The Heat Is on Credit Counselors

  The travails of the credit-counseling industry worsened in March when a U.S. Senate committee heard testimony of classic boiler-room style operations at several major agencies. Within a month, two states filed separate civil suits against one of the firms, charging unfair and deceptive practices.
  While only a few firms have been singled out for criticism, the actions brought a collective black eye to the industry. That has meant calls for reform, including recommendations that agencies be regulated at the federal level, instead of the current patchwork of individual state laws.
  And there have been discussions of how to accommodate the growing role of national, for-profit counseling agencies in a business that has long been dominated by local, not-for-profits.
  The Senate's actions followed hearings last October by the Oversight Committee of the House Ways and Means Committee ("The Crisis in Credit Counseling," February).
  "The House and Senate hearings are in response to inappropriate industry practices," says Susan Keating, president and chief executive of the National Foundation for Credit Counseling Inc., a leading trade organization. "Reform is necessary. This industry is over 50 years old but little over a decade old in its modern form."
  Credit counseling has changed dramatically in the last 10 years as firms marketed themselves on television and provided counseling over the phone and Internet. Previously, counseling agencies were local organizations with counselors who provided face-to-face financial guidance to consumers.
  The government spotlight comes as the industry adjusts to a new compensation method from Citigroup Inc., the largest credit card issuer in the country. Card-issuing financial institutions have played a role in the counseling industries problems by reducing their so-called fair-share payments, the agencies' major revenue source.
  Card bills typically account for about two-thirds of the unsecured debt owed by a consumer entering an agency-arranged debt-management plan (DMP), according to experts.
  Clearly, more consumers are facing trouble. There were 1.6 million non-business bankruptcy filings in 2003, up 33% from 2000, and up 126% since 1990, according to the Administrative Office of the U.S. Courts. All filings, including those by businesses and farms, rose nearly 32% from 2000 to 2003. The NFCC's 137 agencies counseled about 1.1 million consumers in 2002.
  The hearing by the Senate Permanent Subcommittee on Investigations focused on three of the new-style firms. The subcommittee also released a report, "Profiteering In A Non-Profit Industry: Abusive Practices In Credit Counseling."
  These outfits spun a spider's web of companies including for-profit processing divisions that moved debtors' DMP money, according to Senate investigators. In theory, a debtor's regular payment should be transmitted to creditors to whittle down the debt. However, the investigated agencies would often charge excessive fees for their services. Some consumers found that their first month's payment went instead to pay set-up fees at the agencies. Those charges paid for generous salaries for executives and owners, and rarely went to expand education or counseling, according to investigators.
  The Senate zeroed in on Ascend One-Amerix, Cambridge-Brighton, and DebtWorks-Ballenger Group, defining all three as conglomerates due to the complex interlocking nature of their businesses.
  The Senate found that Cambridge-Brighton's for-profit Brighton Debt Management Services Ltd. unit processed about $900 million in consumer debt payments for its sister for-profit and not-for-profit counseling agencies.
  Processing fees helped pay the combined 2001 salaries of $1.2 million of John and Richard Puccio, the two brothers that own Cambridge-Brighton. Cambridge remitted about $300 million to creditors in 2003 and holds a 5% to 7% market share of the credit-counseling industry, according to a statement to the Senate from John Puccio.
  Cleaning the Refrigerator
  The Senate subcommittee heard from a former Cambridge employee who worked briefly as a telephone counselor. John Pohlman testified he was told to use a fake name on the phone and pressure consumers to enter DMPs. Counselors could earn a commission worth 25% of the up-front fee garnered from a client. Pohlman said a sign on the staff refrigerator, "The two lowest producing counselors will be cleaning the refrigerator on Saturdays," summed up the boiler-room atmosphere.
  In April, the states of North Carolina and Massachusetts each filed civil suits against Cambridge charging it with deceptive practices. Massachusetts Attorney General Tom Reilly said that as much as 71% of the fees paid by Cambridge's clients went to for-profit firms affiliated with the firm's executives. Cambridge countered both suits with statements that the charges were without merit.
  In his Senate statement, John Puccio said that Cambridge clients are fully informed of any fees and that his company has received only 600 complaints out of 230,000 clients served.
  The business model of Ascend One-Amerix diverges somewhat from that of Cambridge, the Senate found. The for-profit parent Amerix processes payments for five independent not-for-profit agencies that manage $4.1 billion in consumer debt, according to the Senate.
  Columbia, Md.-based Amerix helped found the agencies and each is tied to it through service agreements Amerix calls "assist rates" and "revenue standards." Amerix requires that 30% of all first-time callers to the agencies be placed into a DMP, and that each DMP must generate on average a minimum of $30 a month.
  In exchange for its processing services, Amerix earns a share of an agency's revenue generated by a consumer who contacts the agency. Amerix reported gross revenues of $386.4 million from 1998 through 2002, the Senate found.
  The Senate investigation may have acted as a wake-up call for Amerix and Bernaldo Dancel, its chief executive. Dancel told the committee that Amerix would eliminate portions of the service agreements and reduce its share of the revenues from new clients.
  Still, it's these agreements that have caught the eye of the Internal Revenue Service. According to federal tax code, a not-for-profit cannot be controlled by, or operate for the benefit of, a for-profit entity.
  Mark Everson, IRS commissioner, told the House Oversight Committee in October that his agency is auditing 30 counseling agencies and their related firms. The IRS won't name them but plans to report some of its findings later this year. (According to the Senate's report Cambridge is being audited.)
  The third component in the Senate's investigation is the DebtWorks-Ballenger Group conglomerate. Andris Pukke, his wife Pamela, and their friends ran 11 for-profit and not-for-profit firms including DebtWorks and AmeriDebt.
  DebtWorks has been sued for deceptive practices by Illinois, Minnesota, Missouri, Texas and the Federal Trade Commission. Those cases are pending.
  Consumers told the Senate that their first payments to DebtWorks went to the processor, not their creditors. Andris Pukke declined to testify to the Senate, citing his Fifth Amendment rights. DebtWorks reported gross revenues of $108.8 million from 1999 through 2002.
  Ballenger insists that Senate investigators are incorrectly linking it to DebtWorks, having bought out Pukke's investment in the processing business in two stages last year, according to a statement from a Ballenger executive to the Senate.
  Confusion
  Frederick, Md.-based Ballenger reported 2003 gross revenues of $37.4 million, and that it was owed another $10.7 million by client agencies, including those still owned by Pukke.
  Ballenger has hired Public Strategies Inc., a Capitol Hill lobbyist and public-relations consultant, to make its case. "There is a fair amount of confusion over who is who. (Ballenger) is not affiliated with AmeriDebt or DebtWorks," says Mike Barnhart, a principal with Public Strategies.
  Last November, Ballenger settled FTC charges that its phone representatives misrepresented AmeriDebt's not-for-profit status and failed to disclose that AmeriDebt keeps as a fee the first payment from a DMP client. Ballenger didn't admit guilt but paid $750,000 in consumer redress and agreed to stop misrepresenting certain fees and profits generated.
  Along with removing the Pukke cloud from Ballenger, Public Strategies is attempting to change the credit counseling industry. With Barnhart in the lead, it has created two organizations, the Coalition for Responsible Credit Practices and Consumers for Responsible Credit Solutions.
  The Consumers group consists primarily of a Web site offering education on maintaining good credit.
  The Coalition is more ambitious. It was developed to represent views held by new agencies like Ballenger to politicians and other influential thinkers. Barnhart, the Coalition's executive director, says about a dozen counseling agencies and vendors across the country are members but declines to name them.
  Barnhart submitted written testimony last October to the House committee. He argued that not-for-profit counselors are overwhelmed as millions of consumers seek assistance. Creditors are cutting back their fair share, the payment they make to counselors in return for helping consumers pay off their debt. Creditors used to pay counselors about 15% of the money repaid to them by debtors under a DMP. That has been cut in half in recent years.
  Citi this year dropped its fair-share system and shifted to a quarterly evaluation process of counselors that it calls a grant program. Citi spokespersons did not return phone calls for comment.
  In Flux
  These changes have counselors in a flux. The situation won't get better if current bankruptcy reform legislation is enacted, says Barnhart. The proposal would require that a consumer filing for bankruptcy undergo credit counseling. Another 40% more consumers will seek help if the measure is enacted, Barnhart contends.
  The bankruptcy legislation has been under consideration since the mid-1990s. It is favored by creditors and has been passed by both the House and the Senate in slightly different forms. The proposal is now held up in a conference committee.
  The explosion of bankruptcy filings and the legislative wrangling coincided with the rise of agencies that process consumer payments through firms like Ballenger.
  These new agencies serve consumers nationwide, contrary to the traditional local agencies that serve their own communities. These established agencies have been regulated at the state level but that oversight model is out of date, says Barnhart.
  "This industry is big. It probably needs national regulation and best-practices (guidelines) from federal agencies," he says.
  Long-time industry players haven't embraced that idea but they haven't shot it down either. The Consumer Federation of America is open to national regulation but it must be as tough, or tougher, than current state rules, says Travis Plunkett, legislative director.
  "When the industry talks uniform federal law, that means a weak federal law," Plunkett says. "The state regulatory approach may not be perfect but (states) have been covering the industry for decades."
  The National Foundation for Credit Counseling, the voice of the traditional counseling agencies, is also open-minded.
  "We'd like to see consistency. That could mean federal legislation," says Keating. The NFCC also has been in discussions with the National Conference of Commissioners on Uniform State Laws to address the problem.
  The second major initiative for Barnhart's Coalition is to fully open the industry to for-profit counselors. Some states bar creditors from making fair-share payments to for-profit agencies. According to Senate investigators some creditors follow the same policy, including MBNA Corp., the second-largest credit card issuer.
  Barnhart says consumers should have the option to choose the type of agency they work with. Under the fair-share system, agencies earn their income from creditors, giving them too much control, he says.
  "That seems like the fox guarding the hen house. The debtor is not in the driver's seat," says Barnhart. "National regulations with competition puts the consumer in control."
  Plunkett isn't entirely against the proposal. "Competition could bring some innovative financial products for debtors," he says.
  While advocates and politicians study this chessboard of suits, proposals and counter proposals, several suggest it is too early for legislation. Washington is focusing on the war in Iraq and the November elections.
  But the deeply troubled credit counseling industry has made its way to the national radar screen. Change is on the horizon.