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Friday, May 22, 2015

SEC ALLEGES ITT EDUCATIONAL SERVICES CONCEALED POOR PERFORMANCE FROM INVESTORS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 23259 / May 13, 2015
Securities and Exchange Commission v. ITT Educational Services, Inc., Kevin M. Modany, and Daniel M. Fitzpatrick, Civil Action No. 1:15-cv-00758 (S.D. Indiana, Indianapolis Division, filed May 12, 2015)

SEC Announces Fraud Charges Against ITT Educational Services

On May 12, 2015, the Securities and Exchange Commission filed fraud charges against ITT Educational Services Inc., its chief executive officer Kevin Modany, and its chief financial officer Daniel Fitzpatrick.

The SEC alleges that the national operator of for-profit colleges and the two executives fraudulently concealed from ITT's investors the poor performance and looming financial impact of two student loan programs that ITT financially guaranteed. ITT formed both of these student loan programs, known as the "PEAKS" and "CUSO" programs, to provide off-balance sheet loans for ITT's students following the collapse of the private student loan market. To induce others to finance these risky loans, ITT provided a guarantee that limited any risk of loss from the student loan pools.

According to the SEC's complaint filed in the U.S. District Court for the Southern District of Indiana, the underlying loan pools had performed so abysmally by 2012 that ITT's guarantee obligations were triggered and began to balloon. Rather than disclosing to its investors that it projected paying hundreds of millions of dollars on its guarantees, ITT and its management took a variety of actions to create the appearance that ITT's exposure to these programs was much more limited. Over the course of 2014 as ITT began to disclose the consequences of its practices and the magnitude of payments ITT would need to make on the guarantees, ITT's stock price declined dramatically, falling by approximately two-thirds.

The SEC's complaint alleges that ITT, Modany, and Fitzpatrick engaged in a fraudulent scheme and made a number of false and misleading statements to hide the magnitude of ITT's guarantee obligations for the PEAKS and CUSO programs. For example, ITT regularly made payments on delinquent student borrower accounts to temporarily keep PEAKS loans from defaulting and triggering tens of millions of dollars of guarantee payments, without disclosing this practice. ITT also netted its anticipated guarantee payments against recoveries it projected for many years later, without disclosing this approach or its near-term cash impact. ITT further failed to consolidate the PEAKS program in ITT's financial statements despite ITT's control over the economic performance of the program. ITT and the executives also misled and withheld significant information from ITT's auditor.

The SEC's complaint alleges that this conduct violated the antifraud, reporting, books and records, internal controls, lying to auditors and false certification provisions of the federal securities laws. The SEC's complaint also alleges that Modany and Fitzpatrick failed to comply with Section 304 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). The SEC seeks permanent injunctions, disgorgement with prejudgment interest, and civil monetary penalties. With respect to Modany and Fitzpatrick, the SEC also seeks officer-and-director bars and reimbursement pursuant to Section 304 of Sarbanes-Oxley.

The SEC's investigation has been conducted by Zachary Carlyle, Jason Casey, and Anne Romero with assistance from Judy Bizu. The case has been supervised by Laura Metcalfe, Reid Muoio, and Michael Osnato of the Complex Financial Instruments Unit. The litigation will be led by Nicholas Heinke, Polly Atkinson, and Mr. Carlyle.

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