oversight

Fifth Third Bank's Eligible Lender Trustee Agreements Compliance with Lender Provisions of the Higher Education Act and Monitoring of Entities With Which It Has Agreements.

Published by the Department of Education, Office of Inspector General on 2009-01-05.

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

    Fifth Third Bank’s Eligible Lender Trustee Agreements
             Compliance with Lender Provisions of
          the Higher Education Act and Monitoring of
            Entities With Which It Has Agreements




                                 FINAL AUDIT REPORT




                                    ED-OIG/A09H0017
                                      January 2009




Our mission is to promote the                         U.S Department of Education
efficiency, effectiveness, and                        Office of Inspector General
integrity of the Department's                         Sacramento, California
programs and operations.
Statements that managerial practices need improvements, as well as
other conclusions and recommendations in this report, represent the
  opinions of the Office of Inspector General. Determinations 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 to
  members of the press and general public to the extent information
      contained therein is not subject to exemptions in the Act.
                                   UNITED STATES DEPARTMENT OF EDUCATION
                                          OFFICE OF INSPECTOR GENERAL

                                                                                                                    Audit Services
                                                                                                                Sacramento Region
                                                                 January 5, 2009
Brian Gardner, Vice President
Fifth Third Bank
Asset Securitization
38 Fountain Square Plaza
MD 109046
Cincinnati, OH 45263

Dear Mr. Gardner:
Enclosed is our final audit report, Control Number ED-OIG/A09H0017, entitled Fifth Third
Bank’s Eligible Lender Trustee Agreements Compliance with Lender Provisions of the Higher
Education Act and Monitoring of Entities With Which It Has Agreements. This report
incorporates the comments you provided in response to the draft report. If you have any
additional comments or information that you believe may have a bearing on the resolution of this
audit, you should send them directly to the following Education Department official, who will
consider them before taking final Departmental action on this audit:
                                           James Manning
                                           Acting Chief Operating Officer
                                           Federal Student Aid
                                           U.S. Department of Education
                                           Union Center Plaza, Room 112G1
                                           830 First Street, NE
                                           Washington, D.C. 20202
It is the policy of the U. S. Department of Education to expedite the resolution of audits by
initiating timely action on the findings and recommendations contained therein. Therefore,
receipt of your comments within 30 days would be appreciated.
In accordance with the Freedom of Information Act (5 U.S.C. § 552), reports issued by the
Office of Inspector General are available to members of the press and general public to the extent
information contained therein is not subject to exemptions in the Act.

                                                                 Sincerely,

                                                                 /s/
                                                                 Gloria Pilotti
                                                                 Regional Inspector General for Audit

Enclosure


 The Department of Education's mission is to promote student achievement and preparation for global competitiveness by fostering educational
                                                   excellence and ensuring equal access.
Final Report
ED-OIG/A09H0017



                                              TABLE OF CONTENTS

                                                                                                                               Page

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

BACKGROUND ............................................................................................................................3

AUDIT RESULTS .........................................................................................................................4

          FINDING NO. 1 – Fifth Third Bank, as an ELT, Violated the
                          Prohibition on Offering Inducements .............................................4

          FINDING NO. 2 – Fifth Third Bank’s Policies and Procedures for
                          Monitoring its ELT Agreements Need
                          To Be Improved...............................................................................14

OTHER MATTER.......................................................................................................................19

OBJECTIVES, SCOPE, AND METHODOLOGY ..................................................................20

ENCLOSURE 1: Fifth Third Bank’s ELT Agreements as of June 30, 2007 ........................21

ENCLOSURE 2: Fifth Third Bank’s Comments on the Draft Report..................................23

ENCLOSURE 3: SLX’s Comments on the Draft Report .......................................................75
Final Report
ED-OIG/A09H0017                                                                     Page 1 of 103



                                EXECUTIVE SUMMARY


Fifth Third Bank is an eligible lender in the Federal Family Education Loan (FFEL) Program.
As an eligible lender, Fifth Third Bank entered into trust arrangements with other entities which
allowed the other entities to originate or purchase student loans. The purpose of the audit was to
1) determine whether Fifth Third Bank, as the eligible lender trustee (ELT) in agreements with
other entities, adhered to the prohibitions on inducements specified in § 435(d)(5) of the Higher
Education Act (HEA), and 2) assess Fifth Third Bank’s monitoring activities for ensuring that
entities, with which it has ELT agreements, have adhered to applicable requirements of the
FFEL Program. Our review covered Fifth Third Bank’s ELT agreements with other entities that
originated or held FFELs under the associated lender identification numbers (LIDs) during the
period from July 1, 2006 to June 30, 2007.

Under § 435(d)(5) of the HEA, a lender may be disqualified from participation in the FFEL
Program if it offers points, premiums, payments, or other inducements, to any educational
institution or individual in order to secure applications for loans. We concluded that Fifth Third
Bank, as the ELT in agreements with other entities, violated this provision. Fifth Third Bank and
Student Loan Xpress, Inc. (SLX) had jointly entered into separate ELT agreements with three
entities: MSA Solution, Inc. (MSA), Pacific Loan Processing, Inc. (PLP), and Law School
Financial (LSF). The ELT agreements specified that SLX (a named party to the trust) will pay a
premium (inducement) to the other entity named in the trust (i.e., MSA, PLP, LSF) for loans
originated under the ELT agreement based on the loan principal. Our review of Fifth Third
Bank’s other ELT agreements disclosed arrangements that also included the offering of
inducements, which we discuss in the OTHER MATTER section of the report. We will be
referring these ELT agreements to the Department for further review. Nothing came to our
attention to indicate that Fifth Third Bank’s ELT agreements included activities that would
violate the other three prohibited practices listed in § 435(d)(5) of the HEA.

We also found that Fifth Third Bank needs to improve its monitoring of the entities with which
it has ELT agreements. Fifth Third Bank did not have written policies and procedures for
evaluating the entities and monitoring their activities. It also did not maintain adequate
documentation of its evaluation and monitoring efforts.

We recommend that the Acting Chief Operating Officer for Federal Student Aid (FSA) terminate
Fifth Third Bank’s participation in the FFEL Program under the three ELT agreements and take
other appropriate action to address Fifth Third Bank’s violation of the inducement provision,
which could range from assessing a fine to terminating the Federal reinsurance on the over
$3 billion of FFELs originated under the agreements. We also recommend that Fifth Third Bank
be required to implement written procedures or maintain other records on the initial evaluations
and the continual monitoring of entities with which it has ELT agreements and maintain the
records in a central location. We recommend that FSA cease entering into new FFEL
participation agreements with Fifth Third Bank for ELT agreements until Fifth Third Bank has
implemented corrective action.
Final Report
ED-OIG/A09H0017                                                                   Page 2 of 103

In its comments to the draft report, Fifth Third Bank disagreed with our findings and
recommendations and commented on the Other Matter section. Fifth Third Bank also provided
SLX’s comments on the draft report for our consideration. Fifth Third Bank’s and SLX’s
comments are summarized at the end of each finding and the Other Matter section, along with
our response to the comments. The entire texts of their comments are included in the report as
Enclosures 2 and 3.
Final Report
ED-OIG/A09H0017                                                                       Page 3 of 103



                                       BACKGROUND


National banks and other types of entities listed in § 435(d)(1) of the HEA can participate as
eligible lenders in the FFEL Program. Eligible lenders may enter into trust arrangements with
entities not listed in § 435(d)(1) of the HEA for the purpose of allowing the other entities to
originate or purchase student loans. The eligible lender, as the ELT for the other entity, applies
and signs for the LID issued by the U.S. Department of Education (Department) and the
Department’s Lender/Servicer Organization Participation Agreement.

Section 435(d)(2) through (6) of the HEA specifies additional requirements for eligible lenders.
Under § 435(d)(5) of the HEA, a lender may be disqualified from participation if the Department
finds that the lender provided certain prohibited inducements. Section 436(b) of the HEA clearly
states that a lender that holds a loan made in the lender’s capacity as a trustee is responsible for
complying with all statutory and regulatory requirements imposed on any other holder of a loan.

Fifth Third Bank is a national bank that offers a range of banking services and loans,
including Federal and private student loans. As an eligible lender, Fifth Third Bank had also
entered into ELT agreements with other entities for the origination of Federal student loans.
On June 30, 2007, Fifth Third Bank had 15 ELT agreements with other entities under which
FFELs were originated or held during the period from July 1, 2006 to June 30, 2007. Between
July 1, 2004 and August 30, 2007, over $13 billion in FFEL loans were originated under Fifth
Third Bank’s ELT agreements. This amount included Subsidized Stafford, Unsubsidized
Stafford, PLUS loans to parents and graduate/professional students, and consolidation loans.
Enclosure 1 provides a list of the ELT agreements in effect as of June 30, 2007, associated LIDs,
and the entities with related agreements for the funding, originating, servicing, and selling of
FFELs.
Final Report
ED-OIG/A09H0017                                                                                    Page 4 of 103



                                           AUDIT RESULTS


Fifth Third Bank, as the ELT in agreements with other entities, violated the provisions
prohibiting inducements specified in § 435(d)(5) of the HEA. Fifth Third Bank and SLX jointly
entered into separate ELT agreements with three entities — MSA, PLP, and LSF — that violated
the provision in § 435(d)(5)(A) of the HEA prohibiting the offering of inducements to secure
borrower applications for FFELs. Our review of Fifth Third Bank’s other ELT agreements
disclosed arrangements that also include the offering of inducements, which we discuss in the
OTHER MATTER section of the report. Nothing came to our attention to indicate that Fifth
Third Bank’s ELT agreements included activities that would violate the other three prohibited
practices listed in § 435(d)(5) of the HEA. 1

We also found that Fifth Third Bank needs to improve its monitoring of the entities with which it
has ELT agreements. Fifth Third Bank did not have written policies and procedures for
evaluating the entities and monitoring their activities. It also did not maintain adequate
documentation of its evaluation and monitoring efforts.


FINDING NO. 1 – Fifth Third Bank, as an ELT, Violated the Prohibition on
                Offering Inducements
Fifth Third Bank and SLX violated the prohibition on offering inducements when they entered
into ELT agreements with each other and the following other entities: MSA, PLP, and LSF. The
Fifth Third Bank’s ELT agreements with SLX/MSA, SLX/PLP, and SLX/LSF violated the
inducement prohibition in § 435(d)(5)(A) of the HEA because each agreement specified that
SLX (a named party to the trust) will pay a premium to the other entity named in the trust
(i.e., MSA, PLP, LSF) for loans originated under the ELT agreement based on the loan principal
when the expressed role of the other entity was to secure applications.

Under § 435(d)(5) of the HEA, lenders may be disqualified from participation in the FFEL
Program if they offer points, premiums, payments, or other inducements, to any educational
institution or individual in order to secure applications for loans. The cited statute states—

        The term “eligible lender” does not include any lender that the Secretary
        determines, after notice and opportunity for a hearing, has after the date of
        enactment of this paragraph—
                 (A) offered, directly or indirectly, points, premiums, payments, or other
             inducements, to any educational institution or individual in order to secure
             applicants for loans under this part . . . . 2

1
  Section 435(d)(5)(B) of the HEA prohibits lenders from conducting unsolicited mailings of student loan applications
to students, except to students who have previously received loans from the lender. Section 435(d)(5)(C) prohibits
lenders from offering an inducement to a prospective borrower to purchase a policy of insurance or other product.
Section 435(d)(5)(D) prohibits lenders from engaging in fraudulent or misleading advertising.
2
  The Higher Education Opportunity Act (Public Law 110-315), enacted on August 14, 2008, amended this provision
of the HEA. In our review and this report, we applied the provision that was in effect during the audit period.
Final Report
ED-OIG/A09H0017                                                                          Page 5 of 103


The Department issued Dear Colleague Letter (DCL) 89-L-129 (February 1989) to provide
lenders and guaranty agencies with guidance in complying with the prohibition in § 435(d)(5) of
the HEA. The DCL states—

       The Department believes these provisions were broadly intended to prohibit the
       direct or indirect offering or payment of any kind of financial incentive by a
       lender to any entity or person to secure applications for . . . loans . . . regardless of
       the form of the incentive or its mode of payment.

The DCL listed the following as an example of a permissible activity between lenders—
       A lender purchases a loan made by another lender at a premium. This is not a
       transaction involving the securing of applicants, but rather the acquisition of loans
       already made. A purchasing lender may also act as the agent of a selling lender
       on a loan to be purchased for purposes of originating and disbursing the loan, and
       purchase the loan at a premium immediately following disbursement. The funds
       used to make the loan would be deemed to have been advanced to the seller by the
       purchaser and subsequently repaid from the sale proceeds.

The payments made by SLX under Fifth Third Bank’s ELT agreements with SLX/MSA,
SLX/PLP, and SLX/LSF and the related agreements violate the prohibited inducement
provisions. As explained in the following section, the activities under the ELT agreements and
related agreements are not, in fact, the sale of existing loans between two lenders. Rather, the
ELT agreements and related agreements provided for the payment of premiums by SLX to
entities (i.e., MSA, PLP, and LSF) to secure loan applications.

ELT Agreements with SLX/MSA,
SLX/PLP, and SLX/LSF Violated
the Prohibition on Inducements

MSA, PLP, and LSF entered into separate trust agreements with SLX and Fifth Third Bank to
create trusts in order for Fifth Third Bank, as the ELT, to hold all rights, title, and interest to
eligible loans and to transfer ownership of the loans from the trusts to SLX. Each of the ELT
agreements contain the same terms. By executing the agreement, MSA, PLP, and LSF agreed
that the trusts would not originate or hold any student loan, other than eligible loans to be sold to
SLX, under the LID specified in the ELT agreement. The ELT agreement was signed by
representatives of Fifth Third Bank, SLX, and the other entity (i.e., MSA, PLP, LSF).

As part of the arrangement, MSA, PLP, and LSF entered into agreements involving SLX,
Education Lending Services, Inc, and Xpress Loan Servicing, all of which are part of Education
Lending Group, Inc., a wholly owned subsidiary of CIT Group, Inc.
Final Report
ED-OIG/A09H0017                                                                             Page 6 of 103

The ELT agreements required MSA, PLP, and LSF to enter into two agreements:

    •   Student Loan Forward Commitment Sale/Purchase Agreement. The agreement provides
        for the sale of consolidation loans to SLX on the same day that funds are disbursed by the
        Servicer (Xpress Loan Servicing) to the former loan holders. The agreement requires the
        seller (i.e., MSA, PLP, LSF) to enter into a Loan and Security Agreement (see below)
        with Education Lending Services, Inc., which is to provide the funds to pay the holders of
        the loan being consolidated. SLX is to transmit the “purchase price” for the loans to
        Education Lending Services. Twice monthly, SLX is to also transmit the “premium” to
        Education Lending Services. The premium is based on the principal amount of the
        consolidation loan. Education Lending Services is to retain a portion of the premium for
        lender loan fees and pay the remaining premium to the seller (i.e., MSA, PLP, LSF). The
        agreement was signed by four parties: the seller, SLX, Fifth Third Bank as ELT for the
        seller, and Fifth Third Bank as ELT for SLX.
    •   Consolidation Loan Origination and Servicing Agreement. The agreement states that the
        lender (i.e., MSA, PLP, LSF) will provide Xpress Loan Servicing with a completed
        consolidation loan application and Loan Verification Certificates. Xpress Loan Servicing
        is to pay the prior loan holders, send the disclosure statement to the borrower, and retain
        the original loan documents. Xpress Loan Servicing is to service the loans and complete
        all forms and reports required by the Department and the guaranty agency. The
        agreement contains a schedule for loan origination, servicing, and other miscellaneous
        fees. The agreement is signed by the lender, Xpress Loan Servicing, and Fifth Third
        Bank as ELT for the lender.
The other agreements entered into by MSA, PLP, and LSF, but not mentioned in the ELT
agreements, were:

    •   Loan and Security Agreement. The agreement provides for the line of credit for
        financing the consolidation loans. The agreement was signed by four parties: the
        borrower (i.e., MSA, PLP, LSF), Fifth Third Bank as ELT for the borrower, Education
        Lending Services, Inc., and Fifth Third Bank as ELT for Education Lending Services,
        Inc.

    •   Administration Agreement. The agreement provides for various financial, statistical,
        accounting, and other administrative services, including the distribution of payments to
        the Xpress Loan Servicing and guarantee agencies. The agreement fee is $100 per year.
        The agreement was signed by the entity (i.e., MSA, PLP, LSF) and Education Lending
        Services, Inc.

Under the terms of the ELT agreements and related agreements, MSA, PLP, and LSF are not
lenders since the origination of FFELs is restricted to those exclusively funded, serviced, and
purchased by SLX and its affiliates. The role of MSA, PLP, and LSF was limited to the securing
of loan applications (marketing) and obtaining loan verification certificates. 3 Also, an arms-

3
 Fifth Third Bank applied for and signed for a LID for each of the ELT agreements. With LIDs, MSA, PLP, and
LSF obtained user accounts for accessing the National Student Loan Data System (NSLDS). Dear Colleague GEN-
05-06 FP-05-04 “Access to and Use of NSLDS Information,” specifically prohibits the use of NSLDS for the
marketing of student loans.
Final Report
ED-OIG/A09H0017                                                                                       Page 7 of 103

length sale of loans did not occur. Fifth Third Bank holds loans in trust under its ELT
agreements and SLX is a party to the trust with exclusive rights to the loans. Basically, SLX is
transferring its interest in the loans held in one trust (trust established by the ELT agreement with
SLX/MSA, SLX/PLP, and SLX/LSF) to another trust to which SLX or an affiliate of SLX is a
party. Thus, the example of a lender-to-lender sale of existing loans at a premium (a permissible
activity described in DCL 89-L-129) would not apply to Fifth Third Bank’s ELT agreements
with SLX/MSA, SLX/PLP, and SLX/LSF.

Based on our interviews with MSA’s President, we concluded that the ELT agreement and
related agreements among Fifth Third Bank, SLX, and MSA were created for the purpose of
creating a structure to pay a financial incentive to secure loan applications. MSA was a
marketer 4 of Federal consolidation loans prior to and after entering into the ELT agreement with
Fifth Third Bank and SLX. Prior to the ELT agreement, MSA had a contract to sell
consolidation loan applications to SLX at a flat rate (without premium) and, after entering the
ELT agreement, MSA continued to sell applications to other lenders at a flat rate. SLX
representatives acknowledge that, under the prior contract with MSA, SLX could not pay a
premium for applications. According to MSA’s President, SLX told MSA that the ELT
arrangement would allow SLX to pay MSA premiums for the loans it purchased. MSA’s
President stated that MSA continued to perform its marketing activities and had no additional
activities resulting from the ELT agreement. MSA also had no additional costs since, under the
terms of the ELT agreement, SLX was to pay Fifth Third Bank a reasonable compensation for
services on behalf of MSA. Thus, under the ELT agreement, MSA remained solely a marketer,
that is, an entity that secured loan applications for lenders. The scenarios are similar for PLP and
LSF since both perform marketing activities and have the same arrangements with SLX and its
affiliates.

The following table shows the amount of loans that were originated under the ELT agreements
with Fifth Third Bank:

                                 FFELs Originated Under ELT Agreements
                                        as of November 15, 2007
                                                       Total Loans Originated Under LID (a)
                      Entity              LID
                                                                 Consolidation Loans

                 SLX/MSA                834243                         $76 million
                 SLX/PLP                834196                        $2.759 billion
                 SLX/LSF                834241                         $256 million
                  (a) The total amount of loans originated under the LID as shown in the National
                 Student Loan Data System (NSLDS) on November 15, 2007. Only consolidation
                 loans were originated under these LIDs.




4
  MSA operated a telemarketing call center that contacted individuals with educational loans to solicit their interest
in FFEL Consolidation Loans. MSA purchased lists of individuals with existing education loans from credit
bureaus.
Final Report
ED-OIG/A09H0017                                                                    Page 8 of 103

Fifth Third Bank officials informed us that the ELT agreements with SLX/MSA and SLX/LSF
have been terminated. On February 20, 2008, Fifth Third Bank advised the Department and the
applicable guaranty agency to terminate the related LIDs.

Violation of the Prohibition on Offering Inducements
Impacts the Federal Guarantee of FFELs and
Interest and Special Allowance Payments

The Federal Government guarantees a portion of each FFEL insured under a program of a State
or nonprofit guaranty agency. A lender’s failure to comply with the HEA and other Federal
requirements may invalidate the Federal guarantee on FFELs originated or held by the lender.
The Department may not pay reinsurance to guaranty agencies on loans that do not have a
Federal guarantee. Also, the Department requires a lender to repay interest and special
allowance payments received on a loan that was made during a period when the lender was not
in compliance with the HEA and other Federal requirements.

Reinsurance. The lender submits a claim to the guaranty agency for the outstanding amount of
the loan balance, including unpaid interest, when a FFEL borrower defaults on a loan or the
lender is otherwise unable to collect the amount owed by the borrower (death, disability, or
bankruptcy). The Department has a reinsurance agreement with the guaranty agency to
reimburse the guaranty agency for a portion of the lender claims. The conditions that must be
met for reinsurance coverage are listed in 34 C.F.R. § 682.406. The condition listed at (a)(12)
states that a reinsurance payment can be received only if the lender complied with “all other
Federal requirements with respect to the loan.” Thus, failure to comply with the prohibition on
offering improper inducements impacts the Federal guarantee of FFELs.

Interest and Special Allowances. The Department pays a lender, on behalf of a borrower, a
portion of the interest on an eligible subsidized Stafford FFEL and on all or a portion of a
qualifying Consolidation FFEL. The Department also pays lenders a special allowance on
eligible FFELs. The regulations at 34 C.F.R. § 682.413(a)(1) state that the Department requires
a lender to repay interest benefits and special allowances or other compensation received on a
loan for periods that the lender failed to comply with requirements set forth in 34 C.F.R.
§ 682.406(a)(12).

Recommendations

We recommend that the Acting Chief Operating Officer for Federal Student Aid—

1.1    Terminate Fifth Third Bank’s participation in the FFEL Program under the ELT
       agreements with SLX/MSA, SLX/PLP, and SLX/LSF, deactivate the LIDs for those ELT
       agreements, and notify the guaranty agencies of the terminations.

1.2    Take appropriate action to address Fifth Third Bank’s violation of the inducement
       provision. The Department should consider taking one or more of the following actions:
       assessing a fine; initiating a limitation, suspension, or termination proceeding under
       34 C.F.R. § 682, Subpart G; requiring reimbursement of amounts paid for default claims,
       interest and special allowances, and any other benefits on FFELs originated under the
       ELT agreements with SLX/MSA, SLX/PLP, and SLX/LSF; or terminating the Federal
Final Report
ED-OIG/A09H0017                                                                       Page 9 of 103

       reinsurance on all FFELs originated under those ELT agreements. As of
       November 15, 2007, over $3 billion of FFELs had been originated under the ELT
       agreements.

Fifth Third Bank Comments

Fifth Third Bank disagreed with the finding and recommendations. Fifth Third Bank stated the
payments at issue were proper because they were for the sale of loans, and not for the marketing
of loan applications. Fifth Third Bank made the following assertions:

   •   The finding is indistinguishable from the prior Department’s administrative enforcement
       proceeding that was overturned by the U.S. District Court for the District of Columbia in
       Student Loan Marketing Ass’n v. Riley, 112 F. Supp.2d 38 (D.D.C. 2000) (Scholl
       College case). The form of the agreements between SLX and the other entities
       (i.e., MSA, PLP, and LSF), like the form of the agreements in the Scholl College case,
       were typical of transactions on the secondary market. Similar to the Department’s
       argument that was rejected by the court in the Scholl College case, the finding
       disregarded the form of the transactions to determine that the combination of the
       agreements suggest that SLX was the originating lender instead of MSA, PLP, and LSF.
       The aspects of the transactions that lead the OIG to disregard the form of the transactions
       were authorized by the HEA or were otherwise permissible. Federal regulations authorize
       a lender to contract or otherwise delegate performance of its functions under the FFEL
       Program to a servicing agency or other party.

   •   The inclusion of SLX as a party to the ELT agreements neither created a beneficial
       interest of SLX in the loans residing in the trusts, nor diminished the full and exclusive
       beneficial ownership interest of MSA, PLP and LSF in the loans residing in the
       respective trusts. SLX’s duties under the ELT agreements were largely ministerial, and
       its obligations were basically to pay, on behalf of MSA, PLP, and LSF, the costs of
       commencing and maintaining the ELT agreements.

   •   MSA, PLP, and LSF gained no more from the transactions with SLX than would any
       other lender. Consequently, the payments made by SLX did not provide any
       unreasonable incentive to take certain actions and, therefore, cannot be said to rise to the
       level of an improper inducement.

In addition, Fifth Third Bank stated the Department has always interpreted the prohibition
against inducements to permit this type of sale of loans between lenders; thus, the Department
cannot change its interpretation of the inducement prohibition without prior notice. Fifth Third
Bank also stated that the payments for Federal consolidation loans did not involve any of the
risks targeted by the HEA’s prohibition against inducements. Lastly, Fifth Third Bank stated the
payments at issue were not prohibited because the payments were made to neither an
“educational institution” nor an “individual,” as required by the plain language of the HEA.

In regards to the recommendations, Fifth Third Bank considered Recommendation 1.1 to be
moot since Fifth Third Bank had terminated the three ELT agreements at issue in the finding.
Final Report
ED-OIG/A09H0017                                                                                Page 10 of 103

Fifth Third Bank stated that Recommendation 1.2 (as stated in the draft report 5) was
disproportionate to the alleged offenses and would be more appropriately addressed through the
Department’s informal compliance procedures, imposition of a fine, or the regulatory provisions
governing limitation, suspension, and termination proceedings. Fifth Third Bank also stated
Recommendation 1.2 was adverse to the best interests of market participants and borrowers.

SLX Comments

SLX also disagreed with the finding and recommendations. SLX made several comments that
were similar to those provided by Fifth Third Bank. In regards to the Scholl College case,
SLX added that ED had repeatedly confirmed in the course of those proceedings that, had the
arrangement in that case involved a non-school lender, it would have been permissible. In
regards to SLX’s duties under the ELT agreement, SLX stated ED has recognized and condoned
the practice of a loan purchaser paying fees due on purchased loans on the seller’s behalf and
cited 34 CFR § 682.305(a)(4)(i) as support for its statement. SLX also noted that OIG did not
conclude that the form of the arrangement involving the Alder School of Professional
Psychology should be disregarded even though its trust agreement calls for SLX to compensate
Fifth Third Bank for the services it renders as trustee for Alder School of Professional
Psychology on loans sold to SLX.

SLX made the following additional assertions in its comments:

    •   MSA, PLP, and LSF accepted substantial obligations not required of mere marketers.
        They borrowed money to fund their loans and obligated themselves to repurchase any
        loan that becomes unreinsured due to a violation that occurs prior to the sale of the loan
        to SLX. SLX stated that one of the entities had repurchased in excess of $1 million in
        loans sold to SLX under their Forward Purchase Agreement that turned out to be
        unreinsured when sold.

    •   Many lenders in the FFEL Program started as marketers and first embarked on that role
        via relationships with established industry participants, such as SLX. The finding’s
        proposed ban on marketing entities becoming lenders via such relationships would
        effectively foreclose program participation to many lenders that have provided vigorous
        competition for Sallie Mae and large bank lenders in the program, to the benefit of
        borrowers and the Federal Government.

    •   Marketing does not constitute securing loan applicants, regardless of how the marketer is
        compensated. The term “secure” in § 435(d)(5)(A) of the HEA prohibits lenders from
        paying schools to steer borrowers to the lender, regardless of the basis of payment,
        while at the same time permitting compensated marketing activities by non-school
        affiliated entities. The term “secure” as used in the HEA permits marketing where
        the lender or marketing agent must rely solely on the merits of the lender’s loan
        products and service, but to prohibit paid referrals (i.e., paying someone who likely
        has the trust of the student to influence the student’s borrowing decisions).
5
  Recommendation 1.2 in the draft report recommended the termination of the Federal reinsurance on all FFELs
originated under the ELT agreements and reimbursement of amounts paid by the Department for default claims,
interest, and special allowance. As we explain in the OIG Response section of this finding, we modified the
recommendation for the final report.
Final Report
ED-OIG/A09H0017                                                                  Page 11 of 103

       DCL 89-L-129 took this approach when it recognized that generalized marketing did
       not constitute securing applicants, and therefore could be compensated as the parties
       saw fit, while at the same time prohibited referral fees to compensate lenders who,
       by exploiting existing relationships with potential FFELP borrowers, were able to
       steer them to another lender for a FFELP loan. Even if the transactions at issue
       could be re-characterized as proposed in the finding, the payments would merely be
       compensation for marketing by a non-school affiliated entity with no special position
       of trust or influence with prospective borrowers, and not for referrals.

OIG Response

We modified Recommendation 1.2 to acknowledge the various actions that the Department
could take to address Fifth Third Bank’s violation of the inducement provision. The language
of the HEA supports termination of the Federal reinsurance on all FFELs originated under the
ELT agreements. However, the Department may determine that other action(s) may be more
appropriate to mitigate the potential harm to borrowers. We did not make other changes to the
finding in response to the comments provided by Fifth Third Bank and SLX.

Scholl College Case. The decision in the Scholl College case was limited to the particular facts
presented. While aspects of the case are similar to the arrangements under the ELT agreements,
there are critical differences. The Scholl College case involved transactions between two
discrete and independent eligible lenders – Dr. William M. Scholl College of Podiatric Medicine
and Student Loan Marketing Association. SLX, MSA, PLP, and LSF are not eligible lenders.
Also, as we noted in the finding, SLX was a party to the trusts created by the ELT agreements at
issue in our finding and those agreements obligated MSA, PLP, and LSF to sell all loans from
the ELT arrangements with Fifth Third Bank to SLX. The transactions that resulted in the
transfer of loans from the LID for the ELT arrangements that Fifth Third Bank and SLX had
with MSA, PLP, and LSF to the LID for the ELT arrangements that Fifth Third Bank had with
SLX did not represent an arms length sale of loans between two discrete eligible lenders. In the
Scholl College case, Scholl College actually borrowed funds from and paid interest to the
Student Loan Marketing Association to fund loans and held the loans for a period of time before
the loans were sold to Student Loan Marketing Association. However, uncertainty exists as to
whether MSA, PLP, and LSF actually borrowed funds under the Loan and Security Agreements.
Under the terms of the agreements, MSA, PLP, and LSF were to provide written “Borrowing
Notices” for loans drawn on the lines of credit. SLX was unable to locate any such notices.
Further, under the arrangements, MSA, PLP and LSF would owe interest to SLX only if the
various transactions processed by SLX and its affiliates were not completed on the same day that
MSA, PLP, and LSF submitted completed applications to SLX. SLX is not aware of any
instances where it earned interest from MSA, PLP, or LSF due to the transactions not being
completed within the same day the eligible loans were sold to SLX.

Beneficial Interest to SLX. We acknowledge that under the terms of the ELT agreements with
Fifth Third Bank, MSA, PLP, and LSF held a beneficial interest in the loans originated and
briefly held under those trust arrangements. However, as a party to those same ELT agreements,
SLX had a direct, financial interest in the loans originated and held in the trusts. Those
agreements obligated MSA, PLP, and LSF to transfer all such loans to SLX. In addition, SLX is
a subsidiary of CIT Group, Inc., and CIT Group, Inc. controlled all transactions related to the
Final Report
ED-OIG/A09H0017                                                                      Page 12 of 103

loans through the related agreements that SLX and its other subsidiaries had with MSA, PLP,
and LSF.

Inducements to MSA, PLP, and LSF. The Student Loan Forward Commitment Sale/Purchase
Agreements, which MSA, PLP, and LSF were required to enter into with SLX under the terms of
the ELT agreements, created an inducement for MSA, PLP, and LSF to provide applications to
Xpress Loan Servicing for origination of loans under the LIDs for the ELT agreements. Under
the Sale/Purchase agreements, SLX paid higher compensation to MSA, PLP, and LSF for
completed consolidation loan applications obtained from FFEL borrowers that had higher loan
balances. The compensation escalated substantially as loan balances increased. For example,
the agreement with PLP shows the following principals and net premiums:

                                  $0                     0%
                                  $10,000             1.60%
                                  $15,000             2.65%
                                  $20,000             3.00%
                                  $30,000             3.65%
                                  $40,000             4.35%
                                  $50,000             4.45%
                                  $65,000 +           4.85%

Thus, MSA, PLP, and LSF received prohibited inducements for securing loan applications.
Other than securing the loan applications, these entities provide no additional services for the
higher fees. SLX also benefited from the market advantage it had by offering the higher
compensation to obtain applications for consolidation loans with higher balances.

Department’s Interpretation of Prohibition on Inducements. The OIG recognizes that the
Department has allowed the sale of existing loans between lenders, including the acquisition of a
loan at a premium. (See Dear Colleague Letter 89-L-129 (February 1989), page 3, example 1,
under permissible activities.) However, the transactions described in this finding did not involve
the sale of existing loans between eligible lenders. In contrast to the permissible activity outlined
in the DCL, the transactions here were the sale of completed consolidation loan applications
between entities participating in the FFEL program through the existence of ELT agreements
with Fifth Third Bank. The transactions did not involve eligible lenders or loans that were
already made. Payments to secure loan applications is specifically prohibited by § 435(d)(5)(A)
of the HEA, and the HEA does not provide an exception for consolidation loan applications.

Educational Institution/Individual. Fifth Third Bank’s literal argument that the HEA prohibits
inducements only if made to an “educational institution” or an “individual” has been rejected by
the Department. In fact, the same DCL 89-L-129 that Fifth Third Bank relies upon in its
attempts to justify its transactions under the example of permissible activities between lenders,
includes examples (i.e., page 2, examples 3, 4 and 8) of prohibited inducements involving
payments to organizations other than institutions or to an individual as a person. Also, in
response to public comments contained in the preamble to the November 1, 2007, Final
Regulations (72 Fed. Reg. 61960, 61978- 61979), the Secretary addressed an argument to
remove the reference in the regulation to “any individual” and replace it with “any employee of a
school or a school-affiliated organization” to clarify the group to which the prohibitions apply.
The Secretary’s position was stated as follows:
Final Report
ED-OIG/A09H0017                                                                    Page 13 of 103

       The Secretary disagrees that the reference to “individuals” should be struck
       from paragraph (5)(i)(A)(2) of the definition of lender in § 682.200(b).
       Section 435(d)(5) of the HEA effectively defines an improper inducement as
       a payment or other inducements “to any educational institution or individual”
       to secure loan applications. The Secretary has never interpreted the reference
       to “individuals” as limited to employees of a school or school-affiliated
       organization.

The Department’s published guidance on inducements, and Fifth Third Bank’s own references to
selected sections of Departmental guidance, when read in their entirety, contradict Fifth Third
Bank’s plain language reading of the HEA.

Fifth Third’s ELT Agreement with Alder School of Professional Psychology. We did not
include this ELT agreement in the finding because the agreement was solely between Fifth Third
Bank and Alder School of Professional Psychology. SLX was not a named party to the trust and
did not sign the ELT agreement. As mentioned in the OTHER MATTER section of the report,
we will be referring other Fifth Third Bank’s ELT agreements that included the offering of
inducements to the Department for further review. Fifth Third Bank’s ELT agreement with
Alder School of Professional Psychology is one of the agreements that we will be providing to
the Department.

MSA, PLP, and LSF Obligations Under the ELT and Related Agreement. The Student Loan
Forward Commitment Sale/Purchase Agreements included provisions requiring MSA, PLP, or
LSF to purchase loans upon the request of SLX if any representations or warranties made prove
to have been materially incorrect or the Department or guaranty agency refuses to honor a claim
filed with respect to a loan as a consequence of any circumstance, event, or omission that was
directly due to acts or omissions of MSA, PLP, or LSF. SLX did not explain how this provision
was more onerous than those placed on other marketers. In any event, the argument is pointless.
Even if MSA, PLP, and LSF had assumed obligations beyond those placed on other entities that
provide marketing services, such obligations are irrelevant in determining whether SLX can pay
inducements to MSA, PLP, and LSF.

Compensation for Permitted Marketing Activities. SLX attempted to draw a distinction
between allowable general marketing compensation and the prohibited compensation for
securing of loan applications. SLX also characterized compensation for general marketing (or
advertising) by non-school affiliate entities with no position of trust or influence with the
borrower, as being the agreed-upon compensation by entities. OIG’s position is that the structure
of the agreements between SLX and the other entities (e.g., MSA) did not provide for general
marketing or advertising. Compensation was based solely and explicitly on the ability to secure
and provide those completed applications. MSA purchased leads from credit bureaus on
borrowers with FFEL loans, solely for the intended purpose of (through direct contact with the
borrower) influencing the borrower to complete a consolidation loan application. Upon
completion of the loan application, MSA provided the secured loan application for a fee. MSA
was not compensated for anything other than secured completed applications. Payments to
secure loan applications is specifically prohibited by § 435(d)(5)(A) of the HEA. The HEA does
not provide any exception for non-school affiliated entities with no position of trust or influence
with prospective borrowers.
Final Report
ED-OIG/A09H0017                                                                     Page 14 of 103

FINDING NO. 2 – Fifth Third Bank’s Policies and Procedures for
                Monitoring its ELT Agreements Need To Be Improved

Fifth Third Bank’s Vice President for the Asset Securitization Department is responsible for the
evaluation of entities for potential ELT agreements and the monitoring of existing ELT
agreements. Fifth Third Bank did not have written policies and procedures for these activities
(including policies and procedures to ensure that the agreements do not include or result in
payment of prohibited inducements) and did not maintain adequate documentation of such
activities. Thus, Fifth Third Bank lacked the internal controls to ensure that evaluation and
monitoring activities were thorough and consistently performed.

Section 436 of the HEA establishes a lender’s responsibility when lender functions are delegated
to other entities. The cited statute states—

       (a) IN GENERAL.— An eligible lender or guaranty agency that contracts with
       another entity to perform any of the lender’s or agency’s functions under this title,
       or otherwise delegates the performance of such functions to such other entity—
               (1) shall not be relieved of the lender’s or agency’s duty to comply with
           the requirements of this title; and
               (2) shall monitor the activities of such other entity for compliance with
           such requirements.
       (b) SPECIAL RULE.— A lender that holds a loan made under part B in the lender’s
       capacity as a trustee is responsible for complying with all statutory and regulatory
       requirements imposed on any other holder of a loan made under this part.

As an eligible lender, Fifth Third Bank is required to comply with all requirements applicable
to lenders participating in the FFEL loan program, including the requirement in
34 C.F.R. § 682.414(a)(4)(ii)(L) to maintain records that are necessary to document the validity
of claims and the accuracy of reports. In its capacity as an ELT, Fifth Third Bank relies on
the entities with which it has ELT agreements and the entities involved in the related agreements
(i.e., loan servicers, etc.) to perform lender functions in compliance with all Federal
requirements applicable to lenders. Thus, under the records requirements specified in
34 C.F.R. § 682.414(a)(4)(ii)(L), Fifth Third Bank needs to maintain records of its activities for
ensuring that valid claims and accurate reports are submitted to the Department and guaranty
agencies for loans originated or held under the ELT agreements.

The U.S. Department of the Treasury, Office of the Comptroller of the Currency oversees the
execution of laws relating to national banks and promulgates rules and regulations governing the
operations of national banks. As a national bank, Fifth Third Bank is subject to the Safety and
Soundness Standards set forth by the Comptroller in 12 C.F.R. Part 30. The Comptroller
recognized the importance of internal controls over banking operations in Appendix A to Part 30,
which provides the operational and managerial standards for national banks. The standards
include—
Final Report
ED-OIG/A09H0017                                                                     Page 15 of 103

       A. Internal controls and information systems. An institution should have internal
       controls and information systems that are appropriate to the size of the institution
       and the nature, scope and risk of its activities and that provide for:
          1. An organizational structure that establishes clear lines of authority and
              responsibility for monitoring adherence to established policies;
          2. Effective risk assessment;
          3. Timely and accurate financial, operational, and regulatory reports;
          4. Adequate procedures to safeguard and manage assets; and
          5. Compliance with applicable laws and regulations.

The U.S. Treasury regulations were not issued to directly address administration of the HEA,
Title IV programs; and the U.S. Treasury, not the Department, is the Federal agency responsible
for enforcing the provisions contained in those issuances. However, the U.S. Treasury
regulations provide a standard of internal control that Federal agencies may reasonably expect
banks to meet when participating in their programs.

The Vice President for the Asset Securitization Department advised us that, as part of Fifth Third
Bank’s risk management, he evaluates the entities and their proposed arrangements prior to
entering into an ELT agreement and, after entering into an ELT agreement, conducts continual
monitoring to verify that the entities remain in good standing in the student loan industry and
maintain their financial standing. In response to our inquiry, Fifth Third Bank prepared a
document to describe its evaluation and monitoring procedures.

The document listed six elements that the bank evaluates to determine whether it will enter into
an ELT agreement with an entity:
   •   Industry experience and management;
   •   Student loan origination and servicing arrangements;
   •   Funding commitments;
   •   Student loan sale and purchase commitments;
   •   Student loan processes and systems; and
   •   Financial strength.

To evaluate the above elements, the Vice President informed us that he, one of the two other
bank officials in the Asset Securitization Department, or a manager from a bank branch office
located near the entity, conducts a site visit to interview the prospective entity to assess its
expertise in the student loan industry and business practices. A site visit is not conducted if the
branch manager has an on-going business relationship with the entity. Fifth Third Bank also
reviews the entity’s financial statements. The Vice President stated that the entity’s loan servicer
and the purchaser of the entities’ loans are significant factors in Fifth Third Bank’s decision to
enter into an ELT agreement with an entity.
Final Report
ED-OIG/A09H0017                                                                    Page 16 of 103

According to the prepared document and explanations provided by the Vice President, Fifth
Third Bank performs the following on-going monitoring activities:

   •   Reviews monthly loan activity for entities with low loan volume;
   •   Reviews annual financial statements;
   •   Reviews the bill of sale for all secondary loan sales;
   •   Maintains continual contact with relationship manager or other Fifth Third Bank
       managers that conduct due diligence for their services with the entity;
   •   Establishes ongoing business relationships with lenders and companies in the industry;
   •   Studies the publications for the industry;
   •   Reviews guaranty agency reports on loan servicers;
   •   Reviews annual marketing and origination process reviews for SLX agreements; and
   •   Attends student loan conferences.

Fifth Third Bank’s Vice President stated that the guaranty agency reports are reviewed to ensure
that the lenders and servicers are processing loans in accordance with Federal laws and
regulations. However, Fifth Third Bank did not have a process to ensure that it received all
pertinent reports from the guaranty agencies. Also, the above activities do not include a review
of the annual independent public accountant audit reports that are required for lenders and loan
servicers that perform activities for loans guaranteed under the FFEL Program.

The Vice President maintained some documents related to initial assessments and ongoing
monitoring, but could not identify the documents related to each ELT agreement. Fifth Third
Bank provided some examples of monthly loan activity reports, financial statements, and
guaranty reports. Correspondence was either not retained or located only after searches of files
in other departments.

Without sufficient written procedures and complete documentation of evaluations, there is a lack
of assurance that Fifth Third Bank is adequately evaluating entities and their relationships with
third parties in a thorough and consistent manner. Also, there is a lack of assurance that Fifth
Third Bank is performing sufficient monitoring of entities with which it has ELT agreements to
ensure that the entities adhered to applicable requirements of the FFEL Program, including the
prohibition on offering inducements to secure loan applications. Until Fifth Third Bank can
demonstrate that it has written procedures or other records that provide a consistent and effective
means for ensuring the other entities’ compliance with applicable FFEL program requirements,
the Department lacks assurance that Fifth Third Bank is meeting its responsibility under § 436(b)
of the HEA or can confirm the validity of claims or the accuracy of reports submitted to the
Department and guaranty agencies.
Final Report
ED-OIG/A09H0017                                                                                Page 17 of 103

Recommendations

We recommend that the Acting Chief Operating Officer for Federal Student Aid—

2.1     Require Fifth Third Bank to implement written procedures or maintain other records that
        document thorough and consistent initial evaluations of entities for potential ELT
        agreements and the continual monitoring of entities with which it has ELT agreements to
        ensure compliance with all FFEL Program requirements, including the prohibition on
        offering inducements to secure loan applications.

2.2     Require Fifth Third Bank to maintain, in a central location, the records related to its
        initial assessment and monitoring of each ELT agreement.

2.3     Cease issuing new LIDs to Fifth Third Bank for ELT agreements until the corrective
        actions under Recommendations 2.1 and 2.2 have been completed.

Fifth Third Bank Comments

Fifth Third Bank disagreed with the finding and recommendations. Fifth Third Bank stated that
written policies and procedures for (1) evaluation of entities for potential ELT agreements and
(2) monitoring of existing ELT agreements do not relate to the requirement that lenders
document the validity of claims and accuracy of reports. Fifth Third Bank stated that such
documentation tasks would likely be performed by the ELT’s lender partners (i.e., entities with
which the ELT has trust agreements). Fifth Third Bank acknowledged that an ELT would be
responsible for the lender partner’s compliance with documentation requirements. However,
Fifth Third Bank stated that an ELT cannot be cited for failing to maintain records documenting
the validity of claims and accuracy of reports on the basis of not having written policies and
procedures for the evaluation of potential lender partners and monitoring of those lenders. Fifth
Third Bank claimed that the finding did not link the two concepts or cite legal authority to
support the linkage.

Fifth Third Bank stated the ED OIG lacked legal authority to make a finding on the basis of the
Treasury Department standards and handbook 6 cited in the finding. Fifth Third Bank
acknowledged that, if ED OIG had legal authority, the Treasury Department standards on
“[e]ffective risk management” and “[a]dequate procedures to safeguard and manage assets” were
important requirements and the requirements most relevant to its role as an ELT. However, Fifth
Third Bank asserted that the shortfalls noted in the finding were minor and not sufficient to
support the conclusion that “[w]ithout sufficient written procedures and complete documentation
of evaluations, there is a lack of assurance that Fifth Third Bank is adequately evaluating entities
and their relationships with third parties in a thorough and consistent manner.”

Fifth Third Bank stated the recommendations were unnecessary because Fifth Third Bank
already uses the recommended procedures and centrally maintains its records. Fifth Third Bank
also stated that whether Fifth Third Bank’s procedures should be written and whether its records

6
 References to the Comptroller’s Handbook on Internal Controls were not included in the final report. The
Handbook, which was issued by the Comptroller of the Currency Administrator of National Banks, contains policies
and procedures for the examination of the commercial activities of national banks.
Final Report
ED-OIG/A09H0017                                                                      Page 18 of 103

are adequately maintained are moot points since Fifth Third Bank has terminated its ELT
agreements with the entities in Finding 1, is transitioning out of the business of serving as an
ELT, and does not intend to enter into new ELT agreements.

SLX Comments

SLX did not provide comments on Finding No. 2.

OIG Response

Fifth Third Bank acknowledged its responsibility as an ELT to assure its contractual partners’
compliance with statutory and regulatory requirements. Fifth Third Bank also did not dispute its
obligation to monitor compliance, or address our finding that it did not maintain adequate
documentation of such monitoring. Fifth Third Bank instead asserted that written policies and
procedures for its compliance activities are not required under 34 C.F.R. § 682.414(a)(4)(ii)(L).
To clarify, we did not cite Fifth Third Bank just for a lack of written policies and procedures,
which is one form of record documenting its internal controls over its contractual partners.
Rather, we concluded that "under the records requirements specified in 34 C.F.R. §
682.414(a)(4)(ii)(L), Fifth Third Bank needs to maintain records of its activities for ensuring
valid claims and accurate reports are submitted to the Department and guaranty agencies for
loans originated and held under the ELT agreements." In the absence of such records, Fifth
Third Bank would have to maintain direct records of the validity of claims and accuracy of
reports submitted by the entities participating in its ELT arrangements. Our finding and
recommendation acknowledged that written procedures or other records could be used to meet
its obligations.

We cited the U.S. Treasury regulations to highlight that a national bank, in addition to meeting
HEA requirements for eligible lenders, would also be expected to maintain written procedures
for internal control. We added language in the finding to acknowledge that the U.S. Treasury is
responsible for enforcing its regulations. We did not change our recommendations. While Fifth
Third Bank serves as an ELT, it needs to continue monitoring those entities involved in the ELT
arrangements. Written procedures and complete documentation would provide assurance that
Fifth Third Bank is performing its monitoring in a thorough and consistent manner. As we noted
in the finding, our review found that documents related to Fifth Third Bank’s assessments and
ongoing monitoring had not been maintained in an organized manner or central location.
Final Report
ED-OIG/A09H0017                                                                                Page 19 of 103



                                          OTHER MATTER

Our review of Fifth Third Bank’s other ELT agreements also disclosed arrangements that
included the offering of an inducement. However, the ELT agreements differed structurally
from the ELT agreements that Fifth Third Bank and SLX had with MSA, PLP, and LSF. Fifth
Third Bank’s ELT agreements with the other entities did not name a third party, such as SLX, in
the ELT agreement. Nevertheless, the related agreements that these entities had with third
parties created scenarios in which the only loans originated under the ELT agreements were
those funded, serviced, and purchased under the agreements and the role of the entity named in
the ELT was limited to the securing of loan applications. The related agreements included
provisions for the entities to receive a premium based on the loan balance.
The ELT and related agreements, taken together, appear to violate the prohibition on improper
inducements, which the Department states in DCL 89-L-129 was “intended to prohibit the direct or
indirect offering or payment of any kind of financial incentive by a lender to any entity or person to
secure applications for . . . loans . . . regardless of the form of the incentive or its mode of payment.”
However, the arrangements were also similar in some respects to an example of a permissible practice
described in DCL 89-L-129 and to an arrangement that was the subject of a previous enforcement
proceeding undertaken by the Department. Thus, we plan to refer these ELT agreements to the
Department for determination of whether the arrangements violated the prohibition on inducements
during the period when loans were originated under the ELT agreements. 7

Fifth Third Bank Comments
Fifth Third Bank stated that this section of the report revealed that the only problem with the
transactions between SLX and MSA, PLP, and LSF is that SLX was a party to the ELT
agreement between Fifth Third Bank and those entities. Fifth Third Bank stated the OIG
conceded that, without that one fact, the 1989 Dear Colleague Letter and the Scholl College case
would preclude a finding of noncompliance. Fifth Third Bank asked that the Other Matter
section be omitted from the final audit report.

SLX Comments
SLX stated that its comments on Finding No. 1 were also applicable to the ELT agreements
questioned in this section of the report.

OIG Response
No changes were made. Fifth Third Bank is correct that we acknowledged in this section that the
significant difference between the ELT agreements cited in Finding No. 1 and Fifth Third Bank’s
other ELT agreements was that the other entities did not name a third party, such as SLX, in the
ELT agreement. As we noted in Finding No. 1, this factor was significant in determining
whether the permissible activity described in DCL 89-L-129 applied to the ELT agreement and
related agreements. We concluded that further review by the Department was warranted to
determine whether these other ELT agreements violated the prohibition on inducements.

7
 The Department advised us in February 2008 that the LID for one of the ELTs in question had been terminated.
In December 2008, the Department advised us that the LIDS for the other ELTs had also been terminated.
Final Report
ED-OIG/A09H0017                                                                    Page 20 of 103



                 OBJECTIVES, SCOPE, AND METHODOLOGY


The purpose of the audit was to determine whether Fifth Third Bank, as the ELT in agreements
with other entities, adhered to the prohibitions on inducements specified in § 435(d)(5) of the
HEA, and assess Fifth Third Bank’s monitoring activities for ensuring that entities, with which it
has ELT agreements, have adhered to applicable requirements of the FFEL Program. Our review
covered Fifth Third Bank’s ELT agreements with other entities that originated or held FFELs
under the associated LIDs from July 1, 2006 to June 30, 2007.

To accomplish our objectives, we gained an understanding of pertinent provisions of the HEA
of 1965, as amended, Federal regulations, and Dear Colleague Letters issued by the Department.
We interviewed Department staff with gate keeping and oversight responsibilities over lenders
and reviewed a U.S. Government Accountability Office report to gain an understanding of ELT
arrangements.

To identify Fifth Third Bank’s ELT agreements, we analyzed data from NSLDS and obtained
additional information by interviewing Fifth Third Bank’s Vice President for the Asset
Securitization Department and officials from various other entities. We also used NSLDS to
confirm that student loans under the FFEL Program were not being originated by dissolved ELTs
or ELTs that were never activated. Our analysis of the Fifth Third Bank’s ELT agreements and
related agreements and data from NSLDS identified 15 ELT agreements with other entities that
originated or held FFELs from July 1, 2006 to June 30, 2007. We also used NSLDS to obtain
information on the amount of loans originated and held under each LID.

We reviewed Fifth Third Bank’s ELT agreements with the 15 entities. When applicable, we
obtained and reviewed the related agreements for the financing, servicing, and purchasing of
loans originated under the ELT agreement, except we did not review the related agreements for
the ELT agreement with SLX, Business Financial Solutions, Inc, and Student Lending Works,
Inc. (See Attachment 1 for explanation.)

We interviewed officials from Fifth Third Bank to gain an understanding of its policies and
procedures for evaluating the entities that entered into the ELT agreements and the other
companies involved in the ELT arrangements. We reviewed Fifth Third Bank’s copies of
servicer audits performed by guaranty agencies, and the monthly loan activity reports and
financial statements of entities involved in the ELT arrangement. Our on-site review of
documentation used for evaluating the entities that entered into the ELT agreements was limited,
as Fifth Third Bank did not maintain centralized files for ELTs or retain related correspondence.
We also reviewed the list of Fifth Third Bank’s internal audits and its written procedures for the
commercial credit approval process.

We performed our fieldwork at Fifth Third Bank’s offices in Cincinnati, Ohio. An exit
conference was held with Fifth Third Bank on February 8, 2008. We performed our audit in
accordance with generally accepted government auditing standards appropriate to the scope of
the review described above.
       Final Report
       ED-OIG/A09H0017                                                                              Page 21 of 103

          ENCLOSURE 1: Fifth Third Bank’s ELT Agreements as of June 30, 2007
   Entities That Signed the
      ELT Agreement                                 Other Entities
                                                                                 Additional Entities That Signed
(In addition to Fifth Third Bank      LIDs          Named in the
                                                                                      Related Agreements
   as Eligible Lender Trustee)                     ELT Agreement
Student Loan Xpress, Inc.          833860          ELT refers to          Not reviewed. OIG review was limited to the
(CIT Group, Inc.)                  833890          “certain affiliates”   information contained in the current and prior
                                   833908          of SLX, but does       ELT agreements between Fifth Third Bank and
(Includes LID from former ELT      834011          not name the           SLX.
agreement with Education Lending   834160          specific entities.
Services, Inc.)

Education Funding Capital          834042          None                   Not applicable. FFELs were not originated
Trust – II (CIT Group, Inc.)       (Agreements                            under this LID. FFELs transferred to this LID
Education Funding Capital          have same       None                   are held in the trust as security for funds
Trust – III (CIT Group, Inc.)      LID)                                   obtained from investors.
Education Funding Capital                          None
Trust – IV (CIT Group, Inc.)
Business Financial Solutions,      834179          None                   Not reviewed. Fifth Third Bank notified FSA
Inc., dba Academic Financial       (See Note)                             on November 1, 2007 that the trust was
Services;                                                                 transferred to U.S. Bank. The Department
                                                                          informed us that the transfer did not take place.



Student Loan Xpress, Inc. and      834196          Education Loan         Education Lending Services, Inc. (Loan and
Pacific Loan Processors            (See Note)      Servicing              Security Agreement)
                                                   Corporation            Education Loan Servicing Corporation
                                                   (CIT Group, Inc.)      (Consolidation Loan Origination and Servicing
                                                                          Agreement)
                                                                          Student Loan Xpress, Inc. (Student Loan Forward
                                                                          Commitment Sale/Purchase Agreement)
FinanSure Student Loans, LLC       834204          None                   Sallie Mae, Inc. (Revolving Financing Agreement)
                                   (The two                               Sallie Mae, Inc. and SLM Education Credit
                                   ELT                                    Finance Corporation (Contract for Sallie Mae, Inc.
                                   agreements                             to originate and service consolidation loans and
                                   have the same                          SLM Education Credit Finance Corporation to
                                   LID)                                   purchase consolidation loans)
                                   (See Note)                             GCO Education Loan Funding Corp (Contract
                                                                          for GCO to purchase loans from FinanSure)
                                                                          Ed Financial Services, LLC (Servicing
                                                                          Agreement)
                                                                          Great Lakes Educational Loan Services, Inc.
                                                                          (Student Loan Origination and Servicing Agreement)
                                                                          ACS Education Services, Inc. (Federal FFEL
                                                                          Servicing Agreement with FinanSure Student Loans
                                                                          former name The Graduate Loan Center)

FinanSure Student Loan
Warehouse Funding I, LLC
       Final Report
       ED-OIG/A09H0017                                                                                          Page 22 of 103

   Entities That Signed the                               Other Entities                   Additional Entities That Signed
      ELT Agreement                        LIDs           Named in the                     Related Agreements Obtained
(In addition to Fifth Third Bank
   as Eligible Lender Trustee)
                                                         ELT Agreement                          During Our Review
Student Loan Xpress, Inc.              834241           Education Loan             Education Lending Services, Inc. (Loan and
(CIT Group, Inc.) and                  (See Note)       Servicing                  Security Agreement)
Law School Financial, Inc.                              Corporation                Education Loan Servicing Corporation
                                                        (CIT Group, Inc.)          (Consolidation Loan Origination and Servicing
                                                                                   Agreement)
                                                                                   Student Loan Xpress, Inc. ((Student Loan
                                                                                   Forward Commitment Sale/Purchase Agreement)
Student Loan Xpress, Inc.              834243           Education Loan             Education Lending Services, Inc. (Loan and
(CIT Group, Inc.) and                  (See Note)       Servicing                  Security Agreement and Administration Agreement)
MSA Solutions, Inc.                                     Corporation                Education Loan Servicing Corporation
                                                        (CIT Group, Inc.)          (Consolidation Loan Origination and Servicing
                                                                                   Agreement)
                                                                                   Student Loan Xpress, Inc. ((Student Loan
                                                                                   Forward Commitment Sale/Purchase Agreement)
Student Lending Works, Inc.            834254           None                       Not reviewed. Student Lending Works is the
                                       (See Note)                                  single nonprofit private student loan lender
                                                                                   designated by the State of Ohio (LID 834225).
Erie Processing Corporation            834311           None                       Sallie Mae, Inc. (Revolving Financing Agreement)
                                       (See Note)
                                                                                   Sallie Mae Servicing (Loan Origination and
                                                                                   Management Services Agreement)
                                                                                   SLM Education Credit Finance Corporation
                                                                                   (Master Loan Sale Terms)

Nova Southeastern University,          834317           None                       Sallie Mae, Inc. (Revolving Financing Agreement)
Inc.                                   (See Note)
                                                                                   Sallie Mae, Inc. and SLM Education Credit
                                                                                   Finance Corporation (Contract for Sallie Mae, Inc.
                                                                                   to originate and service loans and SLM Education
                                                                                   Credit Finance Corporation to purchase the loans)
Logan College of Chiropractic          834319           None                       Sallie Mae, Inc. (Revolving Financing Agreement)
                                       (See Note)
                                                                                   Sallie Mae, Inc. and SLM Education Credit
                                                                                   Finance Corporation (Contract for Sallie Mae, Inc.
                                                                                   to originate and service loans and SLM Education
                                                                                   Credit Finance Corporation to purchase the loans)
Alder School of Professional           834338           Student Loan               Education Lending Services, Inc (Loan and
Psychology, Inc.                       (See Note)       Xpress, Inc.               Security Agreement)
                                                        (CIT Group, Inc.)
                                                        [Only mentioned in
                                                                                   Great Lakes Educational Loan Services, Inc
                                                        Compensation section.      (Student Loan Origination and Servicing Agreement)
                                                        Provides that SLX will     Student Loan Xpress, Inc. (Student Loan Forward
                                                        compensate Fifth
                                                        Third Bank for
                                                                                   Commitment Sale/Purchase Agreement)
                                                        services rendered with
                                                        respect to loans sold to
                                                        SLX]
Note: In its response to the draft report, Fifth Third Bank stated that it was transitioning out of the business of serving as an ELT.
      Department staff confirmed that the lender identification numbers for these ELT agreements have been terminated by the
      Department.
Final Report
ED-OIG/A09H0017                                          Page 23 of 103




    ENCLOSURE 2: Fifth Third Bank’s Comments on the Draft Report
FIFTH THIRD BANK

 June 2, 2008

 Gloria Pilotti
 Regional Inspector General for Audit
 Office ofInspector General
 U.S. Department of Education
 501 I Street, Suite 9-200
 Sacramento, California 95814


         Re:     Fifth Third Bank's Response to the Draft Audit Report
                 Control Number ED-OIG/A09HOOI7


 Dear Ms. Pilotti:

          On behalf of Fifth Third Bank ("Fifth Third"), I appreciate the opportunity to provide a response
 to the Draft Audit Report, which sets forth the preliminary findings and recommendations of the Office of
 Inspector General ("OIG") in connection with its audit of Fifth Third's eligible lender trustee ("ELT")
 relationships. We have welcomed the OIG's scrutiny, and, as a longtime participant in the Federal
 Family Education Loan ("FFEL") Program, we share the OIG's desire to ensure the integrity and
 contii1Ued viability of FFEL.

          After a thorough review of the pertinent facts and of the relevant legal authorities, we have
 determined that the findings contained within the Draft Audit Report lack a sufficient factual, legal, and
 policy basis. Indeed, the OIG's primary finding is not supported by the unambiguous and plain language
 of the Higher Education Act of 1965, as amended ("REA"), and it improperly purports to fundamentally
 change the Department's administrative interpretation without prior notice to Fifth Third. Even more,
 less than ten years ago, the U.S. Department of Education ("Department") litigated the very same issue
 and lost decidedly in federal court in Student Loan Marketing Association v. Riley. We, therefore,
 respectfully request that the OIG immediately terminate its audit or refrain from making any findings of
 non-compliance within a Final Audit Report.

          We also disagree with the recommendations contained within the Draft Audit Report and
 respectfully request that those recommendations be significantly revised if a Final Audit Report
 ultimately includes findings of non-compliance. In particular, we request that the OIG not recommend
 that the Department terminate the federal guarantee on the over $3 billion of outstanding student loans in
 question or require reimbursement for amounts paid for default claims, interest, and special allowance on
 those loans. Such a sanction would be unprecedented, and the mere recommendation that the Department
 eliminate the federal guarantee and require over $300 million dollars in reimbursement on those loans
 could cause extreme disruption in the marketplace for securities backed by federally guaranteed student
 loans. The Department is taking important steps to alleviate the anxiety in student lending, and this
 recommendation could severely undermine those efforts. Fifth Third suggests that the OIG recommend,
 if anything, that the Department use informal compliance procedures, as it has done in the past, to address
 the issue.
        We respectfully request that the OIG carefully review the document that we have enclosed,
which, together with exhibits, constitutes Fifth Third's formal response to the Draft Audit Report. In
addition, we have enclosed for your consideration a document submitted by Student Loan Xpress, Inc.,
which, as you know, has a significant financial interest in this matter.

        We encourage the OIG to reach out and to initiate further discussions with Fifth Third regarding
the audit, generally, and Fifth Third's response to the Draft Audit Report, specifically. We can assure you
that such discussions will be treated with high priority.

         At Fifth Third, we work to instill the same high standards of ethics and legal compliance that the
OIG strives to instill through its audits and other investigative work. We, therefore, remain optimistic
that this audit can be resolved amicably.

        Thank you again for the opportunity to respond to the Draft Audit Report.



                                                                  Sincerely,



                                                                  Brian Gardner
                                                                  Vice President, Asset Securitization

Enclosures




                                                   -2-
     FIFTH THIRD BANK'S RESPONSE TO THE OIG'S DRAFT AUDIT REPORT

                           CONTROL NUMBER ED-OIG/A09H0017

                                            June 2, 2008

FINDING NO.1 --        Fifth Third Bank, as an ELT, Violated the Prohibition on Offering
                       Incentives

                                    Comments on the Finding

                                           Introduction

                 The Higher Education Act's Prohibition Against Inducements

         The Higher Education Act of 1965, as amended ("HEN'), authorizes the Federal Family
Education Loan ("FFEL") Program, a federally guaranteed student loan program in whieh loans
made by eligible lenders are ultimately reinsured by the federal government in the event of
default. See HEA, Title IV, Part B; 20 U.S.c. § 1071 et seq. The federal government
additionally provides participating lenders interest benefits and special allowance payments. As
a result, many lenders are willing to make stndent loans and more people can obtain a
postsecondary education, which has become increasingly important in our digital and service
economy.

        Thc HEA has strict requirements regarding the type of entities that may serve as eligible
FFEL lenders, which, as a result, generally limit eligible-lender statns to banks, state agencies,
and non-profit entities. See HEA § 435(d)(I); 20 U.S.C. § 1085(d)(I). However, an eligible
lender, in its capacity as a trustee, may charge a fee to hold legal title to loans for other lenders
that would otherwise be ineligible to make FFEL loans. See HEA § 426; 20 U.S.C. § 1076. The
ineligible lenders become, under the trust, the sale beneficial owners of the loans, and they serve
an important purpose in FFEL:

       These trustee arrangements allow the ineligible lenders not only to originate
       loans, but also to purchase loans that other lenders have originated. This
       purchasing role -- the primary role for many ineligible secondary markets --
       permits originating lcnders to free up capital to make new loans to stndents.
       Eligible and ineligible lenders agree that participation by ineligible lenders
       increases competition among lenders and can, in tnrn, contribute to improved
       service and lower costs for stndent borrowers.'

Trustee Arrangements Serve Useful Purpose in Student Loan Market, U.S. General Accounting
Office (now U.S. General Aceouutability Office), GAO/HEHS-00-170, at 13 (September 2000)
("GAO Report on ELT Arrangements").




, As of December 1999, eligible lender trustee arrangements accounted for $25.3 billion in
outstanding FFEL loans -- approximately 19% of the outstanding balance of all FFEL loans. See
GAO Report on ELT Arrangements, at 13. It is likely to be much higher today.
         As an eligible lender trustee ("ELT"), the eligible lender is responsible for complying
with all statutory and regulatory requirements imposed on holders of a FFEL loan. See HEA §
436(b); 20 U.S.C. § 1086(b); 34 CFR § 682.203(b). Importantly, a lender, including an ELT, can
lose its status as an eligible lender if the Secretary of Education determines, after notice and an
opportunity for a hearing, that the lender "offered, directly or indirectly, points, premiums,
payments, or other inducements, to any educational institution or individual in order to secure
applicants for [FFELJloans." HEA § 435(d)(5)(A); 20 U.S.C. § I085(d)(5)(A). This condition
for maintaining eligible-lender status, which was enacted in 1986, has come to be known as the
"prohibition against inducements."

        The Department has always treated the purchase of actual loans by one lender from
another lender quite differently than it has treated the purchase of loan applications, for pnrposes
of the prohibition against inducements. For as many years as the Department has interpreted the
HEA as prohibiting lenders from paying other entities a per loan fee for marketing, the
Department has interpreted the HEA as permitting lenders to purchase, for a premium, actual
consummated loans from other lenders. See Dear Colleague Letter 89-L-129, at 3 (February
1989) ("DCL 89-L-129"). In fact, the Department allows lenders to purchase loans from other
lenders immediately following disbursement, enabling the purchasing lender to act as the agent of
the selling lender on loans that are to be purchased. Id. ("The funds used to make the loan would
be deemed to have been advanced to the seller by the purchaser and subsequently repaid from the
sale proceeds."). Indeed, fcderal regulations authorize a lender "to contract or otherwise delegate
performance of its functions under [FFELJ to a servicing agency or other party." 34 CFR §
682.203(a).

        FFEL Program Participants Have Adapted to the Department's Interpretation

        The HEA does not prohibit marketers from adapting into lenders and making loans
pursuant to an EL T agreement, and the Department has never questioned that practice through
regnlations, sub-regulatory guidance, or, until now, an audit of the Officc of Inspector General
("OIG"). In fact, many successful FFEL lenders began as marketers and adapted to become
lenders. The strict requirements of the HEA concerning lender eligibility, of course, require such
entities to enter into ELT agreements with eligible lenders, such as Fifth Third Bank ("Fifth
Third"), in order to originate FFEL loans. But if they do so, then these entities, the ELTs with
which they partner, and the lenders that pay a premium for the loans they originate all adhere to
the Department's interpretation of the prohibition against inducements because the payments are
made to purchase actual loans.

                             Fifth Third Disagrees with the Finding

        The OIG's finding of non-compliance necessarily relies upon a very broad intcrpretation
of the HEA's prohibition against inducements that defies the plain language of the HEA and that
has been previously rejected by a federal court as an improper re-characterization of the roles of
the parties. The OIG interprets the inducement prohibition to disallow payments by onc lender
to another lender for the purchase of actual FFEL loans under circnmstances in which (1) the
selling lender was previously a marketer that adapted into a lender by entering into an EL T
agreement, (2) the selling lender did so for the purpose of originating and then immediately
selling its FFEL loans, (3) the purchasing lender was a party to the selling lender's ELT
agreement, and (4) the selling lender outsourced most, ifnot all, its origination and servicing

                                               -2-
responsibilities to third parties. In those instances, the OIG presumes that the selling lender is
still a marketer, and, thus, the payments made by the purchasing lender to the selling lender were
actually for the marketing of loan applications, and not for actual loans.

        Fifth Third disagrees with the OIG's finding for two reasons, either one of which is
sufficient to require the OIG to withhold a finding of non-compliance. First, the payments at
issue were for the sale of actual loans, and not for the marketing of loan applications. To reach a
contrary conclusion, the OIG must disregard the form of the transactions between each of the
selling lenders and the purchasing lender. However, there is clear, legal precedcnt that concludes
the language and purpose of the HEA would be frustrated by disregarding the form of this type
of transaction. Additionally, the Department has always interpreted the prohibition against
inducements to permit the type of sale of loans betwcen lenders at issue here. The OIG cannot
make a finding of non-compliance on the basis of a new administrative interpretation because the
Department did not provide prior notice to Fifth Third of its fundamental change to the prior
interpretation.

        And second, thc payments at issue were not prohibited bccause they were neither madc to
an "educational institution" nor to an "individual," as required by the plain language of the HEA.
The recipients of the payments in question arc neither educational institutions nor individuals.
Rather, they are lenders that have originated Federal Consolidation Loans and have received
payments from another lender upon the sale of those loans. The payments were, therefore, not
prohibited by the HEA because they were made to neither an educational institution nor to an
individual.

A.     The Payments to the Selling Lenders Were Proper Because They Were for the Sale
       of Loans

       1.      The ~IG's finding relies upon a statutory interpretation that was rejected by
               a federal court

        In the Draft Audit Report, the OIO finds that Student Loan Xpress, Inc. ("SLX"), a lender
for which Fifth Third served as ELT, made prohibited payments to three entities that entered into
ELT agreements with Fifth Third in order to originate loans ("Selling Lenders"). The payments
by SLX to the Selling Lenders complied with the HEA because there is a well-reasoned, federal
court precedent permitting the very type of transaction at issue. The ~IG's finding, which is
premised on a statutory interpretation that has been squarely rejected by a federal court is,
therefore, impropcr and should not be included within a Final Audit Report.

               a.      The Scholl College Case held that payments made pnrsnant to this
                       type of transaction were permissible

        The OIG finds non-compliance with the HEA's prohibition against inducements even
though, less than ten years ago, a federal district court rejected the Department, on the merits, in
its attcmpt to sanction a lender under nearly identical facts and circumstances. In Student Loan
Marketing Association v. Riley, the United States District Court for the District of Columbia
overturned the Departmcnt's detennination that a lender had paid a eollcge, which was acting as
a lender itsclf, an improper inducement under section 435(d)(5)(A) of the HEA, 20 U.S.C. §
1085(d)(5)(A), finding the Department's determination arbitrary and capricious. Student Loan
Marketing Ass 'n v. Riley, 112 F. Supp.2d 38 (D.D.C. 2000) ("The Scholl College Case").
                                                -3-
        The transaction in The Scholl College Case is very similar to the transactions between
SLX and the Selling Lenders. In The Scholl College Case, the Dr. William M. Scholl College of
Podiatric Medicine ("Scholl College") was an eligible lender under FFEL. The Scholl College
Case, 112 F. Supp.2d at 40. When Scholl College became a lender, it entered into agreements
with the Student Loan Marketing Association ("Sallie Mae"), whereby Sallie Mae financed the
student loans, processed the student loan applications, and originated the student loans on behalf
of Scholl College. Id. Scholl College also entered into a forward-purchase agreement with
Sallie Mae that required the college to sell its loans to Sallie Mae. Id. When the loans were
purchased, Scholl College received the full principal balance and accrued interest, as well as an
"incentive fee" of up to 2.5%. Id.

                          The Administrative Enforcement Proceeding

        In July 1995, the Department initiated an administrative enforcement proceeding against
Sallie Mae to limit its eligibility to participate in FFEL. The Scholl College Case, 112 F.
Supp.2d at 41. The Department alleged that the premium paid by Sallie Mae to Scholl College
provided an inducement to Scholl College to steer students to Sallie Mae, in contravention of
section 435(d)(5)(A) of the HEA, 20 U.S.C. § 1085(d)(5)(A). Decision, In the Matter of Student
Loan Mktg. Ass 'n (Sallie Mae), Dkt. No. 96-23-SL (Sept. 26, 1996) ("Initial ALJ Decision").
The Department's theory was that the form of the transaction between Sallie Mae and Scholl
College should be disregarded, and Scholl College should be re-characterized in the transaction
as an educational institution, as opposed to the originating lender. Id. at 5. Once that is done, the
Department asserted, the fee paid by Sallie Mae to Scholl College becomes a payment made by a
lender to an edneational institution in order to secure loan applications. The Scholl College
Case, 112 F. Supp.2d at 41.

        An administrative law judge ("ALJ") rejected the Department's contentions and ruled for
Sallie Mae in a written decision in September 1996. The judge noted that the Department
explicitly permitted lenders to offer premiums to each other on the sale of loans in order to
enhance liquidity. Initial ALJ Decision, at *5. Refusing to disregard the form of the transaction,
the ALJ found that Sallie Mae had complied with the HEA because the fee was paid for actual
loans, not loan applicants. Id. The judge further found that there was no evidence of Scholl
College encouraging parents or students to take out unnecessary student loans, or of any
fraudulent activities by Scholl College. Id. After noting the Department's concession that the
situation would be permissible if the selling lender was not a school, the judge concluded that the
Department was "attempting to legislate a prohibition which exceeds the bounds of the enabling
statute." Id.

        The Department appealed the ALl's decision to the Secretary of Education. In February
1997, the Secretary remanded the case to the ALJ to consider whether the Department could
"characterize a party as a lender under the FFEL program based on the substance of the
transactions involved and in spite of their form." The Scholl College Case, 112 F. Supp.2d at 41.

         The ALJ issued a written decision on remand in July 1997, in which he responded to the
Secretary's query by stating that the form of the transaction could not be disregarded. The ALJ
held that, pursuant to the agreements signed by the parties, Scholl College, and not Sallie Mae,
was the originator of the loans. Decision Upon Remand, In the Matter of Student Loan Mktg.
Ass '/1 (Sallie Mae), Dkt. No. 96-23-SL (July 18, 1997) ("ALJ Decision Upon Remand"). Thus,

                                                -4-
the ALJ concluded, the premium paid to Scholl College for the loans was not an impermissible
inducement for loan applications, but a payment for the sale of actual loans. The Scholl College
Case, 112 F. Supp.2d at 41. And the court again noted the Department's admission that the same
transaction between two non-school lenders would be permissible. AU Decision Upon Remand
at *3.

       The ALI's order on remand was appealed, and the Secretary overturned the judge. The
Scholl College Case, 112 F. Supp.2d at 41.

        Sallie Mae sued the Department in the United States District Court for the District of
Columbia, contending that the Secretary's decision was arbitrary, capricious, an abuse of
discretion, and otherwise contrary to law, in violation of the Administrative Procedures Act
C"APA"), 5 U.S.C. § 706. The Scholl College Case, 112 F. Supp.2d at 42.

                                   The District Court Decision

        At the district court, the Department's defense of its enforcement action rested on
showing that Sallie Mae, and not Scholl College, was the originating lender. The Scholl College
Case, 112 F. Supp.2d at 43. Only then could the Department demonstrate that the payments
were not between lenders for the sale ofloans. The Department admitted that each of the
contracts comprising the transaction was individually permissible, meaning that (1) it was
permissible for Sallie Mae to agree to provide funding to Scholl College to enable the school to
originate student loans, (2) it was permissible for Sallie Mae to agree to provide Scholl College
loan origination and servicing support, and (3) it was permissible for Sallie Mae to agree to
purchase from Scholl College all of the student loans the school was to originate. Id. at 47.
However, the Department contended that the combination of the contracts created a relationship
between the parties in which the payments made by Sallie Mae to Scholl College were
impermissible inducements. Id. at 46. The Department argued that a review of the transaction,
asa whole, showed that Scholl College was not the originating lender, but, instead, a mere loan
marketer for Sallie Mae.

        The district court first found that nothing prevented school lenders, such as Scholl
College, from delegating essentially all of their functions to Sallie Mae, "even if the arrangement
effectively renders the school lender a mere marketer of loans." The Scholl College Case, 112 F.
Supp.2d at 44 (emphasis added). The court noted that such delegations are expressly permitted
under the Department's regulations and that "a lender does not shed its status as the lender in a
transaction even if its functions are delegated to a third party." Id. The court also held that
neither Scholl College's failure to bear the real risks of the lending, nor unproven and unalleged
concerns about student and parent coercion, justified ignoring the college's status as a lender. Id.
at 44-45.

        The court also declined to disregard the form of the transaction between Scholl College
and Sallie Mae because the HEA placed an emphasis on form. See The Scholl College Case, 112
F. Supp.2d at 46 (finding that it can be inferred from the HEA "that the statute placed an
emphasis on form, and that the form is not to be ignored even where the underlying substantive
duties are assigned to another party") (emphasis added). The Department had not alleged that
Sallie Mae was somehow using the structure or labels to gain an improper advantage, or that
Sallie Mae exercised any involvement or control over Scholl College. ld.

                                                -5-
         In response to the Department's contention that the court should find the agreements, in
combination, between Schol1 Col1ege and SaJlie Mae impermissible, the district court noted that,
through the HEA, "Congress has recognized that the individual agreements between [Sal1ie Mae1
and Schol1 College are permissible," and that "Congress clearly intended to grant [Sal1ie Mae1
broad discretion in structuring its loan purchase agreements." The Scholl College Case, 112 F.
Supp.2d at 46. In addition, Department regulations provided that Sehol1 Col1ege could delegate
its duties as a lender. Jd.

         Moreover, because the agreements were indicative of "traditional market transactions,"
and the forward-purchase agreement was negotiated with competitive pricing, Sehol1 Col1ege
gained no more from the transactions "than it would if the loan purchaser and loan financer were
different parties." Jd. at 46-47. The court also noted that official guidance from the Department,
in the form of the 1989 Dear CoJleague Letter, stated that the type of transaction involved here
was an example of an arrangement that would comply with the prohibition against inducements.
Jd. at 48. Consequently, there was, as the court put it, "no rational basis for invalidating the total
arrangement." Jd.

       FinaJly, and most significantly for the matter at hand, the court noted that the Department
"has conceded that the same set of transactions would be permissible if it involved contracts
between two non-school lenders." The Scholl College Case, 112 F. Supp.2d at 48. In short, the
Department had represented to the court that if the situation was the same, except Schol1 College
was replaced by a different kind of lender, then the Department would have had "no complaint."
Jd.
                b.     The OIG's finding of non-compliance is indistinguishable from the
                       Department's unsuccessful administrative enforcement proceeding in
                       The Scholl College Case

        The facts and circumstances of The Scholl College Case are virtually indistinguishable
from those involved here. In The Scholl College Case, the originating lender was a school. But,
just as Sallie Mae provided funding to Scholl College to enable it to originate student loans as a
lender, so, too, did SLX provide funding to three entities to enable them to originate student
loans as lenders. And just as Sallie Mae provided loan origination and servicing support to
Scholl College and agreed to purchase from Scholl College all of the student loans it was to
originate, so, too, did SLX. As in The Scholl College Case, several agreements were entered into
between SLX and the Sel1ing Lenders in order to effectuate the origination and servicing of
FFEL loans, as well as the sale of those loans from the Selling Lenders to SLX -- a transaction
that the Department has expressly condoned since 1989. See DCL 89-L-129, at 3. It is also a
transaction that any prudent EL T would facilitate in order to ensure that the loans in the tmst are
properly funded, serviced, and committed for sale to an experienced, wel1-financed FFEL loan
holder.

       The form of the agreements between SLX and the Selling Lenders, like the form of the
agreements in The Scholl College Case, were typical of transactions on the secondary market. In
The Scholl College Case, the Department attempted to disregard the form of the transaction
because it thought the combination of the agreements suggested that Sallie Mae, and not Schol1
College, was the originating lender. Similarly, the ~IG's finding is premised on disregarding the
form of the transactions to detennine that the combination of the agreements suggest that SLX,

                                                 -6-
and not the Selling Lenders, was the originating lender. See Draft Audit Report, at 6 ("[U]nder
the EL T agreement, MSA remained solely a marketer, that is, an entity that secured loan
applications for lenders."). The OIG's disregard of the form of the transactions that placed
entities in the role oflender is unpersuasive here for the same reasons the Department's disregard
of Scholl College as a lender was unpcrsuasive, and rcjectcd outright, in The Scholl College
Case 2

         The OIG identifies three particular aspects of the transactions that lead it to disregard the
form of the transactions: (I) "the origination of [the Federal Consolidation Loans] [wa]s
restricted to those exclusively funded, serviced, and purchased by SLX and its affiliates"; (2)
"SLX [] transferr[ ed] its interest in the loans held in one trust ... to another trust;" and (3) "the
role of [the Selling Lenders] was limited to the secnring of loan applications (marketing) and
obtaining loan verification certificates." Draft Audit Report at 5-6. However, all of these actions
are either authorized by the HEA or are otherwise pennissible. Consequently, the OIG cannot
eite to them to support the view that the payments from SLX to the Selling Lenders were actually
for loan applications, as opposed to actual loans. OIG has neither a factual nor a legal basis to
re-characterize the Selling Lenders as marketers in order to allege that SLX made improper
inducement payments to them.

                   Forward-Purchase and Third-Party Servicing Agreements

        The Draft Audit Report questions the legality of the forward-purehase and third-party
servicing agreements between the Selling Lenders and SLX (or its affiliates). In essence, the
OIG finds problematic the fact that the Selling Lenders agreed in advance to sell their Federal
Consolidation Loans to SLX and to have them funded and serviced by SLX affiliates. See Draft
Audit Report, at 5 ("Under the tenus of the ELT agreements and related agreements, MSA, PLP,
and LSF are not lenders since the origination of FFELs is restricted to those exclusively funded,
servieed, and purchased by SLX and its affiliates .... "). But the OIG's characterization of these
agreements as evidence of prohibited inducements is factually untenable, and the DIG cited no
legal authority to support its view.

        The form of each agreement within the transaction is clear on its face. The EL T
agreements, which were consummated following anus-length negotiations between the parties,
laid the groundwork for a myriad of rights and obligations of the Selling Lenders in several other
related agreements. For example, the third-party servicing agreements involved the outsourcing
by the Selling Lenders of certain origination and servicing functions to SLX or its affiliates. And
the forward-purchase agreements required the sale of actual loans by the Selling Lenders to SLX.

         In addition, forward-purchase and third-party servicing agreements are not prohibited by
statutes or regulations. In fact, federal regulations provide express authority for SLX and its
affiliates to service Federal Consolidation Loans originated by the Selling Lenders at prices and
on terms and conditions determined by the contracting parties. See 34 CFR § 682.203(a) ("A
school, lender, or guaranty agency may contract or otherwise delegate the performance of its
functions under the [HEA] and [Part 682 of Title 34 of the Code of Federal Regulations] to a


2And The Scholl College Case involved payments to a school, where the concerns regarding the
pernicious effects of improper inducements are the greatest because of the influence schools
have over their student-borrowers in selecting a FFEL lender.
                                                -7-
servicing agency or other party."). This outsourcing authority is -- by its own terms -- very
broad, permitting lenders to delegate any lending function. The Scholl College Case, 112 F.
Supp.2d at 44 ("The regulation does not limit in any way how lending functions may be
delegated; nor docs it exclude any lending functions from delegation."). Despite the OIG's effort
to call into question the Selling Lcnders' use of third-party servicing agreements, nothing in the
regulation can be reasonably interpreted to separate the role of lender and the role of a marketer
that has adapted into a lender to originate loans pursuant to an ELT agreement. See id. C[T]he
regulation cannot be reasonably interpreted as expressing a 'clear intent to separate the role of
the lender and the school,' as claimed by [the Dcpartment].").

        Forward-purchase agreements are expressly permitted by the Department, and they have
been described by the Department as a way in which lenders can comply with the prohibition
against inducements. In its 1989 Dear Colleagne Letter, under thc heading "Examples of
Permissible Activities," the Department expressly authorized the sale ofloans between lenders
and provided specific guidance regarding the nature of the sale and the role a purchasing lender
may play in its acquisition of the loans from the selling lender:

               Examples of Permissible Activities:

               1.      A lender purchases a loan made by another lender at a premium.
               This is not a transaction involving the securing of applicants, but rather the
               acquisition of loans already made. A purchasing lender may also act as
               the agent of a selling lender on a loan to be purchased for purposes of
               originating and disbursing the loan, and purchase the loan at a premium
               immediately following disbursement. The funds used to make the loan
               would be deemed to have been advanced to the seller by the purchaser and
               subsequently repaid from the sale proceeds.

DCL 89-L-129 (emphasis added).

         For the past 20 years, the Department has interpreted the HEA to authorize a lender's
acquisition of loans immediately following disbursement under circumstances in which the
agreement to acquire such loans is struck before the loans are ever made by the selling lender,
i.e., a forward-purchase agreement. Even more, the excerpt shows that the Department has, for
just as long, expressly authorized a purchasing lender to act as the agent of the selling lender by
advancing the necessary funds to the selling lender and by providing other third-party assistance
that aids the selling lender in the origination and servicing of the loans. The Department has
never modified its position regarding the legality of forward-purchase agreements between
lenders.

                  SLX's Transfer ofInterest from one Trust to Another Trust

        The Draft Audit Report found troubling the fact that SLX was a party to the EL T
agreements between Fifth Third and the Selling Lenders, which agreements set forth, among
other things, that the EL T relationships were being formed to effectuate the sale of loans from




                                                -8-
the Selling Lenders to SLX. 3 See Draft Audit Report, at 6. The OIG's concern is that, as a party
to the ELT agreements, SLX seemed to have had an "interest" in the loans held in trust by Fifth
Third for the Selling Lenders that, upon SLX's purchase of those loans, was transferred to
another trust for which Fifth Third served as ELT. This, the OIG concludes, shows that the
transaction was not for a sale of loans from one lender to another lender but, rather, the mere
transfer of SLX's loans from one hust to another trust.

        The ELT agreements created separate trusts, eaeh with its own existence and its own set
of rights and obligations for the parties. By the terms of each ELT agreement, Fifth Third held
the loans constituting trust property "for the benefit of [the Selling Lender]," and the ELT
agrcement required such loans to be "held, administered and pledged and the proceeds thereof
distributed by [Fifth Third] for the benefit of [the Selling Lender]." See, e.g., ELT Agreement
Between Fifth Third and Pacific Loan Processors, Inc., at Sections 1.1 and 1.2 (Apr. 1, 2005).

         In this case, SLX's role under the ELT agreements was limited. Its duties were largely
ministerial, and its obligations were basically to pay, on the Selling Lenders' behalf, the costs of
commencing and maintaining the Selling Lenders' ELT agreements -- an obligation that eould
have easily been included within the forward-purchase agreements or omitted altogether in favor
of an increase in the premiums. The inclusion of SLX as a party to the ELT agreements neither
created a beneficial interest of SLX in the loans residing in the trusts, nor diminished the full and
exclusive beneficial ownership interest of the Selling Lenders in the loans residing in the trusts.
The ~iG's conclusion that SLX transferred an interest from one trust to another trust is,
therefore, not supported by the facts because the terms ofthe Selling Lenders' EL T agreements
shows that SLX had no beneficial ownership interest in those trusts. Additionally, nothing in the
ELT agreements suggested that SLX's presence interfered in any way with the Selling Lenders'
ability, as the sole beneficial owners of the trust property, to effectuate a valid sale of Federal
Consolidation Loans to SLX.

        The form of the EL T agreements in question indicates that those agreements created
legally enforceable trustee-beneficiary relationships between Fifth Third and the Selling Lenders,
not between Fifth Third and SLX. There is nothing in the ELT agreements that provides SLX a
beneficial interest in the trusts established thereunder. Pursuant to the ELT agreements, actual
Federal Consolidation Loans were originated by the Selling Lenders, acting through Fifth Third,
and were held exclusively by Fifth Third for the benefit of each Selling Lender. The form of the
transactions clearly demonstrates that the Selling Lenders, and not SLX, originated Federal
Consolidation Loans that were held by Fifth Third as ELT.

                             The Limited Role of the Selling Lenders

        Nothing in the HEA or federal regulations prohibited the Selling Lenders from entering
into third-party servicing agreements to outsource most of their duties and functions as lenders,
even though doing so may have significantly limited the role of the Selling Lenders primarily to
the marketing of loans. See The Scholl College Case, 112 F. Supp.2d at 44 ("[N]othing in the
statute or regulations prohibits a []lender from establishing a relationship with a third-party


3The OIG is so troubled by this one factor that its absence from several of Fifth Third's other
ELT agreements is the sole reason cited by the OIG for not also including those transactions
within the Draft Audit Report's findings. See Draft Audit Report, at 12.
                                                -9-
servicer ... even if the an-angement effectively renders the []lendcr a mere marketer of loans. ").
The Draft Audit Report nevertheless questions the limited role of the Selling Lenders, derisively
describing their role as one only involving "the securing of loan applications (marketing) and
obtaining loan verification certificates." Draft Audit Report, at 6. The OIG concludes that,
despite their ELT agreements with Fifth Third, each Selling Lender "remained solely a marketer,
that is, an entity that secured loan applications for lenders." ld. However, the HEA, itself,
expressly authorizes lenders to take as limited a role as they desire and many lenders, inclnding
the Selling Lenders, have properly done that.

        The Draft Andit Report's conclusion that the Selling Lenders' limited role supports
treating the form of the transactions as fiction is unsupported by any factual or legal analysis.
The fact that the Selling Lenders held the loans during a period in which they had very few
servicing obligations and assumed reduced financial risk does not lead to the conclusion that
SLX was actually the originating lender. See The Scholl College Case, 112 F. Supp.2d at 44.
The Selling Lenders did, of course, assume some financial risk in the fo= of repurchase
obligations under the forward-purchase agreements, as well as compliance risk and reputation
risk. Still, the Congress did not intend to inject uncertainty into the HENs application by
making the identification of the originating lender dependent upon the breadth of responsibilities
undertaken by the entity. ld. at 45.                                                        .

        The Department's regulations expressly authorize lenders to delegate the performance of
their lender functions under the HEA but holds them responsible for compliance. See 34 CFR §
682.203(a). Thus, whether the lender is a "traditional lender" or a marketer that recently became
a lender pursuant to an ELT agreement, it bears the same risk when it "contract[s] with one party
to handle all of its originating and servicing functions, contract[s] with another party to obtain
capital to fund its loans, and contract[s] with still another party to sell its loans once they have
heen disbursed." ld. at 44. It is, thercfore, of no legal significance that the Selling Lenders' role
was limited on account of the forward-purchase and third-party servicing agreements becausc,
again, "nothing in the statute or regulations prohibits a []lender from establishing a relationship
with a third-party servicer ... even if the arrangement effectively renders the [} lender a mere
marketer of loans." ld.

                                  The "Combination" Approach

        The Draft Audit Report suggests that it is the combination of the contractual rights and
obligations betwccn the Selling Lenders and SLX, rather than any particular provision, that
transgresses the prohibition against inducements. Thus, the OIG takes the same "combination"
approach in the Draft Audit Report that was squarely rejected by the court in The Scholl College
Case. See The Scholl College Case, 112 F. Supp.2d at 48 ("[A] prohibition cannot be
manufactured by a recasting of the roles of the parties in an attempt to argue, as [the Department]
does here, that the contractual arrangements, when taken as a whole, violate the spirit of the anti-
inducement provision of the statute."). The OIG does not mention, let alone attempt to
distinguish, The Scholl College Case within its finding. Plainly, it cannot do so. Therc is no
material difference between the two.

        The arrangements between the Selling Lenders and SLX, likc the an-angcments betwccn
Sch'Oll College and Sallie Mae, "are characteristic of traditional market transactions bctween
lenders." The Scholl College Case, 112 F. Supp.2d at 46. Selling student loans in the secondary

                                               - 10 -
market at a premium, or at an amount above par, is typical. Id. at 47. Pursuant to the forward-
purchase agreements, the premium is computed by multiplying a premium percentage times the
principal amount of each loan sold during the preceding half-month. The premium percentages
increase as the principal amount of the loans increases. The 010 has not contested that the
forward-purchase agreements were negotiated using competitive, market pricing. Thus, the
Selling Lenders gained no more from the transactions with SLX than would any other lender.
Consequently, the payments made by SLX to the Selling Lenders did not provide any
unreasonable incentive to take certain actions and, therefore, cannot be said to "rise to the level
of an improper inducement." Id.

        All of the agreements, and the various aspects thereof, that are challenged by the OIO are
permissible under the HEA. Taken together, these agreements show no more than that the
payments from SLX to the Selling Lenders were for the purchase of loans by one lender from
another lender. As the court noted in The Scholl College Case, the Depal1ment issued guidance
nearly 20 years ago informing lenders that these types of agreements, in combination, arc
permissible. See The Scholl College Case, 112 F. Supp.2d at 48 ("[The Department] implied in
the [Department's] first official guidance given to lenders, the 1989 DCL, that agreements such
as those existing between [Scholl College] and Sallie Mae are unobjectionable in combination, as
an analogous transaction was given as an example of a permissible activity.").

        The OIO's finding seeks to impose its own policy preferences and to replace the policy
preferences and legal interpretations that were previously expressed by the Department in the
1989 Dear Colleague Letter. Since 1989, the Department has generally pennitted the type of
arrangement at issue here, and, subsequently, in The Scholl College Case, the Department
represented to a federal court that the payments made pursuant to this very arrangement are
specifically permissible.

       2.      The Department cannot change its interpretation of the inducement
               prohibition without prior notice

        Federal agencies are required to give notice of a change in administrative interpretation
before taking enforcement action pursuant to the revised interpretation. See Long Island Care at
Home. Ltd. v. Coke, 127 S. Ct. 2339, 2349 (2007) (holding that changes in regulatory
interpretations are acceptable unless unfair surprise results); Abhe & Svoboda, Inc. v. Chao, 508
F.3d 1052 (D.C. Cir. 2007) (holding that regulations must provide fair notice of prohibited
conduct in order for penalties to be deemed appropriate). In fact, under the Administrative
Procedures Act ("APA"), 5 U.S.C. § 551(5), agencies are required to engage in notice-and-
comment rulemaking to change regulatory interpretations. See Paralyzed Veterans of America v.
D.C. Arena L.P., 117 F.3d 579, 586 (D.C. Cir. 1997).

        In Paralyzed Veterans, a group challenged the lower court's decision regarding lines of
sight for wheelchair-bound patrons at an arena. See Paralyzed Veterans, 117 F.3d at 582. One
of the grounds for appeal was that the agency's current interpretation ofthc governing regulation
was "a fundamental modification of its previous interpretation" and that such a change could not
be made "merely by revising the technical manual." Id. at 586. Although the court of appeals
ultimately held that the manual constituted the agency's initial regulatory interpretation and,
thus, did not require rulemaking in order to become effective, it held that rulemaking is required
before an agency can make a fundamental change to a regulatory interpretation. Id. (citing

                                               - 11 -
Shalala v. Guernsey Memorial Hasp., 514 U.S. 87,100 (1995»; see SEC Inc. v. FCC, 414 F.3d
486,498 (3rd Cir. 2005) ("[I]f an agency's present interpretation of a regulation is a fundamental
modification of a previous interpretation, the modification can only be made in accordance with
the notice and comment requirements of the APA."); Shell Offshore Inc. v. Eabbit, 238 F.3d 622,
629 (5th Cir. 2001) (,,[T]he APA requires an agency to provide an opportunity for notice and
comment before substantially altcring a well established regulatory interpretation.").

        Similarly, in this matter, the OIG is proposing a fundamental changc to the administrative
interpretation of the prohibition against inducements. The existing interpretation is that a
transaction between lenders for thc sale ofloans is expressly permitted. Fifth Third and the
lenders for which it served as ELT relied upon that interpretation in structuring the transaction at
issue here. Over the years, billions and billions of dollars in FFEL loans were originated in
reliance on that interpretation. But now, the OIG is proposing to make a finding of non-
compliance for that very typc of transaction, and it is doing so without prior notice to Fifth Third
of the fundamental change of interpretation. The OIG is taking this action in spite of the
Department's recently published Final Rule that amends the regulations to expressly permit this
type of transaction.

        The Department offcred its first authoritative interpretation of the HENs anti-inducement
provision in February 1989 whcn it issued a "Dear Colleague letter" to the student lending
community. See DCL 89-L-129. In that snb-regulatory gnidance document, the Department
stated that a sale of loans between lenders complies with the REA's anti-inducement provision.
It even went so far as to say that the purchasing lender could also act as the agent of the selling
lender by taking on the selling lender's originating and servicing responsibilities, including the
provision of funds to the selling lender to originate the loans. Aside from advancing the view in
the mid to late 1990s that this "safe harbor" did not apply where a school was the selling lender -
- a view ultimately rejected in The Scholl College Case -- the Department has ncver changed its
interpretation of the inducement prohibition in connection with thc salc ofloans. Indeed, it has
recently done the complete opposite -- it has amended the regulations, effective July I, 2008, to
expressly permit the payment of a premium upon a sale ofloans from one lender to another
lender:

       (ii) Notwithstanding paragraph (5)(i) of this definition, a lender, in carrying out
       its role in the FFEL program in attempting to provide better service, may provide


                                            •••
               (H) Purchase of a loan made by another lender at a premium.

72 Fed. Reg. 61960, 61999-62000 (Nov. 1,2007).

        The OIG's finding of non-compliance in the Draft Audit Report relating to payments
made in furtherance of the sale ofloans between the Selling Lenders and SLX -- two non-school
lenders -- would be a fundamental change to an administrative interpretation 4 Even more, it

4 Throughout the litigation of The Scholl College Case, thc Department made its case regarding
the illegality of Sallie Mae's payments to Scholl College by, among other things, drawing a
distinction between those payments and payments made betwecn two non-school lenders. See
                                               - 12 -
would be a change in interpretation made solely for the purpose of the OIG's audit of Fifth
Third, and it would be a change in interpretation that was made without prior notice, thus,
creating undue surprise. As such, it would be improper for the OIG to make that finding. The
Department is bound by its prior administrative interpretation unless and until it provides notice
of a fundamental change to that interpretation.

       3.      The payments for Federal Consolidation Loans did not involve any of the
               risks targeted by the HEA's prohibition against inducements

        The HEA's prohibition against inducements was intended to "foreclose the possibility of
exploitation of student and parent borrowers" so as to discourage them from engaging in
"unnecessary or excessive borrowing." The Scholl College Case, 112 F. Supp.2d at 45. The
payments at issue here were, however, for the purchase of Federal Consolidation Loans, which
involve the consolidation of existing loans, as opposed to the borrowing of additional sums of
money for new loans. The origination of Federal Consolidation Loans does not increase the
principal amount of debt owed by parent and student borrowers and, therefore, cannot lead
student and parent borrowers to incur unnecessary debt.

        Even more, the Department's understandable concern with the influence schools have
over the selection by student and parent borrowers of a FFEL lender does not arise here. The
payments at issne were made by one lender to another lender. No party attempted to influence
the behavior ofborrowcrs by offering payments to schools or to borrowers directly. As such, the
payments here had no direct impact on borrowers and no impact at all on schools. 5 The Draft
Audit Report does not identify, or even suggest, any behavior by Fifth Third that harmed
borrowers.

B.     The HEA's Prohibition Against Inducements Does Not Cover the Recipients of the
       Payments Here

         The statutory definition of an "eligible lender" under the HEA specifically excludes
lenders that have "offered, directly or indirectly, points, premiums, payments, or other
inducements, to any educational institution or individual in order to secure applications for
loans." HEA § 435(d)(5)(A); 20 U.S.C. § l085(d)(5)(A) (emphasis added). Whether the entities
to which such payments are made arc lenders or markcters makes no difference because the
HEA's prohibition against inducements only applies to payments made to "any educational
institution or individual." The Selling Lendcrs were neither, and the Department cannot, through
the issuance of regulations and sub-regulatory guidance, expand the scope of covered recipients
that the HEA clearly and unambiguously limits to educational institutions and individuals.




The Scholl College Case, 112 F. Supp.2d at 48 (,,[The Department] has conceded that the same
set of transactions would be permissible if it involved contracts between two non-school
lenders.").
5 The payments were, therefore, far removed from the types of problematic payments identified
by a key witness for the Departmcnt in The Scholl College Case, e.g., lenders giving away
electronic goods to borrowers.
                                              - 13 -
        1.     The OIG's finding necessarily relies upon an interpretation of the
               inducement prohibition that is contrary to the plain language of the HEA

               a.      The OIG's finding is not consistent with clear and unambiguous
                       language within the HEA that only prohibits inducement payments to
                       "any educational institution or individual"

        A court will look no further than the plain language of the statute when it is called upon
to review the validity of agency action. See Chevron U.S.A. v. Natural Resources Defense
Council, 467 U.S. 837, 842 (1984). Under Chevron, the first step for determining the validity of
agency action is for the court to analyze whether "Congress has directly spoken to the precise
question at issue." ld. If Congress has spoken to the question, then the agency and, if necessary,
the courts "must give effect to the unambiguously expressed intent of Congress." ld. It is
incumbent upon the agency to take only those actions that are consistent with clear and
unambiguous statutory language:

       In detennining whether a challenged regulation is valid, a reviewing court must
       first determine if the regulation is consistent with the language of the statute. "If
       the statute is clear and unambiguous 'that is the end of the matter, for the court, as
       well as the agency, must give effect to the unambiguously expressed intent of
       Congress.' ... The traditional deference courts pay to agency interpretation is not
       to be applied to alter the clearly expressed intent of Congress."

K Mart Corp. v. Cartier, Inc., 486 U.S. 281, 291 (1988) (emphasis added; internal citations
omitted); see Zuni Public Schools Dist. No. 89 v. Department ofEducation, 127 S. Ct. 1534,
1543 (2007) ("Under this Court's precedents, if the intent of Congress is clear and
unambiguously expressed by the statutory language at issue, that would be the end of our
analysis."); Barnhart v. Sigmon Coal Co., 534 U.S. 438,461 (2002) ("In the context of an
unambiguous statute, this Court need not contemplate deferring to an agency's interpretation.");
Estate of Cowart v. Nicklos Drilling Co., 505 U.S. 469, 475-77 (1992) ("Of course, a reviewing
court should not defer to an agency position which is contrary to an intent of Congress expressed
in tlnambiguous terms.").

         If the statute is clear and unambiguous -- that is, if the Congress has directly spoken to
the precise question at issue -- then the agency must follow the letter of the statute and take only
those actions that are consistent with the literal words of the statute. Agency actions that rely for
their justification upon authorities outside of the litcral words of a clear and unambiguous statute
are improper and will be struck as invalid. See Financial Planning Ass 'n, Inc. v. SEC, 482 F.3d
481,492 (D.C. Cir. 2007) (agency could not use statutOlY provision granting authority to exempt
additional groups to issue regulations expanding statute's application); Amalgamated Transit
Union v. Skinner, 894 F.2d 1362, 1364 (D.C. Cir. 1990) (statutory language authorizing specific
federal intervention into local safety programs did not give the Urban Mass Transportation
Administration authority to institute a drug-testing program on all recipients of its grants).

         Three circuits have declined to allow a regulation issued under the Family Medical Leave
Act ("FMLA") to impose an additional legal requirement in light of the plain language of the
statute that speaks to the precise issue. See Woodford v. Community Action of Greene County,
Inc., 268 F.3d 51, 56-57 (2d Cir. 2001); Brungart v. BellSouth Telecommunications, inc., 231
                                               - 14 -
F.3d 791, 797 (11th Cir. 2000), cerl. denied, 532 U.S. 1037 (2001); Dormeyer v. Comerica Bank
- JIlinois, 223 F.3d 579, 582 (7th Cir. 2000). In Woodford, the plaintiff challcnged the lower
court's ruling that she had not worked the requisite number of hours to be covered under the
FMLA. See Woodji)rd, 268 F.3d at 52. The statute required that a person work a certain number
of hours to be eligible under FMLA, but a regulation allowed a person lacking the minimum
hours to qualifY ifhe requested leave and the cmployer confirmed eligibility. ld. at 54-55. In
line with decisions in the Seventh and Eleventh Circuits, the Second Circuit upheld thc lower
court's ruling that the regulation was too broad because it could allow an employee who did not
meet the statutory hours requirement to receive benefits. ld. at 56-57. The Woodford court
found that the congressional intcnt was clear from the language of the statute. ld. at 55. The
regulation was inconsistent with the literal words of the statute and was, thus, struck as invalid.
ld.

        At least one federal court has examined this issue in thc context of whether action takcn
by the Department was consistent with thc clear and unambiguous language of the HEA. In
Sandler v. United Slates Dep 'I of Educalion, No. CIV. A. 00-CV-4432, 2001 WL 884552 (E.D.
Pa. July 19, 2001), the court ruled in favor of a borrower who had been denied a dischargc of her
FFEL loan following her withdrawal from a school that announced it was closing. Relying upon
a regulation that requires borrowers to withdraw from a school not morc than 90 days before its
closing in order to receive a loan discharge, the guaranty agency designated by the Department
had denied the borrower's request for a discharge. See 34 CPR § 682.402(d)(1)(i) ("The
Sccretary reimburses the holder of a loan ... and discharges the borrower's obligation with
respect to the loan, if the borrower ... withdrew from the school not more than 90 days prior to
thc date the school closed.").

       The court, however, noted that the HEA, which addresses the issue of loan dischargc
upon the closure of a school, imposes no such time limitation:

       If a borrower ... is unable to complete the program due to the closure of the
       institution ... then the Secretary shall discharge the borrower's liability on the
       loan (including interest and collection fees) by repaying the amount owed on the
       loan and shall snbsequently pursue any claim available to such borrower against
       the institution ....

HEA § 437(c); 20 U.S.C. § 1087(c) (emphasis added). Because the HEA specifically addresses
the issue clearly and unambiguously, the borrower was entitled to have her loan discharged. See
Sandler, 2001 WL 884552, at *1-2 ("The plain meaning of the statute clearly is that when a
student is unable to complete his or her program due to the closure of the school, the Secretary
shall discharge the borrower's liability on the loan.").

        Just as the HEA directly speaks to the issne ofloan discharge upon school closures, so,
too,does the HEA directly speak to the issue of prohibited inducements. In both contexts, the
statutory language is clear and unambiguous. The HEA conditions a lender's statns as an
"eligible lender" upon its ability to refi'ain from offering inducement payments to "any
educational institution or individual." HEA § 435(d)(5)(A); 20 U.S.c. § 1085(d)(5)(A).
Consequently, the Department must follow the letter of the HEA and only take administrative
enforcement action where payments for loan applications are made by lenders to "any


                                              - 15 -
educational institution or individual." Enforcement actions that involve payments to other
classes of recipients are improper and, if challenged in court, will be struck as invalid.

        None of the recipients of the payments at issue here are, or have ever been, any kind of
"educational institution," under any plausible definition of that term. Thus, the ~iG's finding of
non-complianee necessarily relies on the payments having been made to "individuals." It would,
therefore, have to be the OIG's position that, when Congress used the term "individual" in
section 435(d)(5)(A) of the HEA, 20 U.S.C. § 1085(d)(5)(A), it included legal entities, such as
the Selling Lenders here. Because such an interpretation runs contrary to the definitions
provided in the United States Code, as well as to the structure of the very statutory provision in
question, the OIG should not rely on the payments to the Selling Lenders to make a finding of
non-complianee.

               b.      The HEA's use of the term "individual" is not synonymous with
                       "person" and, thus, does not cover the Selling Lenders

        An interpretation of "individual" to include legal entities, such as the Selling Lenders,
requires blurring the distinction between the use of "individual" and "person" in statutory
drafting. In normal usage, the words are often used as synonyms for "human being," but
"'person' often has a broader meaning in the law." Clinton v. City o/New York, 524 U.S. 417,
428 (1998) (noting the distinction between "person" and "individual" and how "person," and not
"individual," covers corporations). Indeed, the term "person" is described in the primary
definitions section of the United States Code as including legal entities (such as corporations and
partnerships), as well as individuals. See 1 U.s.C. § 1 ("[T]he words 'person' and 'whoever'
include corporations, companies, associations, firms, partnerships, societies, and joint stock
companies, as well as individuals").

        Therefore, when used in federal statutes, the term "individual" is a subset of "person"
and, as a result, cannot carry the same legal meaning. While a "person" can be either a legal
entity or a human being, an "individual" can only be a human being. The HEA's inducement
prohibition, which covers payments to "any educational institution or individual," then, covers
only those payments made to educational institutions or human beings -- a much more narrow
class of recipients than that which would be covered by the term "person." lfCongress intended
to prohibit payments to legal entities other than educational institutions, such as corporations and
partnerships, then it would have used the term "person."

         Another place to look to discern the meaning of "individual," as used in the HEA's anti-
inducement provision, is the context in which it is used. See Whitman v. American Trucking
Ass 'n, 531 U.S. 457, 471 (2001) ("The text of § I 09(b), interpreted in its statutory and historical
context and with appreciation for its importance to the CAA as a whole, unambiguously bars cost
considerations from the NAAQS-setting process, and thus ends the matter for us as well as the
EPA."). In this case, the provisions of the HEA that appear with the anti-inducement provision
in section 435(d)(5) focus on offers of payment (or other conduct) directed toward human
beings. For example, section 435(d)(5)(B) of the !-lEA prohibits lenders from conducting
unsolicited mailings to "students" ofloan application forms. And section 435(d)(5)(C) oftbe
HEA prohibits lenders from offering FFEL loans to a "prospective borrower" to purchase an
insurance policy.


                                               - 16 -
         Indeed, throughout Part B of Title IV of the HEA, which are the provisions governing
FFEL, the term "individual" is universally used to mean "human being." See 20 U.S.C. §§
1077 (a )(2)( C)(i)(II) ("individuals with disabilities"), I 078(b)( I )(M)(i)(II) ("disabled
individuals"), 1078-3(a)(3)(B)(i) ("individual's status as an eligible borrower"; "an individual
who receives eligible student loans"; "an individual may obtain a subsequent consolidation
loan"), I 078-3( c)(2)(A) ("amount outstanding on other student loans to the individual"), 1078-
10(a) ("It is the purpose of this section to encourage individuals to enter and continue in the
teaching profession."), 1078-10(g)(3) ("An individual who is employed as a teacher in a private
school"), 1078-1 I (a)(J) ("to bring more highly trained individuals into the early child care
profession"), 1078-11 (b )(2) ("an individual who has a degree in early childhood education"),
1078-11(f) ("Each eligible individual desiring loan repayment"; "An eligible individual may
apply for loan repayment"), 1078-II(g)(3) ("determine the number of individuals who were
encouraged by the demonstration program assisted under this section to pursue early childhood
education"; "determine the number of individuals who remain employed"; "identify the number
of individuals participating in the program who received an associate's degree and the number of
such individuals who received a bachelor's degree"; "identify the number of years each
individual participates in the program"), 1082(p) ("eligibility of any entity or individual";
"financial interest which such individual may hold in any other entity participating in any
program"), and 1085(m)(2)(B) ("A loan on which a payment is made by the school, such
school's owner, agent, contractor, employee, or any other entity or individual affiliated with such
school").

         Even more, to conclude that "individual" encompasses legal entities in the same manner
as the ten11 "person" would render superfluous the term "educational institution" within the
statutory prohibition. If "individual" is broad enough to include a catch-all category oflegal
entities, then the Congress would not have also included "educational institutions" as a covered
class ofrecipients. The inclusion of "educational institutions" would be unnecessary and,
therefore, rendered "superfluous, void, and insignificant," a statutory construction that the courts
disfavor. Alaska Dep 't of Environment Conservation v. EPA, 540 U.S. 461,489 n.13 (2004)
(holding that courts disfavor rendering statutory provisions superfluous).

         The proper reading of section 435(d)(5)(A) of the HEA, which is compelled by the plain
language of that provision, is that the inducement prohibition only covers payments made to
educational institutions or human beings. See MCl Telecommunications Corp. v. AT&T, 512
U.S. 218, 229 (1994) ("[Aln agency's interpretation ofa statute is not entitled to deference when
it goes beyond the meaning that the statute can bear."). The Selling Lenders are neither. 6

6 The legislative history of the inducement prohibition is consistent with reading the plain
language of the HEA to only cover payments made to educational institutions and human beings.
The Senate Report of the Committee on Education and Labor states that "[tlhe Committee bill
clarifies that no lenders can offer inducements to institutions or individuals to take out loans or to
provide services unrelated to loans, such as insurance policies." S. Rep. No. 99-296, at 30
(1986). In that context, "individuals" must mean "human beings" because only human beings
can take out FFEL loans and the HEA's prohibition regarding the offering of insurance policies
only relates to a "prospective borrower." The House Committee Report notes that the enactment
of the anti-inducement provision reflected a concern over commissioned salespeople catering
directly to students or parents. See H.R. Rep. No. 99-383, at 37 (1985). Clearly, then, the
concern of Congress was that lenders could influence the decisions of student and parent
                                                - 17 -
       2.      The OIG's finding cannot rely upon the HEA's general authority to
               promulgate regulatious governing :FFEL to justify expanding the HEA's
               scope of recipients heyond "any educational institution or individual"

        The Department cannot avoid the HEA's clear and unambiguous language limiting the
scope of indueemcnt recipients to "any educational institution or individual" by relying upon
regulations that were issued pursuant to the HEA's general grant of authority to promulgate
regulations governing FFEL. Evcn where a statute grants an agency general authority to
promulgate regulations, agency actions that rely for their justification upon regulations that go
beyond the literal words of a clear and unambiguous statute are improper and will be struck as
invalid. The Department, then, is prohibited from taking agency action in reliance upon a
regulation that is not consistent with the HEA notwithstanding the HEA 's general grant of
rulemaking authority.

        When a statute contains a general grant of authority and a specific grant of authority,
courts look to the specific grant of authority to discern the limit of the agency's powers. See
Varity Corp. v. Howe, 516 U.S. 489, 511 (1996) (stating that "the specific governs over the
general"); see also Radzanower v. Touche Ross & Co., 426 U.S. 148, 153 (1976) ("[A] statute
dealing with a narrow, precise and specific subject is not submerged by a later enacted statute
covering a more generalized spectrum."); Morton v. Mancari, 417 U.S. 535, 550-51 (1974) ("[A]
specific statute will not be controlled or nullified by a general one."). In Cohn v. Federal Bureau
ofPrisons, 302 F. Supp.2d 267 (S.D.N.Y. 2004), the court held that a specific provision
governing the maximum time to be spent at an early release program took precedence over a
more general grant of authority to the Federal Bureau of Prisons to administer such a program,
and, therefore, bound the agency to adhere to the more specific provision.

        The language of the Department's anti-inducement regulation is the same as the language
of the HEA's anti-inducement provision except that it uses different terms to describe the scope
of covered recipients. Whereas the HEA uses the terms "educational institution" and
"individual," the regulation uses the terms "school" and "other party." Compare HEA §
435(d)(5)(A), 20 U.S.C. § 1085(d)(5)(A), with 34 CFR § 682.200(b) (definition of "Lender").
On its face, the term "other party" is all-encompassing and, therefore, makes the regulation much
more restrictive than the HEA, just as the regulation in Sandler was more restrictive than the
HEA.'



borrowers by paying off schools and financial aid administrators, if not the student and parent
borrowers themselves. Nowhere in the legislative history is there even a suggestion that the
Congress intended the inducement prohibition to cover payments offered to a type of entity other
than educational institutions and human beings.
, In the Sandler case, which rejected the Department's reliance upon a regulation as inconsistent
with the plain language of the HEA, the court noted the HEA's general grant of rule making
authority relating to FFEL. See Sandler, 2001 WL 884552, at *1 (quoting HEA § 432(a)(I), 20
U.S.c. § 1082(a)(I». Thus, the court implicitly rejected the proposition that the I-lEA's general
grant of authority to promulgate FFEL regulations permitted the Department to invoke a
regulation to deny borrower henefits under circumstances in which such benefits were authorized
by the plain language of the HEA. Id. at * 1-2.
                                               - 18 -
        Therefore, to the extent the OlG's finding rests upon the Selling Lenders falling into the
category of "other party" within the anti-inducement regulation, the finding is improper,
Section 435(d)(5)(A) of the HEA specifically addresses the issue of inducements, including the
scope of covered recipients, The term "other party" in the Department's regulation, then, cannot
be invoked by the OlG to find the payments made by SLX to the Selling Lenders to be payments
made to a prohibited recipient -- section 435(d)(5)(A) ofthc HEA would not prohibit those
payments. Despite the HEA's general grant of authority to issue regulations under FFEL, see
HEA § 432(a)(J), 20 U.S.c. § 1082(a)(l) (authorizing the Secretary to "prescribe such
regulations as may be necessary to carry out the purposes of [FFEL]"), the Department is legally
precluded from taking administrative enforcement action under the HEA's anti-inducement
provision to the extent the action is taken in connection with payments made to a recipient other
than an educational institution or individual, i.e., the statutory language. Again, the Selling
Lenders are neither.

                                                ***
        The payments made by SLX to the Selling Lenders were permissible, and the orG lacks a
sufficient legal and policy basis to make a finding of non-compliance.

                              Comments on the Recommendations

A.     Recommendation 1.1 Is Moot

        Recommendation 1.1 merely seeks to have the Department perform internal paperwork
(1) ierminating the agreement with the Department signed by Fifth Third on behalf of the Selling
Lenders, and (2) deactivating the lender identifieation numbers that were obtained to enable the
Selling Lenders to originate loans pursuant to their EL T agreements with Fifth Third. The Draft
Audit Report notes that Fifth Third informed the orG in February 2008 that Fifth Third had
already terminated two of its ELT agreements with the Selling Lenders and had so informed the
Department and the applicable guaranty agencies that they should terminate the necessary
agreements and deactivate the LIDs. See Draft Audit Report, at 7. Fifth Third has now
terminated the remaining ELT agreement at issue. Thus, Recommendation 1.1 is moot.

B.     Fifth Third Disagrees with Recommendation 1.2 Because it is Disproportionate to
       the Alleged Offenses and Adverse to the Best Interests of Both Market Participants
       and Borrowers

       1.      The termination of federal loan guarantees and the demand for
               repayment of over $350 million have the potential to cause extreme
               disruption to the credit markets

        Just as the credit markets are attempting to recover from significant, widespread
disruptions triggered initially by subprime mortgages, the OIG's recommendation would inject a
major new source of risk and uncertainty for current and potential investors in securities backed
by FFEL loans, as well as for student and parent borrowers. The marketplace would likely
perceive the OlG's recommendation to terminate the federal guarantee covering over $3 billion
of outstanding FFEL loans as a significant threat to the viability of the guarantee on those stndent
loans and, thus, an indication that those loans do not have as much value as investors believed.
                                               - 19 -
During a period when the crcdit markets are highly disrupted, the OIG would effectively be
preventing SLX from using over $3 billion of stndent loans to obtain financing that it could then
redeploy in other financing activities. The OIG, thus, risks undoing the Department's recent
work to create liquidity in the marketplace.

         The marketplace would also likely interpret the OIG recommendation to terminate the
federal guarantee -- and the proposal to disregard the form of the transactions among Fifth Third,
thc Sclling Lcnders, and SLX -- as a potential threat to the entire multi-billion dollar student loan
securitization market. If invcstors perceive that the guarantee on FFEL loans will be invalidated
for allcged errors by an ELT in the origination and marketing process, the uncertainty of the
value of such asscts could causc a major disruption in the credit markcts involving billions of
dollars in stndent loans. See Windsor Univ. v. Secretary of Health, Education, and Welfare, 550
F.2d 1203, 1204-05 (9 th Cir. 1977) ("The success of [FFEL] is dependent upon private lenders'
eonfidcncc in the guarantees that the federal government provides when it insures their loans to
needy stndents."). Invalidating a loan guarantee after the FFEL loan has been transferred to a
trust estate in which bondholders or noteholders have invested has typically been the result of
servicing errors and other acts or omissions that could cause the loan to be deemed invalid or
unenforceable. A prohibited inducement payment by a lender justifies a demand from the
Department that the offending conduct immediately cease or else risk a loss of eligibility. It does
not justify hanning innocent investors who purchased securities backed by FFEL loans or
hanning students who may no longer bc able to quickly access a FFEL loan.

        The asset backed securitics market for FFEL loans, which Fifth Third estimates at $65
billion in 2006, declined to less than $50 billion in 2007 due to disruption in the overall credit
market following the onset of the subprime mortgage crisis. The market disruption has adversely
impacted the sales prices for FFEL loans and securities backed by FFEL loans. The market for
securities backed by such loans appears to have stabilized recently, but it has not returned to
2006 levels. If the OIG's recommendations exacerbate the existing market disruptions, the
ability of investors to sell FFEL loans or securities backed by FFEL loans, and the value of those
loans and securities, will be significantly diminished. No investor will know for sure whether its
securities are backed by student loans that were originated pursuant to the same type of
transaction challenged by the Draft Andit Report.

        Furthermore, investor uncertainty as to whether the OIG's reasoning could be extended to
cover other aets or omissions will undennine the market for securities backed by student loans
and may cause the market in student loan bonds and notes to rapidly decline. This will
irreparably hann not only large financial institntions that originate FFEL loans, but also the
nonprofit stndent loan issuers. If FFEL loans cannot be securitized, which cannot easily be done
without a federal guarantee on the loans, then these nonprofit issuers will no longer be viablc and
there will be insufficicnt funds available to students, who will suffer the most harm.

        Similarly, OIG's recommendation that Fifth Third reimburse the Department for amounts
paid for default claims, interest, and special allowances -- which would be well over $350
million -- will be a jolt to the student lending community that is already hindered by severe
liquidity deficiencies. Demanding reimbursement at this level of magnitnde is disproportionate
to the alleged offenses and will be highly disruptive to the markets. The Draft Audit Report's
recommendation to require Fifth Third to repay these funds will serve primarily as a penalty
against students and innocent investors, not as a remedy for the alleged inducements.
                                               - 20-
       2.      The Regulations Set Forth Procedures for the Department to Address
               Alleged Non-Compliance with the Prohihition Against Inducements

               a.     Lender compliance with the prohibition against inducements is a
                      condition for maintaining status as an "eligible lender" under FFEL
                      and is most appropriately addressed through the regulatory
                      provisions governing limitation, suspension, and terminatiou
                      proceedings

        A lender's failure to comply with thc HEA's prohibition against inducements threatens its
status as an "eligible lender" under FFEL and, therefore, its eligibility to continue to make
federally guaranteed student loans. The statutory provision that conditions a lender's eligibility
on its compliance with the indncement prohibition also affords the lender prior notice and an
opportunity for a hearing before the Department can remove the lender from the program. See
HEA § 435(d)(5)(A); 20 U.S.C. § 1085(d)(5)(A). Thus, the logical framework for adjudicating
an alleged inducement is the notice and hearing procedures contained within the limitation,
suspension, and termination provisions of 34 CFR part 682, subpart G. See 34 CFR §§ 682.700
et seq. Those provisions provide the most appropriate means for the Department to afford a
lender the HEA's required procedural protections in connection with a proceeding to limit,
suspend, or terminate a lender's eligibility ("L, S, and T proceedings"). In fact, although L, S,
and T proceedings do not typically apply to lender eligibility determinations, there is an
exception for determinations of whether a lender is ineligible on account of making a prohibited
inducement payment. See 34 CFR § 682.700(b)(1)(i) ("This subpart does not apply -- (l)(i) To a
determination that an organization fails to meet the dcfinition of 'eligible lender' in section
435(d)(l) of the [HEA] or the definition of 'lender' in § 682.200, for any reason other than a
violation of the prohibitions in section 435(d)(5) of the [HEA).") (Emphasis added).

        Pursuant to the provisions relating to L, S, and T proceedings, the Department has thc
discretion to commence (as the name suggests) different types of proceedings, or, as discussed
below, no formal proceedings at all. For example, the Department may begin a limitation
proceeding to condition the lender's continued participation to FFEL on compliance with special
requirements set forth within an agreement with the Department. See 34 CFR § 682.701. This is
the course of action the Department took against Sallie Mae in The Scholl College Case. A
suspension proceeding, on the other hand, would seek to remove the lender's eligibility for a
specified period of time or until the lender fulfills certain requirements. Id. And a termination
proceeding would seek to remove the lender's eligibility indefinitely. Id. The Department also
has the option to use informal compliance procedures, which require no formal proceedings at
all.




                                              - 21 -
               The Department should not seek a termination of the guarantee
          on the loans at issue nor, under these circumstances, a repayment offunds

       The Draft Audit Report recommends that the Department terminate the guarantee on the
over $3 billion of outstanding loans originated by the Selling Lenders and additionally recover
from Fifth Third claim payments, interest, and special allowances associated with those loans.
With one exception, the L, S, and T proceedings described above cannot result in those remedies
because those proceedings cannot "affect a lender's responsibilities or rights to benefits and
claim payments that are based on the lender's prior participation in [FFEL]." 34 CFR §
682.702(a). The exception to the rule does not permit the termination ofloan guarantees at all
and would not permit a repayment of funds under the cireumstances of this case.

        The exception to the rule permits the Department, as part of a limitation or termination
proceeding, to require the lender to take corrective action in the form of a payment to the
Department of any funds, and any interest thereon, that the lender impropcrly received. See 34
CFR § 682. 709(b). Such a payment must, however, be "reasonable" and be imposed in order to
"remedy a violation" of the REA and its regulations. See 34 CFR § 682.709(a). Thus, the
Department should not terminate the guarantee of the loans in question, and the repayment of
funds, in this case, would not be authorized because it would be neither reasonable nor remedial.
Fifth Third estimates that over $350 million in claim payments, interest, and special allowances
on the loans have been received, which is hardly a "reasonable" amount to repay the Department.
Additionally, repayment of that amount of funds by Fifth Third would not "remedy" its alleged
violation of the REA's anti-inducement provision. The true remedy for such a transgression
would be an immediate cessation of the prohibited conduct, which is the remedy the Department
traditionally seeks for non-complianee with the inducement prohibition. Under these
circumstances, repayment would be punitive, not remedial.

                    The Department may use informal compliance procedures
           in lieu of commencing a limitation, suspension, or termination proceeding

        Importantly, the same provisions governing L, S, and T proceedings that the Department
uscs to address alleged prohibited inducements also expressly anthorize the Department to nse
informal compliance procedures in lieu of commencing a limitation, suspension, or termination
proceeding. See 34 CFR § 682.703(a). Informal compliance procedures would be especially
appropriate where, as here, the lender can "[s]how that the alleged violation has been corrected"
or can at least "submit an acceptable plan for correcting the allcged violation and preventing its
recurrence." 34 CFR § 682.703(b)(2).

        Under the informal compliance procedures, the Department provides the lender a
"reasonable opportunity" to respond to the allegations and to make its showing of the corrective
measures it has taken or its submission of a corrective action plan. 34 CFR § 682. 703(b)(1).
There is no reason to terminate the guarantee on the loans at issue, or to require the lender to
reimburse the Department for over $350 million in claim payments, interest, and special
allowances. As described more fully below, the Department has, in the recent past, successfully
employed informal compliance procedures to address non-compliance with the prohibition
against inducements. Yet the Draft Audit Report does not mention that this is even an option for
the Department, let alone the most appropriate option here and the most used option by the


                                               - 22 -
Department in the recent past. The OIG's recommendations should be revised to recommend
informal compliance procedures.

                 The Department may additionally commence a fine proceeding

         In addition to the informal compliance procedures described above, the Department may,
in its discretion, also impose a civil penalty (a fine) against a lender for failing to comply with a
provision of the HEA. See HEA § 432(g)(I); 20 U .S.C. § I 082(g)(l). Such a fine proceeding
would also require adherence to provisions containing procedures for prior notice and an
opportunity for a hearing. See id. Following the procedures prescribed in 34 CFR part 668,
subpart G applicable to fine proceedings against schools, as the Department must do for fine
proceedings against lcnders, see 34 CFR § 682.413( d)(l), the Department may impose a fine of
up to $27,500 per violation. See 34 CFR § 668.84(a).

        The HEA, however, provides several broad limitations upon the Department's authority
to impose a fine. The Department must first find that the violation is "material." HEA §
432(g)(2)(A); 20 U.S.C. § I082(g)(2)(A). Second, the Department must find that the lender
"knew or should have known that its actions violated or failed to carry out the [FFEL provisions
of the HEAl or the regulations thereunder." HEA § 432(g)(2)(B); 20 U.S.C. § 1082(g)(2)(B).
Third, the Department cannot impose a fine if, prior to the notification by the Department of the
fine proceeding, the lender "cures or corrects the violation." HEA § 432(g)(3); 20 U.S.C. §
1082(g)(3). And fourth, violations arising from a specific practice of a lender, and occurring
prior to notification by the Department, shall be deemed to be a single violation, even if the
violation affects more than one loan or more than one borrower, or both. See HEA § 432(g)(4);
20 U.S.C. § 1082(g)(4). The Draft Audit Report did not, however, mention that this is even an
option for the Department, let alone analyze the applicability of a fine proceeding.

               b.      The authorities cited within the Draft Audit Report do not provide the
                       Department an adequate legal basis to take the action recommended
                       by the OIG

        In support of its legal basis for the recommendations, thc Draft Audit Report cites to
regulations that the Department does not use to address non-compliance with the inducement
prohibition. See Draft Audit Report, at 7 (citing 34 CFR §§ 682.406(a)(l2) and 682.413(a)( 1)).
As discussed above, the statutory inducement prohibition requires prior notice and an
opportunity for a hearing before a lender loses its eligibility to participate in FFEL. The
Department's regulations governing the limitation, suspension, or termination of eligible lenders
provide such procedural protections. See 34 CFR §§ 682.700 et seq. Not only should the L, S,
ant T regulations be used to adjudicate alleged inducement payments, they must be used because
the Department expressly states that they are the regulations that apply to determinations of
whether a lender has failed to comply with the prohibition against inducements. See 34 CFR
§682.700(b)(l)(i). Thus, the Department's regulations governing L, S, and T proceedings -- and
not the regulations cited by the OlG -- are the appropriate regulations for the Department to use. 8

8To be sure, the regulations cited by the OIG are not snperfluous or unnecessary. They are
important provisions that, to some extent, tie the FFEL program together by setting some
important conditions for the payment ofreinsuranee. But those generally applicable regulations
must yield to the specific regulatory provisions that are used to determine whether a lender has
                                                - 23 -
       The OIG's citation of section 682.406(a)(l2) is even less persuasive to support a
recommendation that the Department must terminate the guarantee on the over $3 billion of
outstanding loans when it is read together with paragraph (b) of that section. Paragraph (b)
provides that the Department may choose to waive its right to deny a reinsurance payment to a
guaranty agency if it is in the best interests of the United States to do so:

               (b) Notwithstanding paragraph (a) of this section [providing that a
       guaranty agency may make a claim payment and receive a reinsurance payment
       on a loan only if certain requirements are met], the Secretary may waive his right
       to refuse to make or require repayment of a reinsurance payment if, in the
       Secretary's judgment, the best interests of the United States so require.

34 CFR § 682.406(b) (emphasis added). As discussed more fully above, the best interests of the
United States at this moment in time quite obviously tip the scales in favor of the Department
waiving any right it may have to refuse to make or require repayment of a reinsurance payment.
Any refusal by the Department to make reinsurance payments to the applicable guaranty
agencies on the over $3 billion of outstanding loans would necessarily cause those guaranty
agencies to refuse to honor the guarantee on those loans. The resulting significant devaluation of
securities backed by these student loans and the subsequent further inability of lenders to
successfully securitize student loans going forward would likely create disruption in the financial
markets and lead to an even greater decrease in the number of lenders willing to make FFEL
loans. 9

       3.      The Department has not terminated loan guarantees or required repayment
               of funds for non-compliance with the inducement prohibition

         Since at least 1994, with one notable exception, it has been the Department's policy to
use informal compliance procedures to resolve allegations of improper inducements IO As a
result, the Department has never terminated the guarantee on loans alleged to have been
originated in connection with an inducement payment, and the Department has never required
lenders to reimburse the Department for claim payments, interest, and special allowances. Even
when the OIG, in 2003, purported to uncover a prohibited inducement payment made by Sallie

transgressed the prohibition against inducements, which include the types of remedies the
Department may seek to recover from the offending lender. See Long Island Care at Home, Ltd.
v. Coke, 127 S. Ct. 2339, 2348 (2007) (in statutory and regulatory interpretation, "the specific
governs the general").
9 The Department very recently issued a Final Rule that, effective July 1, 2008, amends section
682.406 of the FFEL regulations to expressly require the termination of the loan guarantee
following a finding of an inducement. See 72 Fed. Reg. 61960, 62006 (Nov. I, 2007) (new 34
CFR § 682.406(d)). Until this regulation becomes effective, the Department does not have a
regulation that expressly requires the termination of the federal guarantee upon a finding of a
prohibited inducement.
10 The one exception was the Department's unsuccessful attempt, beginning in 1995, to limit the
participation of Sallie Mae in FFEL. That enforcement proceeding resulted in a series of
administrative decisions and, ultimately, a rebuke of the Department from a federal district court
judge in The Scholl College Case.
                                              - 24 -
Mae to a school, the OIG did not recommend that the Department terminate the guarantee on
affected loans or seek reimbursement from the lender.

               a.      The Department uses informal compliance procedures whenever
                       possible to address non-compliance with the prohibition against
                       inducements and, therefore, does not terminate loan guarantees or
                       require repayment of funds

        It is the longstanding policy of the Department to use informal compliance procedures to
address non-compliance with the prohibition against inducements, In February 1994, Region IV
of the Department asked the Department's headquarters, in connection with an inquiry regarding
an alleged inducement payment discovered during a program review, whether it is the policy of
the Department to terminate the guarantee on affected loans, See Department Q&A Document
(Feb, 4, 1994) (Exhibit 1, attached hereto), In the scenario presented by Region IV, a secondary
market lender paid for loan referrals, A response from Robert Evans, Director, Division of
Policy Development, infonned Region IV that the lender's conduct failed to comply with the
prohibition against inducements but that the Department should use informal compliance
procedures to address the transgression and should not refuse to make reinsurance payments on
the loans:

       We do not believe that this violation warrants a voiding of reinsurance or
       restriction of interest and special allowance on loans previously disbursed under
       the referral program, Instead, the lender should be cited and instructed to
       restructure its referral program by a specified deadline if it wishes to continue it.
       The Department should require submission of some evidence (letter of assurance
       from the Chief Executive Officer or revised policies and procedures) that supports
       the fact that they have discontinued or revised the program, The lender should be
       told that its failure to comply will result in its ineligibility as a lender in the FFEL
       program,

Department Q&A Document (Feb, 4,1994) (emphasis added),

        More recently, the Department has continued to use informal compliance procedures to
resolve alleged inducements, As reported last year by the GAO, "When Education does respond
to instances of non-compliance, the department has commonly sent letters to offending parties
noting the prohibited activity and requesting they cease the activity, but has not imposed
sanctions," GAO-07-750, at 37 (July 2007), In its report, the GAO listed the Department's most
recent inducement-related activities, all of which were consistent with the Department's use of
informal compliance procedures:

         •     For two lenders that were found offering rebates to loan applicants,
               Education sent letters asking them to cease the activity and to return
               pending applications to applicants,

         •     For one school that was denying its students the ability to take loans from
               a particular lender, Education sent a letter requesting that the school cease
               the activity,

                                                - 25 -
         •     Education plans to send a letter to lenders offering gift cards or music
               players to borrowers who complete loans with them.

Id.

        In its response to the GAO report, the Department stated that it leaves open the option to
impose fines and to initiate L, S, and T proceedings for alleged inducements, but that, with
respect to the school cited in October 2006 for an alleged inducement, the Department had
successfully used informal compliance procedures to address and remedy the situation:

       As part of our current review procedures, schools, lenders, and guaranty agencies
       are required to submit evidence that any non-compliance was corrected or to
       establish a corrective action plan, which we then verifY. For example, the school
       cited for non-compliance in the October 2006 targeted review submitted a
       corrective action plan to the Department. We then verified the corrective action
       by reviewing the school's revisions to its Web site clarifYing "borrower choice."

Id. at 46-47 (emphasis added).

         Earlier this year, the Department again used informal compliance procedures to address
non-compliance with the prohibition against inducements. See Letter from P. Trubia to Deutsche
Bank and Academic Loan Group, LLC (Jan. 18,2008) ("ALG Letter") (attached hereto as
Exhibit 2). In its January 18, 2008 letter to a lender and its ELT, the Department purported to
clarify the entities' obligations to comply with the anti-inducement provisions that had been
addressed in an earlier letter, which the Department attached. In both letters, the Department
addressed the situation by ordering the offending lender to immediately terminate its wrongful
conduct:

       I want to clarifY that in order to comply with the anti-inducement provisions of20
       U.S.C. § 1085(d)(5)(A), these rebates [to FFEL borrowers following a payment
       made by them to repay their Federal Consolidation Loans] cannot be paid directly
       to the borrower in the form of a cheek or cash.

       ALG must immediately cease and desist from providing rebates in the form of
       checks or cash to its borrowers.

ALG Letter, at I (emphasis added). I I

       Therefore, the Department has an established practice of using informal compliance
procedures whenever possible and has not terminated the loan guarantee or required repayment

II In an even more recent example, the Department used informal compliance procedures in
ordering an EL T to cease and desist its actions that the Department alleged were in violation of
the HEA's related prohibition against unsolicited mailings. See HEA § 435(d)(5)(B); 20 U.S.C.
§ 1085(d)(5)(B). The Department threatened to commence L, S, and T proceedings only if the
offending conduct did not immediately cease, and the Department required the EL T to confirm
the corrective actions that the ELT has taken to address the matter. See Letter from P. Trubia to
uS Bancorp (Apr. 21, 2008) (attached hereto as Exhibit 3).
                                               - 26 -
of funds for non-compliance with the inducement prohihition. Like the other lenders with which
the Dcpartment previously worked to forge a corrective action plan, Fifth Third would work with
the Department to remedy the alleged inducement. In fact, Fifth Third has already tem1inated
the very ELT arrangements challenged in the Draft Audit Report.

               b.     The OIG did not recommend the termination ofloan guarantees or
                      the repayment of funds when it purported to have uncovered a
                      prohibited inducement in 2003

         In August 2003, the 010 issued an Alert Memorandum to the Assistant Secretary for the
Office of Postsecondary Education, in which the 010 reviewed the issue of prohibited
inducements. See Alert Memorandum from C. Lewis to S. Stroup (Aug. 1,2003) ("010 Alert
Memorandum") (attached hereto as Exhibit 4). In its memorandum, the 010 lamented the
Department's lack of formal guidance to the student lending community, the inadequacy of
providing informal guidance in letters and e-mails, and the paucity of administrative reviews and
enforcement actions. See id. at I. The 010 concluded that the Department should provide
fOll11al guidance clarifying the application of the HEA's anti-inducement provision to private
loans and detell11ine whether statutory changes should be proposed. See id. at 2.

        Notably, the 010 informed the Department that it had come to this conclusion following
the OIO's own review of the practices at two schools. See 010 Alert Memorandum, at 2. The
010 selected two schools for review based on an increase in loan volume for Sallie Mae and
purported to uncover that lenders, generally, provided benefits to schools in exchange for
favorable treatment by the schools that could lead to the referral of loan applications: "We found
evidence that one ofthese schools and Sallie Mae negotiated preferred lender status in exchange
for a specified dollar amount of private loans." Jd. (Emphasis added). Rather than
recommending the termination of the loan guarantees and the reimbursement of funds (or any
sanction at all), the 010 merely suggcsted that the Department consider making regulatory
changes or providing further gnidance. Id.




                                              - 27 -
FINDING NO.2 --        Fifth Third Bank's Policies and Procednres for Monitoring its
                       EL T Agreements Need To Be Improved

                                   Comments on the Finding

                                    Compliance with the HEA

       The Draft Audit Report's finding, to the extent it is premised upon alleged non-
compliance with the HEA, is not legally sound. The oro takes the HEA's requirement that
EL Ts be responsible for complying with all statutory and regulatory requirements imposed on
any FFEL holder, see HEA § 436(b), 20 U.S.C. § 1086(b), and finds that it was violated because
Fifth Third allegedly did not "maintain records that are necessary to document the validity of
claims and the accuracy of reports [submitted to the Department and guaranty agencies]." 34
CFR § 682.414(a)(4)(ii)(L).

         The OIO contends that Fifth Third "did not have written policies and procedures ... for
the evaluation of entities for potential ELT agreements and the monitoring of existing ELT
agreements ... , including policies and procedures to ensure that the agreements do not include or
result in payment of prohibited incentives .... " Draft Audit Report, at 8. The 010 makes that
finding in belief that having such written policies and procedures would necessarily satisfy the
regulatory requirement that Fifth Third "maintain records that are necessary to document the
validity of claims and the accuracy of reports [submitted to the Department and guaranty
agencies]."

        However, written policies and procedures for (I) the evaluation of entities for potential
EL T agreements and (2) the monitoring of existing ELT agreements do not relate to the
requirement that lenders document the validity of claims and the accuracy of reports. Such
documentation tasks would likely be performed by the EL T's lender partner. To be sure, the
ELT would be responsible for the lender partner's compliance with those documentation
requirements. But an ELT cannot be cited for failing to maintain records that are necessary to
document the validity of claims and the accuracy of reports on the basis of not having written
policies and procedures for the evaluation of potential lender partners and for the monitoring of
those lenders. The OlO's finding does not link the two concepts, and it cites no legal authority to
support its linkage.

      Fifth Third, therefore, disagrees with the finding to the extent it is premised upon alleged
non-compliance with the HEA. The OIO has no valid legal basis.

         Compliance with Standards of the Office of the Comptroller of the Currency

         The Draft Audit Report's finding is additionally based on the OIO's application of the
Safety and Soundness Standards set forth by the Office of the Comptroller ofthe Currency at the
U.S. Department of the Treasury, as well as the Comptroller's Handbook on Internal Controls
published by the Comptroller of the Currency Administrator of National Banks. See Draft Audit
Report, at 8-9. To begin, the oro does not appear to have statutory authority to make findings
that allege transgressions of Treasury Department standards or handbooks. Under the HEA, the
oro only has legal authority to conduct audits of lenders to assess compliance with federal

                                              - 28 -
statutes and with rules and regulations of the U.S. Department of Education, not with those of
other federal departments and agencies:

                 (4) AUDIT PROCEDURES. -- In conducting audits pursuant to this
        subsection, ... the Inspector General of the Department of Education shall audit
        thc records to determine the extent to which they, at a minimum, comply with
        Federal statutes, and rules and regulations prescribed by the Secretary, in effect
        at the time that the record was made ....

REA § 432(£)(4); 20 U.S.C. § 1082(£)(4) (emphasis added). The oro, therefore, lacks legal
authority to make a finding on the basis of Treasury Department standards and handbooks.

        Assuming arguendo that the OIO possesses the requisite legal authority to make a finding
under Treasury Department standards and handbooks, its finding is hyper-technical at best, and,
at worst, legally unsupportable. The OIG discerns a few important, though subjectively worded,
requirements from those Treasury Department banking authorities and concludes that, despite
Fifth Third's explanation for its compliance with those authorities, Fifth Third has nonetheless
fallen short of the Treasury Department's expectations. See Draft Audit Report, at 9-10.

        With respect to the finding that Fifth Third lacked adequate written policies and
procedures for the evaluation of entities for potential ELT agreements, the Treasury Department
standards that are most relevant are "[e]ffective risk assessment" and "[a]dequate procedures to
safeguard and manage assets." Draft Audit Report, at 9. OIG concedes that Fifth Third's Vicc
President for the Asset Securitization Department advised that hc evaluates potential ELT lender
partners and the proposed arrangements prior to entering into an ELT agreement. See id. at 9-10.
The oro notes that Fifth Third's Vice President listed six elements that Fifth Third uses to
determine whether it will enter into an ELT agreement with a lender:

       •       Industry experience and management;

       •       Student loan origination and servicing arrangements;

       •       Funding commitments;

       •       Student loan sale and purchase commitments;

       •       Student loan processes and systems; and

       •       Financial strength.

Jd. at 9. Furthermore, Fifth Third's Vice President, or one of two other hank officials (if not a
manager from a hranch office), conducts a site visit to interview the prospective lender partner to
assess its expertise in the student loan industry and its business practices, to review the financial
statements, and to discuss the lender's loan servicer and purchaser arrangements. Id.

        Despite these responsible measures, the OIG finds nothing about which to praise Fifth
Third in connection with its commendahle efforts to evaluate entities for potential EL T

                                                - 29 -
agreements. Instead, it finds something minor about whieh to criticize Fifth Third: "The Vice
President maintained some documents related to initial assessments ... but could not idcntifY the
documents related to each ELT agreement." Draft Audit Report, at 10. And from that relatively
insignificant shortfall, the OIG reaches the most serious of conclusions: "Without sufficient
written procedures and complete documentation of evaluations, there is a lack of assurance that
Fifth Third Bank is adequately evaluating entities and their relationships with third parties in a
thorough and consistent manner." Id. The OIG's finding should not be part of a Final Audit
Report because it is unsupported by the record.

        As for the OIG's finding that Fifth Third did not have written policies and procedures for
the monitoring of existing ELT agreements, including policies and procedures to ensure that the
agreements do not include or result in payment of prohibited incentives, Fifth Third had an even
greater list of actions it takes to ensure that its lender partners comply with applicable legal
requiremcnts. But, again, the OIG finds that Fifth Third's efforts fall short of Treasury
Department standards. In addition to the two Treasury standards dcscribed above, the remaining
three standards arc arguably applicable to Fifth Third's monitoring responsibility: (1) An
organizational structure that establishes clear lines of authority and responsibility for monitoring
adherence to established policies; (2) Timely and accurate financial, operational, and regulatory
reports; and (3) Compliance with applicable laws and regulations. See Draft Audit Report, at 9.

       Fifth Third's Vice President presented the OIG with a long list of actions it takes to
monitor its ELT agreements with lenders. As noted in the Draft Audit Report, he informed the
OIG that Fifth Third:

       •       Reviews monthly loan activity for entities with low loan volume;

       •       Reviews annual financial statements;

       •       Reviews the bill of sale for all secondary loan sales;

       •       Maintains continuous contact with relationship manager or other Fifth
               Third Bank managers that conduct due diligence for their services with the
               entity;

       •       Establishes ongoing business relationships with lenders and companies in
               the industry;

       •       Studies the publications for the industry;

       •       Reviews guaranty agency reports on loan servicers;

       •       Reviews annual marketing and origination process reviews for SLX
               agreements; and

       •       Attends student loan conferences.



                                               - 30 -
Draft Audit Report, at 10. In addition, Fifth Third reviews guaranty agency reports "to ensure
that the lenders and servicers are proccssing loans in accordance with Federal laws and
regulations." Jd.

        The OIG again gives Fifth Third no credit for having these important safeguards in place
to ensurc a high level of monitoring, even though each one of them furthers the Treasury
Department's standards. Instead, the OIG criticizes Fifth Third for perceived, minor shortfalls.
For example, the OIG notes that Fifth Third "did not have a process to ensure that it received all
pertinent reports from the guaranty agencies." Draft Audit Report, at 10 (emphasis added). The
OIG also notes that Fifth Third does not mention whether it reviews "the annual independent
public accountant audit reports that are required for lenders and loan servicers." Jd.

        Just as it did in connection with its finding relating to the evaluation of potential ELT
lender partners, the OIG reaches an overstated conclusion from the facts relating to Fifth Third's
monitoring activities:

       [T]here is a lack of assurance that Fifth Third Bank is performing sufficient
       monitoring of entities with which it as ELT agreements to ensure that the entities
       adhered to applicable requirements of the FFEL Program, including the
       prohibition on offering incentives to secure loan applications.

Jd. The ~IG's finding on this issue should also not be part of a Final Audit Report. Again, the
record simply does not support the finding.

                             Comments on the Recommendations

         The Draft Audit Report recommends that Fifth Third (1) create written procedures to
document how it performs thorough evaluations of potential EL T lender partners and how it
conducts monitoring of its current ELT relationships, and (2) centrally maintain records related
to its evaluation and monitoring activities. Additionally, the OIG recommends that the
Department cease taking actions that further any new ELT agreement involving Fifth Third until
Fifth Third has completed the other recommended actions.

        Each of these recommendations is unnecessary because Fifth Third already uses the
recommended procedures and already cenh'ally maintains its records. Fifth Third and the OIG
may dispute whether those procedures should be "written" and whether the records arc
adequately maintained, but the point is moot. Fifth Third has terminated the ELT agreements at
issue and the LIDs used to originate FFEL loans made pursuant to those agreements have been
deactivated. In addition, Fifth Third is transitioning out of the business of serving as an ELT and
does not intend to enter into any new EL T agreements with lenders. For those reasons, Fifth
Third disagrees with the recommendations.




                                               - 31 -
                                       OTHER MATTER

                                  Comments on Other Matter

         The Draft Audit Report contains a section entitled "Other Matter," in which the orG
notes that it found other transactions "that include the offering of an incentive." Draft Andit
Report, at 12. The OrG did not, however, include those transactions within its finding of non-
compliance because "the EL T agreements differed structurally from the EL T agreements that
Fifth Third Bank and SLX had with the [Selling Lenders]." ld. The only difference, structural
or otherwise, identified by the orG is that "Fifth Third Bank's ELT agreements with the other
entities did not name a third party, such as SLX, in the ELT agreement." Jd. Otherwise, the
arrangements were the same. ld.

        The OrG states that it chose not to inclnde these arrangements within its finding of non-
compliance for two reasons. First, "the arrangements are similar in some respects to an example
of a permissible practice described in DCL 89-L-129." ld. And second, "the arrangements are
similar in some respects ... to an arrangement that was the subject of a previous enforcement
proceeding nndertaken by the Department." ld. As a resnlt, the OIG determined that, rather than
include them within a finding of non-compliance, it would "refer these ELT agreements to the
Department for detennination of whether the arrangements violate the prohibition on incentives."
ld.

        Thus, the OrG reveals in the "Other Matter" section of the Draft Audit Report what it is
that the OrG believes to be the only problem with the transactions between SLX and the Selling
Lenders: SLX was a party to the ELT agreement between Fifth Third and each Selling Lender.
That onc fact is the only difference the OlG can identify between the payments in question and
the payments that are not in question. The OrG concedes that, without that one fact, the 1989
Dear Colleague Letter and the "previous enforcement proceeding undertaken by the
Department," i.e., the proceeding against Sallie Mae that led to The Scholl College Case, wonld
preclude any finding of non-compliance. As discussed above, Fifth Third's view is that, even
with that fact, there was no transgression of the HEA's anti-inducement provision.

        Fifth Third, therefore, respectfully requests that the orG not include this "Other Matter"
sectiou in any Final Audit Report.




                                               - 32 -
EXHIBIT 1
                                                                                                         Mar. 03 2007 03:02PM          P3/3
                                                           FAX NO.
FROM :
                                                                        (MON) 11.21' 05 13:19/ST.13:17/NO.486074S743 P 8
                 .   .
                                                       Question and A.n.swer
    )'



                                                                                                                    &hruao '" '9tH

                         ~i9-
                                                                                                 D~.
                                                                                                 ~~~                           ~
                         Q¥"~ &.Ttdi. io CI4 Opm.l'I"OI/NM~'"                                  @
                         Qr       (Su.to qll""tton IIlItiattath ba~41tofQ anl,y lrllec<l88q.)

                         Refanmce:          UllIA i'31l(dX~);:DeL 119·:':"'129; Ji'ebnlll!'y 1$IBS
                                            QIU ~ 12!aillll!l; QilA. Ma &I2I\lSi lI.I>d QIU 11977 9/13m
                         Tho 'lIenne ...... _..:ond""" lllilr'kn, VI>I"",tee>:' abltu Stu.d~Qt ~ ~ (WSJI(), pan
                         ].... dm In the Stilt. of '.i'erutellll« .. mark4t.!.q toe of 1~ ~6ri~ of \he prilIl:jfl\l. ~ of
                         - 7 Iolm o".;p..a.w..! by VWO 1I'hiclllf_l\uIdM ........ rauIt or t.IIIO lend.... te!'~. 1l'1\
                         tirat d.iabut'U",ehl is ".IIJU\ uul1"'Il1eatl,y IlIl!lC..uqd, VS'SJrC 8tilt 1'Jl18 the n:I('~
                         !.eQ<l.,.. It =.....ltati... l'cc> ilQ. tluIl: .tl.'bIlrsallJ<I'tlt, If the , ...."d o•• ubaoqu",,' dhd.mum.... '
                         ia ClU>.<nlled p-ri.<>r tD beill$ dltb~ "" 1I ..... apPllCllti<ln Is ,,_s~ buIlleve!' fil!>dec!. Q()
                         lIlMi::stmg fea is plllff. VSSFQ \IftYI' a Il$t $"76 rarem>l fet> fur &aah ""I'IBQUdatiOll loan.
                         Th.. $7/; ..quat.\.. to l~ F _ t of t'htdto U6H(l! c..,,,.olldAUQ,, IQan.

                         (c.nUb"oo.     <Ill. """.   ::0   .




     (




   PAGE 313' iiCVo"AT 312120082:01:38 PM [Central Stanaara Tlmel' SVR:CHl2KRF01122' DNIS:4791' CSID:' DURATION \mm·ss\:01·28
  FROM :                                                           FAX NO.                                    Mar. 03 2007 03:01PM        P2/3

   FROM                                ...'   ...   -."
                                                                                (FRI)!I. 25'05     10;40/ST.l0;39/NO.486074~7~3J              3
              ...,,,::...........f".
         /"
v/'/                  •




                                                                              ATTl'\CItM2N'E.
                                 A,           As, liltate4 in Q ~ A #,)77 I ~h ... 1:"e,f~r:t:d ,tee lI1U.,!; be bas<:ol:.!, 'on,




                                                                                                                                          l
                                  "act\~tll,    adl1lin';'stt'atav(> cost", ~.ncurr~d in proce"'''U\9 tb~                  ' .. ,
                                 appJ. .t.".. t:ions .,\,\4 in adv"rth,il)~ the "va;!.'iabiHtv 0:1::' :to"lisi tlh:'¢ugh
                                 the r$I:er)."ing le.nder" (,?IOx>I'il1sis add"",\},; 'l'hus, tb .. ' tee is" ti" ....d
                                 neith~r On numb~r ~t apPliQ~ti~ns processe~ nor on n~be1:" Of
                                 applidill'!:.ions <iis.trlbuteC1, but th.:. ove>:alJ. Clost as",ooiated. with
                                  both adllliniGtrat'fve funi:rtionll.' TIl" Peparfuent i>o).nnit$ 'the ,"'"
                                  lend";';;'- ·'involve.d' to deteminOll wh<i!t 'a 'reasonable t ....· wou1d' l1.¢ ~or
                                  these: ·activit;ies. HowQ.ver, I;II'\Y po'~ti6n of the 1'';'01. tllat; exdQed~
                                  the actual 00S1:5 a,ssooia,i;ed wil:;h pro'cessJ:ng l.oan app;t:i.caj:.io·l'iS·                     or
                                  a.;1.v ..rtiD ing cons!::i tut.. s " rroh.\.bited . in<ll,loen.ent. Aleo, Regio.n. LV




                                                                                                                                           J
                                  :lOll correct in 'its ul'ld..rstanding ·thlllt'.· the' fee mU$t. be pa;id 1:011 all
                                  l.oan ap~l.ieations ~rQ.;:..."sed, not just those that result in a                                              .
                                  di~bu~~e~~nt of ~ loan.  In Q~dGr to bring                              VSSFC baCK into
                                  co~pliance With the statute, they ~ust p~y                              a   re~~onab~e
                                  ~~rketin9/referral              f ..e for all lo~n applioations processed.

                                  We do not );Ielieve that t.h..is Viol. ...t·io\'l w"l:'rant .. a voiding of'
                                  reinsurance or rC>$triction oC interest an~ speciab allowance                                      on           -1f-
                                   loans previously             ~i.hursed     under    pro9ram. In~~ead,
                                                                                         th~·referral
                                  the llmder should be cite'" and in'iltru,ct,tlld to restl',uct.ure its
                                  referral program by ~ speci!1Qd d~adline i~ it, Wishe$" to continue
                                  it. ~he Department sh~Uld r$quire submission of ~ome evidence
                                   (letter ¢f assu)."ance from t.he Chiei: Executiv,," Oftl.cer or revised
                                  policies an" procedures) that support" the faot that they hav... -]-.
                                  ~iscontinued or' revised the pro9ram.      'The lender Shou.ld P<l told
                                  that its failu~e to co~~ly will result in its ineligibil~ty a~ a
                                  lend~r in the fFEL p r o g r a m . '                       .
                                                     , '

                                                                   Robert W.. EVans
                                                                   Di",e.otor, DivisiQn of Policy D.ev¢lopment
                                                                   and   ~e.rnh.)': r   n;tr~et. stu,Q.cnt J...vi).n '1'E.$:t\: ~O-rQ'B




PAGE 213' RCVD AT 31212008 2:01:38 PM [Central standard Timel' SVR:CHI2KRF01122' DNIS:4791' CSID:' DURATION (mm-ss):01·28
EXHIBIT 2
January 18, 2008



Mr. Robert F. Frier
Director
Deutsche Bank
25 DeForest Bank
Summit, NJ 07901

Mr. Paul Marble
President
Academic Loan Group, LLC
10935 Vista Sorrento Parkway
Suite 350
San Diego, CA 92130

Dear Mr. Frier and Mr. Marble:

This letter is to clarify guidance provided to your companies in the attached letter,
 dated March 15,2006, from Mr. Matteo Fontana ofthe Department's Federal
 Student Aid office. A copy of Mr. Fontana's letter is enclosed. In his letter, Mr.
 Fontana addressed Academic Loan Group's (ALG) practice of providing rebates to
 borrowers of Federal Family Education Program loans under certain circumstances.
Mr. Fontana noted that ALG had taken steps.to comply with anti-inducement
provisions of 20 U.S.C. §1085(d) (5) (A), by establishing a requirement thallo
receive a rebate, the borrower must make at least one payment. I want to clarify that
in order to comply with the anti-inducement provisions of 20 U.S.C. §1085(d) (5) (A),
these rebates cannot be paid directly to the borrower in the form of a check or cash.

ALG must immediately cease and desist from providing rebates in the form of checks
or cash to its borrowers.




           830 First Street. NE Union Center Plaza III • /' Floor i WaShington, DC 20202.5430
                                (202) 377-3173 Main: (202) 275-3486 Fax

                                     .'1WW. fede (;JIS!u(Jelltl-lid. i:O. gov
                                             l-eOO-4-FED-A:D


        ILf)lRi\1. SI1JIHCNf AID                      ·.iSL\IU HUH. tiO JURIHLR.
Page 2


If you have any questions or comments about the contents of this letter please
contact Ann Marie Fusco at (646) 428-3774.




Patricia Trubla
Acting Director
Financial Partner Eligibility & Oversight
Program Compliance
Federal Student Aid




           830 First Street, NE i Union Center Plaza HI - t' Floor i Washinglon, DC 20202-5430
                                  (2021377-3173 Main I (202) 275<l486 Fax

                                     wwv.· ,federalslutJen t <'Hd ,ed .gov
                                             1-800-4-FED-AIO



    fEDlRAL SltJIH.Nf AID':1STt\RI HFRF. GO I'lJRI'HtR.
Mr. Robert F. Frier                                                  March 15, 2006
Director, Deutsche Bank
25 DeForest Avenue
Summit, NJ 0790 J

Mr. Paul Marble
President, Academic Loan Group, LLC
10935 Vista Sorrento Parkway
Sulte350
San Diego, CA 92130


Dear Mr. Frier and Mr. Marble,

       The U.S. Depiu1:ntent of Education (Department) bas reviewed your February I
2oo61ettcr regarding your companies' practice of offering appUClIJlts for Federal
Consolidation LoIIDS a one percent rebate for taking out a consolidation loan under the
Family Education Loan Program (FFELP).

        Your letter was in response to my letter dated January 19,2006 to Deutsche Bank,
as eligible lender trustee for Academic Loan Group (ALa). My letter notified Deutsche
Bank that the Department had reviewed ALO's marketing material and practices and
determined that these practices violated the FFELP's prohibition on an eligible lender
offering inducements to secure loan applicants. ~ 20 U.S.C. §108S(d)(S)(A); 34 C.F.R.
§682.2(j()(b) ("Lender"}. In particular, my letter identified ALO's offer of a one percent
cash rebate to Deutsche Bank Consolidation Loan borrowers violated the anti.inducement
provision since the rebate was paid solely because the loan was made. My letter outlined
certain actions that had to be taken by Deutsche Bank to correct this violation.

        Your letter of February 1 constituted the response of Deutsche Bank and ALG to
my letter of January 19. Your letter acknowledged that from May to October 2005, your
companies had offered rebates to borrowers based solely onthe loan being disbursed.
However, you indicated that since November 2005, your companies had been requiring
borrowers to make a payment to receive the rebate.

        Based on the information in your letter, the Department bas determined that
during the period of May 2005 through October 200S, Deutsche Bank, by reason of this         •
practice, violated the prohibition on inducements in 20 U.S.C. §1085(d)(5)(A) and the
Department's regulations by providing a rebate without requiring any payments.

                          830 First SI. N.B., Washington. DC 20202
                             www,FederaIStudentAid.ed.gov
                                    I-S00-4-FED-AlD

   FEDERAL STUDENT AID ,,:»START HERE. GO FURTHER.
Page 2

However, becllll$e the situation has been corrected and the one loan payment requirement
has been reinstated since the beginning of November 2005, the Department has
determined that, with the exceptions listed below, no further action is required of
Deutsche Bank and ALG.

        In your February I" letter, Deutsche Bank and ALG agreed to take certain steps to
address the Department's concerns regarding the loans made in response to the improper
inducement. However, your letter asked the Department to consider certain changes to
the specific steps outlined in my January 19111 letter. r have addressed each of your
requests below:

Applicants who were not Informed of a prior nftYD!ent requirement applicable to the
rebate befgre applying for a loan from Deutsche Bank as eligible lender trustee for
ALG pnrsuant to the rebate offer.
         ALG may offer these individuals a borrower benefit that the Department views as
         pennissible under the statote or may inform them that the prior payment
         requirement must be met to receive the one percent rebate.

         instead of immediately returning the applications to the prospective borrowers in
         this categ0!7' ALGmay first send a letter as described in section (l.b.) of your
         February 1 letter informing the individual of their options and notifying the
         individual that the one percent rebate will only be provided after the borrower
         makes the first payment on the loan. The letter must be submitted to the
         Department for approval prior to being sent to the applicants.

         ALG must track all applicants in this category and maintain records of each
         applicant's written request to proceed with the loan or to withdraw the loan
         appliCation, and those individuals whose applicatioDS are cancelled after 30 days
         due to no response.

Applicants wbo were informed of a prior payment requirement for the rebate
before applying for a loan from ALG pursuant to tbe rebate offer.

            ALG may proceed with processing the applicatioDS for borrowers in this
            category.

Current status of outstanding loans.

            ALG and associated securitization trusts, through the Trustees, may file
            claims for interest benefits, special allowance, and claim payment on
            outstanding lOaDS m3de pursuant to the rebated offer, and may otherwise treat
            such lOaDS as fully guaranteed and reiusured for all pwposes.

No adverse administrative action again.t ALG or the Trustees.
Page)

        •   Asswning satisfactory completion of the steps described above, including
            validation by the Department's Financial Parmer Services office, the
            Department will not take any further adverse administrative action against
            ALG or the Trustee as long as no material misrepresentation of facts have·
            been made or discovered in the course of this matter.

     Please continuc.to use Michael Sutphin, on my staff, at 202-377,3624 as your contact
to addres:i your issues or questious.




Matteo Fontana
General Manager
Financial Partner Services
Federal Student Aid


00:     Theresa S. Shaw, Chief Operating Officer, Federal Student Aid
FedEx I Ship Manager I Label 792490984349                                                                                                                         Page I of!
  From: Orig~ Q): YXNA (202)377-1276                                 SNp O..e: 16JANOa
   Veronica Greene                                                   ArfIi~:lLB
   DeparlnenlctEducalion. FSA                                        Sy_: 4006200IINE17091
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                                                                     Acc:oonW: S UtttUU
                                                                      Delivery Add..... ear Code



  SHIPTO: 1202)377-1275                 BILL SENDER                      Rof#
   Mr. Paul Marble, President                                            !nvolce#
                                                                         po#
   Academic Loan Group, LlC                                              Oopt#
   10935 Vista Sorrento Parkway
   Suite 350
   San Diego, CA 92130
                                                                                                                   MON· 21JAN      A2
                                                                              7924 9098 4349                      PRIORITY OVERNIGHT

                                                                                                                                       SAN

                                                                      XH ..SANA                                                        CA-US
                                                                                                                                     ·92130




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 whether dlrGCt.lncldental, I;()nsequentklll. or special Is limited b the greater of$1oo or the authorized deClared value. Recovery cannot exceed actual dOCUffi!Jlted Ioos.
 Maximum for [terns of extraordinary value) Is $500, e.g. je'welry, precious metals. negotiable Instruments and other Items Usted In OLl' Service Guide. Written claims must
 be filed within strict Ume Itmits, 8e(J current FedEx Service Gui:ie.




https:l/www.fedex.com!ship/domesticShipmentAction.do?method....(!oContinue                                                                                          1/18/2008
EXHIBIT 3
    MAY, 1. 20083! 4:09PM4
"




                                                                                                aPR SHOOS

             Mr. Richard Ie Davis
             President mid CbiefExeoutive Officer
             US Bmcorp
             800 Nioollet Mall
             Minneapolis, MN 55402
                                                Re: LID 834240

             Dear Mr. Davis:
             The US Department (If Education (the Department) has rec~ved Infol1l!atioll wnomrlng
             the solicitation ot student bOl1'OW¢l'S for Federal Fal:Ilily Education Loan (FFEL) program
             consolidation loans by US Bank as EliSibl~ Lender Tl'\IIlteo (ELT) for Colhlgiate
             Solutioils,lender identification number (LID) 834240, ki. part of this solicitation, tIlJiI
             borrower is sent an application for a Federal Consolidation Lam without having
             requested one. The borrower is asked to supply the PIN number that ia used to identify
             the borrower in student financial aid related transaotions with the Department.
             Additionally, the borrower is asked to sign the prQlllillSory uote, but not to provide the
             signature date.

             US Bank is the BLT for Collegiate Solutions as authQIized pursuant to Title J:V of the
             Higher Education Aot of 1965. as 1llUeJlded, 20 U.S.C. §§ 1070 et seq. As the ELT. US
             Bank is the legal hold~t ofFFEL program 101lllll in which other entities hold a beneficial
             interest. US Bank is fully responslble to the Department under section 436(b) of the
             Hi&her Education Act and 34 CFR 6S2.203 (b) of the FFEL p~ogram regulations fw
             ensuring compliance with all statutory and regulatory requirements.

             Section 435{d)(5)(B) of the Higher Education Act of 1965, as amended, stales that the
             teml "eligible lender" does not include any lender that, after notice and an opportunity for
             a hearing, "conducted unsolicited mailings to $t\lClentll of student 10m application mons,
             except to students Who have prli!1liously received !oan~ Jitlm under this part from such
             lender... "            '


                          83D FlflllSlreet NE I Union CenlerPlallillll .7" Floor jWashlng!on, DC 20202-5430
                                                (202) !!77.3tn Mo" j (202) 275-g4ae Pox
                                                    WWW.f«I.....l1id.r>lald.IId.QOV
                                                          1-BOIl.4-FEo-Aib


                      Fl!DI!RAL SiUDENT AIt):5t&START HERE. GO FURTHER.
MAY, 1. 2008~ 4:09PM5                                                                      NO, 6607     r. p   f

         Pagc 2- Mr. Riol1ard K. Davis


         As part oHhis solicitation, at the top of page 2 oithe u:n.soliQited Federal Consolidation
         Loan application, the borrower is e!1g()uraged to provide his or her PIN data, as indioated
         in the :!'bllowing Wltt taIren directly from the application:

         "You can access your federal student loan records on-line, from the National Student
         LoanDllta System, at ~s.ed.g.tr, provided you have a PIN number that the U.S.
         Department ofEd\f.Cation assigned to you. Ifyou don't have Internet access, or you don't
         have a (sic) assigned PIN please follow the direotion~ below. Ifyou provide your pin
         above we will. electronically scan in all federal loan infunnation fur you. Please sign and
         return...."

         The FAFSA PIN munber is a 4-digit number thet is used in e»mbination with a
         oolIOwer'$ Social Security Number. name, and date of birth 10 identify them as someone
         who has the tight to access their own personal infonnation on Fedora! Student Aid Web
         sites.

         The security of the PIN is imjlO11a!lt be\lause it can be used to:

           •    ElectronicallY algn Federal Student Aid documents
           •    Access the student's tmSona:1 records, and
           •    Make binding legal obligations

         The Department has advi:sed students that: "Your PIN CIlJ1 be used each year to
         eleQt:\wical1y apply for federal student aid and to IiCOIlSS your Federal Student Aid
         records online. IfYQU reaeiveaPlN. you agree not to share it with anyone. YourPIN
         serves as your electronic sign.at1l1'e and provides access to your personal records, so you
         ahould never give your PIN to anyon~, incJuding commercial services that offer to help
         you QOIIlPlete l'l>ur FMSA. Be sure to keep your PIN in a safe place."

        Loans made under the FFEL PfOgram must have It valid promissory note. (See 34 en
        682.206(a).) The Department views a promis5\Jry note that the borrower does not sign
        and date as an invalid promissory note. When signing a promis5\Jry note, the borrower is
        certi:t)'ing, among other things, that he or she;s eligible for the loan On that date. An
        instructioll to the boll'owe!' to not provide a signatU:re dale may invalidate the note and
        render the loan \Illl'einsured.

        us Bank as ELl' for Collegiate SOIlltions must immediately cease and desist from the
        mailing ofunsolicited'FFEL loan applications, req~sting a borrower's PIN to access the
        bO!IQw~r's pelSonal records, and instrIIcting a. borrower to not provide II signature date on
        the application promissory noll:. Ifthe Department concludes that this pramice has not
        immediately ceased, the Department will apply sanctions to US Bank and may begin
        limilati"n, suspenSion, and/or tennll\l\tion IICtiOns.
· MAY. 1.2008 9 4:09PM's                                                                    NO. 6607 '-·P. 3'4
  ,   .
           PagIl3· Mr. Richard K. Davis


           Ple!lSe collflmt to 1ho undersigned the COlTCCliVl.l actions you have taken to addrew this
           matter. If you bav~ questions or require additionallniQtmation, ))Iea.se call AIm Maria
                                                                     soo@edtggy.




           Acting Direotor
           Flnsncial Partner Eligibility aIJd Oversight
           l'rogIlllIl Compliance
           Fedml Stndent Aid




                                               '.




                                                                                                        TITTAJ PtA"
EXHIBIT 4
                                                                                                                                 i
                                                                                                                                 I
                                 UNITED STATES DEPARTMENT OF EDUCATION

                                                    OFFICE OF INSPECTOR GENERAl-




    ALERT MEMORANDUM
                                                                                 AUG        1 2003
    TO:             Sally Stroup
                    Assistant Secretary
                    Office of Postsecondary Education

    FROM:           Cathy H. Lewi
                    Assistant Inspector O'e11eral
                    Evaluation, Inspection and Management Services

    SUBJECT:        Review of Lender Inducements (ED/OIG Il3C0003)

    This alert memorandum provides information from our review oflender inducements.
    The Office of Inspector General received an allegation that Sallie Mae was offering
    schools illegal inducements in return for Federal Family Education Loan Program
    (FFELP) loan volume. The allegation, from an anonymous source, did not include any
    specific information or evidence regarding illegal inducements.

    The governing anti-inducement legislation, found in Section 435(d)(5)(A) of the Higher
    Education Act of 1965, as amended (HEA), prohibits a lender from offering, directly or
    indirectly, points premiums, payments, or other inducements, to any educational
    institution or individual in order to secure applicants for FFELP loans. Since the
    enactment of the legislation in 1986, the FFELP market has changed significantly with
    increasing demands for benefits or services by schools, the rising cost of education, and
    escalating competition for FFELP loans.

    The Department's interpretive guidance to the community through Dear Colleague
    Letters has not been updated since 1995. Informal guidance provided in letters and
    e-mails has not resolved the concerns of the FFELP participants as to what constitutes an
    inducement. Formal administrative enforcement action has been limited to one case,
    involving Sallie Mae's agreement with Dr. William M. Scholl College of Podiatric
    Medicine. Federal Student Aid has never performed reviews of lenders for the specific
    purpose of reviewing compliance with the anti-inducement provision.

    The Department held a series of meetings with the FFELP community in the spring and
    summer of2001 to discuss anti-inducement issues, but no consensus was reached. In
    November 2001, the Consumer Bankers Association (CBA) and the Education Finance
    Council (EFC) issued a joint statement on their view of the applicability of the anti-


                                      400 MARYLAND AVF,., S.W. WASHINGTON, D.C. 20202-1510

              Our mission is to ensu.re equal access 10 education and to promote educational excellem:e throughout the Nation.


•
inducement statute to the private credit offerings ofFFELP lenders. In the statement,
CBA and EFC declared that they believe it is illegal for a lender to require a school to
refer FFELP loan applicants (including placing a lender on a preferred lender list) to the
lender in exchange for private credit. A FFELP lender, however, could offer private
credit in hopes of FFELP loan referrals from a school, and could subsequently alter the
tenns of any private loan agreement with a school, or cease to provide private credit if the
FFELP loan volume was less than expected.

Sallie Mae and the National Council of Higher Education Loan Programs did not sign the
statement. The Department has not taken a position on the joint statement and has not
offered guidance on the growing market for private loans.

We met with representatives from Federal Student Aid (FSA), the Office of the General
Counsel, the Office of Postsecondary Education (OPE), and the Office of the Deputy
Secretary. We also interviewed representatives from Sallie Mae and other FFELP
participants, including lenders, guaranty agencies, a school financial aid officer
participating in the William D. Ford Federal Direct Loan Program (Direct Loan Program) .
and a lawyer with the legal aid community representing student interests. Although the
parties we interviewed were knowledgeable and provided useful information on current
practices in the FFELP market, none provided specific information regarding improper
inducements provided by lenders at specific institutions.

We selected two schools for review based on an increase in Sallie Mae loan volume. We
found evidence that one of these schools and Sallie Mae negotiated preferred lender
status in exchange for a specified dollar amount of private loans.

Our review concluded there are bargaining practices between schools and lenders for
FFELP preferred loan status and private loan volume that should be addressed through
statutory and regulatory changes or further Department gUidance. Given the current
marketing practices by schools and lenders, the Department should examine the roles and
responsibilities of schools, as weI! as lenders and lender affiliates in the inducement
issue.

We recommend that in recognition of the current market realities in the FFELP, the
Assistant Secretary for OPE:

      •   Provide guidance on the growing market for private loans by clarifying the
          application ofthe anti-inducement provision to private loans; and

      •   Reevaluate the anti-inducement provision of Section 435(d)(S)(A) of the HEA
          and determine if statutory changes should be proposed in the upcoming
          reauthorization to include schools, lender affiliates and other necessary changes.

cc:       John Danielson
          Harold Jenkins




                                               2
Final Report
ED-OIG/A09H0017                                         Page 75 of 103




          ENCLOSURE 3: SLX’s Comments on the Draft Report
                                    Randall M. Chesler
                                    President


                                                                                               Cil
                                                               June 2, 2008


     Gloria Pilotti
     Regional Inspector General for Audit
     Office of Inspector General
     U.S. Department of Education
     50 I I Street, Suite 9-200
     Sacramento, CA 95814

              Re: Response of Student Loan Xpress (SLX) to the Draft Audit Report Control
                   Number ED-OIGI A09HOOl7

     Dear Ms. Pilotti:

            On behalf of Student Loan Xpress, Inc. (SLX), I would like to take this
    opportunity to provide the Office ofInspector General (OIG) with the attached response
    to the above-referenced Draft Audit Report (the Draft). SLX has reviewed and concurs
    with the response to the Draft being submitted this date by Fifth Third Bank, and believes
    that the magnitude of the subject portfolio and the relative importance of this matter
    warrant the submission of this supplemental response by SLX.

             As stated in the attached response, SLX has a major economic and reputational
     stake in the proper resolution of this matter by orG. SLX very much looks forward to
     working with the orG towards such a resolution as promptly and efficiently as possible.
     Please do not hesitate to contact me if you have any questions concerning the attached
     or if you would like to discuss this matter in greater detail. Thank you very much for
     your careful consideration of this response.




     cc: Brian Gardner
         FIFTH THIRD BANK
         Saul 1. Moskowitz, Esq.
         MOSKOWITZ & AUSTIN, LLC
         Jonathan A. Vogel, Esq.
         SONNENSCHEIN NATH & ROSENTHAL LLP


     Attachments


Student Loan Xpress, tnc., a CIT Company
One CIT Drive                       t: 973.535.5902 f: 973.597.2070
Livingston, NJ 07039                randall.chesler@cit.com
         STUDENT LOAN XPRESS'S RESPONSE TO ED OIG'S DRAFT AUDIT
                                REPORT

                          CONTROL NUMBER ED-OIG/ A09H0017

                                              June 2, 2008


        This is to provide the Office of Inspector General (OIG) with the response of
Student Loan XPress (SLX) to the above-referenced Draft Audit Report (the Draft). SLX
respectfully refers OIG to the response of Fifth Third Bank with respect to Finding No.2.
This response addresses Finding No.1 and the "Other Matter" section of the Draft. As
the current beneficial owner of the loans involved in the transactions that are the focus of
Finding No.1 and some of the loans involved in the transactions discussed in the "Other
Matter" section, SLX has a major economic and reputational stake in the proper
resolution thereof by OIG. SLX requests that OIG give full consideration to this
response in its development of the final audit report.


                                RESPONSE TO FINDING NO.1

         In Finding No.1, the Draft addresses the compliance of three (3) transactions with
§ 435(d)(5)(A) ofthe Higher Education Act of 1965, as amended (HEA). That provision
pl'Ohibits FFELP lenders from paying inducements in order to secure applicants for
FFELP loans. See also 34 CFR 682.200 (definition of "Lender", paragraph (5)(i))(July 1,
2007 ed.)).

        The Draft concludes that the transactions at issue violate § 435(d)(5)(A). It
reaches this conclusion by radically recharacterizing the transactions in a manner that the
Department of Education (ED) and the courts have long rejected, and employing an
interpretation of § 435(d)(5)(A) that conflicts with its plain language. The Draft then
recommends voiding the guarantee retroactively on over $3 billion in loans made
pursuant to these transactions. This proposed penalty, which would cost the parties more
than $350 million, is exceedingly, harsh, disproportionate, and unprecedented.

        The Draft's recommendation does not just violate the legal rights of the parties to
these transactions, however. It calls into question the guarantee and subsidy payments
on tens of billions of dollars in loans held by other lenders all over the country. Expert
Report of Seamus O'NeiII, ~ILa (O'Neill Rep.)(attached hereto as Appendix A). 1 At a
time when the program may well be on the brink of collapse due in substantial part to the

I Transactions in the student loan industry, including those at issue here, are exceedingly complex. The
dynamics of student loan finance, including the process by which outside parties decide to invest in FFELP
loan-backed assets, is perhaps even more so. To assist OrG in understanding the industry, the market for
credit, and the transaction structures and mechanics commonly employed in the industry; we have attached
a report prepared by Seamus O'Neill, a widely recognized expert in such matters. Mr. O'Neill has
reviewed the Draft, as well as the various agreements cited by the Draft with regard to the transactions at
issue.
lack of confidence of the credit markets in the suitability ofFFELP loans as investments,
the Draft would inject a major new source of risk and uncertainty for current and
potential investors in securities backed by such loans, thereby jeopardizing the
fundamental ability of the FFELP to achieve its objectives. Id .. It is certainly within the
province of orG to recommend the promulgation of new regulations or legislation to
override longstanding ED interpretations of the statute and regulations, or to alter the
rules laid down in well-settled judicial precedent. But it would be extremely damaging to
the program, particularly at this point in time, to threaten the guarantee on tens of billions
of dollars in existing loans that were made in reliance on those interpretations and
precedent, and in which untold numbers of securities owners have invested,

       Accordingly, Finding No. I should be omitted from the Final Audit Report. In
the event that it is included, the proposed remedy should be solely that the parties be
required to discontinue making loans under the transactions at issue.


A. Under longstanding ED policy and applicable case law, the form of the
   transactions at issne as sales of consummated loans must be respected.

        1. The structure of the transactions at issue.

        The structure of the transactions at issue is commonplace in the FFELP, and
indistinguishable in all material respects from transactions under which tens of billions of
dollars in FFELP loans have been made by numerous lenders over the years. Id. ~IIl.b.

        The Lenders (PLP, MSA, and LSF) each entered into a trust agreement (each a
"Trust Agreement", and collectively, the "Trust Agreements") with an ELT (Fifth Third
Bank) under which the ELT holds legal title to Consolidation loans in the trust, and the
Lender is the sole beneficial owner of those loans. The Trust Agreements require the
loans to be funded with funds borrowed by the Lenders from a reliable liquidity provider
(ELSI), and originated and serviced by an experienced third-party servicer (ELSI). They
further require that the loans be covered by a forward purchase and sale commitment
agreement with a well-established loan holder (SLX throngh its eligible lender trustee
under a separate trust agreement) under which the loans are to be sold to such holder
promptly after disbursement.

        Each Lender entered into a loan servicing agreement (each a "Servicing
Agreement", and collectively, the "Servicing Agreements") and an Administration
Agreement with ELSI. The Lender thereupon conducted marketing/advertising activities
commonly used throughout the industry in an effort to interest prospective borrowers in
applying for Consolidation loans through the Lender. The Lender, through the ELT, then
made Consolidation loans to eligible borrowers using funds borrowed under a credit and
security agreement (each a "Credit and Security Agreement", and collectively, the
"Credit and Security Agreements") entered into with a financing provider (ELSI). Then,
pursuant to a forward purchase commitmentfloan purchase and sale agreement (each a
"Forward Purchase Agreement", and collectively, the "Forward Purchase Agreements"),
the Lender (through its eligible lender trustee) sold, and SLX (through its eligible lender


                                            -2-
trustee) bought, those loans after they were disbursed. The purchaser, the financing
provider, and the third-party servicer/administrator were all affiliated with one another.
The sale price included a premium above par, allowing the Lender to repay the funds
borrowed from the financing provider and realize a profit.

       The Draft Audit Report proposes to ignore the form of these transactions and treat
them instead as the procuring of marketing services. The Draft recharacterizes the
premiums paid for the loans as per loan marketing compensation, which the Draft then
claims violates the inducements prohibition in § 435(d)(5)(A). The Draft offers only a
cursory justification for recharacterizing the transaction in this manner. According to the
Draft-

         Under the terms of the ELT agreements and related agreements, MSA, PLP, and
         LSF are not lenders since the origination of FFELs is restricted to those
         exclusively funded, serviced, and purchased by SLX and its affiliates and the role
         ofMSA, PLP, and LSF was limited to the securing ofloan applications
         (marketing) and obtaining loan verification certificates. Also, an arms-length sale
         of loans did not occur. Fifth Third Bank holds loans in trust under its ELT
         agreements and SLX is a party to the trust with exclusive rights to the loans.
         Basically, SLX is transferring its interest in the loans held in one trust (trust
         established by the ELT agreement with SLXlMSA, SLXlPLP, and SLXlLSF) to
         another trust to which SLX or an affiliate of SLX is a party .... [U]nder the ELT
         agreement, MSA remained solely a marketer, that is, an entity that secured loan
         applications for lenders.


         2. Under ED's longstanding interpretation ofthe statute and regulations, the
            form of the transactions must be respected.

       Since these transactions involve the sale of consummated loans and not the
securing ofloan applicants, they do not involve illegal inducements. Rather, they reflect
Example No.1 of "Penn is sible Activities" described in ED's Dear Colleague Letter No.
L 89-L-129 (February 1989) (the "DCL"), which reads in pertinent part as follows:

         A lender purchases a loan made by another lender at a preminm. This is not a
         transaction involving the securing of applicants, but rather the acquisition ofloans
         already made. A purchasing lender may also act as the agent of a selling lender
         on a loan to be purchased for purposes of originating and disbursing the loan, and
         purchase the loan at a premium immediately following disbursement. The funds
         used to make the loan would be deemed to have been advanced to the seller by the
         purchaser and subsequently repaid from the sale proceeds 2




2 This type of transaction is also pennitted under ED's new anti~inducements regUlations, which take effect
July I, 2008. See 34 CFR 682.200(b)(defmition of "Lender", paragraph (5)(ii)(H»(2007).



                                                   -3-
        In fact, the transactions at issue here are even more clearly the sale ofloans
funded by the seller with funds borrowed from the buyer than the transaction described in
the DCL. The borrowings here are governed by an express credit extension contract
containing customary tenns and conditions. Unlike in the DCL example, there is no need
to "deem" the funds used to make the loans to have been advanced by the purchaser; the
Credit and Security Agreements make that component of the arrangement crystal clear.

        These transactions are also indistinguishable in all material respects from the
transactions between non-school lenders and financing providers/servicers/purchasers
that ED confirmed are permissible in the proceedings involved in Student Loan
Marketing Ass'n v. Riley. 112 F.Supp. 2d 38, 48 (D.D.C. 2000)(hereinafter "Riley").

        Thus, under ED's lougstanding interpretation of the HEA and implementing
regulations, the form of these transactions must be honored. They are sales of
consummated loans, not the purchase of marketing services, and must be treated
accordingly. As ED is well aware, such transactions have become commonplace in the
industry, as FFELP participants, including the Lenders and SLX, have structured their
relationships in the program in reliance on ED's position as enunciated in the Riley
proceedings and consistently applied thereafter. O'Neill Rep. 'iflII.b. ED is not permitted
to simply renounce that interpretation of the HEA and regulations, as the Draft
recommends, especially with regard to loans made in reliance thereon. See e.g. Smiley v.
Citibank, 517 U.S. 735,742 (1996)(sudden, unexplained, unexpected, policy changc, or
change that does not take account oflegitimate reliance on prior interpretation, may be
arbitrary, capricious, or abnse of discretion); Paralyzed Veterans of America, et al v. r:u;;"
Arena L.P ., 117 F. 3d 579, 586 (CA DC 1997)(reversal of agency's interpretation of
regulations requires notice-and-comment rulemaking); Microcomputer Technology
Institute v. Riley, 139 F. 3d 1044, 1050 (CA 5 1998)(retroactive application of
Secretary's new interpretation of HEA to a party who relied on the prior interpretation
held so unfair as to be arbitrary and capricious); Torch Operating Company v. Babbitt,
172 F. Supp. 2d 113, 125-26 (D.D.C. 2001 )(agency's "consistent practice" in applying its
regulations amounts to an interpretation of such regulations, such that, under Paralyzed
Veterans of America, et al, v. D.C. Arena L.P., the agency may not then adopt a different
interpretation without going through notice-and-comment rnlemaking). 3




3 On November 1, 1999, during the pendency of the Riley case, ED issued regulations implementing the
inducements prohibition of HEA § 435(d)(5)(A). See 34 CPR 682.200 (defmition of "Lender", paragraph
(5)(i)), published in fmal at 64 Fed. Reg. 58952 (Nov. 1, 1999). The specific ED statements alluded to by
the Court in Riley confmning the permissibility of transactions among non-school lenders were made prior
to that date. However, ED's confinuation ofthls interpretation was repeatedly brought up by Sallie Mae in
that case and was an important element in the Court's ruling, yet at no time did ED disavow it. .s.~J~: Riley,
supra, at 48. Moreover, ED's consistent administrative practice since Riley is in accord with that
interpretation. Thus, it is clear that since § 682.200(defmition of "Lender", paragraph (5)(i)) was
promulgated in November 1999, ED has consistently interpreted that regulation as permitting transactions
such as those at issue here. Accordingly, the Draft's recommendation that ED reverse that interpretation
without notice-and-commenting rulemaking is precluded by Paralyzed Veterans of America, et al v. D.C.
Arena L.P ., supra, and Torch Operating Company v. Babbitt. supra.


                                                    - 4-
        3. Settled case law also requires that the form of the transactions be
           respected.

       Under settled case law, it is likewise clear that the fonn of these transactions must
be respected.

        In Riley, at issue was a relationship between a purchaser/servicer/financing
provider for FFELP loans (Student Loan Marketing Association, often referred to as
"Sallie Mae"), and Dr. William M. Scholl College of Podiatric Medicine ("Scholl
College"), a school acting as a FFELP lender for its students. The relationship was
virtually identical to the transactions at issue here, with one major difference: the lender
was a school.

       Under the Sallie Mae/Scholl College arrangement, the loans were originated and
disbursed by Sallie Mae as third party servicer for Scholl College. Sallie Mae lent Scholl
College the funds used to make the loans. The loans were required to be sold to Sallie
Mae at a premium prior to entering repayment pursuant to a forward purchase
commitment/loan sale agreement. Id. at 38-41.

       Unlike the Draft's approach in this instance, ED never sought to void the
guarantee on loans made pursuant to the Sallie Mae/Scholl College arrangement. Instead,
it commenced a "limitation" proceeding, in which it asked an Administrative Law Judge
(AU) to issue an order requiring the arrangement to be discontinued. ED argued that the
form of the arrangement, which was structured as a sale of consummated loans, should be
ignored and the arrangement recharacterized as involving Sallie Mae as the "true lender"
paying inducements to Scholl College to compensate Scholl College for securing loan
applicants for Sallie Mae, in violation of HEA § 435 (d)(5)(A). Id. at 41-43.

       Twice, the AU refused to recharacterize the arrangement, whereupon on each
occasion the Secretary of Education overruled the AU. After the Secretary overruled the
AU for the second time, Sallie Mae sued in the U.S. District Court for the District of
Columbia. Id. at 42.

       The Court overturned the Secretary's decision, rejecting ED's attempt to
recharacterize the Sallie Mae/Scholl College arrangement on several different grounds.
Each of those grounds that is relevant here independently requires rejection of the Draft's
proposed recharacterization of the transactions at issue.

        First, the Court held that, contrary to ED's contention, the HEA, the FFELP
regulations, and the legislative history permit schools to act as lenders, and to hire third
party servicers to carry out the functions of a lender on its behalf, "even if the
arrangement effectively renders the school lender a mere marketer. .. ", and even if it
means that the school lender "assumes no significant financial risk." rd. at 43-44.

       In the instant transactions, the role of schools in the program is simply not at
issue. The Lenders, through the ELT, provide an important source of competition in the



                                             -5-
program. See GAO Report GAO/HEHS 00-170, Trustee Arrangements Serve Useful
Purpose in Student Loan Market, at IS (Sept. 2000)("[T]rustee arrangements between
eligible and ineligible lenders serve an important role in enabling ineligible lenders to
participate in FFELP, and in protecting the federal government's investment in the
program."). Even though the Lender's primary (but not exclusive) activity under the
instant transactions is to market their loans, and even if their financial risks are limited,
Riley makes clear that those facets of the transactions cannot justify recharacterization.

        Second, the Court in Riley held that recharacterizing the arrangement was
unjustified because there was no evidence that it resulted in the exploitation of any
borrowers or resulted in any "unnecessary or excessive borrowing". rd. at 45.

        Here, there is no evidence that any of the transactions caused exploitation of or
any other harm to any borrower. No school or any other party in a position of trust and
influence with a borrower received any payment to steer the student to a lender. It is also
important to remember that, unlike in Riley, the loans at issue here are Consolidation
loans, under which existing debt is restructured to ease the repayment burden of the
borrower. Accordingly, no "unnecessary or excessive borrowing" occurred. Id. at 46.

        Third, the Court held that, since the component agreements were all pennissible,
the Sallie Mae/Scholl College arrangement as a whole could not be deemed
impermissible. Id. at 46-47.

        In this instance, the Draft does not claim, nor can it, that any of the component
agreements violate the HEA or any implementing regulations. Although trust
relationships were not involved in Riley, the HEA and the FFELP regulations specifically
permit loans to be made and held pursuant to trust relationships. HEA §§ 426, 436(b); 34
CFR 682.203(b).

        Fourth, the Court held that the form of the Sallie Mae/Scholl College arrangement
must be respected because each of the component agreements, and the benefits derived
therefrom by Scholl College, were market reasonable for a traditional secondary market
arrangement. 4 rd. at 46-48.

       Each ofthe component agreements in the instant transactions, and the benefits
derived therefrom for the Lenders, are likewise traditional, customary, and umemarkable.
O'Neill Rep. at ~II.c.

        This includes in particular the provisions in the Trust Agreements requiring the
loans to be funded with funds borrowed by the Lenders from a specific reliable liquidity


4 The Court phrased this in a variety of ways: It noted that the agreements contained "tenns which are
characteristic of traditional market transactions"; the contracts did not contain "unreasonable or non-market
terms)); the arrangement was comprised of "market transactions typical of the secondary loan markeC; the
incentive that Scholl College had to enter into the arrangement was "unremarkable"; and the individual
agreements were "traditional [and] customary of second~market transactions, .. ," Riley, at 46-48.



                                                    -6-
provider, originated and serviced by a specific experienced third-party servicer, and
subject to sale promptly after disbursement under a forward purchase and salc
commitment with a specific well-established loan holder. Prudent ELTs, financing
providers, and loan purchasers routinely require such restrictions, especially when the
beneficial owner is new or relatively new to the lender role. Id. lIIII.d. Such provisions
give these parties confidence that loans in the trust are properly funded and serviced, and
are committed for sale to a reliable FFELP loan purchaser prior to the first payment due
date (when administration of a loan becomes substantially more complicated).

        It is indeed ironic that the Draft points to these provisions to justifY disregarding
the form of the transactions, while at the same time criticizing Fifth Third in Finding No.
2 for an alleged failure to take adequate steps to ensure that the Lenders comply with the
FFELP statute and regulations. OIG cannot have it both ways.

       As noted above, each ofthe grounds for rejecting recharacterization cited by the
Court in Riley that is relevant here 5 independently requires rejection of the Draft's
proposed recharacterization. The fact that every one ofthose various rationales precludes
recharacterization here demonstrates, a fortiori, that the Draft's approach is
unsupportable.

        Moreover, Riley involved a school lender, where the concerns regarding the
perniCious effects of illegal inducements are the greatest. Inasmuch as Riley rejected
ED's effort to ignore the form of transactions indistinguishable from those at issue in this
audit, and involving a school lender, it is clear that the form of the transactions involved
here cannot be disregarded. Indeed, ED repeatedly confirmed in the course of the Riley
proceedings that, had the arrangement in that case involved a non-school lender, it would
have been permissible. Id. at 48.

         The Draft places great emphasis on the fact that each Lender was a contract
marketer for SLX prior to the transactions at issue, and allegedly remains "solely a
marketer" under those transactions. The Lenders were not "solely" marketers in these
transactions, however. Among other things, the Lenders borrowed money to fund their
loans pursuant to bona fide credit transactions undertaken pursuant to the Credit and
Security Agreements. Further, they obligated themselves under the Forward Purchase
Agreements to repurchase any loan that becomes unreinsured due to a violation that
occurs prior to the sale of the loan to SLX. This is no small matter. Indeed, one of the
Lenders has already repurchased in excess of $1 million in loans sold to SLX under their
Forward Purchase Agreement that turned out to be unreinsured when sold. Clearly, the
Lenders' roles as debtor and loan seller in the transactions at issue require them to accept
substantial obligations not required of mere marketers. In fact, these are the very types of
obligations that have led other marketers to decide not to become lenders. O'Neill Rep.
lIIII.f.


5 In addition to the various rationales described above, the Court also rejected ED's attempt to
recharacterize the transactions at issue in Riley because it was "irrational" to recharacterize the transaction
~'merelybecause the [lender] was a school. Riley, supra, at 48.
                                             H




                                                     -7-
        In any case, even if the Lenders had not had substantial duties and obligations
beyond marketing loans, Riley makes clear that transactions snch as those at issue here
are permissible "even if the arrangement effectively renders the .,. lender a mere
marketer". Riley, 112 F. Supp. 2d at 44. An otherwise permissible secondary market
transaction cannot become illegal merely because the lender previously acted as a
marketing service provider for the loan purchaser.

        Finally, the Draft's condemnation of the way in which the Lenders converted
from marketing contractors to full-fledged lenders ignores fundamental facets of the
operation ofthe FFELP. Many FFELP lenders, including some of the largest in the
program, started as marketers. O'Neill Rep. at ~II.e. And most new FFELP lenders first
embark on that role via relationships with established FFELP industry participants like
SLX that are substantively indistinguishable from those involved here. Id .. The Draft's
proposed ban on marketing entities becoming lenders via relationships like the ones at
issue here would therefore have effectively foreclosed program participation to many
lenders that have provided vigorous competition for Sallie Mae and large bank lenders in
the program, to the benefit of borrowers and the Federal Government alike.

       4. The Draft's reliance on the fact that SLX was a party to the Trust
          Agreements is misplaced.

        The Draft assigns great importance to the fact that SLX was a party to the Trust
Agreements. In fact, the Draft concludes that the transactions involved here were illegal,
and declines to reach that conclusion with respect to the other trust arrangements it
reviewed, based solely on the fact that the instant transactions, unlike the others, involve
trust agreements to which the loan purchaser is a party. However, the Draft's emphasis
on this particular detail of the transactions at issue is misplaced.

        As a threshold matter, the HEA and the FFELP regulations specifically permit
loans to be made and held pursuant to trust relationships. Nothing in the HEA or the
regulations addresses, much less prohibits, the purchaser ofloans made by a trust from
bcing a party to the trust agreement. Accordingly, since all the component agreements,
including the Trust Agreements, are permissible, the Court's ruling in Riley precludes ED
from treating the instant transactions as a whole as impermissible, regardless of the fact
that SLX signed the Trust Agreements. Riley, at 46-47.

        Moreover, the Draft characterizes SLX's role in the Trust Agreements as
"structural" when it is, in fact, de minimus. While those agreements contain provisions
devoted to detailing the extensive duties of the Lenders and the ELT, there is no such
section for SLX. In fact, SLX's only ongoing role under the Trust Agreements is to pay
the ELT's fees and expenses on the Lenders' behalf. PLP Trust Agreement, § 1.10.
Analytically and economically, this is simply a miniscule component of the loan sale
premiums, and could just as easily (and perhaps more appropriately) have been




                                            -8-
incorporated into the Forward Purchase Agreements, or omitted altogether in favor of a
tiny increase in those premiums 6

        ED has long recognized and condoned the practice of a loan purchaser paying
fees due on purchased loans on the seller's behalf. See 34 CFR 682.305(a)(4)(i)(July I,
1994 ed.)(purchaser may pay origination fees on seller's behalf); 59 Fed Reg 61426
(November 30, 1994) ("A purchasing lender may reimburse the originating lender for the
origination fees [on a purchased loan]"). That SLX paid the ELT's exceedingly modest
fees and expenses On behalf of the Lenders is clearly "unremarkable" and not
"unreasonable or non-market", and therefore cannot be a basis for ignoring the fonn of
the transactions negotiated by the parties. Riley, at 46-48.

        Finally, we note that oro correctly declined to conclude that the fonn of the
arrangement involving the Alder School of Professional Psychology (ASPP) should be
disregarded even though the trust agreement there calls for SLX to compensate Fifth
Third Bank for the services it renders as trustee for ASPP on loans sold to SLX. See Draft
at 15. It should do likewise with respect to the three arrangements involved in this
Finding.

         The Draft erroneously claims that the Trust Agreements grant SLX an "interest"
in loans in the trust. The Lenders, not SLX, are the full and exclusive beneficial owners
of the loans residing in the respective trust estates. See e.g. PLP Trust Agreement, §§
1.2, 1.4(a), 1.4(g); PLP Forward Purchase Agreement, § 4(e). Further, the Lenders incnr
a myriad of obligations and potential liabilities as borrowers under the Credit and
Security Agreements and loan sellers under the Forward Purchase Agreements. See e.g.
PLP Credit and Security Agreement, § 2.1, (PLP obligation to repay funds advanced to
PLP by ELSI), § 2.2 (PLP obligation to pay interest on advanced funds), § 8.1(b)(PLP
obligation to pay all expenses incurred by ELSI as financing provider); PLP Forward
Purchase Agreement, § 3G)(Seller's obligation to pay origination fees, lender fees, and
guarantee fees), § 6 (Seller's obligation to repurchase loans that are not enforceable,
guaranteed, and eligible for Interest Benefits and Special Allowance payments when
sold). The contention that the matrix of rights and duties that comprises each of these
transactions should be ignored simply because the handwriting of an SLX officer appears
on the Trust Agreements, or because SLX paid economically insignificant fees and
expenses on the Lenders' behalf, places far more weight on those innocuous facts than
they can plausibly be asked to bear. Such trivialities are plainly insufficient to invalidate
the guarantee on over $3 billion in loans made under transactions that are otherwise
indistinguishable in all material respects from the paradigm condoned by ED and
approved in Riley. Were it otherwise, it would be impossible to identify from among the
myriad of similar transactions undertaken since Riley, which is pennissible, and which --
due to some insignificant provision purportedly "distinguishing" it from the Riley
transaction -- is not. Substantial doubt would be cast on the guarantees on tens of billions
of dollars in outstanding loans. This is quite simply an unacceptable result for the

6 For example, the total fees paid to the ELT under the three arrangements were $444,720.45, and the
loans originated thereunder totaled $3.332 billion, which would translate into an increase in loan premiums
ofO.Ol3%.


                                                   - 9-
viability of the program, especially given today's tennous conditions in the credit
markets.


        For these reasons, the Draft's attempt to ignore the form of the transactions at
issue should be rejected. They are what they purport to be -- the sale of consummated
loans -- and must be treated accordingly.

B. Marketing does not constitute "securing" applicants, regardless of how the
   marketer's compensation is calculated.

       Section 435(d)(5)(A) provides in pertinent part that a lender can be
disqualified from FFELP participation if the Secretary determines, after notice and
opportunity for a hearing, that the lender has --

                  [O]ffered, directly or indirectly, points, premiums, payments, or other
                  inducements, to any educational institution or individual in order to
                  secure applicants for loans under this part.. ..

20 U.S.C 1085(d)(5)(A). See also 34 CFR 682.200 (definition of "Lender", paragraph
(5)(i»(July I, 2007 ed.).

       The principal focus of § 435(d)(5)(A) was to outlaw lender payments to
schools in exchange for the schools' recommending the lender to their students.
Riley at 45, 48. The school's role as trusted advisor to its students enables it to
exercise substantial influence over a student's decision whether to borrow, in what
amount, and from which lender. When a school uses this influence to steer students
to a particular lender, it is doing much more than merely "marketing" for a lender; it
is incontestably "securing applicants" for that lender. Any reading of the statute that
does not prohibit a lender from paying schools to do this, regardless of the form of
payment, cannot be reconciled with its plain meaning.

        Accordingly, where payments to schools are involved, ED has never made
distinctions based on the form of payments or how they are calculated; any payments
by a lender in exchange for loan referrals by a school are prohibited. See e.g. DCL
at 2-3. ED's treatment of transactions between lenders and non-school affiliated
entities, however, has not been nearly so clear. ED currently takes the position that
marketing fees paid by lenders to non-school affiliated entities are permissible if paid
on a per application basis, but not if they are paid on a per loan basis. 7 If the Draft's


7 This has by no means been ED's consistent position. A review of ED's interpretations, re-
interpretations, and corrections of interpretations on the marketing compensation issue over the years is
set forth in Appendix B to this response. As Appendix B illustrates, the issue remains muddled to this
day. Accordingly~ a court would accord little or no deference to ED's current position. See Goog
Samaritan Hospital, et al. v. Shalala, 508 U.S. 402, 417 (1993)("an agency intetpretation of a relevant
provision which conflicts with the agency's earlier interpretation is 'entitled to considerably less
deference' than a consistently held agency view."); Barnett v. Weinberger, 818 F.2d 953, 962 (CADC


                                                  - 10-
recharacterization of the transactions at issue here were accepted, the premiums paid
to the Lenders on the loans sold pursuant to the Forward Purchase Agreements might
be similarly recharacterized as (purportedly) prohibited per loan marketing compensation
being paid by the "real" lender, SLX (via its trustee). This is apparently the analysis
employed in the Draft. 8

        For the reasons discussed below, however, the "per app/per loan" distinction
relied on by the Draft cannot be squared with the plain language of the statute. 9 Section
435(d)(5)(A) unambiguously states that any payment for securing loan applicants is
impermissible, regardless of how it is calculated. However, marketing does not
constitute "securing" loan applicants, again, regardless of how the marketer is
compensated. Accordingly, even assuming, arguendo, that the transactions at issue can
be recharacterized as involving per loan marketing compensation, that compensation did
not constitute an inducement to secure loan applicants for any lender within the meaning
of HE A § 435(d)(5)(A).

       Section 435(d)(5)(A) establishes two prerequisites for an illegal inducement: (1)
there must be an offer of "points, premiums, payments, or other inducements"; aud (2)
such inducements must be offered "in order to secure applicants" for FFELP loans.

        The first element is unambiguous: any fonn of "payment" suffices ifit is offered
for the proscribed purpose of securing loan applicants. The plain language of the statute


1987)(agency interpretations of a statute that are neither contemporaneous with enactment of the statute
nor consistent with earlier interpretations «do not merit a substantial degree of respect"}; Idaho Power
Co. v. FERC, 312 FJd 454,461 (CADC 2002) (no deference is due to FERC interpretation of a tariff
that is inconsistent with prior agency interpretations); United Transportation Union. et 31.. v. Lewis, 711
F.2d 233, 242 (CADC 1983)(statutory construction to which an agency has not consistently adhered "is
owed no deference"),


8 The Draft's discussion o(the marketing compensation issue is confusing. It repeatedly equates all
marketing with "securing" applicants, yet cites with apparent approval the "flat fee" payments made in the
past to the Lenders when they were mere marketers. Given the broad prohibition in the REA on
I'payments" to secure applicants, it is not clear what the Draft's rationale is for approving these payments
while disapproving the premiums paid to the Lenders Wlder the Fonvard Purchase Commitment/Loan
Purchase and Sale Agreements. Although it does not clearly say so, it appears that the Draft is applying the
"per app/per loan" compensation distinction described above.

9When ED adopts an interpretation of the REA that cannot be squared with its plain language, the courts
will not hesitate to overturn that action. See Jordan v. Secretary of Education, 194 F.3d 169, 172 (D.C.
Cir. 1999) ("the Secretary may not rewrite the [FFELP] statute"); California Cosmetology Coalition
v. Riley, 110 FJd 1454 (9th Cir. 1997); Smithville R-Il School Dist. v. Riley, 28 F.3d 55, 57-58 (8th
Cir. 1994); Atlanta College of Medical & Dental Careers v. Riley, 987 F.2d 821 (D.C. Cir. 1993) ("no
deference is due to [Secretary's] interpretation" that was t!foreclose[dr' by the "textt! of the REA);
Riley, supra, at 48; Bank of America NT & SA v. Riley, 940 F. Supp. 348 (D.D.C. 1996) (Secretary's
interpretation of 20 U.S.C. § § I077a(i)(7)(B) and I0871(b)(2)(A) contradicted express
requirements of statute), aff d. 132 F.3d 1480 (D.C. Cir. 1997); Student Loan Marketino Assn v. Rilev,
907 F. Supp. 464 (D.D.C. 1995) (Secretary's REA interpretation which failed to give effect to "clear
statutory definition" was "arbitrary and capricious"), affd, 104 FJd 397 (D.C. Cir. 1997).



                                                    - II -
does not allow for distinctions based on the fonn ofthe payment or how it is calculated.
Compare HEA § 487(a)(20) (prohibiting schools from paying "any commission,
bonus, or other incentive payment based directly or indirectly on success in securing
enrollments or financial aid" to anyone engaged in recruiting, admissions, or
awarding financial aid). Congress clearly knows how to prohibit marketing
compensation calculated in a particular way while permitting other types of marketing
compensation, yet did not do so in § 435(d)(5)(A). See also DCL at 1 ("The
Department believes these provisions were broadly intended to prohibit the direct or
indirect offering or payment of any kind of financial incentive ... regardless of the
form of the incentive or its mode of payment.").

        Moreover, no reading of the plain language of the statute could support the
contention that paying a fee per application is less aptly characterized as a payment in
order to secure applicants than a fee paid per loan. Such a reading would contort the word
"applicants" beyond all recoguition.

       Once an offer of any form of payment exists, the sole remaining question is
whether it is made in order to "secure" loan applicants. Unlike "payment", the term
"secure" is uuclear. However, it cannot reasonably be read as including all
marketing of FFELP loans, as the Draft appears to contend. First, the tenn "securing
applicants" on its face would seem to require more than the mere delivery of a
brochure or presentation by a marketer who occupies no special position of trust or
influence with the borrower. Second, reading the statute to prohibit all compensated
marketing would mean that virtually every FFELP lender since 1986 has been in
continuous violation of the statute, inasmuch as compensated marketers have long been
the norm in the industry. O'Neill Rep.1IIII.g. It is inconceivable that such a reading
could be supportable today given that the FFELP statute has been reauthorized three
(3) separate times since 1986, and amended on numerous other occasions, with no
suggestion from Congress that thIS widely known element of the FFELP program was
impermissible.

        Thus, the term "secure" must be read to prohibit lenders from paying schools
to steer borrowers to the lender, regardless of the basis of payment, while at the same
time permitting compensated marketing activities by non-school affiliated entities.
The most logical and straightforward approach for doing this is to interpret the term
"secure" to permit mere "marketing", where the lender or marketing agent must rely
solely on the merits of the lender's loan products and service, but to prohibit paid
"referrals",1.&., paying someone who likely has the trust of the student (such as a
school's financial aid office) to influence the student's borrowing decisions. Indeed,
the DCL took this approach. It recognized that "generalized marketing" did not
constitute "securing" applicants, and therefore could be compensated as the parties
saw fit, while at the same time it prohibited "referral" fees to compensate lenders
who, by exploiting existing relationships with potential FFELP borrowers,1O were
able to steer them to another lender for a FFELP loan. DCL at 2_3. 11

10 At the time of the DeL, many banks did not participate in the FFELP. When an existing customer of a
nonparticipating bank asked for a FFELP loan, the bank would refer tile customer to another lender that did


                                                  - 12 -
          Unlike the DeL, the Draft seeks to characterize marketing activity as
"securing" applicants if the activity is compensated on a ger loan basis, but not if the
same activity is compensated on a per application basis. 2 Whether an activity rises
to the level of "securing" applicants, though, depends on the nature of the activity
itself. 13 The form or basis of compensation paid to procure the activity is analytically
irrelevant.

       Thus, even if the transactions at issue could be recharacterized as proposed by
the Draft, the payments made thereunder would merely be compensation for
marketing by a non-school affiliated entity with no special position of trust or
influence with prospective borrowers, and not for referrals. There is no basis under
the HEA to treat any of those payments as being made "in order to secure applicants"
for SLX.14

participate, Because of the likelihood that the referring bank would have the trust of the customer and
therefore be able to effectively steer the customer to the participating lender of its choice, the DeL sought
to ensure that these referrals would not be the subject of compensation. With the prevalence today of
school referrals, the Internet, and direct marketing as the principal means by which students learn about
lenders' FFELP offerings, the sort of compensated lender-ta-Iender referrals of existing customers that the
DeL was concemed about are no longer a significant issue in the program.

II With the exception of a three (3) month period in 1992, this was ED's position from 1989, when the
DCL was issued, until June 1995, when the interpretation abruptly changed. See Appendix B hereto.

12 Moreover, as noted above, treating some payments for a given activity as permissible and others as
prohibited does violence to the clear statutory prohibition on all payments in order to secure
applicants, regardless of how they are calculated.

13 The DCL provides that, while it is pennissible for a lender to pay another lender to process applications
and advertise the originating lender's loans, a lender may not pay another lender a fee that purports to be for
processing or advertising, but is also or in actuality compensation for the payee lender referring borrowers to
the paying lender. DCL at 2 (Example of Prohibited Inducements No.3). As the DCL makes clear, "referral"
is different from "marketing". 14, at 2-3 (prohibiting payments for referrals while permitting payments for
"generalized marketing or advertising"). See also id. at 2 (Example of Prohibited Inducements No. 4)(
payments that are labeled as uprocessing!1 fees, but are in reality compensation for referral by the lender
receiving the payment, are prohibited regardless of the label).

14 We also note that HEA § 435(d)(5)(A) prohibits the payment ofinducements only to an "educational
institution or individual". An interpretation of "individual" to include corporations, such as the Lenders,
requires interpreting the tenn "individual" as synonymous with "person". This is contrary to how those
terms are typically interpreted, however. See Clinton v. City of New York, 524 U.S. 417, 428 (1998)

         Moreover, the tenn "person" is defined in the general definitions section of the United States Code
as follows:

         [T]he words "person" and "whoever" include corporations, companies, associations,
         fIrms, partnerships, societies, and joint stock companies, as well as individuals ....

1 U.S.C. § 1. Clearly, "person'! and "individual" are not synonymous when they are used in the United
States Code. When Congress intends to regulate the activities of both legal entities and human beings, 1
U,S.C. § lstates that Congress uses the tenn "person", not "individual",



                                                     - 13 -
C. Voiding reinsurance on the loans at issue would be unprecedented, unwarranted,
   and harmful to the FFELP.

        Relying solely on regulations that orG claims authorizes treating the loans made
pursuant to the transactions at issue as unreinsured from inception, the Draft recommends
that ED void the guarantee on those loans and require the ELT to reimburse ED for all
claims payments, interest benefits, and special allowances paid in the past thereon. This
recommendation would impose a penalty on the parties of more than $350 million. The
Draft fails to recognize that such a penalty would be utterly unprecedented, and suggests
no reason why such a harsh sanction would be warranted or in the best interests ofthe
FFELP.

        It is our understanding that, in the 22-year history of the inducements trohibition,
ED has never treated a loan as unreinsured due to an inducements violation. I Instead,
the participants in activities found to constitnte inducements violations have typically
been instructed to discontinue those activities. 16

        ED's consistent policy with regard to referral fee violations in particular has been
that such infractions do not justify voiding reinsurance or restricting interest benefits and
special allowance on affected loans. For example, in correspondence between ED's
Division of Policy Development (DPD) and ED's Atlanta Regional Office, DPD
addressed a sitnation in which a lender paid other lenders a referral fee based on loans
disbursed rather than applications processed. DPD directed the Regional Office as
follows:

         [DPD does} not believe that this violation warrants a voiding a/reinsurance or
         restriction a/interest and special allowance on loans previously disbursed under
         the referral program. Instead, the lender should be cited and instructed to
         restructure its referral program by a specified deadline if it wishes to continue



         Finally, interpreting "individual" to include corporations would render superfluous the tenn
"educational institution" as used in § 435(d)(5)(A). See Alaska Dep't of Envirorunent Conservation y.
EPA, 540 U.S. 461,489 n.l3 (2004) (courts disfavor rendering statutory provisions superfluous).
Accordingly, a court may well read § 435(d)(5)(A) to only bar payments made to educational institutions or
human beings. The Lenders are neither,

J5 While technically distinct, "voiding the guarantee" on a loan and treating it as unreinsured have the same
effect -- i,e., they both result in the loan being ineligible for Federal subsidies and guarantor claim
payments, Accordingly, the two concepts are used interchangeably in this response.

16 In the proceedings involved in Riley, ED did not even feel comfortable issuing its own "cease and desist"
directive. Instead, it commenced a limitation proceeding, asking that an Administrative Law Judge issue a
"limitation" directing Sallie Mae to end the relationship with Scholl College. As noted above, the Riley
matter involved alleged inducements paid to a school, a far more serious situation from the perspective of
the inducements prohibition than the alleged "marketing" compensation to non~school affiliated entities
involved in the transactions at issue here.



                                                   - 14 -
         it. ... The lender should be told that its failure to comply will result in its
         ineligibility as a lender in the FFEL program.

See Question & Answer from Robert Evans, Director, DPD, to Barbara Gray, Region IV,
dated March 6, 1994(emphasis supplied). 17

        ED's refusal to penalize the payment of referral fees by unreinsuring affected
loans is sound policy, and consistent with ED's longstanding practices in exercising its
regulatory authority to unreinsure loans. In a Federally-guaranteed loan program that
depends upon voluntary participation by private financial institutions, it is essential that
those institutions be able to rely on the Federal guarantee. O'Neill Rep. 'jIlI.h. In
recognition of this, ED has typically employed the drastic step of voiding reinsurance
only in situations where fraud is involved, or where the violation hanned the collectibility
of the loan. In practice, this has meant that virtually all instances (not involving fraud) in
which reinsurance has been reduced or voided have involved violations of the lender's
obligation to diligently collect a delinquent loan or file a claim thereon in a timely
manner. 18 Moreover, even in cases involving such violations, ED has voided reinsurance
only where the violation was substantial, rather than technical, and the lender was unable
to "cure" the violation by subsequent collection efforts. See DCL 88-G-138
(1988)(inc1uded with revisions as 34 CFR Appendix D).

        The Draft proposes that ED void tbe guarantee on every loan made under the
transactions at issue, despite the lack of any evidence of fraud or hann to the collectibility
of the loans, and despite ED's longstanding policy of not voiding the guarantee for
inducements violations in general and referral fee violations in particular. Thus, the Draft
urges ED to depart radically from its consistent standards and practices in implementing
its regulatory authority to unreinsure a loan. 19 The HEA prohibits OIG from making
such a recommendation, however. HEA § 432(£)(4)(OIG audits ofFFELP lenders must
focus on "rules and regulations prescribed by the Secretary in effect at the time that the
record was made, and in no case shall the ... Inspector General apply subsequently
detennined, standards, procedures, or regulations to the records of such ... lender"). Nor
conld ED adopt such a reconnnendation. Smiley v. Citibank, supra, 517 U.S. at 742;
Paralyzed Veterans of America, et al v. D.C. Arena L.P., supra, 117 F. 3d at 586; Torch
Operating Company v. Babbitt, supra, 172 F. Supp. 2d at 125-26.

17 It is also exceedingly difficult to reconcile the harsh remedy recommended by the Draft with the OIG's
longstanding recognition that the scope and meaning of the anti-inducements prohibition is unclear,
imperfectly understood within ED and in the industry, and in need of clarification by ED. See Alert
Memorandum from C. Lewis to S. Stroup (Aug. 1,2003).

18 ED also treats loans as unreinsured when statutory prerequisites for the payment of reinsurance, interest
benefits, and special allowance are not met - for example, when the loan is held by an ineligible lender. No
such circumstance is involved here.

19 As noted above, even recharacterized, the instant transactions involve compensation for marketing,
where no exploitation of a position of trust or influence wit.h. the borrower is involved) and not referral fees.
Since ED's policy and practice has been to not unreinsure loans based On the payment of illegal referral
fees, a fortiori, it should not do so for purported marketing compensation violations,



                                                     - 15 -
       Furthermore, even if ED could legally adopt the sanction the Draft proposes, there
are compelling reasons why the orG should not recommend that it do so.

        The utter disproportionality of the Draft's recommended $350 million penalty is
manifest. The "violations" alleged by the Draft had no effect on the risk of loss on the
loans. There is no evidence of fraud. There is no evidence that any harm befell any
borrower or ED. There is no evidence that any inducements were offered to any school.
And, as noted above, the loans at issue here are Consolidation loans. No new debt was
created. Thus, the purposes of the inducements prohibition itself - preventing borrowers
from borrowing more than they need or can repay, Riley at 45 are not implicated here.

         The irrationality of the Draft's recommended penalty is underscored by the fact
that the Draft would apparently recommend no penalty at all - indeed it would find no
vio lation - had the alleged "marketing compensation" been calculated on a per
application, rather than per loan, basis. While ELSI is still analyzing the data, it appears
that virtually 100% of the completed applications received nnder the arrangements at
issue became loans. For ED to impose a penalty of more than $350 million dollars based
on such an economically insubstantial distinction would plainly be arbitrary, capricious,
and an abuse of discretion.

        Perhaps most importantly, however, the massive penalty recommended by the
Draft would inject a major new source of risk and uncertainty into the FFELP. Today,
the program may very well be on the brink of collapse due in substantial part to the lack
of confidence of the credit markets in the suitabilityofFFELP loans as investments.
O'Neill Rep. ~III.a. By casting doubt on the guarantee of tens of billions of dollars in
outstanding loans in which untold numbers of securities holders have invested, by doing
so in the context of transactions long condoned by ED and settled case law, and by doing
so despite the utter lack of evidence showing any harm befell any borrower or the Federal
Government, the Draft's approach would greatly exacerbate this condition. rd. As Mr.
O'Neill notes-

         [I]t is essential that [FFELP lenders] be able to rely On the Federal guarantee, and
         consistent application of laws and regulations over time. Consistent treatment of
         like financing and loan origination structures by the government makes the
         financing ofloans possible. Inconsistent treatment will have the opposite effect.

Id. at ~lII.h.

        Finally, it is critical that orG understand that merely including the
recommendation to unreinsure the loans at issue in the Final Audit Report would likely
create a major obstacle for FFELP lenders trying to locate the financing they need to
continue to make loans in the program. Id. ~I1I.a.




                                            - 16 -
                                                  Conclusion

        The Draft's proposed $350 million penalty is exceedingly harsh, disproportionate,
and unprecedented. It fails to accord simple fairness to the parties to these transactions,
and jeopardizes the fundamental ability of the FFELP to achieve its objectives. It is based
on alleged violations that harmed no one and can be "found" only by radically
recharacterizing the transactions in a manner that ED and the courts have both rejected,
and employing an interpretation ofthe statute that conflicts with its plain language. It
should be rejected. Instead, if the Final Report retains this Finding at all, the
recommended remedy should be that the parties be required to discontinue making loans
under the transactions at issue. 20


                   RESPONSE TO "OTHER MATTER" DISCUSSION

        The response to Finding No. I, above, explains why the transactions at issue
there cannot be recharacterized as mere marketing arrangements involving purportedly
illegal per loan compensation. Those arguments also apply to the arrangements that are
questioned in the "Other Matter" section of the DraftY If the Final Report rejects those
arguments, then the action the Draft indicates OIG plans to take - referral of the
arrangements to the Department for a determination as to whether they involve illegal
inducements - would be appropriate not only for those arrangements, but for the
transactions addressed in Finding No. I as well. As noted above, the Draft's
recommendation that a penalty of more than $350 million be assessed for the latter
transactions is unprecedented, unfair, and jeopardizes the ability of the FFELP to
achieve its objectives.


       Thank you very much for your careful consideration of this response. Please do
not hesitate to contact us if you have any questions or would like to discuss this
response in greater detail.


Attachments




20 Due to the combined effects on SLX of subsidy reductions enacted by the Congress and recent adverse
credit market conditions, SLX recently made the decision to discontinue its origination of new FFELP
loans. Accordingly, SLX has terminated the arrangements at issue,

21 The Draft contends that the transactions addressed in Finding No, 1 "differed structurally" from the
arrangements addressed in "Other Matter" because the latter "did not name a third party, such as SLX, in
the ELT agreement." As demonstrated above, however, SLX's role in the Trust Agreements was minimal,
and, under longstanding ED policy and settled case law, can not justify ignoring the fact that these
transactions involve the sale of consummated loans, not the payment of marketing compensation.


                                                 - 17 -
                                   Appendix A

                        Seamus O'l\Ieill Expert Report


I.   Professional Background and Expertise. (See attachment 1)

II. At the request of Saul L. Moskowitz, as counsel to CIT, I have reviewed the
    Fifth Third Bank Draft Audit Report, ED-OIG, A09H0017, March 2008, as well
    as the documents listed below involved in the PLP/SLX arrangement. I have
    confirmed my understanding from Mr. Moskowitz that these documents also
    reflect the analogous documents in the MSAlSLX and LSF/SLX
    arrangements.

     a. PLP Eligible Lender Trust Agreement, April 1 , 2005

     b. PLP Loan and Security Agreement, April 1, 2005

     c. PLP Student Loan Forward Commitment Sale/Purchase Agreement, April
        1,2005

     d. PLP Consolidation Loan Origination and Servicing Agreement, April 1 ,
        2005

     e. PLP Administration Agreement, April 1, 2005

III. Observations and Opinions:

     a. The Draft's recommendation calls into question the guarantee and subsidy
        payments on tens of billions of dollars in loans held by other lenders all
        over the country. At a time when the program may well be on the brink of
        collapse due in substantial part to the lack of confidence of the credit
        markets in the suitability of FFELP loans as investments, the Draft would
        inject a major new source of risk and uncertainty for current and potential
        investors in securities backed by such loans. In fact, merely including the
        recommendation to unrei.nsure the loans at issue in the Final Audit Report
        would likely create a major obstacle for FFELP lenders trying to locate the
        financing they need to refinance existing loans and continue to make
        loans.

     b. The structure of the transactions at issue is commonplace in the FFELP,
        and, in terms of economics and the rights and obligations of the parties,
        indistinguishable in all material respects from transactions under which
        tens of billions of dollars in FFELP loans have been made by numerous
        lenders over the years, and particularly since the Ri!m! decision in 2000.
        In particular, in the course of my work, I have assisted FFELP participants


                                        - 1-
     in creating and/or reviewing numerous transactions involving billions of
     dollars in loans under which former marketers that have become FFELP
     lenders have, through eligible lender trust arrangements, operated as full-
     fledged FFELP lenders. Some of these structures have involved an
     established FFELP holder providing financing, origination and
     disbursement servicing, and a commitment to purchase the loans involved
     promptly after disbursement.

c. Each of the component agreements in the transactions at issue, and the
   benefits derived therefrom for the Lenders, are traditional, customary, and
   unremarkable.

d. This includes in particular the provisions in the Trust Agreements requiring
   the loans to be funded with funds borrowed by the Lenders from a specific
   reliable liquidity provider, originated and serviced by a specific
   experienced third-pariy servicer, and subject to sale promptly after
   disbursement under a forward purchase and sale commitment with a
   specific well-established loan holder. Prudent ELTs, finanCing providers,
   and loan purchasers. routinely require such restrictions, especia lIy when
   the beneficial owner is new or relatively new to the lender role. These
   provisions give the parties confidence that loans in the trust are properly
   funded and serviced, and are committed for sale to a reliable FFELP loan
   purchaser prior to the first payment due date (when administration of a
   loan becomes substantially more complicated).

e. Many FFELP lenders, including some of the largest In the program,
   started as marketers. Most new FFELP lenders first embark on that role
   via relationships with established FFELP industry participants like SLX
   that are substantively indistinguishable from those involved here.

f.   The Lenders' roles as debtor and loan seller in the transactions at Issue
     require them to accept substantial obligations not required of mere
     marketers - the types of obligations, In fact, that have led other marketers
     to decide not to become lenders.

g. Compensated marketers have long been the norm in the industry.

h. In a Federally guaranteed loan program, which depends upon voluntary
   participation by private financial institutions, it is essential that those
   Institutions be able to rely on the Federal guarantee, and consistent
   application of laws and regulations over time. Consistent treatment of like
   fin<;lncing and loan origination structures by the government makes the
   financing of loans possible. Inconsistent treatment will have the opposite
   effect.




                                      -2-
                            Date: May 28, 2008
Seamus O'Neill, Partner
Liscarnan Solutions, LLC




                           -3-
                                                                                Attachment 1


I. Resume - Seamus O'Neill

Professional
Experience

1/1988 to the present   Managing Partner, Liscarnan Solutions, LLC

                        Oversees the firm's financial advisory and consulting services.
                        Liscaman's primary focus is structured financings and securitizations for
                        student loan industry. Additionally, for the several years Liscaman and
                        its predessor company, Kohne O'Neill, LLC, have expanded their
                        consulting services to include student loan business development and
                        corporate growth advice and services. These activities, fostered by Mr.
                        O'Neill, focus primarily on the development of student loan marketing and
                        loan origination activities for clients.

9/1998 to the present   Partner of Kohne O'Neill, LLC

                        Kohne O'Neill is a student loan asset and program management
                        company devoted to the origination, financing and administration of
                        student loan assets and their related structured financings.

8/1983 to12/1987        Principal, Donaldson, Lufkin & Jenrette

                        Specialties included structuring and underwriting of debt for project
                        financings, healthcare and higher education, and student loans.
                        Developed the first taxable/tax-exempt hybrid financing for student loans.

2/1983 to 7/1983        Vice President of Lehman Brothers Kuhn Loeb

                        Focused on student loans and general public finance investment
                        banking. Developed the first commercial paper financing for student
                        loans.




                                            - 1-
                                                                                  Attachment 1


10/1981 to         Vice president, Shearson American Express, Inc.
1/1983
                   Focusing on the development and underwriting of structured debt for student
                   loans, healthcare and higher education. Developed the first successful
                   variable rate financing for student loans.

8/1979 to 9/1981   Associate, AG Becker Incorporated

                   Focused on general investment banking, including: mortgage finance, student
                   loans, healthcare, 'and debt restructuring. Worked on the first debt financing
                   supported solely by student loan revenues,

8/1977 to 7/1979   Legislative economist and financing analyst

                   Focused on state debt, capital expenditures and the financial markets.
                   Developed the first analytical system for forecasting future revenue and
                   expenditure impact of state legislation.

10/1976 to         Bond Market Analyst, Illinois Governor's Budget Office
7/1977
                   Developed the first information system for tracking state general obligation and
                   state related debt. Prepared state general obligation debt offerings.


6/1976 to 9/1976   Economist, Illinois General Assembly

                   Focused on program evaluation and the development of an econometric
                   forecasting model for tax revenues




                                              -2-
                                                                                 Attachment 1


Education

1980 to 1982       Graduate School of Business
                   University of Chicago

                   Various courses in business, accounting and finance at the University of
                   Chicago Graduate School of Business

9/1972 to 6/1976   Duke University

                   Master of Arts In economics

                   Ph.D. candidate in economics with specialty fields in public finance,
                   urban economics and econometrics

9/1970 to 811972   State University of New York at Geneseo

                   Bachelor of Arts, economics, cum laude

9/1969 to 6/1970   University of Southern California




                                            -3-
                                                                             Attachment 1


Professional
Activities

3/21/2007       Investment community presentations in Boston

                "Proposed Changes to the Higher Education Act and the Impact on the
                Student Loan Industry"
3/20/2007       Investment community presentations in New York

                "Proposed Changes to the Higher Education Act and the Impact on the
                Student Loan Industry"

11/8/2005        Investment community presentation in New York City
                 "Private Student Lending - Industry Outlook and Analysis"

7122/2005        Investment community presentation in San Francisco

                 "Private Student Lending - Industry Outlook and Analysis"

1/14/2004        Presentation to the American Association of Medical Colleges at their
                 annual Conference in Burbank, California

                 "Consolidation Loans and How They Got That Wayl"

3/812001         Presentation to the Education Finance Council

                 "The Future of Student Loan Secondary Markets"

Prior Expert
Testimony

2006 and 2007    Royal Indemnity Co. v. Pepper Hamilton LLP, et al.

2002 and 2003    College Loan Corporation   v.   SLM Corporation, et al.




                                        - 4-
                                            Appendix B
           History of ED Interpretations Regarding Marketing Compensation


        In the seminal Dear Colleague addressing inducement issues, ED stated that
the anti-inducements prohibition does not apply at all to payments made to support
"generalized marketing". Dear Colleague 89-L-129, at 2-3 (February 1989)
(distinguishing activities "undertaken to directly secure applications from
individual prospective borrowers" from "generalized marketing or advertising")(the
"DCL"). Referral fees, on the other hand, were expressly prohibited regardless of
how they were calculated. Id. at 2.
        In a March 3,1992, letter from Robert W. Evans of ED to Saul Moskowitz ofClohan
& Dean, Evans stated that proposed compensation for a lender's contractor to market the
lender's loans to schools based on applications generated by the marketer was prohibited
under the DCL, but an annual fixed fee could be paid for the contractor to engage in the
same activities. Moskowitz's March 13, 1992 response to Evans specifically
pointed to the "generalized marketing"l"securing loans" distinction in the DCL and noted
that no distinction between performance-based compensation and a flat fee-based structure
could rationally be implied from the statute or the DCL. Moskowitz's letter stated as
follows:

                If the [marketing] agent's activities fall within the marketing exception,
                the lender is free to choose how to structure the agent's compensation.
                Conversely, if the activities go beyond marketing to the point where they
                involve securing applications, any form of compensation paid by the
                lender to the agent violates the [FFELP statute.] .... In each ofthe
                [proposed compensation structures] described in our letters, though, there
                is no ambiguity as to the activities to be compensated -- in each case the
                activities constitute marketing, not securing loan applicants.

        In his June 11, 1992, response, Evans reversed his March 3 disapproval ofthe
compensation proposal at issue. Evans' June 11 letter unambiguously adopts the
rationale advanced in Moskowitz's March 13 letter quoted above. In particular, the June
11 letter stated as follows:

                Based on your description of [the marketing contractor's] activities, they
                appear to be acceptable general marketing activities. The lender's agent
                may be reasonably compensated for these presentations [to schools] and
                the D<martment does not prescribe the basis for the comgensation.

(Emphasis supplied.)

         Evans' June 11 letter does not even mention the fact that the compensation at issue in
that instance was "per application" rather than "per loan", even though the March 13 letter
to which it responded pointed that out. Accordingly, the June 11 Evans letter cannot be
read as endorsing such a distinction. Rather, its clear language, especially read in the
context of the arguments to which it was responding, confirmed that, in accordance with
the DCL, ED "does not prescribe the basis" for marketing compensation because
marketing, as distinguished from referrals, does not constitute "securing applicants".

         In 1995, after Evans's departure from ED, the Department abruptly, and without
explanation, reversed its position. In a June 7, 1995 letter to Moskowitz, Pamela Moran at
ED stated that "referral payments (including marketing fees) that are based on loans
disbursed [are] a violation" of the anti-inducements prohibition". Moran's letter
attempted to distinguish the June II, 1992 Evans letter because that guidance addressed a
proposal to compensate marketers based on applications received, rather than loans
disbursed. However, as noted above, the June II Evans letter made no such
distinction, but instead broadly disclaimed any authority for ED to "prescribe"
marketing compensation. Moreover, Moran's letter expressly treated marketing fees as a
type of referral fce, contrary to the interpretation in the DCL clearly treating the two as
separate and distinct.

        The June 7, 1995 Moran letter caused an immediate uproar in the FFELP
industry, which had long believed that, under the DCL, as well as the June II, 1992
Evans letter, marketing fees were not "prescribed" by ED, and that, therefore, per
loan marketing fees were permissible. On August 21, 1995, the Consumer Bankers
Association wrote to ED's Assistant Secretary for Postsecondary Education obj ecting
to the Moran letter. A number of individual program participants also contacted ED
to request that the Moran letter be applied prospectively only, pointing out that they
had relied on the June 11, 1992 Evans letter as authorizing the payment of marketing
fees on a per loan basis. Dr. Joe McCormick of ED acknowledged in an August 15,
1995 letter to Daniel Lau of Law Access, Inc., that there had been "apparent
confusion that existed in the past concerning this issue", and agreed to apply the
Moran interpretation only to loans made after that date.

        Subsequent private letter and email guidance from ED extended the purported
ban on per loan marketing fees to include fees paid on a per guaranteed application
basis, and to fees paid on subsequent loan requests made pursuant to a Stafford Loan
Master Promissory Note (MPN) with respect to which a per application marketing fee
had already been paid.

        Then, in 2002, ED ceased providing guidance to the public on the application of
the anti-inducements prohibition to specific issues, instead simply stating in response to
requests for such guidance that "the statute is clear". In response to a request for
clarification as to whether, in light of ED's view that the statute was clear, ED
would reconfirm its original position in the DCL and the June 11, 1992 Evans letter that
the statute does not cover marketing compensation. ED responded by reiterating that
the statute was clear, and that no further guidance was needed.

        One can readily reconcile ED's 2002 position that the statute is clear with ED's
original interpretation as stated in the DCL -- i.e., that marketing is different from



                                            -2-
"referring", does not constitute "securing applicants", and can be compensated as the
parties see fit. However, ED's post-June 1995 position cannot be reconciled with the
notion that "the statute is clear". The plain language of the statute does not make
distinctions based on the form of the payment or how it is calculated. See also DCL at 1
("The Department believes these provisions were broadly intended to prohibit the
direct or indirect offering or payment of any kind of financial incentive ... regardless
of the form of the incentive or its mode ofpayment."). Moreover, no reading ofthe
plain language of the statute could support the contention that paying a fee per application
is less aptly characterized as a payment in order to secure applicants than a fee paid per
loan.

        In 2003, ED reconsidered its refusal to provide guidance to the public on
inducements questions and, at that point, indicated that it would return to its post-
19951 pre-2002 view that marketing compensation paid on a per applicationiMPN
basis is permissible, but compensation paid on a per loan or per guaranteed
application/MPN basis is prohibited. ED officials have reiterated that position on
various occasions thereafter.

         ED's 2007 inducements \1llemaking created even more confusion on the
marketing compensation issue. In ED's June 12, 2007 Notice of Proposed
Rulemaking (NPRM), ED stated that "[marketing] compensation or fees based on the
number of applications ... are improper, regardless oflabel, under the Department's
current and prior policy and would continue to be improper under these proposed
regulations." 72 Fed. Reg 32424 (emphasis supplied). As the above recitation
illustrates, except for a brief period in 1992, ED had never taken the position that per
application marketing fees were problematic. When industry participants objected to
the preamble statement, ED officials confirmed in various emails that, notwithstanding
the preamble statement, its then-current policy permitted per application marketing
compensation. However, the preamble to the final regulations published on November
1, 2007, did not retract the NPRM preamble statement -- and even claimed that it was
the commenters that had mischaracterized current policy. However, the preamble also
states that current policy permits "reasonable [marketing] compensation ... based on
applications referred but not on loans funded or disbursed." 72 Fed. Reg. 61978.

         Given the confusion caused by the preamble to the NPRM, the industry was
hopeful that ED would use the November 1, 2007 final regulations to clearly and
definitively address the marketing compensation issue. It did not. The final regulations
prohibit "referral fees" but do not define that term. See 34 CFR 682.200 (definition of
"Lender", paragraph (5)(i)(A)(5»). The preambles to the NPRM and final regulations,
read together, appear to contemplate that, beginning July 1, 2008, marketing
compensation will not be permitted to be paid on a per application/MPN basis, but will be
permissible if paid on a flat fee basis. ED officials have indicated by telephone that this
is the case, and that "per lead" compensation will also be permissible, but ED has not yet
responded to a reqnest for written confirmation of that guidance submitted six (6) months
ago. Thus, the marketing compensation issue remains muddled to this day.




                                            -3-