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Education Management Suit Brought on Behalf of 11 States

A whistleblower complaint against Education Management Corp. (EDMC), the second-largest chain of U.S. for-profit colleges, was brought on behalf of 11 states and the District of Columbia, according to court records unsealed today.

The suit alleges that the company illegally paid recruiters based on the number of students they enrolled. The U.S. Justice Department joined the suit, Education Management said yesterday. Employees who signed up the most students were rewarded with all-expense-paid trips to resorts in Las Vegas and Mexico, according to the suit in federal court in Pittsburgh.

Congress and the Department of Education have already been scrutinizing the sales practices, student-loan defaults and job placement claims at for-profit colleges, which may receive as much as 90 percent of their revenue from U.S. financial aid. The suit was brought on behalf of California, Florida, New York, Illinois, Indiana, Montana, Massachusetts, Minnesota, New Jersey, New Mexico and Tennessee and the District of Columbia, according to the complaint.

“The complaint alleges an especially egregious, systematic and longstanding violation of the ban on incentive compensation,” Harry Litman, the attorney representing two former Education Management employees making the recruiting- violation claims, said in a telephone interview. The filing doesn’t indicate whether the 11 states will join the suit, he said.

In most cases, the government forbids incentive compensation for colleges accepting federal aid because of concern the practice will encourage companies to enroll unqualified students.

2007 Complaint

“The company intends to vigorously defend itself,” Education Management said in a filing yesterday with the U.S. Securities and Exchange Commission. Several states are likely to join the whistleblower suit, the company said in the filing.

The company’s compensation plan complied with government exceptions to the ban on incentive compensation for college recruiters, Education Management said.

Jacquelyn P. Muller, a spokeswoman for Education Management, didn’t immediately return an e-mail and phone call today seeking comment.

Education Management, which is 40 percent owned by Goldman Sachs Group Inc. (GS) funds, disclosed yesterday that the Justice Department had joined the whistleblower suit.

The company, based in Pittsburgh, rose 17 cents to $17.75 at 4 p.m. New York time in Nasdaq Stock Market trading. The shares have declined 1.9 percent this year.

Lynntoya Washington, a former assistant director of admissions for Education Management, filed her whistleblower complaint under seal in 2007. Michael Mahoney, director of training for the company’s online division and a former car salesman, joined her, according to the papers unsealed today.

‘Bling Bling’

Recruiters worked in a “boiler-room” atmosphere where metrics other than enrollment weren’t considered in compensation, the suit claimed.

“The walls and cubicle partitions of EDMC’s offices are festooned with posters and charts graphing the progress of each ADA (recruiter) toward her sales goals and whatever the current prize is that she is competing for,” the lawsuit said. Managers take material down when college accreditors visit, the suit said.

It cites internal company documents, such as a matrix that showed student enrollment numbers necessary to earn salary increases. The complaint also cited an e-mail sent to recruiters who signed up students. It included a picture of a man counting money and the words, “Bling Bling,” according to the suit.

Along with trips to Puerto Vallarta and Cancun, Mexico and Las Vegas, top recruiters received Godiva chocolates, movie tickets, Pittsburgh Pirates baseball tickets and Starbucks gift cards, according to the suit. Recruiters who didn’t meet sales goals were terminated, it said.

Qui Tam

Education Management, which enrolls more than 148,000 students, operates the Art Institute chain, Argosy University, Brown Mackie College and South University. Analysts project the company will report revenue of $2.89 billion in the year ending in June, according to the average of estimates compiled by Bloomberg News.

In whistleblower, or qui tam, lawsuits, private citizens file fraud complaints on behalf of the federal government. If the government joins a case, the whistleblower may get 15 percent to 25 percent of any money recovered.

At least 27 whistleblower cases have been filed against for-profit colleges under the U.S. False Claims Act since the 1990s, primarily alleging violations of federal incentive- compensation rules, according to a December 2009 article by law firm Gibson, Dunn & Crutcher LLP, which defends companies against such suits.

Safe Harbors

In all but one case, the Justice Department declined to intervene, the article said. In that case, prosecutors joined the suit to address a different issue.

The Education Department plans, in July, to make all incentive compensation for college recruiters illegal, removing 12 types of exemptions, or “safe harbors” that were put into place in 2002 under President George W. Bush. The exceptions allowed the practice when recruiters weren’t paid solely on the basis of enrollments.

Education Management’s pay plan for admissions representatives in July of 2003 was designed to comply with these “safe harbors,” the company said in yesterday’s SEC filing.

The case is U.S. v. Education Management, 07-cv-00461, U.S. District Court, Western District of Pennsylvania (Pittsburgh).

To contact the reporter on this story: John Hechinger in Boston at jhechinger@bloomberg.net.

To contact the editor responsible for this story: Jonathan Kaufman at jkaufman17@bloomberg.net.

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