oversight

Capital City Trade and Technical School, Inc. Compliance with the 85 Percent Rule.

Published by the Department of Education, Office of Inspector General on 2000-02-15.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               AUDIT OF
  CAPITAL CITY TRADE AND TECHNICAL
             SCHOOL, INC.
        COMPLIANCE WITH THE
           85 PERCENT RULE

                                  FINAL AUDIT REPORT




                              Control Number ED-OIG/A06-80008

                                          February 2000



Our mission is to promote the efficient                         U.S Department of Education
and effective use of taxpayer dollars                             Office of Inspector General
in support of American education.                                               Dallas, Texas
                              NOTICE
Statements that management practices need improvement, as well as other
conclusions and recommendations in this report, represent the opinions of the
Office of Inspector General. Determination of corrective action to be taken
will be made by the appropriate Department of Education officials.

In accordance with the Freedom of Information Act (5 U.S.C. §552), reports
issued by the Office of Inspector General are available, if requested, to
members of the press and general public to the extent information contained
therein is not subject to exemptions in the Act.
                           TABLE OF CONTENTS

EXECUTIVE SUMMARY................................................................................. 1

AUDIT RESULTS ............................................................................................. 2

        Proprietary Schools are Required to Generate at least 15 percent
         of Revenue from Non-Title IV Sources .................................................... 2
        Proceeds from the Sale of Delinquent Student Accounts between
         Related Parties were Improperly Included as Non-Title IV Revenue.......... 3
        The Related Parties and Their Relationships .......................................................... 4
        The Sale of Delinquent Student Accounts
         between Related Parties .............................................................................................. 4
        SEOG Matching Funds Included as Non-Title IV Revenue ......................... 5

RECOMMENDATIONS .................................................................................... 7

CAPITAL CITY’S RESPONSE TO DRAFT REPORT ....................................... 7

OIG RESPONSE TO COMMENTS.................................................................... 8

BACKGROUND.............................................................................................. 10

OBJECTIVE, SCOPE, AND METHODOLOGY............................................... 10

STATEMENT ON MANAGEMENT CONTROLS ........................................... 11

APPENDIX I
APPENDIX II
                         EXECUTIVE SUMMARY

Capital City Trade and Technical School, Inc. (Capital City), a proprietary institution located in
Austin, Texas, did not qualify as an eligible institution for participation in the Title IV, Student
Financial Assistance Programs because it received 87.84 percent of its revenue from Title IV
sources during its fiscal year ended December 31, 1997. As a result, Capital City was ineligible
to participate in the Title IV programs for the period January 1 through December 31, 1998.
Capital City received $551,259 in Federal Pell Grant and Federal Campus Based Program funds,
and $1,481,322 in Federal Family Education Loan Program (FFELP) funds during this period.

Section 481(b) of the Higher Education Act in effect during our audit period, required that
proprietary institutions derive at least 15 percent of their revenues from non-Title IV sources to
participate in the Title IV programs. Conversely, no more than 85 percent of total revenue could
be derived from the Title IV programs. This institutional eligibility requirement was commonly
referred to as the 85 Percent Rule. Capital City reported that it met the requirements of the 85
Percent Rule in the “Notes to Financial Statements” for its fiscal year ending December 31,
1997. However, Capital City improperly included $84,429 as non-Title IV revenue. This
amount resulted from transactions between Capital City and a related party that had a controlling
and ownership interest in the institution. Therefore, there was no increase in revenue to the
institution. Capital City also improperly included $24,209 in Federal Supplemental Education
Opportunity Grant (SEOG) matching funds in the non-Title IV component of the 85 Percent
Rule calculation.

We recommend that the Chief Operating Officer for Student Financial Assistance initiate action
to terminate Capital City from participation in the Title IV programs unless Capital City can
demonstrate that it met eligibility requirements for its fiscal year ended December 31, 1998. The
Chief Operating Officer should also require that Capital City return to the Department or lenders
$551,259 in Federal Pell Grant and Federal Campus Based Program funds and $1,481,322 in
FFELP funds that the school received from January 1 through December 31, 1998 while it was
an ineligible institution.

Capital City did not agree with our findings and recommendations. The school’s response did
not convince us to change our recommendations. We have paraphrased the school’s comments
and provided additional OIG comments after the Recommendation section of this report. A copy
of the response is included as Appendix I to this report. Copies of exhibits that were also
included with the response are available on request.
Control Number: ED-OIG/A06-80008                                                                    Page 2

                                      AUDIT RESULTS
We concluded that Capital City did not derive 15 percent of its revenues from non-Title IV
sources during its fiscal year ended December 31, 1997 and therefore was not eligible to
participate in the Title IV programs for the period January 1 through December 31, 1998.
Capital City received $551,259 in Federal Pell Grant and Federal Campus Based Program funds
and $1,481,322 in Federal Family Education Loan Program funds during that period. Capital
City reported that it received 83.3 percent of total revenue from Title IV sources in its 1997
financial statements. Capital City actually received 87.84 percent of its total revenue from Title
IV sources because it improperly included $84,429 as non-Title IV revenue. These funds
resulted from transactions with a related party that had an ownership interest in Capital City and
exercised control over the day-to-day operations of the institution. As a result, the transactions
did not represent an increase in revenue to the institution. Capital City also included $24,209 of
SEOG matching funds in its calculation which did not represent revenue received from a source
independent of the institution.


Proprietary Schools are                  The Higher Education Act (HEA), Section 481(b), in effect
Required to Generate at                  during the audit period stated: . . . the term proprietary
  least 15 percent of                    institution of higher education means a school . . . which
                                         has at least 15 percent of its revenues from sources that are
Revenue from Non-Title                   not derived from [HEA, Title IV] funds . . . . This
     IV Sources.                         institutional eligibility requirement is codified in Title 34 of
                                         the Code of Federal Regulations (CFR), Section
                                         600.5(a)(8), and is commonly referred to as the 85 Percent
                                         Rule. The regulations also provide the formula, at 34 CFR
                                         600.5(d)(1), for assessing whether an institution has
                                         satisfied the requirement and specifies that amounts used in
                                         the formula must be received by the institution during its
                                         fiscal year. The formula is as follows:


              Title IV, HEA program funds the institution used to satisfy tuition, fees,
                            and other institutional charges to students
____________________________________________________________________________________

 The sum of revenues generated by the institution from: Tuition, fees, and other institutional charges for
            students enrolled in eligible programs as defined in 34 CFR 668.8; and activities
             conducted by the institution, to the extent not included in tuition, fees, and other
      institutional charges, that are necessary for the education or training of its students who are
                                    enrolled in those eligible programs
Control Number: ED-OIG/A06-80008                                                        Page 3

Proceeds from the Sale         Capital City improperly included $84,429 in its 85 Percent
 of Delinquent Student         Rule calculation. These funds were received from a related
   Accounts between            party with a controlling and ownership interest in the
                               institution. The regulations provide that revenues included
  Related Parties were         in the calculation are limited to revenues generated for the
Improperly Included as         training of students and received from Title IV sources or
 Non-Title IV Revenue          from sources independent of the institution.

                               In February 1994, the Department published the proposed
                               regulations to implement this portion of the Higher
                               Education Act. In the preamble, the Secretary stated that
                               the purpose of the new statutory criterion was to require
                               proprietary institutions to attract students based on the
                               quality of their programs and not solely because the
                               institutions offer Federal student financial assistance. In
                               proposing this rule, the Secretary was required by the
                               Higher Education Act to interpret the term revenue and
                               chose to limit revenues received to tuition and fees plus
                               revenues from other activities carried out by the institution
                               that were necessary to the education or training offered by
                               these institutions.

                               The preamble provides that proprietary institutions should
                               satisfy a portion of the 85 Percent Rule revenue
                               requirement with funds from non-Title IV programs or
                               from private sources that are independent of the institution.

                               Title 34 CFR 600.31(b) defines control and ownership of
                               an institution as:

                               Control (including the terms “controlling”, “controlled
                               by” and “under common control with”) means the
                               possession, direct or indirect, of the power to direct or
                               cause the direction of the management and policies of a
                               person, whether through the ownership of voting securities,
                               by contract, or otherwise . . . . Person includes a legal
                               person (corporation or partnership) or an individual.

                               Ownership or ownership interest means a legal or
                               beneficial interest in an entity, or a right to share in the
                               profits derived from the operation of an entity . . . .
Control Number: ED-OIG/A06-80008                                                     Page 4

The Related Parties and        Capital City Trade and Technical School, Inc. owns and
 Their Relationships           operates two separate institutions under the single OPE ID
                               Number 02074100. The corporation and its two
                               institutions, Capitol City Trade and Technical School and
                               Allied Health Careers are collectively referred to as Capital
                               City. The stock in Capital City is owned 50 percent by
                               Owner A and 50 percent by Owner B. Owner A serves as
                               the president of Capital City.

                               Timberline I is a general partnership. The partners are two
                               privately held corporations. The two corporate partners are
                               RCH Enterprises, Inc. and Berry Enterprises, Inc. with
                               RCH Enterprises, Inc. designated as the managing partner.
                               RCH Enterprises, Inc. is an Owner A family owned
                               corporation with Owner A as the president. Berry
                               Enterprises, Inc. is an Owner B family owned corporation
                               with Owner B as the president.

                               As outlined above, Owner A has direct control of and a
                               significant ownership interest in both Capital City and
                               Timberline I (See Appendix II for a diagram of the
                               relationship).

                               In a management agreement signed in 1983, Capital City
                               contracted with Timberline I to manage all aspects of
                               Capital City’s operations. Owner A signed the agreement
                               for both Capital City and Timberline I. Under the
                               agreement, Timberline I manages accounts receivable for
                               Capital City. Owner A, as president of RCH Enterprises,
                               Inc., the managing partner for Timberline I, and as
                               president of Capital City makes management decisions for
                               both entities. Thus, Timberline I has a controlling interest
                               in Capital City.

                               The management agreement calls for Timberline I to be
                               paid a management fee of 13 percent of gross receipts and a
                               share in the profits of the institution. During the
                               institution’s 1997 fiscal year, Timberline I received
                               $771,285 in management fees. Thus, Timberline I exhibits
                               an ownership interest in Capital City by having a right to
                               share in the proceeds of the institution.
Control Number: ED-OIG/A06-80008                                                    Page 5

The Sale of Delinquent         Capital City included $84,429 that it received from
  Accounts between             Timberline I as non-Title IV revenue in its 85 Percent Rule
   Related Parties             calculation. Timberline I purchased student accounts from
                               the institution on December 17, 1997 – just two weeks
                               prior to the end of the institution’s fiscal year.

                               Even though the student accounts had been written off as
                               bad debt, Timberline I paid a price equal to 80 percent of
                               the face value for the student accounts. We found no
                               evidence that the bad debt was rehabilitated prior to the
                               purchase. Timberline I subsequently placed the delinquent
                               accounts with a collection agency that was entitled to keep
                               one-third of the collections that it made. The placement of
                               the accounts with the collection agency would result in a
                               loss to Timberline I, even if all the delinquent accounts
                               were successfully collected. The $84,429 sale of
                               delinquent accounts should be excluded from Capital City’s
                               85 Percent Rule calculation for 1997 because it does not
                               represent revenue to the institution from a source that is
                               independent of the institution. The common ownership of
                               Capital City and Timberline I, the sale of delinquent
                               accounts for a price exceeding the buyer’s potential
                               recoveries, the same individual acting as buyer and seller,
                               and the December 17, 1997 date of sale all support the
                               conclusion that the cash from the sale of bad debt should
                               not be treated as revenue received by Capital City for
                               educational programs. We reduced the denominator by the
                               amount of the proceeds from the sale as shown in the Table
                               on page six.


SEOG Matching Funds            Capital City included SEOG matching funds of $24,209 in
 Included as Non-Title         its non-Title IV revenue. Matching funds are not
                               considered revenue from sources independent of the
      IV Revenue
                               institution and should not be included as non-Title IV
                               revenue. We reduced the denominator by the amount of
                               the overstatement as shown in the Table. Revenue does not
                               result when an institution simply transfers funds from one
                               account to another account.
Control Number: ED-OIG/A06-80008                                                                      Page 6

                                                 TABLE
              Capital City and OIG Calculated Percentages of Title IV Revenue
                           January 1, 1997 to December 31, 1997.

                                         Capital City    Funds from       SEOG           OIG
         Funding Source
                                         Calculation    Related Party    Matching     Calculation
         Title IV Receipts                 $1,774,465                                    $1,774,465
         Non-Title IV Receipts               $354,302        ($84,429)    ($24,209)       $245,664
         Total Revenue (Cash Basis)        $2,128,767        ($84,429)    ($24,209)      $2,020,129
         Title IV Revenue as a Percent
         of Total Revenue                     83.36 %                                       87.84%


The Table illustrates that Title IV revenues represented 87.84 percent of total revenue and not the
reported 83.36 percent. Institutions that fail to satisfy the 85 Percent Rule lose their eligibility to
participate in Title IV programs on the last day of the fiscal year covering the period that the
institution failed to meet the requirement [34 CFR 600.40(a)(2)]. As a result, Capital City lost its
eligibility to participate as of December 31, 1997.

Capital City received $551,259 in Federal Pell Grant and Federal Campus Based Program funds
and $1,481,322 in FFELP funds between January 1 and December 31, 1998, based on data
obtained from the Department.
Control Number: ED-OIG/A06-80008                                                             Page 7

                               RECOMMENDATIONS
We recommend that the Chief Operating Officer for Student Financial Assistance:

1.     Initiate action to terminate Capital City from participation in the Title IV programs unless
       Capital City can demonstrate that it met eligibility requirements for its fiscal year ended
       December 31, 1998.

2.     Require that Capital City return to the Department $551,259 of Federal Pell Grant and
       Federal Campus Based Program funds received during the period January 1 through
       December 31, 1998.

3.     Require that Capital City return to lenders $1,481,322 of FFELP funds received during
       the period January 1 through December 31, 1998. This amount does not include loan
       origination fees, interest, or special allowance costs incurred by the Department for the
       loans.


         CAPITAL CITY’S RESPONSE TO DRAFT REPORT

Capital City disagreed with our conclusion that the institution did not comply with the 85 Percent
Rule for the fiscal year ending December 31, 1997. A copy of the letter from Capital City is
included as Appendix I to this report. Exhibits that were included with the letter are available on
request.

Capital City officials argued that they correctly calculated the non-Title IV revenues and
complied with the 85 Percent Rule for fiscal year 1997. Capital City officials further stated that
due to the OIG’s different interpretation of revenue, . . . OIG excluded SEOG matching funds
and certain cash receipts from total revenue received for tuition and fees. Capital City also
contended that . . . its accountant calculated the 85/15 percentage in good faith and without
adequate guidance from the Department or OIG . . . and that . . . Good faith and reasonable
interpretations of the law should be entitled to be made without threat of penalty . . . .

Capital City officials said that SEOG matching funds were properly included in the denominator
of the 85/15 calculation because, while the Secretary stated that they should be excluded from
the numerator, he did not specifically exclude matching funds from the denominator.

Capital City officials did not address the issue of the independence of the related party. Instead,
they stated that the inclusion of the revenue from the related party in the 85/15 calculation was
proper because the transaction was a . . . legitimate transaction that was made in good faith.
. . . the transaction was part of a planned effort to increase availability to and use of non-Title
IV financing alternatives for the students . . . . Capital City officials also stated there is no
. . . proscription on such a transaction within the context of Title IV.
Control Number: ED-OIG/A06-80008                                                              Page 8

The Draft Report contained no finding related to institutional or third party loans. Nevertheless,
Capital City’s response included the argument that it used a very conservative approach to the 85
Percent Rule calculations because it included only the payments received during fiscal year 1997
from students on their institutional and third party loans. Capital City officials identified 74
students who received institutional or third party loans. Capital City officials argue that the
institution was entitled to and could have properly included the face value of the institutional and
third party loans to the 74 students in its calculation. If it had done so, it would have included an
additional $81,874 in non-Title IV revenue thereby complying . . . with the 85 Percent Rule for
FY 1997 with a percentage of 83.3, even allowing for the exclusion by the OIG of $84,429
relating to the sale of accounts.

Capital City officials stated that the institution met the 90 Percent Rule in fiscal year 1998.
While the 90 Percent Rule was not in effect for Fiscal Year 1997, Capital City considers the fact
that it met the new Rule in those years a relevant consideration especially given Congress’ clear
action modifying the rule to 90/10 since the 85 Percent Rule was too restrictive.


                        OIG RESPONSE TO COMMENTS
Capital City’s comments did not persuade us to change our findings or recommendations.

SEOG Matching. In the preamble to the regulation, the Secretary did state that SEOG (and
Perkins) matching funds should not be included in the numerator of the 85/15 calculation.
However, the absence of a statement regarding the denominator does not negate the fact that
matching funds represent cash transfers between institutional accounts. These transfers do not
result in revenue from sources independent of the institution.

Related Party. Due to the common ownership of the institution and the related party, the
purchase of delinquent accounts does not represent revenues to the institution from a source
independent of the institution. Capital City’s comments did not address the issue of revenues
from a source that was not independent of the institution.

Outstanding Loan Balances. Capital City claimed that it had found additional revenue for fiscal
year 1997 of $81,874 in unpaid principal of institutional and third party loans to 74 students. We
returned to the school and determined that the $81,874 did not represent revenue to the
institution during fiscal year 1997. The regulations state that . . . the title IV, HEA program funds
included in the numerator and the revenue included in the denominator are the amount of title
IV, HEA program funds and revenues received by the institution during the institution’s last
complete fiscal year. [34 CFR 600.5(d)(2)(i)]. The unpaid loan principal claimed as revenue by
the institution for fiscal year 1997 was not received as of December 31, 1997, nor was it unpaid
loan principal.
Control Number: ED-OIG/A06-80008                                                             Page 9

The "loans" identified by Capital City officials were actually unpaid balances on retail
installment agreements as of December 31, 1997. The regulations stipulate that the revenue to
include in the denominator is the sum of revenues generated by the institution from tuition, fees,
and other institutional charges. Only those amounts from institutional loans that are used to
satisfy tuition, fees, and other institutional charges may be included in the calculation. The
student ledger cards did reflect amounts owed to Capital City for tuition and fees. However,
there was no indication of institutional or third party loan proceeds paid to the student. In
addition, there was no evidence of promissory notes or similar documents in the student files.
We determined that none of the amounts claimed by Capital City as additional loan principal
were credited to student accounts for tuition, fees, or other institutional charges.

We did find an “Installment Note and Disclosure Statement” (installment agreement) in 24 of the
25 files reviewed. The installment agreements included statements about the credit that was
being extended: The amount of credit provided to you . . . , . . . The dollar amount the credit will
cost you . . . and . . . The cost of your credit as a yearly rate. The documents contained no
indication that the school was loaning money to the student. Rather, the documents were
prepared for students to show the total amount of credit they were being advanced. The
installment agreements generally identified the number and amount of payments the students
would have to make to satisfy the credit agreement. Based on our sample review, payments on
these installment contracts were credited to student accounts as the school received them. We
allowed payments made by students on installment agreements as non-Title IV revenue in our
calculations during the audit because the payments were used to satisfy tuition, fees, and other
institutional charges.
Control Number: ED-OIG/A06-80008                                                         Page 10

                                    BACKGROUND
Capital City Trade and Technical School, Inc. was incorporated in 1972 and operates as a
proprietary institution located in Austin, Texas. Capital City received initial approval to
participate in the Title IV programs in January 1988, and is accredited by the Accrediting
Commission on the Council on Occupational Education. The institution offers vocational
programs in Medical Assistant, Dental Assistant, Automotive Technician, Welding, Drafting,
and Air Conditioning, Heating and Refrigeration Technician.

During January 1, 1997 through December 31, 1998, Capital City received $3,807,046 of
Federal Pell Grant Program, Federal Campus Based Program, and Federal Family Education
Loan Program funds.


              OBJECTIVE, SCOPE, AND METHODOLOGY
The objective of our audit was to determine whether Capital City derived at least 15 percent of
its revenues from non-Title IV sources and properly reported its 85 Percent Rule percentage in
its audited financial statements.

To accomplish our objective, we obtained background information about the institution. We
reviewed selected Capital City files and Department records. We reviewed Capital City’s fiscal
year 1997 corporate financial statements and Student Financial Assistance (SFA) compliance
audit report prepared by its CPA. We also conducted interviews with Capital City officials.

We performed an analysis of and used information extracted from Capital City’s computerized
database. The reliability of the computerized information was tested by verifying selected data
with other sources such as institutional bank statements and student records. We concluded that
the computerized information was sufficiently reliable for the purposes of our audit. We also
used data applicable to the school that we obtained from the Department’s National Student Loan
Data System, Payment Management System, and Grants Administration and Payment System.

Our audit covered the institution’s fiscal year ending December 31, 1997. In addition, we
reviewed the school’s 85 Percent Rule calculation for 1996 to determine whether the school
included revenue from related parties and found that it had not. We performed fieldwork at
Capital City from June 29, 1998 through November 18, 1998. We revisited the school on
September 8, 1999 to evaluate elements of Capital City’s response to our draft report. Our audit
was performed in accordance with generally accepted government auditing standards appropriate
to the scope of the review described above.
Control Number: ED-OIG/A06-80008                                                          Page 11

            STATEMENT ON MANAGEMENT CONTROLS
As part of our review, we assessed Capital City’s management control structure, as well as its
policies, procedures, and practices applicable to the scope of the audit. For the purpose of this
report, we assessed management controls related to the institution’s calculation and reporting of
the percentage of revenues received from non-Title IV sources as required by the 85 Percent
Rule.

Because of inherent limitations, a study and evaluation made for the limited purposes described
above would not necessarily disclose all material weaknesses in the control structure. However,
our assessment disclosed weaknesses in the procedures used to calculate the percentage. The
weaknesses are discussed in the Audit Results section of this report.
                                                                            APPENDIX II

The below chart illustrates the relationships between the various organizations that were
                      involved in the December 1997 transactions.



     ORGANIZATION RELATIONSHIPS


        OWNER A                                                OWNER B
      50% Shareholder                                        50% Shareholder




                               Capital City Trade and
                               Technical School, Inc.
                               OWNER A, President




                                  Timberline I
                               RCH Enterprises, Inc.
                                Managing Partner




       RCH Enterprises, Inc.                             Berry Enterprises, Inc.
      (An OWNER A Family                                (An OWNER B Family
        Owned Enterprise)                                 Owned Enterprises)
       OWNER A, President                                OWNER B, President
                           DISTRIBUTION SCHEDULE
                     Audit Control Number: ED-OIG/A06-80008

                                                                                     Copies

Auditee                                                                                  1

Action Official

       Greg Woods, Chief Operating Officer
       Student Financial Assistance
       Department of Education
       ROB-3, Room 4004
       7th and D Streets, SW
       Washington, DC 20202-5132                                                         1

Other ED Offices

       General Manager for Schools Channel, Student Financial Assistance                 1

       Chief Financial Officer, Student Financial Assistance                             1

       Director, Case Management & Oversight, Schools Channel,
        Student Financial Assistance                                                     1

       Area Case Director, Dallas Case Management Team,
        Case Management & Oversight, Schools Channel, Student Financial Assistance       1

       General Counsel, Office of the General Counsel                                    1

OIG

       Inspector General                                                                 1
       Deputy Inspector General                                                          1
       Assistant Inspector General for Investigation (A)                                 1
       Assistant Inspector General for Audit                                             1
       Deputy Assistant Inspector General for Audit                                      1
       Director, Student Financial Assistance Advisory and Assistance Team               1
       Regional Audit Offices                                                            6
       Dallas Audit Office                                                               6