Beleaguered for-profit tertiary 
level education provider ITT Educational Services closed its doors abruptly in September as U.S. federal regulators clamped down on the company following a long series of accounting and oversight scandals. In an August 2016 letter addressed to the company, the U.S. department of education effectively blocked ITT’s access to tuition income from federal student loan recipients. The decree, described by some as ITT’s death sentence, caused immediate facility closures and sent creditors running for the exits –displacing some 40,000 of ITT’s students and 8,000 faculty members in the process.
Early cracks in ITT’s foundation began to appear 17 years ago, with whistleblowers lamenting the aggressive sales tactics used against its prospective students. In more recent years, the depth of the Company’s woes had not gone unnoticed by its shareholders who had consistently expressed dissatisfaction with, among other things, the Company’s executive compensation programs. Since ITT’s very first say-on-pay vote in 2011, compensation had been a hot topic of controversy at the company. Case and point, Kevin Modany, the CEO who presided over the company’s terminal decline, received total annual compensation payments peaking at more than $8.7 million in fiscal 2012. At each of the 2011, 2012 and 2013 annual meetings ITT’s say on pay vote received substantial opposition from shareholders and only narrowly received majority support at the 2013 meeting. In a muddled response to shareholder concerns, the company made minimal changes to the structure of the pay program and conducted limited outreach, dismissing against votes as incidental based on rigid formulaic shareholder voting policies. In retrospect, this could be seen as setting the tone for ITT’s responsiveness to other stakeholder concerns.
Over the three-year period since its 2013 annual meeting, ITT had lost substantially all of its market value and struggled with a series of accounting restatements. This unravelling began in February 2013 with the first of many SEC subpoenas regarding the Company’s accounting practices. Specifically, the company stood accused of intervening to pay back student loans covered by its sponsored PEAKs and CUSO programs to avoid triggering its guarantee obligations thereunder. Essentially, these programs were investment vehicles created to secure private financing of student loan debt so that the company would remain in compliance with federal regulations capping the percentage of its income from federal sponsored sources at 90% (the “90-10 rule”). In order to entice private investors to finance risky student loan debt, the company sweetened the deal with various guarantee covenants. As student loan default rates increased, these guarantee obligations grew into considerable liabilities. However, ITT erroneously sought to exclude the PEAKs trust entity from its consolidated financial statements leading to a public disagreement with its then-auditor PWC. The company was ultimately forced to restate its financial statements to incorporate these off balance sheet liabilities.
In the aftermath of the financial restatements, the SEC’s enforcement spotlight turned to Mr. Modany and Daniel Fitzpatrick, the company’s then-CFO, alleging deliberate fraudulent misrepresentation of ITT’s financial position and guarantee obligations. Civil claims sought to disgorge the company of any ill-gotten gains and reclaim bonuses and incentive pay from Messrs. Modany and Fitzpatrick. In addition, the DOE banned the company from making any further compensation payments based on enrollment, financial aid, recruitment or admissions targets without prior approval. The Consumer Financial Protection Bureau also took a stand alleging that ITT’s practices were exploitative and that students were coerced into taking out high cost private loans.
As regulators turned up the heat at ITT, Mr. Modany tendered his resignation notice in August 2014 stating his intention to step down the following February. Notwithstanding his apparent resignation, Mr. Modany continued to serve as zombie CEO of ITT until he eventually rescinded his resignation letter altogether in December 2015. Given the succession of setbacks for the company this begs the question: why did ITT’s board allow Mr. Modany to continue his service as CEO? Certainly, the company’s poor performance alone might have been grounds to remove Mr. Modany from his post. In any event, no cogent rationale was provided, except to say that the board determined Mr. Modany’s reappointment was in the best interests of the company and its shareholders.
Ultimately, it wasn’t unresolved questions of accounting fraud or a foray of debt repayments which brought down ITT. The reputational damage suffered by the company caused the Accreditation Council of Independent Colleges and Schools (“ACICS”) to question the company’s commitment to serving the interests of its students. ACICS sent a “show-cause” directive to the company in April 2016 requiring it to demonstrate why its ACICS accreditation should not be suspended or withdrawn. Unsatisfied with the initial response, a second letter was sent to the company in August demanding additional information in relation to these matters and maintaining the show cause directive. Citing the second ACICS letter, the DOE issued its decree demanding, among other things, that ITT increase surety reserve requirements, refrain from enrolling or beginning classes for any new students who were Title IV Program fund recipients and banning the company from paying bonuses, retention payments, raising salaries or making severance payments to its management or directors or making any special dividend payments or disbursements. Less than two weeks after receiving the letter from the DOE, ITT announced that it was ceasing all academic operations.
ITT stands out as an example, albeit an extreme example, of how oversight failures at a company may contribute to adverse outcomes for shareholders. While a number of the accusations made against ITT were never conclusively proven in a court, allegations of fraud and exploitative practices set off a chain of events and a regulatory backlash which ended with the company closing its doors. Arguably a more decisive response to some of these developments may have enabled the company to avoid a winding up.
ITT isn’t the only corporate provider of educational services to come under regulatory scrutiny in the United States: Shareholders at Devry Education Group Inc.’s annual meeting today (November 10) will be mindful of what unfolded at ITT – particularly as Devry is fighting its own battles with the Department of Education.