Sallie Mae benefited from 2004 conflict-of-interest ruling
Matteo Fontana, the student-aid official in the U.S. Department of Education who was suspended last month in an ethics case, issued a controversial high-stakes legal ruling in 2004 that benefited his former employer, Sallie Mae, on the day before the nation’s top student lender completed its transition from a government-founded lender into a for-profit corporation.
In his ruling, Mr. Fontana, who has been placed on administrative leave following reports that he owned stock in another student-loan company, declared that Sallie Mae could legally perform debt-collection services for a partner company, USA Funds, even though federal conflict-of-interest regulations prohibit such work by the same “entity” that holds the loan.
The decision kept intact a key element of a $250-million corporate relationship that had been criticized two years earlier by the department’s inspector general as potentially abusive of the nation’s system of federally backed student loans.
In studying one aspect of that relationship, the inspector general also concluded in the 2002 audit that USA Funds had improperly kept more than $6.6-million in interest from borrower payments that it owed to the government. In the same letter in which he issued the legal ruling, Mr. Fontana authorized a settlement in which USA Funds paid back only $1.7-million.
The December 28, 2004, ruling issued by Mr. Fontana endorsing Sallie Mae’s relationship with USA Funds, on the eve of Sallie Mae’s privatization ceremony, was not publicly disclosed. A copy of the ruling, in the form of a three-page letter signed by Mr. Fontana, was provided by the Education Department at the request of The Chronicle.
Sallie Mae’s relationship with USA Funds, an agency intended by law to serve as an independent nonprofit guardian of federal spending on student loans, now brings $250-million a year in revenue to the lender. Sallie Mae last year reported $1.3-billion in profits and last month tentatively accepted a $25-billion buyout offer from private investors.
The company’s relationship with USA Funds goes back to 2000. Employees of Sallie Mae perform most of the operations at USA Funds, which has only 75 employees. One of the most lucrative and legally controversial services provided by Sallie Mae to USA Funds is tracking borrowers who fall behind in their payments.
As a provider of federally guaranteed student loans, Sallie Mae is required to maintain contact with borrowers for the first 60 days after a payment is overdue. USA Funds, in its role as an independent guarantor in the student-loan system, can collect extra money from the federal government to assist a lender with that job if the borrower’s payment becomes more than 60 days overdue.
The federal government requires the lender and the guarantor to be separate entities, so that they do not have an incentive to collect the federal subsidy by letting borrowers fall further behind on payments.
In the case of Sallie Mae, the potential benefit of letting students accumulate extra late fees and penalties is even bigger because the company also owns a series of debt-collection subsidiaries that perform work for both USA Funds and the federal government.
Criticism in 2002 Audit
Mr. Fontana’s ruling stemmed from the 2002 audit by the Education Department’s inspector general, which concluded that Sallie Mae’s relationship with USA Funds amounted to a violation of the law because the Sallie Mae subsidiary that provided workers to USA Funds was a wholly owned unit of Sallie Mae.
Mr. Fontana, writing to USA Funds in March 2004 in response to the audit, said the department agreed with the finding. Yet nine months later, in his December letter, he told USA Funds that “the department has reconsidered its earlier position” and saw no conflict of interest.
Mr. Fontana, who is head of the Education Department office that oversees lenders and guarantee agencies involved in the federal guaranteed-loan program, was suspended last month when he was found to have owned at least $100,000 worth of stock in another lender, Student Loan Xpress, after joining the department in 2002. Mr. Fontana, who worked at Sallie Mae from 1994 to 2001, reported in his 2002 government disclosure form that his annual salary from Sallie Mae before joining the department was more than $200,000.
In his December 2004 ruling, Mr. Fontana said the conflict of interest cited by the department’s inspector general did not exist because the Sallie Mae subsidiaries that staffed USA Funds had different tax-identification numbers from the subsidiaries that did not.
That logic is disputed by experts both inside and outside the Education Department.
“It is an outrageous distortion of the intent of conflict-of-interest rules,” said Robert M. Shireman, a former senior education-policy adviser in the Clinton administration who now leads the Project on Student Debt, an advocacy group. “It’s hard to imagine that an unbiased regulator would make this type of decision.”
Mr. Fontana also said in his 2004 ruling that “it is apparent” from Sallie Mae’s Web site that the subsidiaries working for USA Funds were separate from other Sallie Mae units, even though they were wholly owned divisions. A 2005 “fact sheet” on the company’s Web site, however, shows all units involved in tracking borrowers as entities of the overall corporation. The fact sheet defines only one unit — its charitable division, the Sallie Mae Fund — as a “separate entity” within its corporate structure.
One Education Department official involved in the matter, who declined to be identified, said the department’s own legal counsel had disputed Mr. Fontana’s conclusion in the December 28 letter. A department spokeswoman, however, said the department’s Office of the General Counsel agreed with Mr. Fontana that Sallie Mae units working inside USA Funds and those working outside it “met the definition of separate entities as defined in the Black’s Law Dictionary,” which is a standard reference book for legal definitions.
The spokeswoman, Samara Yudof, said she could not immediately provide documentation from the legal office confirming that it had taken that position. The letters from Mr. Fontana show they were copied to six officials and units of the department, none of them in the Office of the General Counsel.
“The Office of the General Counsel and the program offices of the department routinely work closely together through the course of the deliberative policy-making process,” Ms. Yudof said. “We have no reason to believe this was not the case with this matter.”
Companies Defend Ruling
Both Sallie Mae and USA Funds contend that Mr. Fontana’s ruling was proper. “The department concluded that there were sufficient fire walls and checks in place that this did not represent a conflict,” said Bob Murray, a spokesman for USA Funds.
Tom Joyce, a spokesman for Sallie Mae, said its employees work just as hard to keep borrowers current in their payments before USA Funds becomes eligible for the federal subsidy as they do afterward. “We try our best to get borrowers to not be delinquent before 60 days for USAF-guaranteed loans and all other guaranteed loans,” he said, “but that just isn’t possible.”
The latest available annual tax filing by USA Funds, for 2004, shows that the nonprofit guarantor paid $250-million to Sallie Mae. Neither company provides a public breakdown of that figure showing how much was attributable to the additional federal subsidy, their spokesmen said.
The federal government guarantees about $70-billion a year in loans to American college students and their parents, mostly through banks and other private lenders such as Sallie Mae, which has the largest share.
The lenders are paid a federal subsidy that lets them offer borrowers a below-market interest rate. In addition, guarantors use federal money to reimburse lenders for virtually the entire cost of the loans in the event that borrowers default, which is defined as letting the debt go unpaid for more than 270 days.
In the case of a default, a guarantor can hire a collection agency to pursue the borrower. The guarantor must return the amount collected to the government, less a share that it keeps as payment for the collection effort.
In the case of USA Funds, which describes itself as “the nation’s leading education-loan guarantor,” Sallie Mae also provides much of its post-default collection work. In the April 2002 audit, the inspector general said that to avoid conflicts of interest, Sallie Mae divisions hired by USA Funds should not perform collection work on defaulted Sallie Mae loans within three years of the dates of the claims. Mr. Fontana said in his letters that he accepted that restriction.
The inspector general’s audit of April 2002 also called on USA Funds to repay the government more than $6.6-million in interest from payments it had collected from defaulted borrowers. USA Funds gained that interest by not immediately crediting government accounts with the collected money, the inspector general said.
Warnings of Lax Supervision
In his March 2004 letter to USA Funds, Mr. Fontana said the department had reached an agreement in which the company would pay back about $1.7-million of that interest, covering the period October 1998 through June 2000. The department promised a further review of the period October 1995 to October 1998. In the December 2004 letter, however, Mr. Fontana said no more reimbursement was necessary. “These findings are considered closed,” he wrote.
The April 2002 audit was among a series of warnings by the inspector general concerning the department’s lax supervision of federal money in the hands of USA Funds and other guarantee agencies.
Sallie Mae was founded by the federal government in 1972 with the mission of freeing up more funds for the fledgling federal student-loan program. Sallie Mae used U.S. Treasury bonds to purchase government-backed student loans from banks, and the banks used that money to make more loans.
One day after Mr. Fontana’s December 2004 letter, Sallie Mae’s chief executive, Albert L. Lord, attended a ceremony at the U.S. Treasury Department, in Washington, where officials signed documents formally establishing Sallie Mae as a private corporation.
“We’re very happy and very proud” to finish the privatization process, Mr. Lord told reporters at the ceremony. He predicted that Sallie Mae’s stock price would grow by 15 percent to 20 percent a year for at least five years.
Mr. Lord received total compensation of $225-million while Sallie Mae’s chief executive from 1999 to 2004, according to Fortune magazine. He stepped down in May 2005, when he became chairman of the board. The magazine this year lists Sallie Mae in 284th place on its list of Fortune 500 corporations, based on its revenue of $8.7-billion.
http://chronicle.com Section: Government & Politics Volume 53, Issue 37, Page A18