Short Seller Scrutiny

An internal audit has largely exonerated the U.S. Department of Education for its handling of sensitive information in the run-up to the release of “gainful employment” rules last year. But the audit report from the department’s inspector general included a few mild rebukes, and two Republican senators are calling for a deeper inquiry.

The inspector general also said a senior official at the department may have violated a government ethics pledge by having contact with his former employer during the rulemaking process. That official, who was not named in the report, has since left the department.

With an initial goal of reviewing how the department followed its protocol around negotiated rulemaking -- the process by which federal agencies craft new regulations -- the audit was expanded last year after several Republican members of Congress called on the inspector general to investigate contact between department officials and investors with a stake in publicly traded for-profit colleges.

So-called “short seller” investment firms had bet that for-profit stocks would drop in price, and the lawmakers wanted to know if short sellers improperly received information during the rulemaking process. Such leaks could have been big moneymakers given the anticipated negative effect of gainful employment on for-profits and their share prices. Joining the lawmakers in that call for an inquiry were a for-profit advocacy group and a government watchdog, which also requested and received e-mails and documents relating to the rule-making process.

But the results of the audit released Friday, a few hours after for-profits received gainful employment data from department -- the first real impact of the controversial rules -- showed that department officials did not release any sensitive information, either to investors or to anyone else. The investigation included scrutiny of e-mail archives of 11 department staff members, as well as e-mail exchanges with a list of investors, student advocates, and others (including journalists). A total of 357,000 e-mails were reviewed.

In its response to the audit, which was included in the report, the department said it was “gratified” that the “very careful handling of sensitive information was validated.”

However, the inspector general found that the department “lacked written protocols” for how to handle communications around the rulemaking process. And perhaps more importantly, the audit said the department had not been appropriately open about meetings that department officials held with outside parties -- a point of contention among for-profits and their advocates, who have decried the access that short sellers had to government officials during the process. They have frequently asserted that investors with a stake in their demise have influenced the agenda of the Obama Administration and Democratic lawmakers in Congress.

“The department participated in meetings with representatives from various organizations while drafting the proposed regulations. However, these meetings were not publicly disclosed,” the report said. “As a result, the public may be less likely to view the rulemaking process as legitimate due to a lack of confidence that the department incorporated a diversity of interests and perspectives throughout the entirety of the negotiated rulemaking process.”

The inspector general also recommended a bulking up of the department’s requirements on financial disclosure forms for officials.

The audit included a review of the potential violation of an ethics code by the former department official despite protests from the department, which claimed the matter fell outside of the audit’s scope.

The department official, whom the report did not name, signed an ethics pledge in 2009 that requires political appointees of the executive branch to avoid contact with former employers on issues related to their duties. The former higher-ranking official, however, exchanged e-mails with his former employer six times, and also provided feedback on two draft documents from the former employer, according to the audit. He did not release sensitive information in those interactions.

The inspector general’s investigations office is continuing its inquiry into the former official’s possible ethics violation.

Sen. Richard Burr of North Carolina and Sen. Tom A. Coburn of Oklahoma, both Republicans, had pushed for the audit. They said Friday that the report had “several weaknesses” and that the investigation tells “potentially half the story.” Reviewing e-mails is not enough, the senators aid.

“Given the sophisticated efforts of individuals who seek to obtain information for financial gain, no investigation is complete without a thorough examination of all sources of communications, including phone logs and records, faxes, text messages, etc.,” they wrote in a letter to the inspector general.

The two senators called for a review of all forms of communication, over a longer time period, and for the inspector general to make public all e-mails from the audit, among other requests.

It’s unclear if the audit will hurt the department’s credibility over gainful employment, but any damage probably will be minimal given the largely favorable findings of the audit. However, for-profits remain frustrated about what they see as an unfair process.

“The inspector general's report represents another example of the concerns we have with the development of the gainful employment regulations,” Steve Gunderson, president and CEO of the Association of Private Sector Colleges and Universities, the primary for-profit trade group, said in a written statement. “Our hope remains that we can find ways for the department, the Congress and the postsecondary education sector to rebuild a working relationship that results in students getting education, skills and jobs."