Control Fraud and For-Profit “Universities” (Et Tu, Bill Clinton?)

Control Fraud and For-Profit “Universities” (Et Tu, Bill Clinton?)

Posted on April 30, 2015 by Lambert Strether

http://www.nakedcapitalism.com/2015/04/control-fraud-profit-universities-et-tu-bill-clinton.html

By Lambert Strether of Corrente.

Corinthian University…. Sounds like Corinthian leather, doesn’t it? And Laureate… like “Poet Laureate.” The branding just reeks of class. In this post, I’ll take a look at the just-collapsed Corinthian University, and then at Laureate University, soon to issue its first successful IPO — one can only hope thatsecond time is the charm[1] — through the lens of Willam R. Black’s concept of accounting control fraud, which he has used so successfully to explain the looting the big banks did during the subprime crisis that preceded the Great Financial Crash of 2007-2008. I should say at once that I can’t make an iron-clad case, partly because my finance skillz are so rudimentary, and partly because Laureate, for reasons we will see, would be a tough nut for any researcher to crack. But the fact set certainly is suggestive!

Before delving in, I should explain that I do have priors; I come from an academic background where scholarship, as such, is a value; and I put “education” (as opposed to training) in the class of endeavors that can’t and shouldn’t be done for money; Donald Knuth’s Art of Computer Programming, written by a scholar as a labor of love, has probably benefitted society, in the aggregate, far more than anything Steve Jobs ever did. Close to (my) home, the author Stephen King came from the much-despised — by “business leaders” — English Department, and yet his charitable work greatly benefitted both the university — he was the largest donor until a corrupt President torched the relationship before punching his ticket and moving on to a higher salary elsewhere — and the state, with libraries, dental clinics, and many other good works. Liz Reisberg puts the case against for-profit universities far more politely than I would in the Inside Higher Ed (numbering mine):

(1) Clearly, for-profit post-secondary education is generating considerable revenue, but to what end? (2) What does it mean when the financial objectives of a university require that income be directed to owners and investors rather than fully invested in the further development of institutional resources, programs and infrastructure? (3) Isn’t it time for public authorities to recognize that not all activities operate best when profit is the key objective and acknowledge that there are some social services that are diminished when revenue has to be diverted to profit individuals and corporations?

To answer Reisberg’s rhetorical questions: (1) Because markets; (2) see #1; (3) yes [2]. (Of course, neo-liberal infestations in universities lead to looting by administrators and cuts for everyone else, but that’s not the same as optimizing the entire institution for profit-making.) And with that, let’s look at Black’s formula for accounting control fraud, then at Corinthian, and finally Laureate and its quondam “honorary chair,” the Big Dog, Bill Clinton.

“Black’s Formula”

Here is Black’s Formula for accounting control fraud; we might go so far as to regard it as an elite playbook.[3]

Here’s the four-part “recipe” for a fraudulent lender optimizing fictional accounting income and real losses:

1. Grow massively

2. By making awful loans at a premium yield

3. While employing extreme leverage, and

4. Providing only grossly inadequate loss reserves

Deregulation and desupervision are more extreme in some industries and regions and certain assets provide superior “ammunition” for accounting fraud. If entry is relatively easy (and it was ridiculously easy for mortgage banking and loan brokers), then accounting control frauds will cluster in particular asset categories, industries, and regions.

From the fraudster’s perspective, the appeal of control fraud is that it’s a “sure thing.” Black explains:

The accounting control fraud “recipe” for a lender, or purchaser of loans, explains why this is true and why it produces the three “sure things.” The fraud recipe guarantees (1) record (albeit fictional) reported profits in the near term, (2) the controlling officers will promptly be made wealthy by modern executive compensation, and (3) and the lender (purchaser) will suffer severe losses, though it will only recognize those losses years later.

So first, let’s take Black’s Formula and apply it to for-profit universities like Corinthian or Laureate. Since the for-profit universities are not banks, they cannot employ leverage, and do not have loan reserves; we will need to vary the formula from that used for the savings and loan or housing industries; suit the honey to the particular bee, as it were. Steps 2, 3 and 4 would read as follows:

2. By originating awful student loans

3. With crapified programs and/or predatory tuition

4. Leaving the student loan guarantor holding the bag

Note that the lack of leverage means that the take from these frauds can’t balloon to the volume of takings in the foreclosure crisis before the bubble, and there are no bailouts, so there’s no massive upward transfer of wealth to an entire class of financiers. However, the profits would be sufficient to provide owners and administrators and the providers of professional services with a reasonable lifestyle. And the relation between the scale of the looting and the scale of damage to human lives isn’t necessarily linear. Many thousands of students were damaged by Corinthian alone, and the damage will persist through the rest of their lives.

Corinthian

If you follow the news, you know that for-profit “university” Corinthian has just collapsed, leaving thousands of students in the lurch for whatever putative education Corinthian would have given them, as well as in debt, often deeply, and the Federal government holding the bag for any student debts that cannot be repaid. Corinthian damaged a lot of students:

16,000 students in California and across the country face grim choices after being displaced by the sudden closure of Corinthian’s remaining campuses. A U.S. Education Department statement called it “the largest college shut-down in American history.”

And took down a lot of campuses:

The schools will close effective Monday. They include 13 Everest College and WyoTech campuses in California, along with 12 Heald College campuses in California, Hawaii and Oregon. Corinthian will also close Everest colleges in Phoenix and Rochester, N.Y., along with an online division in Tempe, Ariz.

Innovation! (Hilariously, the Department of Education referred Corinthian’s one-time students to other troubled non-profits on its website, showing how deep a neo-liberal infestation can go.)

So how did Corinthian collapse? There will be a good deal to untangle in the coming months, but one things is clear: Corinthian has all the earmarks of a control fraud. Let’s apply our modified version of “Black’s Formula.”

1. Grow massively. Of the for-profit industry generally, according to Pro Publica, enrollment at for-profit “colleges” increased by 225%, while enrollment at all degree-granting higher education institutions only grew by 31%. The Los Angeles Times has the numbers for Corinthian:

Like many other large for-profit schools, Corinthian nearly doubled revenue to $1.75 billion from 2007 to 2011, as the Great Recession prompted millions of unemployed workers to seek opportunity in higher education and career training.

Yes, millions of worker actually bought into the “skills mismatch” myth that economists invented (here’s Obama propagating it), and went into debt with for-profit universities to better themselves. As it turns out, that was almost as naïve as seeing your house as an asset whose price would never go down. Go figure. Let’s check the box:

☒ “Grow massively”

2. By originating awful student loans . For-profit universities (like so many other neo-liberal institutional plays) exist in the United States only because the State has structured a market to enable them to do so (that being the purpose of the State in neo-liberal theology). The Oregonian:

[For profit “universities”] often get at least 80 percent of their total revenue from taxpayer-funded federal student loans and grants. In 2013, Corinthian’s total revenue exceeded $1.6 billion, 84 percent of it from federal student aid.

And now we come to the heart of the scam[4]: recruiting. The Los Angeles Times describes Corinthian’s shady recruiting practices:

The U.S. Department of Education levied a $30-million fine Tuesday against Santa Ana-based Corinthian Colleges Inc., alleging the for-profit college operator recruited students with inflated job placement rates.

In a letter to Corinthian outlining the fine, the Education Department alleged widespread deception. In some cases, Heald paid temporary employment agencies to hire graduates in short-term jobs so they could be counted as “placements.” In other instances, Heald considered graduates “placed” in jobs they had well before they enrolled.

At Heald’s Honolulu campus, staff members considered a 2011 accounting graduate to be “employed in the field” based on a food service job she had at Taco Bell since 2006. Documents also show Heald considered business administration graduates to be successfully placed working retail jobs at Safeway and Macy’s.

Macy’s? I’ve seen the parade. Classy! And if all that reminds you of the criminogenic environment that produced liars loans and robosigning, that’s because it should. And not only were the loans awful because the Corinthian sold its marks a bill of goods, they were awful because their default rates were high. Inside Higher Ed writes of the for-profit “universities” generally:

In the US, only 10% of the undergraduate enrollment is in private for-profit universities yet these students account for 25% of federal loan dollars and 50% of the loan defaults.

At Corinthian in 2008, “Nearly 37% of students who left Corinthian’s schools in 2008 defaulted on their loans within three years.” (Because investors were worried, Corinthian managed to get those numbers down, temporarily, with another complex scam; details at Higher Ed Watch.) Let’s check the box:

☒ “Originating awful student loans

3. With crapified programs and/or predatory tuition Why did Corinthian have to falsify job placement numbers when it made its pitch to its marks? Because its programs were crapified and didn’t actually help students find jobs. And why did so many students default? Not only because they couldn’t get jobs, but because Corinthian jacked up the tuition! Dante Atkins wrotes:

Unfortunately for their enrollees, many of these colleges … charge very high tuition for degrees that are essentially worthless. Many students never actually finish the degree programs, and those that do often find that their job prospects are no better than when they started—but just more urgent because of the massive load of student debt they accumulated in the process. For-profit colleges can be twice as expensive as Ivy League universities and often charge 20 times what public community colleges do for the same two-year programs.

Here’s one story from Corinthian:

Rosalyn Harris, an unemployed single mother who had never gone to college, thought getting a degree would be the ticket to a new life. So at age 23, she enrolled in a two-year criminal justice program at for-profit [Corinthian “brand”] Everest College in Chesapeake, Va.

But the wealth of job opportunities the school had touted never transpired, and all she ended up with was more than $22,000 in student loan debt. She said classes were terrible, she didn’t receive any of the training she needed, and as a result, she spent months after graduation searching for criminal justice jobs without ever getting a call back.

Desperate to start paying some of her bills, Harris eventually applied for any entry-level job she could find. A full year after she graduated, she finally found a minimum wage job stocking shelves at Victoria’s Secret.

“My sole purpose of [sic] going to school was bettering my life for me and my son,” she said. “But now I wish I had never gone.”

Let’s check the box:

☒ “Crapified programs and/or predatory tuition”

4. Leaving the student loan guarantor holding the bag . Winding up Corinthian’s operations in an “orderly” way has a lot of moving parts, including accreditation, transfers, applications for student loan dismissal under “closed school discharge” rules, and of course the debt strike. What’s undeniable is that the Feds will backstop the whole shady operation:

Students who were bilked into taking abusive high-interest student loans out from a leading for-profit college company will get some significant relief, the Consumer Financial Protection Bureau (CFPB) announced Tuesday. A total of $480 million in debt will ultimately be forgiven under the arrangement.

Let’s check the box.

☒ “Leaving the student loan guarantor holding the bag”

Ka-ching. As long as the control fraud runs, at least, for-profit universities do quite well for insiders:

Publicly traded schools have been shown to have profit margins, on average, of nearly 20%. A significant portion of these taxpayer-sourced proceeds are spent on Washington lobbyists to keep regulations weak and federal money pouring in. Meanwhile, these debt factories pay their chief executive officers $7.3 million in average yearly compensation. John Sperling, architect of the for-profit model and founder of the University of Phoenix, which serves [sic] more students than the entire University of California system or all the Ivy Leagues combined, died a billionaire in August.

Sweet. As you can see, for-profit universities really are “a sure thing,” just as Black suggests: (1) Recruit as many students as possible, (2) by doing whatever it takes to get them to take out student loans, (3) boost profits by jacking up the price and gutting the product, and (4) pass the bill to the Feds when the marks can’t pay off their debts because they can’t get jobs because of the lousy education you sold them.

Laureate

Let’s now turn our attention to a second for-profit operation, Laureate International Universities. Here, I’m not going to be able to show that all the components of Black’s formula are in operation, because Laureate is much more difficult to research than Corinthian, at least in the time available for a post. For one thing, Laureate operates in 29 countries, and for all I know, there’s an exposé in Turkish, or Thai, or Arabic, but I wouldn’t be able to read it. More centrally, Laureate really an educational conglomerate[5], with each of its subsidiary institutions retaining its own national identity, administration, business model, and branding, and so its finances, operations, and regulatory environments are much more opaque than Corinthian’s. Laureate is simply very large:

Laureate’s footprint outside the United States tops that of any American higher education institution. The company brought in approximately $3.4 billion in total revenue during the 2012 fiscal year, more than 80 percent of which came from overseas.

For comparison, the Apollo Group — which owns the University of Phoenix and is the largest publicly traded for-profit chain — brought in about $4.3 billion in revenue last year. However, Apollo Global, which is an internationally focused subsidiary, only accounted for $295 million of that.

Indeed, in the late 1990s, when most other for-profit education companies were focused on the potential of the U.S. market, Laureate looked abroad. The Baltimore-based company, at that point a K-12 tutoring outfit known as Sylvan Learning Systems, purchased its first campus, Spain’s Universidad Europea de Madrid, in 1999, and has since affiliated with or acquired a total of 78 higher education institutions on six continents, ranging from art and design institutes to hotel management and culinary schools to technical and vocational colleges to full-fledged universities with medical schools.

So lets run through our checklist:

1. Grow massively. Certainly true:

[Laureate] has 800,000 students, up from 243,000 seven years ago, making it America’s largest for-profit college company by enrollment. Since going private in 2007, Laureate’s annual revenue has more than tripled to $4 billion.

Let’s check the box:

☒ “Grow massively”

2. By originating awful student loans

Let’s take a look at Laureate’s recruiting practices (the Brazilian setting reminds us that Corinthian is an international predator, unlike Corinthian, a domestic one). Here’s a boiler room in action:

Inside a building on a narrow Rio de Janeiro street, nine telemarketers sit in small cubicles, talking frenetically into headsets as scripts scroll across their computer screens.

On an October morning, these salespeople are urging high school seniors to attend Centro Universitario IBMR, a for-profit university. Their supervisor, Rafael Morine, paces the room, straining to be heard above the clatter of an air conditioner.

“Remember, today we are offering 30 percent discounts,” he tells a young woman.

Although a boiler room is never good news, Brazil does seem to have a more sane student loan system than our own:

In 2004, then-President Luiz Inácio Lula da Silva began a program called Prouni, which offers scholarships for low-income students to attend private colleges. Since taking office in 2011, President Dilma Rousseff has expanded the program and more than quadrupled the budget for subsidized student loans under a program called Fies.

The subsidized loans carry an annual interest rate of 3.4 percent — an extraordinary bargain in a country where inflation is more than 6 percent and banks often charge over 40 percent interest on personal loans — and students can wait until 18 months after graduation to begin repayment.

About 5.3 million of Brazil’s seven million college students were in private institutions in 2013. Some 31 percent of them received aid from Prouni scholarships or Fies student loans or both.

Laureate is also in Australia, however — but only because Australia introduced the FEE-HELP system especially for for-profits, although there is a 25% fee. FEE-HELP, quite possibly unlike Brazil’s system, is positively begging to be defrauded.

[For-profit “college” Evocca] has reaped more than $130 million in federal funding last year through the controversial federal funding system called VET-FEE-HELP, where private companies get paid for every course, even if students do not complete it.

Helpful, indeed! But to whom?

Check the box? To be fair, no. There’s the obvious possibility of looting in Australia, but not so in Brazil, and there are 27 other countries to consider. But that doesn’t mean that Laureate loot in other ways, as we shall see in step 3.

☐ “Making awful loans at a premium yield”

3. With crapified programs and/or predatory tuition, and

Here’s outright crapification from Laureate in Chile:

In deciding not to renew the Universidad de Las Américas’ accreditation in October, the National Accreditation Commission cited the 34,000-student university’s unsatisfactory graduation rates and its rapid enrollment growth: while the number of students rose by 36 percent over three years, the increase in instructors failed to keep pace.

In addition, we’ve got looting by insiders and self-dealing (both of which are surely available to the Brazilian operation):

The commission also raised concerns about the finances of the university, finding that while spending on academic salaries was low, the amount spent on leases and educational and administrative services provided by companies related to Laureate was substantial

Here’s more crapification in Brazil:

[Teachers, students and government officials] say Laureate boosts revenue at struggling colleges by turbocharging enrollment, often without a parallel increase in academic investment. Since Laureate took over IBMR in 2010, its quality ranking among small colleges in Brazil has dropped to 132 from 41, according to the government’s National Institute of Studies and Educational Research.

Both these examples are from Latin America, where tuition seems not to be predatory. Nevertheless, check the box? I say yes.

☒ “crapified programs and/or predatory tuition”

4. Leaving the student loan guarantor holding the bag We have not seen a Corinthian-style collapse of a for-profit “university” in the Laureate conglomerate. What we do see is for-profits gaming the political system to prop up recruitment numbers, game the accreditation system, and gloss over crapification generally. Inside Higher Education describes matters in Brazil, Chile, and Peru:

In all of the countries that host private universities there is growing concern about the quality and ethics of their activities. To date, there are more anecdotes than data, but enough of the former to be concerned. In Latin America scholars and legislators recount incidents where faculty rosters are padded with distinguished individuals who may show up periodically to give a lecture but who make rare appearances in regular classes, of judges offered nicely remunerated appointments in law schools with limited responsibility, of laboratory equipment and libraries rented for occasions when the institution is being reviewed for accreditation. In Brazil, it has been reported that students performing poorly are “retained” so as not to be eligible for the ENADE, the national exit examination given at three-year intervals and used for monitoring institutional performance. These “irregularities” make it possible for these universities to maintain legitimacy, obtain protection in the courts, and (often) achieve accreditation.

In Chile and Peru, newspapers warn of close relationshipsbetween administrators and investors at for-profits with individual politicians who protect these institutions from sanctions. Chile has witnessed numerous scandals in which individuals and agencies involved in accreditation reviews received suspicious benefits from these interesting “non-profit”, for-profit universities.

So it seems the bag is held differently in Latin America than it is in the United States.

We should also note that Laureate is fueling its expansion with debt:

“We are highly leveraged,” [Laurate] reported. … Moody’s I Investor Service, the credit ratings agency, has downgraded the credit outlook for Laureate Education to negative from stable, citing the global for-profit chain’s increasingly leveraged position. Laureate, which is based in Baltimore and enrolls 800,000 students at 200 campuses around the world, has used debt to finance many of its acquisitions. The pending purchase of a Brazilian university for $500 million would bring the company’s total debt to roughly $6 billion, according to Moody’s.

“The company’s current pace of investment has resulted in leverage that is now quite high,” the ratings agency said in a written statement. “Moody’s believes that the company will be challenged to restore lower leverage over the near team.”

It seems to me that Laureate’s debt is at least in part a bet on growth in emerging economies. What happens when those economies slow down? I would bet those “distinguished individuals” with “close relationships” would be more than happy to bail out the a Laureate brand, for a “nicely remunerated appointment,” say.

Check the box? No, because we have no examples; but Moody’s, bless their hearts, is watching, and so should we.

☐ “Leaving the student loan guarantor holding the bag”

Ka-ching. As you can see, Laureate has “a sure thing” available to it, just as much as Corinthian did, which can be tendentiously summarized in much the same way: (1) Recruit as many students as possible, (2) by doing whatever it takes to get them to enroll, (3) boost profits by gutting the product (and levering up?), and (4) pass the bill to your political cronies when the marks can’t pay off their debts because they can’t get jobs because of the lousy education you sold them.

Bill Clinton

Bringing me to the Big Dog at last. (To be fair, we don’t know know how much Clinton took for lending his name to Laureate because he never disclosed it. Lest it be said that Laureate is backed only by Democrats, Republicans like investor Henry Kravis back it too.) Clinton’s role at Laureate as Honorary Chancellor is important for two reasons:

First, as Bill Black explains, the CEO is critical to running a control fraud:

The big thing about the seemingly legitimate entity when the CEO is the crook is, first, everybody reports to the CEO ultimately, right? So the CEO is the point failure mechanism where if he or she goes bad, almost everything may go bad as well. So all those things that we call internal and external controls, all report to the CEO. And the CEO therefore can, as I’ll describe, use compensation, hiring, firing, praise, and such, to produce the environment that will create allies for his fraud.

The recruiting practices in that Brazilian boiler room and the crapification in Chile, Peru, and Brazil can only have been driven from the CEO level, just as at Corinthian. Clinton, as quondam Chancellor of Laureate International Universities, had the name and the clout to speak to the CEO of the Laureate conglomerate, or the President of any one of the Universities. Clinton is also famously wonky and an omnivore for information. So did he find out how Laureate was running its operations? Or was he just a figurehead?

Second and more centrally, the question isn’t why Bill Clinton was there in the first place, or why, if Laureate is clean, he left when Hillary singled out for-profits for criticism. The question is why he was there in the first place! I said it once and I’ll say it again:

What happened to the brilliant young man who made it all the way from Hope, Arkansas to Oxford, where students have been taught since 1096 A.D., a non-profit, and therefore, like anything public, in the gunsights of sleazy private equity investment banksters everywhere? Where is that young man, Bill? Is he inside you anywhere, now?

Those dreaming spires…. Will they survive in a regime of for-profit universities? How? What will you do to make that happen?

Conclusions

Obviously, Naked Capitalism doesn’t give investment advice, and if I were any good at investment, I’d be doing it, and not what I do. However, the reckless reader could be forgiven for looking at Laureate’s forthcoming IPO with favor; after all, fraud has often made a great number of insiders filthy rich, and why not you? So, let peculation thrive!

NOTES

[1] Laureate was taken private in 2007 in a consortium led by CEO Douglas Becker and private equity firm KKR. Reuters lists the other investors:

Citigroup Private Equity, S.A.C. Capital Management LLC, SPG Partners, Bregal Investments, Caisse de depot et placement du Quebec, Sterling Capital, Makena Capital, Torreal S.A. and Southern Cross Capital.

The 2012 IPO offering was mooted but never made. Laureate had picked its banks: Morgan Stanley and Barclays were to lead, and Citigroup was an “active bookrunner.” Good corporate citizens all. The climate is not good for a 2016 offering either. Bloomberg:

The market climate surrounding for-profit education could be better. The For-Profit Education Index of 13 companies, including DeVry Education Group Inc. and Apollo Education Group Inc., has plunged 55 percent through Wednesday since its peak five years ago. Enrollment has slowed amid recruiting abuses and student debt concerns, leading to a regulatory crackdown. In the past six months, both Corinthian Colleges Inc. and Education Management Corp. were delisted from the Nasdaq Stock Market.

Hopefully, KKR will lose a packet, and we as a society can get on with the job of making a tuition-free university education available to all, as does Germany.

[2] The neo-liberal justification for education is jobs, and their policy is that universities should optimize courses for job categories currently on offer (and, I would cynically hypothesize, job categories useful to the “business leaders” who are on the university’s board of trustees). But this is a case of business sabotaging industry (as Veblen would have it). Consider: A business leader for a buggy whip manufacturing concern would optimize the university for the arts of buggy whip manufacturing. They would have little use of “academic,” “pie in the sky” concepts like “horseless carriages.” Optimizing for training de-optimizes for invention. No doubt the buggy whip manufacturer would argue that “innovation” should take place in corporation labs, and so it would: More flexible whips, new styles for handles, a crackier cracking sound, and so forth. See under Big Pharma.

[3] There are two other pieces besides recruiting: The first is the role of accrediting agencies, who might remind you of appraisers in the foreclosure crisis; and the second is that Corinthian’s role as a predatory lender.

[4] I think one of the limitations of Black’s application of the concept, so far, is that all the steps in the recipe take place within a single firm, as in this post; but the steps can also be unbundled and taken on by different firms, thereby corrupting entire systems of industries.

[5] In their time in the United States, conglomerates enabled accounting fraud. From Erik F. Gerding, Law, Bubbles, and Financial Regulation (The Economics of Legal Relationships):

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