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This Government Rule Should Make You Irate

By Brian Stoffel - Updated Apr 6, 2017 at 9:27PM

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The gainful employment rule has no teeth.

As a former teacher, I've been following the for-profit industry intensely as it has self-destructed over the past year. To say that I'm not a fan of the industry would be a vast understatement.

And yet, last month I went looking to see if there was a diamond in the minefield of for-profit education. Before yesterday, there were three key rules -- as laid out by the Department of Education -- which investors needed to consider before putting their hard-earned cash toward the sector:

  1. New student enrollment numbers.
  2. Adherence to federal funding guidelines.
  3. Student loan default rates.

As of today, we can add a fourth metric to our list: gainful employment rules, which were released yesterday by the Department of Education. The new rules go into effect in July 2012.

A boost for the industry
By far the most contentious piece of legislation, the gainful employment rules are a far cry from what they were before the for-profit education industry sent their lobbyists to Washington. This almost immediately created a boost for investors in the sector, as stock prices sky-rocketed upon market opening today.

The following chart shows percent increases for education stocks on today's market opening.

School

Close on June 1, 2011

Open on June 2, 2011

Change

Corinthian (Nasdaq: COCO) $3.99 $5.44 36.34%
ITT (NYSE: ESI) $70.73 $89.12 26.00%
Education Management $20.30 $25.42 25.22%
Strayer $121.87 $147.88 21.34%
Career Education $22.87 $27.02 18.15%
Lincoln (Nasdaq: LINC) $14.59 $17.06 16.93%
Grand Canyon (Nasdaq: LOPE) $12.82 $14.79 15.37%
DeVry $53.99 $61.75 14.37%
Capella (Nasdaq: CPLA) $47.98 $54.02 12.59%
Apollo Group (Nasdaq: APOL) $42.19 $46.90 11.16%
Bridgepoint (NYSE: BPI) $23.68 $26.30 11.06%
Washington Post (Kaplan) $405.96 $445.99 9.86%
Universal Technical Institute $17.40 $19.09 9.71%
American Public $43.50 $46.72 7.40%

Source: Google Finance.

Shame on the Department of Education
There are three provisions of the gainful employment rule. To avoid punishment, a school need only pass one of these three rules. To lose federal funding, a school would need to fail all three tests for three years in a four-year span.

Below, I've provided a chart of the rules, along with what I consider to be major flaws in the rules.

Provision

Rule

What's wrong with it?

1 At least 35% of former students must be actively paying down their loans. With such a low threshold, schools could have almost two-thirds of their students not paying off their loans and they would pass.
2 Graduates cannot be spending 30% or more of their discretionary income on loan payments To be honest, I'm baffled at how the Department of Education will go about collecting information for this. How will "discretionary income" be determined? It seems to me there's lots of room for distortion in this provision.
3 Graduates cannot spend more than 12% of their income on loan payments I actually think this rule makes sense and -- using tax forms -- can be easily followed.

Even though I think one of the provisions makes sense, the fact that two don't is a huge flaw. Again, a school need only pass one of these criteria to pass the gainful-employment test.

Foolish takeaway
I'm disappointed that the Department of Education didn't take stronger action with this rule. Knowing this, I think the student loan default rate is the most important metric for investors to keep their eye on. It is really able to measure whether an education at these schools creates enough earnings potential for students to justify its cost. It's also less susceptible to manipulation by the schools.

With student enrollments declining and more and more traditional universities offering online courses, I'm still a bear on the industry in general. What do you think of today's news? Sound off in the comments section below, and don't forget to add these companies to your watchlist.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Apollo Education Group, Inc. Stock Quote
Apollo Education Group, Inc.
APOL
ITT Educational Services Inc. Stock Quote
ITT Educational Services Inc.
ESINQ
Zovio Inc Stock Quote
Zovio Inc
ZVO
$1.45 (-0.69%) $0.01
Grand Canyon Education Stock Quote
Grand Canyon Education
LOPE
$75.33 (1.37%) $1.02
Capella Education Company Stock Quote
Capella Education Company
CPLA
Lincoln Educational Services Corporation Stock Quote
Lincoln Educational Services Corporation
LINC
$7.86 (6.07%) $0.45

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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