Grand Canyon University’s Misleading Response to my Testimony
Last week, on May 23, I testified at a meeting of the National Advisory Council on Institutional Quality and Integrity (“NACIQI”). Among my remarks were comments on what I described as the erroneous grant of nonprofit status to a new “charity,” Grand Canyon University. Following that testimony, GCU has issued a press release claiming that I misstated the facts and law related to its exemption application. GCU’s release is, as best I can tell, wrong in almost every respect.
Some background for new readers. NACIQI is an entity operating within the U.S. Department of Education, and it serves to oversee the nation’s accreditors — for example, NACIQI has oversight authority over the American Bar Association when the ABA acts as an accreditor of law schools. Last week, NACIQI held a special session to discuss conversions of for-profit colleges to non-profit status, and to examine whether these conversions were relevant to the mission of higher-education accreditors or the Department of Education (“ED”) generally.
As I had blogged here, I told NACIQI that the conversion of GCU into “New GCU,” a nonprofit organization, was a “just a mistake,” notwithstanding the fact that the IRS has apparently approved GCU’s application for 501(c)(3) status. Statute and IRS regulation prohibit charities from being operated for the benefit of their insiders or other private parties, and GCU — which pays 50% of most of its gross revenues, plus $48m or so in annual interest payments, to its for-profit “old GCU” partner — clearly contravenes that rule. My testimony goes into some more detail about the application of the IRS’s published guidance to the facts of GCU’s conversion.
GCU, understandably, disagrees with my testimony, and their press release raises what they purport to be factual errors in my analysis. My analysis mentions as an adverse factor for GCU’s nonprofit status the fact that they share an overlapping board and management with their nonprofit partner. GCU says I am mistaken, and that “the board of New GCU will consist of members who are entirely different than the board members of Grand Canyon Education.” These board members “may” decide to keep on the prior CEO, but might not.
I did not make up these facts. Instead, I took them directly from securities filings issued by GCU. The form 8K GCU filed on Feb. 26, 2018 says that “GCU’s current faculty, academic leadership and related staff would become employed by New GCU and New GCU would be governed by a board of trustees comprised of the persons who currently serve on the institutional board of trustees of GCU” (emphasis added). A quarterly statement GCU filed just 3 weeks ago repeats this same information: “The University’s current faculty, academic leadership and related staff would become employed by New GCU and New GCU would be governed by a board of trustees comprised of the persons who currently serve on the institutional board of trustees of the University.” I just cut and pasted that sentence directly from the SEC page.
Notwithstanding these statements, perhaps it is true, as GCU’s press release says, that they will in fact have a different “academic leadership” and a different board for the nonprofit than the folks who now run for the for-profit. If so, however, that is information that their investors, and the SEC, should be brought up to date on. I am not expert in such matters, but investors who relied on the February and early-May statements to the contrary may wish to consult a legal professional.
I suppose it is technically possible for GCU’s two apparently contrary statements to both be true. Perhaps the board of the new nonprofit will carry over all the same individuals from the old for-profit, but the remaining for-profit entity will replace every one of its old board members. If so, that too is typically an event that must be disclosed to the public (see Form 8K §5.02(b)), and no such notice appears in an Edgar search of GCU filings.
Let’s now discuss law. GCU asserts that my analysis must be flawed, because they have been granted exemption by the IRS and approved by their regional accreditor. In fact, the exact point of my testimony was that the IRS, burdened by resource constraints and the legacy of the Tea Party scandal, can’t be expected to adequately police new applications for exempt status.
GCU does have one argument that goes somewhat to the merits, but they present that argument misleadingly. In my oral testimony, I note that the IRS test for excessive “private inurement,” or distribution of profits to insiders, “frowns heavily” on arrangements in which the insider receives a share of revenues. That is logical enough: profit sharing contracts are pretty good evidence that managers are in fact receiving a share of profits. GCU points out that many institutions, including my employer Georgetown, have service arrangements in which the service provider receives a portion of the revenues raised through the arrangement. Am I arguing that Georgetown isn’t a real nonprofit?
No, because GCU confuses what is permissible for mere line employees or contractors with what can be permitted to a true insider. IRS regulations are clear that employees with no significant managerial responsibility, such as investment advisors, can be given profit-based incentives awards. These people (or entities) don’t have the power to set their own pay or the organization’s policies, so there isn’t a great danger that their profit incentives will distort the behavior of the school. In contrast, insiders — those who have or recently had power to direct and control the organization — do of course have the power to write their own compensation arrangements and steer the school. If they have profit-based compensation, there is a serious danger they will be motivated to prioritize profit over nonprofit mission.
This distinction is also reflected in other guidance that GCU misunderstands or glosses over. In the regulations I referenced in my testimony, the so-called “whole hospital joint venture” guidance of Revenue Ruling 98–15 (and judicial interpretations of them), profit sharing by a management company that operates or controls all or most of the operations of the nonprofit are an important negative factor weighing against the joint venture retaining nonprofit status. In contrast, later guidance on smaller joint ventures in which a large share of the assets of the nonprofit are not committed allows the for-profit partner to receive incentive awards. GCU’s transaction is clearly a “whole [university]” joint venture, not a mere side-deal with a vendor who, say, operates the dining hall or runs Ivy League alumni tours. The joint ventures Georgetown has are subject to a totally different body of law from the rules that govern GCU’s conversion, and any competent tax lawyer would know as much.
I argued to NACIQI that a fundamental danger these conversions present is that they threaten to mislead the public about the true nature of schools like Grand Canyon, papering over a profit-seeking motive with a “nonprofit” label. If their recent press release is any indication, my worries about GCU misleading the public are not entirely unfounded.
