Debt-settlement fraud rising with lack of regulation

By Ylan Q. Mui
Washington Post Staff Writer
Sunday, March 28, 2010; G01

Baltimore resident Gloria Snowden thought she had found a way out from under her $10,000 credit card bill when she signed up with a company that promised to negotiate with creditors to settle the debt for less than she owed.

It was 2003 and the nascent debt-settlement industry was just taking off. Traditional credit counseling and consolidation organizations devise payment plans and arrange lower interest rates and fees, but debt-settlement companies bargain with banks and collection agencies to forgive part of the amount due. They typically require customers to pay a hefty fee up front and make monthly deposits into an independent account.

Negotiations begin only after the balance reaches a level that they believe creditors will accept -- a red flag for consumer advocates who say the firms are predatory, and in some cases, fraudulent.

Snowden gave the firm she signed up with access to her savings account and deposited at least $400 each month toward her settlement.

But when the collection calls kept coming, Snowden, 65, said she realized that the firm hadn't contacted her creditors. For five years, she battled with the company to negotiate with those she owed, all the while putting money in her savings account. Snowden said she didn't realize she had been swindled out of her deposits until the Maryland attorney general's office called to tell her it had nailed the firm's leaders, who received six months in jail and had to pay $2.5 million in restitution. Snowden said she has not gotten her money back and had to file for bankruptcy.

"I got a job. I work," she said. "I just got caught up in this."

Many debt-settlement firms offer legitimate financial services, but a lack of regulation has made it difficult for people such as Snowden to sort the good from the bad. The fast rise of firms has prompted lawsuits and pressed states to draft laws to protect their most financially vulnerable residents.

The Maryland General Assembly is considering a bill that would cap the firms' fees, which are often paid before they make a single call to a creditor. In one year, complaints about such companies to the state attorney general's office have quadrupled to 121. Investigations have been launched in Illinois, Vermont, Maine, New York and Florida.

"It's a sign of the times. . . . People found themselves in deeper and deeper debt," said Marceline White, executive director of the Maryland Consumer Rights Coalition. "As they were trying to dig out, these firms rose up."

Carried away by easy credit

Debt-settlement companies cater to those who got caught up in the era of easy credit only to find themselves overwhelmed. When changes in federal laws a few years ago made it more difficult to declare bankruptcy, a new class of consumers emerged with massive debt and no way out.

When the Association of Settlement Companies, a trade group, was established in 2005, there were about 300 firms in the sector, according to executive director David Leuthold. Now, he said, about 1,000 firms handle $18 billion in debt across the country. The average customer has $30,000 in credit card debt.

"We're the only alternative out there for them," Leuthold said. "They know that they could get sued. They know that creditor calls could continue to come. They still want to get on the program and repay what they can."

Often, people who opt for debt settlement are in default, or at least 180 days late on payments, and their issuers have sold the loan to a third-party collection agency. Many firms encourage a communications "blackout" -- no payments and no response to calls or letters -- until their customers are ready to cut a deal, which can wreak havoc on credit scores. Leuthold said his group's members cannot require a blackout.

Advocacy groups say the industry's advance-fee model has allowed unscrupulous firms to take advantage of desperate customers. Requiring upfront payment also makes it difficult for people to reach their savings goal and forces some to drop out -- sometimes before any calls to creditors are made. Even the industry's most optimistic estimates put the program completion rate at 34 percent.

The Federal Trade Commission, which is the nation's consumer protection agency, has brought seven cases against debt-settlement companies since 2001 and is considering banning advance fees. But a final decision is not expected anytime soon, an FTC spokesman said, leaving states largely responsible for policing the growing industry.

Several states have banned the practice, including Arkansas, Hawaii, Kentucky, New Mexico and Wyoming. A bill sponsored by Maryland Del. Elizabeth Bobo (D-Howard) that would have outlawed debt-settlement companies died in committee last year.

This year, the Maryland House and the Senate are considering capping fees at 15 percent of the amount that the firms save the customer. A key Senate committee is expected to vote on the measure Tuesday. Companies could collect up to a $50 consultation fee up front, but no more until the services are completed. The Association of Settlement Companies is lobbying to raise the cap to 30 percent of the amount saved, and the state attorney general's office has said it would accept the increase.

Sorting good from bad

Even some debt-settlement companies are seeking better ways for people to separate legitimate firms from the scofflaws. Mike Croxson, president of CareOne Services, a debt-relief firm based in Columbia, supports licensing for debt-settlement companies. His firm charges customers 30 percent of their savings and a set-up fee of $50 to $400, depending on state laws. He said that people typically settle their first debt within six months and that his company carries an A+ rating with the Better Business Bureau. At a recent hearing in Annapolis on debt-settlement legislation, Croxson testified in favor of the bill but urged a higher cap.

"I know that that model can work," he said. "I believe that aligning the providers' interest and the consumers' interest is the smartest way to go."

But some companies say they can't operate unless they collect fees up front. Leuthold said the firms make significant investments in acquiring customers and managing their accounts before they negotiate with creditors. If companies wait until the end to collect, he said, they might wind up as creditors themselves.

Phil Fewster, chief executive of settlement company DebtShield in Columbia, said that signing up a customer costs about $1,000 and that the firm hires one staff member for every 40 to 50 customers, a relatively low ratio. He typically charges clients 8 to 20 percent of their total debt, paid over their time in the program.

"If you're trying to do it for the right reasons, it takes a real investment," he said. "We are barely at a break-even profit every single year."

Josh Sheintal, 35, of Gaithersburg said he dug himself into a credit hole when his construction business tanked along with the economy and he charged about $20,000 to pay his suppliers. He signed up with DebtShield and said he grew nervous when the company asked him to sock away $1,500 a month in a third-party account -- and then took the first two months' payments as service fees. But Sheintal stuck with the program, and he said the company eventually settled his debt for less than half of what he owed.

The next time his credit card issuer contacted him, it was a letter of a different stripe.

"Actually, they sent me another credit card," he said. "But that's a different story."

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