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Debt Settlement Companies to be subject to FTC Regulation, Effective Oct. 27 -- Eight Years after the Capoccia Collapse)

The Federal Trade Commission (FTC) has issued a final rule amending the Telemarketing Sales Rule, restricting many of the most egregious abuses of the debt settlement industry. Some of these changes went into effect September 27, 2010; the rest will go in effect a month later.

Debt settlement companies offer to negotiate with creditors a discount in the amount owed on debts. The settlements are negotiated after the debtor accumulates sufficient funds to offer a discounted cash settlement to the creditor. The debt settlement company usually earns its fee as a portion of the money "saved" by the negotiated reduction.

Despite widespread complaints, (see New York Times, June 19, 2010),the industry has previously been mostly unregulated on the federal level, although it has increasingly come under the scrutiny of various state attorneys general, including the New York State Attorney General (see New York Times, May 20, 2009). As listed in July 29, 2010 press release from the FTC, there are two major and several additional changes to debt settlement company practices. The first, and most important, bans advance payment of fees. In theory, debt settlement companies 'work on a commission basis, earning their fees after they negotiate a settlement and 'save' the client money; in practice, most companies actually got paid well in advance of earning any money, usually keeping the first monthly payments for themselves. If the client, unable to keep up the payments, dropped out of the program before any debts are actually settled, the company keeps its payments, even though it hadn't actually accomplished anything. The new rule only allows the settlement company to collect fees after they actually negotiate a settlement.

A second major change is that client money cannot be deposited into an account controlled by the debt settlement company. For background on this issue, we should consider the father of the debt settlement industry, New York attorney Andrew Capoccia. Mr. Capocia opened his first debt reduction office outside of Albany in February 1997 (WTEN TV, Albany NY)

Within two years, the litigious Mr. Capoccia (Albany City Court May 21, 1999) had 110 employees and 11,000 clients (Albany Times Union, March 6, 2005, Alan Wechsler) Capoccia even had an office in Rochester, and ran ads showing a gaping-mouth shark with the heading "Don't Let Debts Eat You Alive." (Democrat and Chronicle ad, May 23, 1999).

As a bankruptcy trustee in Rochester at the time, I was well aware of the Capoccia operation, from debtors who had been their clients and then filed bankruptcy. I reviewed the 'accounting' of client funds provided by Capoccia in several cases. The 'accounting' purported to show that half of the funds received were put into something called a 'client account' and half in an 'settlement account.' When sufficient funds were in the accounts to settle a debt, they would be transferred to the settlement account, the settlement paid, and the fee for the service deducted.

Allegedly. Actually this was all a paper sham. All of the money was commingled in a general account at the debt settlement company and used, in part, to pay the firm's operating expenses. The funds were not being deposited into any actual attorney trust account or escrow account.

After the New York State Attorney General sued Capoccia for fraud, he moved his office across the border from Albany to Bennington, Vermont, in June 2000. He was disbarred as a New York attorney in September 2000. He remained as an advisor to the new attorneys operating the firm.

Debtors who filed bankruptcy in Rochester and listed on their schedules deposits of thousands of dollars allegedly being held by Capoccia in their so-called client account. As trustee, I would write to Capoccia's office (or whatever, the actual name of the company kept changing), demand an accounting and request a turnover of these funds as an asset of the bankruptcy case. For reasons that were never clear, it would take months for this seemingly simple transaction to take place. I sued this firm several times, and actually arranged for the Bankruptcy Court in Rochester to enter a standing order requiring prompt turnover of these funds in all future cases. I may have received the last payments ever turned over to an outsider from this firm, around $1,700 in early January 2003, about three weeks before it all came to an end.

The successor to the Capoccia firm filed bankruptcy January 27, 2003 (Vermont Attorney General); see also the WTEN article, above.) Millions of dollars of client funds had disappeared. Capoccia and others were found guilty of fraud and money laundering (U.S. Attorney's Office, District of Vermont) Assets were seized but years later, former clients were still awaiting even a partial refund of the money they deposited with the firm (WSYR TV Syracuse, February 20, 2009).

In light of this and other less dramatic abuses, the new FTC rule now states that the debt settlement company cannot compel a client to deposit any funds into an account owned or controlled by the debt settlement company. Any deposits must be made into an insured financial depository where the client retains ownership of the funds and can withdraw them at any time.

The new rules also require that the debt settlement company telemarketer disclose all terms of the arrangement and explain potential negative consequences. This is fine, I suppose, as far as it goes, but I rather suspect that clever phone operators may mention possible negative consequences, but probably only after the client has been sold on program and minimize their significance. More significantly, this rule only deals with the telemarketing phase of the sale of these services, but most clients their first introduction to the business comes from glossy, unsubstantiated claims of these plans in flashy internet sites or TV ads.

I reviewed two dozen websites advertising debt relief services on the date I posted this blog, and only one of them listed the potential drawbacks (creditor lawsuits and, most significantly, possible tax consequences for cancellation of debt income.) I noticed that not a single one of these sites would list an actual person as responsible for their company; most had bland generic trade names and no address.

Federal regulation comes to us from an unusual venue: the FTC and its authority under the Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994. Debt settlement companies usually come to the attention of their clients via ubiquitous late night TV ads and glitzy websites showing up in Google searches, not robocalls during dinnertime. The FTC Rule implementing the Telemarketing Act, 16 CFR Part 310, has previously been used for such things as creating the invaluable "Do Not Call" registry.

The rules related to the debt settlement companies were grafted onto the existing Rule 310 as amendments, not as a new separate rule. Prior to the amendment. Rule 310 mostly applied to Telemarketing outgoing calls. However, even though the initial contact with clients usually came from TV and the web, customers of debt settlement companies mostly interacted with the companies by telephone (never by face-to-face meetings), and these companies have mostly been located outside of New York State (and the New York Attorney General.) The new rule applies to debt settlement companies which are contacted by inbound phone calls.

Additional information:

Brief summary of FCT Rule on Debt Settlement companies

A full copy of the new FTC Rule, along with official commentary

Media articles on the FTC new rules on debt settlement companies:

New York Times, July 29, 2010 (Edward Wyatt)

Washington Post, September 29, 2010 (Michelle Singletary, the Color of Money)

CNNMoney, September 27, 2010 (Blake Ellis)

WalletPop, September 27, 2010 (Martha C. White)

ctwatchdog, August 10, 2010 (George Gombossy; see also September 29, 2010

MoneyTalksNews, September 24, 2010 (Stacy Johnson)

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