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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:

REFUSAL OR ADJUSTMENT OF LOAN CERTIFICATIONS. -- On a case-by-case basis, an eligible institution may refuse to certify a statement that permits a student to receive a loan under part B or D, or may certify a loan amount or make a loan that is less than the student's determination of need (as determined under this part), if the reason for the action is documented and provided in written form to the student. No eligible institution shall discriminate against any borrower or applicant in obtaining a loan on the basis of race, national origin, religion, sex, marital status, age, or disability status.
While the statute contains certain restrictions against discrimination in loan certifications, the regulations at 34 CFR 682.603(e) add more restrictions, including a prohibition against discriminating against particular lenders and guarantee agencies:
A school may refuse to certify a Stafford or PLUS loan application or may reduce the borrower's determination of need for the loan if the reason for that action is documented and provided to the borrower in writing, provided --
  1. The determination is made on a case-by-case basis;
  2. The documentation supporting the determination is retained in the student's file; and
  3. The school does not engage in any pattern or practice that results in a denial of a borrower's access to FFEL loans because of the borrower's race, sex, color, religion, national origin, age, handicapped status, income, or selection of a particular lender or guaranty agency.

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 prohibitions apply regardless of whether the inducements are direct or indirect. Although these terms are not defined by the Higher Education Act, the plain language definition of "indirect" is through or to a third party. This is not just a restriction against the lender paying for expenses that the college would otherwise have to pay, but also payments provided by or to an intermediary, such as an alumni association, booster club, athletic organization, departmental association or other affiliate.
  • The law prohibits the payment of "points, premiums, payments or other inducements". The plain language definition of "points" is units equal to one percent of the principal balance of a loan. The plain language definition of "premiums" is prizes, bonuses or awards given for free or at reduced price as an inducement.
  • The rules prohibit inducements to educational institutions, individuals, or other parties. In particular, inducements to colleges and their employees, as well as inducements to students, are prohibited.
  • The offering of an inducement is prohibited, and not just the provision or payment of an inducement.
  • The restrictions apply to the securing of applicants and loan applications, but not to the purchase of funded loans. When a School as Lender school sells loans to a lender, the premium paid by the lender does not represent an illegal inducement.
  • For an inducement to be illegal, it must be provided as a quid pro quo for loan referrals, as opposed to generalized advertising.
  • Lenders are permitted to provide assistance to schools that is comparable to the assistance provided by the US Department of Education to schools.

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:

  • "removes an economic interest that may affect the school's objectivity as it advises the student with respect to financial assistance"
  • "students' borrowing decisions [be] made on the merits of the loans rather than on extraneous marketing incentives to students and their schools"
  • "such decisions should be based on the merits of the loans and not on extraneous factors, particularly not on monetary benefits given to the schools on which students often rely in such matters"
The court case SLMA v. Riley 112 F. Supp. 2d 38 (D.D.C. 2000) also provides insight into the reasons for the prohibitions:
  • "[T]he committee reports regarding the bill reflect Congress's intent to bar inducements generally to foreclose the possibility of exploitation of student and parent borrowers."
  • "A purpose of the provision was to prohibit educational institutions from encouraging students to take out loans 'whether or not they actually need them' and to take out 'the maximum amount of loan'."

Illegal Inducements - Lenders

The illegal inducements rules for lenders appear in section 435(d)(5) of the Higher Education Act:

DISQUALIFICATION FOR USE OF CERTAIN INCENTIVES. -- The term "eligible lender" does not include any lender that the Secretary determines, after notice and opportunity for a hearing, has after the date of enactment of this paragraph --
  1. offered, directly or indirectly, points, premiums, payments, or other inducements, to any educational institution or individual in order to secure applicants for loans under this part;
  2. conducted unsolicited mailings to students of student loan application forms, except to students who have previously received loans under this part from such lender;
  3. offered, directly or indirectly, loans under this part as an inducement to a prospective borrower to purchase a policy of insurance or other product; or
  4. engaged in fraudulent or misleading advertising.
It shall not be a violation of this paragraph for a lender to provide assistance to institutions of higher education comparable to the kinds of assistance provided to institutions of higher education by the Department of Education.

The corresponding regulations appear in the definition of "Lender" in 34 CFR 682.200(b)"Lender"(5):

The term "eligible lender" does not include any lender that the Secretary determines, after notice and opportunity for a hearing before a designated Department official, has --
  1. Offered, directly or indirectly, points, premiums, payments, or other inducements, to any school or other party to secure applicants for FFEL loans, except that a lender is not prohibited from providing assistance to schools comparable to the kinds of assistance provided by the Secretary to schools under, or in furtherance of, the Federal Direct Loan Program.
  2. Conducted unsolicited mailings to a student or a student's parents of FFEL loan application forms, except to a student who previously has received a FFEL loan from the lender or to a student's parent who previously has received a FFEL loan from the lender;
  3. Offered, directly or indirectly, a FFEL loan to a prospective borrower to induce the purchase of a policy of insurance or other product or service by the borrower or other person; or
  4. Engaged in fraudulent or misleading advertising with respect to its FFEL program loan activities.

Illegal Inducements - Guarantee Agencies

The illegal inducements rules for guarantee agencies appear in section 428(b)(3) of the Higher Education Act:

RESTRICTIONS ON INDUCEMENTS, MAILINGS, AND ADVERTISING. -- A guaranty agency shall not --
  1. offer, directly or indirectly, premiums, payments, or other inducements to any educational institution or its employees in order to secure applicants for loans under this part;
  2. offer, directly or indirectly, any premium, incentive payment, or other inducement to any lender, or any agent, employee, or independent contractor of any lender or guaranty agency, in order to administer or market loans made under this part (other than a loan made under section 428H or a loan made as part of a guaranty agency's lender-of-last-resort program) for the purpose of securing the designation of that guaranty agency as the insurer of such loans;
  3. conduct unsolicited mailings of student loan application forms to students enrolled in secondary school or a postsecondary institution, or to parents of such students, except that applications may be mailed to borrowers who have previously received loans guaranteed under this part by the guaranty agency; or
  4. conduct fraudulent or misleading advertising concerning loan availability.
It shall not be a violation of this paragraph for a guaranty agency to provide assistance to institutions of higher education comparable to the kinds of assistance provided to institutions of higher education by the Department of Education

The corresponding regulations appear in 34 CFR 682.401(e):

Prohibited inducements. A guaranty agency may not --
  1. Offer directly or indirectly any premium, payment, or other inducement to an employee or student of a school, or an entity or individual affiliated with a school, to secure applicants for FFEL loans, except that a guaranty agency is not prohibited from providing assistance to schools comparable to the kinds of assistance provided by the Secretary to schools under, or in furtherance of, the Federal Direct Loan Program;
    1. Offer, directly or indirectly, any premium, incentive payment, or other inducement to any lender, or any person acting as an agent, employee, or independent contractor of any lender or other guaranty agency to administer or market FFEL loans, other than unsubsidized Stafford loans or subsidized Stafford loans made under a guaranty agency's lender-of-last-resort program, in an effort to secure the guaranty agency as an insurer of FFEL loans. Examples of prohibited inducements include, but are not limited to --
      1. Compensating lenders or their representatives for the purpose of securing loan applications for guarantee;
      2. Performing functions normally performed by lenders without appropriate compensation;
      3. Providing equipment or supplies to lenders at below market cost or rental; or
      4. Offering to pay a lender, that does not hold loans guaranteed by the agency, a fee for each application forwarded for the agency's guarantee.
    2. For the purposes of this section, the terms "premium", "inducement", and "incentive" do not include services directly related to the enhancement of the administration of the FFEL Program the guaranty agency generally provides to lenders that participate in its program. However, the terms "premium", "inducement", and "incentive" do apply to other activities specifically intended to secure a lender's participation in the agency's program.
  2. Mail or otherwise distribute unsolicited loan applications to students enrolled in a secondary school or a postsecondary institution, or to parents of those students, unless the potential borrower has previously received loans insured by the guaranty agency;
  3. Conduct fraudulent or misleading advertising concerning loan availability.

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):

(a) No points, premiums, payments, or additional interest of any kind may be paid or otherwise extended to any eligible lender or other party in order to --
  1. Secure funds for making loans; or
  2. Induce a lender to make loans to either the students or the parents of students of a particular school or particular category of students or their parents.

(b) The following are examples of transactions that, if entered into for the purposes described in paragraph (a) of this section, are prohibited:

  1. Cash payments by or on behalf of a school made to a lender or other party.
  2. The maintaining of a compensating balance by or on behalf of a school with a lender.
  3. Payments by or on behalf of a school to a lender of servicing costs on loans that the school does not own.
  4. Payments by or on behalf of a school to a lender of unreasonably high servicing costs on loans that the school does own.
  5. Purchase by or on behalf of a school of stock of the lender.
  6. Payments ostensibly made for other purposes.

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 institution will not provide any commission, bonus, or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any persons or entities engaged in any student recruiting or admission activities or in making decisions regarding the award of student financial assistance, except that this paragraph shall not apply to the recruitment of foreign students residing in foreign countries who are not eligible to receive Federal student assistance.

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:

  • "A lender employs a student at a school to act as the lender's representative for the purpose of persuading individual prospective borrowers to apply for a loan with the lender."
  • "A lender employs a loan solicitor or sales representative who visits schools for the purpose of persuading individual prospective borrowers to apply for a loan with the lender."
  • "A guarantee agency provides computers to a school, or a lender provides computers or computer software to a school, at below market rental or cost."
  • "A lender's promotional activities include providing borrowers the chance to win prizes if they apply for loans."
  • "A lender prints and distributes school catalogs for a school at reduced cost, in order to induce the school to refer loan applicants to the lender."

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:

  • Congress's apparent intent in establishing the School as Lender program,
  • The use of language in the illegal inducement rules in the Higher Education Act focusing on inducements for securing loan applications (as opposed to the purchase of funded loans), and
  • Who the lender really was in such an arrangement (i.e., whether the form of the relationship mattered more than the substance of the relationship).
The court's decision does not prevent enforcement against other forms of illegal inducements. In fact, the judge cited several examples of illegal inducements when arguing that the School as Lender program did not rise to the level of an illegal inducement. These examples included:
  • "A case in which bank tellers were being paid $50.00 to bring their friends into the bank to take out loans."
  • "A case in which a bank was giving away free walkman radios to students who took out loans."
  • "A case in which a bank took a group of financial aid administrators on a cruise to encourage them to do business with that bank."

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:

  • "Other activities provide some financial benefit to prohibited recipients of inducements, but are nevertheless permissible because the financial value of the benefit is nominal, or the activity is not undertaken to directly secure applications from individual prospective borrowers, but rather as a form of generalized marketing or advertising."
  • "A lender purchases a loan made by another lender at a premium. This is not a transaction involving the securing of applicants, but rather the acquisition of loans already made."
  • "A lender declines to collect all or a part of the origination fee chargeable to the borrower."
  • "A lender charges a borrower an interest rate that is lower than the statutory maximum."
  • "A lender or guarantee agency establishes a toll-free telephone number for use by schools or others in obtaining information regarding Part B loans."
  • "A guarantee agency provides training on the administration of the Stafford Loan Program to a school's employees free of charge..."
  • "A lender or guarantee agency provides a school, free of charge, with counseling materials designed to provide a borrower with more comprehensive and detailed counseling than that required to be provided by the school."
  • "A lender or guarantee agency sponsors a luncheon for a recognized organization of schools or a school trade association, provides free pens with the lender's or agency's name inscribed thereon, or provides some other items of nominal value as a form of advertising or creation of good will, rather than as a quid pro quo for loan referrals."

These examples in effect establish several safe harbors, including:

  • Inducements of nominal financial value.
  • Marketing materials, such as imprinted pens, calendars and postit notes.
  • Purchase of funded loans at a premium.
  • Loan discounts, such as origination fee waivers and interest rate reductions.
  • Providing schools with counseling materials for their students, such as financial literacy materials.
  • Sponsoring official conference events at financial aid conferences.
  • Operating toll free numbers for borrowers and financial aid administrators.

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:

  • "No Automatic Referrals"
  • "Must process any loan request made by a student or parent regardless of lender."
  • "May not have unreasonable delays."
  • "Publications, scripts, and staff training should comply."
  • "Does not apply to FFEL/DL choice."

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:

  • Payment for inclusion on or preferred placement within a preferred lender list.
  • Providing college personnel with tickets to athletic and entertainment events.
  • Providing college personnel with Christmas gifts or other holiday presents (or gifts at any other time of year).
  • Tying benefits, such as override or opportunity pools, to inclusion on or preferred placement within a preferred lender list. See August 1, 2003 memo from Cathy H. Lewis, Office of Inspector General, US Department of Education, concerning the use of opportunity pools. (A review of private student loan securitizations suggests that as much as 15% of a lender's private student loans are made without regard to traditional FICO-based underwriting criteria. Allowing a school to override a lender's rejection of one private student loan application for every ten funded private student loans is not in itself an illegal inducement. However, providing such an opportunity pool in exchange for inclusion on the preferred lender list or basing the number or dollar amount of overridden application decisions on FFELP volume, as opposed to private student loan volume, probably crosses the line.)
  • Linking from preferred lender list to loan application form.
  • Paying schools or borrowers based on loan applications, such as paying a referral fee to borrowers to encourage their friends to consolidate with the lender or paying colleges for lead generation activities.
  • Giving prospective borrowers gift cards or preloaded debit cards in exchange for testimonials or other thinly veiled proxies for loan applications
  • Paying alumni association or other college affiliates for loan consolidations.
  • Providing college personnel with boat cruises and trips to exotic locations.
  • Inviting college personnel to dine at expensive restaurants.
  • Providing excessive compensation to college personnel for their "service" on a lender advisory board.

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:

  • Colleges negotiating better terms for their borrowers. Often colleges with low loan default rates will be able to get better loan discounts and interest rates on their loans, especially from private student loan programs.
  • Lenders buying loans from a School as Lender school.

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 criteria used to compile or rank a preferred lender list may not be aligned with the criteria used by students and parents. In particular, the preferred lender list may not necessarily be focused solely on the lowest cost loans or may use additional criteria besides cost when evaluating lenders.
  • The loan discounts offered by lenders are confusing and difficult to evaluate. College personnel, who are often not CPAs or CFPs, may not have the time or expertise to carefully evaluate the tradeoffs of each type of discount. For example, a 2% interest rate reduction after 48 months is less generous than a 1% interest rate reduction that begins at repayment. It is tempting to focus on the magnitude of the discount without regard to the delayed onset or requirements to make payments on time. The fine print can often significantly alter the financial value of a discount.
  • The use of a closed selection process for considering lenders for inclusion on the preferred lender list, instead of issuing an open RFP.
  • Inherent biases against including new and smaller lenders.

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:

  • A disclosure that borrowers are free to select any lender, including lenders that are not on the preferred lender list.
  • A disclosure of the criteria used to select the lenders on the preferred lender list.
Disclosing the preferred lender list's selection criteria represents a good opportunity to educate borrowers about considerations besides cost, such as the quality of a lender's customer service.

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:

  • Requiring lenders to disclose the percentage of borrowers qualifying for each discount and the average duration.
  • Requiring lenders to disclose the average actual discount expressed as a percentage of annual loan volume.

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 solely 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:

  • Revenue sharing and referral fees paid by lenders to colleges.
  • Lenders providing colleges with financial benefits in exchange for placement on the college's preferred lender list.
  • Failure to disclose potential conflicts of interests to borrowers who use the preferred lender lists.
  • Failure to disclose the criteria that were used to create the preferred lender list.
  • Failure to disclose that loans offered by the lenders on the preferred lender list may be sold and that the advertised loan discounts might not be honored by the lender that purchases the loans.
  • Failure to disclose that borrowers are not restricted to using a lender from the preferred lender list.
  • Practices that effectively result in denial of a borrower's choice of lenders, such as unnecessary delays in loan certification for lenders not on the preferred lender list.
  • The use of preprinted forms, such as Master Promissory Notes, that already include a lender preselected by the college.
  • Lenders on the preferred lender list all having forward purchase agreements with the same lender, effectively eliminating any meaningful choice for borrowers.

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:

  • Revenue sharing agreements between lenders and colleges are prohibited.
  • Lenders may not provide anything of value (including computer hardware and printing costs or services) to colleges in exchange for appearing on the preferred lender list or other benefits to the lender.
  • College financial aid administrators (and other college employees) are prohibited from accepting anything of more than nominal value from lenders and guarantee agencies. In particular, college financial aid administrators may not be paid for service on a lender's advisory board and may not receive conference trips and other travel from lenders.
  • The criteria and process used to create a preferred lender list must be clearly and fully disclosed with each publication of the list.
  • The preferred lender list must also disclose that borrowers have the right to choose any lender, including lenders that are not on the preferred lender list, and may do so without any penalty.
  • If a lender on a preferred lender list sells its loans to another lender, this must be disclosed on the preferred lender list. To appear on the preferred lender list, the lender must guarantee that the advertised benefits will continue regardless of whether the loans are sold.
  • The lenders listed on a preferred lender list and the order in which they are listed must be based solely on the best interests of the students and parents who use the list, without regard to the college's interests. The college must review the contents of the preferred lender list at least once per year.
  • Lenders may not provide staff support to college financial aid offices. In particular, lenders are prohibited from operating call centers for colleges or identifying lender employees as agents for the colleges.
  • Opportunity loans, where a lender allows the college to override the normal credit underwriting criteria on its private student loan in exchange for favorable placement on the preferred lender list, are prohibited. Lenders may not use benefits on one type of loan to obtain an advantage with regard to a different type of loan.
  • Colleges may not encourage their alumni to consolidate their loans with a particular lender in exchange for direct or indirect benefits to the college.

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:

  • stop operating call centers and providing temporary staff to financial aid offices
  • not engage in revenue sharing agreements with colleges
  • not provide colleges with computer hardware at below market prices
  • not provide colleges with printing costs or services
  • stop paying financial aid administrators and other college personnel for service on its advisory boards
  • not provide anything of more than nominal value to any college employee
  • end the Sallie Mae Campus Assist program within 18 months, where Sallie Mae provided staff for college financial aid offices
  • not provide opportunity loans in exchange for loan volume or placement on a school's preferred lender list
  • stop paying for trips for financial aid administrators
  • ensure that any loans sold or acquired by Sallie Mae will retain their borrower benefits
  • disclose on its web site and marketing brochures that it is a private company and not part of the federal government

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:

  • To unbiased advice about loans and lenders from schools' financial aid offices.
  • To choose the lender, even if the lender is not included on the school's preferred lender lists.
  • To know what criteria a school uses to select preferred lenders.
  • To know whether preferred lenders are paying the school or financial aid officers.
  • To know what benefits or rate discounts lenders offer, and whether those benefits or discounts will be made immediately available, or only after a certain number of consecutive timely payments.
  • To know if a lender has agreed to sell its loans to another lender.
  • To know whether borrower benefits and discounts will continue if the loan is sold.
  • To know the interest rate for the loan before borrowing.
  • To exhaust federal borrowing options before turning to higher cost private loans.
This and other documents relating to the New York Attorney General's investigation of student loan conflicts of interest can be found on www.oag.state.ny.us. The materials include the Student Bill of Rights (condensed into 8 rights), a set of questions to ask financial aid offices, the College Code of Conduct, copies of sample settlement agreements, and a comprehensive list of all related press releases.

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:

  • Marketing materials that use the word "federal" and an eagle insignia
  • Mailing fake checks
  • Offering gift cards of $300 to $500 for "testimonials" or loan applications
  • Paying students for referrals.
  • Using sweepstakes and prizes to entice students into borrowing from the lender.
  • Failure to disclose forward purchase agreements.
  • Other misrepresentations concerning the loans.
On December 11, 2007, the New York Attorney General announced an agreement with Student Financial Services Inc. (SFS), also known as University Financial Services (UFS), a student loan consolidator. The company had revenue sharing and co-branding agreements with 63 college and university athletic departments, including 57 NCAA Division I schools. The company also had agreements with five sports-marketing firms that had the right to market using the school's insignia, colors and mascots. The company was also designated as the "official student loan consolidation provider" or "preferred student loan consolidation provider" at some of the colleges, in some cases on an exclusive basis. The New York Attorney General and Florida Attorney General jointly entered into a 49-page settlement with the company, in which the company agreed to end its agreements with the 63 colleges and five sports marketing companies by the end of the year. The company also agreed to stop paying cash inducements to students to refer other students to the company and to stop running contests. The attorney general referred to these marketing practices as "deceptive". The company will run a print advertising campaign at the 63 colleges to educate borrowers. The company agreed to adopt a code of conduct and to other provisions, including:
  • Disclosures concerning the impact of consolidation on the borrower's grace period and a required waiver form if the borrower is consolidating a loan more than 30 days prior to the end of the grace period.
  • Disclosures concerning the impact of consolidation on Perkins loan benefits.
  • On private loans, a statement that borrowers should exhaust federal loan eligibility before using private loans.
  • Uniform disclosures concerning federal and private consolidation loans.
  • Disclosure of borrower benefits on the promissory note for a consolidation loan.
  • A ban on consolidating federal and private loans into a single private consolidation loan.
  • A mandatory 14-day "buyer's remorse" cancellation period on all loan applications.
  • For prompt payment discounts that require "timely, consecutive payments", a definition of "timely, consecutive payments".
  • Uniform disclosures of a variety loan terms, such as APR, interest rates, fees, estimated monthly payments, total payments over the life of the loan, borrower benefits, the term of the loan, etc. In effect this extends Truth in Lending Act style disclosures to the student loans.
  • Limit loan amounts to the student's actual cost of attendance.
  • Bans teaser rates without clear and conspicuous disclosures of when and how the interest rates may change.
  • Bans prepayment penalties.
  • Bans gifts, gift cards, prizes, payments or other items of value for loan applications, providing a testimonial, or borrowing from the lender.

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:

  • Misleading marketing tactics, such as fake checks, deceptive rebates, promotional materials that suggest that the lender is part of the government, and misrepresenting the lender as the borrower's current lender.
  • Paying students to steer other students to the lender.
  • Using gift cards, sweepstakes, contests and prizes to attract prospective borrowers.
The code of conduct also requires several disclosures, such as:
  • Uniform disclosures of loan terms to permit easy comparison of different loans. These disclosures must occur at the time of application, the time of loan approval, and the time of promissory note execution.
  • Lenders must advise borrowers to exhaust federal loan eligibility before resorting to a private student loan.
  • Lenders must disclose the intent to resell a student's loan.
The code of conduct also bans certain other practices, such as:
  • Lenders may not sell or release personal information to a third party unless this is clearly and conspicuously disclosed in the lender's privacy policy.
  • Lenders may not charge prepayment penalties.
Note that some of these restrictions are already banned under the federal prohibited inducement rules.

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.

On May 20, 2009, the New York Attorney General issued a Notice of Availability of State and Federal Funds for Student Empowerment Grants to New York State nonprofits, charitable organizations and state government entities. The grants will be funded by the $13 million in settlements paid by colleges and lenders. The grants will fund two projects. One project will involve a a free web-based live-operator staffed Student Loan Center for providing information on how to minimize student loan debt and choose the best student loan options. It will also provide assistance for distressed borrowers and provide loan evaluation and comparison tools. It may also include a reverse auction for student loans to enable borrowers to get lower cost loans. The other project will involve a Public Service Announcement (PSA) advertising campaign that will dovetail with the first project by providing similar advice and generating awareness of the Student Loan Center. See New York Attorney General Student Lending for more information.

On July 21, 2009, the New York Attorney General announced a $780,000 settlement with Emerson College. Emerson College agreed to pay the money to more than 4,000 current and former students and to adopt the Attorney General's student lending code of conduct. Emerson College is the 28th school to settle with the New York Attorney General. Emerson College previously terminated its Director of Student Financial Services, Daniel V. Pinch III, on June 20, 2007. The New York Attorney General alleges that Mr. Pinch received payments in excess of $1,500 per month and totaling approximately $36,000 for consulting services provided to Collegiate Funding Services Inc. (CFS). CFS was listed as a preferred lender by the college. The Attorney General also alleges that Emerson College had entered into a revenue sharing agreement with Education Finance Partners (EFP), a lender of private student loans, and put EFP on its preferred lender list without disclosing the financial relationship.

On December 31, 2010, the New York Attorney General announced that $13 million in settlement funds would be used to create a national student loan call center and web site to provide unbiased advice. The call center and web site will be operated by the New York State Higher Education Services Corporation (HESC), the state's student loan agency. A series of public service advertisements will be created by the New York Public Interest Research Group (NYPIRG). The $13 million figure falls short of the nearly $21 million in settlements because some of the lenders became insolvent after agreeing to the settlements and were unable to make the contributions to the attorney general's fund. It is unclear how the attorney general expects HESC, an education lender, to provide unbiased advice about student loans to students and their families. HESC operates a private student loan program, the New York Higher Education Loan Program (NYHELPs), and a student loan marketplace, representing a potential conflict of interest. The New York Attorney General previously criticized lender-operated call centers in his April 25, 2007 testimony before the US House of Representatives Education and Labor Committee: "The student calling or emails their questions rightfully expected to receive disinterested advice and information regarding lenders. These lender call center employees, however, have an interest in advocating on behalf of the lender that pays them."

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:

  • The definition of lender does not include guarantee agencies, institutions of higher education, or governmental entities. (The exclusion of institutions of higher education would seem to except School as Lender schools from the rules that apply to lenders.)
  • There is no definition of "nominal value" with regard to gifts.
  • It does not ban lender gifts to family members of college employees.
  • It does not address consulting arrangements.
  • Unpaid service on lender advisory boards by financial aid administrators is permitted. College employees who are not financial aid administrators are permitted to partake of paid lender advisory board service, provided that they recuse themselves from any discussions of the college's financial aid operations.
  • It does not address lender call centers and lender staffing for exit and entrance interviews.
  • The restrictions on opportunity loans emphasize a quid pro quo relationship and only "if such alternative loan programs prejudices other students or parents". It seems to allow an exception for opportunity loans for international students, although footnote 7 in item 4 bans trading off benefits on one loan for placement of another in the preferred lender list.
  • It does not require a minimum number of lenders on the preferred lender list.
  • The required disclosure of forward purchase agreements in the 8th bullet of item 4, "where to find information on any agreements by 'preferred lenders' to sell their loans to other lending institutions" does not require the forward purchase agreements to be disclosed in the preferred lender list itself, but rather by reference to a separate source of such information. Likewise for the disclosure of the terms of the lender's loans.
  • Colleges are required to disclose the process and criteria used to select preferred lenders, along with the relative importance of the criteria. But there is no requirement that colleges disclose why each specific lender was included in the list. The code of conduct does not require the order of the lenders on the list to be based solely on the best interest of the students and parents, just the selection of lenders on the list.
  • The code of conduct does not ban colleges from packaging first-time borrowers to particular lenders or prefilling loan applications and promissory notes with a particular lender's name.
  • The ban in item 3 concerning lender use of the school's name, mascot or logo in a manner that creates the impression that the lender is "an employee or agent of the University" does not seem to ban private labeling of a lender's private student loan with the college's name, mascot or logo.
  • It does not discuss revenue sharing with the school's alumni association, only revenue sharing with the school.

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.

On October 24, 2008, the Iowa Attorney General announced a memorandum of understanding with the state loan agency, Iowa Student Loan, and released a report concerning the state loan agency's marketing practices.

Financial Settlements

These settlement figures include amounts refunded to borrowers.

CIT Group (Student Loan Xpress) $3 million
Citi Student Loans $2 million
College Board $675,000.00
College Loan Corporation $500,000
Education Finance Partners $2.5 million
Goal Financial $350,000
Nelnet (NE AG) $1 million
Nelnet (NY AG) $2 million
Sallie Mae $2 million
Student Financial Services (University Financial Services) $60,000
Campus Door, EduCap, GMAC Bank, Graduate Loan Associates, Nelnet, NextStudent and Xanthus Financial Services $1,400,000
Subtotal - Lenders $15.485 million
 
Career Education Corporation $21,200.00
Columbia University $1.125 million
DeVry University $88,112.00
Drexel University $250,053.34
Emerson College $780,000.00
Fordham University $13,840.00
Johns Hopkins University $1.125 million
Long Island University $2,435.41
Mercy College $5,000.00
New York University (NYU) $1,394,563.75
St. John's University $80,553.00
Syracuse University $164,084.74
Texas Christian University $13,883.00
University of Pennsylvania $1,617,580.00
Fairfield University (CT) $28,000.00
Sacred Heart University (CT) $25,000.00
Trinity College (CT) $22,000.00
Subtotal - Colleges $6,756,305.24
 
Total $20,841,305.24

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 (New York Education Laws, Title 1, Article 13-B (620-632), 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. He resigned in September 2008. The Washington Examiner reported on November 1, 2009 that Mr. Fontana has been charged with "conflict of interest and false writing", both misdemeanors, in connection with the reporting of his holdings in the lender on financial disclosure forms and alleged influence peddling. The Chronicle of Higher Education reported on November 2, 2009 that a plea agreement filed on October 29, 2009 includes an agreement to pay a fine of $85,000 to $115,000 but would not include any prison time.

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.

Office of the Inspector General, US Department of Education

On January 5, 2009, the Office of the Inspector General (OIG) at the US Department of Education released an audit of Fifth Third Bank's eligible lender trustee agreements. The audit report finds that Fifth Third Bank violated the prohibition on providing inducements. Specifically, the OIG alleges that the bank and Student Loan Xpress agreed to pay three lenders a premium on loans originated under the ELT agreements. (The three lenders were MSA Solution, Inc., Pacific Loan Processing, Inc. and Law School Financial. Fifth Third Bank had ELT agreements with as many as 15 lenders. However, only these three ELT agreements involved a third party, Student Loan Xpress. The OIG is recommending further review of the other ELT agreements.)

The premiums paid were based on each borrower's loan balance, ranging from 1.6% on a $10,000 loan to 4.85% on a loan of $65,000 or more.

An ELT agreement allows a lender that is not authorized to participate in the federal education loan programs to make loans through a lender, the trustee, that is authorized to participate.

The OIG report recommends terminating the eligibility to participate in the FFEL program for Fifth Third Bank's three ELT agreements. It also recommends taking other actions against Fifth Third Bank, which could include fining Fifth Third Bank, requiring reimbursement of amounts paid for default claims, interest and special allowances, initiating a limitation, suspension or termination proceeding and/or withholding the federal guarantee on the $3.1 billion in loans originated under the ELT agreements. (All three ELT agreements have already been terminated. The lender ids for the other ELTs have also been terminated.)

The OIG report argues the payments made under the ELT agreements represented payments for loan applications and not payments for loans already made, and as such represented a violation of the prohibited inducement rules. The ELT agreements specified that the trusts would only originate and hold consolidation loans to be sold to Student Loan Xpress and that the loans would be "sold" on the day they were disbursed. The OIG report alleges that the role of the three lenders was limited to "securing of loan applications (marketing) and obtaining loan verification certificates" and that there was not an arms-length sale of the loans.

Fifth Third Bank disagrees with the findings and recommendations, pointing out that the same form versus substance issues that arose in SLMA v. Riley 112 F. Supp. 2d 38 (D.D.C. 2000) apply in the present situation. (However, that decision was focused on whether School as Lender should be considered a prohibited inducement, and depended in part on Congress's passing legislation that specifically authorized the School as Lender program. It does not necessarily apply to other types of inducements. In addition, the OIG argues that the fact that the three lenders were not eligible lenders is a material difference in the present case. In all likelihood, consideration of issues of form versus substance as they apply to ELT lenders and whether the compensation was for loans or loan applications will be at the center of any further proceedings stemming from this audit report.)

Fifth Third Bank also argues that the premiums paid to the three lenders were similar to premiums typically paid to non-ELT lenders for acquiring loans and so do not rise to the level of a prohibited inducement. They also argue that a plain language read of section 435(d)(5) of the Higher Education Act and previous Department interpretations do not prohibit this sort of activity. (This argument is contradicted by DCL 89-L-129 and the discussion in the preamble to the November 1, 2007 Final Regulations.) Student Loan Xpress also disagrees with the findings and recommendations. Among other matters, they argue that the prohibition on securing loan applicants does not prohibit compensation for marketing activities. The OIG counters that the ELT agreements were not constructed to compensate for marketing activities but rather for securing completed loan applications. Also at issue is whether marketing compensation on a per application basis is permitted.

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:

  • explicitly require preferred lender lists to contain at least three lenders
  • require disclosure of the criteria used to compile the preferred lender list
  • require a statement that the borrower is not required to use a lender from the preferred lender list
  • prohibit colleges from assigning first-time borrowers to a specific lender or guarantor as part of the financial aid package
  • prohibit delays in the loan certification process based on the borrower's choice of lender not on the preferred lender list
  • provides an exhaustive list of allowable and prohibited practices and services that lenders may provide to students, colleges and other lenders

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:

  • More of an emphasis on the quid pro quo nature of payments or other benefits in exchange for loan applications, application referrals, or specified volume or dollar amount of loans made, or placement on preferred lender lists.
  • Emphasizes that emergency staffing is a one-time nonrecurring event.
  • Includes financial literacy outreach in addition to student aid outreach among the permitted activities.
  • Defines school-affiliated organizations as including alumni associations, athletic associations, college foundations, and social, academic and professional organizations.
  • The language concerning "rebuttable presumptions" was expanded to explain that rebutting a presumptive violation requires presenting evidence that "the activities or payments were provided for a reason unrelated to securing applications for FFEL loans or securing FFEL loan volume".
  • Emphasizes that providing a preferred lender list is optional and that there is no requirement that a school have one, but if there is one, it must comply with the standards.
  • Requires that the minimum of three lenders on the preferred lender list must be unaffiliated with each other. The definition of affiliated focuses on ownership and control and does not address sales of loans through forward purchase agreements. Guidance from the US Department of Education has indicated that all lenders on a preferred lender list must be unaffiliated with each other and that the list must include at least three lenders.
  • Requires preferred lender lists to provide "comparative information to prospective borrowers about interest rates and other benefits offered by the lenders".
  • Requires that "any benefits offered to borrowers by the lenders are the same for all borrowers at the school".
  • Prohibits guarantee agencies from discriminating by charging additional costs or denying benefits to schools and lenders because of their failure to participate in the guarantee agency's programs or to deliver a specified volume of loans or loan applications or to put a lender that uses the guarantee agency on the school's preferred lender list.
  • Prohibits colleges from refusing to certify or delaying the certification of federal education loans based on the borrower's selection of a particular lender or guarantee agency.
  • Prohibits colleges from packaging first-time borrowers to particular lenders.
  • Permits guarantee agencies to provide travel and lodging reimbursements that are "reasonable as to cost, location, and duration" for training, "service facility tours" and to serve on official advisory boards, governing boards and "other official activities".

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.

Payment of entertainment expenses, including expenses for private hospitality suites, tickets to shows or sporting events, meals, alcoholic beverages, and any lodging, rental, transportation, and other gratuities related to lender-sponsored activities for employees of a school or a school-affiliated organization
However, 34 CFR 682.200(b)(5)(ii)(C) permits an exception for meals in connection with training and conference events.
Meals, refreshments, and receptions that are reasonable in cost and scheduled in conjunction with training, meeting, or conference events if those meals, refreshments, or receptions are open to all training, meeting, or conference attendees
In regard to guarantee agencies, the regulations at 34 CFR 682.401(e)(1)(i) parallel the prohibition on lender-provided entertainment.
Payment of entertainment expenses, including expenses for private hospitality suites, tickets to shows or sporting events, meals, alcoholic beverages, and any lodging, rental, transportation or other gratuities related to any activity sponsored by the guaranty agency or a lender participating in the agency's program, for school employees or employees of school-affiliated organizations
However, the regulations at 34 CFR 682.401(e)(2)(iii), (iv) and (iv) provide for exceptions that are more permissive than the regulations for lenders. (The paragraph label 'iv' is repeated in the May 31, 2007 document.)
(iii) Meals and refreshments that are reasonable in cost and provided in connection with guaranty agency provided training of program participants and elementary, secondary, and postsecondary school personnel and with workshops and forums customarily used by the agency to fulfill its responsibilities under the Act;

(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:

  • Modified the list of permissible activities to permit the US Department of Education to identify and approve additional permissible activities in the future through publication of a Federal Register notice.
  • Clarified that prohibited "processing" fees do not include fees paid to satisfy the requirements of other federal or state laws.
  • Clarified that there is no distinction drawn in the new regulations between loan applications and loans funded or disbursed with regard to the payment of referral fees. Referral fees are now banned for both, in part because the existence of the Master Promissory Note blurs the distinction.
  • Continued to emphasize that prohibited inducements must involve a quid pro quo relationship ("in exchange for").
  • Clarifies that state and public service loan forgiveness programs (e.g., nursing loan forgiveness programs offered by state loan agencies) do not represent a prohibited inducement so long as they are not marketed to secure loan applications or loan guarantees.
  • Specifically bans lenders from soliciting school employees for paid advisory board service.
  • Defines "reasonable cost" in terms of the "prudent person test", namely the per-person cost that would normally be incurred by a prudent person for his/her own benefit. Also notes that a "reception" must be open to all conference or meeting attendees, held in conjunction with the conference or meeting, and generally be held at the conference site. Modifies the regulations to require that meals, refreshments and receptions sponsored by guarantee agencies be reasonable in cost.
  • Bans lenders and guarantee agencies from participating in entrance and exit counseling. Clarifies that the regulations do not ban lender participation in student aid and financial literacy outreach programs. Requires that the name of the entity that developed and paid for the outreach program materials be disclosed to participants and that the lender does not promote its student loan or other products and services as part of the outreach program.
  • Defines emergency basis (in connection with the provision short-term, non-recurring emergency staffing services) as limited to a federally-declared national disaster, a state or federally-declared natural disaster, and localized disasters or emergencies identified by the Department.
  • With regard to preferred lender lists, clarifies that the rules (including the three-lender minimum) apply to each preferred lender list if the school has more than one preferred lender list.
  • Requires preferred lender lists (and accompanying information) to be updated at least once a year.
  • Clarifies that financial benefits are not the only criteria that a school may consider in creating its preferred lender list. In particular, cites "the quality of a lender's customer service in loan origination and loan servicing, its effectiveness in providing consumer information, counseling and debt management services, and its delinquency and default prevention efforts" as appropriate factors that can be considered.
  • Backpedaled on Jeff Baker's public statement that affiliated lenders would include post-disbursement forward purchase agreements, loan portfolio sales and secondary market activity. Instead, it would be limited to affiliates that are under common ownership and control.
  • Struck lender trustees from the definition of affiliated lenders.
  • Clarified that the list of permitted activities for lenders in 34 CFR 682.200(b) should not be considered by schools when they are compiling their preferred lender lists.
  • Permits lenders to offer different borrower benefits based on the school attended by the borrower. Struck the requirement that lender benefits must be the same for all borrowers at a school, thereby allowing lenders to offer different benefits to students at a school based on their program, debt level and state restrictions (e.g., state residency), among other criteria.

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.

  • Schools that are unable to identify at least three lenders that will make loans to the school's students and parents may provide a list of all of the lenders that are willing to make FFEL loans to the school's students and parents. Such a list must make clear that it is not an endorsement of the lenders and that borrowers can choose any FFEL lender.
  • Schools may provide a comprehensive list of all lenders that have made loans to the school's students and parents in the last 3-5 years and which have indicated that they will continue to make such loans. Such a list cannot include any additional information about the lender. The list must make clear that borrowers can choose any FFEL lender.
  • The requirement that the list must include at least three unaffiliated lenders means that at least three lenders on the list must be unaffiliated with each other. The Department recommends, but does not require, that any known affiliations be disclosed as part of the preferred lender list.

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 supporting documentation (38 mb, 530 pages) and press release (alternate). The report refers to the problems as widespread ("systemic") and not isolated to a handful of colleges. The report argues that inducements are inappropriate regardless of whether an explicit quid pro quo arrangement exists since it taints the relationship and interferes with the trust families place in the integrity of the college's representation of their best interests. The report describes several new inappropriate practices and provides details about others, including:

  • A college soliciting and receiving payments from lenders to appear on the preferred lender list on the college's web site.
  • Lender sponsorship of golf tournaments, t-shirts & sweatshirts, USB flash drives, yoyos, alcohol, catered lunches, meals at expensive restaurants, spa treatments and other items and entertainment for individual colleges.
  • Lenders providing expensive printing services to colleges, including printing and directly manipulating the school's preferred lender list.
  • Lenders using entrance and exit counseling sessions and loan workshops to market their loan products.
  • Lenders providing colleges with free legal services.
  • Lenders using advisory board membership as a marketing ploy to influence college financial aid administrators and gain market share.
  • Lenders linking school-as-lender deals with presence on preferred lender lists for undergraduate, PLUS and private loans.
  • Lenders paying financial aid administrators to lobby Congress on their behalf and to influence financial aid administrators at other colleges.

On September 4, 2007, Senator Kennedy issued a second 50-page report on lender ethics entitled Second Report on Marketing Practices in the Federal Family Education Loan Program. See also the supporting documentation (15mb, 312 pages) and press release. The report discusses additional practices not discussed in the first report, including:

  • Use of donations (including the donation of scholarship funds and sponsorship of events) in exchange for FFELP loan volume or placement on a school's preferred lender list. In some cases the donations were solicited by college personnel.
  • Leveraging existing commercial banking relationships with a college to gain student loan market share.
  • Use of opportunity loans (private student loans that waive the traditional credit-based underwriting criteria) to obtain FFEL exclusivity, placement on the preferred lender list or other methods of steering FFEL market share. Such loans are treated by the lenders as a loss leader due to the high default rate of such loans resulting negative yield.
  • Providing tickets to athletic events to college personnel.
  • Use of "value-added services" (printing, financial aid office staffing, call centers) to obtain FFEL loan volume and placement in the preferred lender list.
  • Use of exit and entrance counseling to market student loan products.
  • Payments from lenders to guarantee agencies in exchange for FFEL loan volume.
  • A school-as-lender school excluding lenders with better borrower benefits from the school's preferred lender list because they would compete with the school-as-lender product. Another school-as-lender school enterring into an agreement to exclusively recommend a particular lender's consolidation loan product.
  • Schools steering borrowers to particular lenders or away from zero-fee loans.
  • Use of alumni association affinity agreements to obtain consolidation loan volume.
Several of the practices detailed in the report are clear violations of the rules concerning prohibited inducements. The report calls for "vigorous enforcement of existing law" in order to "end these flagrant abuses and protect the interest of millions of parents and students struggling to afford a college education".

Other press releases from Senator Kennedy's office include:

On March 30, 2007, Rep. George Miller, chairman of the House Education and Labor Committee, also sent a letter to five education lenders asking for information about their relationships with colleges. Rep. Miller has also been conducting his own investigation into the student loan scandal.

On April 23, 2007, Rep. Howard "Buck" McKeon, ranking member of the House Education and Labor Committee, introduced the Financial Aid Accountability & Transparency Act of 2007 (H.R. 1994). The legislation would require a minimum of three unaffiliated lenders on each preferred lender list, disclosure of the criteria used to select lenders for a preferred lender list, and disclosure that borrowers are not required to use lenders recommended by the school. Schools in the Direct Loan program would also be required to disclose why they chose Direct Lending over the FFEL program. The legislation also requires colleges to establish a code of conduct that limits gifts, payments and financial benefits (including stock) from lenders and guarantee agencies to college employees and officers. It would also prohibit any payments or financial benefits from lenders and their affiliates to any employee of a college's financial aid office (or other employee with responsibilities involving student aid). It would permit informational brochures, reimbursement for travel, lodging and meals in connection with service on advisory boards (limited to one night and two days), and training. The legislation would ban revenue sharing or other material benefits to colleges and their employees from any lender recommended by the college. It would also ban colleges from accepting call centers and staffing assistance from lenders. It permits colleges to negotiate with lenders for better rates and fees for their students and parents. It requires private student lenders to clearly and conspicuously disclose the availability of federal student aid, including federal loans, to prospective borrowers.

On May 1, 2007, Rep. George Miller, Chairman of the House education committee, asked the White House and the US Department of Education to turn over all communications relating to the federal student loan program. This is part of Rep. Miller's ongoing investigation into the student loan scandal.

On May 2, 2007, Rep. George Miller, Chairman of the House education committee, sent a letter to the Federal Trade Commission asking the FTC to investigate "unfair and deceptive" marketing practices by education lenders.

On May 2, 2007, Sen. Michael B. Enzi, the ranking member of the Senate education committee, introduced a bill which would bar colleges from using preferred lender lists and which would phase out the school as lender program. The Student Loan Accountability and Disclosure Reform Act (S.1262) would also include "stock or other securities, prizes, travel, entertainment expenses, tuition repayment" as well as referral fees and additional financial aid funds within the list of prohibited inducements, ban paid service of financial aid administrators on lender advisory boards, ban lenders from entering into consulting arrangements with financial aid office staff and other college staff with oversight over student loans and student aid. The legislation would also require colleges to establish a code of conduct that bans revenue sharing, lender-paid gifts and trips of more than nominal value, consulting arrangements with lenders, and advisory board compensation beyond reasonable travel expenses. It would also require disclosures of lender forward-purchase agreements and that students have the right to select the lender of their choosing. It would also ban preferential packaging of first-time borrowers to particular lenders.

On May 4, 2007, Rep. Miller, Chair of the House education committee, announced that the Inspector General at the US Department of Education launched an investigation into potential conflicts of interest among Department employees with oversight over student loans.

On May 9, 2007, the US House of Representatives passed the Student Loan Sunshine Act (HR 890) (summary) by a vote of 414-3. The act includes the following provisions:

  • Requires colleges to establish and publish a code of conduct that prohibits conflicts of interest and the appearance of a conflict of interest with regard to student loans and financial aid. The code of conduct should include provisions to ensure compliance with the Sunshine Act.
  • Bans gifts from lenders, guarantors and servicers to any officer, employee or agent of a college, or to their family members. Gifts are defined to include any gratuity, favor, discount, entertainment, hospitality, loan or other item worth more than a "de minimus" amount. (Previous versions of the act specified $10 as the threshold. The use of a vague term allows for the threshold to be specified in regulations and adjusted periodically.) The definition includes gifts of services, transportation, lodging, meals. There is an exception for loan brochures and financial literacy materials. There are also exceptions for informational material and food provided in connection with a training session, for loans offered to students employed by the college (provided that the same terms are available to all students), and lender-neutral exit counseling services.
  • Bans financial aid administrators and other employees and officers with oversight over student loans and financial aid from receiving a fee or payment or other financial benefit (including stock) for consulting services or service on an advisory board.
  • Bans financial aid administrators from serving on lender advisory boards, although an exception is made to permit colleges to provide advice on improving products and services for borrowers, provided that there are no gifts or compensation (including transportation and lodging).
  • Bans referral fees and revenue sharing agreements between lenders and colleges and their employees where the college recommends the lender or loan products of the lender.
  • Bans opportunity loans in exchange for "concessions or promises" by the school to the lender (e.g., quid pro quo).
  • Bans lenders from providing staffing assistance and call centers to colleges. Exceptions are made for providing professional development training to financial aid administrators and for providing counseling, financial literacy and debt management materials to borrowers.
  • Colleges are required to disclose on any preferred lender list involving FFEL Stafford, PLUS or consolidation loans:
    • Why each lender was selected as a preferred lender, highlighting any terms and conditions favorable to the borrower.
    • That students and parents are not required to borrow from a lender on the preferred lender list.
  • Preferred lender lists are required to include at least three unaffiliated lenders and to disclose affiliate relationships among the lenders. (Affiliate is defined in terms of control and does not include forward purchase agreements in which one lender has agreed, in advance, to sell the loans it originates to another lender.)
  • Preferred lender lists must be created exclusively with the borrower's best interest in mind.
  • Prohibits colleges from denying or otherwise impeding a borrower's choice of lender or causing unnecessary delays in loan certification for lenders not recommended or suggested by the college.
  • Colleges who have a preferred lender list are prohibited from allowing lenders to use the name or logo of the institution in any way which implies that the institution endorses the private education loans of the lender.
  • Colleges are required to disclose to prospective borrowers their options for borrowing and other assistance under Title IV (including Stafford and PLUS loans), including information the terms of any loans that are more favorable to the borrower.
  • Lenders are required to disclose, for each college, the average amount borrowed by students at the college during the previous year, disaggregated by type, and the average interest rate on such loans (including APR).
  • Lenders are required to disclose for each college their philanthropic contributions to the college, in addition to other relationships.
  • Lenders are required to disclose, in connection with any solicitation, marketing or advertisement relating to a private student loan, that borrowers may qualify for federal student aid. The disclosure must include the interest rates on federal loans and the private loans, including how the interest rate on the private student loans is determined.
  • Before a lender can disburse a private student loan, the lender is required to notify the college about the amount of the loan. The college, in turn, is required to notify the borrower about their remaining options for borrowing from federal loan programs. Existing guidance dictates that if a college is aware of a private student loan, the college must consider it an overaward to the extent that it exceeds cost of attendance minus other aid.
  • The act applies not just to colleges and universities, but also to alumni associations, booster clubs and other affiliates of the institutions.
  • Establishes penalties for violating the terms of the act.
  • Lenders are required to certify compliance with the act annually.

The Student Loan Sunshine Act was incorporated into the Higher Education Opportunity Act of 2008 (HR 4137, P.L. 110-315) which was signed into law on August 14, 2008. Section 402(f) of the technical corrections to the Higher Education Act of 1965 (HR 1777, P.L. 111-39) amended sections 428(b)(3)(A)(i) and 435(d)(5)(A) of the Higher Education Act of 1965, inserting "any individual or entity" after "any institution of higher education or the employees of an institution of higher education" in the prohibited inducement statutory language, yielding final language that is consistent with the existing US Department of Education regulations: "offer, directly or indirectly, premiums, payments, stock or other securities, prizes, travel, entertainment expenses, tuition payment or reimbursement, or other inducements to -- (i) to any institution of higher education, any employee of an institution of higher education, or any individual or entity in order to secure applicants for loans under this part".

Associations

On April 26, 2007, the Association of American Universities announced that its members had agreed to a Statement of Principles on Relationships with Student Loan Providers. The statement uses the word "should" and not "must" and is less specific than the New York Attorney General's Code of Conduct.

During the April 2007 meeting of the board of directors of the National Association of Student Financial Aid Administrators (NASFAA), the board drafted a proposal to ban lender sponsorship of receptions and other events at its national conference. The proposal would allow lenders to contribute to a general sponsorship fund and to exhibit at the conference.

On May 31, 2007, the National Association of Student Financial Aid Administrators (NASFAA) agreed to adopt a Code of Conduct for Institutional Financial Aid Professionals, expanding on the association's April 1999 Statement of Ethical Principles, and to implement changes in its national conference. The code of conduct provides detailed practical guidance for financial aid professionals to implement the association's ethical principles, with special focus on avoiding actual, potential or perceived conflicts of interest. It recognizes that the mere appearance of a conflict of interest is problematic and should be avoided. It emphasizes that a financial aid administrator's decisions and advice must always be accurate, transparent and objective and disconnected from personal benefit or gain. It bans gifts of more than nominal value ($10) and any other form of remuneration from student loan businesses and other entities, including a ban on reimbursement of expenses for service on an advisory board or as part of a training activity, entertainment, expense-paid trips and club memberships. The gift ban includes financial aid administrators and their family members. It requires financial aid administrators to disclose to their institutions "any involvement with or interest in any entity involved in any aspect of student financial aid".

The code of conduct establishes the following principles with regard to preferred lender lists:

  • Financial aid administrators must ensure that students and parents understand that they are free to choose any lender, not just those recommended by the college.
  • Colleges must fully disclose the process by which lenders are selected for the preferred lender list.
  • The selection of lenders for a preferred lender list must focus solely on the best interests of the borrower.
  • Inclusion of a lender on a preferred lender list must be based solely on the merits of the loan in question and not on external factors such as benefits provided to the institution or its employees or to students "in connection with loans not covered by such list", such as opportunity loans.
  • Colleges must certify the loans selected by a borrower without delay.
  • The preferred lender list must provide detailed information about the loan products offered by the lenders, including information about interest rates, fees, terms and conditions, discounts and other benefits, and quality of customer service.
  • The master promissory note and other institutional policies and procedures must preserve a "student's right to select the lender of his or her choice".
  • Lenders included on a preferred lender list must disclose agreements to sell their loans to other entities.

The NASFAA Exhibits Sponsorship Policy limits permitted activities at the association's conferences and advertisement in NASFAA publications. The limitations serve to distance exhibitors and sponsors from conference attendees and association members, helping to prevent both actual conflicts of interest and the appearance of a conflict of interest. It bans all prize drawings, including scholarships, and gifts or give-aways of more than nominal value. It bans lenders and exhibitors from sponsoring or organizing social activities for conference attendees, named sponsorship of conference activities and events, and tiered recognition of sponsorship levels. (Sponsors will be listed in alphabetical order.) Non-social events such as focus and advisory group meetings are permitted. Exhibitors may not sell products and services at the Financial Aid Business Solutions Seminars. Only non-alcoholic beverages and light snacks are permitted.

On August 2, 2007, NASFAA submitted comments on the proposed regulations. NASFAA opposed the proposed regulations on preferred lender lists and prohibited inducements, arguing that implementing such regulations is premature given pending federal legislation. NASFAA also made suggestions for changes in the regulations, including:

  • Waive the three-lender minimum for colleges with less than 150 borrowers.
  • Modify the ban on lender inclusion in the preferred lender list to allow schools to include lenders who provided benefits specifically allowed by 34 CFR 682.200(b)(5)(ii).
  • Permit lenders and guarantee agencies to perform exit and entrance counseling provided that there is no marketing of loan products.
  • Express concern about regulations that may limit lender/guarantor participation in educational outreach, early awareness and financial literacy efforts.

On August 22, 2007, the College Board announced that it was ending its student loan program. The College Board had previously received fees from education lenders such as Sallie Mae and Citi to market their student loans under the College Board brand. The new conflict of interest rules would prohibit education lenders from reimbursing college personnel for travel and lodging expenses to travel to meetings. Since the College Board depends heavily on volunteers, the new rules would have interfered with its ability to hold meetings attended by college personnel nationwise.

On January 28, 2008, the American Council on Education (ACE) released a Working Paper on Conflict of Interest to provide advice to colleges on conflict of interest policies. This working paper addresses conflict of interest policies in a broader context than just the student loan arena. As such, it is somewhat less specific than a more-targeted discussion of potential lender-college conflicts of interest, although it does such issues as the difference between ethical and legal standards, policies intended to minimize the perception of a conflict in addition to actual conflicts, and the core notion that a conflict may influence or impair judgment. Some of the key recommendations include:

  • Conflict of interest policies should be written.
  • Require disclosure of significant financial interests involving "outside organizations that do or seek to do business with, or may otherwise benefit from association with, the institution, where the individual has actual or apparent influence over an institutional decision that may affect the organization".
  • Conflict of interest policies should require review of the disclosures by the institution's management and specify procedures for addressing conflicts of interest.
  • Annual notification of the institution's staff of the conflict of interest policies.
  • Periodic review of conflict of interest policies and practices.
The document includes a good collection of links to related resources on conflict of interest policies.

On June 17, 2008, the American Medical Association (AMA) adopted policies requiring medical schools to inform students about government education loans in addition to private student loans and to disclose the criteria used to select preferred lenders.

On December 8, 2008, the New York and Connecticut attorneys general announced settlements with the College Board in connection with the College Board's lending activities. (The College Board had previously announced on August 22, 2007 that it was exiting the student loan business.) The attorneys general alleged that the College Board had given colleges discounts on its financial aid products and services in exchange for preferred lender list placement for the College Board's student loans. According to the settlement, the College Board has agreed to invest $675,000 to develop a set of tools to help financial aid administrators and families "compare student loan offers and identify the lowest-cost student loan options". As part of the agreement the College Board will develop two student loan calculators. One will help families compare loans from different lenders. The other will help college financial aid administrators provide advice about loans that is individually tailored to the specific student's needs. The College Board has also agreed to adhere to the Attorney General's Direct-to-Consumer Marketing Code of Conduct if the College Board ever decides to re-enter the student loan market.

Similar Abuses in Other Areas

Study Abroad. On August 15, 2007, NAFSA: Association of International Educators announced that it would launch a task force to examine current practices in the management of study abroad programs and to recommend guidelines for the industry. This move comes in the wake of a New York Times article about college financial relationships with third party providers of study abroad programs. The New York Times reported about such questionable practices as free travel to foreign destinations, revenue sharing and assistance with back-office expenses. The students whose participation generates these perks are not necessarily receiving the benefits. These perks and other anti-competitive practices may result in higher prices being paid by students. Moreover, there is concern that colleges may be restricting student choice for business reasons by denying financial aid or college credit for courses the students obtain on their own. The New York Attorney General has launched an investigation into these practices, issuing subpoenas to study abroad program providers.

Colleges

On May 14, 2007, the University of Texas at Austin announced that it has fired Lawrence W. Burt, Associate Vice President and Director of Student Financial Services. The university also released the 33 page report on the investigation into allegations of improper conduct by Dr. Burt and the UT Austin financial aid office. Dr. Burt had previously resigned from the Advisory Committee on Student Financial Assistance (ACSFA) over allegations that he had received stock from Student Loan Xpress.

The UT Austin report recommends that preferred lender lists be created using guidelines such as choosing lenders that provide the maximum benefit to the greatest number of borrowers, using and disclosing objective criteria for creating the lists, listing lenders in alphabetical order or rotating the lists on a regular basis, and having an objective third party audit the list creation process. The report also recommends requiring all financial aid staff to disclose, on an annual basis, all interests and relationships with education lenders regardless of value. The report recommends instituting a temporary ban on service on lender advisory boards. The report recommends requiring senior financial aid staff to complete annual financial disclosure and conflict of interest statements. These recommendations are intended to improve the transparency, accountability and ethical management of the financial aid office.

On May 21, 2007, Johns Hopkins University announced that Ellen Frishberg, director of student financial services, had resigned on Friday, May 18, 2007. The university reported that while one of her consulting relationships had been approved, others had neither been disclosed nor approved according to university policy. Some of the lenders had been on the college's preferred lender lists and others had not. The university stated that "it found no evidence that any student or parent borrower was harmed financially because of any arrangement between Frishberg and a lender". The university had previously dropped all preferred lender lists on April 25, 2007. Dr. Frishberg issued this statement through her attorney: "During the last 18 years, Dr. Frishberg, a national leader in the field of higher education administration, served the university, its students and their parents with dedication. At all times, her priority was to open the doors to higher education to worthy students. She never intended to do anything that would be perceived as harmful to either Johns Hopkins University, its students or their parents, and has always acted in good faith."

On May 21, 2007, Columbia University announced that it had fired David Charlow, its director of financial aid. Colubmia University had put him on paid leave in early April after Higher Education Watch reported that he owned 7,500 shares of stock in the parent company of Student Loan Xpress (SLX), an education lender. Columbia stated that Mr. Charlow had "violated the university policy on conflicts of interest".

On May 29, 2007, the University of North Carolina system adopted rules requiring a minimum of three lenders on any preferred lender list (including at Direct Loan schools), disclosure of the process by which the list is compiled, disclosure that borrowers have the right to choose any lender, and annual review of the lender list. The rules also require disclosure of federal aid eligibility to private loan borrowers, bans the use of university name and trademarks by lenders, and bans lender gifts to personnel involved in admissions, financial aid and student loans. They also ban quid pro quo gifts to the university from lenders. Conference travel must be paid by the campus or individual, not a lender. The new policy bans exclusive agreements with FFELP lenders and Direct Loans, requiring any school that participates with Direct Loans to also participate in FFELP. The policy bans preferred student loan consolidation arrangements with any lender by campuses and "associated entities".

On May 31, 2007, USC announced that Catherine C. Thomas, its director of financial aid, had retired. The university had previously put her on paid leave after it was reported that she owned 1,500 shares of stock in Student Loan Xpress's parent.

On June 6, 2007, Capella University announced that it had fired Tim Lehmann, its financial aid director, effective the end of the third quarter of 2007. Capella University had put him on paid leave in April after it was reported that he had be paid by Student Loan Xpress for consulting. Capella University had previously signed settlements with the New York and Minnesota attorneys general in May.

On June 6, 2007, Widener University announced that Walter Cathie, its assistant vice president for finance, had retired. Widener University had put him on paid leave in April after it was reported that his consulting firm, Key West Higher Education Associates, had received payments from Student Loan Xpress and other lenders for sponsorship of the school as lender conferences.

On June 8, 2007, the University of Wisconsin Board of Regents adopted rules banning revenue sharing, paid advisory board service, and reimbursement of travel expenses for meetings. The rules also require a minimum of three lenders on any preferred lender list and disclosures that students are not required to borrow from a lender on the preferred lender list.

On June 15, 2007, Emerson College put Daniel Pinch, its dean of enrollment, on paid leave according to a report in the Boston Globe. The development came after a US Senate report (page 48) revealed that he had received payments from Collegiate Funding Services (CFS), an education lender that is now part of J.P. Morgan Chase. The report alleges that "CFS was on the preferred lender list at Emerson during this period" from July 2001 to July 2003. Daniel Pinch disputes this. However, a January 31, 2002 archived copy of the Emerson College loans page, which was located at www.emerson.edu/fin_aid/new/pages/loans/loans_01.html, recommends consolidation loans from CFS. On June 20, 2007, Emerson College fired Daniel Pinch, according to a report in the Boston Globe.

On June 22, 2007, the University of Maryland system's Board of Regents voted to endorse the Maryland Attorney General's code of conduct, asking all 11 campuses to adopt the code of conduct. The Maryland code of conduct is similar to the one proposed by the New York Attorney General.

Public Policy Advocates

Consumers Union, the publishers of Consumer Reports, published a report of policy recommendations entitled Helping Families Finance College: Improved Student Loan Disclosures and Counseling (July 2007). Consumers Union interviewed more than 130 students and parents in five major metropolitan areas while developing this report. The recommendations include:

  • Providing advice on how to minimize education debt and the cost of that debt, such as "maximize scholarships and grants before using student loans", "exhausting federal loans before turning to private student loans" and "the need to shop around for federal and private student loans".
  • Providing clearer information about college costs through standardization of financial aid award letters, such as clearly distinguishing between aid that does not need to be repaid and loans and providing a standard format that allows for "easy comparison across colleges".
  • Providing plain english disclosure of student loan rates and terms, emphasizing that private student loans are more expensive than federal education loans.
  • Providing personal finance counseling and financial literacy for college students as a required supplement to existing entrance and exit counseling.
  • Publish institution-specific information about the rates and terms students received during the previous year at the institution.
  • Add private student loan information to NSLDS and then use this information to provide student-specific counseling information about all their education loans (private and federal) on the NSLDS Student Access Portal and on the Student Aid Report (SAR). The counseling information should include information about monthly payments based on the loan term and interest rates, total cost over the life of the loans, and salary ranges needed to repay the total education debt.

Tips for Avoiding Conflicts of Interest

The following are a few basic suggestions for minimizing the chances of a conflict of interest.

  • Establish or update written standards. The college's standards should equal or exceed any requirements set by state or federal law, including the US Department of Education regulations, the Higher Education Act of 1965, the New York SLATE legislation, and Sarbanes-Oxley. The standards should address not just any actual conflicts of interest, but also the appearance of a conflict of interest. It is also a good idea to establish a buffer around any rules, to minimize opportunities for confusion or misinterpretation. Ensure that the policies are easy to apply, include practical examples, and provide clear penalties for failing to comply with the standards (e.g., termination of employment). If there are multiple standards, create a stricter uniform and comprehensive college-wide standard that supersedes the individual standards. There must be clear standards because being accused of a conflict is often just as bad as being guilty, with serious ramifications for the college's reputation.

  • Question assumptions. Just because the US Department of Education hasn't enforced the rules, or a practice is in widespread use in the industry doesn't mean that it is acceptable.

  • Perform a comprehensive review of existing practices. Implement a centralized review of all institution partnerships and contracts, evaluating the potential impact on each individual stakeholder. Review all relationships, not just those affecting the financial aid office. Consider how the potential conflict might appear to an independent third party. Policies, partnerships and contracts must be in the best interests of all affected individuals, not just a group of individuals. Likewise, ask all employees to disclose their potential conflicts and to submit them for review and approval. Take proactive steps to eliminate or mitigate any potential conflicts.

  • Perform a periodic review of potential conflicts. Employees should be provided with a copy of the conflict of interest policy when hired and also annually. Employees in management positions or with oversight authority should be required to complete an annual disclosure statement. There should also be a centralized review of new partnerships for potential conflicts.

  • Provide adequate disclosure of any potential conflicts. All affected parties to a transaction must be are aware of all potential conflicts. This means providing clear and conspicuous information of any conflicts that may be contrary to their best interests.

  • Establish independent oversight and a whistleblower hotline. The reporting and review of potential conflicts, as well as enforcement of the standards, must be independent of the office or individual that is the subject of the complaint. Some colleges establish a dedicated ombudsman who reports directly to the college president or board of trustees. The ombudsman should not have any significant financial ties to the institution or be related to anybody with significant financial ties to the institution. Others engage the services of an outside compliance monitoring firm.

Additional Information

Mark Kantrowitz gave a talk entitled Preferred Lender Lists at the 2008 EASFAA Graduate and Professional Symposium in Portland, Maine, on May 17-18, 2008. The talk discussed principles for creating a preferred lender list and a review of the current and pending legislation and regulations affecting preferred lender lists.

Consensus

There is a growing consensus regarding steps to be taken concerning prohibited inducements and preferred lender lists. The following chart highlights the positions regarding key elements of the code of conduct, proposed regulations, and pending legislation.

 
 

Requirement New York Atty Gen.
Code of Conduct
New York SLATE Act of 2007 Student Loan Sunshine
(S. 486)
Student Loan Sunshine
(HR 890)
US Dept. of Education
(Proposed Regulations)
Financial Aid Accountability and Transparency
(H.R. 1994)
Student Loan Accountability and Disclosure Reform
(S. 1262)
Revenue Sharing No No   No No No No
Opportunity Loans No No   No No    
Payment/Benefits for Placement on Preferred Lender List No No   No No No No
Gifts to College Employees No No No No No No No
Paid Advisory Board Service No No No No   No No
Expense-paid "Conference" Trips No No No No No No No
Disclose Lender List Criteria/Process Yes Yes Yes Yes Yes Yes Yes
Disclose Borrower May Choose Any Lender Yes Yes Yes Yes Yes Yes Yes
Minimum of 3 Unaffiliated Lenders     Yes Yes Yes Yes  
Disclose Forward Purchase Agreements, Benefits Survive Sale Yes Yes Affiliates only Affiliates only Affiliates only    
Annual Review of Preferred Lender List Yes Yes          
P.L.L. Based on Best Interest of Borrower, Not College Yes Yes Yes Yes      
Refusal or Delay in Loan Certification for Non-Preferred Lenders No Penalty No Penalty   No No    
Lender Staff Support for Colleges, Call Centers No No   No Nonrecurring Emergency Only No  
Bans Preferred Lender Lists             Yes
Repeals School as Lender             Yes

 

 
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