GCU a 'captive client' to for-profit company, feds say

Rachel Leingang | The Republic | azcentral.com

The U.S. Department of Education will continue to treat Grand Canyon University like a for-profit entity because the school benefits a for-profit company and has significant overlap with that company, the department explained Tuesday.

The department's strongly-worded letter denying nonprofit status to the school calls into question whether the school operates mostly for the benefit of shareholders of a for-profit company. GCU is a "captive client" of that company, according to the department.

In particular, the department pointed out that GCU and Grand Canyon Education, the for-profit company that previously owned GCU and now provides services to the university and other institutions, share a key employee: Brian Mueller serves as president of the university and CEO of the for-profit company, the department noted.

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In addition, the department noted that many of the executive leaders responsible for managing GCU are actually employed by GCE.

The arrangement doesn't comport with the Higher Education Act and department regulations because "nonprofit institutions of higher education must operate for the benefit of the institution, not any other person or entity," said Angela Morabito, the department's press secretary, in an emailed statement.

The department's review "determined that it could not approve GCU as a nonprofit for purposes of its participation in federal financial aid programs because its operation is benefiting GCE," she said.

GCE is a publicly traded company.

Grand Canyon University, a private Christian university with a campus on the west side of Phoenix and a sizable online presence, has more than 100,000 students. It was a for-profit entity from 2004 until last year, when it received approval from its accreditor, the Internal Revenue Service and state regulators to once again become a nonprofit school.

The department's move surprised many and could signal trouble for other schools that have sought to convert to nonprofit status.

For-profit institutions are subject to more stringent regulations. For example, a 90/10 rule requires for-profit institutions to get no more than 90% of their revenue from federal financial aid programs.

The regulations were necessary, some policymakers and advocates argued, to protect students from exploitation by bad actors in the for-profit sector, some of whom graduated students with massive debt and minimal job prospects.

Under Betsy Devos, U.S. Secretary of Education for the Trump administration, the department has sought to repeal some rules enacted during President Barack Obama's administration. A regulation regarding gainful-employment for graduates was repealed this summer.

GCU repeatedly has said it didn’t return to nonprofit status to avoid for-profit regulations. Mueller said last week that GCU expects little to no impact on its operations because of the change.

A GCU spokesman said the university already "fully exceeds" the for-profit regulations set by the federal government. For instance, GCU is at 73% for 90/10 purposes, they said.

Department finds flaws

The decision was announced by Grand Canyon Education during an earnings call late last week.

On Tuesday, the department released a letter it sent to GCU on Nov. 6 explaining the decision. GCU also released a lengthy response to the department's letter.

The letters include insight into how the deal between GCU and GCE is structured. Under the terms, GCE will receive a "services fee" of 60% of revenue from tuition, various fees paid by students, sports ticket sales and operations for the hotel, golf course and arena, according to the department's letter.

But, the department notes, the cost to operate GCU will increase significantly, and not because of enhanced services. Citing a report prepared for GCE by Barclays, the department says the costs to operate GCU would increase from $810 million to nearly $1.5 billion for fiscal year 2019, solely because of the services fee.

Despite the fee, it's not always GCE that provides the services GCU pays for. In many of the operations, a third party is providing the services, the department said. As an example, the department said GCU couldn't get an outside payroll provider despite the fact that GCE uses a third party for payroll.

Overall, GCE is taking on 28% of the operating costs but receiving 60% of revenue under the agreement, the department said.

GCU disputed the department's math and interpretation of the Barclays report. The $1.5 billion figure refers to a hypothetical consolidated expense for both GCU and GCE, the university said.

"GCU's true operating expenses ... did not increase at all as a result of the transaction," GCU said.

The net income of both parties actually increased as a result of the separation, GCU said, largely because of reduced real estate taxes and stock-based compensation.

Department: Purpose is for shareholders

The department determined the services agreement and transaction's "primary purpose ... was to drive shareholder value for GCE with GCU as its captive client — potentially in perpetuity."

That means the school doesn't meet the department's test of whether it can qualify as a nonprofit for purposes of participation in federal aid programs, the department said. In particular, GCU failed to meet requirements that its primary activities and its revenue stream would benefit the nonprofit itself.

"This violates the most basic tenet of nonprofit status — that the nonprofit be primarily operated for a tax-exempt purpose and not substantially for the benefit of any other person or entity," the department wrote.

The letter notes Mueller's dual roles at GCU and GCE, calling them "obviously conflicting loyalties." In addition, nearly 75% of the executive team that oversee and manage GCU are employed by GCE, not the university, the department pointed out.

GCU said Mueller's dual role is permitted by its accreditor, the Higher Learning Commission, which had "far greater substantive interaction" with GCU during its review of the transaction. The boards of both GCU and GCE, which include no overlapping members, approved Mueller, GCU said.

The department said it was "skeptical" that any nonprofit could outsource so many of its functions and still be deemed the operator of the institution. The agreement gives GCE "enormous leverage" over GCU, the department said. And, as a "practical matter," GCU isn't the entity that's "actually operating the institution as is required under the Department's regulations."

A GCU spokesman said there's nothing to support the department's claim that GCE is exerting leverage in the university's operations. And, the university pointed out, Mueller is the only employee who works for both GCU and GCE.

The department also said GCU must stop any advertising or notices that refer to its "nonprofit status."

"Such statements are confusing to students and to the public, who may interpret such statements to mean that the Department considers GCU a nonprofit under its regulations," the department said.

GCU 'disappointed' by decision

In a lengthy statement in response to the department's letter, GCU said it was "surprised and disappointed" by the department's decision and that the department made "critical errors in its understanding of the facts and its application of the law in reaching its conclusion on this important decision."

GCU reiterated in the statement that it is "reviewing its options" to challenge the decision.

And the university seems to disagree that it must not identify itself as a 501c3 tax-exempt organization. Instead, it means the university must only comply with the increased for-profit regulations, which haven't been an issue for it and weren't a factor in its changed status, the university said.

GCU's response details efforts it has made over the past few years to discuss the potential change with the department, to no avail. GCU said the decision was arrived at without discussion with GCU over the department's concerns and is thus "replete with errors that easily could have been avoided."

The transaction wasn't entered into lightly, GCU contends: It was reviewed by several independent advisers from the tax, legal, real estate and financial fields.

And the department's decision doesn't analyze GCU's track record of success, the university says. It hasn't increased tuition in 12 years on its physical campus and its students' outcomes have been positive, it said.

Reach reporter Rachel Leingang by email at rachel.leingang@gannett.com or by phone at 602-444-8157, or find her on Twitter and Facebook.

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