A little over a year ago, the idea of shorting for-profit education was practically fashionable.

Steven Eisman, made famous by Michael Lewis' "The Big Short" for his role in shorting the mortgage market, championed the idea that proprietary education would implode just as subprime mortgages had. Meanwhile, the Department of Education planned regulations that would hold for-profits accountable if graduates could not repay school loans and find work.

The rules carried serious consequences. If a program failed the "gainful employment" test, it would lose eligibility for federal student aid that accounts for the great bulk of its revenue. And Sen. Tom Harkin, D-Iowa, began hearings before the Senate's Committee on Health, Education, Labor and Pensions that questioned for-profits' tactics and the value of their degrees.

Then last year the threats seemed to recede. Education Secretary Arne Duncan's gainful-employment rules turned out to be softer than expected. Though Harkin continues to bang the drum, most recently accusing the sector of targeting GIs too aggressively, any legislation will be difficult after Democrats lost the House of Representatives. And even Eisman has gone quiet.

Still, the question remains: Does the short thesis on for-profit education still hold? The answer involves a tangle of issues and considerations that goes to the heart of a sector designed to educate and retrain hundreds of thousands of mostly adult Americans.

For some observers, the short argument never had great validity andcertainly doesn't now. John Higgins, a partner at Huron Capital Partners LLC, believes "some of the air is coming out of the balloon" of the short thesis. "Two or three years ago was the perfect storm for a short seller," he says. There was a combination of rich stock valuations and record enrollment growth. The gainful-employment proposal changed the risk profile. "For short sellers, I suppose you can build a thesis over a few months' period of time," he adds. "In the long term, it's a dangerous game because the long-term fundamentals are against you, and now valuations are, by most measures, relatively low and seemingly pricing in the key risks."

But for others, while political outcomes have changed the dynamics, operational and legal challenges, competition and periodic swings in equity values still support some aspects of the short thesis. "It's difficult to find people who say, 'I'm going to short the group because they are all going away, they are going to be regulated out of business,'?" says Brandon Dobell, who follows the sector for William Blair & Co. in Chicago. "You have specific short stories on a handful of names."

The issue, in fact, has become less a regulatory argument and more an operational one. "Gainful employment was never the basis for the short thesis," insists analyst Robert MacArthur of Alternative Research Services Inc., a short-sale research firm based in Ridgefield, Conn., that advises hedge funds.

Even with weaker regulatory standards, he argues, the industry faces a number of serious problems. "In the five years I have been recommending Apollo [Group Inc.] as a short, I don't know of any short seller that has shorted the stock on valuation or gainful employment," he says. "Good shorts are often contingent upon bad management and/or bad or failing business models, some of which covers the publicly traded for-profit companies."

Both for-profit supporters and for-profit shorts have at least one thing in common: the belief that the long-term outlook supports their case. Supporters view the private sector as an indispensable partner with nonprofit schools and necessary to meet President Obama's goal of producing 8 million more college graduates by 2020. The shorts believe that even if regulators do not reduce the flow of Title IV dollars, the for-profits' marketing-heavy business models will unravel as companies adapt to rules that limit their recruiting.

Share prices of the for-profit companies have indicated varying bursts of confidence and anxiety. There was exuberance in June when the Department of Education's rules appeared, followed by sideways trading and periodic multipercent drops. Recent weeks demonstrate the pattern. Hedge fund manager James Chanos, founder of short-selling firm Kynikos Associates LP, who is credited with foreseeing the collapse of Enron Corp., jarred the stocks when he called the sector a "national disgrace" at a New York conference.

Days later, bellwether Apollo Group Inc. announced that new enrollments had declined by "just" 33%, an improvement over the 40% decline in each of the three prior quarters. Apollo said it would post positive starts in the next quarter, as it compares numbers to other soft quarters. The stock jumped nearly 8%, and other education stocks spiked as well. On Oct. 26, DeVry Inc.'s shares fell 17% after it reported disappointing enrollments.

Government grants and loans authorized by Title IV of the Higher Education Act can account for up to 90% of a school's revenue. Harkin's office puts the amount paid to proprietary schools at $30 billion a year. The 10% stub can include other government outlays from sources such as GI Bill funds paid to servicemen and -women.

Duncan sought to tighten the rules in 2010, claiming that some for-profits were "saddling students with debt they cannot afford in exchange for degrees and certificates they cannot use." The Department of Education then laid out thresholds that a school would have to meet to maintain its Title IV eligibility in July 2010. Full eligibility would require 45% of a school's students to be repaying the principal on their loans, or that its graduates had annual loan payments of less than 20% of discretionary income or 8% of total income. Programs would be ineligible if less than 35% were paying down principal, and grads' yearly payments exceeded 30% of discretionary income and 12% of total income.

In the first draft, schools could have lost eligibility as soon as 2012-'13.

Those proposed rules were daunting, and they sparked vocal opposition and lobbying. The Association of Private Sector Colleges and Universities hired Lanny Davis, the Washington lawyer and lobbyist who advised President Clinton during the Monica Lewinsky scandal. In the final rules, announced in June, schools would have to meet the lower threshold to be fully eligible: either 35% of students repaying at least $1 of principal, or the graduates having annual loan payments less than 30% of discretionary income or 12% of total earnings.

To lose standing, a school would have to miss all three measures for three out of four years. The result: The earliest a school could lose eligibility is 2015, by which time there could be a new administration in power.

Meanwhile, two key proponents of gainful employment have departed from the Department of Education. Robert Shireman, a deputy under secretary of Education who was closely associated with the regulations, left the government in 2010 to start an educational consulting group, California Competes. His successor, James Kvaal, recently went to work on Obama's re-election campaign.

"There has never been less clarity about future earnings streams than there was in the last two years," Huron's Higgins says.

Huron has made two investments in for-profit ed, backing Virginia Beach, Va., trade school operator Delta Educational Systems Inc. and St. Clair, Mich., healthcare school specialist Ross Education LLC. Huron made profitable exits in both cases.

"As we sit here today, there is more clarity as to the new regulations," he says. "Still, the next step from an investment analysis perspective is to figure out how the new rules will affect revenues and margins, and the answer is very different from one school to the next."

That "next step" could be a doozy. To some observers, Apollo's earnings report may indicate a path out of the gainful-employment thicket. But short analyst MacArthur predicts that ultimately "good old-fashioned capitalism" in the form of competition amongst the growing field of for-profits, and from nonprofit schools that are expanding online, will be the demise of some companies.

Apollo co-CEO and chairman Greg Cappelli acknowledged in the company's October earnings call that there are "more schools than ever before" competing in the online market. "You see them advertising all over the place," he said. "I was on a United flight the other day, and there were probably 60 advertisements for nonprofit schools in the magazine, in the in-flight magazine."

Though the gainful-employment rules will not shut off the spigot of federal dollars, they have caused for-profits to change their enrollment practices. The Department of Education has also recently eliminated a 2002 safe-harbor provision that allowed schools to base salaries, though not bonuses, in part on enrollments.

MacArthur argues that for-profit ed has fundamental problems that will lead to the elimination of some companies. The model will hold up for some of the companies, but there is a "major contraction occurring causing profits to collapse as companies clean up their behavior," he says.

The sector's profit margins range from 16% to 37%, according to Harkin's staff. MacArthur questions how operating margins can be 2 to 3 times higher than government contractors such as Lockheed Martin Corp. and Northrop Grumman Corp. "This tells me there is still a lot of predatory recruiting of unqualified students," he says, suggesting that industry margins will be "much, much lower" and earnings may never grow again.

The analyst outlines some of the problems. For starters, students hold too much bad debt, relative to the value of the diplomas.

Second, revenue and cash flow are misleading because of the high numbers of withdrawals and the cycle of government aid payments. Students can tap about $5,000 in Pell Grants and thousands more in loans per year. This represents up-front revenue for the schools. Apollo has said that the Securities and Exchange Commission has made informal inquiries into its revenue recognition practices, including "student refunds, the return of Title IV funds to lenders and bad debt reserves," in SEC filings.

Student churn is one of the issues that Harkin has targeted. Harkin's staff analyzed 16 schools' enrollments for the 2008-'09 year. Fourteen had new enrollees that exceeded their total student base at the start of the year. Yet the group had a net gain of 22%. One added 120,000 students during 2008-'09, but showed a net gain of 18,000 enrollments.

Third, MacArthur believes alleged fraud that state attorneys general and others have targeted is greater than the Street expects. Pushing the 90-10 calculation to 80-20 would resolve some of the problems, he suggests, by eliminating recruitment of less-qualified students.

The industry and its supporters often accuse its critics of elitism. Sen. Mike Enzi of Wyoming, the ranking Republican on the HELP Committee, has argued that nonprofits need to be held to the same level of scrutiny as for-profits. In addition, Enzi has asked for an investigation into the influence that short investors had upon the Department of Education's formulation of the gainful-employment rules.

One private equity investor with a background in the sector says, "The shorts' job is to make money for their investors, not to provide context." The shorts and other critics misleadingly compare debt levels of for-profit students to graduates of community colleges, which have lower tuition rates because of direct government subsidies. Likewise, graduates of elite private colleges and universities will have greater academic and financial success upon graduation. The more appropriate comparison on that score, the person says, is to community college graduates.

A school's tax status should not influence the view of how successful the institution is, he says. "We should be welcoming the robust participation of the private sector. We should not make a fetish of whether or not they happen to pay taxes or not."

The federal government and some states have joined qui tam lawsuits, legal actions that whistleblowers bring on behalf of the government. Qui tam suits against Apollo and Pittsburgh-based post-secondary education provider Education Management Corp., or EDMC, allege that the companies have illegally based recruiters' pay on the number of students they enrolled. To prevent headhunting and registration of unqualified students, the law prevents schools from paying bonuses based on recruitment. The government and EDMC clash over whether the educator violated the incentive compensation ban or stayed within the bounds of the 2002 safe harbor.

The U.S., California, Florida, Illinois, Indiana, Massachusetts, Minnesota, Montana, New Jersey, New Mexico, New York, Tennessee and the District of Columbia have filed suit against EDMC in the Western District of Pennsylvania. They charge the company submitted false claims for payment because it allegedly violated the spirit, if not the word, of the incentive compensation ban.

EDMC declined to comment for this article. Legal adviser Bonnie Campbell, a former state attorney general for Iowa and DOJ official, described the government's assertions as "flat-out wrong" in an official statement.

In its motion to dismiss, EDMC says it did not determine pay "solely" by success at enrolling students, and that it only used recruitment within the previously allowed review of salaries. Moreover, the company says the government is attempting to use a false claims suit to enforce regulation, which the 3rd Circuit has not supported.

The government charges that qualitative factors in EDMC's compensation system are "window dressing" and that it raises pay "solely" on the basis of recruit numbers. There were also "lavish trips," reminiscent of subprime mortgage brokers before 2007, to locales such as Puerto Vallarta, Mexico, and Las Vegas that are "unabashedly compensation" to top recruiters.

One of the whistleblowers in the suit is Michael Mahoney, a 15-year veteran of the auto industry who had been director of training for the company's online higher education unit. The complaint says the hiring manager was "extremely interested in Mr. Mahoney's ability to train sales people in car dealers' high-pressure 'closing' techniques."

The plaintiffs say they can seek $11,000 for each claim plus treble damages. That would add up to a hefty sum. The complaint lists billions of dollars that EDMC has collected.

Separately, Apollo Group and its University of Phoenix subsidiary face a suit in California that former employees brought on behalf of the federal government and the state of California. Unlike the EDMC suit, the Department of Justice declined to intervene in the case against Apollo. The DOJ's decision does not prevent the case from proceeding.

Like the suit against EDMC, the whistleblowers and the government charge Apollo with basing payments on incentives. The complaint says that the school has drawn hundreds of millions of dollars in aid while falsely claiming that it complied with the incentive compensation ban. The suit also alleges that management told sales staff to shred training scripts.

Apollo settled a similar suit, Hendow vs. University of Phoenix, in 2009 for about $80 million. The for-profit school argues that the current case is "nothing more than a stripped-down version of the prior Hendow complaint" and rehashes charges for which it has already received releases.

Qui tam cases have a mixed record. Washington Post Co.'s Kaplan Inc. unit settled a qui tam case this summer for a mere $1.6 million.

Even a heavier fine, such as the $80 million Hendow settlement, would hardly dent the balance sheet of the bigger schools.

The suits can create repercussions in other areas of government oversight, however. About a decade ago, a qui tam suit led the Department of Education to pursue Computer Learning Centers of Manassas, Va. CLC had been a high-flying stock in the late 1990s but sought Chapter 7 protection in 2001 after the Department of Education required the company to repay almost $190 million it had received in Title IV funding. The implosion of CLC motivated for-profits to seek Department of Education guidance about incentive compensation, leading to the 2002 safe harbor.

"Is somebody going to get dinged for $10 million? Yeah," William Blair's Dobell says of the current litigation. "I just don't think it's going to be a cataclysmic hit for the companies."

Phoenix-based Apollo, founded in 1973, has long had outsized influence in for-profit education. The parent of the University of Phoenix is the largest proprietary school operator, with some 380,000 students -- though not as large as it was a year ago, when it totaled 470,000. Even in its diminished state, Apollo looms over its next-largest peer, Education Management, which has about 140,000 students.

Although Apollo Group did not make anyone available for an interview, a statement from a spokesman addressed the for-profits' role in higher ed and student protections. The spokesman noted Obama's pledge to regain pre-eminence in global college graduation rates and said University of Phoenix is well suited to students for whom "the traditional educational system often falls short," those who cannot attend a university full-time and who may not have funding from parents. He also said UOP initiatives such as the free three-week orientation and the restructuring of recruiter pay provide a model for higher ed programs.

The company projects a return to single-digit new enrollments in the next quarter, and through fiscal year 2012.

Dobell says that it is a bit early to see the company, and its recent earnings report, as a precursor of the industry's performance. "Five years ago, if Apollo had a strong quarter, investors might have decided to buy the rest of the group," he says. "It's hard to make that argument right now."

MacArthur raises questions about the composition of the company's student body. "Apollo is recruiting too many students that have no ability to succeed," he says. "Investors don't know the volatility of the dropout rate among Pell recipients and how they are recognizing revenue from them."

Apollo has taken steps to improve the quality of its enrollees, including implementing an orientation program to prepare students for college. During orientation, students do not take on debt. Apollo says about 20% of prospective students drop out after the free trial. The company has also changed its incentive plans to remove links between pay and enrollments.

To varying degrees, schools such as San Diego-based Bridgepoint Education Inc., Phoenix-based Grand Canyon Education Inc., Schaumburg, Ill.'s Career Education Corp. and Education Management are going through similar processes, but are further behind. "Next quarter will be more instructive," Dobell says.

Apollo's influence goes beyond enrollment policies. Many of the large for-profits have borrowed heavily from Apollo's management playbook, and former Apollo executives are scattered throughout the industry. EDMC CEO Todd Nelson once held the same position at Apollo, and EDMC's senior vice president of marketing and admissions, Tony Digiovanni, worked there for more than a decade. Grand Canyon CEO Brian Mueller and CFO Dan Bachus are also Apollo veterans. And Bridgepoint Education founder and CEO Andrew Clark was once Apollo's youngest regional vice president. Clark founded Bridgepoint with backing from Warburg Pincus in 2005, and he has expanded its online programs at a staggering rate.

Harkin once devoted an entire hearing to Bridgepoint and its online expansion. The company acquired regionally accredited Iowa school Mount St. Clare College and grew enrollment from 330 students to more than 77,000 by 2010.

The new gainful-employment rules will go into effect in 2013. "We still don't know the impact," admits Brian Moran, interim president of the APSCU.

The effects will depend upon the economy, he says, tuition rates and the qualifications of the students that schools recruit. The new enrollment policies have already begun to change demographics.

The APSCU has filed a suit against the new rules. And it's appealing a ruling on the Department of Education's elimination of the incentive safe harbors. "The whole concept of a debt-to-income-based definition of gainful employment continues to be objectionable," he says.

Both for-profit and nonprofit schools face risks from what appears to be a bubble in educational pricing. A report this summer from Moody's Analytics Inc. states that the cost of tuition and fees has more than doubled since 2000, surpassing the inflation rates for energy, housing and healthcare.

"Despite all of the attention house prices receive," Moody's Analytics analyst Cristian deRitis wrote, "it is noteworthy that even during the housing bubble, real estate appreciation was far exceeded by the growth rate in tuition."

A recent paper from the Center for College Affordability and Productivity argues that financial aid contributes to inflation in higher ed: "Colleges and universities charge what the market will bear." The center describes higher education funding as an "arms race" in which schools that fail to capture financial aid dollars likely will suffer diminished stature and enrollments.

You don't need to visit Zuccotti Park to know that tuition, student debt and a shortage of jobs for highly leveraged grads are charged issues. "What happens if college tuitions collapse for any school but the most elite?" Dobell asks.

In this year's fiscal battles in Congress, there has been talk of reducing Pell Grants, which provide Apollo alone more than $1 billion a year. There is growing concern about abuse of Pell Grants within the Department of Education as well; Kathleen Tighe, the department's inspector general, issued a report in September about fraud rings, in which a leader applies for online programs under the name of multiple co-conspirators. After paying tuition, schools deliver the balance of the Pell Grant. The excess is meant to cover the cost of books and other legitimate expenses. In fraud rings, however, the ringleader and bogus students split the refund.

The political element has never been far removed from the maneuverings over for-profit education. Former President George W. Bush's Department of Education wrote the safe-harbor provision that allowed schools to use enrollment as one element of determining salary. The Obama administration eliminated the provision last year. Meanwhile, an election looms. The ultimate question for for-profits, and for the shorts, may be what a Romney, Cain or Perry administration would make of gainful employment. Whatever happens will provide a real lesson in political economy.