The U.S. Department of Education (ED) published the change in ownership (CIO) rule in the fourth quarter of 2022. The rule goes into effect July 1, 2023, and impacts every step of this process. It includes new notifications that are required before any CIO, an updated approval process, and requirements on institutions post-close.
This makes it crucial that institutions and acquirers understand the potential impact before considering a merger or acquisition. We recommend careful review of the new requirements and an assessment how they could affect your CIO’s approval process before investing in any diligence procedures.
This article will break down the key changes while also highlighting additional changes that could be on the horizon.
As always, McClintock & Associates is here to help. We are recognized experts in Title IV compliance for the education sector.
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Why did ED make the changes?
ED defines nonprofit
Updates to requirements for notification, reporting, review level for CIO
Codified post-close requirements
Why did the Department of Education Update Change in Ownership Requirements?
Over the last few years, ED expressed growing concerns about the ways that higher education CIOs have grown in number and complexity. This growth significantly increased the amount of time ED needed to review transactions, with some taking up to a year. The longer timeframe created pressure for ED and made it difficult for the institutions in limbo to know which regulations applied to them.
In particular, ED is most concerned about CIOs that convert a for-profit institution to a nonprofit institution. ED’s stated goals for the rule include providing adequate notice to ED before transactions occur and developing a more streamlined process for approval that ensures compliance with regulations.
ED Defines Nonprofit Institution
Different regulations and requirements apply to nonprofit and for-profit institutions. ED’s concern about nonprofit conversion stems from these differences.
Therefore, the new rule states that a nonprofit institution is generally not an institution that (emphasis added):
- Owes debt to a former owner of the institution (or a person or entity affiliated with a former owner)
- Maintains a revenue sharing agreement directly, or through any entity it owns or controls, with former owners, current or former employees, board members or otherwise affiliated persons
- Is a party, directly or indirectly, to any agreements with former owners (including lease agreements), current or former employees, board members or otherwise affiliated persons
- Engages in an excess benefit transaction with any natural person or entity
There’s a caveat for the revenue sharing or other agreement criteria if ED determines the agreements to be reasonable. However, it is difficult to assess what ED would consider reasonable, so avoiding these agreements is the best path toward obtaining approval for any CIO.
For-profit institutions undergoing a change in status to nonprofit will remain for-profit for all ED purposes until ED approves the nonprofit status.
Updates ED Change-in-Ownership Review and Reporting Requirements
The new rule changes a variety of aspects institutions must consider in a CIO.
Reporting the Change in Ownership to ED
While the new rule lowers the bar for the CIO threshold that requires reporting to ED, the required timing was slightly relaxed. Institutions now must report any ownership interest change of 5 percent or more (compared to current threshold of 25%). However, in nearly all situations, the CIO between 5-25% can be reported quarterly versus the current requirement to do so within 10 days. The intention is to increase ED’s transparency without significantly increasing the burden on institutions.
Requirements for a Full ED Review
The new rule also increases the threshold of CIO that requires a full review by ED from 25% to 50%, though ED maintained the ability to require for smaller CIO as deemed appropriate by the Secretary.
When measuring the CIO change percentage, the new standards include somewhat vague references to considering common ownership, management, or control of the entity directly or indirectly. ED expects ownership interests to be combined if there are proxy agreements or voting agreements whether they are written or not. In addition, events such as the change in the general partner of a limited partnership or managing member of a limited liability company would require a review by ED.
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New 90-Day Requirement to Notify ED and Students
The most significant change to CIO regulations is a new requirement to notify ED, as well as currently enrolled and prospective students 90 days prior to a change in ownership. ED’s notification includes a prescribed form accompanied by current effective accreditation and state authorization documents and audited financial statements for the two most recently completed fiscal years. The student notifications can be handled through email or other electronic communications, though simply posting to a web page was described as insufficient.
Post-Close Requirements for Change in Ownership
The new CIO rule continues to require that a “materially complete” application for CIO requiring ED approval must be submitted with ten business days following the transaction to receive a Temporary Provisional Program Participation Agreement (TPPPA). However, watch for slight tweaks to what must be provided. And the rule codifies ED’s standard practice regarding financial protections, mainly in the form or Letters of Credit.
Documentation to be Provided
ED continues to require that institutions submit state and accreditation approvals of the CIO. These must be in effect as of the day before the CIO. Institutions must also provide two years of audited financial statements from both the institution undergoing the CIO and the proposed new owners.
However, this requirement now specifies that these audited financial statements must be for the two most recently competed fiscal years. This new requirement could create large windows of time when it would be impossible to complete a CIO. Institutions can’t complete transactions during the period of time it takes to audit financial statements. This issue would be compounded when the institution and proposed new owners have different fiscal year ends.
Same Day Balance Sheet Requirements and Considerations
As part of ED’s review process, the new entity must submit the same-day balance sheet (SDBS), often also referred to as the Opening Balance Sheet. ED has consistently required the SDBS to reflect the entity at the highest unfractured ownership level, not at the institutional level. This can create difficulties due to the size of and complexities of these entities. With the expiration of the Covid-19 national emergency, the due date of the SDBS will go back to the last day of the month following the month in which the transaction occurred. As an example, transactions closing August 1 and August 31 would both be due September 30.
ED considers two ratios when reviewing the SDBS: the Acid Test and the Tangible Net Worth Test.
The Acid Test compares current portions of cash and student receivables to current liabilities. To pass, the cash and student receivables must exceed current liabilities by at least $1. Even though nonprofits do not typically report assets as current versus long-term on their statement of financial position, they are still subject to this test and are required to disclose the amounts. The recently implemented lease standard can put pressure on the Acid Test because the current portion of lease liabilities increases the bar for cash and student receivables needed to pass.
The Tangible Net Worth Test simply compares tangible assets, defined as total assets less intangible assets, to total liabilities. The tangible assets less total liabilities must be at least $1.
ED Codifies Standard Practices for Letters of Credit
ED has been requiring financial protection in the form of letters of credit post-close for quite some time. The new rule partially codified the practice we have seen. The letters of credit are based on a percentage of the total Title IV aid awarded in the previous year. However, the new rule indicates that if the new entity holds at least a 50% interest in another institution, ED may consider the amount of Title IV awarded by the other institution when determining the amount of financial protection required.
If the new owner cannot provide two years of audited financial statements, the letter of credit will be at least 25% of the prior year’s Title IV awarded. If only a single year of audited financial statements can be provided, the minimum is at least 10%. ED can obtain additional financial protection, as deemed necessary of at least 10%. Historically, additional amounts have been required when the new combined entity fails the Acid Test and/or the Tangible Net Worth Test.
Insight into Financial Protection Requirements Expected Pre-Close
Per Electronic Announcement dated September 15, 2022, ED discontinued the Comprehensive Pre-Acquisition Review and made the Abbreviated Pre-Acquisition Review (APAR) the only option available to institutions. The APAR is a limited review of a proposed CIO that is intended to help new owners submit a materially complete application within the required ten-day timeframe. As part of the APAR ED will indicate whether financial protection will be required post-close. In addition, for new owners with multiple levels of ownership, the APAR will determine the highest unfractured ownership level that must submit audited financials for the two previous years and the SDBS.
Why do the New Change of Ownership Requirements Matter?
Proprietary institutions undergoing a CIO or converting to nonprofit status could encounter major disruptions to their timeframe or find that their documentation to ED is now inadequate.
This could result in lost revenue or wasted investments in due diligence and other processes.
Understand what these requirements mean to your institution and start your CIO prepared. Our people are dedicated experts in higher education accounting and Title IV compliance. We’re ready to help you navigate these complex regulations and undergo the smoothest possible change in ownership.
