This month, there have been important developments in three pending qui tam (whistleblower) lawsuits involving large for-profit postsecondary educational institutions and their employee compensation practices. The three developments are: (1) the intervention of the U.S. government and several states in a qui tam lawsuit against Education Management Corporation, (2) the reinstatement by a federal appeals court of a previously dismissed qui tam lawsuit against Corinthian Colleges Inc., and (3) the dismissal by a federal district court of a qui tam lawsuit against ITT Educational Services, Inc. The developments in these three cases, and their importance to other schools, are discussed below.

Background

The False Claims Act (“FCA”) is a federal statute that allows individuals (known as “relators”) to bring civil lawsuits (known as “qui tam” suits) on behalf of the federal government against parties that they allege have made a false or fraudulent claim for government funds. The FCA incentivizes relators to bring such claims by allowing relators to receive a percentage of the proceeds, which may reach into the millions of dollars, for a successful qui tam suit. Many of the FCA lawsuits against higher education institutions over the past decade have claimed that an institution falsely certified its compliance with the “incentive compensation” prohibition of the Higher Education Act (“HEA”) and therefore illegally obtained federal student financial aid funds from the U.S. Department of Education (“ED”).  

The incentive compensation prohibition forbids institutions that participate in the Title IV programs (both for-profit and non-profit schools) from providing any commission, bonus, or other incentive payment based on success in securing enrollments or financial aid to individuals or entities engaged in recruiting or admissions activities or in making decisions concerning the awarding of financial aid funds. In revisions to the incentive compensation regulations that became effective July 1, 2011, ED dramatically increased the scope and coverage of the prohibition.  

Federal Government and Four States Intervene in Education Management Corporation Qui Tam Suit

On August 8, 2011, the Federal Government filed a joint complaint with the states of California, Florida, Illinois, and Indiana in the U.S. District Court for the Western District of Pennsylvania intervening in a qui tam lawsuit against Education Management Corporation (“EDMC”). The qui tam suit had originally been filed by two former EDMC employees in April 2007, and in May of this year EDMC announced that the Federal Government had decided to intervene in the case. The intervention complaint alleges that EDMC misrepresented to ED and the four state governments that it was in compliance with the incentive compensation prohibition, and in doing so knowingly made false claims and statements to obtain and maintain eligibility to participate in the federal Title IV programs and state financial aid programs. The complaint alleges that, as a result of these false claims, from July 1, 2003 to the present EDMC or students enrolled in EDMC’s institutions received over $11 billion in Title IV funds and over $100 million in state financial aid funds from the named states.

The complaint alleges that EDMC’s compensation system for admissions personnel violated the incentive compensation prohibition for several reasons. Between July 1, 2003 and June 30, 2011, a “safe harbor” in the ED regulations permitted schools to pay recruiters a fixed salary and adjust that salary up to two times per year as long as the adjustments were not based solely on the number of students recruited or enrolled. The complaint alleges that the adjustments to salaries of EDMC admissions personnel who had succeeded in being placed on a salary “matrix” were based solely on the number of students recruited. The complaint alleges that other “quality factors” had no real impact on the implementation of the compensation plans and were “nothing more than window-dressing” for incentives based on recruitment, which included not only raises, but also other gifts such as trips and paid time off from work.  

The complaint alleges that admissions personnel’s base compensation was not permissible “fixed compensation” under the ED regulations because EDMC accumulated salary adjustments and then paid them out to its employees in bi-weekly installments during the following six-month period to create prohibited incentive payments rather than a true fixed salary. The complaint further asserts that EDMC regularly terminated admissions personnel for failing to meet minimum student enrollment numbers. Finally, the complaint asserts that EDMC’s senior management knew it was not in compliance with the incentive compensation law, in part because several EDMC executives were former employees of the University of Phoenix (“UOP”), and were employed at UOP in 2004 when an ED program review found that UOP’s compensation plan, which the complaint alleges was not materially different from EDMC’s, violated the incentive compensation prohibition.

An August 8, 2011 press release issued by EDMC states that EDMC’s compensation plan, in design and in implementation, complied with the law, and that the “pursuit of this legal action by the federal government and a handful of states is flat-out wrong.”

The government’s complaint against EDMC is significant in that, to our knowledge, it is the first time the Federal Government has intervened in a qui tam suit against a postsecondary institution relating to employee compensation, despite the fact that the allegations in the complaint are arguably very similar to the allegations made against other companies in other qui tam cases in which the Federal Government declined to intervene. The Federal Government’s decision to intervene in this case could portend additional government interventions in other qui tam cases addressing other institutions’ employee compensation practices.

Federal Appeals Court Reinstates Qui Tam Case Against Corinthian Colleges

On August 12, 2011, the U.S. Court of Appeals for the Ninth Circuit reversed a district court’s dismissal of a qui tam lawsuit against Corinthian Colleges, Inc. (“Corinthian”) and granted the relators an opportunity to amend their complaint. The relators, former employees of Corinthian, had filed the original suit in 2007, and the U.S. Department of Justice had declined to intervene in the case in 2009. The qui tam suit alleged that the company, with the help of its auditor, Ernst & Young LLP, falsely certified to ED its compliance with the incentive compensation prohibition in order to be eligible for Title IV funds.

The qui tam suit alleged that Corinthian compensated admissions representatives based only on the number of students they enrolled, even though Corinthian claimed the semi-annual raises for its recruiting employees were based on both recruitment numbers and an overall performance rating. While noting that, on its face, such a system appeared to fall within the “safe harbor” for salary adjustments in the former ED regulations since it was not based solely on recruitment numbers, the Ninth Circuit held that more facts were needed as to how Corinthian assigned performance ratings in order to determine whether the compensation plan violated the incentive compensation prohibition. In order for the compensation to fall within the safe harbor, the court noted that the overall performance rating must be “driven by concrete, merit-based metrics” that are separate from recruitment numbers and are more than “basic performance requirements that are expected of any employee (such as showing up on time).”  

The Ninth Circuit’s opinion stated that additional facts could cure deficiencies in the relators’ complaint, and then spelled out several possible theories on which the plaintiffs could amend their complaint to “render plausible their claims against Corinthian:” (1) that the Corinthian employee performance rating system was simply a proxy for employee recruitment numbers, (2) that the qualitative aspects of the Corinthian employee performance rating system were based merely on those basic requirements that any employee would be required to meet, and (3) that Corinthian’s salary increases were in practice determined solely on the basis of recruitment numbers, even if its written policy appeared to comply with the incentive compensation prohibition. The court also instructed plaintiffs to amend their complaint to include specific facts showing Corinthian’s knowledge that its recruiter compensation fell outside of the ED safe harbor and violated the incentive compensation prohibition, and the court even went so far as to include specific examples of facts that, if properly alleged, could support an inference that Corinthian acted with fraudulent intent.

The court also reversed the district court’s dismissal as to Corinthian’s board of directors and auditor, Ernst & Young, which had been named as co-defendants in the case. This part of the decision serves as a reminder that relators may make allegations against other parties beyond the company itself that received the Title IV funds.

A significant element of this decision is that the court rejected the relator’s claim that Corinthian violated the HEA by firing admissions representatives who failed to recruit a minimum number of students, stating, “This does not state a violation of the incentive compensation ban.” The court stated that “Even as broadly construed, the HEA does not prohibit any and all employment-related decisions on the basis of recruitment numbers; it prohibits only a particular type of incentive compensation,” and that “adverse employment actions, including termination, on the basis of recruitment numbers remain permissible under the statute’s terms.”

That holding is very significant for schools because it clearly states that termination of employees is permissible under the incentive compensation statute, not just under the prior ED regulations that expired June 30, 2011. The holding therefore will continue to be an important precedent to institutions as they operate under the new incentive compensation regulations that became effective July 1, 2011. In the Corinthian case opinion, the Ninth Circuit cited to U.S. ex rel. Bott v. Silicon Valley Colleges, an unpublished 2008 Ninth Circuit Court of Appeals decision that had also stated that the decision to fire a recruiter is not covered by the HEA “because termination is not a prohibited ‘commission, bonus, or other incentive payment.’”  

While the Ninth Circuit opinion in the Corinthian qui tam case provides schools, especially those under the jurisdiction of the Ninth Circuit, with clear support on the termination issue, it is not clear whether other circuits will follow this rule. Additionally, ED has not provided any statement or guidance indicating whether it will attempt to assert a different position under the new regulations.

District Court Dismisses Qui Tam Suit Against ITT Educational Services

Another positive development occurred on August 8, 2011, when the U.S. District Court for the Southern District of Indiana granted the motion of ITT Educational Services, Inc. (“ITT”) to dismiss a qui tam lawsuit that had been filed against that company. The dismissal was based on a threshold jurisdictional question under the FCA, which prevents an individual relator from prevailing in a lawsuit that is based upon allegations and information that had already publicly disclosed – for example, through an administrative hearing, a Congressional investigation, or the news media – unless that relator is also an “original source” of the information upon which the lawsuit is based.

According to the court’s decision, the qui tam suit against ITT was originally filed in 2007 by a former employee who, after she left ITT, was alerted by an attorney to recent qui tam lawsuits against for-profit colleges, and filed suit after “conduct[ing] research on the internet regarding ITT’s compliance with Title IV regulations and review[ing] qui tam suits that had previously been filed against ITT.” The district court found that she lacked the personal knowledge to be an “original source” of the allegations against ITT since her allegations were based on identical allegations made in a separate qui tam suit against ITT. The district court decided that she was not a “true whistle-blower who gained direct and independent knowledge of the fraud she has alleged while employed at ITT,” because while she possessed facts relating to ITT’s compensation practices, she had no personal knowledge “related to the overall claim of fraud and facts that evidence ITT’s alleged scheme to intentionally and knowingly deceive the Department of Education.” Thus, the trial court granted ITT’s motion and dismissed the qui tam case. The case may still be appealed to the U.S. Court of Appeals for the Seventh Circuit.

The ITT case confirms that the “original source” rule can be an effective defense to qui tam lawsuits.  

The Future

The claims in the qui tam suits described above were based on the ED incentive compensation regulations that expired on June 30, 2011. The revised ED regulations effective July 1, 2011 are significantly more restrictive of schools’ compensation practices and also create new areas of ambiguity. Because many crucial areas of the new ED regulations lack clarity, they expose schools to greater risk that opportunistic relators will file still more qui tam suits in the future.

Similarly, as the Obama Administration has signaled its interest in cracking down on perceived abuses in the proprietary school sector, we are likely to see increases in U.S. Department of Justice interventions in qui tam suits brought by individual relators against for-profit schools, under both the incentive compensation regulations that expired on June 30, 2011 as well as the new incentive compensation regulations effective July 1, 2011. We also expect that conditions are ripe for an increasing number of non-profit institutions to be subjected to qui tam suits based on their employee compensation and incentive practices.

While schools cannot change their past compensation practices, going forward it is crucial to ensure that institutional compensation plans are in compliance with the new incentive compensation regulations and are applied to all of the individuals covered under the new regulations. Additionally, implementing proper policies and training employees is more important than ever since, as the above cases demonstrate, qui tam complaints may be based on a school’s improper implementation of a facially compliant compensation plan.