Checking Up on Credit Charities

Debt-advice groups sparking new government scrutiny

Following a divorce, a series of moves to pick up acting work, and a string of temporary jobs that dried up when the economy soured in 2001, Alyssa Polacsek owed $20,000 to two credit-card companies. Looking for help, she turned to Debticated, a New York nonprofit group that counsels people who spend far more on their credit cards than they can afford.

But instead of helping her pay off her debt, Ms. Polacsek contends that Debticated mishandled her finances. She says the company also broke its promises, including its assurance that she wouldn’t have to pay an upfront fee to the organization. She says she was required to make what the company called a donation of $552 before she could start making the payments to her creditors that Debticated had arranged.

“I became increasingly uncomfortable with them being a so-called charity,” Ms. Polacsek says. “Nothing they did, starting with the voluntary contribution I had to make to them — which was not voluntary at all — seemed like they were acting like a nonprofit.”

Ms. Polacsek was so angry she filed a class-action lawsuit challenging Debticated’s tax-exempt status. The lawsuit contends that Debticated is able to operate improperly in part because its nonprofit status allows it to avoid government regulation.

Debticated has denied any wrongdoing. But the lawsuit is just one of many controversies over the charity status of credit-counseling organizations, the number of which has boomed in recent years.

State and local regulators, as well as the Internal Revenue Service, have started to take a hard look at credit-counseling agencies, and consumer activists are putting pressure on governments to do more to regulate the organizations. Critics contend that many of the new groups overcharge for services, fail to disclose their fees, pay too-high salaries to their officials, or act as a front for for-profit bill-paying and loan companies.

Rapid Growth

Credit-counseling groups, which first became eligible for charity status in 1965, took off in the 1970s when credit-card companies and retailers looking for ways to recoup money from their financially strapped customers helped create a network of organizations around the country. For many years, most of these groups were neighborhood-based nonprofit groups that dispensed in-person financial advice and helped people set up bill-paying plans. But over the last 15 years, the industry has grown significantly, becoming dominated by organizations that advertise heavily, serve clients nationwide, and focus nearly exclusively on running credit-card payment plans.

Consumer-credit experts estimate that more than 1,000 credit-counseling organizations are now operating, five times as many as a decade ago. And the number of groups is expected to keep growing as consumer debt, which the Federal Reserve says already tops $1.7-trillion, continues to soar. Federal bankruptcy-reform legislation, which appears likely to be passed by Congress in the next few months, would probably spur the expansion of the industry even more. The legislation now pending would require people to speak with credit counselors before they file for bankruptcy.

The potential for even more expansion worries consumer advocates, who describe many of the newer credit-counseling groups as debt mills that provide no education to clients and do little more than make money by setting up bill-paying plans. The advocates question whether the groups ought to be designated as charities, and fret that the industry is subject to too little scrutiny.

Exemptions for Charities

No federal laws directly regulate credit-counseling organizations, and some of the state laws that do exist exempt nonprofit groups. At least two trade groups set rules for their member organizations — limiting fees, for example, and requiring counselors to get some financial-education training — but many organizations are independent, and are thus not subject to any standards.

Operating as a charity not only exempts credit-counseling groups from some supervision, but, say some observers, it also gives them a so-called halo effect, allowing them to woo customers by touting their nonprofit status.

“People automatically think that if it’s a nonprofit it is working for their best interests,” says Robert D. Manning, author of Credit Card Nation: The Consequences of America’s Addiction to Credit and a humanities professor at the Rochester Institute of Technology. But, he says, some dishonest organizations are “hiding behind their nonprofit status and are really just out to make money for themselves.”

Officials at credit-counseling groups, new and old, say that, like other charities, they provide a valuable service to the public, helping debt-laden consumers avoid bankruptcy, pay their bills, and learn to better manage their money.

“Credit-counseling agencies are really part of the social-services safety net,” says David C. Jones, president of the Association of Independent Consumer Credit Counseling Agencies, a Fairfax, Va., organization that represents 45 credit-counseling groups. “We’re equal partners with other organizations like Alcoholics Anonymous and other agencies that are a resource for people who need help.”

A key service the credit-counseling groups provide is to set up debt-management plans intended to help people consolidate and pay their bills. In such a plan, a debtor sends one monthly payment to the credit-counseling organization, which then disburses money to the consumer’s creditors. Typically, the counseling group has negotiated concessions with the creditors, such as lower interest rates.

The creditors give the counseling organizations donations, called fair-share contributions, based on the amount of money they recover. The counseling organizations also earn money by charging clients fees to operate the credit-card payment plans. Because the organizations are nonprofit groups, the fees are sometimes described as voluntary donations.

For some, such donations appear to be lucrative. National Credit Counseling Services, in Orlando, Fla., for example, reported nearly $50-million in donations in 2001 on its federal informational tax return. AmeriDebt, in Germantown, Md., brought in more than $55-million in donations that same year. The Cambridge Credit Counseling Corporation, in Agawam, Mass., reported getting nothing in contributions in 2001, but more than $38-million in income from service fees. In that same year, two of the group’s top officials, John Puccio and Richard Puccio, earned nearly $400,000 each in salary and benefits.

In some cases, a hefty share of the credit-counseling groups’ revenue is paid to for-profit companies that promote the groups’ services or provide the back-office processing for the payment plans, raising questions about whether the charities do much more than funnel business to for-profit enterprises. At AmeriDebt, for example, about $28-million, or more than half of the contributions it reported collecting in 2001, was paid to Debtworks, a Maryland bill-paying company, which used to share offices with AmeriDebt and is owned by the spouse of one of AmeriDebt’s former directors. Another $11.4-million went to four other businesses to pay for advertising.

AmeriDebt officials declined to be interviewed for this article. In a February letter written by AmeriDebt’s president, Doug Nunes, to the Consumer Federation of America, in Washington, Mr. Nunes says that AmeriDebt has an “arms-length relationship with Debtworks” that is “completely proper” and similar to typical relations between a charity and the companies that provide services to it.

Officials at other credit-counseling organizations also defend the heavy use of outside contractors to operate the debt-management plans. They say working with bill-paying companies allows them to provide efficient, professional services to their clients, and to meet the requirements of creditors, many of which insist, for example, that monthly payments be made electronically.

As for advertising expenses, such outreach is necessary, officials at some groups say, to alert consumers about available services.

Even some of the industry’s old guard may be getting into the public-relations act.

The National Foundation for Credit Counseling, in Silver Spring, Md., is an association of 150 credit-counseling organizations representing many of the oldest local groups in the business. In response to the heavy advertising and high profile of many of the newer credit-counseling groups, the foundation plans to start its own television advertising campaign by the end of the year. The group not only wants to steer consumers to its member offices, but also would like to burnish the industry’s reputation, particularly in the eyes of lawmakers, who have been increasingly interested in tightening oversight of the industry.

“New legislation would be welcomed because it will help to weed out the bad apples,” says Lydia Sermons-Ward, a foundation spokeswoman. “But you have to be wary of going too far, putting an unnecessary burden on the organizations that are following the rules, that are doing a good job of providing the necessary services in their communities.”

Increased Scrutiny

Government regulators are already stepping up their scrutiny of counseling groups, and consumer organizations are putting pressure on them to do more. Among the key developments:

• The IRS has increased its supervision of credit-counseling groups to determine if they are legitimate charities. The tax agency has provided investigators with special training, and directed officials to do in-depth examinations of all credit-counseling groups seeking tax-exempt status. It is also auditing some groups already operating as nonprofit counselors, and has appointed an internal panel to determine whether such groups require more oversight or regulation.
• Maryland and Mississippi each approved new laws requiring credit-counseling organizations to register with the state, post bonds, and limit their fees. A similar law passed last year in California went into effect in January, and at least four other states — Georgia, Iowa, Maine, and Massachusetts — are considering new rules.
• The Consumer Federation of America, along with the National Consumer Law Center, in Boston, issued a report that documented the rise in abusive practices and outright scams among credit-counseling groups. The report says that “honest, reputable agencies are losing out to companies that are in the ‘nonprofit’ credit counseling business to make quick money.” It calls on the IRS to more aggressively enforce its rules, and to punish credit-counseling groups that provide “excessive compensation” to their officials. The report also says that Congress and the states should enact and strongly enforce laws that govern nonprofit credit counselors.

But some observers of the credit-counseling industry say that stricter and better enforced rules won’t do much. At best, critics say, working with most credit groups is a bad deal, since debtors can usually contact creditors on their own to negotiate payment plans. In addition, they say, even the credit-counseling groups with the best intentions will always have a monetary incentive to steer debtors into payment plans, since a hefty portion of their revenue comes from the creditors who pay them for helping collect debtors’ money.

“Consumers should think about going to lawyers, financial planners, other community groups that provide financial counseling, rather than to these credit groups, where it’s often too hard to tell whose best interests are being served,” says Karen Gross, a professor at the New York Law School and president of the Coalition for Consumer Bankruptcy Debtor Education, a New York charity that promotes financial literacy.

Still, many charity officials believe that well-run credit-card counseling groups play an important role in helping people in crisis. Larry E. Walton, president of the United Way of Central Maryland, in Baltimore, says his organization refers people who call for help in straightening out their finances to the Consumer Credit Counseling Services of Maryland and Delaware.

“Dealing with the financial well-being of a family is as much a part of supporting families in need as dealing with other problems, such as mental-health issues,” he says.

In Orlando, Fla., a local credit-counseling group receives money each year from the city’s Heart of Florida United Way. Emery Ivery, the United Way’s senior vice president, says the credit-counseling group provides critical services, especially to low-income home buyers.

“Debt is a huge barrier to homeownership,” he says. “It makes sense for the United Way to support an organization that helps people remove that barrier.”

But Mr. Ivery, like other observers, remains worried about the potential for scams. No matter how tightly the industry is regulated, desperate consumers looking for a quick fix to their problems will still turn to the groups that claim to offer the best deals, even if the deals are too good to be true, say experts on debt.

“People are at their most vulnerable, most stressed when they feel they are on the verge of bankruptcy,” says Mr. Manning, the Rochester Institute of Technology professor. “By the time someone is soliciting their business, they are in such dire circumstances that they are easy to take advantage of.”