Debt settlement companies skirt new rules

NEW YORK (CNNMoney.com) -- Many companies that charge big upfront fees to consumers drowning in debt are skirting new federal rules that ban abusive debt-settlement practices, according to consumer advocates and government officials.

Federal Trade Commission rules that took effect this fall ban debt-fixers engaging in telemarketing from misrepresenting their services, such as swearing to cut your debt in half if they can't, and charging fees before services are delivered.

While debt settlement companies are supposed to negotiate with a customer's creditors to whittle down the amounts owed, some firms collect fees amounting to thousands of dollars without making a dent in the customer's balance, according to the FTC, which regulates telemarketers.

And the new rules haven't stopped them from collecting those up-front fees.

"Instead of complying with the new rules, the majority of debt settlement companies are evolving to evade them," said Chris Viale, CEO of Cambridge Credit Counseling, a nonprofit consumer advocacy group. "They are doing everything they can to continue charging these advance fees to consumers and mislead consumers."

Cambridge Credit Counseling and 11 other nonprofit debt counselors warned about some worrisome practices in a letter to the FTC last week.

The firms are targeting prospective customers via text message, Skype or Internet chats, or setting up in-person meetings with potential customers, in the belief that these techniques won't fall under U.S. telemarketing regulations, the advocates said. They also warn that debt-fixers may pose as law firms or hire attorneys, since lawyers are exempted from the rules.

Evan Zullow, an attorney in the FTC's division of financial practices, said he's aware that companies are looking for loopholes. The FTC, he said, is closely monitoring the industry to make "sure that what they're doing actually meets the exception."

Simply hiring lawyers and calling the debt-fixing company a law firm, for example, or meeting with customers at Starbucks to sign paperwork won't cut it, he said. Settlement companies must give actual in-person sales presentations if they want to collect upfront fees, according to the FTC.

What they're up to: Some debt-fixers are baiting prospective customers with text messages, said Viale. As long as the consumer makes the initial call, some companies believe they can still charge upfront fees, but this kind of behavior typically isn't exempt from the FTC rules, said Zullow.

Whether a debt settler's ad is on TV, radio or text, if the ad prompts a consumer to call, the companies are not allowed to charge advance fees, said Zullow.

Viale shared a text he said one of his organization's staffers received recently. The text asked the staffer to call to speak with a credit analyst. When the staffer called back, the rep asked if his debt totaled more than $10,000, said Viale, then transferred him to a company it said was a law firm that would charge a "retainer," an up-front fee for legal services.

Whether the company is indeed a law firm could not be confirmed, but debt settlers hoping to skirt the new rules have been pretending to be backed by a legal firm or hiring attorneys, said Viale.

Weeks after the first batch of Federal rules banning deceptive practices went into effect, the North Carolina Attorney General sued the Consumer Law Group of Boca Raton, Fla. The Attorney General accused CLG of being a debt relief company posing as a law firm to collect $2.6 million in fees from more than 3,000 consumers in North Carolina. CLG agreed to stop soliciting new customers and collecting money from existing customers, according to the attorney general's office.

Debt settlement companies might also move their operations offshore to evade regulation. Steve Rhode, a consumer advocate and founder of Getoutofdebt.org, a website providing debt relief advice, published slides from a presentation that The Association of Settlement Companies, a debt settlement industry group, gave at a recent industry conference.

One slide discussed basing operations overseas, "similar to online gambling setups," in the Dominican Republic, Costa Rica or Panama, noting that many payday lenders "are now completely based in Bermuda."

The presentation also tossed around the idea of using Internet chat and Skype to target consumers.

The association, in an interview with CNNMoney, stressed that TASC was not suggesting its members evade the new rules, but was instead providing examples of how other companies may be trying to get around them.

"The presentation was given in anticipation of some gaps within the law and ways people could get around it," said Wesley Young, legislative director at the group, who confirmed that the slides were part of its presentation. "We weren't saying they should, we were explaining how it works and what the legal exemptions are."

But the up-front fees -- typically around 15% or more of a customer's outstanding debt -- are a key source of revenue for debt settlement firms.

Jenna Keehnen, executive director of United States Organizations for Bankruptcy Alternatives, said her trade group represented about 200 such companies before the new rules went into place, but only about 100 companies have survived.

"It's unfair to require companies to provide a service for months and months without pay," she said.