• by Thom Forbes  @tforbes, August 9, 2011

The Justice Department and four states have accused the second-largest for-profit college company in the U.S. of running a boiler-room operation to illegally recruit students who received about $11 billion in financial aid that they were allegedly not entitled to receive. The civil lawsuit was filed in Pittsburgh, the headquarters of Education Management Corp. (EDMC), which operates 105 schools in 32 states and Canada under four names -- Art Institute, Argosy University, Brown Mackie College and South University.

EDMC, in which Goldman Sachs has a 41% stake, increased the size of a stock buyback plan by 30% just this past Friday, the AP reported. http://buswk.co/oqpTki The stock, which has traded between $7.76 and $28.61 in the past 52 weeks, closed at $19.39 Friday and dropped 11.24% to $17.21 yesterday, hit with the double whammy of the suit and the worst day on Wall Street since the 2008 financial crisis.

The suit charges that EDMC violated the federal False Claims Act in that employees were compensated based on the number of students they recruited. Colleges that process student grants and loans aren't supposed to do that because, the thinking goes, they might be inclined to pursue people who are not qualified but who receive borrowed funds that often go unpaid.

"EDMC has created a 'boiler room' style sales culture and has made recruiting and enrolling new students the sole focus of its compensation system," charges the federal complaint, which was joined by attorneys general in Indiana, Illinois, Florida and California.

"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 an adviser for the company's legal counsel, responds in the Pittsburgh Tribune-Review. "EDMC's 2003 compensation plan followed the law in both its design and implementation, as EDMC's response to the governments' complaint will show."

Bloomberg's John Lauerman and John Hechinger report that at least 27 whistleblower cases have been filed against for-profit colleges under the U.S. False Claims Act since the 1990s. They primarily allege "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." The Justice Department has only joined one of them, however, and it was "to address another issue," according to the article.

According to Chris Kirkham in the Huffington Post, "the for-profit higher education industry has faced increased federal scrutiny over the past year amid increasing evidence that some schools are preying on disadvantaged students in an attempt to harness federal student aid dollars as profits." The complaint against EDMC "represents one of the most direct challenges" to "enrolling as many students as possible, regardless of whether they are likely to succeed." The company has received more than $11 billion in federal student aid dollars since July 1, 2003.

"Recruiters were encouraged to enroll even applicants who were unable to write coherently, who appeared to be under the influence of drugs or who sought to enroll in an online program but had no computer," the New York Times' Tamar Lewin reports that the suit charges. It also claims that recruiters exploited applicants' psychological vulnerabilities -- "for example, a parent's hopes of moving a child out of a dangerous neighborhood."

Kirkham quotes from an email allegedly sent by Gregg Schneider, a director of admissions at EDMC's Art Institute Online, that's cited in the compliant: "Each of you knows your plan for November," it read. "This number is not a casual level that I want you to be at but rather a number that you must hit to have a good review, get promoted or keep your position here. This number is set by the VP of Admissions and the Director of Admissions."

The company also created a "President's Club," with perks like all-expenses-paid vacations and passes to baseball games and amusement parks. SOP in many sales operations, of course, but evidently not kosher under these circumstances.

The action comes four years after two former employees -- Lynntoya Washington, an assistant director of admissions at the Art Institute of Pittsburgh Online Division, and Michael T. Mahoney, the director of training for the Online Higher Education Division -- filed a whistleblower complaint. The two stand to receive 15% to 25% of any money recovered.

Under federal law, the actual damages against the company could triple and the government could seek a penalty of $5,500 to $11,000 for each student aid claim that was fraudulently filed, Thomas Farrell, one of the attorneys representing the whistleblowers, tells the Tribune-Review's Brian Bowling.

"The depth and breadth of the fraud laid out in the complaint are astonishing," said Harry Litman, a former federal prosecutor who is also representing Washington and Mahoney. "It spans the entire company -- from the ground level in over 100 separate institutions up to the most senior management -- and accounts for nearly all the revenues the company has realized since 2003."

It will also account for a lot of rich lawyers if they are able to prove the case.