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For-Profit Colleges Seeking to Become Nonprofits May Face Tighter Regulations


Pexels Karolina Grabowska 4386476In a process called negotiated rulemaking, the U.S. Department of Education (ED) has been weighing proposed regulations for when colleges change owners, particularly when for-profit colleges seek to become nonprofit colleges.

Some conversions in recent years have led to what critics have called “covert for-profit colleges.” This term largely refers to new nonprofit colleges that operate in significant ways like their for-profit predecessors. Yet the new nonprofit status means such institutions can evade the additional federal scrutiny applied to proprietary colleges.

“Most people have an impression that a nonprofit is somehow dedicated more clearly to what is best for students or the public. But most people are not aware of what the technical differences are between a nonprofit and for-profit,” said Robert Shireman, director of higher education excellence and senior fellow at The Century Foundation, a nonprofit, nonpartisan public policy think tank. “That has created an opportunity for mischief on the part of some for-profit colleges that have wanted to call themselves nonprofits to gain that positive image without abiding by what has actually made nonprofit higher education less predatory toward students.”

In 2015, Shireman published a report for The Century Foundation outlining four case studies of for-profit colleges that converted to nonprofits but continued to practice much of that same "predatory" behavior. Shireman found, for instance, that several former owners continued to reap personal financial benefits from the institutions after the conversions.

“The difference between a for-profit and nonprofit is a basic question of incentives,” said Brian Galle, a professor of law at Georgetown Law and an expert in nonprofits and tax law. “With a for-profit, someone can get rich even when the college’s educational standards are lowered. So, someone can aggressively recruit students because this is supposed to be a money-making operation. You’re not about serving the needs of students. The bottom line is the main incentive. Whereas with a nonprofit, there is less of an incentive for that. Usually, a nonprofit educational institution is run by people who can’t get rich from the choices they make—they work there for reasons other than to get wealthy.”

Shireman and Galle said that a nonprofit has no owners and is run by a board of trustees. These individuals make major decisions about the organization, but they cannot personally make money from the nonprofit, unlike the shareholders of a for-profit entity. Yet Shireman said that what he has called “covert for-profits” tend to happen when former owners still make money from the new college, post-conversion. In some cases, past owners have been on the nonprofit's board of trustees. 

“Certainly, plenty of us have complaints about nonprofit higher education in general,” he said. “But those for the most part are not complaints about students being deceived or misled, about a failure to provide an adequate education for the price.”

Shireman pointed out that one possible benefit of a for-profit college converting to a nonprofit is sidestepping what is known as the 90/10 rule. This regulation states that no more than 90% of a for-profit college’s revenue can come from federal financial aid sources. The other 10% of revenue must come from alternative sources. Nonprofit colleges are not subject to this rule.

However, Nicholas Kent, senior vice president of policy and regulatory affairs at Career Education Colleges and Universities (CECU), a national trade association that represents for-profit colleges, stressed that a for-profit can weigh many factors when deciding to convert.

"There are several legitimate reasons why a for-profit college may seek nonprofit tax status, such as to align the institution's mission and status better, to gain eligibility for federal and state research grants to attract and retain faculty, and to receive charitable donations," wrote Kent in an email to Diverse. "But the suggestion that these conversions happen frequently is untrue."

Kent noted that ED approved only 35 for-profit colleges to convert to nonprofit status between 2011 and 2020.

"The reality is that these transactions happen infrequently, in part because they typically take several years for federal and state agencies and college accreditors to assess the legitimacy of the conversion," he added via email. "For those that allege that a for-profit college may want to transition to nonprofit status simply to benefit from public perception or to escape regulatory scrutiny, that concern could be easily addressed if we hold all institutions to the same accountability rules."

Philip Hackney, an associate professor of law at the University of Pittsburgh, researches the law that governs the nonprofit tax-exempt sector. For the Internal Revenue Service (IRS) in particular, he pointed out it can be tough to hold institutions accountable because of how tax law works.

“One of the difficulties with the nonprofit world is that these organizations are supposed to be dedicated to charitable purposes, and education is a charitable purpose. They’re not supposed to have for-profit owners,” said Hackney. “But it can be hard for regulators, whether the IRS or state entities, to necessarily detect when someone is running a school in order to deliver profits to themselves.”

He explained this is partially because there is no charity care requirement for educational institutions under the tax code. That essentially can allow any education to qualify as charitable.

“And what that means is that as long as I’m educating, as long as I’m teaching courses, then the tax code doesn’t really care if I’m delivering services to lower income individuals, for example,” he said. “That makes it difficult to detect so-called ‘covert for-profits’ because all I need to do is educate. Even if I have some red flags that I may be a charitable organization operating for a for-profit individual or entity, I’m probably going to pass the tests at the IRS.”

Yet some red flags were raised in December 2020 when the U.S. Government Accountability Office (GAO) issued a report. It voiced concerns that former for-profit college insiders sometimes were staying involved with converted universities. Titled “IRS And Education Could Better Address Risks Associated with Some For-Profit College Conversions,” the report analyzed 59 for-profit college conversions that happened from January 2011 to August 2020. Almost all of the conversions involved the college’s sale to a tax-exempt organization.

For about a third of those deals, the GAO report found that a former owner was part of the conversion either by creating the nonprofit or holding onto the presidency post-sale. The GAO noted that this kind of involvement risks insiders benefiting inappropriately from the sale, such as possibly influencing the tax-exempt buyer to overpay for the college beyond its actual worth. As Kent had noted, this report also documented that only 35 for-profit college conversions were approved in that time period.

Shireman and Galle said that ED under the Biden administration has been taking the issue seriously thus far. To better protect students and taxpayers during such transactions, ED this week is proposing regulations that include ensuring the former owner of a college cannot keep a financial stake in the school after the conversion. Shireman applauded the proposal.

“A sale is a sale. If a transfer of ownership is really occurring, then having a contract that maintains a marriage with the former owner undermines that transfer,” he said. “I think the language that ED proposed in this rulemaking so far did a good job of creating some clear, general exclusions of these kinds of deals.”

But Shireman noted it is possible that ED’s proposed regulation around this point could be weakened through the rulemaking process. He said that one “dangerous safe harbor,” for instance, would be to allow a contract with a former owner if an independent appraiser decides the contract is at fair market value. However, as Shireman put it, “it’s not hard to find an appraiser to give you the value you want even if they are independent.”

Another one of ED’s proposed regulations is that after a change of ownership from a for-profit, institutions would have to continue complying with certain for-profit regulations, such as the 90/10 rule, for a period of time, possibly two years. An additional ED proposal is that an institution would not be allowed to advertise that they are a nonprofit until ED approves their conversion.

With for-profit colleges facing greater scrutiny under the Biden administration so far, Galle added he expects more for-profits in the near future will seek conversions. Like many in higher education, he will be watching ED does next on this issue.

Rebecca Kelliher can be reached at [email protected].

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