The Education Department proposed much-anticipated regulations Friday that would cut off federal aid to for-profit college programs if too many of their students default on loans or don't earn enough after graduation to repay them.
"Some proprietary schools have profited and prospered but their students haven't, and this is a disservice to students and to taxpayers," Education Secretary Arne Duncan said in a briefing with reporters. "And it undermines the valuable work, the extraordinarily important work, being done by the for-profit industry as a whole."
To qualify for federal student aid programs, career college programs must prepare students for "gainful employment."
The Obama administration, amid intense lobbying from both for-profit college officials and consumer and student advocates, is proposing a complicated formula that would weigh both the debt-to-income ratio of recent graduates and whether all enrolled students repay their loans on time, regardless of whether they finish their studies.
Early reaction was mixed, with a Republican senator and a for-profit college lobbying group panning it and advocates for tougher regulation questioning whether it does enough to protect students and taxpayers.
On Wall Street, shares of several for-profit education companies jumped Friday at the news. DeVry Inc., which is among the companies analysts predicted would be least affected by the proposal, climbed 15 percent and was one of the biggest gainers in the Standard & Poor's 500 index.
But shares were mixed among companies such as ITT Educational Services Inc., Corinthian Colleges Inc., Education Management Corp. and Career Education Corp. Those companies operate career colleges focusing more on two-year programs or lower-income students and may need to make big changes if the proposal is adopted, analysts said.
Mark Kantrowitz, publisher of the FinAid.org Web site, said the government's proposal "appears to represent a reasonable compromise that separates the wheat from the chaff without discarding too much wheat."
For-profit colleges have faced increased scrutiny in recent months for some questionable recruiting tactics, high loan default rates, and low graduation and job placement rates. The government is taking notice because for-profit colleges are bringing in record amounts of federal aid money — $26.5 billion last year, up from $4.6 billion in 2000.
Under the Obama administration proposal, vocational programs would fall into one of three categories:
—Programs fully eligible for aid will either have at least 45 percent of their former students paying down the principal on their federal loans — or their graduates will have a debt-to-earnings ratio of less than 20 percent of discretionary income or 8 percent of total income.
—Ineligible programs will have less than 35 percent of their former students paying down the principal on their federal loans — and their graduates will have a debt-to-earnings ratio above 30 percent of discretionary income and 12 percent of total income.
—Those programs that don't fit either definition would be restricted — meaning they would be subject to limits on enrollment growth and schools would be required, among other things, to warn of their high debt levels.
Duncan said the department estimates that if schools make no changes, 5 percent of for-profit college programs would be ineligible for aid in 2012 — affecting 8 percent of all students in the fast-growing sector.
If the rules went into effect now, 55 percent of for-profit schools would be required to disclose unflattering loan data in their promotional materials, making for a strong consumer protection tool, the agency said.
To give schools time to improve and to target "the bottom of the barrel," Duncan said the administration would cap the number of programs it would strip of aid eligibility at 5 percent in fall 2012, when that penalty would first be assessed.
The Career College Association, the for-profit college sector's main lobbying group, said establishing a ratio between student debt and anticipated graduate earnings is unwise, unnecessary and unproven.
"Amounts borrowed today do not indicate what you will be able to repay in five years, ten years or over a working lifetime," the association's president, Harris Miller, said in a statement.
Others who were hoping for tougher rules were disappointed, as well.
Pauline Abernathy, vice president of the Institute for College Access & Success, said while the proposal is significant and has teeth, programs could continue to profit from federal aid when more than half their students can't afford to pay down the principal on their loans.
"It is not as strong as it should be to protect students and taxpayers from getting ripped off by career education programs that over-promise and under-deliver," she said.
Republican Sen. Lamar Alexander of Tennessee criticized the proposal, saying the government could in effect "institute price controls on certificate and degree programs at thousands of institutions of higher education." Sen. Tom Harkin of Iowa, a Democrat who is holding oversight hearings on for-profit colleges, said at first glance, "the regulation appears to set a low bar."
The proposed rules will be published Monday in the Federal Register and a 45-day public comment period will follow. The final rules are scheduled to be announced in November and would take effect next year, although enforcement action that would strip schools of aid eligibility would not begin until the 2012-2013 school year.
Associated Press Business Writer Tali Arbel contributed to this report.