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ITT Educational Services (ESI) Just Pushed For-Profit Colleges Over the Cliff

Just when you think it can’t get any worse for the for-profit colleges like Apollo Education Group Inc (NASDAQ:APOL), ITT Educational Services, Inc. (NYSE:ESI) and Strayer Education Inc (NASDAQ:STRA), it gets worse.

itt-educational-services-esi-stock-logo-185The latest chapter in a saga that’s largely crippled the industry put ITT Educational Services at center stage on Monday, and sent ESI shares down a stunning 42% as a result.

The prod for the pullback? An accusation by the Securities and Exchange Commission that the school’s CEO and CFO knowingly concealed from ITT Educational Services shareholders just how badly its home-grown student loan portfolio was performing.

The company denies the accusation and says it will fight the action in court. Knowing what we know about the credibility (and accreditation) woes most for-profit colleges are experiencing, however, it seems unlikely the SEC is merely grasping at straws.

More than that, the SEC’s decision to pursue its claim is one of the strongest signs yet that for-profit colleges are desperately struggling for survival. Investors should take the hint.

ESI is Under Fire

The complaint, filed in a U.S. District Court in Indiana, accuses Chief Executive Officer Kevin Modany and Chief Financial Officer Daniel Fitzpatrick of disguising the fact that the loans it had made to its own students were not actually being repaid as the company’s books implied.

It wasn’t just a matter of doctored accounting statements the commission is concerned about, however. This loan portfolio was a guaranteed loan portfolio. That is, if it didn’t collect repayments as described — a technical default — it would trigger cash payments to the loan portfolio’s backers.

The SEC ‘s complaint claims that not only did the school not adequately disclose the true risk these guaranteed loans posed to ESI investors, but that default has already occurred.

It’s not the only legal trouble ITT is dealing with right now — last year, the Consumer Financial Protection Bureau sued the school for predatory lending practices. ITT Educational Services sought to have that case dismissed, claiming the CFPB lacked jurisdiction. The judge unsurprisingly disagreed in March, only throwing out one of the claims the Bureau made against the company.

That case is moving forward; some say it could result in refunds made to affected students.

It’s Not Just ITT

While ESI shareholders were made victims on Monday, ITT Educational Services is hardly the first school to run into a fiscal roadblock that became something of a legal hurdle.

Take Corinthian Colleges Inc. (OTCMKTS:COCOQ) as an example. In mid-April the Department of Education fined the for-profit school $30 million for making a total of 947 misrepresentations regarding graduates’ job prospects.  On May 4, Corinthian Colleges filed Chapter 11 bankruptcy, accelerating plans to wind down its entire operation.

Plenty of other for-profit colleges besides ESI or COCO have run afoul of government agencies, however, spurring debilitating trouble for themselves. In 2013, Apollo Education Group arm University of Phoenix was put on probation by the Higher Learning Commission, which was a first step toward the loss of its accreditation. Although APOL dodged that bullet, there’s little doubt that the Higher Learning Commission’s concern further damaged the company’s already-weakening reputation.

Bottom Line For the For-Profit Colleges

At the risk of sounding like I’m gloating, I told ya so. That is, I started warning investors the for-profit schools were too far gone to salvage.

The first clarion call came way in February 2014. I said:

“It’s the proverbial beginning of the end for the for-profit schools unless they can do something miraculous, and fast … like actually help someone get a job they wouldn’t have otherwise gotten on their own without crushing them with debt.”

The next one came on Aug. 11, when yours truly opined:

“It may be too generous to call this the beginning of the end of for-profit colleges as we know them. It’s closer to the middle of the end. Yes, there are exceptions to the generalization. As a whole, however, the woes COCO stock and now ESI stock are experiencing are just a microcosm of an industry-wide hurdle.”

The next step is the end of the end. Well, thanks to the latest ITT Educational Services debacle, we’re there. Guilt is irrelevant — with most of these stocks already at or near multi-year lows, investors have had enough.

Don’t read that too literally. This isn’t to say that the legal wall ESI hit on Tuesday is going to inspire all the other for-profit colleges to simply close shop on Wednesday. The mountain of financial and legal problems these names are collectively facing now, however, just became insurmountable for the industry as we know it.

Time to let it die.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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