The Sketchy Legal Ground for Online Revenue Sharing

Ever since some colleges took unfair advantage of World War II veterans using the GI Bill, the National Association for College Admission Counseling has insisted that its members’ relationship with prospective students should be as honest advisers acting in students’ best interests rather than as salespeople hell-bent on getting the student to enroll. In 1992, to prevent colleges from incentivizing manipulative recruiting, Congress barred colleges that accept federal aid from paying commissions for enrolling students.

Since the ban on incentive compensation applies not only to how employees are paid but also to colleges’ arrangements with contractors, it would seem to rule out paying any company that is responsible for recruiting on a per-student basis. Yet many colleges pay a share of every tuition dollar to online program management companies that recruit students, among other responsibilities.

It would seem to present a pretty clear violation of the ban that Congress enacted and which remains, supposedly, the law of the land. The prohibited arrangements continue, however, because companies with connections asked officials at the U.S. Department of Education -- including me, when I was there -- to paper over the law. Now, with the role of OPMs recently coming under greater scrutiny, congressional offices have asked student advocates like us whether the law needs to be clarified in some way to prevent tuition-sharing contracts that include recruiting. It has been a difficult question to answer, because it seems pretty clear already that the many colleges that currently pay a tuition share to contractors that recruit students are violating the law, at least as the law is laid out in the Higher Education Act.

The story of how we ended up in this strange situation starts in 2001. That year, the department’s independent inspector general conducted audits of two small colleges (William Penn and Olivet Nazarene Universities) that had arranged for a company to run extension programs enrolling working adults. The contracts were very similar to some of today’s OPMs, providing an array of services -- including recruiting -- in exchange for a share of tuition.

Under the contracts, the company (the Institute for Professional Development, an affiliate of the for-profit University of Phoenix) was paid 50 percent of the tuition revenue. The inspector general found that because the contractor’s activities included recruiting students and the contractor was paid a percentage of tuition, the arrangements violated the incentive compensation ban.

In citing the law, the inspector general boldfaced the key words of the Higher Education Act: “The HEA prohibition on incentive payments is clear: ‘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 …’”

In the audits the inspector general labeled the violations as “statutory,” meaning that they were not just breaches of interpretations by the department, but instead they were contrary to the plain language of the law passed by Congress. Presumably, that means that letting schools use these types of contracts would require an act of Congress, not simply a regulation or guidance from the agency. The for-profit industry seemed aware of this, since at the time of the audits it was lobbying Congress to weaken the 1992 law.

In 2001, however, industry friends in the newly elected Bush administration were amenable to the idea of bypassing Congress and launched a process to punch holes in the incentive compensation law.

The 2002 Bundling Loophole

In 2002 the deputy secretary of the U.S. Department of Education declared that violations of the law would be treated leniently, resulting in only a fine rather than requiring any return of federal funding. Further, the agency adopted, by regulation, a dozen safe harbors, or “specific payment arrangements that an institution may carry out that have been determined not to violate the incentive compensation prohibition.”

Included among those safe harbors was one that allowed exactly the type of payment that IPD had received from William Penn and Olivet Nazarene. Thus provision allowed “payments to third parties, including tuition sharing arrangements, that deliver various services to the institution, even if one of the services involves recruiting or admission activities.”

In today’s parlance, the safe harbor allowed tuition sharing if recruiting was part of a “bundle” of services.

Analysts at the time thought this bundling loophole, in particular, was on legally shaky ground, going beyond what could be accomplished by regulation. In its audits, in fact, the inspector general had rejected the bundling excuse as “irrelevant” given the language of the statute: “Once IPD became responsible for recruiting students, even among other activities, and received compensation from William Penn based on the number of students enrolled in the program, William Penn was in violation of the HEA.” The arrangement constituted, according to the inspector general, a “statutory violation of providing a commission, bonus, or other incentive payment based directly or indirectly on the success in securing enrollments.”

Inspector general audits are advisory, however; the department leadership is not obligated to accept or follow up on the inspector general’s recommendations. The adoption of the safe harbors was a repudiation of the inspector general’s concern. Companies like IPD could pretty safely rely on the regulatory safe harbors adopted by the department, since the same department that drafted them would be responsible for deciding what would or would not be considered a violation of the law.

Tuition-Sharing OPMs Emerge Slowly, Then Grow Quickly

The 2002 bundling safe harbor did not result in any immediate explosion of OPM companies or independent contractor arrangements to dodge the commission ban. Initially, those taking advantage of the bundling safe harbor were companies that had been providing online program services to colleges previously. For companies like Bisk Education, the bundling loophole was not their core business model but instead offered an additional, profitable marketing tool with colleges: the company could offer to build and operate a school’s online programs at no up-front cost, recouping the investment and more on the back end by taking a cut of the tuition. By including student recruitment in the bundle, the company could be more assured of a hefty profit.

When I joined the U.S. Department of Education in 2009, after the election of President Obama, Bisk is the company that I recall visiting me to discuss what are now known as OPMs. The department had proposed rescinding the Bush administration’s safe harbors, and Bisk officials were concerned. They argued that unless nonprofit and public colleges could ramp up their online offerings, for-profit schools, with a poor track record in terms of quality, would continue to dominate. At the time, the OPM industry was small and tame -- today’s name-brand OPMs, Academic Partnerships and 2U, were only two and three years old. We were sympathetic to Bisk’s argument and I, at least, was ignorant of the hazards of the loophole.

In 2010, the department did rescind the safe harbors, including the section that allowed the bundling. However, consistent with discussions that I and others had had with companies like Bisk, the agency in 2011 issued a memorandum carving out some room for bundled-services OPMs to continue. In general, the memo said, paying a contractor on a tuition-sharing basis is prohibited if the contractor is involved in recruiting. However, the memo declared, the tuition-share payments are not problematic if the school is independent from the contractor and the school is setting enrollment levels.

Why did the Obama administration OK the OPM bundling despite objections raised by the inspector general? Lobbyists using the names of trusted and politically powerful universities certainly made a difference. Beyond that, policy makers, including myself, wanted to view the companies as white-hat warriors helping to build nonprofit and public alternatives to predatory for-profit online colleges. Over time, the theory was, the innovation and competition that they would infuse into the field of online higher education would bring down tuition and elevate quality.

With the apparent continued federal endorsement of their modus operandi, the OPM industry took off. The success of start-ups like 2U and Academic Partnerships prompted traditional education vendors to rush to get into the game. As reported in Inside Higher Ed, in a single week in 2012, both Pearson and John Wiley & Sons purchased OPM companies, and campus tech provider Blackboard added an OPM operation. In 2014 2U filed to become a publicly traded company. Today, OPMs are estimated to be a $3.5 billion market, growing at 15 percent a year.

All was not well, however. The idea that OPMs would bring cost reductions to education consumers was not materializing. Frustrated that the industry was too focused on profiteering, John Katzman, one of the founders of 2U, left the company to start a lower-cost competitor. Recently, several exposés have exposed the downsides, in terms of cost and the hazard of incentivizing predatory recruiting, of OPMs that take large shares of tuition (see here, here and here). Faculty organizations have begun to organize to oppose campus administrations that are too eager to jump into deals that give too much control to outside companies.

The use of the bundling guidance goes beyond OPM companies running online add-ons to traditional universities. In three controversial conversions of for-profit colleges -- Purdue Global, Grand Canyon and Ashford University -- a bundled tuition-sharing agreement is at the core of relationship between the new nonprofit institution and the for-profit company. In the case of Grand Canyon, for example, the for-profit company operates as a giant OPM, running the recruitment and other operations for the entire 90,000-student university in exchange for 60 percent of tuition revenue. These monster contracts are a far cry from the small online extension programs Bisk described when the company defended the bundling loophole to me a decade ago. As one nonprofit law expert put it, these deals put “a trustworthy-looking wrapper around a for-profit business.”

What Should Policy Makers Do?

With the drawbacks of tuition-sharing OPMs becoming more evident and well-known, concerned faculty, consumer advocates and policy makers have asked whether reforms should be proposed in Congress to protect against OPM-stoked cost escalation and recruiting abuses. The needed reforms go beyond just the incentive compensation ban. Stephanie Hall, my colleague at the Century Foundation, for example, has recommended that colleges be required to disclose the companies running their programs, to provide consumers with net price calculators for the programs and to report marketing and other expenditure data.

But one reform does not need to await action in Congress: enforcing the statutory ban on incentive compensation to contractors. Enforcement could begin at any time, in various ways. The department, under this administration or another, could decide to rescind or revise the guidance, recognizing in hindsight that it opened up truck-size loopholes inconsistent with the statute. Or the question of the validity of the guidance could come before a judge, if a harmed student or faculty member, or a competitor school, were to file a suit against a school that is relying on the guidance. Under certain circumstances, a suit filed against the department could lead to a judge throwing out the guidance as contrary to the plain language of the statute.

Enforcing the incentive compensation law as written would not upend the OPM industry. Schools can still pay contractors on a tuition-share basis if they want -- the contract just cannot include recruiting responsibilities. Alternatively, the arrangement can be on a fee basis that is not linked to tuition or student enrollment.

Colleges spooked by recent OPM scandals have already begun to push the industry away from the problematic tuition-sharing model, so enforcing the prohibition would only accelerate the current, positive trend.