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ITT/ESI Fraud Investigated by the SEC

False Promises of Jobs and Student Loan Defaults are Ethical Concerns

Perhaps you heard that ITT Educational Services, Inc (ESI) is involved in an enforcement action with the SEC. The SEC has taken issue with ESI's handling and disclosure of complex accounting issues that arose several years ago and disclosures about its student loan programs.

ITT/ESI provides technology-oriented undergraduate and graduate degree programs through its accredited postsecondary institutions, ITT Technical Institutes and Daniel Webster College, to help students develop skills and knowledge that they can use to pursue career opportunities in a variety of fields. It owns and operates more than 130 centers of learning. ITT/ESI serves approximately 50,000 students at its campuses in 39 states and online.

According to the company, throughout the relevant time period it repeatedly expanded its disclosures in an effort to present material information to investors.  It also contends that it repeatedly conferred with outside experts, as well as its outside, registered independent auditor, PricewaterhouseCoopers (PwC).  The company claims to have shared extensive information with these experts to confirm that its accounting treatment was reasonable and appropriate. 

ESI has reached out to the U.S. Department of Education, accrediting agencies and appropriate state regulatory authorities to ensure they understand the company's legal and financial position. According to a spokesperson at ESI, “We look forward to helping ensure that they have all of the information necessary to inform their judgment, and to share the basis for our strong views about the misguided and inappropriate nature of the SEC's action.  We would expect any regulator would refrain from taking any action against the company, and thereby against our students and employees, until we have had our day in court.”

In its fraud charges against the company, the SEC says that ITT/ESI and two of its executives, CEO Kevin Modany and CFO Daniel Fitzpatrick, hid financial information from the company's investors regarding the "poor performance and looming financial impact of two student loan programs that ITT financially guaranteed."

The suit broadly charges that Modany and Fitzpatrick concealed from investors the “extraordinary failure” of two off-balance-sheet student loan programs ITT helped set up six years ago after the financial crisis shut down the market for traditional private education loans.

The SEC alleges that the pair “routinely misled” its auditor on numerous fronts—including by not sharing internal projections that showed big problems brewing—which “helped to further the defendants’ fraudulent scheme.”

“Our complaint alleges that ITT’s senior-most executives made numerous material misstatements and omissions in its disclosures to cover up the subpar performance of student loans programs that ITT created and guaranteed,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement. “Modany and Fitzpatrick should have been responsible stewards for investors, but instead, according to our complaint, they engineered a campaign of deception and half-truths that left ITT’s auditors and investors in the dark concerning the company’s mushrooming obligations.”

As for PwC, its name never appears in the 56-page fraud lawsuit that the SEC filed in May. The Big-4 accounting firm had served as the ITT’s outside auditor for at least two decades before it abruptly announced last November it would step down.

The SEC refers to PwC only generically, as the company’s “external auditor.” But it is clear SEC investigators have discussed accounting matters with the firm from the language of the enforcement action.

From an accounting perspective, the issue is whether the auditors were purposefully misled by management and, more important, whether PwC should have followed sufficient procedures to ferret out the fraud. Auditors are expected to look for the red flags that fraud may exist, and then increase their investigation to properly identify and report it. It does not appear from the limited information available at this time that PwC lived up to its ethical obligations in this regard.

The failure of PwC seems to be its inability to exercise the degree of professional skepticism that would have uncovered the fraud. The firm did not ask enough probing questions about the student loan programs to discover the fraud.

As for ITT, it maintains that: “Nowhere in the complaint is there a citation to a document or email that evidenced any intent to deceive anyone. The company believes that the SEC should not have brought an action because the key ingredient of scienter, knowledge of the fraud, did not exist. Time will tell whether sufficient evidence is discovered to establish intent, an essential act for the fraud charges to be sustained.

The for-profit educational industry has taken big hits during the past few years. Some make false promises about job availability at the end of the educational road, such as Corinthian, which was investigated in recent years for its predatory lending practices and misrepresented job placement rates. It was shut down for good on April 27. Students enrolled at Corinthian colleges at that time were eligible for closed school loan discharge if they gave up any credits earned. If they chose to transfer and keep their credits, their federal loans remained.

Now, the students who attended the Corinthian colleges are refusing to pay back their federal loans. The students argue their schools scammed them and the federal government was complicit because it funded for-profits like Corinthian. Some students called on Education Secretary Arne Duncan to forgive their loans -- something politicians such as Sen. Elizabeth Warren (D-Mass.), and Sen. Dick Durbin, (D-Ill.), have pushed for in their own letters to the department.

It seems as though student concerns have not fallen on deaf ears. The Obama administration announced earlier in the week that it would forgive the loans if students can show they were lured to the colleges by fraudulent recruiting. The only problem is the high cost of the policy to the American taxpayer, as much as $3.5 billion. Still, it is the right thing to do -- the ethical thing to do.

Something needs to be done to insure that other for-profit institutions are not playing fast and loose with its promises of job placement thereby misleading students who trust that these institutions will not only provide needed technical training but help to find them jobs at the end of the educational road. This is an ethical issue because it affects thousands of students involved with these colleges and the ability of such technical training schools to provide a pool of capable workers in the increasingly competitive global economy.

Institutional responsibility is the issue of importance in the ITT/ETS situation. If, as the SEC contends, the institution misled the students and public about their student loan programs, then the government should hold it to account for its actions.

Blog posted by Dr. Steven Mintz, aka Ethics Sage, on June 11, 2015. Professor Mintz is on the faculty of the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at: