On November 1, 2007, after months of controversy concerning alleged conflicts of interest in student loan programs, the U.S. Department of Education published final rules applicable to federal student loan programs. 72 Fed. Reg. 61960 (2007). Among other changes, the rules are intended to prevent actual and potential conflicts of interest on the part of postsecondary education institutions, lenders, and guaranty agencies in administering federal student loan programs. The final rules do not directly regulate private student loan programs.

While the department has been working on these regulations, Congress has also been considering reauthorization of the Higher Education Act (HEA) and legislation to regulate private student loans. The U.S. Senate passed an HEA reauthorization bill in July 2007, and action on a companion bill in the U.S. House of Representatives is anticipated soon. The HEA reauthorization bill is likely to address some of the same topics, including preferred lender lists and prohibited inducements, as the department regulations. In the final regulations, the department undertakes to “provide any clarifying guidance that may be necessitated by future legislation in these areas.”

Below we highlight key aspects of the final rules relating to postsecondary education institutions and lenders. Although the new rules on preferred lender lists apply directly to postsecondary education institutions and the new rules on prohibited inducements apply directly to lenders and guaranty agencies, postsecondary education institutions should also be cognizant of the rules applicable to lenders and guaranty agencies, and vice versa. The rules are effective July 1, 2008, but institutions, lenders, guaranty agencies, and loan servicers may implement certain rules on or after November 1, 2007.

Preferred Lender Lists

For the first time, the department has prescribed standards for postsecondary education institutions that choose to compile and use preferred lender lists for Federal Family Education Loan Program (FFELP) loans (e.g., Stafford and PLUS loans). Among other requirements, schools must: 

  • Include at least three “unaffiliated” lenders 
  • Disclose the method and criteria used to select lenders 
  • Provide comparative information about benefits offered by listed lenders 
  • Include a “prominent statement” that borrowers may select a lender not on the list 
  • Update the list and accompanying information at least annually 
  • Not include any lender that has offered benefits in exchange for placement on the list
  • Not assign a specific lender to first-time borrowers
  • Not delay loan eligibility certification if a borrower selects a lender not on the list

Anti-Inducement Provisions

The HEA and department regulations have long prohibited lenders and guaranty agencies from offering “inducements” to borrowers, institutions, and other parties to secure applicants for FFELP loans or to sell other products. Past department regulations and guidance have identified certain lender and guaranty agency activities that would violate the anti-inducement rule. The new rule expands the list of permissible and prohibited lender and guaranty agency activities, in some instances reversing previous department guidance.

Permissible activities

In addition to previously approved lender and guaranty agency activities, the final rule clarifies that the following activities do not run afoul of the anti-inducement provisions: 

  • Repayment incentives and loan forgiveness programs for public service and other department-approved purposes, provided such programs are not marketed to secure FFELP loan applications 
  • Reasonable costs for meals, refreshments, and receptions provided to institution officials and scheduled in conjunction with conference events open to all attendees 
  • Participation in an institution’s or guaranty agency’s student aid and financial literacyrelated outreach (excluding in-person, school-required entrance and exit counseling) as long as the financial sponsor is disclosed and the lender does not promote its student loan or other products 
  • Toll-free telephone numbers for institutions or borrowers to obtain FFELP information

Prohibited activities

Going beyond the prohibited activities previously enumerated in department regulations and guidance, the department has expanded the list of lender activities that presumptively violate the anti-inducement provisions. The final rule reverses in some respects the department’s previous guidance, which was understood to permit formerly common practices such as lenders’ and guaranty agencies’ conduct of entrance and exit counseling, school officials’ service on advisory boards, and payment of loan referral fees in certain circumstances. Under the final rule newly prohibited activities include:

Benefits to institutions and “school-affiliated organizations” 

  • Philanthropic activities, such as grants, scholarships, or financial contributions, as well as other payments, premiums, or benefits, in exchange for FFELP loan applications, referrals, loan volume, or placement on a preferred lender list 
  • Staffing for financial aid functions on more than a short-term, non-recurring, emergency basis 
  • In-person, school-required entrance or exit counseling for student borrowers

Benefits to employees of institutions or school-affiliated organizations

  • Payments for entertainment expenses or any lodging, rental, transportation, or other gratuities related to lender-sponsored activities 
  • Payments for registration, transportation or lodging at conferences and trainings 
  • Solicitation of school employees to serve on advisory boards and payments related to such service Referral fees 
  • Payment of any referral or processing fees to another lender or other party (except processing fees necessary to comply with federal or state law)

The department defines a “school-affiliated organization” as “any organization that is directly or indirectly related to a school” and expressly includes alumni organizations, foundations, athletic organizations, and social, academic, and professional organizations. The permissible and prohibited activities for guaranty agencies are largely the same as those for lenders.

Enforcement

The department also took steps to heighten enforcement of the anti-inducement provisions: 

  • The department will apply a “rebuttable presumption” that payments or benefits specified on the list of prohibited activities were undertaken to secure FFELP loan applications or loan volume 
  • A loan made in violation of the anti-inducement provisions (as determined by the department or a guarantor) loses its federal guaranty and thus is ineligible for federal subsidy payments 
  • A lender is subject to claims or defenses that a borrower can assert against a school with respect to a FFELP loan if, among other circumstances, the lender that made the loan provided an improper inducement to the school or any other party in connection with making the loan

Preemption

In the preamble to the final rules, the department states that “State statutes, regulations, or rules that conflict with or hinder the accomplishment of the Department’s rulemaking relating to inducement practices are preempted.” The department anticipates future rulemaking to clarify preemption-related issues.

College Cost Reduction and Access Act

The final rules implement certain changes to the federal student loan programs enacted by the College Cost Reduction and Access Act (CCRAA), Pub. L. No. 110-84. The CCRAA was generally effective on October 1, 2007. On October 3, 2007, we published an Education Investors Update regarding the CCRAA. The changes made by CCRRA and implemented in the final rules include: 

  • Reductions in subsidized Stafford Loan interest rates for undergraduates 
  • Reductions in lenders’ special allowance payments
  •  Reductions in subsidies to guarantors 
  •  Increase in per-loan lender fee payable to the department 
  • Elimination of “exceptional performance” status for lenders and lender third-party servicers