GCU statement regarding Dept. of Education decision

GCU News Bureau

November 12, 2019

Grand Canyon University

Response to Department of Education approval of GCU’s change in control and analysis of Department of Education's determination that it will not treat Grand Canyon University as a nonprofit for purposes of Title IV, HEA programs.

PREAMBLE

Grand Canyon University has prepared the following statement in response to a letter issued by the Department of Education regarding GCU’s transaction of July 1, 2018, to revert to its historical status as a nonprofit university.

The University appreciates the Department of Education’s approval of its change in control application and the issuance of a provisional program participation agreement through September 30, 2022, but it was surprised and disappointed by the Department of Education’s position regarding the University’s nonprofit status. The University believes the Department made critical errors in its understanding of the facts and its application of the law in reaching its conclusion on this important decision. Many of the errors in the Department’s analysis could have been avoided if it had been willing to discuss the application with the University at any point since the initial application was filed in January 2018. Instead, despite repeated requests, the Department has been unwilling to have any meaningful discussions with the University over the past 22 months. As a result, the University strongly believes the Department reached the wrong conclusion on its nonprofit status and is reviewing its options to challenge this decision.

The University is hopeful that the disagreements it has with the Department on this topic can be resolved promptly with professional, productive discussions with the Department, and the University is willing to work cooperatively with the Department if there is any reasonable opportunity to do so.

Perhaps most disappointing, however, is the Department’s failure to acknowledge the accomplishments that have occurred at GCU, both before and since the transaction closed – from an institution that was on the verge of closing more than a decade ago, to one that today is extremely important to the City of Phoenix, the State of Arizona and hundreds of thousands of students and alumni across the world. By the Department’s own metrics, GCU has been a resounding success story, with the University’s most recent cohort loan default rate of 5.6% for the 2016 cohort (the latest year for which data is available), well below the national average of 10.1%, no failing programs under the former gainful employment rules, and a 90/10 calculation of 72.91% for the year ended June 30, 2019, well below the Department’s 90% requirement. The University has also invested over $1.5 billion back into the development of educational infrastructure over the last 10 years. And, all of this has been accomplished without raising tuition on the University’s ground campus for 12 straight years and with only nominal 1% annual increases in online tuition over the last 10 years. As a result, after institutional scholarships, students attending the University’s traditional campus pay on average only $8,700 per year in tuition. Average room and board costs at GCU ($8,038) are also well below the national averages for public four-year schools ($11,510) and private, nonprofit four-year universities ($12,990), according to the College Board, as the University is intent on making private Christian education affordable to all socioeconomic classes of Americans. The University’s students graduate with less debt on average ($18,750 according to the latest College Scorecard data) than at public and private nonprofit universities ($28,650 according to 2017 data from the Institute for College Access & Success). A tremendous benefit of the University’s low cost of attendance is that the University has created one of the most diverse student bodies in the country with its ground campus student body consisting of 47% students of color, including 29% Hispanic and 7% African-American.

None of the foregoing could have been accomplished without the tremendous efforts of the thousands of dedicated students, faculty, staff and alumni who have poured themselves into the transformation of GCU to create one of the greatest higher education success stories this country has ever seen. For that, the University wants to recognize your efforts and thank you for your hard work and dedication to Grand Canyon University. The University’s future has never been brighter and, together, the GCU community looks forward to the even greater accomplishments that lie ahead for this remarkable University.

RESPONSE

By letter dated November 6, 2019 (the “Decision Letter”), the Department of Education (the “Department”) approved the July 1, 2018 change in ownership transaction (the “Transaction”) in which Grand Canyon Education, Inc. (“GCE”) sold Grand Canyon University to an Arizona nonprofit corporation (in this document, Grand Canyon University and its Arizona nonprofit corporation owner are referred to jointly as “GCU” or the “University”). As a result of the approval, the Department awarded GCU a provisional program participation agreement (“PPPA”) that permits the University to participate in Title IV, HEA programs through September 30, 2022. The Department awarded the PPPA without any requirement to post a letter of credit or any growth restrictions or other conditions. The Department’s approval of the Transaction is significant – it means that there will be no disruption to students and that the University will be allowed to continue to operate as it has for many years, both before and after the Transaction.

The University disagrees, however, with the Department’s position that the University does not satisfy the Department’s definition of a nonprofit entity and, as a result, will continue to be treated as a proprietary entity for purposes of its participation in Title IV, HEA federal student aid programs.

Like all other private, nonprofit universities in the United States, GCU is a nonprofit corporation under the laws of its state of organization, and the Internal Revenue Service (“IRS”) has determined that GCU qualifies as a tax-exempt educational organization under Section 501(c)(3) of the Internal Revenue Code (“IRC”)[1]. In its decision approving the Transaction, the Department acknowledges both that GCU has the legal authority under Arizona law to operate as a nonprofit organization and that GCU has been granted 501(c)(3) status by the IRS; however, the Department nevertheless determined that GCU “does not satisfy the Department’s definition of a nonprofit” and, thus, concluded that the Department, contrary to the State of Arizona and the IRS, would continue to treat GCU “as a for-profit institution for purposes of its participation in Title IV, HEA programs.” The Department’s position is plainly at odds with these existing nonprofit determinations by state and federal agencies that are specifically authorized to make such determinations. The University is reviewing its options for challenging the Department’s determination on this issue.

The decision of the Department to continue to treat the University as a proprietary institution for Title IV, HEA program purposes does not affect the University’s operations or its students, nor does it affect the University’s right to identify itself as a 501(c)(3) tax-exempt organization like its private, nonprofit university peers. It only means that the University will need to continue to comply with certain heightened regulatory requirements which, as can be seen from the above-described metrics, have never been an issue for the University and were not a factor in the University’s decision to return to its historical nonprofit status. 

The Department has informed GCU that it intends to make the Decision Letter publicly available. It also offered GCU the opportunity to request that various portions of the Decision Letter be redacted. The University advised the Department that it would not request any redactions to the Decision Letter and asked that it be released in full.

The Decision Letter omits any description of the massive efforts GCU undertook to analyze and plan the Transaction, to establish and support GCU’s status as a nonprofit organization, and to ensure that, if consummated, the Transaction and GCU’s resulting status would benefit GCU and its students, faculty, staff and alumni. These efforts included engaging an independent tax advisor (PwC) and an independent legal advisor (Nixon Peabody LLP) to guide GCU and its Board of Trustees through the 501(c)(3) application process, as well as an independent financial advisor (Wells Fargo Securities, LLC), an independent tax advisor (Deloitte LLP), two independent law firms (Gallagher & Kennedy and Cooley LLP), independent real estate advisors, independent appraisers and others to guide GCU and its Board of Trustees through the Transaction process. The Decision Letter also fails to describe the extent to which GCU sought to engage with the Department over several years regarding the Transaction. GCU made extensive efforts to advise the Department in advance of its intention to proceed with the Transaction and to keep the Department well-informed regarding the details of, and the proposed timetable for, the Transaction, including promptly responding to multiple additional requests for information and offering to make its representatives available for meetings and consultations, to which the Department did not respond. As a result, the Decision Letter is replete with errors that easily could have been avoided, ignores information provided by GCU to the Department, and, among other things, fails to credit the extensive and substantive review of the Transaction conducted by GCU’s accreditor, the Higher Learning Commission, during its approval process. Instead, the Department of Education has chosen to substitute its judgment regarding the application of the relevant tax law for that of the United States federal agency responsible for administering and interpreting the Internal Revenue Code.

The Department notes in the Decision Letter that GCU received its 501(c)(3) determination letter “three years prior to the Transaction,” that “there is no evidence that the IRS conducted a comprehensive review” of the Transaction or supporting materials, and that “[u]nlike the IRS’s initial grant of tax-exempt status, the Department’s determination of nonprofit status considers the structure and planned operations of the Institution….” These statements appear to be the Department’s way of indirectly stating, as others have publicly, that the IRS “rubber stamped” its decision to grant GCU tax-exempt status and failed to conduct an in-depth review of this Transaction. But, this is not true. GCU’s 501(c)(3) application fully detailed the “structure and planned operations” of the University. Furthermore, in contrast with the Department’s refusal to speak with GCU, during the period when GCU’s 501(c)(3) application was under review and thereafter in connection with further efforts to structure the relationship between GCE and GCU, GCU and its tax advisors engaged in multiple discussions with IRS staff and modified various elements of the deal structure (including, in particular, various aspects of GCU’s governance structure) to satisfy IRS requests. In addition, the Department purports to prohibit the University from referring to its “nonprofit status” in its advertising materials while at the same time acknowledging that GCU is legally authorized to operate as a nonprofit corporation and has been granted status as a Code Section 501(c)(3) tax-exempt organization. This attempt by the Department to prohibit GCU from accurately describing its legal status in its commercial communications seems constitutionally questionable. 

GCU strongly believes that the Department’s decision cannot be supported on the merits. As is apparent to anyone that pays any attention or has ever been to GCU’s campus, and as detailed below, GCU is an outstanding university that has a very positive record of service to its students, faculty, staff and alumni. After the Transaction, GCU has continued to enhance that positive record and is well positioned to continue on that path. Accordingly, while GCU considers the appropriate path to challenge the Department’s interpretation of its nonprofit status, GCU is issuing this detailed statement outlining some of the inaccuracies and faulty logic applied by the Department in its Decision Letter.

I. Background of the Transaction

On January 18, 2018, in connection with GCE’s proposed sale of the University to GCU, GCU voluntarily filed a request for pre-acquisition review of the Transaction with the Department seeking the Department’s review of the proposed Transaction and guidance as to any regulatory limitations, such as a letter of credit or growth restrictions, that the Department might choose to impose on GCU following the closing of the Transaction. While GCU sought ongoing engagement with the Department about the Transaction throughout the ensuing months, the Department failed to respond timely to the request, even though the change in control applications of other universities who engaged in similar transactions were approved. However, based on this limited engagement and a number of other factors, including the historical financial strength and performance of GCU, the importance to GCU of completing the transaction and reverting to its historical nonprofit status, and advice from the outside counsel to GCE and GCU about the risks involved in closing the transaction prior to receiving the Department’s feedback, the Board of Directors of GCE and the Board of Trustees of GCU separately concluded, after more than five months of waiting for the Department to respond, that the benefits of consummating the Transaction at that time were numerous and any regulatory limitations imposed by the Department could be managed (particularly since GCU’s regional accreditor, the HLC, and the Arizona state regulator had already approved the Transaction). Accordingly, the parties closed the Transaction on July 1, 2018. Since that time, GCE has since operated as a services provider to GCU and, following its acquisition of Orbis Education in January 2019, to 21 other university partners, while GCU has operated as an independent, private university, accorded nonprofit status by the State of Arizona and status as a tax-exempt organization under Section 501(c)(3) of the Internal Revenue Code by the IRS.

II. GCU’s October 1, 2018 Letter (the “GCU Letter”).

Following the closing of the Transaction, in a letter to GCU, dated September 10, 2018, the Department requested that GCU provide support for why it should be treated as a nonprofit entity for Title IV, HEA program purposes. In an October 1, 2018 letter to the Department (the “GCU Letter”), GCU provided a comprehensive response in which it fully addressed the Department’s request and covered many of the same topics reviewed by the Department in the Decision Letter. The Department, however, never responded to the GCU Letter, never followed up on any questions or issues with GCU regarding the issues the Department has now raised in the Decision Letter, and seemingly ignored the substance of the letter in reaching the conclusions set forth in the Decision Letter.

GCU believes the GCU Letter provides significant background information regarding the Transaction and makes a compelling case for treating GCU as a nonprofit entity for Title IV, HEA program purposes. Today, we are publicly releasing the GCU Letter and it is attached in its entirety as Exhibit A (see below) to this statement.

III. GCU’s Response to the Department’s November 6, 2019 Letter.

In addition to its release of the GCU Letter, in the pages that follow, GCU provides its additional responses to various portions of the Decision Letter that it believes are inaccurate, misinformed, or lacking in support. In certain instances, the responses borrow from the GCU Letter.

The Decision Letter (page 1)

“GCU seeks approval of its change in ownership and request to convert to nonprofit status for purposes of its participation in Title IV, HEA programs. Although the parties had requested the Department to conduct a pre-acquisition review, the Transaction closed on or about July 1, 2018, prior to completion of the Department's pre-acquisition review. This letter constitutes the Department's post-closing decision on the change in ownership ("CIO") and requested change of status from proprietary to nonprofit.”

GCU’s Response:

GCU believes that the statement above, while accurate, does not credit the extensive efforts undertaken by GCU to seek engagement with the Department regarding the Transaction. To summarize:

Despite all of the work that went into the Transaction, and the numerous efforts GCU made to engage with the Department regarding the Transaction from early 2018 on, the Department never substantively engaged with GCU. Instead, with no advance warning and no discussion of any substantive issues with GCU over a nearly two-year period, the Department issued the Decision Letter - more than 22 months after the pre-acquisition review application was filed, more than 16 months after Transaction closed, and more than 13 months after GCU substantively responded to the Department regarding the nonprofit issue.

Please see Section III, beginning on page 3, of the GCU Letter attached as Exhibit A, for a further description of the extensive review of the Transaction, and GCU’s nonprofit status, made by other governmental bodies.

The Decision Letter (p. 4)

“The Department was provided with several reports (the “Reports”) and valuations that were commissioned to support the Transaction, including reports from Barclays Capital Inc. ("Barclays") and Deloitte Tax, LLP ("Deloitte).”

GCU’s Response:

The Decision Letter strongly implies that GCU based its decision to pursue the Transaction on advice received from Barclays and Deloitte. In fact, GCU did not engage Barclays as its financial advisor on the Transaction, did not review Barclays report, and had no interaction with Barclays on any matter. Instead, Barclays acted as financial advisor to GCE in the Transaction. It is unclear why the Department relies on the Barclays report as part of its analysis when it played no role in GCU’s evaluation and approval of the Transaction.

GCU did engage Deloitte to provide the transfer pricing analysis. It also engaged: an independent tax advisor (PwC) and an independent legal advisor (Nixon Peabody LLP) to guide GCU and its Board of Trustees through the 501(c)(3) application process, as well as an independent financial advisor (Wells Fargo Securities, LLC), an independent tax advisor (Deloitte LLP), two independent law firms (Gallagher & Kennedy and Cooley LLP), independent real estate advisors, independent appraisers and others to guide GCU and its Board of Trustees through the Transaction process. To ensure that a nonprofit organization does not violate the private inurement rules of the IRS, it must ensure that the payment for services received are at or below fair market value. The Deloitte transfer pricing analysis provides full support for the payments made to GCE for the services provided. Despite having access to this information regarding the extensive efforts made by GCU and its Board of Trustees to seek appropriate advice regarding the Transaction, the Department fails to mention any of this. The Department’s reliance upon materials provided to GCE by GCE’s financial advisor in determining GCU’s nonprofit status is completely misplaced – which is frustrating given the amount of time it had to review the materials and its open invitation to discuss the Transaction with GCU if it ever had any questions about any aspect of the Transaction or supporting documents. Again, if the Department had simply engaged with GCU on this matter, this fundamental mistake could have easily been avoided.

The Decision Letter (p.5)

“The Barclays Report provides a side-by-side comparison of the Institution's operating costs in 2019 based on two different assumptions — (1) GCE continues to own the Institution and incurs the costs to operate the Institution or (2) the Transaction closes, and Gazelle is required to hire GCE to perform some of the operational activities. See Barclays Report at 33. The comparison shows that under the planned separation (and as effectuated on July 1, 2018) the costs to operate the separated Institution increase from $810 Million to $1.496 Billion for fiscal year 2019, solely as a result of the Service Fees paid to GCE.”

GCU’s Response:

The Department goes to extensive lengths in the Decision Letter to portray the Transaction as financially detrimental to GCU. In doing so, it makes mathematical errors and incorrectly interprets the financial models provided. It also fails to acknowledge that GCU, both before and after the Transaction, has been a higher education success story that is in excellent financial condition on a standalone basis.

As an example of the types of errors in the Decision Letter, the quote above references the Department’s assertion that GCU, as a result of the Transaction, incurred operating costs of $1.496 billion. However, the $1.496B figure referred to in the Barclays report is a hypothetical “consolidated” expense figure that combines the projected operating expenses of both GCE and GCU post-Transaction, and it includes the projected annual revenue share payment from GCU to GCE, which cannot fairly be designated as an operating cost of GCU. In other words, GCU’s true operating expenses (overhead required to generate revenue) did not increase at all as a result of the Transaction – rather, those combined costs were split between GCU and GCE just as revenues are split. The fact that GCU receives 100% of the revenue in the first instance and then remits 60% to GCE does not create any actual additional expenses.

In fact, the Barclays analysis shows that, on a consolidated basis, assuming the Transaction did not occur, GCE/GCU would earn $254 million in net income for fiscal year 2019, and that, on a separated basis, the two entities would earn a combined $271 million. Thus, the net income of the parties, as a result of the separation, actually increased primarily owing to reduced real estate tax and stock-based compensation.

The expected beneficial impact of the Transaction to GCU was well-understood by the HLC, GCU’s accreditor, which noted in its report on the Transaction:

“The updated application and financial model shows that . . . . [GCU]’s revenues would be more than sufficient to fund its projected expenses including the fees due under the MSA, as well as interest payments that would be required to be made on the note (in connection with the purchase agreement).”

More broadly, the HLC’s analysis has been confirmed in the time since the Transaction closed. GCU’s revenue net of expenses and revenue net of expenses after interest for the year ended June 30, 2019, its first fiscal year of operations as a stand-alone tax-exempt educational institution, were $78.8 million and $26.1 million, respectively. In addition, for the year ended June 30, 2019, GCU generated over $123 million in operating cash flows and, as of June 30, 2019, held over $325 million in cash reserves. It also owns a nearly-300 acre campus and educational assets that have an excess value of approximately $360 million over the purchase price it paid GCE for those assets. Overall, the University is in a very strong financial position.[3]

The Decision Letter (pages 4-9)

The Department’s analysis on pp. 4-9 of the Decision Letter focuses almost entirely on how GCE may have analyzed the Transaction and how the Transaction may have benefitted GCE. Yet, the Decision Letter fails to include any analysis, or even any reference, to the process undertaken by GCU and its Board of Trustees, or the advice and counsel that GCU and its Board of Trustees received from their own independent advisors.

GCU’s Response:

The Department’s focus on GCE’s analysis of the Transaction gives the false impression that GCE structured and approved the Transaction by itself. As has been voluminously disclosed in public filings and in GCU’s filings with the Department, GCU has its own independent Board of Trustees and engaged its own independent financial, legal, tax, accounting and other professional advisors to guide it through the Transaction. Over the course of the roughly three-year period during which the parties sought to effect the Transaction, the GCU Board of Trustees met seventeen times to review the Transaction. With the help of its own independent advisors, the GCU Board of Trustees applied for and obtained the 501(c)(3) determination letter; analyzed the Transaction terms, the deal documents (including the Services Agreement), other services agreements in the industry, and the impact of the Transaction on the University’s financial condition and projected future financial performance; and also analyzed the impact of the Transaction on GCU’s faculty, staff, student body, alumni and surrounding community. In the end, the GCU Board of Trustees independently determined that consummating the Transaction was in the best interests of the University and its students, faculty, staff and alumni. For reasons that remain unclear, the Department purposely chose not to reference any of this or the countless hours of hard work undertaken by the GCU Board of Trustees and its advisors in completing this Transaction. The Department cannot fairly analyze the Transaction as it relates to GCU without discussing the steps that GCU and its Board of Trustees took in evaluating and ultimately approving the Transaction. The Department’s omission of this information defies explanation.

As to the analysis of the Transaction from GCE’s perspective -- which as noted is detailed at length in the Department’s letter -- it is not surprising that GCE’s management and board of directors received advice from their financial advisor regarding the benefits that the Transaction could provide to GCE. The determination by GCE’s board of directors that the Transaction was in GCE’s best interests does not mean that the Transaction was not also in GCU’s best interests. These two perspectives are not mutually exclusive. The Department is simply ignoring the determination by the GCU Board of Trustees that this Transaction was, and continues to be, in the best interests of GCU’s students, faculty, staff and alumni.

The Decision Letter (pages 6-9)

“Significantly, Deloitte did not identify the Institution's physical campus as revenue-generating, which is at odds with statements made by GCE to its shareholders. Notwithstanding the campus facilities' undeniable contribution to revenue, Deloitte did not consider it as a revenue-generating asset.”

“…because the Deloitte Report failed to identify the Institution's campus as a revenue-generating asset, it failed to consider the fact that Gazelle is incurring significant fixed-cost risk in connection with the campus. Gazelle owes a lump sum payment to GCE on July 1, 2025 of $853,068,386, which represents the purchase price for the campus.”

GCU’s Response:

In fact, Deloitte did identify the physical campus as revenue generating. The Department’s confusion here appears to stem from Deloitte’s identification and discussion of 7 “key departments” within the pre-Transaction organization that were “value creating drivers” for the University. Id. at p. 19. The Department’s misunderstanding of Deloitte’s analysis is made clear by its statement that “Deloitte found that the Institution generates revenue from seven activities,” when it was not activities but personnel departments that Deloitte identified as driving value. This statement leads up to the erroneous statement that Deloitte did not consider the campus as revenue-generating, which gives the impression that the Department inferred this belief from the fact that Deloitte did not include the physical campus as one of the seven activities.

The Department’s contention that Deloitte failed to consider the campus as a significant fixed-cost risk to GCU also indicates the Department’s misunderstanding – not only did Deloitte identify the campus as revenue-generating, but all parties involved (including financial advisors for both sides) were aware that the physical campus assets were being sold to GCU at below market value. In fact, the value of the campus and other educational assets acquired by GCU in the Transaction was $360M more than the purchase price, which greatly mitigated any risk to GCU in this regard.

Again, the Department could have avoided this critical mistake if it had simply engaged with the University prior to issuing its Decision Letter.

The Decision Letter (p. 9)

“It also bears mentioning that the main opinions in the Deloitte Report do not appear to be based on information that Deloitte independently tested and analyzed on behalf of Gazelle. Rather, those opinions in key areas appear to have been based on information supplied by GCE management. For example, Deloitte states that it identified revenue-generating activities based on 'fact finding discussions with key management personnel,’ that the classification of fixed costs was made "in conjunction with GCE management," and that the calculation of the share of fixed costs Gazelle and GSA would each pay under the MSA was determined by 'Deloitte Tax and GCE.’"

GCU’s Response:

As the Department well knows, prior to the closing of the Transaction, Gazelle was a newly formed nonprofit corporation. While it had an independent Board of Trustees, and had been granted 501(c)(3) tax exempt status by the IRS, it did not have any employees because it did not yet own the University. Thus, prior to the Transaction, all employees of the University were employed by GCE and all information provided by management necessarily was provided by GCE management (which included academic management that would ultimately transfer to GCU).[4] Deloitte, however, was engaged by GCU’s independent Board of Trustees, not GCE, and the Deloitte report was issued to and reviewed by GCU’s independent Board of Trustees and its independent financial and legal advisors in connection with their review of, and decision to approve, the Transaction.

The Decision Letter (p. 9 and p. 15)

“Because Gazelle seeks to participate in Title IV, HEA programs as a nonprofit institution, it must meet the Department's requirements for that status. The Higher Education Act ("HEA") defines an institution of higher education as "a public or other nonprofit institution." HEA §101(a)(4), 20 U.S.C. §1001(a)(4); HEA §102(a)(l), 20 U.S.C. §1002(a)(l). The Department regulations define a nonprofit institution as an institution that:

34 C.F.R. §600.2. 14”

“Based on the tax authority cited above, the Department has determined that GCU does not meet the operational test's requirement that both the primary activities of the organization and its stream of revenue benefit the nonprofit itself. Rather, the materials that the Department has reviewed demonstrate that GCE and its shareholders — rather than Gazelle/GCU -- are the primary beneficiaries of the operation of GCU under the terms of the MSA. This violates the most basic tenet of nonprofit status — that the nonprofit be primarily operated for a tax-exempt purpose and not substantially for the benefit of any other person or entity.”

GCU’s Response:

In Section III of its Letter, the Department analyzes its requirements for nonprofit status relating to participation in Title IV, HEA programs. In doing so, the Department cites to its regulatory definition of a nonprofit institution found in 34 C.F.R. 600.2. This three-prong test is succinct – roughly 80 words – and appears to comprise the entirety of the Department’s regulatory basis for whether an institution qualifies for nonprofit status. In analyzing the definition, the Department acknowledges that GCU satisfies the “owned and operated by one or more nonprofit corporations” requirement of prong (i) of the definition and that GCU also satisfies prongs (ii) and (iii) of the definition, such that the sole issue as to GCU’s qualification is “whether its net earnings benefit any private shareholder or individual” (this is often referred to as the “Private Inurement Test”). The Department states that the determination as to whether the Transaction satisfies the Private Inurement Test requires a further review of “relevant authority under the Internal Revenue Code”. The Department then provides two pages of detailed analysis of IRS statutes, IRS private letter rulings, and tax decisions of the Federal courts before concluding that “based on the tax authority cited above, the Department has determined that GCU does not meet the operational test’s requirements that both the primary activities of the organization and its stream of revenue benefit the nonprofit itself.” This conclusion, however, does not address the Private Inurement Test, but rather addresses the so-called “operational test” (the “Operational Test”). The Operational Test, while it includes a judicially imposed private benefit prohibition, is different than the Private Inurement Test and actually is subsumed within prong (iii) of the Department’s definition above. In other words, when conceding that GCU satisfies prong (iii) of the definition of “nonprofit institution,” the Department has thus conceded (i.e. by its own regulation, it has deferred to the IRS’s determination) that GCU satisfies the Operational Test. It is unclear on what authority the Department relies to substitute its judgment regarding the Operational Test for that of the IRS, nor is it clear why the Department of Education believes that it has the ability to interpret tax law better than the IRS.

Because the IRS is the agency tasked with determining an entity’s 501(c)(3) tax exempt status, GCU believes that the IRS’s determination that an institution qualifies as a 501(c)(3) tax exempt entity (and, by definition, satisfies the Operational Test) should be given appropriate deference by the Department in making its decision. Indeed, GCU believes that the Department’s very own regulations mandate this deference.

Code Section 501(c)(3) imposes several requirements in order to qualify as a tax-exempt organization. The Private Inurement Test is just one of those requirements. The other requirements are that (i) the organization be “organized and operated exclusively” for a tax-exempt purpose (e.g., educational, charitable, religious, etc.) (which incorporates the Operational Test), (ii) no substantial part of the activities of the organization include legislative activities; and (iii) the organization not participate in any political campaign. If the authors of the Department’s regulations wanted the Department to be able to substitute its judgment for that of the IRS on these other three requirements, including on the Operational Test, then they could have easily done so in the Department’s regulations. Had they done so, then prong (iii) of the Department’s definition of “nonprofit institution,” which cedes to the IRS the authority to determine the elements of tax-exempt status set forth in Code Section 501(c)(3) other than the Private Inurement Test, would have obviously been superfluous. Alas, they didn’t. Instead, the only requirement from Code Section 501(c)(3) over which the Department reserved judgment is the Private Inurement Test.

In its application, the focus of the Private Inurement Test is limited to private shareholders and individuals and courts have interpreted the test to apply to insiders, such as founders, directors, and officers. Given that the only Code Section 501(c)(3) requirement over which the Department has explicit authority in its own definition of “nonprofit institution” is the Private Inurement Test, one would have expected that there would have been an extensive analysis by the Department of GCE’s role as an insider of GCU. Yet, there is absolutely none, likely because it is clear that GCE is not an insider of GCU – it has no ownership interest in GCU and there is no overlap between GCE’s Board of Directors and GCU’s Board of Trustees – and the Department knows that GCE is not an insider of GCU. Instead of engaging in the proper analysis, the Department takes an unfathomable leap in its authority to substitute its judgment for that of the IRS’s regarding the Operational Test. The Department’s very own regulations clearly do not give it the authority to substitute its judgment for the IRS’s on this Code Section 501(c)(3) requirement.

Moreover, even if the Department had the authority to determine whether GCU satisfied the Operational Test and to determine whether there was a prohibited private benefit under that test, there is clearly none. Except for the three principal transaction documents – the APA, the Credit Agreement, and the MSA – and a Facilities Services Agreement, copies of which were provided to the Department, there are no other agreements between GCU and GCE.

We believe the foregoing amply demonstrates that GCU, both on paper and in fact, satisfies the definition of a nonprofit institution.

The Decision Letter (p.15)

“GCU’s IRS approval 'was issued three years prior to the Transaction’ and 'there is no evidence that the IRS conducted a comprehensive review of the MSA or any of the studies that were later performed to support the MSA.’”

GCU’s Response:

During 2015, GCU filed a Form 1023 with the IRS and sought a determination that it was qualified under Section 501(c)(3) of the Internal Revenue Code to operate as a nonprofit university. The Form 1023 was filed specifically in contemplation of the proposed transaction with GCE and contained extensive details regarding the terms of the proposed transaction between GCU and GCE, including the terms of the proposed MSA and the fact that Mr. Mueller would serve both as President of GCU and Chief Executive Officer of GCE.

In November 2015, the IRS issued its determination letter designating GCU as a tax-exempt educational organization pursuant to Section 501(c)(3) of the Internal Revenue Code. While GCU obtained this approval nearly three years prior to the completion of the Transaction, the basic structure of the transaction as described in the Form 1023 is not different from the terms of the Transaction as consummated on July 1, 2018, and the terms of GCU’s governance structure, including Mr. Mueller’s dual role, as well as the terms of the MSA, were described in detail. On August 31, 2018, at GCU’s request, the IRS issued an affirmation letter confirming GCU’s status as a tax-exempt entity under Section 501(c)(3) of the Internal Revenue Code. A copy of the Form 1023, as filed with the IRS, the IRS determination letter, and the IRS affirmation letter were provided to the Department.

The financial terms of the Transaction did change between the 2015 application and the closing of the Transaction on July 1, 2018. At the time of the 2015 application, the third party valuation and transfer pricing studies that GCU initiated for purposes of informing the pricing of the acquisition of GCU and the terms of the MSA had not yet been completed. However, GCU believes that the terms of the Transaction as closed on July 1, 2018, based on very recent valuation and transfer pricing studies, were more favorable to GCU than the terms that were anticipated in 2015. And the Department’s conclusory statement that the IRS did not comprehensively review the proposed Transaction and related structure is simply not supported.

As noted above, during the period when GCU’s 501(c)(3) application was under review and thereafter in connection with further efforts to structure the relationship between GCE and GCU, GCU and its tax advisors engaged in multiple discussions with IRS staff and modified various elements of the deal structure (including, in particular, various aspects of GCU’s governance structure) to satisfy IRS requests.

Moreover, as noted above, other than the reference to the requirement that no part of the net earnings may benefit any private shareholder or individual, the Department’s regulations explicitly defer to the IRS’s determination whether the organization satisfied the other requirements of Code Section 501(c)(3).

The Decision Letter (p.17)

“Mr. Mueller, as the CEO of GCE, 'is the key executive responsible for providing the services under the MSA, with duties of loyalty to shareholders of GCE. Yet, as the Institution's President he will have responsibility to manage matters large and small with its primary service provider, notwithstanding the appointment of a Designee and the independent trustees who comprise the MSA Committee. Given those obviously conflicting loyalties, and the breadth of the services provided under the MSA, the Department is not satisfied that these structures are sufficient to ensure that Mr. Mueller's undivided loyalty is to the Institution.’”

GCU’s Response:

The Department’s analysis of Mr. Mueller’s dual role conflicts with the standards of the HLC, which permit overlapping management between a university and a service provider, contradicts the findings of the HLC that the governance structures in place are adequate and provide for independent governance of the University, and also is in contrast with the IRS’ determination to grant GCU 501(c)(3) status after being fully informed of Mr. Mueller’s proposed dual role. Given the HLC’s far greater substantive interaction with GCU during its review process, which included a multi-day campus visit with live interviews with many relevant parties, we fail to see the basis for the Department’s conclusion. It is also important to note that the decision to employ Mr. Mueller was made independently by both GCU’s Board of Trustees and GCE’s Board of Directors, each of which is fully independent of the other, with no overlapping members. Each board made its decision with full knowledge of his overlapping roles, based on a determination by each that he is the best person to lead their respective organization. In addition, the MSA, as well as GCU’s bylaws and conflict of interest policy, all contain significant conflict of interest protections.

IV. Conclusion.

While the Decision Letter makes other errors, GCU believes that the above provides sufficient indication of the grave errors in the Department’s response, especially in light of the obvious success of GCU over the years and in the 16 months since the Transaction closed.

Again, perhaps most importantly, GCU’s success has been accomplished without the University raising tuition at its ground campus for 12 straight years, with tuition holding at $16,500 per year, and with only nominal 1% tuition increases for its online campus over the last 10 years. After institutional scholarships, students attending the University’s traditional campus pay on average only $8,700 per year in tuition. Average room and board costs at GCU ($8,038) are also well below the national averages for public four-year schools ($11,510) and private four-year universities ($12,990), according to the College Board, as the University is intentional about making private Christian education affordable to all socioeconomic classes of Americans. The University’s students graduate with less debt on average ($18,750 according to the latest College Scorecard data) than at public and private nonprofit universities ($28,650 according to 2017 data from the Institute for College Access & Success). A tremendous benefit of the University’s low cost of attendance is that the University has created one of the most diverse student bodies in the country with its ground campus student body consisting of 47% students of color, including 29% Hispanic and 7% African-American.

The University continues to be a vital component of Arizona’s higher education infrastructure, currently educating over 21,000 students on its ground campus and over 80,000 online. The University’s campus is currently ranked No. 19 out of 1,417 universities in the country and its dorms are ranked No. 6 out of 1,384 universities in the country according to niche.com. The University offers over 220 degree and certification programs across nine colleges, with an accomplished student body having an average incoming GPA over 3.5 for each of the last four years, and an Honors College with over 2,000 students and an average incoming GPA of 4.1 in Fall 2019. As just one example of the demonstrated quality of the University’s student body, graduates of the University’s College of Nursing achieved a 91.5% first-time pass rate on the NCLEX professional nursing exam in calendar year 2018, with a 98.2% pass rate in the first quarter of 2019 and a 98.6% pass rate in the second quarter of 2019.

The University’s success isn’t limited to its campus alone. The University has partnered with its surrounding community to help transform one of the most impoverished communities in the City of Phoenix. In particular, the University entered into a $1.6 million eight-year partnership with the City of Phoenix Police Department that has resulted in a 26.8% decline in property crimes (compared to a 3.8% drop citywide) and an 8.6% decline in violent crimes (compared to a 13% increase citywide) during the first 5 years of the program from 2012 to 2017. From a home value perspective, the University partnered with Habitat for Humanity to raise $2 million and contribute 21,000 volunteer hours to renovate more than 250 homes in its community, resulting in a 302% increase in home values for residents in the 85017 zip code since 2011. From a community education standpoint, the University created a groundbreaking Learning Lounge program that provides free tutoring and mentoring to more than 3,000 K-12 students at 150 neighboring schools in the last six years. As part of the Learning Lounge program, the University has awarded 262 full-tuition scholarships to low-income students who sought assistance in the Learning Lounge and had a demonstrated financial need. From a jobs perspective, in addition to the thousands of jobs created on its campus, the University has also launched several new business enterprises that provide management opportunities for recent graduates and employment opportunities for hundreds of current students and local residents.

On a combined basis, prior to the closing of the Transaction, over $1.5 billion had been invested into improvements in educational infrastructure for the benefit of students, through the development of the University’s campus and technology. Subsequent to the closing of the Transaction, the University continues to invest in the growth and development of its educational infrastructure, including classrooms, dorms, and experienced, high-quality faculty, while simultaneously benefitting from GCE’s continued investment in educational infrastructure, including the development of a new online learning management system that supports the learning experience for GCU students.   

GCU’s nonprofit articles of incorporation identify its primary purpose of operating for general educational purposes, including the conferring of academic degrees, diplomas, honors or certificates. Notwithstanding the Department’s erroneous Decision Letter, GCU will not be deterred in the continued pursuit of its nonprofit purpose.

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[1] As the IRS notes on its website: “State law governs nonprofit status, which is determined by an organization’s articles of incorporation or trust documents. Federal law governs tax-exempt status.” See https://www.irs.gov/charities-non-profits/before-applying-for-tax-exempt-status

[2] This GCU balance sheet met the financial tests that the Department applies in the context of a change in control transaction, further reinforcing that GCU is in strong financial health after the Transaction.

[3] When GCU files its audited financial statements for the year ended June 30, 2019, those statements again will show that the University is in sound financial health with a passing financial composite score under the Department’s measurements.

[4] Upon the closing of the Transaction, approximately 1,500 faculty, admission, staff and other employees, along with 6,000 part-time employees, transferred employment to GCU.

EXHIBIT A

OCTOBER 1 2018 LETTER TO THE DEPARTMENT OF EDUCATION RE GCU NONPROFIT STATUS

GCU Response Letter to ED re NFP Conversion 100118