U.S. District Judge J. Paul Oetken during his nomination hearing in 2011.
U.S. District Judge J. Paul Oetken during his nomination hearing in 2011. (Photo: Diego M. Radzinschi)

ITT Educational Services Inc.’s courtroom woes expanded on Tuesday, when a judge refused to dismiss most of a shareholder class action alleging that the for-profit education company duped investors about its troubles coping with rising student loan default rates. The ruling is a win for lead plaintiffs counsel at Cohen Milstein Sellers & Toll.

In an 18-page ruling, U.S. District Judge J. Paul Oetken in Manhattan mostly denied arguments by ITT’s lawyers at Gibson, Dunn & Crutcher that he should dismiss the securities fraud claims. The judge ruled that Cohen Milstein adequately alleged that ITT’s executives misstated the company’s liability under an agreement with SLM Corporation (commonly known as Sallie Mae) to jointly absorb losses from defaulted student loans. He also green-lighted claims that ITT concealed from investors that Sallie Mae was demanding repayment.

The vast majority of ITT students take out loans to pay tuition. Students and alumni began defaulting more frequently in the years leading up to the 2008 financial crisis, and lenders like Sallie Mae became more reluctant to extend credit to new students. In order to boost enrollment, ITT entered into risk-sharing agreements (RSAs) with Sallie Mae and private loan providers. The RSA with Sallie Mae stipulated that ITT would bear the cost of defaulted loans if students’ overall default rate exceeded 24 percent.

By 2011, more than a quarter of Sallie Mae’s loans to ITT students were in default. Sallie Mae sued ITT later that year, demanding repayment under the RSA. ITT agreed in January 2013 to settle the case for $46 million.

The $46 million settlement ended up being just one of ITT’s many problems in early 2013. On February 22 of that year, after the markets closed for the weekend, ITT disclosed that the U.S. Securities and Exchange Commission was investigating its student lending programs. The disclosure sent ITT’s stock price down 17 percent in single-day trading on the following Monday. Two days later, the Consumer Financial Protection Bureau filed a lawsuit against ITT alleging predatory lending.

In a March 2013 complaint, Cohen Milstein alleged that ITT’s CEO Kevin Modany misled investors during a 2011 conference call by stating that he wasn’t projecting any payments to Sallie Mae. Cohen Milstein also alleged that ITT’s CFO Daniel Fitzpatrick is liable for asserting between 2008 and 2011 that any payment under the RSAs would be immaterial. Finally, in an amended complaint filed in October, Cohen Milstein added a third allegation that ITT overstated the likelihood that it could reach a new RSA with a third-party lender. Modany and Fitzpatrick are named as codefendants in the case along with ITT itself.

In Tuesday’s ruling, Oetken dismissed the allegation that ITT lied about the possibility of a new RSA, writing that the plaintiffs failed to show the falsity of the claim. But he allowed the rest of the case to proceed, ruling that the plaintiffs clearly met the high pleading standard for securities fraud.

“Securities plaintiffs need not plead facts ‘of the smoking-gun genre’ to be entitled to relief. But plaintiffs here have done just that,” Oetken wrote. “They allege that ITT, through its CEO, told investors that it did not expect to make any payments on the Sallie Mae RSA, all the while knowing that it already needed to make such payments.”

Lead plaintiffs counsel Carol Gilden of Cohen Milstein wasn’t immediately available for comment. ITT lead counsel Wayne Smith of Gibson Dunn didn’t immediately return a call seeking comment.

ITT and Gibson Dunn suffered another setback in July 2013, when the U.S. Court of Appeals for the Seventh Circuit revived a whistleblower suit alleging that ITT’s recruitment practices violated the False Claims Act. A judge had called the case “frivolous” and sanctioned Motley Rice and other plaintiffs firms a combined $400,000, but the Seventh Circuit ruled that the firms acted properly and presented a solid case, as we reported here.