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Issue Paper 3

Session 3: February 12-15, 2018

Issue: Financial Responsibility and Administrative Capability

Statutory cite: §498 of the Higher Education Act of 1965, as amended

Regulatory cite: 34 CFR 668.91, 668.94, 668.171, 668.172, and 668.175

Summary of changes: For institutions that are not financially responsible, we propose to expand the 

types of financial protection those institutions may provide. In addition, we 

propose to recalculate the composite score for institutions that incur debts and 

liabilities from borrower defense claims.

Updates the actions of the hearing official.

Identifies actions or events that the Secretary may consider in determining 

whether an institution is financially responsible.

Provides that the Secretary may accept other types of surety or financial 

protection in lieu of letters of credit.

Provides for a four-year transition period for operating leases entered into 

before January 1, 2019.

Updates the Appendices to Subpart L to account for changes in accounting 

standards and terminology.

Changes: See attached regulatory text.

§ 668.91 Initial and final decisions.

(a)...

(3) Notwithstanding the provisions of paragraph (a)(2) of this section—

(i) If, in a termination action against an institution, the hearing official finds that the institution has 

violated the provisions of §668.14(b)(18), the hearing official also finds that termination of the 

institution's participation is warranted;
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(ii) If, in a termination action against a third-party servicer, the hearing official finds that the servicer has 

violated the provisions of §668.82(d)(1), the hearing official also finds that termination of the 

institution's participation or servicer's eligibility, as applicable, is warranted;

(iii) If an action brought against an institution or third-party servicer involves its failure to provide surety 

in the amount specified by the Secretarya letter of credit or other financial protection under §668.15 or 

§668.171, the hearing official finds that the amount of the suretyletter of credit or other financial 

protection established by the Secretary under §668.15 or §668.175 was appropriate, unless the 

institution can demonstrate that the amount was unreasonablenot warranted;

(iv) In a termination action taken against an institution or third-party servicer based on the grounds that 

the institution or servicer failed to submit a required audit by the deadlines established in §668.23 or 

otherwise failed to comply with the requirements of §668.23(c)(3),, if the hearing official finds that the 

institution or servicer failed to meet those deadlines or requirements, the hearing official finds that the 

termination is warranted;

(v)(A) In a termination action against an institution based on the grounds that the institution is not 

financially responsible under §668.15(c)(1), the hearing official finds that the termination is warranted 

unless the institution demonstrates that all applicable conditions described in §668.15(d)(4) have been 

met; and or

(viB) In a limitation or termination action against an institution on the grounds that the institution is not 

financially responsible-

(1) Upon proof of the conditions in §668.174(a), the hearing official finds that the limitation or 

termination is warranted unless the institution demonstrates that all the conditions in §668.174(f) have 

been met; or

(2) Upon proof of the conditions in §668.174(b)(1), the hearing official finds that the limitation or 

termination is warranted unless the institution demonstrates that all applicable conditions described in 

§668.174(b)(2) or §668.175(g) have been met.

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§ 668.94 Limitation.

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(h) A change in the participation status of the institution from fully certified to participate to 

provisionally certified to participate under §668.13(c).

(hi) A requirement that a third-party servicer obtain surety, in a specified amount, to assure the 

servicer's ability to meet the servicer's financial obligations under a contract; or

(ij) Other conditions as may be determined by the Secretary to be reasonable and appropriate.
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§ 668.171 General. 

(a) Purpose. To begin and to continue to participate in any title IV, HEA program, an institution must 

demonstrate to the Secretary that it is financially responsible under the standards established in this 

subpart. As provided under section 498(c)(1) of the HEA, the Secretary determines whether an 

institution is financially responsible based on the institution’s ability to--

(1) Provide the services described in its official publications and statements;

(2) Administer properly the title IV, HEA programs in which it participates; and Meet all of its financial 

obligations; and

(3) Provide the administrative resources necessary to comply with title IV, HEA program requirements.

(b) General standards of financial responsibility. Except as provided under paragraphs (c) and (d) of this 

section, the Secretary considers an institution to be financially responsible if the Secretary determines 

that--

(1) The institution's Equity, Primary Reserve, and Net Income ratios yield a composite score of at least 

1.5, as provided under § 668.172 and appendices A and B to this subpart;

(2) The institution has sufficient cash reserves to make required returns of unearned title IV, HEA 

program funds, as provided under § 668.173; 

(3) The institution is current in its debt payments. An institution is not current in its debt payments if—

(i) It is in violation of any existing loan agreement at its fiscal year end, as disclosed in a note to its 

audited financial statements or audit opinion; or

(ii) It fails to make a payment in accordance with existing debt obligations for more than 120 days, and 

at least one creditor has filed suit to recover funds under those obligations; and 

(4) The institution is meetingable to meet all of its financial obligations, (including but not limited 

tomaking refunds—

(i) Refunds that it is required to make under its refund policy, including the return of and returning title 

IV, HEA program funds for which it is responsible under §668.22 and provide the administrative 

resources necessary to comply with title IV, HEA program requirements. An institution may not be able 

to meet its financial or administrative obligations if it is subject to an action or event described in 

paragraph (c) of this section that has or is likely to have an adverse material effect on the institution’s 

operations or ability to continue as a going concern; and
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(ii) Repayments to the Secretary for debts and liabilities arising from the institution's participation in the 

title IV, HEA programs.

(5) The institution or persons affiliated with the institution are not subject to a condition of past 

performance under § 668.174(a) or (b).

(c) Other factors or events. The Secretary may determine that an institution is not able to meet its 

financial or administrative obligations under paragraph (b)(4) of this section if—

(1) After the end of the fiscal year for which the Secretary has most recently calculated an institution’s 

composite score, the institution incurs a debt or liability from borrower defense claims adjudicated by 

the Secretary, and as a result of that debt or liability the institution’s recalculated composite score is less 

than 1.0, as determined by the Secretary under paragraph (d) of this section;

(2) For a proprietary institution whose composite score is less than 1.5, there is a withdrawal of owner’s 

equity from the institution by any means, including by declaring a dividend, unless the withdrawal is a 

transfer to an entity included in the affiliated entity group on whose basis the institution’s composite 

score was calculated;

(3) For a publicly traded institution—

(i) The U.S. Securities and Exchange Commission (SEC) notifies or warns the institution that it may 

suspend trading on the institution’s stock or suspends trading on its stock;

(ii) The institution failed to file a required annual or quarterly report with the SEC within the time period 

prescribed for that report or by any extended due date under 17 CFR 240.12b-25; or

(iii) The exchange on which the institution’s stock is traded notifies the institution that it is not in 

compliance with exchange requirements, or its stock is delisted for any reason; or

(4) For its most recently completed fiscal year, a proprietary institution did not derive at least 10 

percent of its revenue from sources other than title IV, HEA program funds, as provided under § 

668.28(c).

(d) Recalculating the composite score. The Secretary recognizes the actual amount of the debt or 

liability incurred by an institution for borrower defense claims under paragraph (c)(1) of this section as 

an expense, and accounts for that expense by—

(1) For the Primary Reserve ratio, increasing expenses and decreasing adjusted equity by that amount;

(2) For the Equity ratio, decreasing modified by that amount; and

(3) For the Net Income ratio, decreasing income before taxes in the net income ratio by that amount.

(e) Reporting requirements. (1) In accordance with procedures established by the Secretary, an 

institution must notify the Secretary of the following actions or events--
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(i) For a withdrawal of owner’s equity described in paragraph (c)(2), no later than 10 days after the 

withdrawal is made;

(ii) For the SEC and stock exchange provisions for publicly traded institutions described in paragraph 

(c)(3), no later than 10 days after the SEC or exchange notifies, warns, or takes an action against the 

institution, or 10 days after any extension granted by the SEC; or

(iii) For the non-title IV revenue provision in paragraph (c)(4), no later than 45 days after the end of the 

institution’s fiscal year, as provided in § 668.28(c)(3).

(2) The Secretary may take an administrative action under paragraph (h) of this section against the 

institution if it fails to provide timely notice under this paragraph (e) . 

(3) In its notice to the Secretary under this paragraph, or in its response to a determination by the 

Secretary that the institution is not financially responsible because of an action or event under 

paragraph (c) of this section, the institution may—

(i) Demonstrate that the reported withdrawal of owner’s equity under paragraph (c)(2) was used 

exclusively to meet tax liabilities of the institution or its owners for income derived from the institution; 

(ii) Show that the action or event has been resolved, or demonstrate that the institution has insurance 

that will cover all or part of the debts and liabilities that arise from borrower defense claims under 

paragraph (c)(1); or

(iii) Explain or provide information about the conditions or circumstances that precipitated that action 

or event that demonstrates that the action or event has not or will not have a material adverse effect on 

the institution. 

(f) Public institutions. (1) The Secretary considers a domestic public institution to be financially 

responsible if the institution--

(i)(A) Notifies the Secretary that it is designated as a public institution by the State, local, or municipal 

government entity, tribal authority, or other government entity that has the legal authority to make that 

designation; and

(B) Provides a letter from an official of that State or other government entity confirming that the 

institution is a public institution; and

(ii) Is not in violation subject to a condition of any past performance requirement under § 668.174.

(2) The Secretary considers a foreign public institution to be financially responsible if the institution--

(i)(A) Notifies the Secretary that it is designated as a public institution by the country or other 

government entity that has the legal authority to make that designation; and
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(B) Provides documentation from an official of that country or other government entity confirming that 

the institution is a public institution and is backed by the full faith and credit of the country or other 

government entity; and

(ii) Is not in violation subject to a condition of any past performance requirement under § 668.174.

(d)g) Audit opinions and past performance provisions.. Even if an institution satisfies all of the general 

standards of financial responsibility under paragraph (b) of this section, the Secretary does not consider 

the institution to be financially responsible if (1), in the institution's audited financial statements, the 

opinion expressed by the auditor was an adverse, qualified, or disclaimed opinion, or the auditor 

expressed doubt about the continued existence of the institution as a going concern, unless the 

Secretary determines that a qualified or disclaimed opinion does not have a significant bearing on the 

institution's financial condition; or.

(2) As provided under the past performance provisions in §668.174 (a) and (b)(1), the institution violated 

a title IV, HEA program requirement, or the persons or entities affiliated with the institution owe a 

liability for a violation of a title IV, HEA program requirement.

(e)(h) Administrative actions. If the Secretary determines that an institution is not financially 

responsible under the standards and provisions of this section or under an alternative standard in § 

668.175, or the institution does not submit its financial and compliance audits by the date permitted 

and in the manner required under § 668.23, the Secretary may--

(1) Initiate an action under subpart G of this part to fine the institution, or limit, suspend, or terminate 

the institution's participation in the title IV, HEA programs; or

(2) For an institution that is provisionally certified, take an action against the institution under the 

procedures established in § 668.13(d).

§ 668.172 Financial Ratios.

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(d) Transition period for certain operating leases. (1) As a result of changes to the accounting for leases 

required by Financial Accounting Standards Board Accounting Codification ASC 842 (Leases), for an 

institution’s four consecutive fiscal years beginning on or after January 1, 2019 for which the Secretary 

calculates the institution’s composite score, the Secretary also calculates a transition score by excluding 

from the calculation operating leases that the institution entered into before July 1, 2019, provided that 

those leases are properly disclosed in the Supplemental Schedule required under Appendix A or B of this 

subpart. For each year of the transition period, the Secretary uses the higher of the composite or 

transition score in determining, in part, whether the institution is financially responsible.
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(2) For the transition period described in paragraph (d)(1), the Secretary suspends the conditions in § 

668.175(d)(1)(i)(B) and (ii) under which an institution continues to qualify for the zone alternative. For 

any fiscal year following the transition period, the institution’s transition period scores have no bearing 

on whether the institution qualifies under an alternative standard in §668.175(c), (d), or (f).

§ 668.175 Alternative standards and requirements.

(a) General. An institution that is not financially responsible under the general standards and provisions 

in §668.171, may begin or continue to participate in the title IV, HEA programs by qualifying under an 

alternate standard set forth in this section.

(b) Letter of credit alternative for new institutions. A new institution that is not financially responsible 

solely because the Secretary determines that its composite score is less than 1.5, qualifies as a 

financially responsible institution by submitting an irrevocable letter of credit or other surety described 

under paragraph (h)(1)(i) of this section, that is acceptable and payable to the Secretary, for an amount 

equal to at least one-half of the amount of title IV, HEA program funds that the Secretary determines 

the institution will receive during its initial year of participation. A new institution is an institution that 

seeks to participate for the first time in the title IV, HEA programs.

(c) Letter of credit alternative for participating institutions. A participating institution that is not 

financially responsible either because it does not satisfy one or more of the standards of financial 

responsibility under § 668.171(b) or (c), or because of an audit opinion described under § 668.171(dg), 

qualifies as a financially responsible institution by submitting an irrevocable letter of credit or other 

financial protection described under paragraph (h) of this section, that is acceptable and payable to the 

Secretary, for an amount determined by the Secretary that is not less than one-half of the title IV, HEA 

program funds received by the institution during its most recently completed fiscal year, except that this 

provision does not apply to a public institution.

(d) Zone alternative. (1) A participating institution that is not financially responsible solely because the 

Secretary determines that its composite score under § 668.172 is less than 1.5 may participate in the 

title IV, HEA programs as a financially responsible institution for no more than three consecutive years, 

beginning with the year in which the Secretary determines that the institution qualifies under this 

alternative.

(i)(A) An institution qualifies initially under this alternative if, based on the institution's audited financial 

statement for its most recently completed fiscal year, the Secretary determines that its composite score 

is in the range from 1.0 to 1.4; and

(B) An institution continues to qualify under this alternative if, based on the institution's audited 

financial statement for each of its subsequent two fiscal years, the Secretary determines that the 

institution's composite score is in the range from 1.0 to 1.4.
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(ii) An institution that qualified under this alternative for three consecutive years, or for one of those 

years, may not seek to qualify again under this alternative until the year after the institution achieves a 

composite score of at least 1.5, as determined by the Secretary.

(2) Under thise zone alternative, the Secretary—--

(i) Requires the institution to make disbursements to eligible students and parents under either the 

heightened cash monitoring or reimbursement payment method described in § 668.162;

(ii) Requires the institution to provide timely information regarding any of the following oversight and 

financial events—

(A) Any adverse action, including a probation or similar action, taken against the institution by its 

accrediting agency;

(B) Any event that causes the institution, or related entity as defined in the Statement of Financial 

Accounting Standards (SFAS) 57Codification (ASC) 850, to realize any liability that was noted as a 

contingent liability in the institution's or related entity's most recent audited financial statement; 

(C) Any violation by the institution of any loan agreement;

(D) Any failure of the institution to make a payment in accordance with its debt obligations that results 

in a creditor filing suit to recover funds under those obligations; or

(E) Any withdrawal of owner's equity from the institution by any means, including by declaring a 

dividend; or

(F) Any extraordinary losses that are unusual in nature or infrequently occur, or both, as defined in 

accordance with Accounting Principles Board (APB) OpinionStandards Update (ASU) No. 30.2015-01 and 

ASC 225;

(iii) May require the institution to submit its financial statement and compliance audits earlier than the 

time specified under § 668.23(a)(4); and

(iv) May require the institution to provide information about its current operations and future plans.

(3) Under the zone alternative, the institution must—--

(i) For any oversight or financial event described under paragraph (d)(2)(ii) of this section, in accordance 

with procedures established by the Secretary, by certified mail or electronic or facsimile transmission , 

notify the Secretary no later than 10 days after that event occurs. An institution that provides this 

information electronically or by facsimile transmission is responsible for confirming that the Secretary 

received a complete; and legible copy of that transmission; and

(ii) As part of its compliance audit, require its auditor to express an opinion on the institution's 

compliance with the requirements under the zone alternative, including the institution's administration 

of the payment method under which the institution received and disbursed title IV, HEA program funds.
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(4) If an institution fails to comply with the requirements under paragraphs (d) ()(2) or (3) of this 

section, the Secretary may determine that the institution no longer qualifies under this alternative.

(e) [Reserved]

(f) Provisional certification alternative. (1) The Secretary may permit an institution that is not 

financially responsible to participate in the title IV, HEA programs under a provisional certification for no 

more than three consecutive years if—

(i) The institution is not financially responsible because it does not satisfy the general standards under § 

668.171(b), its recalculated composite score under § 668.171(d) is less than 1.0, it is subject to an action 

or event under § 668.171(c) that has or is likely to have an adverse material effect on the institution, or 

because of an audit opinion described under §in § 668.171(dg); or

(ii) The institution is not financially responsible because of a condition of past performance, as provided

under § 668.174(a), and the institution demonstrates to the Secretary that it has satisfied or resolved 

that condition.; and

(2) Under this alternative, the institution must—

(i) SubmitProvide to the Secretary an irrevocable letter of credit that is acceptable and payable to the 

Secretary, or other financial protection described under paragraph (h) of this section, for an amount 

determined by the Secretary that is not less than 10 percent of the title IV, HEA program funds received 

by the institution during its most recently completed fiscal year, except that this requirement does not 

apply to a public institution;

(ii) Demonstrate that it was current on its debt payments and has met all of its financial obligations, as 

required under § 668.171(b)(3) and (b)(4), for its two most recent fiscal years; and

(iii) Comply with the provisions under the zone alternative, as provided under paragraph (d) (2) and (3) 

of this section.

(3) If at the end of the period for which the Secretary provisionally certified the institution, the 

institution is still not financially responsible, the Secretary may again permit the institution to participate 

under a provisional certification, but the Secretary—

(i) May require the institution, or one or more persons or entities that exercise substantial control over 

the institution, as determined under § 668.174(b)(1) and (c), or both, to submit provide to the Secretary 

financial guarantees for an amount determined by the Secretary to be sufficient to satisfy any potential 

liabilities that may arise from the institution's participation in the title IV, HEA programs; and

(B)(ii) May require one or more of the persons or entities that exercise substantial control over the 

institution, as determined un § 668.174(b)(1) and (c), to be jointly or severally liable for any liabilities 

that may arise from the institution’s participation in the title IV, HEA programs.

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(h) Financial protection. (1) In lieu of providing a letter of credit for the amount determined by the 

Secretary under this section, the Secretary may permit an institution to—

(i) Provide the amount required Requires the institution to comply with the provisions under the zone 

alternative, as provided under paragraph (d)(2) and (3) this section in the form of other surety or form of 

financial protection as specified by the Secretary in a notice published in the Federal Register;

(ii) Provide cash for the amount required under this section; or

(iii) Enter into an arrangement under which the Secretary offsets the amount of title IV, HEA program 

funds that an institution has earned in a manner that ensures that, no later than the end of a six to 

twelve-month period, the amount offset equals the amount of financial protection the institution is 

required to provide. The Secretary uses the funds to satisfy the debts and liabilities owed to the 

Secretary that are not otherwise paid directly by the institution , and provides to the institution any 

funds not used for this purpose during the period covered by the agreement, or provides the institution 

any remaining funds if the institution