Another Conversion Bonanza?

As student-loan groups shift status to for-profit, questions are raised

Just as health causes have seen an infusion of grant dollars as a result of the conversion of non-profit hospitals

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New Philanthropic Organizations Created By Student-Loan Groups

and health-insurance plans to for-profit businesses, education programs now stand poised to take advantage of new pots of money.

As many as 23 non-profit groups that finance student loans — worth a combined $12-billion or more — have the option of changing their tax classifications, thanks to a provision of a 1996 federal law. So far, loan institutions in four states — Massachusetts, Nebraska, Ohio, and South Dakota — have taken steps toward converting to for-profit companies, and others are expected to follow suit. Those four were among the largest, having overseen roughly half of the student loans handled by all such groups.

The conversions have translated into four new grant-making organizations, which will be worth an estimated $600-million by the time the deals are completed. Under many state laws, non-profit organizations that change their tax status to become for-profit businesses must find a way to make sure their assets are used for charitable purposes — typically through the creation of a grant-making charity.

For schools, colleges, museums, literacy groups, and other educational charities, the conversions could prove to be a substantial windfall.

But some observers worry that without careful monitoring of these conversions, non-profit organizations — and the public — may end up with less than they are due.

“This has been one of those sleepers that people haven’t paid a great deal of attention to, although the dollars involved are staggering,” says Ed Skloot, president of the Surdna Foundation, in New York. The foundation has given grants to Consumers Union, the non-profit publisher of Consumer Reports, to keep an eye on non-profit conversions and push for changes it believes are needed.

Mr. Skloot and others say the four student-loan conversions that have occurred thus far illustrate the need for scrutiny by state attorneys general and others — as well as the obstacles that often impede tough oversight, including variations in state laws and regulatory approaches.

They also show the potential problems that can arise during the conversion process, many of them similar to those associated with the conversion of non-profit hospitals to for-profit status. Among them: issues of accountability and public access to information.

For example, the conversions in Ohio and Massachusetts required court approval, while those in Nebraska and South Dakota did not. Advocates say requiring the courts to approve any deal insures greater accountability.

But it does not necessarily insure full access.

Although Ohio requires a court hearing, state law prevents most records collected during a non-profit investigation from being made public. After getting the Ohio foundation’s approval, the Attorney General has been able to release about 30 pages of the case, but the rest remains out of the public’s reach. (In 1997, that law was amended to require disclosure of some conversion documents — but only for cases involving hospitals and other health-care organizations.)

Among other areas of concern identified by consumer-advocacy groups and regulators who have reviewed the four student-loan conversions: potential conflicts of interest by board members, a too-limited focus and geographic reach for grants, and misuse of the grant-making charities to further the business goals of the new for-profit loan companies created from the conversions.

“These are public funds,” says Patrick Gardner, a lawyer for the West Coast office of Consumers Union. “And yet we’ve seen high levels of secrecy. We’ve seen conflicts of interest. We’ve seen a foundation, in effect, be used to help private companies.”

This latest round of conversions by so-called secondary educational-loan organizations — which finance loans but, unlike banks, do not work directly with students to initiate them — was sparked by a 1996 change in federal law.

Two decades ago, the federal government encouraged the creation of secondary-loan buyers because it feared that banks alone would not be able to come up with enough money to help students. By issuing tax-exempt bonds, those organizations bought government-backed loans from banks as part of what is now known as the Federal Family Education Loan Program.

But the dynamics of the student-loan market changed in 1993 when the Department of Education created the Federal Direct Loan Program, which lets students borrow directly from the government rather than having to go through commercial banks. What’s more, the move by states to limit the amount of tax-exempt bonds that they offer has made it difficult for many secondary-loan organizations to grow.

As a result, those organizations lobbied Congress and won a one-time opportunity, at any future point, to transfer their student-loan activities to a new for-profit company. A key aspect of the law exempted the for-profit company from having to pay back taxes on bonds that had been issued as tax-exempt in the past.

Lawrence W. O’Toole, the founding president of the Massachusetts secondary-loan organization known as Nellie Mae, who led the effort to change the federal law, says the change will mean huge benefits for educational causes. “We started from a point of being at risk with our future, but now we’re able to make a commitment to support education to the tune of $400-million or so,” he says.

Much of the task of overseeing the conversions has fallen to state regulators. And, as the four transactions so far demonstrate, each state has approached the task in a different way and has had to confront its own set of issues.

In Massachusetts, Nellie Mae went through the most-extensive review process of the four student-loan conversions. Public documents in the case total more than 200 pages.

Consumer advocates are also pleased by the value of the assets that will end up in the hands of the Nellie Mae Foundation after the loan company owned by the foundation is sold to Sallie Mae, the nation’s largest financer of student loans, for $320-million. Once the deal is made final this summer, the charity’s assets will soar to $395-million, making it the largest organization of its kind in New England.

Consumers Union also gave the secondary-loan group good grades for its efforts to seek public input, including the six “information meetings” that foundation officials held throughout New England with members of the public, including potential grantees, and state lawmakers.

In Nebraska, by contrast, the student-loan conversion, which involved one of the state’s largest non-profit groups, took place without the supervision of the Attorney General or the approval of the state courts. The situation frustrated consumer advocates and a member of the University of Nebraska Board of Regents, Chuck Hassebrook, all of whom urged action.

“There were real problems,” says Mr. Hassebrook, who is program director of the Center for Rural Affairs, in Walthill, Neb. “I think the new non-profit took actions that were blatantly illegal and were a violation of its tax-exempt status.”

Adds Mr. Hassebrook: “The Attorney General’s Office didn’t really take note of the conversion when it happened. The truth is, nobody even knew this was coming on.”

The Attorney General eventually opened an investigation into the conversion that created the Foundation for Educational Funding, which has about $115-million in assets and has denied any wrongdoing.

One issue of particular concern to the Attorney General was the foundation’s decision to limit eligibility for an initial round of scholarships to students who borrowed money through banks and other private lenders, such as the for-profit company created as part of the Nebraska secondary-loan conversion.

That decision excluded students at the state’s largest institution of higher education — the University of Nebraska at Lincoln — which only participates in the direct federal lending program. Critics saw the move as an attempt to pressure the university into allowing students to borrow from private lenders.

The Attorney General’s Office concluded that the Foundation for Educational Funding’s policy was an improper step that could help the for-profit loan provider, NebHelp. “That is a no-no. You can’t do that,” says Jason W. Hayes, an assistant attorney general. He says that the foundation immediately agreed to allow all students to be eligible for its scholarships after his office pointed out the need for a change.

But W. Scott Davis, chairman of the board of the Foundation for Educational Funding, says that his organization always intended to include all students after its first round of scholarships.

Mr. Davis says one reason the charity restricted the initial scholarship offering was because it wanted to give back to the schools who had “contributed to the wealth” in the foundation by participating in the private-lending program.

In Ohio, questions have arisen about the grant-making decisions of the Thomas L. Conlan Education Foundation, a charity with assets of about $140-million.

Mr. Gardner of Consumers Union worries about what he sees as signs that officials of the foundation have had too narrow a view of how the money should be used.

For example, many of the grants awarded during the foundation’s first year went to projects with which foundation board members had some direct connections. A $1-million grant went to the National Underground Railroad Freedom Center, a Cincinnati project that board member Lawrence Hawkins co-chaired. A $500,000 grant went to Resources Instruction for Staff Excellence, a teacher-training charity that the foundation’s president, Chad P. Wick, used to head.

Even the name of the foundation has raised some eyebrows. Unlike the other student-loan conversion foundations, which are named for the non-profit organizations that spawned them, the Ohio foundation honors Thomas L. Conlan, Sr., a founder of the secondary-loan organization who is credited with overseeing its huge growth.

Says Mr. Gardner, “That’s like my raising $5-million as an employee of Consumers Union to pay for a new building and then naming it the Patrick Gardner Memorial Building. There’s a big problem with that.”

Joseph D. Booth, assistant director of the Conlan Foundation, counters that without Mr. Conlan and his son, Thomas L. Conlan, Jr., there would be no money for educational grants.

Mr. Booth also defends the practice of making grants to groups with ties to foundation board members as inevitable and necessary since board members have strong educational and non-profit involvement in Ohio.

“To suggest that credible and deserving organizations who may have some affiliation with a trustee should be excluded from our grant making is to handcuff the foundation from achieving our mission,” he says.

Still, Mr. Booth says the foundation “recognizes the importance of eliminating conflicts” and has adopted a policy of having board members remove themselves from grant reviews that involve charities with which they are affiliated.

Regulators and advocacy groups also had some concerns about the grant-making focus of the Great Plains Education Foundation, in Aberdeen, S.D. The group this month announced that it is getting $86-million in assets through a secondary-loan conversion of what once was known as the South Dakota Student Loan Corporation.

As records filed with the state seem to indicate, the grant-making organization sought to limit much of its giving to helping unemployed people in a single location, Brown County, where the foundation is based.

Attorney General Mark Barnett now says that the concern has been “completely resolved at our suggestion,” but offered no further details.

At the announcement earlier this month of the infusion of money into the foundation, South Dakota Governor William J. Janklow said grants would go toward helping the state’s school students, “especially in areas such as computer and Internet technology.”

Consumer advocates say that the four student-loan conversions point out problems in an oversight system that has not been revised to take into account major changes in the non-profit world, including an increase in earned income by charities and an explosion in for-profit subsidiaries.

They say that the legal standard sometimes applied to conversion cases, known as the cy pres doctrine, was originally intended to cover trusts set up by a donor that must be altered for some reason to insure that the new mission remain as near as possible to what a donor originally intended.

Mr. Gardner fears that the doctrine may be too narrow to answer all the questions raised by complicated non-profit conversions, be they health-care groups or secondary-loan organizations.

“In a non-profit conversion, you can’t point to a particular person who gave the money with these constraints and say, Oh this is what this non-profit is about,” says Mr. Gardner. “So states find it much harder than in the past to decide what the non-profit mission is and how that mission should be protected in the event that it goes out of business.”

Monitoring these complicated changes is a tall task for attorneys general, especially given the shortage in money and staff members that many regulators face, and requires the public to get more involved in determining how non-profit conversions are sorted out, says Mr. Gardner.

One solution he suggests: revising state laws to allow members of consumer-advocacy groups and the public to raise questions about the transactions in court.

Even if states do not change their laws, says Mr. Gardner, the non-profit world must find better ways to keep tabs on conversions because some of the 19 remaining secondary-loan groups may begin to move their work into businesses. Additional conversions to for-profit companies could also be ahead, he says, in the area of vocational and trade schools.

In cases where non-profit conversions have already occurred, Mr. Gardner says, there is still a key role for advocacy groups to play. For example, he says, those organizations should encourage grant-making charities formed during conversions to pay out 5 per cent or more of their assets each year as private foundations must do, even though those organizations are usually structured as charities with no payout requirements.

Adds Mr. Skloot of the Surdna Foundation: “We all have a serious stake in being sure that these dollars remain in the public trust and get used for charitable purposes.”