Education Management Violated Student-Aid Rules, U.S. Says

Education Management Corp. (EDMC), the second-largest U.S. for-profit college chain, used improper recruitment practices to secure more than $11 billion in U.S. student aid, prosecutors said in a civil lawsuit.

Education Management, 41 percent owned by Goldman Sachs Group Inc. (GS) funds, illegally paid recruiters based on the number of students signed up, a violation of rules for colleges that get U.S. student grants and loans, the Justice Department said today in a complaint filed in federal court in Pittsburgh.

Prosecutors spelled out their case against the company for the first time since May, when the Justice Department joined an employee whistleblower suit. Colleges that receive federal aid are barred from paying recruiters incentives tied to enrollment because it may encourage companies to register unqualified students. The government claimed Education Management enrolled students who appeared to be under the influence of drugs.

Education Management “fraudulently induced” the Education Department to make the company eligible for more than $11 billion in federal grants and loans since 2003, according to the complaint. “Each and every one of the claims it submitted or caused a student to submit violated” the U.S. False Claims Act, the government said.

States Join Suit

The industry has been under scrutiny by Congress, state lawmakers and attorneys general who are investigating sales practices and students’ debt loads. Illinois, Florida, California and Indiana have also intervened in the case, and filed today’s suit along with the Justice Department.

Education Management, based in Pittsburgh, denied violating government rules.

“The pursuit of this legal action by the federal government and a handful of states is flat-out wrong,” Bonnie Campbell, a former Iowa attorney general who is advising Education Management, said in an e-mailed statement. The company’s compensation plan “followed the law in both its design and implementation,” she said.

Charles Miller, a spokesman for the Justice Department, declined to comment.

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.

Whistleblower lawsuits let private citizens file complaints that may be joined by the government. The citizens collect a share of any recovery.

‘Boiler Room’

Education Management fell $2.18, or 11 percent, to $17.21 at 4 p.m. New York time in Nasdaq Stock Market trading. The shares have dropped 4.9 percent this year.

The company, which enrolls almost 140,000 students, operates the Art Institute chain, Argosy University, Brown Mackie College and South University. The company reported $2.89 billion in revenue in the year ended June 30.

Echoing the whistleblower complaint, the Justice Department and four states said recruiters worked in a “boiler-room” atmosphere where metrics other than enrollment weren’t considered in compensation and top salespeople received trips to Las Vegas and the Mexican resorts of Puerto Vallarta and Cancun.

Education Management instructed recruiters to enroll students “regardless of their qualification,” according to the complaint. Some were unable to write coherently or appeared to be under the influence of drugs, while others who registered for online courses didn’t have computers, prosecutors said.

Apollo Case

The Education Department in July moved to make all incentive compensation for college recruiters illegal, removing 12 types of exemptions or “safe harbors” that were put into place 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 recruiters in July of 2003 was designed to comply with these “safe harbors,” said Campbell, the company adviser.

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 complaints.

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

In 2009, Apollo Group Inc., operator of the University of Phoenix and the nation’s largest chain of for-profit colleges, agreed to pay $78.5 million to settle a whistleblower lawsuit also alleging that the company tied employee compensation to enrollment. The government didn’t join that case. Phoenix-based Apollo admitted no wrongdoing.

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

To contact the reporters on this story: John Lauerman in Boston at jlauerman@bloomberg.net; 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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