Catfight in California

Long-simmering tension between state student aid commission and its student loan subsidiary boils over into accusation of federal rule breaking.
September 18, 2008

The California Student Aid Commission and its student loan auxiliary, EdFund, have been at odds, on and off, for years. Many college officials in the state have written off the battling as white noise, given that its impact on students and institutions has been negligible.

But the long-seething tension has exploded into full-blown and highly public conflict in recent weeks, bringing Gov. Arnold Schwarzenegger into the fray (dismissing the student aid commission's chairman after his administration blocked a move to scuttle EdFund's board) and revealing potentially serious allegations that EdFund has run afoul of federal rules that prohibit student loan guarantee agencies from offering "inducements" to lenders to use their services.

The allegations -- made in the form of a confidential memorandum from California's attorney general that the student aid commission released this month, nearly two years after the memo was written -- only served to intensify the warring between the two entities. Edfund officials disputed the charges and, in a news release, questioned "the timing and motives" of the release of "this confidential attorney client privileged draft memo 23 months after it was written."

Officials of both agencies have sought to ease any concerns among college officials and students in the state that the governance conflict, visible and potentially embarrassing as it is, will affect them. "I want to reassure you that these matters are neither operational issues nor issues that involve the delivery of services to students and schools," Carlene Moore Ellis, vice chair of EdFund's Board of Directors, said in an "open letter to the financial aid community" last week.

It's not surprising that financial aid officers and others who might be following the brouhaha might need reassurance, given how voluble the situation is between the student aid commission and EdFund, which CSAC created as a nongovernmental nonprofit entity in 1997 to help CSAC manage (and aggressively market) its participation in the Family Federal Education Loan Program.

It would take the Internet equivalent of pages of newsprint to recount all of the history and tension between the two entities, which have revolved around such fundamental questions as whether EdFund's business strategy should focus on state vs. national priorities, how aggressive it should be, the compensation of EdFund executives, and the extent to which its operating surpluses should be plowed back into EdFund's student loan business or used to support other CSAC initiatives.

The fact that the student aid commission's board appoints all members of the EdFund board hasn't stopped the two bodies from clashing repeatedly, and a series of governmental audits and reports (including one in 2006 by the Legislative Analyst's Office) have called for consolidation or the sale of EdFund -- an idea that Schwarzenegger embraced, as a way to raise $1 billion, as part of his fiscal 2008 budget plan.

But it is widely believed that a sale of the agency would fetch nowhere near that amount now, due partly to the changes in the overall economic and student loan climates but also, according to supporters of EdFund, because of the continued hamstringing of EdFund's business by the student aid commission.

If EdFund and CSAC have long engaged in low-level skirmishing, they moved to all-out war in recent weeks. At a meeting on September 4, the student aid commission's board voted to freeze the compensation of EdFund's executives, disband the board of EdFund, and replace its members with themselves. “Working to clean up the existing structural disorder and dysfunctional, wasteful bureaucracy at EdFund is the best course of action for the strength of the State’s federal student loan program,” the aid commission's chair, Peter Hankwitz, said in a news release.

But that move was blocked the next day by the director of the state's finance department, saying his department had to approve any action that had the potential to impair the value of the loan agency's portfolio. Then, last Friday, Schwarzenegger went a step further, withdrawing the nomination of Hankwitz as head of the student aid commission, a nomination that had yet to be approved by the State Senate. A spokeswoman for the governor declined to explain the reasons for his actions to local reporters.

Lost amid the shouting, the student aid commission quietly issued a news release on September 5 in which it said it had declined to reimburse $6 million in expenses sought by EdFund because it had concluded that the expenses are "related to inducements prohibited under federal law." To back up that bombshell of an assertion, the student aid commission said it had waived "attorney-client privilege" to release a confidential memorandum that it had received in September 2007 from the office of Attorney General Edmund G. (Jerry) Brown Jr., which concluded that a 2006 EdFund policy on default fees violated federal rules barring improper inducements to lenders by guarantee agencies. Under the policy, which CSAC's board had approved, EdFund agreed to pay borrowers' default fees on loans provided by certain lenders if those lenders met certain conditions on the types of loans they originated and the volume of loans that CSAC/EdFund guaranteed for the lenders.

"In our view, the policy creates a prohibited inducement because it directly links the fee payment by CSAC, which benefits the lender, to the lender's selection of CSAC as the guaranty agency for other loans," the attorney general's office wrote. "The payment of the fee appears to be a quid pro quo or reward for the lender's selection of CSAC as the guaranty agency for its consolidation loans and thus provides an incentive or inducement for the lender to select CSAC as the guaranty agency for its consolidation loans."

It added: "Based on the available information provided to date, and the limited timeframe provided for our review, we are unable to conclude that the proposed policy is legally consistent with the applicable federal law."

Despite repeated attempts, officials at CSAC could not be reached for comment about their reasons for releasing the confidential memo now, or about why they approved the EdFund policy at the time but are challenging it now.

Officials at EdFund, however, raised those issues in a statement they released upon being notified of the news release by Inside Higher Ed.

"It has been brought to EdFund’s attention that there was a press release by the California Student Aid Commission on Friday, September 5, 2008 releasing confidential attorney-client privileged documents to the public," the statement said. "The reasons for the public release of these documents are not clear to EdFund and furthermore these documents have never been shared with EdFund prior to or since this press release."

The statement continued: "Federal law requires students to pay a one percent fee on all student loan proceeds to the federal government. In an effort to minimize the financial impact to students, the Commission approved the policy “Student’s First: A Partnership for America’s Future.” The purpose of the policy was to help students and only students. One hundred percent of the fees associated with the policy were paid to the federal government on behalf of college students to cover the required one percent federal default fee. At no point in time did EdFund provide any benefit or inducement to any lender to obtain loan volume.

"The commission approved the above referenced policy on September 7, 2006 and directed EdFund to implement a program effective July 1, 2007.... The commission is the designated guarantor for the State of California. EdFund is an auxiliary organization of the Commission charged with administering the federal student loan program on the commission’s behalf. Consequently, EdFund cannot deploy a policy of this nature without explicit authorization by the commission.

It concluded: "EdFund questions the timing and motives of the public release of this confidential attorney client privileged draft memo 23 months after it was written. EdFund is fully aware and abides by the inducement prohibitions contained in federal law. We are confident that there was no inducement and will work with the United States Department of Education to clear up any confusion that this draft memo may have caused."


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