This report was published on 12/17/09.

The education stocks are trading off today following the release of a memorandum from the Department of Education’s Office of Inspector General (OIG).   You can find the memorandumhere.  Effectively the OIG has asked the Department of Education to review the status of the HLC and potentially “limit, suspend, or terminate HLC’s recognition by the Secretary”.  In a recent inspection, the OIG identified serious issues with the HLC’s decision to grant initial accreditation toCECO (29.95 ↑0.10%)’s American Intercontinental (IHG 14.93 ↑1.77%) University, specifically related to AIU’s assignment of credit hours to certain undergraduate and graduate programs.

In the 10-years we have been following the for-profit education sector we have never seen the Dept. of Ed. or the OIG act this aggressively in such a public forum.  We HIGHLY doubt that the Dept. of Ed. will actually revoke the HLC’s recognition.  However, we think this is yet another sign that the administration will use whatever tools available to increase oversight and enforcement of the for-profit education sector.  We think the most likely outcome of today’s action by the OIG is the application of more strict oversight by the HLC of the schools it accredits.

The HLC accredits more than 1,000 institutions including those that are both non and for-profit.  Historically, regionally accredited schools have been viewed as higher quality.  Today’s Dept. of Ed. memorandum calls into question the thoroughness of oversight among those schools that are accredited by the HLC.  APEI (45.61 ↑1.88%), APOL (63.44 ↑0.13%), CECO, CPLA (86.25 ↑0.22%), DV (66.76↑1.46%), EDMC, and WPO (451.55 ↓0.43%) all own schools that are accredited by the HLC, so in some respects this could be viewed as an indictment of the sector.

We find it particularly noteworthy that “assignment of credit hours” is the primary issue the OIG raised. The definition of credit hour and how it is applied is a fairly controversial subject and one that the Dept. of Ed. does not have 100% control over.  It appears the Dept. of Ed. wants to lean on the accrediting bodies to enforce stricter and more consistent application of the definition of a credit hour.

In our view, today’s memorandum should serve as a warning to any investor that the Dept. of Education wants to bring tighter oversight on the for-profit postsecondary education sector in order to execute on its access and affordability mandate.  We think many schools will increasingly adopt “self-regulation” policies to reel in any perceived regulatory transgressions or areas of lax compliance.  Additionally, those schools that have high default rates or offer students low returns on educational investment are most likely be subject to heightened regulatory scrutiny.  In our view, COCO (17.42 ↓0.40%), ESI (109.51 ↑0.02%) and WPO all fall into that category and shares could see continued downside as a result.

As always, please act accordingly…