Comments:
(1) The OP doesn't seem to know the definition of MSA
(2) The Chief Instructor does seem to share the common, but in my opinion very wrong, view that you can effectively practice engine failures without going below 500ft agl.
(3) Much (not quite all) of the world has the 500MSD rule, which the OP seems to have been following quite legally. (And I'm sure that his post saying he was careful to always have something nearby to be within 500ft of is a typing error). In the UK it is part of what we call "Rule 5", but that is a solely UK definition.
(4) However, what did the flying school have in its own rules (known in the UK as the FOB or Flying Order Book)? If these clearly said not below 500ft AGL, then the OP was in breach of his conditions of employment.
(5) Overall, it seems to me that the best bet is to grovel, apologise, promise not to do it again, and ask for clear clarification of the working rules at that school.
G