Contingencies

9 Months Ended

Sep. 30, 2013

Commitments And Contingencies Disclosure [Abstract]

Contingencies

12. Contingencies

As part of our normal operations, one of our insurers issues surety bonds for us that are required by various education authorities that regulate us. We are obligated to reimburse our insurer for any of those surety bonds that are paid by the insurer. As of September 30, 2013, the total face amount of those surety bonds was approximately $20,000.

We are also subject to various claims and contingencies, including those related to litigation, business transactions, guarantee arrangements and employee-related matters, among others. We record a liability for those claims and contingencies, if it is probable that a loss will result and the amount of the loss can be reasonably estimated. Although we believe that our estimates related to any claims and contingencies are reasonable, we cannot make any assurances with regard to the accuracy of our estimates, and actual results could differ materially. As of September 30, 2013, our recorded liability for these claims and contingencies was approximately $81,235, consisting of approximately:

• $40,000 related to our guarantee obligations under the PEAKS Program;

• $32,910 related to our guarantee obligations under the 2009 RSA; and

• $8,325 related to other claims and contingencies not directly associated with the PEAKS Program or 2009 RSA.

The 2009 RSA and PEAKS Program are hereinafter collectively referred to as the “RSAs.” As of September 30, 2013, $43,314 of the recorded liability was included in Other current liabilities and $37,921 was included in Other liabilities on our Condensed Consolidated Balance Sheet. The $43,314 included in Other current liabilities as of September 30, 2013 included $8,023 that we claimed as an offset against amounts owed to us under the Revolving Note. See “ – Guarantees” below for further discussion of the amounts we claimed as offsets under the Revolving Note. The $37,921 included in Other liabilities as of September 30, 2013 represents our estimate of the loss that we believe we will realize over the next seven to ten years related to our estimated guarantee obligations under the RSAs.

The following table sets forth the activity with respect to our recorded liability related to our claims and contingencies in the periods indicated:

	Nine Months Ended September 30,
	2013			2012
Balance as of January 1	$	123,439		$	36,028
Increases (decreases) from:
Additional reserves:
PEAKS Program		721			0
2009 RSA		8,957			9,600
Other		3,085			272
Payments, net		(55,770	)		(1,653	)
Estimated recovery		803			0
Balance as of September 30	$	81,235		$	44,247

We had guaranteed the repayment of private education loans made by a lender to our students in 2007 and early 2008 (the “2007 RSA”) that the lender charged off above a certain percentage of the total dollar volume of private education loans made under the 2007 RSA. In January 2013, we paid $46,000 in a settlement to absolve us from any further obligations with respect to our guarantee obligations under the 2007 RSA. The liability for this settlement was included in Other current liabilities on our Condensed Consolidated Balance Sheet as of December 31, 2012.

In connection with estimating our recorded liability for claims and contingencies as of September 30, 2013, we considered whether additional losses for claims and contingencies were reasonably possible, could be estimated and might be material to our financial condition, results of operations or cash flows. In order to estimate the possible range of losses under the RSAs, we made certain assumptions with respect to the performance of the private education loans made under the RSAs over the life of those loans. The life of a private education loan made under the RSAs may be in excess of ten years from the date of disbursement. Therefore, our estimate of the possible range of losses under the RSAs was based on assumptions for periods in excess of ten years, and those assumptions included, among other things, the following:

• the repayment performance of the private education loans under each of the RSAs;

• the timing and rate at which the private education loans will be paid;

• the changes in the variable interest rates due on the private education loans and PEAKS Senior Debt;

• the amounts that will be collected in the future on the private education loans that have defaulted; and

• the fees and expenses associated with servicing the private education loans.

We consulted with two third-party consumer credit consulting firms in arriving at our assumptions and estimates. The assumptions have changed, and may continue to change, significantly over time as actual results become known, which would affect our estimated range of possible losses related to the RSAs. With respect to our guarantee obligations under the RSAs, we believe that it is reasonably possible that we may incur losses in an estimated range of $9,000 less than to $41,000 greater than the recorded liability for those contingencies. As with any estimate, as facts and circumstances change, the recorded liability and estimated range of reasonably possible losses could change significantly. With respect to legal proceedings, we determined that we cannot provide an estimate of the possible losses, or the range of possible losses, in excess of the amount, if any, accrued, for various reasons, including but not limited to some or all of the following:

• there are significant factual issues to be resolved;

• there are novel or unsettled legal issues presented;

• the proceedings are in the early stages;

• there is uncertainty as to the likelihood of a class being certified or decertified or the ultimate size and scope of the class;

• there is uncertainty as to the outcome of pending appeals or motions; and

• in many cases, the plaintiffs have not specified damages in their complaint or in court filings.

Litigation. We are subject to various litigation in the ordinary course of our business. We cannot assure you of the ultimate outcome of any litigation involving us. Although we believe that our estimates related to any litigation are reasonable, deviations from our estimates could produce a materially different result. Any litigation alleging violations of education or consumer protection laws and/or regulations, misrepresentation, fraud or deceptive practices may also subject our affected campuses to additional regulatory scrutiny. The following is a description of pending litigation that falls outside the scope of litigation incidental to the ordinary course of our business.

On December 22, 2008, we were served with a qui tam action that was filed on July 3, 2007 in the United States District Court for the Southern District of Indiana by a former employee (“relator”) on behalf of herself and the federal government under the following caption: United States of America ex rel. Debra Leveski v. ITT Educational Services, Inc. (the “Leveski Litigation”). We were served with the Leveski Litigation after the U.S. Department of Justice declined to intervene in the litigation. On June 3, 2008, the relator filed an amended complaint in the Leveski Litigation. On September 23, 2009, the court dismissed the Leveski Litigation without prejudice and gave the relator an opportunity to replead her complaint. On October 8, 2009, the relator filed a second amended complaint. In the second amended complaint, the relator alleges that we violated the False Claims Act, 31 U.S.C. § 3729, et seq., and the Higher Education Act of 1965, as amended (the “HEA”) by compensating our sales representatives and financial aid administrators with commissions, bonuses or other incentive payments based directly or indirectly on success in securing enrollments or federal financial aid. The relator alleges that all of our revenue derived from the federal student financial aid programs from July 3, 2001 through July 3, 2007 was generated as a result of our violating the HEA. The relator seeks various forms of recovery on behalf of herself and the federal government, including:

• treble the amount of unspecified funds paid to us for federal student grants;

• treble the amount of unspecified default payments, special allowance payments and interest received by lenders with respect to federal student loans received by our students;

• all civil penalties allowed by law; and

• attorney’s fees and costs.

A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) on behalf of the federal or state government for an alleged submission to the government of a false claim for payment. A qui tam action is always filed under seal and remains under seal until the government decides whether to intervene in the litigation. Whenever a relator files a qui tam action, the government typically initiates an investigation in order to determine whether to intervene in the litigation. If the government intervenes, it has primary control over the litigation. If the government declines to intervene, the relator may pursue the litigation on behalf of the government. If the government or the relator is successful in the litigation, the relator receives a portion of the government’s recovery.

On August 8, 2011, the district court granted our motion to dismiss all of the relator’s claims in the Leveski Litigation for lack of subject-matter jurisdiction and issued a judgment for us. On February 16, 2012, the relator in the Leveski Litigation filed a Notice of Appeal with the 7^th Circuit Court of Appeals regarding the final judgment entered by the district court dismissing all claims against us. On March 26, 2012, the district court in the Leveski Litigation awarded us approximately $395 in sanctions against the relator’s attorneys for filing a frivolous lawsuit. Relator’s attorneys also appealed this award to the 7^th Circuit Court of Appeals. On July 8, 2013, the 7^th Circuit Court of Appeals reversed the district court’s dismissal of the Leveski Litigation for lack of subject-matter jurisdiction and the award of sanctions against relator’s attorneys. In addition, the 7^th Circuit Court of Appeals remanded the Leveski Litigation back to the district court for further proceedings.

We have defended, and intend to continue to defend, ourselves vigorously against the allegations made in the complaint.

On March 11, 2013, a complaint in a securities class action lawsuit was filed against us and two of our current executive officers in the United States District Court for the Southern District of New York under the following caption: William Koetsch, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc., et al. (the “Koetsch Litigation”). On July 25, 2013, the court named the Plumbers and Pipefitters National Pension Fund and Metropolitan Water Reclamation District Retirement Fund as the lead plaintiffs and consolidated the Koetsch Litigation and the MLAF Litigation (defined below) under the following caption: In re ITT Educational Services, Inc. Securities Litigation (the “Securities Litigation”). On October 7, 2013, an amended complaint was filed in the Securities Litigation. The amended complaint alleges, among other things, that the defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by:

• our failure to properly account for the 2007 RSA, 2009 RSA and PEAKS Program;

• employing devices, schemes and artifices to defraud;

• making untrue statements of material facts, or omitting material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading;

• making the above statements intentionally or with reckless disregard for the truth;

• engaging in acts, practices, and a course of business that operated as a fraud or deceit upon lead plaintiffs and others similarly situated in connection with their purchases of our common stock;

• deceiving the investing public, including lead plaintiffs and the purported class, regarding, among other things, our artificially inflated statements of financial strength and understated liabilities; and

• causing our common stock to trade at artificially inflated prices and causing the plaintiff and other putative class members to purchase our common stock at inflated prices.

The putative class period in this action is from April 24, 2008 through February 25, 2013. The plaintiffs seek, among other things, the designation of this action as a class action, an award of unspecified compensatory damages, interest, costs and expenses, including counsel fees and expert fees, and such equitable/injunctive and other relief as the court deems appropriate. All of the defendants intend to defend themselves vigorously against the allegations made in the amended complaint.

On April 17, 2013, a complaint in a securities class action lawsuit was filed against us and two of our current executive officers in the United States District Court for the Southern District of New York under the following caption: Massachusetts Laborers’ Annuity Fund, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc., et al. (the “MLAF Litigation”). The complaint alleges, among other things, that the defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by:

• our failure to properly account for the 2007 RSA, 2009 RSA and PEAKS Program;

• our failure to establish adequate reserves associated with our guarantee obligations under the 2007 RSA, 2009 RSA and PEAKS Program, which caused us to misrepresent our earnings, liabilities, net income and financial condition throughout the putative class period;

• making false and misleading statements;

• engaging in a scheme to deceive the market and a course of conduct that artificially inflated the price of our common stock;

• operating as a fraud or deceit on purchasers of our common stock by misrepresenting our liabilities related to the 2007 RSA, 2009 RSA and PEAKS Program, financial results and business prospects;

• artificially inflating the price of our common stock; and

• causing the putative class members to purchase our common stock at artificially inflated prices.

The putative class period in this action is from April 24, 2008 through February 25, 2013. The plaintiff seeks, among other things, the designation of this action as a class action, and an award of unspecified compensatory damages, interest, costs, attorney’s fees and equitable/injunctive or other relief as the Court deems just and proper. All of the defendants intend to defend themselves vigorously against the allegations made in the complaint. On July 25, 2013, the MLAF Litigation was consolidated into the Securities Litigation.

On May 8, 2013, a complaint in a shareholder derivative lawsuit was filed against two of our current executive officers and all of our current Directors in the United States District Court for the Southern District of New York under the following caption: Sasha Wilfred, Derivatively on Behalf of Nominal Defendant ITT Educational Services, Inc. v. Kevin M. Modany, et al. (the “Wilfred Litigation”). The complaint alleges, among other things, that from April 24, 2008 through February 25, 2013, the defendants violated state law, including breaching their fiduciary duties to us, grossly mismanaging us, wasting our corporate assets and being unjustly enriched, by:

• causing or allowing us to disseminate to our shareholders materially misleading and inaccurate information relating to a series of risk-sharing agreements through SEC filings, press releases, conference calls, and other public statements and disclosures;

• willfully ignoring obvious and pervasive problems with our internal controls and practices and procedures, and failing to make a good faith effort to correct these problems or prevent their recurrence;

• violating and breaching fiduciary duties of care, loyalty, reasonable inquiry, oversight, good faith and supervision;

• causing or allowing us to misrepresent material facts regarding our financial position and business prospects; and

• abandoning their responsibilities and duties with regard to prudently managing our businesses in a manner imposed upon them by law.

The complaint seeks:

• unspecified damages;

• restitution;

• disgorgement of all profits, benefits and other compensation obtained by the individual defendants;

• an order directing us to take all necessary actions to reform and improve our corporate governance and internal procedures; and

• costs and disbursements, including attorneys’, accountants’ and experts’ fees, costs and expenses.

All of the individual defendants intend to defend themselves vigorously against the allegations in the complaint. On August 6, 2013, the parties agreed to stay the Wilfred Litigation until the Securities Litigation is dismissed with prejudice or the defendants file an answer in the Securities Litigation.

Although the derivative action is brought nominally on behalf of us, we expect to incur defense costs and other expenses in connection with the derivative lawsuit.

There can be no assurance that the ultimate outcome of the Leveski Litigation, Securities Litigation, Wilfred Litigation or other actions (including other actions under federal or state securities laws) will not have a material adverse effect on our financial condition, results of operations or cash flows.

The current officers named in the Securities Litigation and the Wilfred Litigation include Daniel M. Fitzpatrick and Kevin M. Modany.

Certain of our current and former officers and Directors are or may become a party in the actions described above. Our By-laws and Restated Certificate of Incorporation obligate us to indemnify our officers and Directors to the fullest extent permitted by Delaware law, provided that their conduct complied with certain requirements. We are obligated to advance defense costs to our officers and Directors, subject to the individual’s obligation to repay such amount if it is ultimately determined that the individual was not entitled to indemnification. In addition, our indemnity obligation can, under certain circumstances, include indemnifiable judgments, penalties, fines and amounts paid in settlement in connection with those actions.

Guarantees. We entered into the PEAKS Guarantee in connection with the PEAKS Program. Under the PEAKS Guarantee, we guarantee payment of the principal and interest owed on the PEAKS Senior Debt, the administrative fees and expenses of the PEAKS Trust and the required ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt. The PEAKS Senior Debt bears interest at a variable rate based on the LIBOR plus an applicable margin and matures in January 2020. The PEAKS Guarantee agreement contains, among other things, representations and warranties and events of default customary for guarantees. In addition, under the PEAKS Program, some or all of the holders of the PEAKS Senior Debt could require us to purchase their PEAKS Senior Debt in certain limited circumstances that pertain to our continued eligibility to participate in the federal student financial aid programs under Title IV (the “Title IV Programs”) of the HEA. We believe that the likelihood of those limited circumstances occurring is remote. Our guarantee and purchase obligations under the PEAKS Program remain in effect until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. At such time, we will be entitled to repayment of the amount of any payments made under the PEAKS Guarantee (which do not include Payments on Behalf of Borrowers) to the extent that funds are remaining in the PEAKS Trust. To the extent that any funds remain in the PEAKS Trust after repayment of the amounts that we paid under the PEAKS Guarantee, we will be entitled to repayment of the Subordinated Note. The amount owed to us under the Subordinated Note was approximately $73,000 as of September 30, 2013. Payments made under the PEAKS Guarantee that we expect to recover, net of accrued discount, were approximately $7,800 as of September 30, 2013 and $6,700 as of December 31, 2012 and are included in Other assets on our Condensed Consolidated Balance Sheet.

The maximum future payments that we could be required to make under the PEAKS Guarantee include:

• up to $256,000 in principal of PEAKS Senior Debt, which was the approximate outstanding principal balance of the PEAKS Senior Debt as of September 30, 2013;

• accrued interest on the PEAKS Senior Debt;

• the fees and expenses of the PEAKS Trust; and

• amounts by which the ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt falls below the required level.

We are not able to estimate the undiscounted maximum potential amount of future payments that we could be required to make under the PEAKS Guarantee, because those payments will be affected by:

• the repayment performance of the private education loans made under the PEAKS Program, the proceeds from which will be used to repay the PEAKS Senior Debt and to pay the fees and expenses of the PEAKS Trust and the performance of which also affects the ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt;

• the fact that those loans will consist of a large number of loans of individually immaterial amounts;

• the fact that the interest rate on the PEAKS Senior Debt is a variable rate based on the LIBOR plus a margin; and

• the amount of fees and expenses of the PEAKS Trust, much of which is based on the principal balance of the private education loans held by the PEAKS Trust.

In the nine months ended September 30, 2013, we made Payments on Behalf of Borrowers in connection with the PEAKS Program. We made those payments after assessing:

• the likelihood of us being contractually required to make payments under the PEAKS Guarantee in the near future;

• the effect on our liquidity that would result from making payments under the PEAKS Guarantee compared to making Payments on Behalf of Borrowers;

• the effect that Payments on Behalf of Borrowers may have on the funds available to the PEAKS Trust to repay the Subordinated Note to us following full payment of the PEAKS Trust’s other obligations; and

• the fact that we will not be able to recover Payments on Behalf of Borrowers directly from the student borrowers on whose behalf we made those payments.

Payments on Behalf of Borrowers assist in:

• maintaining the ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt at the required level; and

• satisfying the following month’s required payment of interest on the PEAKS Senior Debt and administrative fees and expenses of the PEAKS Trust.

We will continue to assess whether it would be economically beneficial to us to make Payments on Behalf of Borrowers in future periods, and we may make Payments of Behalf of Borrowers in the future based on our assessment of the above factors.

Making Payments on Behalf of Borrowers:

• may result in us paying amounts to the PEAKS Trust in advance of when a guarantee payment would be due, which would negatively impact our liquidity in a particular period;

• may result in us paying a lesser amount than we otherwise would have been required to pay in future periods under the PEAKS Guarantee, which would positively impact our liquidity in a particular period; and.

• may reduce the amount that we could receive following full payment of the PEAKS Senior Debt and fees and expenses of the PEAKS Trust, because that amount is limited to the amounts we paid under the PEAKS Guarantee (which do not include Payments on Behalf of Borrowers) and the amount due to us under the Subordinated Note.

The amount owed to us under the Subordinated Note was approximately $73,000 as of September 30, 2013. In determining the estimated default rate used in the assumptions to establish our liability for guarantee obligations, we considered the payment performance of the private education loans under the PEAKS Program. Any Payments on Behalf of Borrowers that we made with respect to those loans, however, were not considered to be payments on those loans for purposes of that determination.

No new private education loans were or will be originated under the PEAKS Program after July 2011, but immaterial amounts related to loans originated prior to that date were disbursed by the lender through March 2012.

We entered into the 2009 RSA in connection with the 2009 Loan Program. Under the 2009 RSA, we guarantee the repayment of the principal amount (including capitalized origination fees) and accrued interest payable on any private education loans that are charged off above a certain percentage of the private education loans made under the 2009 Loan Program, based on the annual dollar volume. The total initial principal amount of private education loans that the 2009 Entity purchased under the 2009 Loan Program was approximately $141,000. No new private education loans were or will be originated under the 2009 Loan Program after December 31, 2011, but immaterial amounts related to loans originated prior to that date were disbursed by the lender through June 2012. Our obligations under the 2009 RSA will remain in effect until all private education loans made under the 2009 Loan Program are paid in full or charged off. The standard repayment term for a private education loan made under the 2009 Loan Program is ten years, with repayment generally beginning six months after a student graduates or three months after a student withdraws or is terminated from his or her program of study.

Under the 2009 RSA, we have the right to elect to make Discharge Payments with respect to private education loans that have defaulted. The effect of a making a Discharge Payment related to a private education loan is to reduce the aggregate amount that we may have to pay under our guarantee obligations with respect to that loan. To date, we have claimed as an offset against the Revolving Note amounts that would have the effect of discharging our obligations with respect to certain defaulted loans under the 2009 RSA. If we believe that doing so would be economically beneficial to us, we may make Discharge Payments in future periods. Making Discharge Payments may result in us paying amounts to the 2009 Entity in advance of when a guarantee payment would be due, which would negatively impact our liquidity in a particular period, but may result in us paying a lesser amount than we otherwise would have been required to pay under our guarantee obligation in future periods under the 2009 RSA.

Pursuant to the 2009 RSA, we are required to maintain collateral to secure our guarantee obligation in an amount equal to a percentage of the outstanding balance of private education loans disbursed to our students under the 2009 Loan Program. As of September 30, 2013, the total collateral maintained in a restricted bank account was not material. This amount is included in Other assets on our Condensed Consolidated Balance Sheet as of September 30, 2013. The 2009 RSA also requires that we comply with certain covenants, including that we maintain certain financial ratios which are measured on a quarterly basis. We were in compliance with these covenants as of September 30, 2013.

The following table sets forth the approximate aggregate amount of guarantee payments and Payments on Behalf of Borrowers that we made related to the RSAs, net of recoveries, in the periods indicated:

	Three Months Ended September 30,				Nine Months Ended September 30,
Type of Payment	2013		2012		2013		2012
Guarantee:
PEAKS Guarantee	$	138	$	243	$	1,377	$	502
2009 RSA		458		560		738		1,141
Payments on Behalf of Borrowers		2,502		0		7,647		0
Total	$	3,098	$	803	$	9,762	$	1,643

We asserted the right to offset amounts owed to us by the 2009 Entity under the Revolving Note related to the 2009 RSA, net of recoveries, of $47 in the three months ended September 30, 2013 and $8,023 in the nine months ended September 30, 2013. Approximately $6,800 of the amount that we claimed as an offset against the Revolving Note in the nine months ended September 30, 2013 related to our election under the 2009 RSA to discharge our guarantee obligations with respect to certain defaulted private education loans under the 2009 Loan Program. We recorded all of the amounts claimed as offsets in Other current liabilities on our Condensed Consolidated Balance Sheet as of September 30, 2013.

At the end of each reporting period, we assess whether we should recognize a contingent liability related to our guarantee obligations under the RSAs and, if so, in what amount. As with any assessment, as facts and circumstances change, the recorded liability could change, and has changed, significantly. In order to make this assessment, we made certain assumptions with respect to the performance of the private education loans made under each of the RSAs over the life of these loans. The life of a private education loan made under the RSAs may be in excess of ten years from the date of disbursement. Therefore, our assessment was based on assumptions for periods in excess of ten years, and those assumptions include among other things, the following:

• the repayment performance of the private education loans under each of the RSAs;

• the timing and rate at which the private education loans will be paid;

• the changes in the variable interest rates due on the private education loans and PEAKS Senior Debt;

• the amounts that will be collected in the future on the private education loans that have defaulted; and

• the fees and expenses associated with servicing the private education loans.

We consulted with two third-party consumer credit consulting firms in arriving at our assumptions. The assumptions have changed, and may continue to change, significantly over time as actual results become known. In determining the estimated default rate used in the assumptions to establish our liability for guarantee obligations, we considered the payment performance of the private education loans under the PEAKS Program. Any Payments on Behalf of Borrowers that we made with respect to those loans, however, were not considered to be payments on those loans for purposes of that determination. Our recorded liability for our guarantee obligations under the RSAs is included in Other current liabilities and Other liabilities on our Condensed Consolidated Balance Sheets.

As previously disclosed, on February 8, 2013, we received a subpoena from the SEC. In a letter accompanying the subpoena, the SEC states that it is conducting an investigation of us. The SEC’s subpoena requests the production of documents and communications that, among other things, relate to our actions and accounting associated with: (a) agreements that we entered into with the 2009 Entity to create the 2009 Loan Program, including, without limitation, the 2009 RSA; and (b) agreements that we entered into to create the PEAKS Program. On May 9, 2013, we received a second subpoena from the SEC requesting the production of certain communications related to the same subject matter as the subpoena received on February 8, 2013. We are cooperating with the SEC in its investigation, and we have provided documentation, communications and other information, including testimony of one of our officers, to the SEC in response to both subpoenas. There can be no assurance, however, that the ultimate outcome of the SEC investigation will not have a material adverse effect on our financial condition or results of operations.