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Sallie Mae Cheated Soldiers On Federal Student Loans, Government Investigators Find

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Federal investigators have uncovered evidence that Sallie Mae cheated active-duty soldiers on federal student loans, according to people familiar with the matter.

The findings, if eventually made public as part of a lawsuit or settlement agreement, may threaten Sallie Mae's lucrative contract with the U.S. Department of Education to collect payments on federal student loans. The department's contract requires loan servicers comply with all federal laws when handling federal student loans.

The allegation also may further embarrass the Education Department, already under fire for lax oversight of student loan companies that are paid by taxpayers, yet are alleged to have repeatedly violated federal rules. The department told Sallie Mae in October that it planned to renew its contract to service federal student loans.

The probe into how Sallie Mae has treated members of the military, disclosed by the company in August, had previously concentrated on Sallie Mae’s handling of their private student loans, or those debts not guaranteed by taxpayers. A spokesman for the Department of Education said then that Sallie Mae confirmed to the department that the investigation “did not impact any federal student loan borrowers whose loans were serviced by the company.”

The probe has since expanded, and investigators have found instances in which Sallie Mae denied military borrowers on active duty with federal student loans their rights under the Servicemembers Civil Relief Act, a federal law intended to ease certain legal, administrative and financial pressures on active-duty members of the military.

“The contract is black and white -- if you violate federal law, you lose your contract,” said Chris Hicks, an organizer who leads the Debt-Free Future campaign for Jobs With Justice, a Washington-based nonprofit that is among organizations that have called on Education Secretary Arne Duncan to suspend the department’s contract with Sallie Mae.

“If the Education Department fails to enforce that clause of the contract, they are letting down borrowers, soldiers and taxpayers,” Hicks said. “The department needs to take this seriously, because Sallie Mae’s actions are obscene. They’ve betrayed our trust.”

Sallie Mae services federal student loans for 5.8 million borrowers on the Education Department's behalf, up from 4.8 million borrowers this time last year, according to the company.

The Consumer Financial Protection Bureau, Federal Deposit Insurance Corp., and Department of Justice are the federal agencies leading the investigation. Representatives for the FDIC, CFPB and Justice Department declined to comment. Representatives for the Education Department and Sallie Mae did not respond to inquiries.

In a Wednesday news release detailing the company’s latest quarterly earnings, Sallie Mae said it is in talks to settle numerous government probes. In addition to the investigation involving the servicemembers law, authorities have said they are probing whether Sallie Mae violated laws banning unfair or deceptive practices, and discriminatory lending. The company had previously set aside $70 million in anticipation of a settlement, but warned Wednesday that the ultimate cost may be larger.

Sallie Mae, the nation’s largest student loan servicer, has been in regulators’ crosshairs for months amid CFPB warnings that industrywide problems in how student loans are serviced may rival the servicing breakdowns that occurred in the mortgage market during the recent financial crisis, when documents were “robosigned” and distressed borrowers were routinely given the runaround in their attempts to modify their loans.

In February, a group of state attorneys general led by Lisa Madigan, the Illinois top law enforcement officer, announced that they, too, are investigating Sallie Mae.

The growing regulatory cloud over the company could derail its ambitions. Sallie Mae recently announced it was splitting itself into two entities -- Sallie Mae bank and a servicing unit known as Navient -- as it anticipates expanding its dealings with the Education Department.

Despite the litany of government probes, the Education Department in October told Sallie Mae it intended to renew its servicing contract. At the time, a department spokesman said the government was “not aware of any issues that would prevent us from exercising this extension.”

In a December letter, the department told Sen. Elizabeth Warren (D-Mass.) that it had declined to levy any fines on Sallie Mae, despite previously secret determinations over the past 10 years that alleged the company had harmed borrowers and incorrectly billed the department, among other servicing and management failures.

More recently, when Sallie Mae announced that it was splitting itself into two, the Education Department helped the company publicize the move, sending a memo to the higher education community about the change. The department sent the memo despite a warning at the time from Sallie Mae that the proposed split was contingent on regulators' approval.

It’s unclear whether violations of the servicemembers law while handling student loans on behalf of the Education Department would force the department to reconsider its contract with Sallie Mae.

The servicemembers law requires loan servicers to reduce borrowers’ interest rates to no more than 6 percent upon request by soldiers entering active duty. As of July 2012, about 57 percent of federal student loans carried interest rates above 6 percent, according to data the Education Department last year provided to the Center for American Progress, a Washington policy organization.

The CFPB has previously highlighted the apparently pervasive denial of military members’ rights under the servicemembers law. According to the agency, servicemembers have complained that loan companies wouldn’t reduce their interest rates unless their loans were in forbearance or deferment -- a violation of the law. Others complained of having to navigate unnecessary hurdles, such as being forced to obtain more paperwork proving they’re in active duty than is required under the law.

In 2012, Holly Petraeus, CFPB servicemember affairs assistant director, said that problems affecting soldiers’ student loans may eclipse the issues that have plagued their mortgages, where servicers failed to reduce interest rates for thousands of borrowers and illegally foreclosed on more than 300 homes.

Financial companies, including Bank of America and JPMorgan Chase, have paid millions of dollars to settle federal claims that they cheated servicemembers on home loans. Jamie Dimon, JPMorgan chief executive, publicly apologized for the lapse.

A recent survey of the armed forces found that 41 percent of servicemembers said they are paying off student loans, and borrowers in active duty who graduated college in 2008 carried on average nearly $26,000 in student debt, according to the CFPB.

The CFPB’s warnings of mass noncompliance with the servicemembers law have not been limited to private student loans, which suggests that the agency has long been probing loans the Education Department pays companies to service.

Federal authorities for months have been trying to design an industrywide plan in an attempt to ensure that, in the future, active-duty members of the armed forces receive the benefits they’re owed under the servicemembers law, people familiar with the efforts said. The Education Department has been involved in the negotiations.

Criminal penalties could result from violating the servicemembers law. While private student loans have long been subject to the 6 percent cap on rates under the servicemembers law, in 2008 Congress extended that protection to federal student loans as well.

The cap on interest rates could mean thousands of dollars for the typical servicemember with student loans. The CFPB has estimated that a servicemember with $39,000 in debt whose rates are not reduced in accordance with the law may have to pay more than $12,000 in extra costs over a 10-year period.

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