Private colleges and universities will face new financial reporting requirements when the Department of Education finalizes its rules on debt relief for student loan borrowers. ED has until November 1 to finalize the new rules in order for them to go into effect July 1, 2019.
On July 31, ED unveiled new rules for relieving student borrowers—who were misled by their institutions or if their institutions have closed—of their federal debt. The proposal is set to replace a 2016 package of regulations, which had not yet gone into effect. The so-called borrower defense rules were originally created in response to the sudden closure of Corinthian Colleges, a for-profit institution that left thousands of students with federal student loan debt for degrees that they could no longer complete. Similar to the 2016 proposed regulations, the new proposal also includes provisions related to recalibrating financial responsibility ratios and redefining triggering events that might call an institution’s financial responsibility into question.
There are many differences between the 2016 proposed regulations and ED’s latest proposal. Notably, the new borrower defense rules reduce the administrative burden for institutions while still providing some relief to defrauded students. However, there are key aspects of the new proposal that go too far in limiting student eligibility for loan forgiveness. At the same time, ED’s treatment of triggering events—the events that the federal government deems as calling into question an institution’s financial responsibility—is a general improvement over those found in the 2016 proposal. However, an unforeseen proposed change to the financial responsibility ratios could be concerning for private institutions.
On August 30, NACUBO submitted comments to ED, urging the department to revisit certain elements of the proposal before finalizing the rule. In the letter, NACUBO expressed concern over (1) the curtailing of several student borrower protections, (2) the proposed financial statement disclosures, and (3) a new definition of debt obtained for long-term purposes related to financial responsibility composite score calculations as put forth in the notice.
Further, NACUBO recognized the responsibility the federal government has to protect taxpayers from the real costs of discharge relief, and fully supported ED’s undertaking to penalize institutions that are deceitful and have lied or misled students, leaving them without a degree but the burden of debt.
For both nonprofit and for-profit colleges, the proposal provides a methodology for calculating the three key composite score ratios, which is required by ED for Title IV eligibility, that aligns with accounting standards issued by the Financial Accounting Standards Board (FASB). The proposal specifically addresses sweeping accounting changes reflected in FASB Accounting Standards Update (ASU) 2016–02 (Leases) and ASU 2016–14 (Financial Statements of Not-for-Profit Entities). The specific overarching changes in the proposal would:
- Update definitions and revise ratio terminology. The proposal includes updates to appendices A (for-profit institutions) and B (nonprofit institutions) of the financial responsibility standards found in 34 CFR 668 Subpart L that contain ratio terminology revisions and definitions. New terminology and definitions are most prevalent for nonprofit institutions and are needed to conform to FASB’s nonprofit financial statement changes in ASU 2016–14.
- Introduce a new supplemental schedule. Under the new rules, institutions must provide a new supplemental schedule with their annual financial statement submission as part of the department’s EZ Audit requirement. The supplemental schedule must contain all financial elements needed to calculate the composite score ratios, reference where the information can be found in the financial statements, and be evaluated in relation to the financial statements by the institution’s independent auditors.
- Establish a six-year transition period for certain schools. This transition period is meant for institutions whose composite scores are negatively impacted by the adoption of FASB’s lease standard (ASU 2016–02). Negatively impacted institutions will include the result of capitalizing their former operating leases on the new supplemental schedule so that ratios can be calculated without the impact of FASB ASU 2016–02. (Capitalized “right-of-use” assets are considered part of an institution’s property, plant, and equipment (PP&E); the equity ratio can be negatively affected by material additions to the balance sheet that represent leased “right-of-use” assets.) Lease transition calculations will be allowed for a period of six years.
- Provide a new definition of “debt obtained for long-term purposes.”
- The new definition changes the meaning of the term “debt obtained for long-term purposes,” which includes both the short- and long-term portion of lease liabilities for lease “right of-use” assets up to the net amount of the amount capitalized for the lease. However, all debt obtained for long-term purposes used in the calculation of expendable net assets (in the primary reserve ratio) would have to be used to fund capitalized assets (PP&E or other per generally accepted accounting principles). Further, a required debt disclosure in the financial statements and referenced in the supplemental schedule must include the issue date, term, and nature of capitalized amounts and amounts capitalized.
- This final overarching requirement to relate all debt obtained for long-term purposes to capitalized assets was not recommended by the financial responsibility subcommittee during negotiations. Therefore, there was no discussion or opportunity for consensus.
Concerns With Proposed Changes
NACUBO’s greatest objection to the proposed financial responsibility changes is the return to a discontinued 1998 provision that tethered long-term debt to specific PP&E the institution had acquired for long-term purposes. In a 2003 Dear Colleague Letter (DCL), the department rolled back this definition in light of its unintended and problematic effects. It is often difficult to associate particular debt issues with the direct acquisition of PP&E, especially with second- or third-generation refinancing arrangements and contributed funds. Even in the best-case scenario, mapping back to the purpose of the original loan would pose a significant administrative burden for many institutions.
In NACUBO’s comment letter, the association expressed surprise and disappointment at ED’s proposal to examine long-term debt beyond long-term lines of credit. NACUBO asked that the department apply proposed changes only to long-term lines of credit and retain DCL guidance for all other long-term debt. Alternatively, NACUBO suggested that ED consider either requiring long-term debt be collateralized by specific PP&E or providing prospective modification to the 2003 DCL guidance.
NACUBO also has concerns with the recommendation about disclosures in the notes to the financial statements that would inappropriately create new generally accepted accounting principles, which is outside the department’s authority.
Regarding triggering events, the latest proposed rules differ from their 2016 counterparts in a number of ways. Most notably, there are fewer triggers overall and the department narrowed their scope, limiting them only to events with known and quantified impacts.
NACUBO is concerned that when tabulating composite scores the new regulations do not provide special dispensation for liabilities stemming from the now-expired Perkin’s Loan program. This omission could have a significant impact on composite scores for smaller schools, including public institutions, potentially resulting in a mandatory triggering event.
Borrower Defense to Repayment
ED’s new borrower defense rules differ significantly from the 2016 proposal in certain key areas. Notably, they would establish a uniform federal standard for a borrower’s defense to repayment, replacing the state law-based standard currently in effect. While this approach would streamline claims, it is expected to provide weaker protections to students in most states.
Affirmative Defenses and Claim Timelines
Perhaps most controversially, ED’s primary proposal limits who can file a defense against repayment claim exclusively to students who have already defaulted on their loans, potentially incentivizing some borrowers to strategically default despite the severe financial consequences. Multiple student veterans groups have raised serious concerns with this proposal, as any type of loan defaults can interfere with service members’ abilities to obtain or maintain security clearances.
ED has also floated a secondary proposal that extends relief to those with “affirmative” claims made by students who have not yet entered collection proceedings, but with higher evidentiary standards for all borrowers. Currently, borrowers must provide a preponderance of evidence to successfully have their federal loans forgiven, which the department’s primary proposal would maintain. However, the secondary proposal allowing both defensive and affirmative claims would require all borrowers to provide clear and convincing evidence, a significantly higher threshold to meet. Such a change in evidentiary standards would needlessly burden claimants without a compelling justification.
Eligibility of Borrower Defense Claims
The newly proposed regulations also establish a higher standard for school actions that make students eligible for borrower defense. ED is proposing that borrowers would have to show that an institution intentionally misled a student or acted with reckless disregard for the truth, which caused financial harm. NACUBO had some concerns with the 2016 rules, which had an overly broad definition of misrepresentation.
Group Claims and Arbitration Agreements
The new proposal will only consider individual claims, even when there is evidence that entire groups of borrowers were misled. The rules also allow colleges to make mandatory pre-dispute arbitration agreements and class-action waivers a condition of enrollment as long as schools explain these legal agreements in plain language. Under the new proposal, schools will also be permitted to deny transcripts to students with successful defense claims.
NACUBO joined the American Council on Education and a number of other higher education associations in expressing to ED, in regard to the proposed changes to the process for granting borrowers relief due to the sudden closure of, or fraud or misrepresentation by, their institution, that “we strongly support regulatory measures that are targeted, effective, and provide a necessary balance between protecting students and ensuring appropriate responsibility on the part of institutions. It is our belief that the proposed rule moves far too much in one direction, and if implemented as drafted, would further penalize borrowers for the actions of certain institutions operating in a manner contrary to the public interest.”
Timing for Final Rules
Under master calendar provisions for Title IV of the Higher Education Act, ED must issue final rules no later than November 1, for the rules to become effective at the start of the next award year—July 1, 2019. NACUBO submitted its letter in August, highlighting our concerns during the designated comment period. At this time, there is no indication whether ED will incorporate industry feedback into the final rules.