Student loan firms hit by probes, reform calls

NEW YORK (Reuters) - The largest U.S. student loan company reached a settlement with New York's attorney general on Wednesday, and federal lawmakers called for further investigation of the widening scandal in the $85 billion-a-year industry.

SLM Corp. <SLM.N>, known as Sallie Mae, agreed to pay $2 million and to end some of its practices, which Attorney General Andrew Cuomo said were deceptive and unlawful. SLM will pay the $2 million into a fund that will educate students about financial aid.

Meanwhile in Washington, Sen. Edward Kennedy asked the U.S. Securities and Exchange Commission to investigate stock dealings of a CIT Group <CIT.N> subsidiary, school financial aid officers who did business with the company and an official of the U.S. Education Department.

These developments came as investor James Chanos, a well-known short-seller, told Reuters that many more student loan companies face serious legal issues. Chanos, who profits by betting stock prices will decline, expects lenders' shares to drop.

Investigators will uncover "many tens of billions of dollars in fraud" at loan companies, Chanos said at the Reuters Hedge Funds and Private Equity Summit. Chanos, who anticipated the Enron scandal months before the company collapsed, declined to name exactly which companies he is betting against.

His firm, Kynikos Associates, has been shorting companies in the sector for three years, he said.

"The real fraud they will find is the herding of middle- and lower-income kids into all kinds of degree schools, and they come out with $40,000 to $50,000 in loans," said Chanos. "We've only just scratched the surface."

ONGOING PROBE

Cuomo told reporters his investigation continues into other schools and lenders, including CIT Group's Student Loan Xpress. SLM, the first to reach a settlement with New York, has agreed to cooperate with the ongoing probe.

"To the schools and lenders, you now have a choice: you can either settle with us or the investigation will continue," Cuomo said at a Manhattan press conference.

New York, which began probing financial arrangements between loan companies and schools late last year, said several student lenders paid kickbacks and offered perks to financial aid officers. In exchange, lenders wanted to be included on

schools' lists of preferred lenders.

Cuomo said these practices were not disclosed to students, who as a result might not get the best terms possible.

The lists are an important source of business for lenders, with 90 percent of students using a preferred lender, the attorney general said.

In the settlement, SLM denied having broken the law.

"We're happy to put this matter behind us," SLM spokesman Tom Joyce said.

According to the settlement, SLM did not take part in widespread "revenue sharing" arrangements, which Cuomo called kickbacks. These are payments to schools based on the number of students who apply for loans.

The settlement said Sallie Mae provided clerical staff to financial aid offices, set up call centers that answered phones in the name of the school and funded trips for school officials, among other practices.

Last month, Cuomo set forth a "code of conduct" that prohibits lenders from providing anything of value to schools or their officials in exchange for special treatment. Lenders and schools must disclose any relationship they have.

REFORMS

SLM, which agreed to the code, will no longer staff financial aid offices and will provide full disclosure to students if it sells their loans to other companies, the settlement said.

Earlier this month Citigroup <C.N>, the largest U.S. bank and a major student lender, agreed to pay $2 million into Cuomo's financial aid education fund and adopt his code of conduct for student loan practices.

Student advocates said the U.S. student loan system needs more sweeping reforms.

"More disclosure is fine, but this entire system requires overhaul so there's real market competition and our resources go to providing students with the best benefits," said Luke Swarthout, an education advocate with the U.S. Public Interest Research Group.

Also last month, Cuomo filed a notice of intent to sue Education Finance Partners, which would be his first legal action arising from the investigation of several lenders and about 100 schools.

Since then, the investigation has intensified as more school have been drawn in.

On Monday, Johns Hopkins University put a financial aid director on paid leave after learning she received $65,000 of consulting fees from Student Loan Xpress. CIT placed three of the unit's executives on paid leave.

Last week, Cuomo said school officials at New York's Columbia University, University of Southern California and University of Texas had owned stock in the former parent of Student Loan Xpress, Educational Lending Group Inc.

Kennedy, a Massachusetts Democrat, said an inquiry by his staff into connections between lending firms and school financial aid officers revealed a "pattern of back-room dealing that has no place in financing higher education."

Last month, U.S. Rep. George Miller asked five major lenders to detail their relationships with college financial aid offices.

(Additional reporting by Sarah Coffey, Edith Honan and Dane Hamilton in New York and Kevin Drawbaugh in Washington)