The Consumer Financial Protection Bureau has filed its first lawsuit against a for-profit educational company, accusing ITT Educational Services of making predatory loans to its students.
ITT is one of the largest and most expensive for-profit post-secondary education chains in the country. It has schools in 40 states, including more than 135 ITT Technical Institutes and Daniel Webster College. Courses range from electronics and drafting to criminal justice and nursing.
In its lawsuit, filed Wednesday, the CFPB claims that ITT used high-pressure tactics to push many students into high-cost private loans it knew they couldn't repay.
"Although ITT marketed itself as improving consumers' lives, it was really just improving its bottom line," said CFPB Director Richard Cordray. "The result was that while many students got poorer, the investors and shareholders got richer."
When asked about the lawsuit, Nicole Elam, ITT's vice president of government relations, told NBC News, "We do not comment on pending litigation other than to say that the bureau's claims are without merit and we intend to vigorously defend ourselves against the charges."
According to the CFPB, ITT has among the highest tuition expenses of any for-profit school in the country. Earning an associate's degree can cost more than $44,000, and a bachelor's degree $88,000.
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Federal student loans won't cover the entire bill, so most ITT students need private loans. The school offered to help new students bridge that tuition gap with a zero-interest loan—called "temporary credit"—that typically had to be repaid at the end of the first academic year.
The CFPB claims that ITT knew that most students would not be able to repay that temporary credit loan or fund their second year's tuition.
The lawsuit alleges that between July and December 2011, ITT persuaded many students to repay the temporary credit and cover the tuition gap for year two with a high-priced private loan that it set up for just this purpose.
"ITT kept students in the dark about its lending model that it freely shared with investors," Cordray said.
For students with credit scores under 600, the loans carried interest rates as high as 16.25 percent for 10 years, plus a 10 percent origination fee.
Cordray compared it to financing a college education on a credit card.
"We found that ITT used its financial aid staff to rush students through an automated application process without affording them a fair opportunity to understand the loan obligations involved," he said. "In some cases, students did not even know they had a private student loan until they started getting collection calls."
The National Consumer Law Center (NCLC) commended the CFPB for taking the action. In 2011, NCLC released a report that documented many of the problems associated with loans offered by private, for-profit schools.
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It found that most of their loans had higher interest rates and origination fees than federal loans, particularly for less creditworthy borrowers. and a "shockingly high" default rate. Many also came with "hair-trigger default clauses" that can kick in if the student misses just one payment or leaves school without graduating, the center said.
Other problems
The "unfair, deceptive or abusive" practices alleged in the CFPB lawsuit deal with more than student loans.
According to the bureau, the ITT misled prospective students by overstating job prospects and likely salaries after graduation. In reality, the lawsuit claims, ITT knew the most students (about 64 percent, by its own estimate) would default on their loans and not finish school.
Defaulting on private student loans can have devastating consequences, including limiting employment opportunities and making it impossible to get any kind of loan for years. And private loans are nearly impossible to discharge in bankruptcy.
Joe Larson, who attended the ITT Technical Institute in Clive, Iowa, to get a degree in electrical engineering and had filed a complaint about the school with the Iowa State Attorney General, was happy to hear about the federal lawsuit.
"I have not taken a single class that has been oriented toward Electrical Engineers," he wrote. "The curriculum is a joke."
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Larson, who spent $16,000 for two semesters at the school, told NBC News the recruiter promised him "awesome job opportunities" after graduation. But he feels he didn't learn anything.
An industry under scrutiny
There's nothing wrong with an educational institution's making a profit. Indeed, students who attend the right for-profit school may indeed get a pay increase, promotion or better job.
But there is a growing sense among government regulators that some of these schools take the money—federal aid and student loans—without deliver on the promise of providing degrees that lead to good employment.
Look at these numbers from the National Center for Education Statistics: For students starting a four-year bachelor's degree program in 2004, just 28 percent of those attending for-profit schools graduated within six years. That's half the rate for students at public institutions.
Prosecutors in several states, including California, Colorado, Illinois, Massachusetts and New York, have sued various for-profit schools.
"It's easy to identify the bad actors," said Illinois Attorney General Lisa Madigan. "It's the very aggressive and misleading marketing and advertising, the very heavy-handed recruitment, excessive tuition, lack of accreditation, the low-completion and job-placement rates, and high default levels."
A task force of attorneys general from 13 states is investigating four of the larger for-profit colleges, including ITT, after receiving numerous complaints from students and former students. Last month they filed legal papers demanding documents from ITT, Corinthian Colleges, Education Management Corp. and Career Education Corp. (This demand for documents is not an accusation of wrongdoing.)
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Iowa Attorney General Tom Miller, a member of that task force, said he is concerned about for-profit schools that use boiler-room operations to recruit students "where there's pressure to make sales, and over time deception creeps in.
"That's a terrible way to sign up people for something as important as college education," he said.
The Consumer Financial Protection Bureau has a great deal of information on its website to help you decide how to pay for college.
—By CNBC contributor Herb Weisbaum. Follow him on Facebookand Twitter @TheConsumerman or visit The ConsumerMan website.