Apollo Group Inc fraud case 2004

Apollo Group

In 2008, a federal jury ordered the Apollo Group to pay $280 million to shareholders, or $5.55 per share, as a result of a finding of fraud in 2004. Apollo, which runs the University of Phoenix, had misled investors by not divulging a report that had found the group in violation of Department of Education policies. The report found that Apollo systematically tried to keep its recruiting practices hidden from the Department. At the time, the Apollo Group was paying its recruiters solely on commission based on the number of enrollments they secured (Kahn, 2008).

The report had been issued in February 2004, but news of the report was not announced to investors until September of that year. By that point, the stock was already freefalling, a result of a slide that began in June. The stock's slide continued, however, until the end of that year. The long-term trend shows that the stock fell until November 2006, when after a separate scandal involving the accounting department, key senior officials left the company.

Ultimately, the $280 million judgment was reversed, as a judge found that the company was not liable for declines in share price even though it had misled investors on several counts (Blumenstyk, 2008). The Apollo Group has attempted to rebuild its franchise over the past several years, including a new leadership team. Revenues and profit have continued to grow steadily since the scandal broke.

The Situation in 2004

The Apollo Group had already seen its stock price drop over the summer of 2004 when the recruiting scandal broke. Despite increased revenues and net profit, earnings per share had decreased, a result of shares outstanding peaking at that time.

The company had suffered a slight deterioration in liquidity, but with no long-term debt on its books had remained in a very sound position financially.

It is reasonable to expect that part of the rapid growth at the University of Phoenix owed to the aggressive recruiting practices that had been the subject of the report. The company's growth rate was staggering at the time. For example, it needed to add almost 57,000 students in 2004 just to meet its growth target. Industry observers felt that Apollo's rate of growth was unsustainable, but that there was still more room for the company to find new students (Symonds, 2005).

For the Apollo Group, the coming years were faced with numerous challenges. The first was to put the recruiting scandal behind them. The second was to hit their aggressive growth targets. Apollo also needed to minimize legal exposure for the company going forward. Increased competition was also a concern.

The External Environment

The Apollo Group was faced with a difficult political environment. The Department of Education had found them in violation of federal law with respect to their recruiting practices. In particular was the practice of paying recruiters based on their results. The scandal had shaken the image of the University of Phoenix and resulted in legal exposure. Traditional universities, longtime adversaries of the Apollo Group, would be expected to leverage the scandal to exert increasing pressure on government to place tighter controls on the Apollo Group.

The economy was on the upswing, which was a positive indicator for the Apollo Group. Demand for western-style education was perceived as increasing around the world (Symonds, 2005). Moreover, with the rapid growth in wealth in developing nations such as Mexico, China and India offered seemingly limitless growth opportunities for the Apollo Group. Operations in those countries would be difficult for the DoE to scrutinize, which indicated that strong expansion without changing the existing business model was a possibility.

Aside from investors, the general public did not seem concerned with the scandal. Investors punished the stock. There was already fear in the marketplace that the company's growth trajectory could not be maintained, and a forced shift to less aggressive recruiting tactics would surely result in slower growth domestically.

The rapid proliferation of the Internet had changed the technological landscape. While it opened up new opportunities for University of Phoenix-style distance education, it also lowered barriers to entry for competitors. As a result, even public universities were competing in the sector now, in addition to a slew of new private schools. This competition had dramatically increased marketing costs, which at the Apollo Group were closing in on $400 million, just over 20% of the Group's total revenues.

Internally, the scandal had revealed governance issues as a key weakness. The recruiting practices were illegal, and management had clearly deemed the company's growth more important than obeying the law. The profits to be gained were greater than the potential legal exposure. The only real risk was that of being shut down completely, something the Department of Education seemed reticent to do. Rising marketing costs aside, the firm's financial situation was a key strength, as Apollo's balance sheet was very robust and its growth rates high. Other strengths included a strong brand name and established technology.

The influx of competitors was a greater threat than legal exposure. While the latter could result in fines, the former could result in an erosion of market share. A shift in the economy was also a threat that could result in a downturn in business. However, overseas markets presented a significant opportunity, in part due to growing interest in Western-style education and in part because there are less limits on recruiting practices. The domestic market remained a strong opportunity, but competition and saturation limited opportunities in the long run. Demographics, however, supported a continued marketing push, as the baby boom echo generation is graduating peak numbers of students from high school at this time.

Recommendations and Conclusion

In the domestic market, the cost of each new student is increasing. For the 57,000 new students in 2004, $383 million was spent on marketing, or $671 per student. This cost is increasing due to intensifying competition and market saturation that threatens to put Apollo at the point of diminishing returns. However, there is still tremendous potential in the domestic market. Certainly, Apollo should move to fill its existing capacity. It is recommended, however, that the growth strategy for Apollo in the domestic market be tempered as the cost of attracting each student rises. Defense of the existing market position should be the most important near-term strategy.

In the international market, there is tremendous room for growth, and at a lower marketing cost per student. Focusing on international markets will allow Apollo to continue its current high growth rate while simultaneously reducing the cost to attract each new student. Furthermore, technological changes threaten to open up international markets rapidly, which means that if the Apollo Group wishes to stake out a strong position, akin to their dominant position in the United States, it needs to move quickly.

With respect to the scandal, it is not expected to impact international operations. It may, however, impact domestic operations in that recruiting practices will need to change. The company will need to develop new means of motivating its recruiters in order to bring recruiting policies in line with the law. This will also help to assuage investors.

The company's primary obligation is to increase shareholder wealth. Yet at this point, the stock price is deteriorating at least in part due to the scandal. Strong operational performance will help to turn that around, but ultimately investor confidence is also required and in the wake of a series of accounting scandals, any scandal is cause for a reduction in stock price. Thus, Apollo must move to find new means of motivating recruiters, to restore investor confidence and all the stock price to rise in line with the company's strong performance and solid financials. This may also have a financial benefit as well. One anecdote stated that a recruiter was paid $85,000 after recruiting 151 students, a rate of $562 per student. A lower-performing recruiter was paid $32,000 for 79 students, a rate of $405. Apollo was therefore paying more per student from the top recruiters. Therefore, the commission structure did not make sense from the company's perspective, if we assume that over time only the highest-paid recruiters will remain. It is recommended that the commission structure be scrapped entirely in favor of system that delivers a lower per student payment to recruiters.