A troubled for-profit college network that was led by former Maine Gov. John McKernan controlled a nonprofit foundation in Portland for years that critics say should not have had charitable tax status and may have been designed to help circumvent federal rules governing access to student aid programs.

Education Management Corporation, the Pittsburgh-based college network, disputes the charges, saying the foundation operated in accordance with tax law and that its giving did not help it get around the federal rules.

McKernan was CEO of EDMC, as the company is known, from 2003 to 2007. After that, he was chairman of its board until 2012, by which time the firm was facing a multibillion-dollar financial aid fraud lawsuit brought by the U.S. Justice Department as well as investigations by four states’ attorneys general and the inspector general of the U.S. Department of Education. McKernan was governor of Maine from 1987 to 1995.

Critics accused EDMC of having saddled thousands of students with crushing debt and useless degrees while leaving taxpayers with the tab for defaulted loans. EDMC settled the lawsuits last November, paying $95.5 million in fines and forgiving more than $100 million in student loans.

While the lawsuits made national news, the role of Maine’s former chief executive in EDMC’s fall from grace has received scant attention, including the operations of the little-known nonprofit EDMC Foundation, which was housed in McKernan’s Portland offices from 2003 to 2012 and was staffed and governed by former aides and employees of the governor and his wife, longtime U.S. Sen. Olympia Snowe.

A three-month investigation by the Maine Sunday Telegram found that while the EDMC Foundation was registered as a charitable nonprofit, its stated purpose was to provide scholarships exclusively to students attending EDMC’s schools, even as it was controlled by employees of the company or McKernan himself during the nine years it was based in Maine.

This arrangement was unorthodox. Charitable nonprofits are not supposed to primarily benefit a for-profit entity, especially one whose officials set up and controlled the foundation in question.

“If the Coca-Cola Foundation’s purpose was to give grants to people to buy Coke, that would not be seen by the IRS as an appropriate use of the charity,” says Bob Shireman, a former U.S. Department of Education official in the Obama administration, now a senior fellow at the Century Foundation. “This is clearly a charity designed to feed money into a for-profit entity, which means it should not have been tax-exempt.”

EDMC, which provided online degrees at its Art Institutes, Brown Mackie College, Argosy University, South University and Western University College of Law brands, was accused by federal prosecutors and whistle-blowers of enrolling thousands of students who had little hope of succeeding in its programs, knowing it could pocket their student loans and leave the taxpayer on the hook if they went unpaid.

McKernan was CEO and then board chairman of EDMC as it quadrupled its enrollment, a period when prosecutors said many of the worst abuses occurred. His company stock and annual pay – the latter in some years exceeding $1.5 million – at one point made his wife the ninth wealthiest member of the United States Senate, with a 2007 estimated net worth of $33.3 million, the majority from EDMC stock.

“Gov. McKernan was the president and CEO of EDMC at its very worst period, when it expanded too fast, admitted students it couldn’t help just to cash their federal financial aid checks, when it overcharged tuition, and let itself be acquired by Goldman Sachs and private equity firms,” says David Halperin, a former legal counsel to the Senate Intelligence Committee and speechwriter for President Bill Clinton who has written extensively and critically of for-profit college networks. “It went from being a quality institution to being one of the worst predatory companies, and he was very well paid for his services.”

Forty-eight hours after McKernan’s departure was announced in 2012, U.S. Senate investigators released an unflattering report, suggesting the $1.8 billion that taxpayers had provided the company in the form of federal student aid had not been “a worthwhile investment.” In his final eight months as chairman, EDMC’s stock price had tumbled from $28 a share to $3, and would fall to just 30 cents two years later.

“Looking back, it’s stunning, the damage they have done,” says Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers. “So many tens of thousands of people with enormous, crushing debt for, of all things, art degrees, which gave them less than what they were promised.”

An EDMC spokesman, Bob Greenlee, defended McKernan’s tenure, saying “employees who worked with Jock McKernan overwhelmingly praised his leadership and his commitment to increasing opportunities for EDMC students.”

A WELL-REGARDED NETWORK TRANSFORMS

When McKernan was recruited as vice chairman of the board in 1999, EDMC was one of the best regarded for-profit college networks in the country, says Stephen Burd, a fellow at the New America Foundation, a nonpartisan think tank in Washington, D.C., who focuses on higher education. For three decades EDMC had been led by Robert Knutson, who’d overseen the purchase of its first school, the Art Institute of Pittsburgh, and slowly and methodically expanded it to 19 art schools enrolling 24,000 students.

Burd says McKernan’s arrival at EDMC was a turning point and that he went on a “shopping spree” upon becoming the company’s chief executive officer in 2003, buying non-arts schools such as Argosy (which focused on education and health care), South (health sciences) and Brown Mackie (business and computing).

By 2006, McKernan presided over more than 70 schools enrolling nearly 80,000. That March the company was purchased by Goldman Sachs and two private equity firms for $3.4 billion and, according to critics, became narrowly focused on rapid growth. “Once Goldman took it over, that was sort of the end of the game; the transformation was complete,” Burd says. “McKernan played a pivotal role in transforming EDMC from one of the best for-profits to one of the worst and most predatory.”

With the change in ownership, the old management and board were swept out, largely replaced by partners from Goldman Sachs and its two equity partners. The one prominent exception: McKernan, who served another year as CEO and then became chairman of the board, a position he would occupy until 2012.

Former employees have previously described a radical shift with the Goldman takeover, with an overarching emphasis on recruiting students and the federal student grants, loans and G.I. benefits they paid their tuition with, which accounted for about 80 percent of EDMC’s revenues and nearly 90 percent at some of its schools.

Former EDMC admissions employees told reporters in 2011 that admissions staff nearly tripled to 2,600 after the takeover, with management handing down “revamped telemarketing scripts designed to prey on poor and uneducated consumers.”

“You probe to find a weakness,” former admissions employee Brian Klein told the Huffington Post that year. “You basically take all that failure and all those bad decisions and you spin around and put it right back in their face as guilt, to go to this (expletive) university and run up all this debt.”

Whistle-blowers charged in a suit taken up by the U.S. Department of Justice that EDMC’s online schools targeted single parents, the disabled and unemployed precisely because they typically had no income or assets and so would qualify for substantial federal student aid packages. EDMC “employees quip that the schools are actually changing lives for the worse because they push students that are not ready for the rigors of college into their schools and set them up for financial ruin when the student inevitably fails to complete their program of study,” prosecutors wrote in their court filings.

‘IT WAS THE STORY OF SUBPRIME GOES TO COLLEGE’

In June 2010, the U.S. Senate’s oversight committee for higher education, led by Tom Harkin, D-Iowa, began a two-year investigation of for-profit colleges, on account of their rapidly increasing enrollments and consumption of federal student aid.

In the process, investigators obtained a telemarketing script from EDMC’s Argosy University that coached admissions officers on how to hard-sell the school by overcoming common objections such as not having enough money, wanting to enroll at a community college instead, not wanting to quit a job and not feeling able to succeed at Argosy. Prospective students were told that Argosy – which is based in Orange, California, and has 28 campuses in 12 states plus an online division – “is the best possible investment they can make” and that going to a community college would be “settling for second best.”

Internal company emails obtained by Senate investigators showed managers pressuring admissions officers to meet recruiting targets. “PLEASE EVERYONE HIT THE PHONES!!!” the director of admissions at EDMC’s Art Institute of Charlotte wrote his staff in January 2008. “WE ARE FAR BEHIND WHERE WE NEED TO BE!!! … PUSH!!!!!!!!!!!!!!!!” Later that year, the same official – whose name was redacted by investigators – advised that one of the admissions officers “might be going to Hawaii” while “some of you are going to detention,” apparently based on whether recruiting quotas were met.

By 2010 the company employed 5,669 recruiters, or one for every 28 students in its system, but only 321 career counselors, or one for every 493 students, investigators working for the Senate committee that oversees federal higher education programs and student loans discovered.

“The company transformed from an education institution to primarily a marketing machine, and they knew where the buttons were to push for human hope and aspirations and how to manipulate people,” Nassirian says. “Growth was spectacular, but we now know most of it was the story of subprime goes to college. It was the same sleazy practices of getting people who were fundamentally unfit for the offering, getting them into debt, and leaving the taxpayer on the hook for any defaults.”

Default rates were high. In 2008 alone, 6,533 EDMC loan holders defaulted, a default rate of 16 percent, or nearly double the rate at private nonprofits and public universities. That year at EDMC’s Brown Mackie College in Tucson, Arizona, the default rate was 33.3 percent. Exactly how much this cost taxpayers is unclear – Senate investigators did not release a dollar figure – but with student debt typically in the tens of thousands of dollars, the figure would likely be many tens of millions a year.

The Senate investigation noted that EDMC had high numbers of students leaving programs without completing them, and concluded that this was therefore not a good use of federal student loan funds. “It is not clear that the $1.8 billion taxpayers made in the company in 2010 is a worthwhile investment,” the report concluded.

In 2012, federal prosecutors charged EDMC with having “engineered a business aimed at maximizing the amount of federal education assistance funds back to their companies rather than one geared towards providing quality educational services to students.” The U.S. attorneys alleged in court filings that in an effort to increase enrollment, EDMC had pushed admissions representatives to pursue students who were unlikely to complete degree programs. These students would drop out, but not before accumulating “a substantial amount of student loan debt that they are required to pay back to the federal government.” Unable to find well-paying work, they defaulted on their loans at “an alarming rate,” leaving taxpayers holding the bag.

EDMC colleges, the prosecutors added, “laugh all the way to the bank while they are allowed to retain the federal educational assistance funds and recruit a new round of unsuspecting students the following semester.” This was one of the cases EDMC settled last November.

McKernan declined an interview request, but in written comments he said he disagreed that the company had transformed for the worse after the private equity firms purchased it. He declined to elaborate.

THE COMPANY’S PORTLAND-BASED FOUNDATION

Shortly after McKernan joined EDMC’s board, the company began paying the rent on his Portland office. In 2001, McKernan also joined the board of a new and unusual entity that the company’s co-founder, Robert Knutson, had set up in Pittsburgh – one that would move its headquarters into McKernan’s Portland office in 2003 and would be staffed by close aides and allies of the former governor or his wife, Olympia Snowe.

This entity, the EDMC Foundation, was a registered charitable nonprofit, but its stated purpose was to provide scholarships exclusively to students attending EDMC’s schools. When it was first created and approved as a charitable entity by the IRS, the majority of its board were not employees or owners of EDMC. But shortly thereafter the balance of the board changed, with company officials and investors forming a supermajority of its governing board.

Experts say this arrangement was troubling, as charitable nonprofits are not supposed to primarily benefit a for-profit entity, especially one whose officials set up and controlled the foundation in question.

“Whenever you have a 501(c)3, tax-exempt entity that is closely connected to providing support or benefits for a related for-profit entity, there is significant risk of what is called inadmissible private benefit,” says Jeffery S. Tenenbaum, chairman of the nonprofit organizations practice at Venable, a law firm in Washington, D.C. “If I were advising such a foundation, I would strongly advise them not to limit their grants and scholarships to students attending the for-profit entity.”

In a hypothetical audit involving such closely related entities, Tenenbaum said, the Internal Revenue Service would have been “looking to see if that tax-exempt foundation has a governing structure that allows it to be truly independent or if it is really controlled by individuals who come from the for-profit side, who are employees and stakeholders of EDMC, because that would be a very problematic pattern.” Had the IRS found such a problem, the foundation could have lost its tax-exempt status. (Whether the IRS ever audited EDMC or the EDMC Foundation is unclear. An IRS spokesman told the Maine Sunday Telegram that federal law prohibits federal employees from discussing audits and other tax filing matters.)

During the period when the foundation was based in Portland – from 2003 to 2012 – its tax returns show its board was overwhelmingly made up of EDMC employees and former McKernan and Snowe aides. They included the company’s vice presidents for communications, lobbying, student finance, recruitment and its Art Institutes: Dave Lackey, who had been communications director for both McKernan and Snowe; McKernan’s former chief of staff and campaign aide Shannon Miller; and Lucas Caron, a longtime McKernan and Snowe aide who currently runs Olympia’s List, the nonprofit Snowe set up shortly after her 2013 retirement from the Senate.

During this period, the foundation’s executive director was Ruth Summers, vice president of the Maine Republican Party and wife of perennial congressional candidate and former Maine Secretary of State Charlie Summers, a close Snowe ally until 2012, when the two had a falling out over Summers’ failure to endorse Snowe in her re-election bid, which she ended in February 2012. Ruth Summers, now director of admissions at Cheverus High School in Portland, did not respond to repeated interview requests.

In a statement sent to the Maine Sunday Telegram, the EDMC Foundation – which moved back to Pittsburgh after McKernan resigned as EDMC chairman in 2012 and has renamed itself the Education Foundation – said Pennsylvania law did not require the majority of directors to be independent and that “independence” was judged based on not having business relationships with the foundation itself, not EDMC.

McKernan said in a written statement that the foundation’s board followed the legal advice it received from a Pittsburgh law firm specializing in nonprofit organizations “whether on its organization, structure, or in its determinations of board membership.” The arrangement, he wrote, was “approved by the IRS so EDMC schools could provide additional financial support to their students.”

Like many other nonprofits, the foundation does not disclose its donors on its tax filings, and the foundation’s current executive director, Frank Orga, did not respond to a request to discuss them.

WAS NONPROFIT’S ROLE TO GET AROUND THE ’90/10 RULE’?

Several experts said the foundation’s real purpose was to help EDMC institutions comply with a federal rule intended to make it difficult for poor-quality schools to qualify to receive federal student aid funds. The company denies that assertion.

“A foundation that provided ostensibly private scholarships would be very useful for these institutions in getting around this regulation,” says David Hawkins of the National Association for College Admission Counseling in Arlington, Virginia. “It gives you a nonprofit charitable entity you can channel money through that becomes a tax write-off as well.”

The so-called “90/10 rule” requires for-profit institutions to raise at least 10 percent of their revenue from sources other than Pell Grants, Perkins Loans and other “Title IV” federal student aid programs, on the theory that a school unable to attract even a small amount of outside funds is probably disreputable. Failure to meet the requirement two years in a row would disqualify a school from receiving Title IV aid, effectively putting it out of business. In 2010, EDMC collected $1.8 billion in federal education funds, 97.5 percent of which were Title IV, including $351 million in Pell Grants.

Senate investigators obtained internal company documents that led them to conclude in their final report that EDMC had created the foundation “to bestow scholarships that count towards the 10 percent side.”

The documents show company officials were extremely concerned about making these targets, even though student aid from the U.S. Department of Veterans Affairs and state governments could be counted toward the 10 percent requirement.

In these documents, EDMC managers identified the EDMC Foundation as part of the solution. The emails indicate EDMC managers believed foundation scholarships would count toward the 10 percent requirement, thereby helping a distressed school remain eligible for federal student aid dollars.

One document presented an urgent “90/10 plan” for fiscal year 2010 at EDMC’s Brown Mackie College-Akron to ensure the school met its 10 percent non-Title IV quota. Among measures like retraining admissions officers to push all incoming students to apply for alternative loans, the plan had created “numerous fundraising campaigns on campus” to feed the EDMC Foundation’s scholarship fund, including “silent auction items, pie in the face campaign, raffle of student parking spaces, book buy-back funds and other planned events.”

Another document from November 2009 tracked company-wide efforts to ensure 90/10 compliance, which included an EDMC Foundation campaign to “quadruple the amount of employee contributions and school fundraising activity” to the scholarship fund.

EDMC and the foundation insist that foundation scholarships were not counted toward the 10 percent non-Title IV requirement, at least for the period after 2007. “I have been advised that EDMC treats Education Foundation scholarships as non-cash items for purposes of the 90/10 rule, and that EDMC has maintained this treatment for at least the last nine fiscal years,” Orga, the foundation’s current executive director, said by email.

The company denies any misconduct.

Greenlee, the EDMC spokesman, said the company documents were discussing potential strategies that weren’t acted on. “No EDMC institution has treated an EDMC Foundation scholarship as a cash item that would count for 90/10 purposes,” Greenlee added. “These have uniformly and exclusively been treated as non-cash/non-countable items.”

Orga also asserted that “even had these payments been treated as cash, the amount of scholarship aid awarded in any given year would not have had any impact on the 90/10 analysis for any of EDMC’s institutions.” He noted that the foundation awards $200,000 in scholarships each year, while EDMC schools together pull in over $1 billion in federal Title IV student aid.

But an examination of EDMC’s filings with the Securities and Exchange Commission suggests that some EDMC schools barely made their 90/10 targets during the period the foundation was operated out of McKernan’s Portland office. In 2012 the Art Institute of Phoenix received 86 percent of its funds via Title IV, the Art Institute of Pittsburgh and South University 84 percent. In the 2004 and 2005 fiscal years, at least one unnamed school also hit 86 percent, just 4 percent shy of noncompliance.

By comparison, Title IV funds constitute a tiny percentage of the revenue of nonprofit higher education institutions. At public colleges and universities, tuition and fees account for only 21 percent of average revenues, and only a fraction of that comes from Title IV sources, according to the National Center for Education Statistics. At private nonprofits, tuition and fees account for 32 percent of revenues, with research grants, endowment earnings and private gifts making up the rest.

The foundation also gave out far more scholarships in many of those years, more than $1 million in fiscal 2008. On at least some occasions, it focused awards to particular schools, with over a fifth of all scholarships awarded in fiscal 2007 going to the Art Institute of Pittsburgh, according to the foundation’s tax filing for that year, the only time it provided a breakdown of its giving.

‘GREAT DEAL’ FOR EDMC: SETTLING AT PENNIES ON DOLLAR

In 2011 the U.S. Justice Department and state attorneys general joined a 4-year-old whistle-blower lawsuit that alleged the company illegally paid its admissions personnel based on the number of students they enrolled.

The suit – eventually joined by Maine, 38 other states and the District of Columbia – sought the return of $11 billion the company had received in federal student aid since 2003, which was the year McKernan became its CEO.

The case never went to trial. Instead, last Nov. 16 the federal government approved EDMC’s offer to settle the case for just $95.5 million, about 4 percent of the company’s annual revenue. The firm was not required to admit wrongdoing, and no individuals were charged for their roles in approving and tolerating the recruitment practices.

Separately, EDMC agreed to forgive $103 million in loans it had given to 80,000 former students, including 244 in Maine. Attorney General Janet Mills at the time called it “a rigorous agreement” that “ensures that the company will make substantial changes to its business practices for future students.” (Mills declined to comment for this story.)

But Jesse Hoyer, a Tampa attorney who represented some of the whistle-blowers, described the settlement as a “sweetheart deal” for EDMC. “It’s a pittance compared to what their schools did in financial damage to the taxpayers,” Hoyer says. “There are only a handful of people like McKernan who benefited from this fraud, but many, many people are suffering.”

“Our clients put their entire lives on hold trying to fight these cases,” she added. “For them not to have to admit they did anything wrong is a slap in the face for whistle-blowers who were so brave to come forward.”

Ben Miller, senior director for postsecondary education at the progressive Center for American Progress, is also critical of the settlement. “It strikes me as a great deal for EDMC to commit questionable acts for years, rake in billions of dollars in federal financial aid, and walk away with fines equivalent to just a small portion of what you put in,” he says. “The government settled because they said if they had asked for more money, EDMC would have gone out of business. Well, maybe they should have.”

Nassarian agrees. “The guys who make the money are on their yachts at the moment, and the suckers who are holding the shares are your retirement funds and mine,” he says. “There were no fines on individuals, and nobody went to jail. Whoever thinks crime doesn’t pay hasn’t looked at for-profit higher education.”

Asked to respond to criticisms of the settlement and the failure to penalize individuals, McKernan issued a statement saying: “I agree with the company’s statement at the time of settlement that ‘we continue to believe the allegations in the cases are without merit’; and would further point out the agreement between EDMC and the Justice Department includes no admission of wrongdoing on the part of EDMC.”