U.S. Department of Education Issues New Regulations on Changes of Ownership, 90/10 and Prison Education Programs

PDF

On October 28, 2022, the U.S. Department of Education (“ED”) announced new Final Regulations (“Regulations”) in the Federal Register making changes to the rules regarding changes of ownership and conversions to nonprofit status, the 90/10 Rule, and Prison Education Programs. ED also issued a press release and a fact sheet describing the new rules and highlighting the key provisions and changes. These Regulations are effective as of July 1, 2023.

The new Regulations are the result of expansive negotiated rulemaking exercises undertaken by the Biden Administration to address these and a host of other topics. Additional regulations and rules changes, including on the subject of borrower defense to repayment, have been issued and will be addressed in a separate Client Alert, and still other regulations are expected to be announced in the first part of 2023.

All references herein to a specific regulatory section are to the new and revised Regulations in Title 34 of the Code of Federal Regulations unless otherwise specified.

Changes of Ownership and Conversions to Nonprofit Status

ED reported that the Regulations regarding changes of ownership are intended to “address the increased complexity of changes in ownership and help mitigate increased risk to students and taxpayers.” It also noted that the nonprofit conversions provisions in part are in response to a 2020 report by the U.S. Government Accountability Office finding that a significant number of such conversions resulted in “impermissible benefits” to “insiders” who had been part of the pre-conversion ownership.

The Regulations make several changes to the definition of a change of ownership that results in a change of control. Section 600.31(c)(3)(ii) generally increases the threshold for such changes to the acquisition or loss of 50% or more of the voting interests of the ownership entity, up from the current 25% threshold, and describes other governance revisions that would constitute changes of ownership resulting in changes of control. Sections 600.31(c)(3)(iii) and (iv) provide additional clarification and explanation regarding the new provisions.

At the same time, ED lowered the threshold for reportable changes in ownership percentages from 25% to 5%, and it introduced a new timeline for reporting these changes. Under Section 600.21(a)(6)(i), institutions will now be required to report any acquisition of at least 5% but less than 25% of the entity ownership interests that does not otherwise result in a change of control under Section 600.31 on a quarterly basis. If, however, the institution is planning for a change of ownership, all such incremental changes not yet reported must be reported before the institution files the new 90-day notice described below. In addition, any acquisition of ownership interests in excess of 25%, as detailed in Section 600.21(a)(6)(ii), which ED retains the discretion to deem a change of control, still must be reported within 10 days.

An institution planning a change of ownership is now required to provide notice of such plans both to ED and to its students at least 90 days prior to the anticipated transaction date pursuant to Section 600.20(g). The notice to ED, which must include copies of current state and accreditor approvals and evidence that notice was made to students, generally will prompt ED to begin a review of the proposed transaction.

In addition, although ED no longer offers a comprehensive preacquisition review process, institutions have the option of asking ED for an abbreviated preacquisition review for the limited purpose of determining whether ED will require a post-closing letter of credit from the new owners. The Regulations also codify current ED practices that require a letter of credit representing 25% of the institution’s prior-year Title IV volume if the new owner does not have two years of acceptable audited financial statements, or a 10% letter of credit if only one year of acceptable audited financial statements is available.

Notably, the Regulations also eliminate the current requirement that ED continue an institution’s participation in the Title IV programs while it is reviewing the change of ownership under the same terms and conditions to which the institution was subject prior to the change of ownership. ED now has flexibility to impose new conditions while it is completing the review, and Section 600.20(g)(2) specifically provides that ED may determine that an institution’s eligibility should not continue following the change of ownership.

Proprietary institutions seeking to convert to nonprofit status now face additional hurdles to obtain approval. Section 600.2 is revised to update the definition of a nonprofit institution as one “to which the Secretary determines that no part of the net earnings of the institution benefits any private entity or natural person” and that meets other specific requirements. These include prohibitions on serving as an obligor on any debt owed to a former owner, entering into any revenue-sharing agreement with a former owner or director unless ED determines the terms are reasonable, having lease or other contractual payment obligations to any former owner or director unless ED determines that such obligations are comparable to the terms of an arms-length transaction at fair market value, and engaging in any other “excess benefit transaction” with any person or entity.

The Regulations specify that an institution undergoing a conversion to nonprofit status must be owned by a nonprofit entity, authorized to operate as a nonprofit institution in each state in which it has a physical location, and approved by the Internal Revenue Service as a 501(c)(3) entity. However, Section 600.31(d)(7) makes clear that any institution undergoing such conversion continues to be a proprietary institution for Title IV purposes until ED approves the change to nonprofit status.

90/10 Rule

The most significant change to the 90/10 Rule has been known for some time. The American Rescue Plan Act (“ARP”) that became law in Spring 2021 included a provision that expanded the sources of funds that comprise the 90% side of the calculation to include all federal education assistance funds, rather than restricting the calculation simply to Title IV funds. The ARP directed ED to engage in rulemaking to flesh out the new rule and stipulated that it could not take effect before January 1, 2023.

The primary motivation for this expansion was to move the federal funds provided to military veterans and active-duty servicemembers from the 10% side to the 90% side of the 90/10 calculation, thereby closing the so-called “90/10 Loophole.” Advocates for the change argue that it eliminates the incentive for proprietary institutions to focus aggressive recruiting efforts on veterans and servicemembers.

In addition to education assistance funds for veterans and service members, however, there are numerous other programs that provide funds that are or could be characterized as federal education assistance funds. Section 668.28(a)(i) notes that ED will publish a notice in the Federal Register identifying the other federal agency programs that qualify as federal education assistance funds and will publish update notices from time to time as the guidance changes. Institutions are required to obtain a certification from a federal agency denoting any federal education assistance funds provided directly to students or to undertake a good-faith effort to collect this information for the 90/10 calculation.

For all proprietary institutions’ fiscal years beginning on or after January 1, 2023, compliance with the 90/10 Rule will be calculated on the basis of the expanded list of federal education assistance funds, excluding any such funds provided directly to students to cover expenses other than tuition, fees and other institutional charges. In the Preamble to the Regulations (87 Fed. Reg. 65447), ED advised that in instances where it updates the list of federal education assistance funds with a Federal Register notice partway through an institution’s fiscal year, “the proprietary institution will be responsible for including those funds paid for institutional costs the fiscal year starting after the Federal program has been identified on the published list.”

ED also made several other changes to the 90/10 calculation. Section 668.28(a) limits the inclusion of revenue generated from institutional aid and income share agreements to principal payments that satisfy specified conditions, and it excludes amounts received by the institution from the sale of accounts receivable and loan or income share agreements. It also clarifies the rules for counting revenues from activities that are required for the training of students, and it tightens the permissible sources of revenues from ineligible programs to include only those funds paid by students for such programs that are provided by the institution and taught by its faculty at an approved or employer facility and that do not contain any courses that are part of an eligible program.

The Regulations also require institutions to draw down eligible funds and make disbursements of such funds to students prior to the end of the fiscal year, thus prohibiting the delaying of such payments until the new fiscal year in order to avoid failing the 90/10 Rule in the current year. If an institution fails the 90/10 Rule in any fiscal year, it now must notify its students of the possible loss of Title IV eligibility, in addition to notifying ED within 45 days after the close of its fiscal year.

Prison Education Programs (“PEPs”)

The Regulations establish that certain incarcerated students enrolled in qualified PEPs are eligible to receive Pell Grants. As defined in Section 600.2, a “confined or incarcerated individual” is someone serving a criminal sentence in a federal, state or local correctional facility. Eligibility to offer PEPs is limited to nonprofit institutions, and Section 600.7(c) authorizes ED to waive the existing 25% limitation on the enrollment of incarcerated individuals upon application by an institution, subject to conditions.

PEPs must meet all of the current requirements for eligible programs, including having state and accreditor approval. Under Section 668.236(a), the institution offering the PEP also must be approved to operate in the correctional facility by the “oversight agency,” which is defined in Section 668.235 as the state agency responsible for overseeing a state’s correctional facilities or the Federal Bureau of Prisons in the case of federal facilities.

Section 668.236 also specifies certain operational and compliance requirements for initial and continued approval of PEPs, including a determination by the oversight agency after the PEP has been in operation for two years that the program is operating “in the best interest of students.” Section 668.241 details the requirements for the best interest determination, including assessments of faculty quality and turnover, transferability of credits, and the quality of academic and career advising services provided to incarcerated students. Other relevant considerations may include the impact on recidivism, completion and job placement rates, and post-release earnings rates.

In addition to the standard accreditor approvals for locations and programs, eligibility requires specific accreditor evaluation of an institution’s PEP programs offered at the first two correctional facilities and the first additional PEP offered by a new method of delivery. The evaluation must include a site visit within one year of the initiation of PEPs at the first two correctional facilities. Accreditors must review and approve the institution’s methodology for determining that its PEPs meet the same standards as similar programs offered by the institution that are not PEPs.

The institution also must apply for and obtain specific ED approval for the initiation of PEPs in the first two correctional facilities. Institutions offering PEPs must make regular reports in accordance with instructions that ED will announce in the Federal Register.

# # #

Maynard is a full-service firm with attorneys experienced in all regulatory and operational aspects of higher education, including federal and state oversight, accreditation, employee and benefits issues, and real estate concerns.

Roger Swartzwelder advises regionally and nationally accredited institutions of higher education, investors, and accrediting agencies regarding legal, administrative, regulatory, accreditation, transaction, and operational matters.

Brandon Sherman advises postsecondary institutions, accrediting agencies, and education investors on matters pertaining to federal financial aid eligibility, accreditation, cybersecurity, and Title IX.