SEC litigation against former ITT executives continues

The U.S. Securities and Exchange Commission’s lawsuit against two principal officers of ITT Educational Services, Inc., continues to proceed to trial after a federal court Friday denied most of the partial summary judgment motions filed separately by the SEC and the defendants.
Kevin Modany, ITT’s chief executive officer and chairman of the board of directors since 2008, and Daniel Fitzpatrick, ITT’s chief financial officer, principal accounting officer and executive vice president since 2009, are being accused of violating various federal securities laws. 
Indianapolis-based ITT Educational Services declared bankruptcy in 2016 shortly after the U.S. Department of Education banned the for-profit college from enrolling new students who were dependent on federal aid. The school shuttered more than 130 campuses in 39 states, impacting about 8,000 employees and 40,000 students.
The focus of the litigation against Modany and Fitzpatrick are two loan programs ITT created for its students – the Program for Education Access and Knowledge (PEAKS) and the Credit Union Service Organization (CUSO). When the loans began defaulting at high rates in 2011 and 2012, the SEC alleges that Modany and Fitzpatrick engaged in deceptive acts to conceal the health of the loam programs and the impact on ITT’s financial condition. 
To avoid having to make the guaranteed payments needed to maintain the parity ratio between the PEAKS Trust’s assets and liabilities, Modany and Fitzpatrick allegedly began making the minimum loan payments for student borrowers who were in danger of defaulting. Neither the students nor the investors were made aware of the “Payments on Behalf of Borrowers” program.
By the end of 2012, ITT had made about $2.4 million in POBOB payments which enabled the for-profit school to avoid having to pay about $30 million in guaranteed payments to the PEAKS Trust.
As part of CUSO program, ITT guaranteed payment of principal, interest and fees on any loans that defaulted over the risk-share threshold of 35 percent. The SEC alleges that ITT made only the minimum payments on the amounts due on the high-interest loans. This, in turn, increased the amount the school would ultimately have to pay on the CUSO guarantee to a total well-beyond the amount of the liability disclosed in public filings.
Among other things, the SEC alleges Modany and Fitzpatrick misrepresented to ITT’s auditor that institutional investors in the PEAKS program had consented to the POBOB payments; withheld from ITT’s auditor that the school had receive a legal opinion finding the POBOB payments were likely not permitted under the terms of the PEAKS agreements; and failed to disclose to ITT’s auditor that ITT was projecting more than $100 million in CUSO payments if it continued using the minimum monthly payment method.
The U.S. District Court for the Southern District of Indiana considered dueling motions for partial summary judgment and issued an order in United States Securities and Exchange Commission v. ITT Educational Services, Inc., Kevin M. Modany and Daniel M. Fitzpatrick, 1:15-cv-00758.
ITT and the SEC reached a settlement but the claims against Modany and Fitzpatrick remain pending. A trial has been set for July 9, 2018.
On the few issues where the federal court did grant summary judgment, Modany and Fitzpatrick were found to be “control persons” and therefore liable for the claims related to the representations in the public filings they signed. 
The SEC argued that Modany, in his position, “would have possessed the ultimate management authority of the corporation on a daily basis,” and that Fitzpatrick had control over the school’s financial reporting. Moreover, both “had, at least, the power to indirectly influence the specific corporate policies which resulted in ITT’s violations.” 
The defendants countered ITT’s board of directors controlled the school’s business affairs, and neither Modany nor Fitzpatrick exercised control over the board. In addition, neither defendant had the power to control the relevant SEC filings because the documents were subject to review and approval by the board as well as ITT’s audit committee.
Although none of the courts within the 7th Circuit seems to have considered this issue, the Southern Indiana District noted “numerous other courts” have held that signing statements make the officer a control person for liability. Pointing to In re Metropolitan Securities Litigation, 532 F. Supp.2d 1260, 1296-97 (E.D. Wash. 2007) and In re Alstom SA Sec. Litig., 406 F.Supp.2d 433, 487 (S.D.N.Y. 2005), the Indiana federal court granted in part SEC’s motion for summary judgment in that the defendants were control persons for the documents they signed.
However, the district court did not find that the defendants were control persons for representations in public filings which they did not sign or other violative acts. The court held that a genuine dispute of fact exists as to whether Modany and Fitzpatrick had general control over ITT’s operations and the power to control the specific violative acts.