BILL ANALYSIS Ó SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE Senator Juan Vargas, Chair SB 1058 (Lieu) Hearing Date: April 11, 2012 As Amended: March 26, 2012 Fiscal: Yes Urgency: No SUMMARY Would revise and recast the provisions governing administration of the Victims of Corporate Fraud Compensation Fund (the Fund) by the Secretary of State, by codifying certain existing regulations promulgated by the Secretary of State to administer the Fund, codifying changes to other existing regulations promulgated by the Secretary of State, and adding new statutory language to facilitate the approval of valid claims from the Fund. DESCRIPTION 1. Would codify existing Secretary of State regulations governing administration of the Fund, which define "application," "claimant," "complaint," and "corporation," but would expand the definition of "court of competent jurisdiction" to include small claims, municipal, or superior courts of any state (not just California), and United States district courts and bankruptcy courts located in any state (not just California). 2. Would expand the existing Secretary of State's regulatory definition of "final judgment" to additionally include, but not be limited to, any findings of fact, conclusions of law, jury verdicts, jury special verdicts, statements of decision, memorandum decisions, or any other indication by a court of jury, as the case may be, of its decision and the reasons for the decision. Existing Secretary of State regulations, which this bill would also codify, provide that final judgments also include judgments, arbitration awards, and criminal restitution orders for which the period of appeal has expired, enforcement of which is not barred by the order of any court or by any statutory provision, and which have not been nullified or rendered void by any court order or statutory provision. SB 1058 (Lieu), Page 2 3. Would codify existing Secretary of State regulations, which provide that, when an aggrieved person obtains a final judgment in a court of competent jurisdiction against a corporation based on the corporation's fraud, misrepresentation, or deceit, made with intent to defraud, the aggrieved person may, upon the judgment becoming final, file an application with the Secretary of State for payment from the Fund, as specified, for the amount remaining unpaid on the judgment, which represents an actual and direct loss to the claimant in the transaction. Would require the application to be submitted to the Secretary of State within 18 months after the judgment becomes final. 4. Would specify the information that must be included in a claimant's application, and would codify the following three specific changes, which are departures from existing Secretary of State regulations: a. A copy of a judgment that specifies the facts of the allegations of the complaint would be satisfactory to satisfy the requirement that each application contain a detailed narrative statement of the facts in explanation of the allegations of the complaint on which the underlying judgment is based. b. A court's determination or finding of a corporation's insolvency or lack of assets to pay the claimant would be sufficient to satisfy the requirement that the claimant sought to obtain restitution from the corporation. c. Would expressly prohibit the Secretary of State from conditioning an award of payment from the Fund upon submission of any additional information by the claimant, beyond that required in the application. 5. In the event a claimant's application fails to include all required information, would decrease the length of time the Secretary of State has in which to mail an itemized list of deficiencies to the claimant from 21 to 15 days. (This change is consistent with Real Estate Recovery Fund rules). 6. Would add a requirement that the Secretary of State render a final written decision to each claimant within 90 days of receipt of a completed application, unless the claimant SB 1058 (Lieu), Page 3 agrees in writing to extend the time within which the Secretary of State may render a decision. This change is consistent with Real Estate Recovery Fund rules, but differs from existing Secretary of State regulations, which require the Secretary of State to render a final written decision on applications no later than July 31st of the fiscal year following the fiscal year in which the application was submitted. 7. Would codify the existing Secretary of State regulation authorizing the Secretary to deny or grant an application or enter into a compromise with the claimant to pay less in settlement than the full amount of the claim, and would codify the Secretary of State regulation which states that if a claimant refuses to accept a settlement of the claim offered by the Secretary of State, the written decision of the Secretary of State shall be to deny the claim. 8. Would codify the existing Secretary of State regulation giving claimants whose applications have been denied up to six months in which to file an application in superior court for an Order Directing Payment out of the Victims of Corporate Fraud Compensation Fund, based upon the grounds set forth in the application submitted by the claimant to the Secretary of State. 9. Would codify the requirement that the Secretary of State notify any corporation whose fraudulent activities gave rise to a claim against the Fund regarding the Secretary of State's decision on that application, and the existing regulation that authorizes the Secretary of State to assume the claimant's interest in the judgment against the corporation. Would add a new requirement, based on the provisions of the Real Estate Recovery Fund, which would give the Secretary of State authority to pursue damages against the corporation's officers for the amount that was paid to the claimant from the Fund. This new provision differs from existing regulations, which require the claimant to pursue the corporation and all of the corporation's officers for compensation, before the claimant is eligible to apply to the Fund for compensation. 10. Would cap the total amount that may be paid to any claimant for any one action by a corporation at $20,000, with respect to applications from the Fund that were filed before January SB 1058 (Lieu), Page 4 1, 2013 (thus codifying existing regulations), and would increase that amount to $50,000 for applications filed on or after January 1, 2013 (an increase relative to existing regulations). 11. Would add a provision based on the Real Estate Recovery Fund, which states that when multiple corporations are involved in a transaction, and the conduct of two or more of the corporations results in a judgment meeting the requirements of the bill, claimants may seek recovery from the Fund based on a judgment against any of the corporations, subject to the limitations in Number 10 above. 12. Would add a new provision, not found in existing Secretary of State regulations or the Real Estate Recovery Fund, stating that, when multiple claimants are involved in a corporate fraud or in misrepresentation or deceit by a corporation, resulting in a judgment meeting the requirements of the bill, each claimant may seek recovery from the fund individually, subject to the limitations in Number 10 above. 13. Would add a new provision, based on the Real Estate Recovery Fund, stating that if, at any time, the money in the Fund is insufficient to satisfy any duly authorized claim, the Secretary of State shall, when sufficient money has been deposited into the Fund, satisfy the unpaid claims or portions thereof, in the order that the claims were originally filed, plus accumulated interest at a rate of 4% per year. This differs from existing Secretary of State regulations, which require the Secretary of State to prorate the money available in the Fund among eligible applicants, if there is insufficient money in the Fund to pay all applicants the full amount to which they are entitled. 14. Would add a new provision, based on the Real Estate Recovery Fund, making it unlawful for any person or the agent of any person to file any document with the Secretary of State in connection with any application for restitution from the Fund, which is false or untrue or contains any willful, material misstatement of fact. Penalty for filing such a document would constitute a public offense punishable by imprisonment in a county jail for a period of not more than one year, or a fine of not more than $1,000, or both. EXISTING LAW SB 1058 (Lieu), Page 5 15. Establishes the Fund within the State Treasury, authorizes the Secretary of State to administer the Fund, and directs the Secretary of State to adopt regulations regarding administration of the Fund and the eligibility of victims to receive compensation from the Fund. Provides that the Fund exists for the sole purpose of providing restitution to the victims of a corporate fraud (Corporations Code Section 1502.5). Regulations promulgated by the Secretary of State to administer the Fund are contained in Title 2, Division 7, Chapter 12, Sections 22500 et seq.) 16. Raises money for Fund by directing one-half of the $5 disclosure fee required to be paid by corporations when they file their annual Statements of Information with the Secretary of State (Corporations Code Sections 1502 and 2117). 17. Provides for the Real Estate Recovery Program (also known as the Consumer Recovery Program within the Real Estate Fund; Business and Professions Code Section 10470 et seq.), administered by the Department of Real Estate for the purpose of providing a fund of last resort to compensate persons who are defrauded by real estate licensees. The Secretary of State's Office used the Real Estate Recovery Program rules as a guide, when developing regulations to administer the Fund. COMMENTS 1. Purpose: This bill is sponsored by the author, to help ensure that the Fund works as intended ten years ago, when it was created, and "to ensure that all corporate fraud victims collect the restitution to which they are entitled, without enduring a bureaucratic nightmare." 2. Background and Discussion: This bill is based on an article authored by Sacramento Bee columnist Dan Morain on October 9, 2011, profiling the challenges faced by the approximately 500 victims of a corporate fraud perpetrated by James Walker and his now-defunct Senior Care Advocates, Inc. In his article, Morain detailed the nearly 18-month struggle of victims scammed by James Walker and Senior Care Advocates to obtain compensation from the Secretary of State's Office through the Victims of Corporate Fraud Compensation Fund. SB 1058 (Lieu), Page 6 A review of the correspondence between Mr. Mark Redmond, representing approximately 500 elderly victims of Senior Care Advocates, and the Secretary of State's Office, regarding the claims submitted by Mr. Redmond on the seniors' behalf, reveals a lengthy saga of frustrated communication. Following Mr. Redmond's submission of initial applications on the victims' behalf on May 14th, 2010, the Secretary of State's Office and Mr. Redmond exchanged no fewer than ten letters back and forth regarding the applications (the first dated June 4, 2010, and the most recent dated August 29, 2011). In these letters, each of which runs for several pages, the Secretary of State's office details deficiencies it observed in the victims' applications, and Mr. Redmond, responding on behalf of the victims, attempts to resolve these deficiencies by providing explanations and additional documentation. The correspondence suggests that there is significant room for improving the rules governing the victims' application process, as well as the process by which the Secretary of State evaluates applications, deems them complete, and disburses money from the Fund. Existing shortcomings seem to have created procedural hurdles, which blocked timely access to the Fund by the Senior Care Advocates victims. After reading the Dan Morain article and the correspondence between Mr. Redmond and the Secretary of State, several legislative offices contacted the Secretary of State's office in an attempt to determine whether the case summarized in the Bee article and detailed in the lengthy correspondence between Mr. Redmond and the Secretary of State's office was an aberration, or was, instead, representative of a pattern of over-protectiveness toward the Fund within the Secretary of State's Office. Findings from those inquiries are summarized immediately below. 3. How Many Claimants Are Receiving Compensation From the Fund? a. When first contacted, the Secretary of State's Office indicated that, from the Fund's inception through August 1, 2011 , the Secretary of State had received 701 claims for restitution from the Fund. Of these 701 claims, five claims were awarded, one claim was settled during litigation, and one court appeal by a victim resulted in a judgment confirming the Secretary of SB 1058 (Lieu), Page 7 State's settlement offer. When summed, all seven of these claims resulted in a payout from the Fund of $92,497. Of the remaining claims, 102 did not qualify for payment, because they did not meet the eligibility criteria established by the Secretary of State, 28 claims were withdrawn, 3 claims were denied, and 561 claims (most related to Senior Care Advocates) were pending resolution. b. On October 14, 2011 , the Secretary of State's office responded to legislative requests for a breakdown of the 102 claims which did not qualify for payment, because they did not meet the eligibility criteria established by the Secretary of State's office in its regulations (a number which grew to 103 by the date of the Secretary of State's response). The 103 claims were rejected for the following reasons: -------------------------------------------------------- | Reason for Denial | Number of | | |Applications| | | Denied | |-------------------------------------------+------------| |The victims applied for compensation based | 52 | |on judgments that were not based on | | |corporate fraud | | |-------------------------------------------+------------| |A judgment was lacking, or the judgment | 23 | |was not issued by a court in California | | |-------------------------------------------+------------| |Applications were based upon judgments | 14 | |against entities that were not | | |corporations | | |-------------------------------------------+------------| |Applications were based on judgments that | 5 | |were not final | | |-------------------------------------------+------------| |Applicants demonstrated insufficient proof | 4 | |regarding their attempts to collect from | | |the corporation and its corporate officers | | |prior to filing a claim with the Fund | | |-------------------------------------------+------------| |Applications were submitted more than 18 | 3 | |months following final judgment | | SB 1058 (Lieu), Page 8 |-------------------------------------------+------------| |Applicant was not a party to the court | 1 | |judgment | | |-------------------------------------------+------------| |Application was based on a judgment issued |1 | |prior to January 1, 2003 | | -------------------------------------------------------- c. By March 28, 2012 , the Secretary of State's office had resolved a considerable number of its outstanding applications. From the Fund's inception through March 28, 2012 , a total of 225 claims have been approved or resulted in victims being offered settlements (up from less than ten through August 1, 2011), and 25 claims are pending resolution (down from over 550 through August 1, 2011). An additional 27 claims have been deemed complete and are pending a decision. 118 claims have been rejected, because the Secretary of State's office found the victims did not qualify for payment from the Fund (see reasons cited immediately above). 294 claims have been denied, because the applicants could not prove damages. 30 claims have been withdrawn. 4. How Much Money Is In The Fund? The Fund collects approximately $1.5 million per year, through the $2.50 annual disclosure fee paid by corporations pursuant to the Fund's enabling legislation. At present, the Fund holds approximately $5 million. Because the Fund went several years without making any significant payments to victims, and thus built up a significant reserve, it was raided in the 2010-11 fiscal year, to help address General Fund shortfalls. The Fund currently has an outstanding $10 million loan to the General Fund, which is required to be repaid, with interest, when it is needed to pay claims out of the Fund. From the Fund's inception to date, the Secretary of State's office has approved the payout of approximately $2.1 million in compensation to victims (most, as cited above, in the last eight months). 5. Summary of Arguments in Support: None received. However, the Secretary of State submitted a letter in which she expresses several concerns with the March 26th version of SB 1058, and offers to support the measure if it is stripped down to do only two things: a) authorize the Secretary of SB 1058 (Lieu), Page 9 State to make payments from the fund within 90 days after approving an award, rather than the Secretary of State's existing process of waiting until the close of each fiscal year, before making payments to victims; and b) increase the maximum amount of restitution to victims from $20,000 to $50,000. 6. Summary of Concerns Raised by the Secretary of State: In her letter, the Secretary asserts her belief that the Fund and victims of corporate fraud would benefit from more statutory direction, and states that she is working on a new set of regulations to the Fund, which are currently under review by the Office of Administrative Law (these regulations were unavailable for review by Committee staff as of the date this analysis was finalized). The Secretary is concerned that, as the bill is currently drafted, it will have the unintended effect of enabling and encouraging people to defraud a fund set up to assist victims, which will leave less money is available to assist those who have truly been victimized. Among the Secretary's specific concerns: a. The Fund would become a fund of first resort rather than one of last resort, because the bill removes the requirements that claimants show a proof of loss, proof of final judgment for fraud from a California court against a corporation registered in California, and proof of attempts to collect on the judgment before applying to the Fund. b. Significantly more people would be able to apply for restitution from the Fund, because the bill would allow claims against all United States corporations (not just corporations doing business in California), would allow supporting judgments and decisions to come from any court in the United States (not just courts in California), and would not require the claimant to demonstrate that he or she was a California resident at the time of the alleged act. c. The bill's definition of a final judgment is too loose, because it uses language (page 7, line 22), to the effect that "final judgment shall include, but not be limited to...," SB 1058 (Lieu), Page 10 d. The bill would eliminate the Secretary of State's ability to request supplementary documents from an applicant, beyond the basic self-verified information required in a victim's application. e. The bill would likely result in more denials of applications by the Secretary of State, which could increase the courts' workload, as these denied applicants take their cases to the courts. At the same time, Sections 2287 and 2288 of the bill (page 11, beginning on line 13 through page 12, ending on line 31) could be read to preclude a court from requiring a claimant to provide documentation or evidence beyond what was provided to the Secretary of State in its initial application. 7. Summary of Arguments in Opposition: None received. 8. Amendments: a. This bill's author is negotiating amendments to the bill with the Secretary of State's office. However those negotiations are currently at too early a stage for the author to offer amendments, when this bill is heard on April 11th. Staff is refraining from suggesting any specific amendments at this time, in hopes of allowing the negotiations between the author and the Secretary of State's office to move forward unimpeded. Staff notes, however, that if the bill is stripped down as suggested by the Secretary of State's office, before leaving this Committee, and is subsequently amended to include more substantive changes to the operation of the Fund, this Committee would likely request that the Senate Rules Committee return the bill to our Committee to review the added policy. 9. Prior and Related Legislation: a. AB 55 (Shelley), Chapter 1015, Statutes of 2002: Enacted the California Corporate Disclosure Act, created the Victims of Corporate Fraud Compensation Fund, and directed the Secretary of State to promulgate regulations regarding administration of the Fund and the eligibility of victims to receive compensation from the Fund. b. AB 2454 (Emmerson), Chapter 279, Statutes of 2008: Increased the amount of money available to claimants from SB 1058 (Lieu), Page 11 the Real Estate Recovery Account from $20,000 for any one transaction and $100,000 for acts by any one licensee to $50,000 for any one transaction and $250,000 for acts by any one licensee, effective January 1, 2009. LIST OF REGISTERED SUPPORT/OPPOSITION Support None received Opposition None received Consultant: Eileen Newhall (916) 651-4102