By Jennifer Harper and Gregg Clifton
The U.S. Department of Education has published a new rule that, among other measures aimed at strengthening federal student aid programs, prohibits all institutions participating in programs under Title IV of the Higher Education Act of 1965, as amended (HEA), from paying any incentive compensation based directly or indirectly on securing student enrollments or financial aid; The Department’s final regulations, issued on October 29, 2010, abolish 12 safe harbor provisions specifically carved out from the general prohibition on incentive compensation in the 2002 amendments to the Higher Education Act.
The final regulations, which go into effect on July 1, 2011, apply to personnel at all levels, including athletic directors and coaches, who are “engaged in any student recruitment or admission activit[ies],” including “higher level employee[s] with responsibility for recruitment or admission of students;” The Department’s interpretation of the statutory prohibition on incentive compensation is expansive. Of particular interest to collegiate athletic programs, the final regulations contain a broader definition of “securing enrollment” that covers incentive pay based on non-enrollment factors such as program completion and graduation. At the same time, however, the Department stated in its comments that incentive compensation based on team athletic performance would not be considered prohibited.
History of the Ban on Incentive Compensation
In 1992, Congress amended the Higher Education Act to ban educational institutions from using any “commission, bonus, or other incentive payment” based directly or indirectly on “securing enrollments or financial aid;” The purpose of the law was to eliminate reported abuses in the recruiting and admissions process, particularly in the enrollment of unqualified students.
Prior to the 1992 amendment, a loophole in the law permitted educational institutions to keep federal financial aid even if the student did not enroll or attend the institution’s program. Congress believed that some institutions were engaging in unethical student recruiting practices designed to increase federal financial aid to the schools. Incident to this practice, some schools paid incentive commissions to recruiters and admissions officers based solely on rising enrollment counts. Not surprisingly, the student loan default rate skyrocketed as an increasing number of unqualified students enrolled in programs but eventually dropped out or failed to attend. By 1990, the average default rate at all schools was at an all-time high of 22;4 percent; Press Release, U;S; Dept; of Education, “Student Loan Default Rates Increase,” (September 14, 2009).
Meanwhile, the government was unable to recoup its financial investment while “rogue” schools pocketed the remaining financial aid;
To eradicate the misuse of federal funds and reform the student admissions process, Congress amended the Higher Education Act to prohibit schools from linking any kind of incentive payments to student enrollment numbers or financial aid receipts. Schools were required to return unused financial aid and the Department of Education was empowered to prohibit a school from participating in the Title IV program if its default rates were too high. The Department of Education was authorized to investigate complaints and impose penalties upon schools and third parties found in violation of the statute.
After the amendments, more than 1100 schools were terminated from participation in the Title IV program. Many “rogue” schools were shut down and the student loan default rate dropped; By 2002, the U;S; Department of Education recognized that “most of [the] unscrupulous institutions were terminated from participating in Title IV HEA programs because of their high cohort default rate” and the opportunity for institutions to keep Title IV financial aid money awarded to unqualified students was “no longer possible;” Federal Student !id Programs, U;S; Dept; of Education, 67 Fed; Reg; 67054 (Nov. 1, 2002).
The Rise of Safe Harbors
Despite initial success, the 1992 amendments proved difficult to apply in practice. Terms such as “incentive pay” and “securing enrollment” were vague and undefined; The statute was silent on what constituted an incentive that was “indirectly” based on securing enrollment; It was equally unclear whether the prohibition applied to compensation arrangements only partly based on student enrollment or financial aid receipts.
From 1992 to 2002, the Department attempted to resolve questions about the scope and meaning of the statute through informal guidance. But this led to contradictions in interpretation and confusion in application. Thus, in 2002, the Department issued new regulations designed to clarify its position. After extensive consultation with educational institutions and other interested organizations, the Department identified 12 compensation arrangements that it deemed not to violate the ban. These “safe harbors” were set out in the 2002 regulations, and can be summarized as follows:
12 Safe Harbors
1. Adjustments to employee compensation—34 CFR 668.14(b)(22)(ii)(A)
2. Enrollment in programs that are not eligible for Title IV program funds—34 CFR 668.14(b)(22)(ii)(B)
3. Payment for arranging contracts with employers to provide training—34 CFR 668.14(b)(22)(ii)(C)
4. Profit-sharing or bonus payments—34 CFR 668.14(b)(22)(ii)(D)
5. Compensation based upon students completing their educational programs—34 CFR 668.14(b)(22)(ii)(E)
6. Payments to employees for pre-enrollment activities—34 CFR 668.14(b)(22)(ii)(F)
7. Compensation to managerial and supervisory employees not involved in admissions or financial aid—34 CFR 668.14(b)(22)(ii)(G)
8. Token gifts—34 CFR 668.14(b)(22)(ii)(H)
9. Profit distributions—34 CFR 668.14(b)(22)(ii)(I)
10. Internet-based recruiting activities—34 CFR 668.14(b)(22)(ii)(J)
11. Payments to third parties for non-recruiting services to the school—34 CFR 668.14(b)(22)(ii)(K)
12. Payments to outside entities for recruiting or admissions activities—34 CFR 668.14(b)(22)(ii)(L)
Among the safe harbors is compensation based upon students completing their educational programs, or Safe Harbor (E). Incentives based on successful completion of all or a portion of a student’s educational program are often considered in drafting compensation plans for athletic personnel, particularly head coaches. In 2002, the Department permitted this form of compensation on the premise that the statutory prohibition was intended to prevent abuses on the “front-end” of the enrollment process; that is, the admission of unqualified students. Under Safe Harbor (E), the Department reasoned that “a student who successfully completes an educational program in which he or she was enrolled means, for this purpose, that the student was qualified to attend the institution;” 67 Fed. Reg. 67056.
For similar reasons, Safe Harbor (G) allowed schools to make incentive payments to personnel who were not directly involved in the admissions or financial aid process, such as presidents, supervisors, and athletic personnel.
Together, Safe Harbors (E) and (G) allowed schools to make incentive payments to athletic staff based on academic performance factors such as program completion, graduation, and student grades. Debates abound on whether bonuses designed to increase student performance are effective, but one of the convincing reasons to include pay incentives for academic completion and graduation rates is the need to appropriately balance educational objectives. This is especially pertinent in collegiate athletics where students and coaches alike can feel extreme pressure to exceed on the field, sometimes at the expense of academic study. Indeed, the Department once commented, “[A]s a general matter, retention and completion of programs by students is a positive result that should be encouraged.” 67 Fed. Reg. 67056. However, under the new regulations, this is no longer an acceptable objective.
The New Regulations
On October 29, 2010, the Department issued final regulations regarding the ban on incentive compensation. The new rule requires that an institution accepting Title IV funds
will not provide any commission, bonus or other incentive payment based in any part, directly or indirectly, upon success in securing enrollments or the award of financial aid, to any person or entity who is engaged in any student recruitment or admission activity, or in making decisions regarding the awarding of title IV, HEA program funds.
34 CFR 668.14(b)(22)(i) (as amended). Among other changes to existing law, the Department eliminated all of the safe harbors it established in the 2002 amended regulations.1 Barring certain interpretive flexibility, Safe Harbors (E) and (G) are no longer available.
In addition to removing the safe harbors, the Department made some important changes to the scope of the prohibition. Under the new regulations, the Department defined “securing enrollment” in part to mean “activities that a person or entity engages in… for the purpose of the admission or matriculation of students for any period of time….” 34 CFR 668.14(b)(22)(iii)(B). The Department further defined “securing enrollment” to include recruitment “contact in any form with a prospective student…..” Id. The Department offered a few examples such as preadmission activities, scheduling an appointment and visiting the enrollment office, or signing an enrollment agreement or financial aid application; however, the definition contemplates any form of contact.
The Department also explained what is meant by incentive payment: “Commission, bonus, or other incentive payment means a sum of money or something of value, other than a fixed salary or wages, paid to or given to a person or an entity for services rendered;” 34 CFR 668.14(b)(22)(iii)(A). The definition of incentive payment appears to reject the more limited interpretation once held by some in which “incentive payment” was a mere synonym for commission or bonus.
Some institutions noted the Department’s definitions create the same ambiguities that led to the safe harbors in the first place. But the Department disagreed, stating:
We believe that institutions can readily determine if a payment or compensation is permissible under section 487(a)(20) of the HEA by analyzing—
(1) Whether it is a commission, bonus, or other incentive payment, defined as an award or a sum of money or something of value paid to or given to a person or entity for services rendered; and
(2) Whether the commission, bonus, or other incentive payment is provided to any person based in any part, directly or indirectly, upon success in securing enrollments or the award of financial aid, which are defined as activities engaged in for the purpose of the admission or matriculation of students for any period of time or the award of financial aid.
If the answer to each of these questions is yes, the commission, bonus, or incentive payment would not be permitted under the statute.
75 Fed. Reg. 66873.
The Department explained the two-part test is for guidance only, and that institutions may decide to use the test or not. But even if schools do follow the two-part test, it does not offer anything that cannot be gleaned from the statute itself.
The Impact on Compensation to Athletic Personnel
The new regulations bring incentive compensation to athletic staff within the ambit of the prohibition. With regard to Safe Harbor (E), the Department reversed its prior position that incentive payments based on program completion did not constitute “enrollment.” Instead, the Department commented, “[W]e believe that paying bonuses to recruiters based upon retention, completion, graduation, or placement remain in violation of the HEA’s prohibition on the payment of incentive compensation;” 75 Fed. Reg. 66874.2 Thus, under the new regulations, the Department makes it a violation of the Act if incentive payments are tied to program completion or graduation rates, directly or indirectly.
On the other hand, the Department’s comments regarding the elimination of Safe Harbor (G) indicate that coaches who are paid bonuses for team academic performance are exempt from the prohibition on incentive compensation. As noted, Safe Harbor G was designed to exclude from the prohibition those managerial and supervisory personnel who were not directly involved in the recruiting process. In eliminating Safe Harbor G, the Department explained the prohibition will cover all employees who are engaged in any student recruitment, including any “higher level employee with responsibility for recruitment or admission or students;” The Department specifically included athletic personnel as employees governed by the restrictions, reasoning that “recruitment of student athletes is not different from recruitment of other students;” 75 Fed. Reg. 66875. The Department stated in its comments, however, that incentive compensation based on team athletic performance would not be considered prohibited:
….the Department does not consider “bonus” payments made to coaching staff or other athletic department personnel prohibited if they are rewarding performance other than securing enrollment or awarding financial aid, such as a successful athletic season, team academic performance, or other measures of a successful team.
75 Fed. Reg. 66875.
The Department’s comments were in response to questions by some institutions as to whether incentive compensation to coaches based on program completion and graduation rates is prohibited. The Department’s answer does not directly address whether bonuses paid according to program completion and graduation rates are exempted in the athletic context. While it is reasonable to consider program completion and graduation a form of academic performance, the Department’s strong stance against the exclusion of such factors in its elimination of Safe Harbor E appears to have created a split position. Perhaps unintentionally, the Department has drawn a line between two factors that, for student athletes, are often part of the same continuum.
The Department’s interpretation of the ban on incentive compensation suggests that any incentive offered or provided to athletic personnel based in whole or in part on recruiting and retaining students (including student-athletes) will be covered by the Act. With the elimination of Safe Harbor E, the Department made any incentive compensation based on program completion or graduation rates a violation of the Act. But the Department’s comments in eliminating Safe Harbor G offer some flexibility when it comes to team academic performance. Thus, bonuses paid according to academic performance—such as team GPAs or team academic improvement—appear to be acceptable, but bonuses paid according to program completion and graduation rates likely are not. The conflict between the Department’s strict reading of the prohibition under Safe Harbor E and its more practical reading under Safe Harbor G will make it difficult to apply the prohibition when it comes to the unique compensation arrangements that often accompany high-level athletic personnel, such as head coaches. While the Department may clarify its position in the future, it has indicated the agency will not entertain individual questions regarding specific circumstances:
To the extent that ongoing questions arise on a particular aspect of the regulations, the Department will respond appropriately in a broadly applicable format and will distribute the information widely to all participating institutions. This response may include a clarification in a Department publication, such as the Federal Student Aid Handbook or a Dear Colleague Letter. The Department does not intend to provide private guidance regarding particular compensation structures in the future and will enforce the regulations as written.
75 Fed. Reg. 66875.
In light of the Department’s reluctance to offer specific guidance, it is likely some of the less certain aspects of the final regulations will play out in enforcement.
The Department’s final regulations take effect July 1, 2011. During this grace period, it is critical that all Title IV recipients, including non-profit educational institutions, re-examine their policies and procedures regarding incentive compensation and conduct a thorough review of their contracts with employees and third parties to ensure they are in compliance with the new rules. The review should include compensation plans for athletic personnel. Title IV recipients should engage in a three-part review that focuses (1) on whether the compensation plan as written complies with the new regulations; (2) if not, how the plan can be drafted or revised to ensure compliance; and (3), how the institution can effectively negotiate compensation plans with athletic personnel that will achieve the school’s long and short-term goals while remaining consistent with the law. Because contracts with head coaches are often negotiated in great detail, and include specific achievement incentives, we do not recommend a generic review of compensation plans. For more information about how the new regulations affect incentive compensation in collegiate athletics, or for assistance with achieving compliance under the new regulations, please contact Gregg Clifton at gregg.clifton@jacksonlewis.com or Jennifer Harper at harperj@jacksonlewis.com.
Harper and Clifton are attorneys at Jackson Lewis. Clifton can be reached at Gregg.Clifton@jacksonlewis.com
1 Incentive compensation remains permissible with respect to the recruitment of foreign students, who are ineligible for financial aid. Merit-based compensation that is not based on securing enrollments or financial aid is also permissible.
2 The Department’s reasoning was as follows:
Such compensation is “indirectly” based upon securing enrollments–unless the student enrolls, the student cannot successfully complete an educational program, and with the proliferation of short-time, accelerated programs, the potential exists for shorter and shorter programs, and increased efforts to rely upon this “safe harbor” to incentivize recruiters; This safe harbor may lead to lowered or misrepresented admissions standards and program offerings, lowered academic progress standards, altered attendance records, and a lack of meaningful emphasis on retention.
U.S. Dept. of Education Issue Paper #4.
