BILL ANALYSIS SENATE COMMITTEE ON BANKING, FINANCE, AND INSURANCE Senator Ronald Calderon, Chair SB 1188 (Wright) Hearing Date: April 7, 2010 As Amended:March 25, 2010 Fiscal: Yes Urgency: No SUMMARY Would, effective January 1, 2012, add a new division to the Financial Code related to debt settlement organizations, as specified, and would give the Department of Corporations limited regulatory authority over companies engaging in debt settlement. DIGEST Existing law 1. Provides for the Check Sellers, Bill Payers, and Proraters Law (Proraters Law; Financial Code Section 12000 et seq), administered by the Department of Corporations (DOC), which defines a prorater as a person who, for compensation, engages in whole or in part in the business of receiving money or evidences thereof for the purpose of distributing the money or evidences among creditors in payment or partial payment of the obligations of the debtor (Section 12002.1); 2. Limits the fees that may be charged by a prorater, or by any other person for the prorater's services, to an origination fee of up to $50, plus 12% of the first $3,000 distributed by the prorater to the creditors of a debtor; 11% of the next $2,000; and 10% of any of the remaining payments, except for payments made on recurrent obligations, as defined (Section 12314); 3. Defines recurrent obligations for purposes of the aforementioned fee cap as current rent payments, current utility payments, current telephone bills, current alimony payments, current monthly insurance premium payments, and first lien mortgage payments, and authorizes a fee not to exceed $4 per disbursement on recurrent obligations consisting of current rent payments or first lien mortgage payments, and not to exceed $1 on other recurring obligations (Section 12314); SB 1188 (Wright), Page 2 4. Provides that when a debtor has not canceled or defaulted on the performance of his or her contract with the prorater within 12 months after engaging in the contract with the prorater, the prorater must refund the origination fee (Section 12314); 5. Provides that if a prorater contracts for, receives, or makes any charge in excess of the maximum allowed under the Check Sellers, Bill Payers, or Proraters Law, except as the result of an accidental and bona fide error, the prorater's contract with the debtor is void, and the prorater is required to return to the debtor all charges received from the debtor (Section 12316); 6. Provides for administrative penalties of up to $2,500 per violation of the Check Sellers, Bill Payers, and Proraters Law, and states that any licensee or person who willfully violates any provision of the law, or any rule or order adopted pursuant to the law, is liable for a civil penalty of up to $10,000, enforceable by the Commissioner of Corporations (Section 12105). This bill 1. Would define "debt settlement services" or "services" as acting as an intermediary between an individual and one or more of the individual's creditors in order to obtain concessions for that individual's unsecured debts, but without holding or disbursing funds to the individual's creditors, for a fee to be paid by the individual; 2. Would provide that it is unlawful for a person to provide debt settlement services unless it obtains and maintains insurance coverage for employee dishonesty, depositor forgery, and computer fraud, in an amount not less than $100,000, and with a deductible of no greater than 10% of the face amount of the policy. Each person providing debt settlement services would have to provide a copy of its policy to any party upon request, and would have to file a form establishing proof of the required insurance coverage with the Commissioner of Corporations; 3. Would require a debt settlement organization to enter into a written contract with an individual, which is signed and dated by the individual, and given to the individual upon the contract's consummation, before the debt settlement organization may provide debt settlement services to that SB 1188 (Wright), Page 3 individual. The contract would be required to include the following information: a. A full and detailed description of the debt settlement services to be performed and the estimated date by which, or length of time in which, they will be performed; b. All terms and conditions of payment, including the estimated total of all payments to be made by the individual; c. The organization's principal business address and the name and address of its agent in the state who is authorized to receive service of process; d. A clear and conspicuous statement in boldface type, in immediate proximity to the space reserved for the individual's signature, which states, "You may cancel this contract within 5 business days after the date the contract is signed." The organization is also required to give a separate document to the individual titled, "Notice of Right to Cancel," whose language is specified in the bill; 4. Would establish the following rules with respect to fees that are allowable and prohibited by a debt settlement organization: a. A debt settlement organization would be prohibited from collecting any fees, until after settlement of an account with the individual's creditor is agreed upon, and documentation memorializing the funding of the settlement is executed; b. Settlement fees and other monetary settlement charges may not exceed 30% of the difference between the debt principal and the concession agreed upon with the individual's creditor; c. No fee or other charge may be imposed, either directly or indirectly, on an individual for debt settlement services, until the individual agrees in writing to the fees or charges and to the plan negotiated by the debt settlement organization; SB 1188 (Wright), Page 4 d. In the event that a multiple pay settlement is negotiated (i.e., a settlement that will be paid in installments), the debt settlement organization may only collect a fee based on the amount of the multiple installment payment, at the time that installment payment is made; 5. Would prohibit a debt settlement organization from doing any of the following: a. Making or using any false or misleading representations or omitting any material fact in the offer or sale of services offered, or engaging in any fraudulent, false, misleading, unconscionable, unfair, or deceptive act or practice in connection with the offer or sale of any of its services; b. Providing services to an individual without executing a written contract; c. Failing to provide copies of all contracts and other documents the individual is required to sign; and, d. Failing to obtain insurance coverage or failing to make that coverage information available for public inspection; 6. Would exempt a debt settlement organization from the provisions of the Prorater's Law, except to the extent the organization is performing services and activities governed under that law; 7. Would exempt the following entities and their employees from its provisions, when the entities or employees are engaged in the regular course of their business or profession: a person licensed to practice law in California, a licensed public accountant or certified public accountant; a depository institution; any subsidiary or affiliate of a bank holding company; Fannie Mae; Freddie Mac; any consumer reporting agency; any title insurer, escrow company, or other person that provides bill paying services, if the person does not provide debt settlement services; and any person who engages in debt adjustment to adjust the indebtedness owed to that person. Would also exempt from the bill's provisions a family member of an individual who negotiates concessions, with or without SB 1188 (Wright), Page 5 compensation, from the creditor's of that individual; 8. Would provide that a violation of the bill is an act of unfair competition within the meaning of Business and Professions Code Section 17200 et seq., and would authorize any individual injured by a violation of the bill to bring an action to enjoin and restrain any violation and to recover damages. COMMENTS 1. Purpose of the bill To provide a regulatory scheme other than the Prorater's Law, under which debt settlement services may be provided in California. 2. Background The business model of debt settlement service providers involves working on behalf of individuals behind on their debts, and helping these debtors negotiate reductions in the amounts owed to their creditors. A customer who signs up with a debt settlement services provider is commonly instructed to put money aside in a bank account, and add money to that bank account each month. Because creditors typically want assurances that an individual will pay his/her settled debts, the debt settlement service providers use the existence of money in the bank account as leverage, when they seek out the consumer's creditors to negotiate a reduction in the amount the consumer owes. Once a reduction in a person's debts is negotiated by a debt settlement service provider, one of several business models is followed. Some providers direct the negotiated amount to the creditor, using a power of attorney granted to the debt settlement provider by the debtor (though reportedly, this practice has fallen out of favor in recent years). Other providers notify the debtor about the negotiated amount, and the debtor is responsible for sending money to the creditor. Still other providers work with a third party financial institution, which facilitates the transfer of money from the debtor's account to a creditor. Alternate business models are also possible. According to the representatives of the debt settlement industry, the average amount of consumer debt brought into a debt settlement program ranges from $20,000 to $30,000. Most debt settlement programs are set up to last three SB 1188 (Wright), Page 6 years, although about half the people who complete their programs finish those programs in 24 months or less. Although estimates of the percentage of customers who finish their programs vary (consumer groups claim percentage completion rates as low as 2%), industry representatives assert that about half of all customers complete their programs. The remainder drop out at some time before completion. The fees charged by providers vary. Some providers charge front-end fees and collect the remainder of their fees over a subsequent period of 12 months or less. Others providers charge flat fees, which are collected over the first half of the total enrollment period. Still others charge relatively small monthly fees (or no monthly fees at all), and then charge the consumer a percentage of the money they are able to save the consumer, upon completion of the program. These fee models have been described by the Federal Trade Commission as the "front-end fee model," "flat fee model," and "back-end fee model," respectively. The diversity in business models among debt settlement providers has resulted in a fragmentation of the industry, and in the legislation its members have advocated in the recent past. One segment of the industry, represented by The Association of Debt Settlement Companies (TASC) and United States Organizations for Bankruptcy Alternatives (USOBA) has promoted a licensing scheme administered by DOC, as an alternative to the Prorater's Law. Under the model preferred by TASC and USOBA (see AB 350, Lieu, from the 2009-10 Legislative Session), debt settlement providers may charge up front fees of up to 5% and total fees of up to 20% of the debt a consumer brings into a debt settlement program. This Committee passed AB 350 on a vote of 10-0 in July, 2009. AB 350 is currently awaiting a hearing in the Senate Judiciary Committee. More recently, the American Coalition of Companies Organized to Reduce Debt (ACCORD) presented the Legislature with an alternative debt settlement model that bans advance fees, but allows fees of up to 30% to be charged once debts are settled. Unlike TASC and USOBA, ACCORD does not propose licensing of debt settlement providers; instead, ACCORD would like to establish a series of allowable and prohibited actions, and to authorize individuals injured by a violation of its rules to bring an action to recover damages. SB 1188 SB 1188 (Wright), Page 7 contains ACCORD's proposal. A limited comparison of the two measures is provided immediately below: ----------------------------------------------------------------- | | SB 1188 (Wright) | AB 350 (Lieu) | |---------------------+---------------------+---------------------| |Coverage |Companies that |Companies that | | |attempt to settle |attempt to settle | | |all types of |all types of | | |unsecured debts |unsecured debts for | | | |individuals who | | | |reside in California | |---------------------+---------------------+---------------------| |Licensing scheme |No license |A license issued by | | |necessary. Debt |DOC would be | | |settlement companies |necessary to engage | | |would have to comply |in debt settlement | | |with the |services in the | | |requirements of the |state. | | |bill, but would not | | | |be required to | | | |obtain a license in | | | |order to do business | | | |in the state. | | |---------------------+---------------------+---------------------| |Law to be |DOC would review |DOC | |administered by |compliance with | | | |insurance | | | |requirements. | | |---------------------+---------------------+---------------------| |Fees |No up front fees |Fees capped at 20% | |allowed/prohibited |would be allowed. |of the amount of | | |Companies could |debt brought into a | | |collect fees of up |debt settlement | | |to 30% of the amount |program, including a | | |of debt settled. |set-up (up-front) | | | |fee of 5%. Fees | | | |plus settlements | | | |could not exceed the | | | |amount of debt | | | |brought into the | | | |program. | |---------------------+---------------------+---------------------| |Interaction with |Debt settlement |Licensed debt | SB 1188 (Wright), Page 8 |Prorater's Law |organizations would |settlement companies | | |be exempt from the |would be exempt from | | |Prorater's Law, |the Prorater's Law. | | |except to the extent | | | |the organization is | | | |performing services | | | |and activities | | | |governed under that | | | |law. | | |---------------------+---------------------+---------------------| |Companies exempted |Attorneys and |Attorneys and | |from the bill |certified public |certified public | | |accountants when |accountants when | | |rendering services |rendering services | | |in the course of |in the course of | | |their practice; a |their practice; a | | |family member of an |family member of an | | |individual that |individual that | | |negotiates financial |negotiates financial | | |concessions from the |concessions from the | | |individual's |individual's | | |creditors; |creditors; judicial | | |depository |officers; persons | | |institutions, bank |acting under a court | | |holding company |order or | | |subsidiaries and |administrative | | |affiliates, Fannie |order; assignees | | |Mae, Freddie Mac, |acting for the | | |title insurers, |benefit of | | |escrow companies, or |creditors; | | |other persons that |financial | | |provide bill-paying |institutions | | |services, if those |licensed under state | | |persons do not |or federal law; | | |provide debt |persons licensed or | | |settlement services, |registered to | | |and persons who |originate loans | | |engage in debt |secured by real | | |adjustment |property; title | | | |insurers, escrow | | | |companies, or other | | | |persons that provide | | | |bill-paying | | | |services, if those | | | |persons do not | | | |provide debt | SB 1188 (Wright), Page 9 | | |settlement services; | | | |and financial | | | |planning services | | | |providers, as | | | |specified | |---------------------+---------------------+---------------------| |Remedies for |Authorizes persons |Authorizes DOC, law | |violations of the |injured by a |enforcement | |law |violation of the law |agencies, and | | |to bring a private |individuals to bring | | |right of action |actions against | | |against violators. |violators, and | | | |subjects violators | | | |to administrative, | | | |civil, and criminal | | | |penalties for | | | |failure to comply | | | |with the law. | ----------------------------------------------------------------- 3. FTC Proposed Regulations In August 2009, the Federal Trade Commission (FTC) issued a draft proposal to regulate the sale of debt relief services (Federal Register Volume 74, No. 159, Wednesday, August 19, 2009, pp. 41998-42024). The FTC's proposal would define the term debt relief service, ensure that, regardless of the medium through which such services are initially advertised, telemarketing transactions involving debt relief services are subject to the proposed rule, mandate certain disclosures and prohibit misrepresentations in the telemarketing of debt relief services, and prohibit any entity from requesting or receiving payment for debt relief services, until those services have been fully performed and documented to the consumer. Written comments on the FTC's proposal were due by October 9, 2009. To date, the FTC has not issued its final rule. Those familiar with the FTC's review of debt relief services believe the rule will be issued sometime during 2010, but are unsure of its timing. If enacted in anything approaching its proposed form, the FTC's debt relief rules will significantly impact the debt settlement services policy debate in California. As proposed, the FTC's rule would apply to credit counseling, debt management plans, debt settlement, and debt negotiation (i.e., it would be broader than either SB 1188 or AB 350). The rule would apply to all inbound debt relief calls to SB 1188 (Wright), Page 10 debt relief service providers. Thus, even if a debt relief provider uses a third party to solicit potential customers via print, electronic, or broadcast media, that provider would be covered by the FTC rule, once a potential customer contacts the debt relief provider for more information about their services via an inbound phone call. Under the proposed rule, no up-front fees could be collected. "Telemarketers of debt relief services" (i.e., those who receive inbound phone calls regarding their debt relief services) would have to disclose a significant amount of information to prospective debt services customers, intended to fully inform them about the way(s) in which the program will work, the likely length of the program, the potential impact of the customer's participation in the program on his/her credit score and tax liability, and the possibility that debt collection efforts may continue to be directed toward the customer, even after he or she enters a debt services relief program. The proposed rule also contains language intended to prohibit telemarketers of debt relief services from making misrepresentations regarding any material aspect of the services they provide. 4. Licensing disputes: The FTC proposal must also be considered in the context of an ongoing debate regarding the extent to which for-profit debt settlement service providers should be licensed, and under which law. The FTC proposal neither requires nor prohibits the licensure of debt relief providers. In California, there has been a long-standing disagreement between DOC and the debt settlement industry over whether debt settlement providers must be licensed under the Prorater's Law. DOC's enforcement staff believe that for-profit debt settlement service providers should be licensed under the Proraters Law, and has taken enforcement action against some debt settlement service providers who have failed to obtain licenses as proraters. Some members of the debt settlement services industry maintain that, because they do not physically hold money for debtors, nor control debtors' assets, they do not fall under the definition of a prorater under the Check Sellers, Bill Payers, and Proraters Law, and need not obtain a prorater's license. Instead, they assert that they need a separate licensing law. Toward that end, TASC and USOBA sponsored AB 69 (Lieu), AB 2611 (Lieu), and SB 1188 (Wright), Page 11 SB 1678 (Florez) during the prior Legislative Session, and are sponsoring AB 350 (Lieu) this year. Despite a variety of court cases on the subject, the ongoing debate over whether, under what circumstances, and under which law, debt settlement services providers should be licensed has continued. This bill provides a limited exemption from the Prorater's Law. AB 350 provides an express exemption from the Prorater's Law. 5. Support The American Coalition of Companies Organized to Reduce Debt (ACCORD) is sponsoring SB 1188, to create a more consumer-oriented model for the debt negotiation industry to follow in California. 6. Opposition Consumers Union (CU) and the Center for Responsible Lending (CRL) have endorsed the concept, embodied in SB 1188, that consumers should be charged for debt settlement services, only after their debt is eliminated. "Consumers should not be required to pay for services before they are provided. This general rule is amplified in the case of debt settlement services where the evidence shows that often, payment before performance translates into payment without performance, and, typically, more consumers lose than win." CU and CRL submitted very similar letters of opposition, stating that, while SB 1188 adopts the right structure for debt settlement fees, the bill sets the fee cap too high. Both organizations cite the California Prorater's Law cap of 10% to 12% and a Maine law that limits fees to $75 up-front and 15% of savings. CU also expresses concern that SB 1188 permits fees to be collected on installment plan payments, regardless of whether a customer completes the installment plan. CU is also concerned that the bill triggers the fee obligation upon documentation "memorializing funding of a settlement," rather than upon a completed settlement, with a full release of the debt. Both groups advocate for additional consumer protections, beyond those proposed in SB 1188. In addition to the fee cap cited above, these groups would like to see an ability for a customer to leave his or her debt settlement program at any time, without owing future fees; a requirement that debt SB 1188 (Wright), Page 12 settlement companies sign up customers only if the debt settlement program is suitable for the customer and there is evidence that the customer can make the expected savings payments; a requirement that a contract be void if the debt settlement provider fails to comply with certain statutory requirements; strong conduct prohibitions and rules regarding advertising disclosures; and a restriction on unsubstantiated claims of savings. CU's and CRL's letters of opposition sidestep the issue of whether these groups believe that debt settlement firms should require licenses in order to do business in California. However, the organizations offered the author six pages of amendments, which do not include a licensing scheme, and stated that they would remove their opposition to the bill, if it is amended consistent with the language they provided. The Coalition for Quality Credit Counseling (CQCC) shares the concerns of CU and CRL regarding the fee cap proposed in SB 1188. Like CU and CRL, CQCC favors the "no advance fee" approach in SB 1188, but believes that the proposed 30% cap should be lowered. CQCC cites the Prorater's Law cap of between 10% and 12% and references a cap of 5% in federal legislation expected to be introduced during the current Congress by Charles Schumer. Much of CQCC's opposition letter urges the California Legislature to follow the approach of the soon-to-be-introduced Schumer legislation. Like CU and CRL, CQCC attached proposed language to its opposition letter, and stated that it would remove its opposition, if SB 1188 is substantially amended. Among the concerns expressed by CQCC in its letter of opposition: The bill's definition of debt settlement services and settlement accounts should be changed. The bill fails to elaborate on any of the details that must be contained in the written contract it requires. CQCC urges the California legislature to perform a thorough analysis of the proposed FTC regulations and the proposed federal legislation and move toward a more comprehensive approach, while looking at stronger consumer protections and licensing provisions. The Association of Settlement Companies (TASC), a national trade association of the debt settlement industry, is co-sponsoring a competing debt settlement measure, AB 350 SB 1188 (Wright), Page 13 (Lieu). TASC is opposed to SB 1188, because it believes that the bill, if enacted, would place numerous California debt settlement companies out of business. TASC observes that SB 1188 contains a series of rules related to the operation of debt settlement companies, which TASC does not oppose, but which the organization believes are less protective of consumers than the rules contained in AB 350 (Lieu). TASC's primary concern with SB 1188 is the bill's proposal to ban the collection of advance fees. "While on the surface that may seem like a laudable goal, such a fee structure is most often not in the best interest of consumers and is rarely feasible for the industry that has been operating for years in California utilizing a different fee structure." TASC notes that it does not oppose some form of a contingency model as an alternative for consumers, and is intending to ask that Assemblyman Lieu amend AB 350 to allow for both the "flat fee" and "contingency fee/percentage of savings" model fee structures. The United States Organizations for Bankruptcy Alternatives (USOBA), another debt settlement industry trade group, and the other co-sponsor of AB 350, also opposes SB 1188. USOBA states that, "unlike AB 350, SB 1188 unfairly penalizes a large segment of the industry by requiring the use of a fee structure that is unproven and not always in the best interest of the consumer." Like TASC, USOBA also believes that SB 1188 lacks the meaningful consumer protections contained in AB 350. 7. Questions a. Should the state adopt a law intended to govern the activities of debt settlement services providers before the proposed FTC regulations are finalized? b. Should a state law intended to govern the activities of debt settlement services providers require that those providers be licensed? Or, should the state enact a series of required and prohibited actions by companies that meet the definition of a debt settlement services provider, and leave enforcement of the law to the courts? 8. Prior and Related Legislation SB 1188 (Wright), Page 14 a. AB 350 (Lieu), 2009-10 Legislative Session: Would enact the Debt Settlement Services Act, administered by DOC, and operative January 1, 2012. Would provide a similar regulatory scheme for debt settlement service providers as the one proposed in AB 2611 (Lieu) and SB 1678 (Florez) from the 2007-08 Legislative Session, but contained several amendments to address technical concerns raised regarding the earlier bills. Passed the Senate Banking, Finance & Insurance Committee; currently pending in the Senate Judiciary Committee. b. AB 2611 (Lieu) and SB 1678 (Florez), 2007-08 Legislative Session: Contained debt settlement provisions similar to those contained in AB 69. Died in the Senate Banking, Finance & Insurance Committee; c. AB 69 (Lieu), 2007-08 Legislative Session: Would have enacted two separate regulatory schemes, one tailored to the licensure of debt settlement service providers, and the other tailored to the licensure of debt management providers. Language amended out; d. AB 535 (Calderon), 2005-06 Legislative Session: Would have enacted a law regulating nonprofit credit counselors and increased the fees that could be charged by these licensees, relative to the fees allowed of nonprofit community service organizations under the Check Sellers, Bill Payers, and Proraters Law. Vetoed by the Governor; e. AB 403 (Correa), Chapter 360, Statutes of 2004: Increased the fees that may be charged by a nonprofit community service organization to their current levels and added additional components to the best practices that nonprofit community service organizations must adopt, in order to qualify for an exemption from the Check Sellers, Bill Payers, and Proraters Law; f. AB 2293 (Liu), Chapter 779, Statutes of 2002: Revised the provisions of the Check Sellers, Bill Payers, and Proraters Law authorizing an exemption for nonprofit community service organizations, provided SB 1188 (Wright), Page 15 they meet certain requirements; authorized the commissioner to investigate violations of the Check Sellers, Bill Payers, and Proraters Law; imposed various civil penalties for violations of that law; and required DOC to conduct a study of the consumer credit counseling industry in California. SB 1188 (Wright), Page 16 POSITIONS Support American Coalition of Companies Organized to Reduce Debt (sponsor) Oppose Center for Responsible Lending Coalition for Quality Credit Counseling Consumers Union The Association of Debt Settlement Companies United States Organizations for Bankruptcy Alternatives Consultant: Eileen Newhall (916) 651-4102