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| 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                                 |
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## 

## 

## FINAL AUDIT REPORT

![](media/image1.wmf){width="2.5in" height="2.497916666666667in"}

**ED-OIG/A09H0017**

**January 2009**

+-------------------------+----------------------+---------------------+
| Our mission is to       | ![](media/image      | U.S Department of   |
| promote the efficiency, | 2.png){width="0.8in" | Education           |
| effectiveness, and      | height="0.8in"}      |                     |
| integrity of the        |                      | Office of Inspector |
| Department\'s programs  |                      | General             |
| and operations.         |                      |                     |
|                         |                      | Sacramento,         |
|                         |                      | California          |
+-------------------------+----------------------+---------------------+

> 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.
>
> ![](media/image3.wmf)**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

TABLE OF CONTENTS

####### Page

[**EXECUTIVE SUMMARY 1**](#__RefHeading___Toc210462264)

[BACKGROUND 3](#__RefHeading___Toc210462265)

[AUDIT RESULTS 4](#__RefHeading___Toc210462266)

[FINDING NO. 1 -- Fifth Third Bank, as an ELT, Violated the Prohibition
on Offering Inducements 4](#__RefHeading___Toc210462267)

[FINDING NO. 2 -- Fifth Third Bank's Policies and Procedures for
Monitoring its ELT Agreements Need To Be Improved
14](#__RefHeading___Toc210462268)

[OTHER MATTER 19](#__RefHeading___Toc210462269)

[OBJECTIVES, SCOPE, AND METHODOLOGY](#__RefHeading___Toc210462270) 20

[ENCLOSURE 1: Fifth Third Bank's ELT Agreements as of June 30,
2007](#__RefHeading___Toc210462271) 21

[ENCLOSURE 2: Fifth Third Bank's Comments on the Draft Report
23](#__RefHeading___Toc210462272)

[ENCLOSURE 3: SLX's Comments on the Draft
Report](#__RefHeading___Toc210462273) 75

[]{#__RefHeading___Toc210462264 .anchor}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.

[]{.mark}

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. []{.mark}

[]{.mark}

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.

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.

[]{#__RefHeading___Toc210462265 .anchor}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.

[]{#__RefHeading___Toc210462266 .anchor}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.

[]{#__RefHeading___Toc210462267 .anchor}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]

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.

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

-   [Student Loan Forward Commitment Sale/Purchase
    Agreement]{.underline}. 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]{.underline}. 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]{.underline}. 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]{.underline}. 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-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**         |            |                                        |
+----------------+------------+----------------------------------------+
| **Entity**     | **LID**    | **Total Loans Originated Under LID**   |
|                |            | (a)                                    |
+----------------+------------+----------------------------------------+
|                |            | **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.          |            |                                        |
+----------------+------------+----------------------------------------+

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]{.underline}. 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]{.underline}. 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  {#recommendations .RptSubcaption}

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

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.

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 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]{.underline}, 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.

```{=html}
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```
-   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. 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). 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]{.underline}. 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]{.underline} 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]{.underline}. 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 loans through the related agreements that SLX and its other
subsidiaries had with MSA, PLP, and LSF.

[Inducements to MSA, PLP, and LSF]{.underline}. 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]{.underline}.
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]{.underline}. 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:

> 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]{.underline}. 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]{.underline}. 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]{.underline}
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]{.underline}. 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.

[]{#__RefHeading___Toc210462268 .anchor}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---

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:

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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.

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.

**Recommendations**

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

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

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 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.

[]{#__RefHeading___Toc210462269 .anchor}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.

[]{#__RefHeading___Toc210462270 .anchor}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.

[]{#__RefHeading___Toc210462271 .anchor}ENCLOSURE 1: Fifth Third Bank's
ELT Agreements as of June 30, 2007

+-------------------+--------+-----------+-----------------------------+
| **Entities That   | **     | **Other   | **Additional Entities That  |
| Signed the**      | LIDs** | Entities  | Signed**                    |
|                   |        | Named in  |                             |
| **ELT Agreement** |        | the ELT   | **Related Agreements**      |
|                   |        | Ag        |                             |
| **(In addition to |        | reement** |                             |
| Fifth Third Bank  |        |           |                             |
| as Eligible       |        |           |                             |
| Lender Trustee)** |        |           |                             |
+-------------------+--------+-----------+-----------------------------+
| Student Loan      | 833860 | ELT       | Not reviewed. OIG review    |
| Xpress, Inc.      |        | refers to | was limited to the          |
|                   | 833890 | "certain  | information contained in    |
| (CIT Group, Inc.) |        | af        | the current and prior ELT   |
|                   | 833908 | filiates" | agreements between Fifth    |
| (Includes LID     |        | of SLX,   | Third Bank and SLX.         |
| from former ELT   | 834011 | but does  |                             |
| agreement with    |        | not name  |                             |
| Education Lending | 834160 | the       |                             |
| Services, Inc.)   |        | specific  |                             |
|                   |        | entities. |                             |
+-------------------+--------+-----------+-----------------------------+
| Education Funding | 834042 | None      | Not applicable. FFELs were  |
| Capital           |        |           | not originated under this   |
|                   | (Agre  |           | LID. FFELs transferred to   |
| Trust -- II (CIT  | ements |           | this LID are held in the    |
| Group, Inc.)      | have   |           | trust as security for funds |
|                   | same   |           | obtained from investors.    |
|                   | LID)   |           |                             |
+-------------------+--------+-----------+-----------------------------+
| Education Funding |        | None      |                             |
| Capital Trust --  |        |           |                             |
| III (CIT Group,   |        |           |                             |
| Inc.)             |        |           |                             |
+-------------------+--------+-----------+-----------------------------+
| Education Funding |        | None      |                             |
| Capital Trust --  |        |           |                             |
| IV (CIT Group,    |        |           |                             |
| Inc.)             |        |           |                             |
+-------------------+--------+-----------+-----------------------------+
| Business          | 834179 | None      | Not reviewed. Fifth Third   |
| Financial         |        |           | Bank notified FSA on        |
| Solutions, Inc.,  | (See   |           | November 1, 2007 that the   |
| dba Academic      | Note)  |           | trust was transferred to    |
| Financial         |        |           | U.S. Bank. The Department   |
| Services;         |        |           | informed us that the        |
|                   |        |           | transfer did not take       |
|                   |        |           | place.                      |
+-------------------+--------+-----------+-----------------------------+
| Student Loan      | 834196 | Education | Education Lending Services, |
| Xpress, Inc.      |        | Loan      | Inc. *(Loan and Security    |
| [and]{.underline} | (See   | Servicing | Agreement)*                 |
| Pacific Loan      | Note)  | Co        |                             |
| Processors        |        | rporation | Education Loan Servicing    |
|                   |        |           | Corporation *(Consolidation |
|                   |        | (CIT      | Loan Origination and        |
|                   |        | Group,    | Servicing Agreement)*       |
|                   |        | Inc.)     |                             |
|                   |        |           | Student Loan Xpress, Inc.   |
|                   |        |           | *(Student Loan Forward      |
|                   |        |           | Commitment Sale/Purchase    |
|                   |        |           | Agreement)*                 |
+-------------------+--------+-----------+-----------------------------+
| FinanSure Student | 834204 | None      | Sallie Mae, Inc.            |
| Loans, LLC        |        |           | *(Revolving Financing       |
|                   | (The   |           | Agreement)*                 |
|                   | two    |           |                             |
|                   | ELT    |           | Sallie Mae, Inc.            |
|                   | agre   |           | [and]{.underline} SLM       |
|                   | ements |           | Education Credit Finance    |
|                   | have   |           | Corporation *(Contract for  |
|                   | the    |           | Sallie Mae, Inc. to         |
|                   | same   |           | originate and service       |
|                   | LID)   |           | consolidation loans and SLM |
|                   |        |           | Education Credit Finance    |
|                   | (See   |           | Corporation to purchase     |
|                   | Note)  |           | consolidation loans)*       |
|                   |        |           |                             |
|                   |        |           | 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    |        |           |                             |
+-------------------+--------+-----------+-----------------------------+
| **Entities That   | **     | **Other   | **Additional Entities That  |
| Signed the**      | LIDs** | Entities  | Signed**                    |
|                   |        | Named in  |                             |
| **ELT Agreement** |        | the ELT   | **Related Agreements        |
|                   |        | Ag        | Obtained**                  |
| **(In addition to |        | reement** |                             |
| Fifth Third Bank  |        |           | **During Our Review**       |
| as Eligible       |        |           |                             |
| Lender Trustee)** |        |           |                             |
+-------------------+--------+-----------+-----------------------------+
| Student Loan      | 834241 | Education | Education Lending Services, |
| Xpress, Inc.      |        | Loan      | Inc. *(Loan and Security    |
|                   | (See   | Servicing | Agreement)*                 |
| (CIT Group, Inc.) | Note)  | Co        |                             |
| [and]{.underline} |        | rporation | Education Loan Servicing    |
|                   |        |           | Corporation *(Consolidation |
| Law School        |        | (CIT      | Loan Origination and        |
| Financial, Inc.   |        | Group,    | Servicing Agreement)*       |
|                   |        | Inc.)     |                             |
| []{.mark}         |        |           | Student Loan Xpress, Inc.   |
|                   |        |           | (*(Student Loan Forward     |
| []{.mark}         |        |           | Commitment Sale/Purchase    |
|                   |        |           | Agreement)*                 |
+-------------------+--------+-----------+-----------------------------+
| Student Loan      | 834243 | Education | Education Lending Services, |
| Xpress, Inc.      |        | Loan      | Inc. *(Loan and Security    |
|                   | (See   | Servicing | Agreement [and]{.underline} |
| (CIT Group, Inc.) | Note)  | Co        | Administration Agreement)*  |
| [and]{.underline} |        | rporation |                             |
|                   |        |           | Education Loan Servicing    |
| MSA Solutions,    |        | (CIT      | Corporation *(Consolidation |
| Inc.              |        | Group,    | Loan Origination and        |
|                   |        | Inc.)     | Servicing Agreement)*       |
|                   |        |           |                             |
|                   |        |           | Student Loan Xpress, Inc.   |
|                   |        |           | (*(Student Loan Forward     |
|                   |        |           | Commitment Sale/Purchase    |
|                   |        |           | Agreement)*                 |
+-------------------+--------+-----------+-----------------------------+
| Student Lending   | 834254 | None      | Not reviewed. Student       |
| Works, Inc.       |        |           | Lending Works is the single |
|                   | (See   |           | nonprofit private student   |
|                   | Note)  |           | loan lender designated by   |
|                   |        |           | the State of Ohio (LID      |
|                   |        |           | 834225).                    |
+-------------------+--------+-----------+-----------------------------+
| Erie Processing   | 834311 | None      | Sallie Mae, Inc.            |
| Corporation       |        |           | *(Revolving Financing       |
|                   | (See   |           | Agreement)*                 |
|                   | Note)  |           |                             |
|                   |        |           | Sallie Mae Servicing *(Loan |
|                   |        |           | Origination and Management  |
|                   |        |           | Services Agreement)*        |
|                   |        |           |                             |
|                   |        |           | SLM Education Credit        |
|                   |        |           | Finance Corporation         |
|                   |        |           | *(Master Loan Sale Terms)*  |
+-------------------+--------+-----------+-----------------------------+
| Nova Southeastern | 834317 | None      | Sallie Mae, Inc.            |
| University, Inc.  |        |           | *(Revolving Financing       |
|                   | (See   |           | Agreement)*                 |
|                   | Note)  |           |                             |
|                   |        |           | Sallie Mae, Inc.            |
|                   |        |           | [and]{.underline} 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  | 834319 | None      | Sallie Mae, Inc.            |
| Chiropractic      |        |           | *(Revolving Financing       |
|                   | (See   |           | Agreement)*                 |
|                   | Note)  |           |                             |
|                   |        |           | Sallie Mae, Inc.            |
|                   |        |           | [and]{.underline} 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   | 834338 | Student   | Education Lending Services, |
| Professional      |        | Loan      | Inc *(Loan and Security     |
| Psychology, Inc.  | (See   | Xpress,   | Agreement)*                 |
|                   | Note)  | Inc.      |                             |
|                   |        |           | Great Lakes Educational     |
|                   |        | (CIT      | Loan Services, Inc          |
|                   |        | Group,    | *(Student Loan Origination  |
|                   |        | Inc.)     | and Servicing Agreement**)* |
|                   |        |           |                             |
|                   |        | \[Only    | Student Loan Xpress, Inc.   |
|                   |        | mentioned | *(Student Loan Forward      |
|                   |        | in        | Commitment Sale/Purchase    |
|                   |        | Com       | Agreement)*                 |
|                   |        | pensation |                             |
|                   |        | section.  |                             |
|                   |        | Provides  |                             |
|                   |        | that SLX  |                             |
|                   |        | will      |                             |
|                   |        | c         |                             |
|                   |        | ompensate |                             |
|                   |        | Fifth     |                             |
|                   |        | Third     |                             |
|                   |        | Bank for  |                             |
|                   |        | services  |                             |
|                   |        | rendered  |                             |
|                   |        | with      |                             |
|                   |        | respect   |                             |
|                   |        | to loans  |                             |
|                   |        | sold to   |                             |
|                   |        | SLX\]     |                             |
+-------------------+--------+-----------+-----------------------------+
| **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.       |        |           |                             |
+-------------------+--------+-----------+-----------------------------+

[]{#__RefHeading___Toc210462272 .anchor}ENCLOSURE 2: Fifth Third Bank's
Comments on the Draft Report

June 2, 2008

Gloria Pilotti

Regional Inspector General for Audit

Office of Inspector 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/A09H0017

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 continued 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
("HEA"), 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,

/s/

Brian Gardner

Vice President, Asset Securitization

Enclosures

**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]{.underline}**

**Introduction**

***The Higher Education Act's Prohibition Against Inducements***

The Higher Education Act of 1965, as amended ("HEA"), authorizes the
Federal Family Education Loan ("FFEL") Program, a federally guaranteed
student loan program in which 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 student loans and more people can obtain a postsecondary education,
which has become increasingly important in our digital and service
economy.

The HEA has strict requirements regarding the type of entities that may
serve as eligible FFEL lenders, which, as a result, generally limit
eligible-lender status to banks, state agencies, and non-profit
entities. *See* HEA § 435(d)(1); 20 U.S.C. § 1085(d)(1). 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 sole 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 lenders to free
> up capital to make new loans to students. Eligible and ineligible
> lenders agree that participation by ineligible lenders increases
> competition among lenders and can, in turn, contribute to improved
> service and lower costs for student borrowers.^1^

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

^\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_^

^1^ 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 \[FFEL\] loans." HEA § 435(d)(5)(A); 20 U.S.C.
§ 1085(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 purposes 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,
federal regulations authorize a lender "to contract or otherwise
delegate performance of its functions under \[FFEL\] 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 ELT agreement, and the Department has never
questioned that practice through regulations, sub-regulatory guidance,
or, until now, an audit of the Office 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
interpretation 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 one lender to another lender for the purchase of actual FFEL
loans under circumstances in which (1) the selling lender was previously
a marketer that adapted into a lender by entering into an ELT 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, if not all, its origination and servicing

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 precedent 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
between 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, the payments at issue were not prohibited because they were
neither made to an "educational institution" nor to an "individual," as
required by the plain language of the HEA. The recipients of the
payments in question are 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 OIG's finding relies upon a statutory interpretation that was
rejected by a federal court**

In the Draft Audit Report, the OIG 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 OIG's finding, which is premised on a
statutory interpretation that has been squarely rejected by a federal
court is, therefore, improper and should not be included within a Final
Audit Report.

**a. *The Scholl College Case* held that payments made pursuant 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 attempt 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 Department's determination
that a lender had paid a college, which was acting as a lender itself,
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*").

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 educational 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 ALJ'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'n (Sallie Mae)*, Dkt. No. 96-23-SL
(July 18, 1997) ("ALJ Decision Upon Remand"). Thus, 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. ALJ
Decision Upon Remand at \*3.

The ALJ'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 ("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 of loans. 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, as a 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. *Id*.

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

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

Finally, 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 Scholl College was replaced by a different kind of
lender, then the Department would have had "no complaint." *Id*.

**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 Selling 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 ELT would
facilitate in order to ensure that the loans in the trust are properly
funded, serviced, and committed for sale to an experienced,
well-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 Scholl College, was the originating lender. Similarly, the OIG's
finding is premised on disregarding the form of the transactions to
determine that the *combination* of the agreements suggest that SLX, and
not the Selling Lenders, was the originating lender. *See* Draft Audit
Report, at 6 ("\[U\]nder the ELT 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 of lender is unpersuasive here for the same
reasons the Department's disregard of Scholl College as a lender was
unpersuasive, and rejected outright, in *The Scholl College Case*.^6^

The OIG identifies three particular aspects of the transactions that
lead it to disregard the form of the transactions: (1) "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 securing 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 permissible. Consequently, the OIG cannot cite 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-purchase
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 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. . . ."). But
the OIG's characterization of these agreements as evidence of prohibited
inducements is factually untenable, *and the OIG cited no legal
authority to support its view*.

The form of each agreement within the transaction is clear on its face.
The ELT agreements, which were consummated following arms-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

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^2^ And *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.

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 does it exclude any lending functions from delegation.").
Despite the OIG's effort to call into question the Selling Lenders' 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.* ("\[T\]he regulation cannot be reasonably
interpreted as expressing a 'clear intent to separate the role of the
lender and the school,' as claimed by \[the Department\].").

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
Colleague Letter, under the heading "Examples of Permissible
Activities," the Department expressly authorized the sale of loans
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]{.underline}:
>
> 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 of Interest from one Trust to Another Trust***

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

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 trust to another trust.

The ELT agreements created separate trusts, each 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
agreement 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
could 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 OIG's
conclusion that SLX transferred an interest from one trust to another
trust is, therefore, not supported by the facts because the terms of the
Selling Lenders' ELT 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 ELT 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

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^3^ The 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.

servicer . . . even if the arrangement effectively renders the \[\]
lender 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." *Id.* However,
the HEA, itself, *expressly authorizes lenders to take as limited a role
as they desire* and many lenders, including the Selling Lenders, have
properly done that.

The Draft Audit 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 form 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 HEA's application by making the identification of
the originating lender dependent upon the breadth of responsibilities
undertaken by the entity. *Id.* 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 been disbursed." *Id.* at 44. It is, therefore,
of no legal significance that the Selling Lenders' role was limited on
account of the forward-purchase and third-party servicing agreements
because, 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*." *Id.*

***The "Combination" Approach***

The Draft Audit Report suggests that it is the *combination* of the
contractual rights and obligations between 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.
There is no material difference between the two.

The arrangements between the Selling Lenders and SLX, like the
arrangements between Scholl College and Sallie Mae, "are characteristic
of traditional market transactions between lenders." *The Scholl College
Case*, 112 F. Supp.2d at 46. Selling student loans in the secondary
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 OIG 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 OIG 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
Department issued guidance nearly 20 years ago informing lenders that
these types of agreements, in combination, are 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 OIG'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* permitted 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 of the 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
*Shalala v. Guernsey Memorial Hosp.*, 514 U.S. 87, 100 (1995)); s*ee SBC
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. Babbit*, 238 F.3d 622, 629 (5th Cir. 2001)
("\[T\]he APA requires an agency to provide an opportunity for notice
and comment before substantially altering a well established regulatory
interpretation.").

Similarly, in this matter, the OIG is proposing a fundamental change to
the administrative interpretation of the prohibition against
inducements. The existing interpretation is that a transaction between
lenders for the sale of loans 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 type 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 offered its first authoritative interpretation of the
HEA's anti-inducement provision in February 1989 when it issued a "Dear
Colleague letter" to the student lending community. *See* DCL 89-L-129.
In that sub-regulatory guidance document, the Department stated that a
sale of loans between lenders complies with the HEA'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
never changed its interpretation of the inducement prohibition in
connection with the sale of loans. Indeed, it has recently done the
complete opposite \-- it has amended the regulations, effective July 1,
2008, to expressly *permit* the payment of a premium upon a sale of
loans 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 of loans between the Selling
Lenders and SLX \-- two non-school lenders \-- would be a fundamental
change to an administrative interpretation.^4^ Even more, it

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^4^ Throughout the litigation of *The Scholl College Case*, the
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 between two *non-school
lenders*. *See*

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 issue were made by one
lender to another lender. No party attempted to influence the behavior
of borrowers 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. § 1085(d)(5)(A) (emphasis
added). Whether the entities to which such payments are made are lenders
or marketers makes no difference because the HEA's prohibition against
inducements only applies to payments made to "any educational
institution or individual." The Selling Lenders 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.

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*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 Department in
*The Scholl College Case*, *e.g.*, lenders giving away electronic goods
to borrowers.

**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." *Id*. 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." *Id*. It is
incumbent upon the agency to take only those actions that are consistent
with clear and unambiguous statutory language:

> In determining 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 of Education*, 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 unambiguous
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
literal 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 statutory 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 F.3d 791, 797 (11th Cir. 2000), *cert.
denied*, 532 U.S. 1037 (2001); *Dormeyer v. Comerica Bank - Illinois*,
223 F.3d 579, 582 (7th Cir. 2000). In *Woodford*, the plaintiff
challenged the lower court's ruling that she had not worked the
requisite number of hours to be covered under the FMLA. *See Woodford*,
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 if he requested leave and the
employer confirmed eligibility. *Id*. at 54-55. In line with decisions
in the Seventh and Eleventh Circuits, the Second Circuit upheld the
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. *Id*. at 56-57. The *Woodford* court found that the
congressional intent was clear from the language of the statute. *Id*.
at 55. The regulation was inconsistent with the literal words of the
statute and was, thus, struck as invalid. *Id*.

At least one federal court has examined this issue in the context of
whether action taken by the Department was consistent with the clear and
unambiguous language of the HEA. In *Sandler v. United States Dep't of
Education*, 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
discharge 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 more 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 CFR § 682.402(d)(1)(i) ("The Secretary 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 the date the school closed.").

The court, however, noted that the HEA, which addresses the issue of
loan discharge 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
> subsequently 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 issue of loan 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 status as an
"eligible lender" upon its ability to refrain 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 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 OIG's finding of non-compliance
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-compliance.

**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 of 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." If Congress
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 § 109(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 HEA
prohibits lenders from conducting unsolicited mailings to "students" of
loan application forms. And section 435(d)(5)(C) of the HEA prohibits
lenders from offering FFEL loans to a "prospective borrower" to purchase
an insurance policy.

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"), 1078(b)(1)(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"), 1078-3(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"),
1078-11(a)(1) ("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"), 1078-11(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 term "person" would render superfluous the term
"educational institution" within the statutory prohibition. If
"individual" is broad enough to include a catch-all category of legal
entities, then the Congress would not have also included "educational
institutions" as a covered class of recipients. 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 MCI Telecommunications Corp. v.
AT&T*, 512 U.S. 218, 229 (1994) ("\[A\]n agency\'s interpretation of a
statute is not entitled to deference when it goes beyond the meaning
that the statute can bear."). The Selling Lenders are neither. [^8]

**2. The OIG's finding cannot rely upon the HEA's general authority to
promulgate regulations governing FFEL to justify expanding the HEA's
scope of recipients beyond "any educational institution or individual"**

The Department cannot avoid the HEA's clear and unambiguous language
limiting the scope of inducement 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. Even 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 of Prisons*, 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.[^9]

Therefore, to the extent the OIG'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 OIG to find the
payments made by SLX to the Selling Lenders to be payments made to a
prohibited recipient \-- section 435(d)(5)(A) of the HEA would not
prohibit those payments. Despite the HEA's general grant of authority to
issue regulations under FFEL, *see* HEA § 432(a)(1), 20 U.S.C. §
1082(a)(1) (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 OIG lacks a sufficient legal and policy basis to make a finding of
non-compliance.

**[Comments on the Recommendations]{.underline}**

**A. Recommendation 1.1 Is Moot**

Recommendation 1.1 merely seeks to have the Department perform internal
paperwork (1) terminating the agreement with the Department signed by
Fifth Third on behalf of the Selling Lenders, and (2) deactivating the
lender identification numbers that were obtained to enable the Selling
Lenders to originate loans pursuant to their ELT agreements with Fifth
Third. The Draft Audit Report notes that Fifth Third informed the OIG 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 OIG'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 student
loans and, thus, an indication that those loans do not have as much
value as investors believed. During a period when the credit markets are
highly disrupted, the OIG would effectively be preventing SLX from using
over \$3 billion of student 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, the Selling Lenders, and SLX
\-- as a potential threat to the entire multi-billion dollar student
loan securitization market. If investors perceive that the guarantee on
FFEL loans will be invalidated for alleged errors by an ELT in the
origination and marketing process, the uncertainty of the value of such
assets could cause a major disruption in the credit markets involving
billions of dollars in student 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'
confidence in the guarantees that the federal government provides when
it insures their loans to needy students."). 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 harming innocent investors who purchased securities
backed by FFEL loans or harming students who may no longer be able to
quickly access a FFEL loan.

The asset backed securities 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 Audit Report.

Furthermore, investor uncertainty as to whether the OIG's reasoning
could be extended to cover other acts or omissions will undermine 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 harm not only large financial institutions that originate
FFEL loans, but also the nonprofit student 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
viable and there will be insufficient 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
magnitude 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.

**2. The Regulations Set Forth Procedures for the Department to Address
Alleged Non-Compliance with the Prohibition 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 termination proceedings**

A lender's failure to comply with the 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 inducement 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 \-- (1)(i) To a
determination that an organization fails to meet the definition of
'eligible lender' in section 435(d)(1) 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 the 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.

***The Department should not seek a termination of the guarantee***

***on the loans at issue nor, under these circumstances, a repayment of
funds***

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 of
loan guarantees at all and would not permit a repayment of funds under
the circumstances 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 improperly 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 HEA 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 HEA'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-compliance 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 uses to address alleged prohibited inducements also
expressly authorize the Department to use 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 alleged 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 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)(1); 20 U.S.C. § 1082(g)(1). 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 lenders, *see* 34 CFR § 682.413(d)(1), 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. §
1082(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
\[FFEL provisions of the HEA\] 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, the 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)(12) 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)(1)(i). Thus,
the Department's regulations governing L, S, and T proceedings \-- and
not the regulations cited by the OIG \-- are the appropriate regulations
for the Department to use.[^10]

The OIG's citation of section 682.406(a)(12) 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.[^11]

**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.[^12] 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 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, informed 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.

-   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 of 20 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 check or cash.
>
> *ALG must immediately cease and desist from providing rebates in the
> form of checks or cash to its borrowers*.

ALG Letter, at 1 (emphasis added).[^13]

Therefore, the Department has an established practice of using informal
compliance procedures whenever possible and has not terminated the loan
guarantee or required repayment of funds for non-compliance with the
inducement prohibition. Like the other lenders with which the Department
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* terminated the very ELT arrangements
challenged in the Draft Audit Report.

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

In August 2003, the OIG issued an Alert Memorandum to the Assistant
Secretary for the Office of Postsecondary Education, in which the OIG
reviewed the issue of prohibited inducements. *See* Alert Memorandum
from C. Lewis to S. Stroup (Aug. 1, 2003) ("OIG Alert Memorandum")
(attached hereto as Exhibit 4). In its memorandum, the OIG 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 1. The OIG concluded that the Department should provide formal
guidance clarifying the application of the HEA's anti-inducement
provision to private loans and determine whether statutory changes
should be proposed. *See id.* at 2.

Notably, the OIG informed the Department that it had come to this
conclusion following the OIG's own review of the practices at two
schools. *See* OIG Alert Memorandum, at 2. The OIG 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
of these schools and Sallie Mae negotiated preferred lender status *in
exchange for* a specified dollar amount of private loans." *Id.*
(Emphasis added). Rather than recommending the termination of the loan
guarantees and the reimbursement of funds (or any sanction at all), the
OIG merely suggested that the Department consider making regulatory
changes or providing further guidance. *Id.*

**FINDING NO. 2 \-- Fifth Third Bank's Policies and Procedures for
Monitoring its ELT Agreements Need To Be Improved**

**[Comments on the Finding]{.underline}**

***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 OIG takes
the HEA's requirement that ELTs 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 OIG 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 OIG 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 (1) the evaluation of
entities for potential ELT 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 ELT'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 OIG'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 OIG 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 OIG's
application of the Safety and Soundness Standards set forth by the
Office of the Comptroller of the 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 OIG does not
appear to have statutory authority to make findings that allege
transgressions of Treasury Department standards or handbooks. Under the
HEA, the OIG only has legal authority to conduct audits of lenders to
assess compliance with federal 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.]{.smallcaps} \-- In conducting audits
> pursuant to this subsection, . . . the Inspector General of the
> Department of Education shall audit the 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. . . .

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

Assuming *arguendo* that the OIG 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 Vice President for the Asset Securitization
Department advised that he evaluates potential ELT lender partners and
the proposed arrangements prior to entering into an ELT agreement. *See
id.* at 9-10. The OIG 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.

*Id.* at 9. Furthermore, Fifth Third's Vice President, or one of two
other bank officials (if not a manager from a branch 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 commendable efforts to
evaluate entities for potential ELT agreements. Instead, it finds
something minor about which to criticize Fifth Third: "The Vice
President maintained some documents related to initial assessments . . .
but could not identify 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 requirements. But, again, the OIG finds
that Fifth Third's efforts fall short of Treasury Department standards.
In addition to the two Treasury standards described above, the remaining
three standards are 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.

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

The OIG again gives Fifth Third no credit for having these important
safeguards in place to ensure 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." *Id.*

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.

*Id.* The OIG'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]{.underline}**

The Draft Audit Report recommends that Fifth Third (1) create written
procedures to document how it performs thorough evaluations of potential
ELT 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 centrally maintains its
records. Fifth Third and the OIG may dispute whether those procedures
should be "written" and whether the records are *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 ELT agreements with lenders. For those
reasons, Fifth Third disagrees with the recommendations.

**OTHER MATTER**

**[Comments on Other Matter]{.underline}**

The Draft Audit Report contains a section entitled "Other Matter," in
which the OIG notes that it found other transactions "that include the
offering of an incentive." Draft Audit Report, at 12. The OIG did not,
however, include those transactions within its finding of non-compliance
because "the ELT agreements differed structurally from the ELT
agreements that Fifth Third Bank and SLX had with the \[Selling
Lenders\]." *Id.* The only difference, structural or otherwise,
identified by the OIG 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." *Id.* Otherwise, the arrangements were the same. *Id.*

The OIG states that it chose not to include 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." *Id.* And second, "the arrangements are
similar in some respects . . . to an arrangement that was the subject of
a previous enforcement proceeding undertaken by the Department." *Id.*
As a result, the OIG determined that, rather than include them within a
finding of non-compliance, it would "refer these ELT agreements to the
Department for determination of whether the arrangements violate the
prohibition on incentives." *Id.*

Thus, the OIG reveals in the "Other Matter" section of the Draft Audit
Report what it is that the OIG 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 one fact
is the only difference the OIG can identify between the payments in
question and the payments that are not in question. The OIG 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*,
would 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 OIG not include
this "Other Matter" section in any Final Audit Report.

EXHIBIT 1 through EXHIBIT 4

Report Pages 58 through 74

> The exhibits provided by Fifth Third Bank in its comments on the draft
> report were not available in Word format. The exhibits are available
> in the final report in Acrobat format on the ED OIG website at
> <http://www.ed.gov/about/offices/list/oig/areports.html>.

[]{#__RefHeading___Toc210462273 .anchor}ENCLOSURE 3: SLX's Comments on
the Draft Report

> June 2, 2008

Gloria Pilotti

Regional Inspector General for Audit

Office of Inspector General

U.S. Department of Education

501 I Street, Suite 9-200

Sacramento, CA 95814

> Re: Response of Student Loan Xpress (SLX) to the Draft Audit Report
> Control Number ED-OIG/A09H0017

Dear Ms. Pilotti:

On behalf of Student Loan Xpress, Inc. (SLX), I would like to take this
opportunity to provide the Office of Inspector 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 OIG. SLX
very much looks forward to a working with the OIG 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.

Sincerely,

/s/

[\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_]{.underline}

Randall M. Chesler

cc: Brian Gardner

FIFTH THIRD BANK

Saul L. Moskowitz, Esq.

MOSKOWITZ & AUSTIN, LLC

Jonathan A. Vogel, Esq.

SONNENSCHEIN NATH & ROSENTHAL LLP

Attachments

**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]{.underline}**

In Finding No. 1, the Draft addresses the compliance of three (3)
transactions with § 435(d)(5)(A) of the Higher Education Act of 1965, as
amended (HEA). That provision prohibits FFELP lenders from paying
inducements in order to secure applicants for FFELP loans. [See
also]{.underline} 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'Neill, ¶III.a (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

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

^1^ 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 OIG 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 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, thereby jeopardizing the fundamental ability of the FFELP
to achieve its objectives. [Id]{.underline}.. It is certainly within the
province of OIG 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. 1 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 issue as sales of consummated loans must be
respected.]{.underline}**

**1. [The structure of the transactions at issue.]{.underline}**

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]{.underline}. ¶III.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 through 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 commitment/loan 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 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 of MSA, PLP, and LSF was limited to
> the securing of loan 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 SLX/MSA, SLX/PLP,
> and SLX/LSF) 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 of the statute and
> regulations, the form of the transactions must be
> respected.]{.underline}**

Since these transactions involve the sale of consummated loans and not
the securing of loan applicants, they do not involve illegal
inducements. Rather, they reflect Example No. 1 of "Permissible
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 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.^2^

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

^2^ This type of transaction is also permitted under ED's new
anti-inducements regulations, which take effect July 1, 2008.
[See]{.underline} 34 CFR 682.200(b)(definition of "Lender", paragraph
(5)(ii)(H))(2007).

In fact, the transactions at issue here are even more clearly the sale
of loans 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 terms 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]{.underline}, 112 F.Supp. 2d 38, 48 (D.D.C. 2000)(hereinafter
"[Riley]{.underline}").

Thus, under ED's longstanding 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]{.underline}
proceedings and consistently applied thereafter. O'Neill Rep. ¶III.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]{.underline}. [Smiley v.
Citibank]{.underline}, 517 U.S. 735, 742 (1996)(sudden, unexplained,
unexpected, policy change, or change that does not take account of
legitimate reliance on prior interpretation, may be arbitrary,
capricious, or abuse of discretion); [Paralyzed Veterans of America, et
al v. D.C. Arena L.P.]{.underline}, 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]{.underline}, 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]{.underline}, 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.]{.underline}, the agency may not then adopt a different
interpretation without going through notice-and-comment rulemaking).^3^

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

^3^ On November 1, 1999, during the pendency of the [Riley]{.underline}
case, ED issued regulations implementing the inducements prohibition of
HEA § 435(d)(5)(A). [See]{.underline} 34 CFR 682.200 (definition of
"Lender", paragraph (5)(i)), published in final at 64 Fed. Reg. 58952
(Nov. 1, 1999). The specific ED statements alluded to by the Court in
[Riley]{.underline} confirming the permissibility of transactions among
non-school lenders were made prior to that date. However, ED's
confirmation of this 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. [See]{.underline} [Riley]{.underline},
[supra]{.underline}, at 48. Moreover, ED's consistent administrative
practice since [Riley]{.underline} is in accord with that
interpretation. Thus, it is clear that since § 682.200(definition 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.]{.underline}, [supra]{.underline}, and [Torch Operating Company v.
Babbitt]{.underline}, [supra]{.underline}.

> **3. [Settled case law also requires that the form of the transactions
> be respected.]{.underline}**

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

In [Riley]{.underline}, 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]{.underline}. 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 (ALJ) 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]{.underline}. at 41-43.

Twice, the ALJ refused to recharacterize the arrangement, whereupon on
each occasion the Secretary of Education overruled the ALJ. After the
Secretary overruled the ALJ for the second time, Sallie Mae sued in the
U.S. District Court for the District of Columbia. [Id]{.underline}. 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]{.underline}, 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."
[Id]{.underline}. 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 program. [See]{.underline} GAO Report
GAO/HEHS 00-170, [Trustee Arrangements Serve Useful Purpose in Student
Loan Market]{.underline}, at 15 (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]{.underline} makes clear that those facets of the
transactions cannot justify recharacterization.

[Second]{.underline}, the Court in [Riley]{.underline} 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". [Id]{.underline}.
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]{.underline}, 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]{.underline}. at
46.

[Third]{.underline}, the Court held that, since the component agreements
were all permissible, the Sallie Mae/Scholl College arrangement as a
whole could not be deemed impermissible. [Id]{.underline}. 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]{.underline},
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]{.underline}, 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^ [Id]{.underline}. at 46-48.

Each of the component agreements in the instant transactions, and the
benefits derived therefrom for the Lenders, are likewise traditional,
customary, and unremarkable. O'Neill Rep. at ¶III.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 "terms 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 market"; 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]{.underline}, at 46-48.

provider, originated and serviced by a specific experienced third-party
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, especially when the beneficial
owner is new or relatively new to the lender role. [Id]{.underline}.
¶III.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 of the grounds for rejecting recharacterization
cited by the Court in [Riley]{.underline} that is relevant here ^5^
*independently* requires rejection of the Draft's proposed
recharacterization. The fact that *every one* of those various
rationales precludes recharacterization here demonstrates, [a
fortiori,]{.underline} that the Draft's approach is unsupportable.

Moreover, [Riley]{.underline} involved a school lender, where the
concerns regarding the pernicious effects of illegal inducements are the
greatest. Inasmuch as [Riley]{.underline} 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]{.underline} proceedings that, had
the arrangement in that case involved a non-school lender, it would have
been permissible. [Id]{.underline}. 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]{.underline} 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. ¶III.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
"merely because the \[lender\] was a school." [Riley]{.underline},
[supra]{.underline}, at 48.

In any case, even if the Lenders had not had substantial duties and
obligations beyond marketing loans, [Riley]{.underline} makes clear that
transactions such as those at issue here are permissible "even if the
arrangement effectively renders the ... lender a mere marketer".
[Riley]{.underline}, 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 of the FFELP. Many FFELP lenders,
including some of the largest in the program, started as marketers.
O'Neill Rep. at ¶III.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]{.underline}.. 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.]{.underline}**

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 of loans made by a trust from being a party to the trust
agreement. Accordingly, since all the component agreements, including
the Trust Agreements, are permissible, the Court's ruling in
[Riley]{.underline} precludes ED from treating the instant transactions
as a whole as impermissible, regardless of the fact that SLX signed the
Trust Agreements. [Riley]{.underline}, at 46-47.

Moreover, the Draft characterizes SLX's role in the Trust Agreements as
"structural" when it is, in fact, [de minimus]{.underline}. 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

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]{.underline} 34 CFR 682.305(a)(4)(i)(July 1, 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 form of the transactions negotiated
by the parties. [Riley]{.underline}, at 46-48.

Finally, we note that OIG correctly declined to conclude that the form
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]{.underline} 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.]{.underline} PLP Trust Agreement, §§ 1.2,
1.4(a), 1.4(g); PLP Forward Purchase Agreement, § 4(e). Further, the
Lenders incur 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.]{.underline} 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, § 3(j)(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]{.underline}. Were it otherwise, it would be
impossible to identify from among the myriad of similar transactions
undertaken since [Riley]{.underline}, which is permissible, and which
\-- due to some [insignificant]{.underline} provision purportedly
"distinguishing" it from the [Riley]{.underline} 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 of *0. 013%.*

viability of the program, especially given today's tenuous 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.]{.underline}**

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]{.underline} 34 CFR 682.200
(definition of "Lender", paragraph (5)(i))(July 1, 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]{.underline} 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.]{.underline} 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]{.underline} [Good Samaritan
Hospital, et al. v. Shalala]{.underline}, 508 U.S. 402, 417 (1993)("an
agency interpretation 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]{.underline}, 818 F.2d 953, 962 (CADC

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 HEA § 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"; and (2) such inducements must be offered "in
order to secure applicants" for FFELP loans.

The first element is unambiguous: any form of "payment" suffices if it
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]{.underline}, 312 F.3d 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
al., v. Lewis]{.underline}, 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 of 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 HEA on "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 under the Forward
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.

^9^ When ED adopts an interpretation of the HEA that cannot be squared
with its plain language, the courts will not hesitate to overturn that
action. [See]{.underline} [Jordan v.]{.underline} [Secretary of
Education,]{.underline} 194 F.3d 169, 172 (D.C. Cir. 1999) (\"the
Secretary may not rewrite the \[FFELP\] statute\"); [California
Cosmetology Coalition v. Riley,]{.underline} 110 F.3d 1454 (9th Cir.
1997); [Smithville R-II School Dist. v. Riley,]{.underline} 28 F.3d 55,
57-58 (8th Cir. 1994); [Atlanta College of Medical & Dental Careers v.
Riley,]{.underline} 987 F.2d 821 (D.C. Cir. 1993) (\"no deference is due
to \[Secretary\'s\] interpretation\" that was \"foreclose\[d\]\" by the
\"text\" of the HEA); [Riley,]{.underline} [supra]{.underline}, at 48;
[Bank of America NT & SA v. Riley,]{.underline} 940 F. Supp. 348 (D.D.C.
1996) (Secretary\'s interpretation of 20 U.S.C. §§ 1077a(i)(7)(B) and
1087­1(b)(2)(A) contradicted express requirements of statute), [aff
d,]{.underline} 132 F.3d 1480 (D.C. Cir. 1997); [Student Loan Marketing
Assn v. Riley,]{.underline} 907 F. Supp. 464 (D.D.C. 1995) (Secretary\'s
HEA interpretation which failed to give effect to \"clear statutory
definition\" was \"arbitrary and capricious\"), [affd,]{.underline} 104
F.3d 397 (D.C. Cir. 1997).

does not allow for distinctions based on the form of the payment or how
it is calculated. [Compare]{.underline} 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]{.underline} 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 recognition.

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 unclear. However, it cannot reasonably
be read as including all marketing of FFELP loans, as the Draft appears
to contend. First, the term \"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. ¶III.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",
[i.e.]{.underline}, 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,^10^ were able to steer them to another lender for a FFELP
loan. DCL at 2-3.^11^

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

^10^ At the time of the DCL, 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 the customer to another lender that did

Unlike the DCL, the Draft seeks to characterize marketing activity as
"securing" applicants if the activity is compensated on a per loan
basis, but not if the same activity is compensated on a per application
basis. ^12^ 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 DCL
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-to-lender referrals of existing customers that the DCL was
concerned about are no longer a significant issue in the program.

^11^ 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]{.underline} 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 permissible 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". [Id]{.underline}.
at 2-3 (prohibiting payments for referrals while permitting payments for
"generalized marketing or advertising"). [See also id.]{.underline} at 2
(Example of Prohibited Inducements No. 4)( payments that are labeled as
\"processing\" 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 of
inducements only to an "educational institution or individual". An
interpretation of "individual" to include corporations, such as the
Lenders, requires interpreting the term "individual" as synonymous with
"person". This is contrary to how those terms are typically interpreted,
however. [See]{.underline} [Clinton v. City of New York]{.underline},
524 U.S. 417, 428 (1998)

Moreover, the term "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. § 1states that Congress uses the term "person", not "individual".

**C. [Voiding reinsurance on the loans at issue would be unprecedented,
unwarranted, and harmful to the FFELP.]{.underline}**

Relying solely on regulations that OIG 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 of the FFELP.

It is our understanding that, in the 22-year history of the inducements
prohibition, ED has *never* treated a loan as unreinsured due to an
inducements violation.^15^ Instead, the participants in activities found
to constitute 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 situation 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 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

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Finally, interpreting "individual" to include corporations would render
superfluous the term "educational institution" as used in §
435(d)(5)(A). [See]{.underline} [Alaska Dep't of Environment
Conservation v. EPA]{.underline}, 540 U.S. 461, 489 n.13 (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.

^15^ While technically distinct, "voiding the guarantee" on a loan and
treating it as unreinsured have the same effect \-- [i.e.]{.underline},
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]{.underline}, 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]{.underline} 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.

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

[See]{.underline} 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. ¶III.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 harmed 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]{.underline} DCL 88-G-138 (1988)(included with revisions as 34 CFR
Appendix D).

The Draft proposes that ED void the guarantee on every loan made under
the transactions at issue, despite the lack of any evidence of fraud or
harm 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(f)(4)(OIG audits of FFELP 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 determined, standards, procedures, or regulations to the
records of such ... lender"). Nor could ED adopt such a recommendation.
[Smiley v. Citibank]{.underline}, [supra]{.underline}, 517 U.S. at 742;
[Paralyzed Veterans of America, et al v. D.C. Arena L.P.]{.underline},
[supra]{.underline}, 117 F. 3d at 586; [Torch Operating Company v.
Babbitt]{.underline}, [supra]{.underline}, 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]{.underline} 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 with 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]{.underline},
it should not do so for purported marketing compensation violations.

 

Furthermore, even if ED could legally adopt the sanction the Draft
proposes, there are compelling reasons why the OIG 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]{.underline} 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 violation -- 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 under 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 suitability of FFELP 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.
[Id]{.underline}. 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 of loans possible.
> Inconsistent treatment will have the opposite effect.

[Id]{.underline}. at ¶III.h.

Finally, it is critical that OIG 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]{.underline}. ¶III.a.

**[Conclusion]{.underline}**

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 of the 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]{.underline}**

The response to Finding No. 1, 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 Draft.^21^ 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. 1 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.

**[Appendix A]{.underline}**

**Seamus O'Neill 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 MSA/SLX 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 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 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 [Riley]{.underline}
         decision in 2000. In particular, in the course of my work, I
         have assisted FFELP participants 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-party
         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, especially 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 financing
         and loan origination structures by the government makes the
         financing of loans possible. Inconsistent treatment will have
         the opposite effect.

/s/

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ Date: May 28, 2008

Seamus O'Neill, Partner

Liscarnan Solutions, LLC

**I. Resume -- Seamus O'Neill**

+-----------------+----------------------------------------------------+
| **Professional  |                                                    |
| Experience**    |                                                    |
+-----------------+----------------------------------------------------+
|                 |                                                    |
+-----------------+----------------------------------------------------+
| 1/1988 to the   | **Managing Partner, Liscarnan Solutions, LLC**     |
| present         |                                                    |
|                 | Oversees the firm's financial advisory and         |
|                 | consulting services. Liscarnan's primary focus is  |
|                 | structured financings and securitizations for      |
|                 | student loan industry. Additionally, for the past  |
|                 | several years Liscarnan and its predecessor        |
|                 | 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   | **Partner of Kohne O'Neill, LLC**                  |
| present         |                                                    |
|                 | 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          | **Principal , Donaldson, Lufkin & Jenrette**       |
| to12/1987       |                                                    |
|                 | 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       | **Vice President of Lehman Brothers Kuhn Loeb**    |
| 7/1983          |                                                    |
|                 | Focused on student loans and general public        |
|                 | finance investment banking. Developed the first    |
|                 | commercial paper financing for student loans.      |
+-----------------+----------------------------------------------------+

+------------+---------------------------------------------------------+
| 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  | **Associate, AG Becker Incorporated**                   |
| 9/1981     |                                                         |
|            | 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  | **Legislative economist and financing analyst**         |
| 7/1979     |                                                         |
|            | 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       |
| 7/1977     | Office**                                                |
|            |                                                         |
|            | Developed the first information system for tracking     |
|            | state general obligation and state related debt.        |
|            | Prepared state general obligation debt offerings.       |
+------------+---------------------------------------------------------+

+------------+---------------------------------------------------------+
|            |                                                         |
+------------+---------------------------------------------------------+
| 6/1976 to  | **Economist, Illinois General Assembly**                |
| 9/1976     |                                                         |
|            | Focused on program evaluation and the development of an |
|            | econometric forecasting model for tax revenues          |
+------------+---------------------------------------------------------+
|            |                                                         |
+------------+---------------------------------------------------------+

+--------------+-------------------------------------------------------+
| *            |                                                       |
| *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    | **Duke University**                                   |
| 6/1976       |                                                       |
|              | Master of Arts in economics                           |
|              |                                                       |
|              | Ph.D. candidate in economics with specialty fields in |
|              | public finance, urban economics and econometrics      |
+--------------+-------------------------------------------------------+
|              |                                                       |
+--------------+-------------------------------------------------------+
| 9/1970 to    | **State University of New York at Geneseo**           |
| 8/1972       |                                                       |
|              | Bachelor of Arts, economics, cum laude                |
+--------------+-------------------------------------------------------+
|              |                                                       |
+--------------+-------------------------------------------------------+
| 9/1969 to    | **University of Southern California**                 |
| 6/1970       |                                                       |
+--------------+-------------------------------------------------------+

+--------------+-------------------------------------------------------+
| **           |                                                       |
| 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"                                            |
+---------------+------------------------------------------------------+

+---------------+------------------------------------------------------+
| 7/22/2005     | 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 Way!"     |
+---------------+------------------------------------------------------+
|               |                                                      |
+---------------+------------------------------------------------------+
| 3/8/2001      | 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.  |
+---------------+------------------------------------------------------+
|               |                                                      |
+---------------+------------------------------------------------------+

**[Appendix B]{.underline}**

**[History of ED Interpretations Regarding Marketing
Compensation]{.underline}**

> 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]{.underline}. at 2.
>
> In a March 3, 1992, letter from Robert W. Evans of ED to Saul
> Moskowitz of Clohan & 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"/"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 \[FFELP
> statute.\]\....]{.underline} In each of the \[proposed compensation
> structures\] 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
> of the 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]{.underline} [the Department does
> not prescribe the basis for the compensation.]{.underline}
>
> (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 11, 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 11 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 fee, 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 11, 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 objecting 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.,]{.underline} that marketing is different from
>
> "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]{.underline} 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*.
>
> 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-1995/ pre-2002 view that marketing compensation
> paid on a per application/MPN 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 rulemaking 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 of
> label, *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]{.underline} 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 request for written
> confirmation of that guidance submitted six (6) months ago. Thus, the
> marketing compensation issue remains muddled to this day.

[^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.

[^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.

[^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.

[^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.

[^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.

[^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.

[^8]: 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
    "\[t\]he 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 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.

[^9]: 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 rulemaking authority
    relating to FFEL. *See* *Sandler*, 2001 WL 884552, at \*1 (quoting
    HEA § 432(a)(1), 20 U.S.C. § 1082(a)(1)). Thus, the court implicitly
    rejected the proposition that the HEA's general grant of authority
    to promulgate FFEL regulations permitted the Department to invoke a
    regulation to deny borrower benefits under circumstances in which
    such benefits were authorized by the plain language of the HEA.
    *Id.* at \*1-2.

[^10]: To be sure, the regulations cited by the OIG are not superfluous
    or unnecessary. They are important provisions that, to some extent,
    tie the FFEL program together by setting some important conditions
    for the payment of reinsurance. But those generally applicable
    regulations must yield to the specific regulatory provisions that
    are used to determine whether a lender has 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\").

[^11]: 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. 1,
    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.

[^12]: 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*.

[^13]: In an even more recent example, the Department used informal
    compliance procedures in ordering an ELT 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 ELT 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).