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Will cut-your-debt ads stampede to Web?

Those late-night TV ads promising 50-cents-on-the-dollar relief from credit card bills might soon be a thing of the past, thanks to new Federal Trade Commission rules that will take effect Sept. 27.

The rules explicitly ban some of the more outrageous advertising claims made by debt settlement companies and later this year will ban the firms from accepting up-front payment of fees.

But expect this industry to go down with a bang, not a whimper as debt settlement companies ramp up advertising ahead of that deadline. And you can also expect some of the more unsavory firms to exploit the few slim loopholes left behind by the FTC, turning to aggressive Internet advertising and chat-room based sales or inviting consumers to in-person events at hotels and ballrooms.

Steve Rhode, a former credit counselor who operates a consumer reference Web site named GetOutOfDebt.org,  said he believes a flurry of advertising will crowd TV and radio airwaves before the new rules kick in Sept. 27.

"Their current strategy is sell, sell, sell," Rhode said.

The FTC used its authority to amend the Telemarketing Sales Rule in banning many common practices used by debt settlement companies, publishing the rules in a scathing 229-page document full of damning information about the industry.  The rule, published in late July, includes research showing some firms in the industry had success rates as low as 1 percent.  It was also critical of firms that subtly linked their debt relief programs in ads to government assistance programs, and in some cases, even used President Barack Obama's image in advertising.

But the strict new rules only apply to debt settlement products that are sold over the phone, meaning those firms could shift their attention to Internet-based sales or person-to-person sales.

Still, FTC staff attorney Alice Hrdy said she was confident the rules would eliminate bad actors from the industry.

"Based on our enforcement experience, this is an industry that relies on telemarketing to sell its service, so the telemarketing rule is a perfect vehicle for the commission to put in place more specific rules," Hrdy said. "The new  … rules make clear what kind of substantiation they must have before they make bold claims such  'we'll reduce your debt by 50 percent .'"

The new FTC rules were two years in the making, and many firms in the debt settlement industry fought them intensely.  An industry trade group, The Association of Settlement Companies, argued most strongly against the advance fee ban, saying it would push many companies out of business.

"The benefits of debt settlement far outweigh the risks for consumers," it said in comments on the new rules.  It cited a survey of members saying they'd helped consumers settle more than $700 million in debt during 2008, and another $550 million in the first half of 2009. "It is plainly against the interests of consumers for the FTC to impose regulations that limit (or eliminate) this important alternative."

Another firm told the FTC during a comment period that the new rules violated its First Amendment free speech rights. The FTC dismissed that claim, citing the differences between commercial speech and personal speech.

The FTC report found that state enforcement officials had filed 127 cases against debt settlement firms in recent years.  Meanwhile, it cited research contributed by the Colorado attorney general's office that found only 8 percent of consumers who entered a debt relief program since 2006 had completed it by 2008.

If the industry's ads seem ubiquitous, that's because they are.  Information provided by the industry to the FTC indicated that debt settlement firms spent an average of $987 on marketing to acquire each new customer.

'Rogue industry'

The debt settlement industry has slowly acquired a terrible reputation, and several states have passed even stricter rules. Illinois, for example, passed a law limiting up-front fees to $50 and capping total fees at 15 percent of the consumers' savings. The FTC rule contains no fee cap. Legislation has been introduced on Congress that would include a fee cap and other provisions that are stricter than the new FTC rule.

Still, there is concern that the industry may file a lawsuit claiming the FTC has overstepped its authority, according to Susan Grant, director of consumer protection at the Consumer Federation of America.  By attaching the regulations to the Telemarketing Sales Rule, the FTC avoided a lengthy process for creating a brand new regulation -- a process so time-consuming the agency hasn't done it in 35 years.

But the strategy of using the FTC's authority to regulate telemarketing to deal with debt settlement might also push debt settlement companies onto the Internet, Grant said.

"It's possible that we may see efforts to eliminate any use of the phone, such as using online chats instead," Grant said.  Debt settlement firms that close sales entirely online might evade the provisions of the new rule.

But Hrdy said the FTC would still be able to sue companies that engage in unfair practices through Internet-only sales or any other sales arena. And Rhode, of GetOutOfDebt.org, said debt settlement firms are highly unlikely to succeed that way.

"They might get some business, but we tell people all the time not to give money to someone when you can't at least talk to them," he said. "Is someone going to sign up with a service that says, 'pay us $8,000' through a chat room? And the firms that comply will just advertise that they charge no up-front fees and kill those guys."

Debt settlement is one of three broad techniques used to help to consumers who have trouble paying credit card bills. The other two are debt consolidation and credit counseling. In debt consolidation, consumers use a single loan to pay all their bills, which usually results in lower interest costs. Credit counseling involves enrolling in a program with a nonprofit agency that helps consumers lower their interest rates and fees, but requires them to pay back their entire debt.

Debt settlement involves hiring a third-party company to negotiate partial debt forgiveness from creditors. Often, consumers are told to stop paying their bills and instead make monthly payments into  a special account, with the strategy of building up a lump sum that can be used as a negotiating tactic.

While debt settlement isn't fundamentally unfair, the industry has gotten a bad name. In many cases, most of the money paid into the special account is used to pay the settlement company's fees, leaving consumers even deeper in debt.

New York attorney general Anthony Cuomo last year called debt settlement a "rogue industry" while announcing a series of lawsuits.  Gail Hillebrand, legislative director for Consumers Union, told msnbc.com that "the concept is nuts."

"Basically you are saving your money instead of paying your bills, and paying someone to do that," she said.

Rhode said the bad reputation is well-deserved, and he expects the new rules will quickly result in the disappearance of many of the 2,000 companies the FTC says are currently offering debt settlement.

"Eighty percent of them are opportunists and don't care," he said. "...They will squeeze as much money as then on a business like this and then move to Costa Rica, or on to the next thing," he said. In fact, he's already seen evidence that some operators have turned their attention to another industry with a bad reputation -- selling extended automobile warranties.

Others, he said, have one last chance to show that debt settlement is a legitimate business.

"Basically, this is a message for them to get their S%%^ together. The industry can survive this, but this  is the last chance they have to stand up and embrace regulation," he said.

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