I don't fully understand it, but this is my best summary of it with the limited knowledge I have. Basically every school is assigned a number (not sure what formula is used to get to that number) based on players graduating, transferring, or dropping out. That number has to be over some threshold (around 900 I think) or the school is subject to penalties. The first year you are under the threshold, you get no penalties, basically a warning, but every year after that one year, you lose scholarships and I believe the school is also fined.
That could all be totally off base, but that's my best understanding of it. I'm sure someone will correct whatever errors I made.