State of the State: Audit Report Cites Reason to Worry About College Illinois Investments

May 1, 2011

Jamey Dunn
Credit mattpenning.com 2014 / WUIS/Illinois Issues
Illinois families who purchased prepaid tuition through the College Illinois program have some reasons to be worried. 

In recent audits of the prepaid tuition program and the Illinois Student Assistance Commission, state Auditor General William Holland found some serious problems with the way the commission has made investment choices for the savings plan. He said the program, which had a $338 million deficit as of last June, failed to use “sound business practices” and did not follow the state’s procurement law when seeking an outside firm to provide advice. 

According to the ISAC audit: “The commission was created to establish and administer a system of financial assistance through student loans and loan guarantees; scholarships and grant awards; and a prepaid tuition program for the residents of the state to enable them to attend qualified public or private institutions of their choice.” In addition to College Illinois, ISAC administers the Monetary Award Program, Illinois veterans and National Guard grants, Future Teachers Corps, and scholarship programs for minority teachers and nurse educators, as well as several other scholarship, grant and loan programs. 

College Illinois was created by the legislature in 1997 (see related story, page 10.) The next year, Illinois residents could start buying contracts to lock in tuition costs at current levels and avoid future increases at state public universities. The contracts can be used at private and out-of-state-schools. According to ISAC, 34,000 families have purchased contracts with College Illinois, and 55,000 beneficiaries of those contracts are entitled to future tuition benefits. The program manages $1.25 billion and has paid out $250 million in tuition benefits during the past five years. 

The audit of the program says ISAC did not follow the state’s procurement requirements when hiring the San Francisco-based investment banking and financial advisement firm Grigsby and Associates to provide advice on where to invest College Illinois funds. The firm provided a price estimate for advisement services without actually providing any qualifications. ISAC was not clear in the original request that it was seeking help with investment choices, and none of the nine other firms competing for the contract gave a price quote for that type of service. The request focused on bond issuance and debt restructuring, so the other bidders did not include costs for advisement, and ISAC never sought that information from them. The audit says there was “no clear basis” for awarding the contract or ensuring that all who were interested got a chance to bid.

Holland also notes that other companies besides the nine that entered bids may have opted to compete for the job if ISAC had been clear about what it was looking for. “By circumventing the competitive process, the commission may have paid higher fees than it otherwise might have obtained through a truly competitive process.” 

Grigsby and Associates advised ISAC to invest $12.78 million of College Illinois funds in a Chicago-based Shorebank investment, even though, according to Holland, the bank showed signs of trouble. College Illinois lost the $12.78 million when the bank later failed. “Despite the red flags noted, the vendor recommended the investment in the Bank, and the Commission purchased the $12.78 million investment on September 30, 2008. By the end of fiscal year 2010, the Commission determined the entire $12.78 million value of the investment was worthless when the Bank was taken over by the FDIC,” the audit of the program says. 

In addition to the obvious flaw in that investment — the loss of the $12.78 million — there were other problems with the manner in which the deal was executed. First, the investment was made before Grigsby and Associates had even signed a contract with ISAC. Holland says once a contract was signed, it was not for the services that Grigsby and Associates provided. ISAC told Holland that problems with the contract occurred because of miscommunications with the investment firm. 

A second problem was the way in which the firm was compensated. Grigsby and Associates was only paid if ISAC followed its investment advice, and the only bank up for consideration was Shorebank. Grigsby and Associates made $255,600, or a 2 percent commission, on the deal. “There was no contractual means for the vendor to be paid under the signed contract if the investment was not made,” the audit says.

In addition to those issues, the Chicago Sun-Times reported that the founder of the firm, Calvin Grigsby, had been cited by a California ethics board because of campaign contributions and twice indicted and later acquitted of federal bribery charges.

It is understandable that ISAC made a bad investment decision and even that it lost some money. During the recent recession, many investors lost their shirts, and other state investments, such as pension funds, also took hits. However, ISAC’s pool for advisers and potential investments was severely limited. Looking at only one bank, contracting the vetting of that bank in a sloppy way and paying the advisement firm on commission makes the investment at Shorebank look like a foregone conclusion. 

“Best practices require that vendors contracted to provide their opinion on investment purchase decisions do not be compensated on a basis that is contingent upon the opinion rendered,” Holland says. “It would generally be considered to be a prudent business practice for management to consider a variety of alternative private equity investments to allow for greater opportunity to make sound investment choices.” 

Unlike other commitments Illinois makes, such as borrowing, the state does not guarantee the funds that the 55,000 potential college students are counting on for their future tuition through the College Illinois program. ISAC portrays the program as a safe investment, but some lawmakers say College Illinois’ portfolio has shifted in recent years to riskier ground. According to a legislative resolution that calls for an investigation of College Illinois — pending in the House as of press time — the fund was primarily invested in stocks and bonds in 2009. By 2011, 38 percent of the program’s investments, or $419 million, were made in other areas such as hedge funds, real estate and private banks. The program plans to continue to seek those kinds of investments until they represent 47 percent of its portfolio.

“This is not the type of investment that should be used for this type of program,” says Rep. Jim Durkin, sponsor of the House resolution. “It’s the type of investment you use for large endowments that have investment horizons over hundreds of years, not on a contract which is a 15- to 18-year lifespan.” He says that the marketing ISAC has done in the past promised parents a safe investment that would not be affected by “market fluctuation.”

Durkin, who also is a College Illinois contract holder, says, “[The marketing was] very persuasive, and that’s why a lot of people signed up for it.” However, he says, the new, more volatile investments do not back up ISAC’s little-to-no-risk claims. Durkin, a lawyer, says he believes that if the fund were to become insolvent, contract holders would have a legal case against the state, and under a worst-case scenario, the legislature might have to bail out the fund. He adds, however, that a default is not at all imminent, and ISAC can and should work to overcome its deficit and repair its reputation. “You can still put this back in a good position, on good footing, by going into a more conservative investment policy.”

A parent who wants to pay for a child’s college education has some compelling reasons to lock in today’s tuition rates. The University of Illinois, for instance, increased tuition rates by 6.9 percent this year and 9.5 percent last year. It seems that the best-case budget scenario for public universities is flat state funding for the next fiscal year. When university presidents testified before the legislature earlier this year, they agreed that tuition rates would continue to rise if state funding did not increase. And it is unlikely that universities will see large state funding increases in the coming years, as the state crawls out from under a deep recession and an unprecedented budget crisis. 

However, when it comes to their children’s education future, most parents seek as much certainty as possible. Holland’s audits found that College Illinois will remain solvent over the next few years, and its financial outlook will likely improve as the economy recovers. That may not be enough to reassure parents who are disturbed by the audit’s findings and the fund’s riskier investments. To keep the program alive and selling new contracts, people must believe it is a sound investment. A serious drop in confidence could lead to the program’s failure, much like runs on banks contributed to the failure of institutions during the Great Depression. If enough participants decide to pull their investments, then College Illinois could be sunk. 

“Public confidence is extremely important for this type of program,’’ Durkin says. “You need people to invest. You need individuals to sign up and purchase contracts. … I receive calls from people every day, e-mails from people every day, asking whether they should take their money out. … Perception is reality. Public confidence is right now in question.”

ISAC has some work to do — on the image and the investment practices of College Illinois.

 

34,000 families have purchased contracts with College Illinois, and 55,000 beneficiaries of those contracts are entitled to future tuition benefits.

Unlike other commitments Illinois makes, such as borrowing, the state does not guarantee the funds that the 55,000 potential college students are counting on for their future tuition through the College Illinois program.

Illinois Issues, May 2011