Progress and Peril for Career Education

Company has resolved significant legal and regulatory challenges, but major problems remain, including a potential shareholder revolt.
May 18, 2006

After a year in which it had seemed to be in a virtual free fall, facing a series of regulatory and legal challenges and watching its stock price drop by more than half, Career Education Corporation has, one by one, fended off or otherwise resolved many of the lawsuits and investigations in recent weeks. But several serious problems remain -- perhaps none more so than one it faces at its annual meeting today: a direct challenge to its management by a dissident shareholder, which has resulted in a bitter war of words and worse in the last few days.

Career Education is one of the biggest and most successful publicly traded higher education companies, and in the middle of 2004, it was flying high, with its stock trading at $70 a share. But 2005 brought a steady drumbeat of news that went from bad to worse, bringing it a reputation as a bad boy of the for-profit higher education sector. Among the hits:

  • In January, “60 Minutes” aired one of its typically harsh reports that used Brooks College, a Career Education campus in Long Beach, Calif., to illustrate perceived pitfalls of for-profit higher education. The report accused Brooks officials of grossly misrepresenting graduation and job placement rates, and graduates’ starting salaries, to woo prospective students.
  • In July, the company announced that the U.S. Education Department U.S. Education Department had imposed a freeze on the establishment of any new campuses or acquisitions while it investigated Career Education’s compliance with federal student aid regulations. The federal agency’s scrutiny followed a review announced in 2004 by the U.S. Securities and Exchange Commission.
  • Also in July, California’s Bureau for Private Postsecondary Vocational Education concluded that a campus owned by Career Education had “willfully” provided misleading and falsified information and omitted other information that “persuaded prospective students to enroll” in its educational programs. The agency significantly restricted the operations of Brooks Institute of Photography, including barring it from enrolling new students until it submitted a slew of information and requiring it to get written statements from employers of all of its current and future graduates.
  • Career Education said in August that regulators in Pennsylvania and New Jersey had begun investigations of campuses the company operates in those states, prompted by critical news articles and, in New Jersey, the “60 Minutes” report.
  • In December, the Southern Association of Colleges and Schools placed Career Education’s American Intercontinental University on probation for shortcomings in, among other things, the “integrity of student academic records.”
  • The company continued to be dogged by a series of lawsuits filed by students and shareholders, most of which accused the company of providing misleading information.

Not surprisingly, the litany of problems gave Career Education a major public relations black eye and deflated the value of the company’s stock, which fell from that $70 high in the middle of 2004 to the mid-30s throughout most of 2005.

The company’s travails also invited unwelcome scrutiny of another kind, in the form of a group of dissatisfied investors who at Career Education’s 2005 annual meeting persuaded a sizable majority of the company’s stockholders to support three nonbinding proposals, signaling a lack of confidence in company officials.

Career Education has taken significant steps in recent months to try to rebuild public and investor confidence in the company -- and it has done so in large part by aggressively taking on its courtroom and other challengers. It put together what Jeffrey Silber, who analyzes for-profit education for the investment firm Harris Nesbitt, calls an in-house legal “dream team,” and the team’s work over the past year has paid off in recent weeks with a series of legal and regulatory victories. Among them:  

  • Career Education announced in late March that a federal judge had for the second time thrown out a securities class action accusing the company of misleading investors. Although the lawsuit has since been refiled for a third time, company lawyers are hopeful that the judge will dismiss it yet again.
  • Last month, the company said that the staff of the Securities and Exchange Commission’s Midwest office had recommended that the agency drop its investigation of the company and take no action against it.
  • The Wall Street Journal reported this month that the company had paid the U.S. Education Department $490,000 in recent months to resolve investigations into potential financial aid violations at Career Education campuses in Pennsylvania and Arizona.
  • Last Friday, the company said a federal judge had dismissed one of two shareholder derivative lawsuits that had been filed against Career Education.
  • And Monday, the California Department of Consumer Affairs ruled that the Bureau for Private Postsecondary Vocational Education, which it oversees, had violated its own rules last August when it cracked down on Brooks Institute of Photography. The agency invalidated the bureau’s findings, directing it to extend Brooks’s existing ability to operate at full capacity and to reconsider the college’s application for renewed approval on the merits.

Taken together, says Janice L. Block, the former Microsoft lawyer who leads Career Education’s legal team, the events of the last two months are important steps in “vindicating the company,”  which she described as an “ongoing process.”

“It’s been really critical for the company to have an internal legal department like we do now, to be able to bring some strategy to bear on the closure of these lawsuits and investigations,” said Block, Career Education's senior vice president, general counsel and secretary.

She added that company officials had come to believe that many of the investigations and lawsuits were linked, with charges made in a securities lawsuit, for example, piquing the interest of state or federal regulators, who then begin to investigate. So just as the filing of one lawsuit might motivate the filing of another, or the start of a regulatory inquiry, Block said, the resolution of one investigation can take the steam out of another.

Block is not sanguine, however, about the uphill climb that still faces the company from a legal and regulatory standpoint. And while Silber of Harris Nesbitt acknowledges that “compared to a year ago, [the company has] won some victories on the legal and regulatory front,” he notes that Career Education’s “operating fundamentals have weakened” – its most recent financial statements showed a decline in net income, despite an increase in revenue.

The most significant threat facing the company in the short term is the challenge that will be formally waged today at its annual meeting by R. Steven Bostic, who owned a company that sold American Intercontinental University to Career Education in 2000. In a series of SEC filings, letters to investors and an aggressive campaign if advertising in major financial newspapers, Bostic has accused company officials of driving the stock down through mismanagement.

Bostic has asked the company’s stockholders to vote him and two other men onto Career Education’s 9-member board. In recent weeks two of the three major firms that advise shareholders on how to vote their proxies -- Glass Lewis & Co. and Institutional Shareholder Services -- have endorsed the Bostic group over the company’s own slate. The company's biggest shareholder, however, Ariel Capital Management, is backing current management, Career Education announced this week.

Career Education officials are “definitely taking this challenge seriously,” says Silber, who predicted a “battle to the finish.”

A sign of just how seriously the company takes the threat can be seen in the flurry of filings and letters that the company's lawyers have issued in recent days. Yesterday morning, Career Education filed a complaint with the Securities and Exchange Commission accusing Bostic of using misleading information in his appeals for shareholders' votes.


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