As the country’s economic crisis continues, the FTC, Congress and states are focused on taking an aggressive approach to protecting consumers in financial distress and increasing oversight and enforcement over providers of consumer financial services and assistance such as foreclosure consulting, credit counseling, debt management, and debt settlement.

FTC Testimony and U.S. Senate Hearing on Protecting Consumers in Financial Distress

On February 26, 2009, during a hearing of the U.S. Senate Commerce Committee, the Federal Trade Commission (the “FTC”) testified on its increased focus on protecting consumers in financial distress. The testimony described the FTC’s “stepped-up” law enforcement and consumer education efforts addressing mortgage foreclosure rescue scams, debt relief and credit repair services, and unlawful debt collection. The FTC also recommended legislative and other remedies to enhance the FTC’s effectiveness. Joining the FTC in testifying to the committee were the Consumer Federation of America (the “CFA”), the American Financial Services Association (the “AFSA”), a University law professor, and a consumer. No representatives from the credit counseling or debt settlement industries testified.

A significant part of the testimony highlighted the FTC’s recent law enforcement actions against alleged foreclosure rescue scams – six cases in the past year – including a case announced in mid-February. In these cases, the FTC alleged that the defendants promise to stop foreclosure in exchange for an up-front payment. After a consumer makes the payment, the FTC alleged that the defendants do little or nothing to stop foreclosure. In the most recent case, the FTC obtained (in central California) an ex parte temporary restraining order, appointment of a receiver to run the company, and a freeze of the defendants' assets pending trial. In addition, the FTC testimony noted its involvement with federal, state, and local task forces in several regions where foreclosures are most prevalent both to coordinate enforcement and develop consumer outreach strategies. [1]

The FTC testimony also included an overview of the of the FTC’s enforcement efforts and concerns with the debt settlement, credit counseling (largely historical), credit repair, debt collection, and mortgage servicing. [2]

FTC Recommendations on Legislative and Other Remedies

The FTC recommended legislative and other remedies to enhance the FTC’s effectiveness, including:

  • Permit the FTC to employ notice and comment rulemaking procedures to declare acts and practices relating to financial services to be unfair or deceptive in violation of the FTC Act;
  • Authorize the FTC to obtain civil penalties for unfair or deceptive acts and practices related to financial services, and authorize the agency to bring suit in federal court to obtain civil penalties;
  • Authorize the FTC to issue rules to implement the Fair Debt Collection Practices Act; and
  • Provide additional resources to assist the FTC in increasing its law enforcement activities related to consumer financial services and expanding its critical empirical work on the efficacy of disclosures.

Consumer Advocates and Creditors Call for New Legislation to Protect Consumers

Other testimony before the Senate Commerce Committee by Travis Plunkett of the CFA and Prentiss Cox of the University of Minnesota Law School supported adoption of federal legislation – similar to the “Foreclosure Consultant Acts” that many states have adopted, which often prohibit the charging of advance fees – that would act as a floor and would not preempt the states. There was also support expressed for comprehensive efforts by states to regulate debt relief companies.

State Foreclosure Consultant Acts and the state laws that regulate debt relief companies provide state Attorneys General, other state enforcement entities, and, often, private plaintiffs with the authority to seek fines, penalties, consumer redress, and disgorgement in civil actions (including class actions). In addition, these laws sometimes allow authorities to pursue criminal action.

In addition, Bill Himpler of the AFSA, which represents the consumer credit issuing industry, advocated for more effective enforcement, mentioning the FTC’s recent enforcement sweep against credit repair companies, Operation Clean Sweep. [3]

Both Himpler and Plunkett also testified that states should be encouraged to adopt the Uniform Debt-Management Services Act (the “UDMSA”). For a detailed analysis of the UDMSA, please see “Summary of Provisions in the Uniform-Debt Management Services Act,” available at: http://www.venable.com/summary-of-provisions-in-the-uniform-debt-management-services-act-03-24-2006/.

Economic Crisis Impacts Credit Counseling and Other Debt Relief Alternatives

Of particular relevance to credit counseling agencies and debt settlement companies, the FTC and Plunkett both noted a growing trend that fewer consumers are eligible to enroll in creditor-approved debt management plans. According to the FTC, this “means that there are more consumers in debt who are looking for relief but cannot obtain that relief from non-profit credit counseling services.”

In addition, Plunkett stated, “[A]s more consumers struggle to continue to pay their credit card loans, it is becoming increasingly clear that the DMP is a less viable tool in helping consumers significantly reduce their unsecured debt because creditors have kept interest rates too high.”

Federal regulators (such as the Office of the Comptroller of the Currency) have, to date, been unwilling to make a regulatory and accounting exception (supported by the CFA and the Financial Services Roundtable) to permit less-than-full balance debt management plans to proceed. Lenders generally insist that settlements be paid in full within 3-6 months and lenders must recognize as a loss any amount forgiven within 3-6 months, triggering an obligation to report potential income tax liability for the borrower to the Internal Revenue Service.

Plunkett said that “[r]educed principal DMPs could not only help many families in debt trouble stay solvent, but also create a legitimate, pro-consumer alternative to debt settlement scams.” If regulators cannot make this happen by incentivizing creditors to lower principal payments over a longer period of time, Plunkett called on Congress to act.

Within this context, Plunkett also said the debt settlement business model used by for-profit companies was “structurally flawed” because they cannot guarantee a settlement with a consumer’s creditors. “The essential promise made by debt settlement firms to the public, that they can settle most debts for significantly less than what is owed, is often fraudulent,” said Plunkett. “There is a general consensus that credit counseling, if done well, can provide significant benefits for some financially distressed consumers. No such consensus exists for debt settlement,” he concluded.

CFA’s concerns were not limited to debt settlement companies, however. Plunkett added that “[c]onsumer groups have serious questions about the efficacy and necessity of a credit counseling session [provided largely by nonprofit credit counseling agencies] for debtors on the verge of bankruptcy, many of whom have suffered a severe reduction in income or a sharp increase in medical expenses not covered by insurance.”

State Attorneys General and State Lawmakers Address Consumer Economic Crisis

As part of National Consumer Protection Week (March 1-7, 2009), state Attorneys General in a number of states have issued consumer advisories on foreclosure consultant and loan modification offers, which have been cited as the source of a high level of complaints to their offices. Several lawsuits and public enforcement actions have been brought across the country against loan modification companies and others promising relief to homeowners, including ones brought under Foreclosure Consultant Acts and the state debt adjusting statutes that were the subject of discussion at the Senate Commerce Committee hearing. Many have warned consumers to steer clear of companies that seek to charge for services related to the new Homeowner Affordability and Stability Plan initiated by the Obama Administration.

In the wake of numerous state enforcement actions and private lawsuits (often class actions) against debt relief companies over the last several years, the push to regulate and to update and modernize existing laws that address these services continues. Lawmakers in more than twenty states have introduced legislation that seeks to regulate or, in some cases, restrict debt relief services, including debt adjusting, debt settlement, and foreclosure consulting.

Some of the more notable introductions have included various versions of the UDMSA in Colorado (amendment), Connecticut, Minnesota, Missouri, Tennessee, Utah (amendment), and Washington. In addition, there are other changes to existing state debt adjusting laws pending in a number of states, including California, Florida, Iowa, Maryland, Montana, and Oregon. There also are several states considering the adoption of Foreclosure Consulting Acts, as discussed above.