any of the following standards: 1. Have former students exhibit a Repayment Rate of at least 35 percent 2. Impose a Debt Burden of not more than 12 percent of a typical graduate s actual income or 3. Impose a Debt Burden of not more than 30 percent of a typical graduate s discretionary income In this respect, while the GE Rule is still complicated, it is much simpler than the Draft Version. A programmatic analysis The GE Rule focuses on programmatic compliance as opposed to institutional compliance. A program is identified by the institution s OPEID number, the six-digit Classification of Industrial Program (CIP) code assigned to it by the institution and the credential level (certificate, associate s degree, bachelor s degree, master s degree, doctoral degree and first-professional 5

6 degree). Thus, a school could have separate programs within the same related discipline. The CIP code is created by the National Center for Education Statistics and, although assigned by the institution, the Secretary determines whether the institution assigned the proper CIP code. Presumably the Department will establish procedures for determining CIP codes and set the consequences, if any, for an improper initial assignment. Importantly, the program is viewed on an institutional basis. Consequently, if a school has multiple campuses that offer the same program (CIP code and degree level) within its six-digit OPEID number, all of those programs will be evaluated together. REPAYMENT RATE In considering the Repayment Rate, the Department considers the original outstanding principal balance, including capitalized interest (OOPB), on loans owed by students that attended a program as of the date those loans entered repayment. This would include loans of graduates who have entered repayment as well as any loans for students that have withdrawn from a program and triggered a repayment obligation. The full OOPB is then measured against the amount of the OOPB of both loans paid in full (LPF) and loans where qualifying payments are being made (Payments-Made Loans or PML). The formula is: Loans included in OOPB ((OOPB of LPF) + (OOPB of PML)) OOPB = Repayment Rate For purposes of determining OOPB, the Department will include Federal Family Education Loans (FFEL) and Federal Direct Loans from a program that first entered repayment within the Two-Year Period or the Four-Year Period. The two-year and four-year periods The Two-Year Period (2YP) covers the third and fourth fiscal years ( FY ) 5 prior to the most recently completed FY for which the Debt Measures are calculated. 6 For example, if the most recently completed FY is 2012, the 2YP is FYs 2008 and For a program whose students are required to complete a medical or dental internship or residency, as identified by an institution, a two-year period is the period covered by the sixth and seventh FYs (2YP-R) prior to the most recently completed FY for which the Debt Measures are calculated. For example, if the most recently completed FY is 2012, the 2YP-R is FYs 2005 and The Four-Year Period (4YP) covers the third, fourth, fifth and sixth FYs prior to the most recently completed FY for which the Debt Measures are calculated. 7 For example, if the most recently completed FY is 2017, the 4YP is FYs 2011, 2012, 2013 and For a program whose students are required to complete a medical or dental internship or residency, as identified by an institution, the four-year period (4YP-R) covers the sixth, seventh, eighth and ninth FYs (4YP-R) prior to the most recently completed FY for which the Debt Measures are calculated. For example, if the most recently completed FY is 2017, the 4YP-R is FYs 2008, 2009, 2010 and The Four-Year Period is only used when calculating Debt Measures for programs for which the Two-Year Period results in 30 or fewer borrowers in the cohort. 8 In addition, during fiscal years 2012, 2013 and 2014, institutions may base their Repayment Rates on borrowers in the first and second FYs prior to the most recently completed FY (2YP-A) if they have better loan repayment rates than borrowers in the third and fourth years of 6

7 repayment. This will presumably encourage institutions to enact changes designed to improve student Repayment Rates by allowing programs to benefit from the improved near-term performance. For example, if the most recently completed FY is 2012, the 2YP-A is FYs 2010 and The OOPB does not include PLUS loans made to parents, or TEACH Grant-related unsubsidized loans. 9 Further, in contrast to the Debt Burden, the OOPB does not include private or education loans or debt obligations arising from institutional financing plans. Also excluded from this calculation are: Loans subject to an in-school deferment status during any part of the fiscal year Loans under military-related deferment during any part of the fiscal year Loans that were discharged as a result of the death of the borrower pursuant to relevant statutory provisions, and Loans under consideration for, or fully discharged as a result of, the borrower s total and permanent disability Only debt that is associated with the relevant program is included in the calculation. Thus, if a student attended multiple programs at the same institution, each program would be judged separately for Repayment Rate purposes. Similarly, if a student entered a program with debt from another institution, that debt would not be included in the Repayment Rate calculation either. Loans in default The Department has chosen to exclude from the definition of a Loan Paid in Full or a Payment-Made Loan any loan that has been in default. Previously defaulted loans include: Loans related to the debt incurred at the program under review that have defaulted, and In the case of consolidation loans, when either the consolidation loan or any of the underlying loans that were consolidated have defaulted Thus, if a student has a prior default and consolidates subsequent debt from a program subject to the GE Rule (a common situation), the Repayment Rate of the program will be negatively impacted. This is because, while the debt from the program will appear in the OOPB (and the denominator of the formula), it will never be counted as a LPF or PML (in the numerator of the formula). Loans Paid in Full Loans Paid in Full are those loans that the borrower has successfully paid entirely (and that were never in default). Importantly, a loan that is subsequently consolidated under a federal loan program is not considered paid in full until the entire consolidated loan is fully paid by the borrower. 10 Payment-Made Loans The primary changes to the regulation are reflected in the provision on Payment-Made Loans. PMLs are loans that have never been in default and where the borrower has engaged in some type of activity that moves them toward reducing their debt. 11 PML includes loans where: 7

8 The borrower has reduced the total amount outstanding on the loan during that fiscal year, including unpaid accrued interest that has not been capitalized 12 If the program under review is a graduate program, the borrower has reduced the total amount outstanding on the consolidated loan during that fiscal year, including unpaid accrued interest that has not been capitalized 13 The borrower is in the process of qualifying for Public Service Loan Forgiveness (PSLF) under 34 CFR (c) and makes qualifying payments on the loan during that fiscal year 14 For loans that are under certain income-based repayment plans, the borrower makes payments equal to at least the amount of the interest accruing on the loan during the fiscal year, subject to anti-abuse limits 15 The Department calculated that 1.1 percent of borrowers (by loan balance) within the incomebased repayment, income-contingent repayment or graduated repayment plans are negativelyamortized or interest-only. Based on this, and to curb potential abuse of these programs, up to 3 percent of a program s loan balance may be in these repayment plans and counted in the numerator of the loan repayment rate. With regard to the PSLF program, the Department has addressed the lack of transparency into who qualifies for the program by limiting those deemed eligible for GE Rule purposes to those borrowers who submit an employment certification demonstrating the borrower is engaged in qualifying employment and the borrower made qualifying payments on the loan during the most recently completed [fiscal year]. At present, students do not have an affirmative obligation to submit such annual certifications to maintain eligibility for PSLF. Challenging Department results As with the cohort default rate, the Department will issue a draft Repayment Rate calculation that institutions may challenge. 16 Within 45 days of the issuance of draft results, institutions may challenge the accuracy of the list of borrowers used to calculate the Repayment Rate as well as the accuracy of the loan data used. Causes for concern Assessing compliance Assessing compliance with the Repayment Rate will be a challenge for most institutions. While the data used to assess Repayment Rate performance will largely be available on the National Student Loan Data System (NSLDS), queries to that system will be complex and the results will take many hours to review. Underwriting criteria Another cause for concern is the potential penalty programs face for admitting students who have previously defaulted on a student loan. While more data is needed to assess the impact of this provision, at least initially, institutions may be wary of admitting students who have prior defaults. Focus on large loan values Although not necessarily a cause of concern, the GE Rule, like the Draft Version, focuses on the original borrower loan balance. In doing so, the GE Rule places greater weight on large loans that are in repayment as opposed to smaller value loans. This will likely focus borrower remediation services on former students with large loans. 8

9 DEBT MEASURES Assessing compliance with the Debt Burden The Debt Burden is a comparison of the annual loan payment experienced by graduates of a program using either the Discretionary Income Threshold or the Actual Earnings Threshold. As discussed above, a program will be considered to provide training that leads to gainful employment in a recognized occupation if that program s annual loan payment is less than or equal to: (1) 30 percent of discretionary income; or (2) 12 percent of annual earnings. The formulas are as follows: Annual Loan Payment 30% of discretionary income Discretionary Income 17 (Discretionary Income Threshold) Annual Loan Payment 12% of Annual Earnings Median/Mean Annual Earnings (Actual Earnings Threshold) Annual Loan Payment An institution must calculate the Annual Loan Payment for a program by first determining the median loan debt for a program. An institution can do this for each program graduate during the cohort period (whether 2YP, 2YP-R, 4YP or 4YP-R), by determining the lesser of: (1) the actual median amount of loan debt for the cohort; or (2) if provided by the institution, the total amount of tuition and fees the institution charged the student for enrollment in all programs at the institution. This amount is the Median Loan Debt. What counts as loan debt? In determining the loan debt for graduates, the Department will include FFEL, Federal Direct Loans (except for parent PLUS or TEACH Grant-related loans) and any private or education loans or debt obligations arising from institutional financing plans. Accordingly, while further clarification would be desirable, the calculation of loan debt appears to exclude loans that are not explicitly education loans, such as debt incurred to pay institutional expenses with credit cards, revolving lines of credit or home equity lines of credit. The Department will not include any loan debt incurred by the student for attendance in programs at institutions that are not under common ownership or control. In addition, in calculating the actual median loan debt, the Department will also exclude debt from any graduate who died, is enrolled at another institution during the calendar year for which the Department obtains earning information, whose loans were in military-related deferment status during the calendar year, or for whom one or more of the loans are being considered for discharge as a result of total or permanent disability. After finding the Median Loan Debt, an institution must determine the amount to be annually repaid on such debt. For regulatory purposes, the Department deems all debt to be repaid at the interest rate currently in effect for Federal Direct Unsubsidized Loans (6.8 percent in ). The amortization periods differ based on degree type: A 10-year repayment schedule for programs leading to a certificate or to an associate s degree A 15-year repayment schedule for programs leading to a bachelor s or master s degree, and 9

10 A 20-year repayment schedule for programs leading to a doctoral or first-professional degree The Department will then calculate the Annual Loan Payment. For example, if the Median Loan Debt is $30,000 for an associate s degree program (10-year amortization), at a 6.8 percent interest rate, a graduate of this program will pay $41, in total and have a $4, Annual Loan Payment. Median or mean annual earnings The Department will obtain from SSA 19 (or another federal agency, such as the Internal Revenue Service), the most currently available mean and median annual earnings of the students who completed the program during the 2YP, the 2YP-R, the 4YP, or the 4YP-R. 20 The Department will calculate the debt-to-earnings ratios using the higher of the mean or median annual earnings. An institution may also submit alternative earnings data based on statesponsored longitudinal data studies or an institutional survey conducted in accordance with National Center for Education Statistics standards. During a transitional period (FY calculations), institutions may submit analyses based upon BLS data on typical earnings for particular jobs. 21 Only otherwise failing programs may use this option. Furthermore, the institution must provide the Department with documentation of the occupation by SOC code, or combination of SOC codes, in which more than 50 percent of the students in the 2YP or 4YP found employment and that number of students is more then The required documentation must either be that used to satisfy any accreditor or state-related requirement to disclose placement data, employment records, or other documentation showing the SOC codes in which graduates 23 found employment. Thresholds Once the Department calculates the Annual Loan Payment and the Actual Annual Earnings, the Department will compare the resulting ratio (e.g., the Annual Loan Payment divided by Actual Annual Earnings or the Annual Loan Payment divided by Discretionary Income) to the appropriate threshold. If the debt-to-discretionary income ratio is 30 percent or less, then the program qualifies for Title IV aid. Similarly, if the debt-to-total earnings ratio is 12 percent or less, then the program qualifies. 24 In our example, let us assume the higher of the mean or median annual earnings for students completing the program is $40,000. If we use the discretionary income threshold for the first two-year period the resulting equation is as follows: $4, (Annual Loan Payment) $40,000 minus $16,335 (150% of the Poverty Guideline) = 17.51% Accordingly, the program has a percent Debt Burden and would be deemed eligible to receive Title IV funding. 25 Alternatively, if we used the actual earnings threshold for the first twoyear period, the program in question would also be eligible: $4, (Annual Loan Payment) $40,000 (Actual Annual Earnings) = 10.35% 10

11 Below are tables, based on one distributed by the Department, of maximum median debt levels based upon 10-year, 15-year and 20-year repayment plans and using the 2010 HHS Poverty Guidelines (which are slightly lower than the 2011 schedule). Maximum Debt 10-Year ANNUAL DEBT UNDER EARNINGS 12% OF TOTAL EARNINGS DEBT UNDER 30% OF DISC. EARNINGS MAXIMUM MEDIAN DEBT (HIGHER OF TWO) MAXIMUM MEDIAN MONTHLY PAYMENT $10,000 $8,690 $0 $8,690 $100 $20,000 $17,379 $8,157 $17,379 $200 $30,000 $26,069 $29,881 $29,881 $344 $40,000 $34,758 $51,605 $51,605 $594 $50,000 $43,448 $73,329 $73,329 $844 $60,000 $52,137 $95,064 $95,064 $1,094 $70,000 $60,827 $116,788 $116,788 $1,344 $80,000 $69,517 $138,512 $138,512 $1,594 Maximum Debt 15-Year ANNUAL DEBT UNDER EARNINGS 12% OF TOTAL EARNINGS DEBT UNDER 30% OF DISC. EARNINGS MAXIMUM MEDIAN DEBT (HIGHER OF TWO) MAXIMUM MEDIAN MONTHLY PAYMENT $10,000 $11,265 $0 $11,265 $100 $20,000 $22,530 $10,576 $22,530 $200 $30,000 $33,796 $38,739 $38,739 $344 $40,000 $45,061 $66,916 $66,916 $594 $50,000 $56,326 $95,079 $95,079 $844 $60,000 $67,592 $123,242 $123,242 $1094 $70,000 $78,857 $151,405 $151,405 $1344 $80,000 $90,122 $179,568 $179,568 $1594 Maximum Debt 20-Year ANNUAL DEBT UNDER EARNINGS 12% OF TOTAL EARNINGS DEBT UNDER 30% OF DISC. EARNINGS MAXIMUM MEDIAN DEBT (HIGHER OF TWO) MAXIMUM MEDIAN MONTHLY PAYMENT $10,000 $13,100 $0 $11,265 $100 $20,000 $26,201 $12,298 $26,201 $200 $30,000 $39,301 $45,065 $45,065 $344 $40,000 $52,401 $77,816 $77,816 $594 $50,000 $65,501 $110,567 $110,567 $844 $60,000 $78,602 $143,318 $143,318 $1094 $70,000 $91,702 $176,068 $176,068 $1344 $80,000 $104,802 $208,819 $208,819 $1594 Challenging Department results For each FY beginning with FY 2012, the Department will issue draft results of the Debt Measures for each program offered by an institution. The institution may correct the data used 11

12 to calculate the draft results under 668.7(e) before the Department issues final Debt Measures pursuant to 668.7(f). Pre-draft challenges Institutions may, within 30 days of the Department sending a pre-draft list of students to the institution, provide evidence that a particular student should not be included or otherwise provide corrections to the identity information for the student. Failing to challenge a student or the identity information during this time precludes an institution from making a later challenge or correction to this information. Post-draft challenges Within 45 days of the issuance of draft results, institutions may challenge the median loan debt that the Department used in the Debt Burden formula. An institution may not challenge the mean and median earnings data provided by SSA for the program. Causes for concern Institutions cannot obtain/challenge the salary data Although the use of the BLS data during the transition phase ( ) is helpful, starting in 2015, institutions will be unable to assess actual compliance with the Debt Burden. Unfortunately, because institutions cannot obtain salary data from SSA or any other government source, this creates a distinct lack of transparency for institutions as to their regulatory compliance. To be sure, the three years worth of actual salary data compiled by the Department during the transition should aid institutions in determining the Actual Earnings. The potential for salary swings caused by disruptions in the economy, however, may create disparities from the baseline established in Holding institutions to account for such deviations without any notice is problematic to say the least. Furthermore, because institutions cannot obtain the underlying salary data, there is greater risk that accompanies any mistake by SSA in calculating the Debt Burden. While there is no reason to believe this will be a common occurrence, if the experience with cohort default rate challenges is any guide, honest mistakes can and will be made. The difference is that institutions can at least check the accuracy of the cohort default rates calculations (and the Repayment Rate). This lack of due process is problematic and, for this reason especially, the Department should consider amending the GE Rule to provide for the use of BLS salary data in these calculations, as originally proposed during negotiated rulemaking. 26 Potential for underreported income In addition to the lack of transparency and due process inherent in using actual income rather than BLS salary data, programs are at risk for graduates, particularly those who are selfemployed, underreporting their salary data. This could have a dramatic effect in 2015, when institutions no longer have the option of using BLS data for otherwise failing programs. According to the BLS, there are very high rates of self-employment among the following professions 27 : barber shops (48.8 percent of the profession is self-employed) personal and household goods repair and maintenance (43.1 percent) nail salons and other personal care services (41.8 percent) beauty salons (33.5 percent) and health care practitioners (39.4 percent) 12

13 Further, according to the Imagine America Foundation, a non-profit foundation that provides information related to career schools, the top fields of study in programs that are subject to the GE Rule are the very fields dominated by self-employment. 28 Persons who are self-employed receive statements of non-employee compensation contained on a Form 1099-MISC. 29 This is in contrast to employees who receive a W-2 statement from their employers. Importantly, while the earnings on a W-2 statement are reported directly to SSA by an employer, and income and Social Security taxes are similarly withheld by the employer, income on a 1099-MISC is not reported to the SSA by the issuer of the 1099-MISC. 30 In fact, SSA relies solely on the self-employed individuals to pay Social Security taxes and otherwise report income while filing annual tax forms. 31 Without a third party reporting the income, it is likely that the income reported to SSA will not be entirely accurate. As the IRS has noted, compliance is highest where there is third-party reporting or withholding. 32 Worse, the IRS estimated that, as part of a study of approximately 46,000 randomly selected tax filings, 53.9 percent of the individual income tax gap was related to filers providing little or no information. 33 Without third-party reporting, the self-employed, due to lack of sophistication, confusion or mistakes (or otherwise), are more likely to underreport income than other tax filers. Here, programs may be unfairly held accountable for the failures of individual graduates to properly report income. PENALTIES AND REQUIRED DISCLOSURES The GE Rule abandoned the complicated compliance matrix for what is a much simpler system. Further, rather than immediately strip Title IV eligibility from programs for noncompliance, the GE Rule provides programs with intermediate penalties and time for remediation. First-time failure For a program that fails to meet the Debt Measure minimum standards for the first time, the institution must provide a warning to each student and prospective student enrolled in a failing program that (a) explains the Debt Measures and the amount by which the program did not meet the minimum standards and (b) describes how the institution intends to improve the program s performance. The warning may be delivered orally or in writing and the institution must maintain documentation regarding how it delivered the warning. Of course, institutions would be wise to establish a compliance program under which such warnings would be made in writing and, perhaps, require students to sign an acknowledgment that they received the disclosure. Failing twice in three years A program that has failed to meet the Debt Measure minimum standards for two years, either consecutively or in a three year time frame, must provide the same written warning the program provided after its first year failure, along with four additional disclosures. The additional disclosures include: (a) setting forth the timeline for discontinuing the program (if applicable); (b) explaining the risks to students of enrolling or continuing in the program; (c) identifying the resources available to the student through and others that the student may use to research educational options and programs; and (d) stating that the student enrolled in and continuing the program should expect to have difficulty repaying his or her student loans

14 The warning must also be displayed on the program home page on the institution s website and in all promotional materials provided to prospective students regarding the program. 35 In fact, institutions must provide the warning to all students enrolled in the program as soon as administratively feasible, but no later than 30 days after the date the Secretary notifies the institution of the second programmatic failure. Further, institutions must provide the notice to prospective students at the time the student first contacts the institution requesting information about the program. Given that such a follow-up warning may be given orally, it would be prudent to require students to acknowledge receipt of this warning as well as any past warnings given, in writing as part fo the enrollment process. In addition to the warning, institutions must give prospective students a cooling-off period of three days between the day the prospective student receives the warning and enrolling the student in the failing program. If, however, 30 days lapse from the date the warning was provided, the institution must provide the warning again and provide the student with the threeday cooling-off period as well. Failing three times in four years If a program does not meet the acceptable Debt Measures for three of the past four Fiscal Years, the program is ineligible to disburse Title IV funds to students enrolled in the program. 36 Further, an institution may not seek to reestablish the eligibility of an ineligible program (or a substantially similar program) until the end of the third fiscal year following the fiscal year the program became ineligible. In addition, if, within 90 days of notice that the program has failed for a second time in two years, an institution voluntarily discontinues that program, it may seek to reestablish eligibility at the end of the second fiscal year after the program was discontinued. PARTING THOUGHTS There is no question that the Department made significant modifications to the Draft Version and that the final GE Rule has a number of favorable modifications. It is, however, unclear just how the GE Rule will impact programs subject to its provisions and the severity of necessary mitigation efforts to ensure compliance. In this light, some of the concerns raised in this document may turn out to be relatively minor. While it may be an odd philosophical choice, the impact on a program s Repayment Rate from enrolling students who have prior loan defaults (and who will presumably consolidate those loans with loans from the new program and thus adversely affect a program s Repayment Rate) may be negligible. There are a few additional questions for which data is not yet available and which may have an impact on the manner in which institutions approach their GE Rule compliance efforts. The impact of utilizing data from Years Three and Four Assessing compliance with the Debt Measures later in a former student s career will likely be a positive change. Salaries are likely to be higher than in the first two years after leaving a program. Consequently, the chances that former students will be repaying their loans and have sufficient income to meet the Debt Burden will increase. 14

15 It is currently not known, however, if there are programs that may be negatively affected by this feature. For example, certain student populations are more likely to exit the workforce to accomplish other life goals. If such life choices are more likely to occur in years three and four after leaving a program, then programs that cater to such students will have a more difficult time maintaining GE Rule compliance. The GE Rule harms programmatic compliance for former students who are on parental leave or taking a working mother deferment (as opposed to inschool deferment and military deferment, which are treated neutrally). The impact on bachelor s programs Clearly, the 15-year amortization term for debt service of bachelor s program graduates increases the potential that such programs will achieve regulatory compliance relative to the rule as proposed in the Draft Version. If the wage stratification that naturally occurs over time between holders of different degree levels within the same program for example, a bachelor s degree in Criminal Justice as opposed to an associate s degree in that program manifests itself in years three and four after graduation, then institutions may opt to offer the higher-level degree program. This would reverse a recent trend that has seen institutions replacing bachelor s degrees for associate s degrees within the same program as a result of the Draft Version s focus on salaries in the first three years after graduation. For more information, please contact: Dennis M. Cariello Dennis.Cariello@dlapiper.com Patricia V. Edelson Patricia.Edelson@dlapiper.com Allison L. Kierman Allison.Kierman@dlapiper.com David P. Lewis David.lewis@dlapiper.com Lawrence E. Levinson Lawrence.Levinson@dlapiper.com Jacob Frumkin Jacob.Frumkin@dlapiper.com This Alert was written with the assistance of Sarah Castle. 1 See 34 CFR 668.7(a)-(c) USC 1002(b)(1)(A) and (c)(1)(a). 3 See 34 CFR 668.7(a). 4 See 34 CFR 668.7(a)-(c). 5 Fiscal Year is defined as the 12-month period starting October 1 and ending September 30 that is designated by the calendar year in which it ends; for example FY 2013 is from October 1, 2012 to September 30, That designation also represents the FY for which the Secretary calculates the Debt Measures CFR 668.7(a)(2)(iv). 7 See 34 CFR 668.7(a)(2)(v). 8 See 34 CFR 668.7(d). 9 See 34 CFR 668.7(b)(1)(ii) CFR 668.7(b)(2)(i) CFR 668.7(b)(3)(i) CFR 668.7(b)(3)(i)(A)(1) CFR 668.7(b)(3)(i)(A)(2) CFR 668.7(b)(3)(i)(B) CFR 668.7(b)(3)(i)(C)(1). 16 See 34 CFR 668.7(e). 15

16 17 Discretionary Income is actual income minus 150 percent of the Poverty Guideline. The Poverty Guideline is published by the Department of Health and Human Services and is for a single person in the continental United States. See 34 CFR 668.7(a)(vi). For 2011, the applicable rate (150% of the Poverty Guideline) is $16,335. See 2011 HHS Poverty Guidelines, located here. 18 See Direct Loan Page for Students (last visited June 2, 2011). 19 The Department currently has an articulation agreement with SSA to provide this data (a copy of the agreement is on file with authors) CFR 668.7(c)(3). 21 See 34 CFR 668.7(g)(4) CFR 668.7(g)(4). 23 While the regulation refers to students, the Debt Burden test focuses on the performance of graduates. As such, while further clarification is desirable, it is likely institutions must obtain graduate employment data and not that of all students who attended the institution. 24 See 34 CFR 668.7(a)(1)(ii). 25 See 34 CFR 668.7(h) for the definition of a failing program. 26 See, e.g., Department of Education Position Paper on Gainful Employment in a Recognized Occupation, at 7 (Jan. 25, 2010), located here. 27 See Steven Hipple, Bureau of Labor Statistics, Self-employment in the United States: an update, (July 2004), at 20, printed in the Monthly Labor Review, located here. 28 Imagine America Foundation, Filing America s Labor Shortage: The Role of Career Colleges, at 4 (2006) located here 29 Non-employee compensation totaled about $2.3 trillion and accounted for about 55 percent of all 1099-MISCs submitted. See GAO Report, Tax Gap IRS Could Do More to Promote Compliance by Third Parties with Miscellaneous Income Reporting Requirements, at 9 (Jan. 2009), located here. 30 See Form 1099-MISC and Instructions, at Box 7 and Instructions for Box 7 (noting that non-employee compensation is for SE [self-employment] income and that the recipient received this form instead of a Form W-2 because the payer did not consider you an employee and did not withhold income tax or social security tax ), located here. 31 See id. at instructions for Box 7 (recipient received this form instead of a Form W-2 because the payer did not consider you an employee and did not withhold income tax or social security tax ). 32 IRS Updates Tax Gap Estimates (Feb. 14, 2006), located here. In fact, this is not a new issue. As the GAO reported in 1999: In general, self-employed taxpayers are less likely to report their earnings or pay their tax liability than are wage-earners, who are subject to withholding. IRS data show that the compliance rate for reporting income for taxpayers subject to withholding is 99 percent versus 80 percent for selfemployed taxpayers. GAO Report, Tax Administration: Billions in Self Employment Taxes Are Owed, at 34 (Feb. 1999), located here. 33 Chart, Individual Income Tax Underreporting Gap, located here. 34 See 34 CFR 668.7(j)(2). 35 See 34 CFR 668.7(j)(4). 36 See 34 CFR 668.7(h)(i). 16