New Jersey bankruptcy Article
Article printed in the New York Times, October 14, 2003
By JENNIFER BAYOT
he Internal Revenue Service is investigating the business practices of nonprofit credit counseling services, which advise millions of people in debt.
The investigation could jeopardize the agencies’ nonprofit status and upend the industry just as a proposed change in federal bankruptcy law stands to steer many thousands more people to debt counseling. As nonprofit concerns, the agencies are now exempt from dozens of state and federal regulations.
The I.R.S., the Federal Trade Commission and state regulators plan to issue an unusual joint advisory today warning consumers to be wary about the total costs when seeking help from tax-exempt credit counseling organizations.
“Consumers need to know not to read too much into not-for-profit status — that’s no guarantee that someone is legit,” said C. Steven Baker, director of the Federal Trade Commission’s Midwest operations. “A lot of these credit counseling companies are using tax-exempt status as a get-out-of-regulation-free card. That’s why we’re teaming up with the I.R.S. on this issue.”
Consumer advocates say the actions are long overdue, and many credit counselors say they welcome the scrutiny because they believe that some new entrants are giving the entire industry a bad name.
An estimated nine million people sought the help of credit counseling services last year, according to the National Consumer Law Center and the Consumer Federation of America. From these and earlier inquiries, at least one million people have consolidated their debts, and are now making a single payment each month to the agencies, which in turn distribute the money to creditors.
The I.R.S. declined to identify the agencies it was investigating. In a rare disclosure about its enforcement efforts, though, the tax agency said it was auditing “a significant number” of credit counselors and is conducting a more rigorous review of new ones that apply for tax exemption. The agency is examining the fees charged consumers, the salaries paid to officers and a host of transactions with for-profit companies.
Illinois and Missouri have sued AmeriDebt, one of the biggest agencies, saying it charges excessive fees and diverts money to companies that are affiliated with it.
A close look at tax records and other documents shows that some executives of Cambridge Credit Counseling and Consolidated Credit Counseling Services also have relationships with companies that they pay for various services. Cambridge and Consolidated say that there is nothing improper about their businessr elationships and that they have been examined by independent parties.
If any of these companies are found to be improperly benefiting for-profit companies, they risk losing their nonprofit status.
“We take a dim view of the use of the tax code by credit counseling groups to game the system, and are concerned by recent developments,” said Mark W. Everson, the I.R.S. commissioner. “Those groups that are using the tax code to skirt consumer protection laws should think twice. We will work with other federal agencies and state regulators to combat abuse in this area.”
To be exempt from taxes, a credit counseling agency must limit its services to poor customers or must primarily provide education and counseling to the public, the I.R.S. said. Simply enrolling people in payment plans is not enough.
The industry has changed drastically in the last decade from mostly small local organizations to very visible national operations that advertise aggressively. These big companies have ushered in some welcome improvements, like 24-hour customer service lines and electronic payments.
But consumer advocates say that some agencies seem more intent on making money by overcharging their customers or by funneling money to related companies rather than acting in the best interests of their clients.
A potential for conflicts of interest has existed since the industry’s beginnings in the 1960’s. Credit counselors receive contributions from credit card companies, which provide incentives to push people into repayment plans — even people who need only budgeting tips or who might be best served by bankruptcy protection. Recently, though, the contributions from credit card companies have been shrinking, and consumers are being asked to pay more for the help.
“Because of the work that we do, we have to be an arbiter for both sides, and I do think some tension comes from that,” said Suzanne Boas, president of the Consumer Credit Counseling Service of Greater Atlanta. “But if you’re very clearly focused on providing value for consumers, I think that’s a tension that can be resolved.”
Credit counseling helps many people find a way to regain their financial footing. They learn to trim costs and stick to a budget and determine whether bankruptcy is a reasonable option. Clients who enroll in the agencies’ payment plans may benefit because the agencies can negotiate lower interest rates, smaller minimum payments and the elimination of late charges.
Many Americans are struggling to pay their bills, and those out of work find job opportunities bleak. Research by the Federal Reserve indicates that household debt has risen to a record 14 percent of disposable income. Personal bankruptcies are on track this year to surpass last year’s record of 1.5 million, according to the American Bankruptcy Institute.
Bankruptcy legislation passed by the House could steer even more people to counseling agencies. It would require, among other things, that anyone who wants to file for personal bankruptcy consult first with a credit counselor.
“You’re going to have people forced en masse to become victims due to Congress’s beneficence,” predicted Stephen Gardner, a lawyer in Dallas who has served as an assistant attorney general for consumer protection in Texas.
A look at some of the big agencies’ practices and financial statements shows a variety of complicated fee structures and a quagmire of related companies.
The credit agencies say that they are generally asking for higher fees because of the smaller contributions from credit card companies and that their fees are strictly voluntary. But consumer advocates say that some agencies fail to mention that the fees are optional or pressure customers to pay them, pointing out that the agencies are nonprofit.
The Consumer Federation of America says a reasonable setup fee should not exceed $50.
AmeriDebt — which is based in Germantown, Md., and has close to 100,000 clients — retains 3 percent of customers’ overall debt, typically the equivalent of a month’s worth of payments, as an initial voluntary contribution. It then collects $7 a month for each credit card account it handles, at a minimum of $20 a month per consumer.
“It has been AmeriDebt’s longstanding policy to provide its services to all consumers who ask for our help, whether or not they make a voluntary contribution,” the company said in a statement.
AmeriDebt emphasized that the fees are voluntary and that it can reduce people’s monthly payments by roughly 50 percent.
Cambridge Credit Counseling, which is one of the country’s five largest credit counselors and is adding 4,000 customers a month, initially consolidates payments and then deducts the equivalent of one month of the consumer’s payment under the new plan. It also charges maintenance fees of 10 percent of each month’s payments or $25, whichever is greater. Cambridge, which is based in Agawam, Mass., says the enrollment fees help people stay committed to the repayment programs.
Furthermore, customers who stick to their payment plans for six months can claim half of any contributions that Cambridge receives from their creditors, thus recouping some fees. The company says that since 1996 it has returned close to $12 million to its customers through this program.
While it is evaluating fees in the industry, the I.R.S. is looking at what counseling agencies do with money they receive. Many are paying what seem like excessive salaries, it said. Some owners of the nonprofit concerns also own stakes in profit-making companies, which they send business to in various ways, prompting further investigation by the I.R.S. Again, the agency declined to identify the companies, but complicated business dealings are common in the industry.
The lawsuits filed by the Illinois and Missouri attorneys general say that AmeriDebt operates more like a for-profit enterprise, and both suits accuse the company of charging excessive fees.
Over the last three years, AmeriDebt has paid $75 million to have its customers’ accounts managed by companies owned by Andris Pukke, the husband of its founder, Pamela Shuster, and a former officer.
AmeriDebt said “it would cost millions of dollars to invest in the same technology and personnel that are available at less cost from vendors.” Mr. Pukke, 34, left AmeriDebt three years ago, the company said, and has since had no affiliation with it.
Cambridge Credit manages its own accounts. But it pays much of its revenues to for-profit companies owned by its founders, John and Richard Puccio, who are brothers.
Tax returns show that it paid millions during its fiscal year ended July 31, 2002, to a debt-referral company owned by John Puccio.
Cambridge also paid the brothers $984,000 last year toward its $14.1 million purchase of two other for-profit credit counseling companies that the Puccios founded. The sale price, said Cambridge’s lawyer, Paul Kaplan, was independently reviewed and approved by the accounting firms BDO Seidman and KPMG. Cambridge said that its executives’ salaries had also been reviewed and approved by an outside firm. John and Richard Puccio earn six-figure salaries from either Cambridge or two related companies, adding up to more than $500,000 a year for each, according to tax returns.
Last year, a report by a Massachusetts Senate committee expressed concern about Richard Puccio, noting that the Securities and Exchange Commission barred him for five years from the securities industry in 1996 for “engaging in high-pressure, fraudulent sales tactics in utter disregard of his obligations to customers and their welfare.”
Mr. Kaplan, Cambridge’s lawyer, said no regulators had objected to Mr. Puccio’s role at the group. “He sits on the board, but he has no office or title, and he doesn’t deal with consumers,” Mr. Kaplan said.
On its most recent tax return, Consolidated Credit Counseling in Fort Lauderdale, Fla., another of the biggest agencies, lists five for-profit businesses as related organizations.
Florida public records list Howard Dvorkin, the president of Consolidated Credit, as the sole officer of three of those organizations.
The five companies provide Consolidated with office space, software, accounts processing, marketing and office equipment — often at substantial discounts, Mr. Dvorkin said.
“We’ve had compensation studies on any related-party transactions,” he responded to inquiries. “We have an independent board review them to make sure they’re at market or below.”
Mr. Dvorkin said that the affiliated companies helped shield Consolidated from various liabilities and that keeping the businesses separate was more efficient. “We don’t do anything wrong,” he said. “We’re a legitimate service.”
The draft of the statement to be released by regulators today tells consumers to beware of quick fixes offered by some credit advisers. Among other things, it suggests consumers look at total costs, any voluntary contributions and monthly service charges, which “may add to your debt and defeat your efforts to pay your bills.”
Mark Pacella, president of the National Association of State Charity Officials, said, “State charity officials are working with other state and federal agencies to remedy abuses.”