[Senate Report 109-55]
[From the U.S. Government Publishing Office]
109th Congress S. Rept.
SENATE
1st Session 109-55
_______________________________________________________________________
PROFITEERING IN A NON-PROFIT INDUSTRY:
ABUSIVE PRACTICES IN CREDIT COUNSELING
__________
R E P O R T
prepared by the
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
APRIL 13, 2005
COMMITTEE ON GOVERNMENTAL AFFAIRS
SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio CARL LEVIN, Michigan
NORM COLEMAN, Minnesota DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania THOMAS R. CARPER, Delaware
TOM COBURN, Oklahoma MARK DAYTON, Minnesota
LINCOLN D. CHAFEE, Rhode Island FRANK LAUTENBERG, New Jersey
ROBERT F. BENNETT, Utah MARK PRYOR, Arkansas
PETE V. DOMENICI, New Mexico
JOHN W. WARNER, Virginia
Michael D. Bopp, Staff Director and Chief Counsel
Joyce A. Rechtschaffen, Minority Staff Director and Counsel
Amy B. Newhouse, Chief Clerk
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PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
NORM COLEMAN, Minnesota, Chairman
TED STEVENS, Alaska CARL LEVIN, Michigan
TOM COBURN, Oklahoma DANIEL K. AKAKA, Hawaii
LINCOLN D. CHAFEE, Rhode Island THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah MARK DAYTON, Minnesota
PETE V. DOMENICI, New Mexico FRANK LAUTENBERG, New Jersey
JOHN W. WARNER, Virginia MARK PRYOR, Arkansas
Raymond V. Shepherd, III, Staff Director and Chief Counsel
Katherine E. English, Counsel
Steven A. Groves, Counsel
Elise J. Bean, Minority Staff Director and Chief Counsel
Laura E. Stuber, Minority Counsel
Mary D. Robertson, Chief Clerk
C O N T E N T S
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Page
I. INTRODUCTION.................................................. 1
II. EXECUTIVE SUMMARY............................................ 2
III. OVERVIEW OF THE CREDIT COUNSELING INDUSTRY.................. 4
A. History of the Credit Counseling Industry................. 4
B. Current Law Governing the Credit Counseling Industry...... 5
IV. GDEBTWORKS, AMERIX, AND CAMBRIDGE: THREE CASE STUDIES........ 9
A. DebtWorks and The Ballenger Group Conglomerate............ 10
(1) GFormation of DebtWorks and The Ballenger Group
Conglomerate................................................... 10
(2) Control of the Affiliated Credit Counseling Agencies.. 13
(3) Private Benefits to the For-Profit Corporations....... 14
(4) Harm to Consumers..................................... 15
B. The Ascend One-Amerix Conglomerate........................ 18
(1) Formation of the Ascend One-Amerix Conglomerate....... 18
(2) Control of the Affiliated Credit Counseling Agencies.. 20
(3) Private Benefits to the For-Profit Corporations....... 20
(4) Harm to Consumers..................................... 22
C. The Cambridge-Brighton Conglomerate....................... 23
(1) Formation of the Cambridge-Brighton Conglomerate...... 24
(2) Control of the Affiliated Credit Counseling Agencies.. 25
(3) Private Benefits to the For-Profit Corporations....... 26
(4) Harm to Consumers..................................... 28
V. REGULATION AND ENFORCEMENT.................................... 32
A. Industry Self-Regulation.................................. 32
B. Creditor Standards........................................ 34
(1) History of the Creditor-Credit Counseling Agency
Relationship................................................... 34
(2) Three Creditor Models................................. 36
(3) Using Fair Share Payment Standards to End Abuses...... 38
C. State Regulation and Enforcement.......................... 40
D. Federal Regulation and Enforcement........................ 41
(1) Internal Revenue Service.............................. 41
(2) The Federal Trade Commission.......................... 43
(3) Pending Bankruptcy Legislation........................ 44
VI. POST HEARING CHANGES IN THE INDUSTRY......................... 45
A. DebtWorks and The Ballenger Group......................... 46
(1) AmeriDebt Files for Chapter 11 Reorganization......... 46
(2) The Ballenger Group................................... 47
B. The Ascend One-Amerix Conglomerate........................ 49
C. The Cambridge-Brighton Conglomerate....................... 51
D. Recommendations........................................... 53
PROFITEERING IN A NON-PROFIT INDUSTRY: ABUSIVE PRACTICES IN CREDIT
COUNSELING
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I. INTRODUCTION
In September 2003, the U.S. Permanent Subcommittee on
Investigations of the Committee on Governmental Affairs, began
an investigation into the credit counseling industry. The
investigation focused on new entrants into the industry, the
marketing of debt management plans, the relationship between
non-profit credit counseling agencies and for-profit service
providers, and the quality of the counseling that clients
received. The Subcommittee's Majority Staff initiated the
investigation at the direction of the Subcommittee's Chairman,
Senator Norm Coleman, with the concurrence and support of the
Subcommittee Ranking Minority Member, Senator Carl Levin. The
information in this report is based on the ensuing bipartisan
investigation by the Subcommittee's Majority and Minority
staffs.
Credit counseling agencies (``CCAs'') have traditionally
been non-profit companies that rely upon contributions from
creditors and charities and small fees from consumers to cover
the operating costs of providing advice, debt counseling, and
debt management plans to consumers who have trouble paying
their credit card bills. Some new entrants to the industry,
however, have developed a completely different business model--
a ``for-profit model'' designed so that their non-profit credit
counseling agencies generate massive revenues for for-profit
affiliates through advertising, marketing, executive salaries,
and any number of other activities other than actual credit
counseling. The new model looks to the consumer to provide
those revenues.
Many of the new non-profit and for-profit companies are
organized and operated to generate profits from an otherwise
non-profit industry. Evidence of the new entrants' intention to
create profits is indicated in several ways, including: (1) the
manner in which the new entrant is organized, (2) the extent of
control exercised by a for-profit entity over its non-profit
CCA affiliate, and (3) the massive revenues funneled to the
for-profit entity from the non-profit agency.
When profit motive is injected into a non-profit industry,
it should come as no surprise that harm to consumers will
follow. Indeed, the primary effect of the for-profit model has
been to corrupt the original purpose of the credit counseling
industry--to provide advice, counseling, and education to
indebted consumers free of charge or at minimal charge, and
place consumers on debt management programs only if they are
otherwise unable to pay their debts. Some of the new entrants
now practice the reverse--they provide no bona fide education
or counseling and place every consumer onto a debt management
program at an unreasonable or exorbitant charge.
II. EXECUTIVE SUMMARY
Consumer debt has more than doubled in the past 10
years.\1\ The nation's credit card debt is currently $735
billion.\2\ The rapid increase in credit card balances is one
factor in the corresponding increase in personal bankruptcies.
Since 1996, more than one million consumers have filed for
bankruptcy each year, with a record 1.66 million new filings in
2003.\3\ As Chairman Coleman stated in his opening statement at
the hearing entitled Profiteering in a Non-Profit Industry:
Abusive Practices in Credit Counseling, March 24, 2004, ``The
growth in both debt and bankruptcy demonstrates the need for
much better financial education. Although the immediate cause
of most bankruptcies is a sudden setback such as divorce,
serious illness, or unemployment, the amount of debt these
individuals carried when faced with this tragic event indicates
their poor understanding of credit and finances.''
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\1\ Eileen Powell, ``Consumer Debt More Than Doubles in Decade,''
The Washington Times, January 6, 2004.
\2\ Id.
\3\ The American Bankruptcy Institute, available at
www.abiworld.org.
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The social need for better financial education is one of
the primary reasons why credit counseling has long been
recognized as a charitable and educational activity worthy of
tax exempt status under Section 501(c)(3) of the U.S. tax code.
For the past several decades, consumers in debt regularly
turned to the non-profit credit counseling industry for advice
and financial education. Consumers who could not afford to make
all of their payments often enrolled in a debt management
program, which allowed them to consolidate their debts from
several credit cards, reduce their monthly payments, and lower
their interest rates.
Over the past several years, however, the credit counseling
industry has undergone significant changes. The activities of
some ``new entrants'' have resulted in increasing consumer
complaints about excessive fees, non-existent education, poor
service, and generally being left in worse debt than when they
initiated their debt management program. With this in mind, the
Subcommittee initiated an investigation to determine the state
of the credit counseling industry and whether solutions are
available to remedy its problems.
The Subcommittee's investigation included a thorough
examination of credit counseling agencies, their for-profit
affiliates, major credit card issuers, Federal and state
agencies and officials, consumer advocates, and their
interrelated relationships. Additionally, current and former
credit counselors and CCA clients were interviewed and
Subcommittee staff responded to advertisements from various
agencies to see what advice was being given. The Subcommittee
held a hearing on March 24, 2004 in which the Subcommittee's
preliminary findings were disclosed and members of the industry
testified.
The hearing illustrated the new entrants' model of credit
counseling. High consumer fees and lucrative contracts that
benefit the related for-profit company characterize this model.
The Subcommittee focused on three debt management conglomerates
to illustrate the unfriendly consumer practices eviscerating
the industry. These conglomerates were DebtWorks and The
Ballenger Group, Ascend One-Amerix, and Cambridge-Brighton. The
hearing consisted of four panels representing consumers, and
former CCA employees, CCAs, their for-profit affiliates, and
Federal regulators.
The first panel included two victims of the new entrants'
predatory practices. Jolanta Troy testified about her
experience with AmeriDebt, Inc. (``AmeriDebt''). AmeriDebt is a
very large CCA with multiple class action suits pending against
it with the Federal Trade Commission and the attorneys general
of multiple states. The second witness was Raymond Schuck, a
former client of Cambridge Credit Counseling (``Cambridge''),
another large CCA with suits pending from the Attorneys General
of Massachusetts and North Carolina. Two former employees of
AmeriDebt and Cambridge also testified. These former
``counselors'' discussed the sales tactics they were instructed
to practice in order to convince debt-ridden consumers to sign
onto debt management plans (``DMPs'') rather than offering
financial education or counseling.
The second panel consisted of CCAs known for high-pressure
sales of DMPs in conjunction with their operations as part of a
for-profit conglomerate. The witnesses included representatives
of AmeriDebt, American Financial Solutions (``AFS''), and
Cambridge. These non-profit CCAs provided little to no
counseling and education to consumers, poor service, and had a
controversial relationship with their for-profit affiliates.
For contrast, a member of the National Foundation for Credit
Counseling (``NFCC''), an association of CCAs still following
the ``old school'' model, testified about its very different
approach to credit counseling.
The for-profit affiliates to the above-mentioned CCAs
comprised the third panel. The Ballenger Group, Amerix, and
Brighton Debt Management Services provide processing services,
marketing and advertising, lead generation, and other services
to their non-profit CCAs. The Subcommittee found that these
for-profit affiliates use their non-profit CCAs to generate
significant revenues that are siphoned out of the non-profit
CCAs through contracts at above market prices. Through these
contracts, the for-profit affiliates exert a great deal of
control over the non-profit CCAs by setting minimum rates for
DMP sign ups and fee collections.
Completing the hearing, on the fourth panel, was
Commissioner Mark Everson of the Internal Revenue Service and
Commissioner Thomas Leary of the Federal Trade Commission. Each
discussed their agency's actions to address abuses in the
credit counseling industry. The Internal Revenue Service
announced the implementation of a new program for reviewing the
applications of credit counseling agencies for non-profit
status. The IRS has also initiated audits of over 50 CCAs.
Commissioner Leary discussed the Federal Trade Commission's
concerns about the industry and the actions it has taken
against AmeriDebt and The Ballenger Group, as well as
generally, to protect the American consumer from deceptive and
unfair practices. Commissioner Everson stated in his testimony,
``Based on the FTC data and our examinations, it appears that
some organizations are operating solely on the Internet and are
providing debt management and not credit counseling. In many
cases, credit counseling services have been replaced by
promises to restore favorable credit ratings or to provide
commercial debt consolidation loans.'' Clearly, something is
wrong with the credit counseling industry.
III. OVERVIEW OF THE CREDIT COUNSELING INDUSTRY
A. History of the Credit Counseling Industry
The practice known as ``credit counseling'' was initiated
by creditor banks and credit card companies during the mid-
1960s in an effort to stem the growing volume of personal
bankruptcies. Most, if not all, of the original CCAs were
members of the National Foundation for Credit Counseling
(``NFCC'').\4\ NFCC member agencies were generally community-
based, non-profit organizations that provided a full range of
counseling, often in face-to-face meetings with consumers.
Trained counselors would advise consumers about how to remedy
their current financial problems, counsel them on budget
planning, and educate them as to how to avoid falling into debt
in the future. These counseling sessions were traditionally
one-on-one meetings in which an educated counselor performed a
detailed analysis of an individual's income, expenses, debts,
and other budget requirements. A consumer would meet with a
counselor more than once and for significant periods of time,
often over an hour. After a budget analysis, the counselor
might recommend that the consumer readjust his or her budget,
utilize a debt management plan, or seek legal assistance,
possibly to declare bankruptcy.
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\4\ For more information on the NFCC, visit the organization's
website at www.NFCC.org.
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From the outset, a popular credit counseling option was the
``debt management plan'' (``DMP''). In order to initiate a DMP,
a consumer would authorize the credit counselor to contact each
of the consumer's unsecured creditors--primarily credit card
companies. The counselor would then negotiate with each
creditor to lower the consumer's monthly payment amount, to
lower the interest rate, and to waive any outstanding late
fees. All of the consumer's lowered monthly payments were then
``consolidated'' into a single payment. The consumer would send
a single payment to the CCA, which would then distribute
payments to each of the consumer's creditors.
DMPs were prevalent because each party involved--the
consumer, the creditor, and the CCA--received a tangible
benefit. Consumers got their finances under control and
received concessions from their creditors, such as reduced
interest rates, waiver of late fees, and forgiveness of overdue
payment status. Creditors, rather than taking a loss from a
bankruptcy, received all of the principal debt owed by the
consumer. The CCA, in return for organizing the DMP, would
receive ``fair share'' payments from the creditor to cover
their expenses, salaries, and operational costs. The fair share
remittance generally amounted to 12-15% of the payments
received by the creditor as a result of the DMP.
This mutually beneficial system operated smoothly for
several decades. Some NFCC CCAs charged nominal fees or
requested contributions from consumers. Such fees or
contributions were used to defray their costs for counseling
and initiating and maintaining the DMP. Such fees and
contributions were small in comparison to the creditor
concessions received by the consumer. Today, the fees charged
by NFCC CCAs remain minimal. The average initial fee to set up
a DMP with a NFCC agency in 2002 was $23.09 and the average
monthly maintenance fee was $14.\5\
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\5\ NFCC 2002 Member Activity Report, p. 30.
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Growth in consumer credit card debt in the 1990s however,
brought many new and aggressive entrants into the credit
counseling industry. Since 1994, 1,215 CCAs have applied to the
IRS for tax exempt status under Section 501(c)(3).\6\ Over 810
of these applicants applied between 2000 and 2003.\7\ There are
currently 872 active tax-exempt CCAs operating in the United
States.\8\ Many of these new entrants are not centered around
community-based, face-to-face counseling, but rather upon a
nationwide, Internet and telephone-based model focused
primarily, if not solely, upon DMP enrollment. Many of the new
entrants are set up on a for-profit model. The for-profit model
is designed to provide the maximum benefit to related for-
profit corporations, which enter into contracts with non-profit
CCAs to siphon off revenue from the CCA. A common method used
by the for-profit entity to collect revenue from the CCA is to
set itself up as a ``back-office processing company,'' which
contracts to provide data entry and DMP payment processing for
the CCA. The Subcommittee found that these contracts are often
executed by officers or directors of a CCA who have familial
ties or close business relationships with the owners of the
for-profit entity. The Subcommittee also found that, in many
instances, multiple non-profit CCAs would send processing fees
to a single for-profit company, which reaped substantial
profits.
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\6\ Letter, dated 12/18/03, to the Subcommittee from IRS
Commissioner Mark Everson, p. 2 (``Everson letter'').
\7\ Everson letter, p. 2.
\8\ Id.
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B. Current Law Governing the Credit Counseling Industry
CCAs are almost exclusively organized as non-profits under
26 U.S.C. Sec. 501(c)(3). The Credit Repair Organizations Act
of 1997 (``CROA'') sought to regulate organizations claiming to
offer ``credit repair services.'' \9\ However, this
legislation, which is administered by the Federal Trade
Commission (``FTC''), does not apply to Section 501(c)(3)
organizations. In fact, the significant increase in tax-exempt
CCAs roughly coincides with the passage of CROA, presumably
because CCAs organized as non-profits to avoid CROA
regulation.\10\ Moreover, the provisions of the Federal Trade
Commission Act generally do not apply to organizations with
tax-exempt status.\11\ Section 501(c)(3) status provides
protection from scrutiny from many state regulators as well.
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\9\ 15 U.S.C. Sec. Sec. 1679 et. seq.
\10\ Credit Counseling in Crisis, Consumer Federation of America
and the National Consumer Law Center (April 2003).
\11\ 15 U.S.C. Sec. Sec. 41 et. seq.
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Two more recent developments provide additional incentives
for companies to enter the credit counseling industry with
Section 501(c)(3) status. First, prospective Federal bankruptcy
legislation proposes requiring individuals to obtain credit
counseling before being eligible to file for bankruptcy. If
enacted, most likely the industry would see large increases in
persons seeking their services. Second, in the same vein, the
recent ``Do Not Call'' list, established by the FTC to prevent
unwanted telephone solicitations, exempts ``charitable
solicitations.'' This exemption means CCAs with Section
501(c)(3) status can continue to make telephone solicitations
seeking business.
A corporation may qualify for tax-exempt status under
Section 501(c)(3) if it is organized and operated exclusively
for certain aims, such as charitable, religious, scientific, or
educational purposes.\12\ No part of the corporation's net
earnings may inure to the benefit of any individual or any
private shareholder in the corporation.\13\ The corporation may
not be organized or operated for the benefit of any private
interests, such as the interests of the creator, the creator's
family, any shareholders of the corporation, or any persons
controlled directly or indirectly by such private
interests.\14\ Organizations claiming tax-exempt status are
required to apply for such status by filing an Application for
Recognition for Exemption Under Section 501(c)(3) with the
IRS.\15\ IRS agents review each application and recognize or
deny tax-exempt status.\16\ Once an organization is recognized
as having tax-exempt status, it must operate under the
requirements of Section 501(c)(3) or risk losing its tax-exempt
status. Each year, the tax-exempt organization must file an
information return with the IRS detailing its activities,
revenues, and expenses.\17\
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\12\ 26 U.S.C. Sec. 501(c)(3).
\13\ Id.
\14\ IRS Publication 557, Tax-Exempt Status for Your Organization
(Rev. May 2003), p. 17.
\15\ 26 U.S.C. Sec. 508(a).
\16\ Everson letter, p. 6.
\17\ IRS Publication 557, supra, at p. 8.
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Credit counseling organizations have been recognized as
proper tax-exempt entities for several decades.\18\ In 1969,
the IRS affirmed that Section 501(c)(3) tax-exempt status was
properly granted to an ``organization [that] provides
information to the public on budgeting, buying practices, and
the sound use of consumer credit through the use of films,
speakers, and publications.'' \19\ The ruling noted that such
organizations may enroll debtors in ``budget plans'' where the
debtor makes fixed payments to the organization and the
organization disburses payments to each of the debtor's
creditors.\20\ The budget plan services were to be ``provided
without charge to the debtor.'' \21\ The organization offered
education to the public on personal money management through
informative tools and provided individual counseling to ``low
income individuals and families.'' An aspect of the counseling
included the use of debt management plans constructed free of
charge. This ``free'' service was possible because the primary
source of funding for the organization was contributions from
creditors through ``fair share'' contributions. Because the
organization provided assistance to low income individuals
without charge and provided education to the public, it
qualified for tax-exempt status under Section 501(c)(3).
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\18\ Providing credit counseling is not an inherently charitable
activity. Whether an organization providing credit counseling qualifies
for exemption under Section 501(c)(3) depends upon whether the manner
in which it provides such counseling serves recognized charitable or
educational purposes. Treas. Reg. Sec. 1.501(c)(3)-1(d)(2) provides
that the term ``charitable'' is used in Section 501(c)(3) in its
generally accepted legal sense, and includes relief for the poor and
distressed or underprivileged. ``Educational'' as used in Section
501(c)(3) includes instruction of the public on subjects useful to the
individual and beneficial to the community. Treas. Reg.
Sec. 1.501(c)(3)-1(d)(3)(i)(b).
\19\ Rev. Rul. 69-441, 1969-2 C.B. 115.
\20\ Id. at *2-3.
\21\ Id. at *3.
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In 1978, the U.S. District Court for the District of
Columbia expanded the activities a CCA could perform under
Section 501(c)(3) in Consumer Credit Counseling Service of
Alabama v. United States.\22\ The ``principal activities'' of
the CCAs were to, without charge, ``provide (a) information to
the general public, through the use of speakers, films, and
publications, on the subjects of budgeting, buying practices,
and the sound use of consumer credit, and (b) counseling on
budgeting and the appropriate use of consumer credit to debt-
distressed individuals and families.'' \23\ As an ``adjunct''
to those principal activities, agencies could enroll debtors in
a ``debt management program'' for a ``nominal'' fee which ``may
not exceed the sum of $10.00 per month'' and which is ``waived
. . . in instances where its payment would work a financial
hardship.'' \24\ Only an ``incidental'' amount of revenue was
to be realized by the agency through the debt management
programs.\25\
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\22\ No. 78-0081, 1978 U.S. Dist. LEXIS 15942 (D.D.C. Aug. 18,
1978); see also, Credit Counseling Centers of Oklahoma v. United
States, No. 78-1958, 1979 U.S. Dist. LEXIS 11741 (D.D.C. June 13,
1979).
\23\ Id. at *3.
\24\ Id. at *3-4.
\25\ Id. at *5.
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In this case, the IRS had revoked the exempt status of
Credit Counseling Services of Alabama because it did not
restrict its services to the poor and it charged a nominal fee
for its services. The IRS made this decision even though the
agency provided free information on credit to the public and
would waive its fee if it created a hardship. When CCCS of
Alabama challenged the revocation, the court found that the
agency fulfilled charitable purposes by educating the public on
subjects useful to the individual and beneficial to the
community without any fees.\26\ The court found the counseling
program was both educational and charitable. The court found
that the debt management plans were an integral part of the
agency's counseling function and thus were charitable and
educational as well. The court also found the DMPs were
incidental to the agencies' primary function of education
because the counselors spent only 12% of their time on the DMPs
and the fees were nominal.
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\26\ Treas. Reg. Sec. 1.501(c)(3)-1(d)(3)(i)(b).
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Existing case law indicates that an organization may
qualify for Section 501(c)(3) status if it is organized and
operated for charitable purposes. The term charitable includes
the relief of the distressed or poor.\27\ The term also
includes educational organizations. The term ``educational''
includes (1) instruction or training of an individual for the
purposes of improving or developing his/her capabilities and
(2) instruction of the public on subjects useful and beneficial
to the community.\28\ Thus the two components of education are
individual training and public education. Whether a CCA
operates exclusively for charitable purposes depends on the
application of the operational test set forth in the IRS code:
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\27\ Treas. Reg. Sec. 1.501(c)(3)-1(d)(2).
\28\ Id. at (3).
LAn organization will be regarded as ``operated
exclusively'' for [charitable] purposes only if it engages
primarily in activities which accomplish one or more
[charitable] purposes specified in Section 501(c)(3). An
organization will not be so regarded if more than an
insubstantial part of its activities is not in furtherance of a
[charitable] purpose.\29\
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\29\ Treas. Reg. Sec. 1.501(c)(3)-1(c)(1).
An organization is not organized or operated exclusively
for an exempt purpose unless it serves a public rather than a
private interest. To meet this requirement, an organization
must establish ``that it is not organized or operated for the
benefit of private interests such as designated individuals,
the creator or his family, shareholders of the organization, or
persons controlled, directly or indirectly, by such private
interests.'' \30\ This prohibition covers ``inurement'' of
earnings to insiders in the form of excessive compensation or
other benefits, but it can even apply where the benefit to the
private interest is reasonable compensation that is no more
than fair market value for the services.\31\ An organization
may also be considered to serve private interests if it
provides a substantial private benefit to outsiders who do not
constitute a charitable class.\32\
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\30\ Id. at (ii).
\31\ See, e.g., est of Hawaii v. Commissioner, 71 T.C. 1067 (1979)
(``Nor can we agree with petitioner that the critical inquiry is
whether the payments made to International were reasonable or
excessive. Regardless of whether the payments made by petitioner to
International were excessive, International and Est, Inc., benefited
substantially from the operation of petitioner.''); Church by Mail v.
Commissioner, 765 F. 2d 1387 (9th Cir. 1985).
\32\ See, e.g., American Campaign Academy v. Commissioner, 92 T.C.
1053, 1064 (1989), in which the Tax Court upheld denial of recognition
of exemption under Section 501(c)(3) of an organization that provided
training to political campaign workers because the organization's
services were provided to persons affiliated with a particular
political party.
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A charitable organization may operate a trade or business
if it furthers an exempt purpose. The regulations under Section
501(c)(3) provide:
An organization may meet the requirements of Section
501(c)(3) although it operates a trade or business as a
substantial part of its activities, if the operation of such
trade or business is in furtherance of the organization's
exempt purpose or purposes and if the organization is not
organized or operated for the primary purpose of carrying on an
unrelated trade or business. . . . In determining the existence
or nonexistence of such primary purpose, all circumstances must
be considered, including the size and extent of the trade or
business and the size and extent of the activities which are in
furtherance of one or more exempt purposes.\33\
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\33\ Treas. Reg. Sec. 1.501(c)(3)-1(e).
This test requires determining ``whether the [organization's]
exempt purpose transcends the profit motive rather than the
other way around.'' \34\ In the context of credit counseling,
the regulations require determining whether the goal of the
claimed educational activity is benefiting the public or simply
generating profits for individuals and related businesses.
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\34\ Elisian Guild, Inc. v. United States, 412 F.2d 121, 124 (1st
Cir. 1969), rev'g 292 F. Supp. 219 (D. Mass 1968).
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Tax-exempt CCAs face harsh penalties from the IRS if they
fail to confine their activities exclusively to educational and
charitable purposes. If a CCA is held to have conferred private
benefits or to have violated the prohibition on inurement, its
tax-exempt status is subject to revocation. In lieu of having
its exemption revoked, the IRS may instead choose to impose
``intermediate sanctions'' against the CCA or a related entity.
Intermediate sanctions may also be imposed upon certain
individuals who are not employed by the CCA but have engaged in
an ``excess benefit transaction'' with the CCA, meaning that
the person personally benefited from the CCA through, for
example, drawing an excessive salary. An excess benefit
transaction is any transaction where a CCA provides an economic
benefit to a ``disqualified person'' that has a greater value
than the value of goods or services that the CCA receives from
the disqualified person.\35\ The tax code provides that, where
an individual outside the CCA has substantial influence over
the affairs of the CCA and engages in an excess benefit
transaction with that CCA, the individual is subject to
sanction. The sanction imposed upon such an individual is an
excise tax equal to 25% of the excess benefit.\36\ Further, if
the individual fails to correct the harm caused by the excess
benefit transaction within the taxable period, a tax equal to
200% of the excess benefit may be assessed against the
individual.\37\
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\35\ 26 U.S.C. Sec. 4958(c)(1)(A). A ``disqualified person'' is
someone who, at any time during the 5 years preceding an excess benefit
transaction, was ``in a position to exercise substantial influence over
the affairs of the organization.''
\36\ 26 U.S.C. Sec. 4958(a)(1).
\37\ Id. at (b).
---------------------------------------------------------------------------
In addition to the serious tax consequences that could be
assessed against CCAs and their affiliated for-profit entities,
consumer protection laws provide additional protection against
improper conduct in the credit counseling industry. The Federal
Trade Commission (``FTC'') is charged with enforcing Section
5(a) of the FTC Act, which prohibits unfair and deceptive acts
or practices in or affecting commerce.\38\ Although the FTC
generally lacks jurisdiction to enforce consumer protection
laws against bona fide non-profits, it may assert jurisdiction
over a CCA if the FTC can demonstrate that the CCA is
``organized to carry on business for its own profit or that of
its members,'' that it is a ``mere instrumentality'' of a for-
profit entity, or that it is operating within a ``common
enterprise'' with one or more for-profit entities.\39\
---------------------------------------------------------------------------
\38\ 15 U.S.C. Sec. 45(a).
\39\ 15 U.S.C. Sec. 44; Sunshine Art Studios, Inc. v. FTC, 481 F.2d
1171 (1st Cir. 1973); Delaware Watch Co. v. FTC, 332 F.2d 745 (2d Cir.
1964).
---------------------------------------------------------------------------
The Subcommittee has uncovered alarming abuses of the
preceding regulations by three credit counseling conglomerates,
as described in the following section.
IV. DEBTWORKS, AMERIX, AND CAMBRIDGE: THREE CASE STUDIES
As noted above, the ``traditional'' CCA model has been in
operation for several decades. This model was generally a
community-based, modest operation with minimal overhead and
expenses. There were no large fees, no large executive
salaries, no high-priced advertising blitzes, and no expensive
marketing campaigns. Day-to-day operations were characterized
by face-to-face meetings between consumers and credit
counselors that lasted in some cases for several hours. If a
consumer enrolled in a DMP, the employees of the CCA would
negotiate with the consumer's various creditors, set up the
plan, and distribute payments to the creditors until the
consumer's debts were paid in full. The traditional CCA did not
``outsource'' any of its essential functions to for-profit
companies, and millions of dollars did not flow through the CCA
to for-profit companies.
The ``new'' CCA model has modified or even reversed the
practices of the traditional CCA. The new model is
characterized by high consumer fees and lucrative contracts
that benefit related for-profit companies. The revenue
generated through DMPs is seldom spent on improving or
expanding education or counseling, but rather on advertising,
marketing, and other activities unrelated to assisting
consumers with their financial problems. Although there are
likely scores of such new CCAs currently operating, this Report
focuses on the following three major debt management groups:
(1) DebtWorks and The Ballenger Group conglomerate, (2) the
Ascend One-Amerix conglomerate, and (3) the Cambridge-Brighton
conglomerate.
A. DebtWorks and The Ballenger Group Conglomerate
The first case study examines DebtWorks, Inc.
(``DebtWorks''), later purchased by The Ballenger Group, LLC
(``Ballenger''), which provides DMP processing services to 11
non-profit CCAs, including (1) AmeriDebt, Inc. (``AmeriDebt''),
(2) A Better Way Credit Counseling, Inc. (``A Better Way''),
(3) CrediCure, (4) Debticated Consumer Counseling, Inc.
(``Debticated''), (5) Debtscape, Inc. (``Debtscape''), (6)
DebtServe, Inc. (``DebtServe''), (7) Fairstream, Inc.
(``Fairstream''), (8) Mason Credit Counseling (``Mason''), (9)
Nexum Credit Counseling, Inc. (``Nexum''), (10) The Credit
Network, Inc. (``The Credit Network''), and (11) Visual Credit
Counseling (``Visual''). The aggregate consumer debt managed by
those 11 CCAs has exceeded $2.5 billion.\40\
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\40\ Letter from Ballenger to Subcommittee, dated 11/26/03, at
Exhibit A.
---------------------------------------------------------------------------
(1) Formation of DebtWorks and The Ballenger Group Conglomerate
DebtWorks was organized by Andris Pukke and his wife Pamela
Pukke (also known as Pamela Schuster). Andris Pukke entered the
credit counseling industry by organizing and operating a for-
profit CCA in Gaithersburg, Maryland, called Consumer Debt
Resources.\41\ In 1996, after the State of Maryland ordered
Consumer Debt Resources to cease operations because it was a
for-profit company, it began to wind down its affairs. At that
same time, however, Pamela Pukke was organizing a non-profit
CCA--AmeriDebt--Pamela Pukke acted as vice president,
secretary, and director of the new CCA.\42\ Although not listed
as an officer or director, Mr. Pukke regularly held himself out
to be the president of AmeriDebt.\43\
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\41\ Subcommittee interview of Ballenger representatives (3/12/04).
\42\ Articles of Incorporation, dated 12/23/96 (originally named
Consumer Counseling Services, Inc.); AmeriDebt Form 1023, dated 3/19/
97.
\43\ Subcommittee interview of Ballenger representatives (3/12/04).
---------------------------------------------------------------------------
After operating as a non-profit CCA for approximately 3
years, AmeriDebt decided to ``spin off'' its DMP processing
function and turn it into a for-profit entity called DebtWorks,
which was wholly owned and controlled by Mr. Pukke.\44\
DebtWorks was incorporated on July 21, 1999, purchased certain
assets of AmeriDebt on September 1, 1999, and signed its first
contract with AmeriDebt to provide DMP processing on the same
day.\45\ AmeriDebt simply moved its DMP enrollment employees to
a building next door while the DMP processing function
(DebtWorks) remained in AmeriDebt's original office space.\46\
AmeriDebt also opened ``branch'' DMP enrollment locations in
New York and Florida. AmeriDebt was initially DebtWorks' sole
client, but that was soon to change as AmeriDebt officers,
directors, and employees fanned out to form multiple CCAs, each
of which subsequently contracted with DebtWorks for DMP
processing services.
---------------------------------------------------------------------------
\44\ Articles of Incorporation of DebtWorks, Inc., Bates DWS
001538-1541.
\45\ Id.; Asset Purchase Agreement between AmeriDebt and DebtWorks,
dated 9/1/99, Bates DWS 001526-1535; Fulfillment Agreement between
AmeriDebt and DebtWorks, dated 9/1/99. AmeriDebt asserts that a
``disinterested board'' at AmeriDebt chose DebtWorks to be AmeriDebt's
DMP processor after reviewing several bids from other entities.
Subcommittee interview of AmeriDebt representative (2/27/04).
\46\ Subcommittee interview of AmeriDebt representative (2/27/04).
Most or all of the 11 non-profit DebtWorks CCAs were
organized by insiders of AmeriDebt or by friends of Mr. Pukke,
including: (1) Edward Catsos, the managing director of
AmeriDebt's Florida office and who also organized DebtServe;
\47\ (2) Edward's brother, James Catsos, who had served as
AmeriDebt's secretary and formed Debticated with Mr. Pukke's
brother, Eriks; \48\ (3) Andrew Smith, who served as interim
president for AmeriDebt and formed Fairstream; (4) William
Sargent, an AmeriDebt counseling manager who formed Debtscape;
\49\ (5) Jeffrey Formulak and Richard Brennan, respectively
vice president and general counsel of AmeriDebt who currently
operate CrediCure; \50\ and, (6) Harold Patrie, an AmeriDebt
counseling manager, who formed The Credit Network.\51\ Matthew
Case, the current chief operating officer of AmeriDebt and long
time family friend of Mr. Pukke, acted as president of The
Credit Network prior to his employment with AmeriDebt.\52\ This
proliferation of CCAs served both the interests of DebtWorks
and the various former AmeriDebt employees: DebtWorks was
affiliated with a larger number of CCAs and could therefore
capture a larger market share of the DMP enrollment business,
while the former AmeriDebt employees apparently paid themselves
higher salaries from their CCAs than they had received at
AmeriDebt.\53\
---------------------------------------------------------------------------
\47\ Id.
\48\ Id.
\49\ Id., AmeriDebt 1998 Form 990, p. 7.
\50\ Subcommittee interview of CrediCure representatives (4/7/04).
\51\ Id.; see also AmeriDebt 1998 Form 990, p. 7.
\52\ Deed of Lease Agreement for The Credit Network, dated 5/13/99.
\53\ For example, Eriks Pukke made approximately $51,000 as an
AmeriDebt counseling manager, but makes $85,000 as president of
Debticated. AmeriDebt 1997 Form 990, p. 7; Debticated 2002 Form 990, p.
4.
---------------------------------------------------------------------------
The Subcommittee investigation uncovered significant
evidence that these CCAs formed a common enterprise. Spirer &
Goldberg, P.C., a law firm with a long-time relationship with
Mr. Pukke, filed the Section 501(c)(3) applications for almost
every CCA in the current conglomerate, including AmeriDebt, A
Better Way, Mason, Nexum, Visual, The Credit Network, and
Debticated. Moreover, in its application to the IRS, Mason
listed its billing address as 12850 Middlebrook Road in
Germantown, Maryland--the address of DebtWorks. In addition,
some of these CCAs, such as Debticated, signed a contract with
DebtWorks before they were even granted non-profit status.\54\
At least two CCAs--A Better Way and Visual--received ``start-
up'' loans from Infinity Resources Group, Inc. (``Infinity
Resources''), a private lending institution wholly owned and
operated by Mr. Pukke.\55\ None of the Section 501(c)(3)
applications filed with the IRS by the new CCAs mentioned the
fact that the applicant CCA intended to contract with DebtWorks
for processing services, although each such CCA did.
---------------------------------------------------------------------------
\54\ Fulfillment Agreement between Debticated and DebtWorks (8/1/
00); Letter from IRS granting Section 501(c)(3) status to Debticated
(8/16/00).
\55\ See, e.g., A Better Way 2000 Form 990, indicating loan of
$150,000 from Infinity Resources.
---------------------------------------------------------------------------
At the end of 2002, Mr. Pukke formed Ballenger for the
purpose of purchasing the operating assets--the right to
service DMP accounts--from DebtWorks.\56\ The DebtWorks
managers then teamed with industry outsiders to execute a
management buyout from Mr. Pukke for $43 million, financed with
cash and a promissory note. Ballenger still owes Mr. Pukke and
DebtWorks more than $37 million on this promissory note.\57\
---------------------------------------------------------------------------
\56\ Subcommittee interviews of Ballenger representatives (1/15/04
and 3/12/04).
\57\ Id.
---------------------------------------------------------------------------
Since DebtWorks and The Ballenger transaction, Ballenger
has continued the practice of assisting with the organization
of CCAs. For example, both Debtserve and Fairstream obtained
start-up capital of $250,000 by way of a loan, which Ballenger
signed as a secondary guarantor.\58\ In addition, both
Debtserve and Fairstream were extended a functional line of
credit by Ballenger for remittance of initial payments that
were due to Ballenger.\59\
---------------------------------------------------------------------------
\58\ Subcommittee interview of Ballenger representatives (3/12/04).
\59\ Id.
---------------------------------------------------------------------------
(2) Control of the Affiliated Credit Counseling Agencies
DebtWorks exercised control of its affiliated CCAs through
certain contracts, termed ``Fulfillment Agreements,'' with each
CCA. Basically, the Fulfillment Agreements contracted all
functions of the CCAs to DebtWorks except for the actual
enrollment of consumers into DMPs: ``DebtWorks shall perform
all fulfillment, back-office, and customer relations services
for budget plan clients of [the CCA], with the exception of
intake and counseling services.'' \60\ In effect, the CCA
served as a mere ``call center'' from which consumers could be
enrolled into DMPs. All operations from that point forward were
contractually turned over to DebtWorks.
---------------------------------------------------------------------------
\60\ See, e.g., Fulfillment Agreement between DebtWorks and Mason,
dated September 6, 2001.
---------------------------------------------------------------------------
After Mr. Pukke sold the DMP portfolio of DebtWorks to
Ballenger, Ballenger added a new term to the Fulfillment
Agreements that conferred additional control over the CCAs.
Specifically, Ballenger added a term that charged each CCA a
standard fee of $50 for each new DMP enrollment, and an
additional $25 per month for each active DMP.\61\ However, if
the CCA could not for some reason obtain the standard fee from
the consumer, Ballenger required a minimum $20 start-up fee and
a minimum $10 monthly fee for each DMP. As a result, each CCA
was contractually required to pay Ballenger for each DMP that
it initiated and maintained. Each CCA was therefore required to
generate income from its consumers or be considered in breach,
regardless of the fact that the income it generated from
consumers supposedly consisted solely of ``voluntary''
contributions. The result was that Ballenger required each non-
profit CCA to pay it for DMP enrollment and maintenance, even
if a new DMP generated no revenue for the CCA. Such control
over the CCA's revenue limited the CCA's ability to direct
funding toward counseling, education, or other matters.
---------------------------------------------------------------------------
\61\ Id. at para. 4.1.
---------------------------------------------------------------------------
Other provisions in the Fulfillment Agreement further
demonstrated Ballenger's control over its CCAs. For example,
Ballenger required exclusive rights to each CCA's consumer
trust accounts and reserved the right to withdraw funds
electronically as well as draw checks on those accounts. In
fact, if the CCA itself accessed its account, it was deemed a
breach of the agreement subject to termination and entitled
Ballenger to ``liquidated damages.'' \62\ Another provision in
the Fulfillment Agreement allowed Ballenger to determine, by
its sole discretion, that (1) a CCA was in breach of the
agreement, and (2) if not cured within 30 days, Ballenger may
transfer the CCA's DMPs to another CCA serviced by
Ballenger.\63\ Thus a consumer that signed up for a DMP with a
particular CCA could be transferred to another CCA of
Ballenger's choice without consulting the consumer. In effect,
Ballenger had total control over the DMP once established.
---------------------------------------------------------------------------
\62\ Id. at para. 2.3.
\63\ Id. at para. 6.4.2.
---------------------------------------------------------------------------
(3) LPrivate Benefits to the For-Profit Corporations
DebtWorks reported gross revenues of $2,160,100 in 1999,
$15,411,072 in 2000, $38,066,044 in 2001, and $53,117,661 in
2002.\64\ These figures document a 2359% increase in gross
revenues over 3 years. In all, between 1999 and 2002, DebtWorks
obtained nearly $109 million in gross revenues from its ``non-
profit'' CCA affiliates. Even if those revenues were realized
by DebtWorks through arms-length transactions at fair market
value, the evidence suggests that the DebtWorks CCAs are not
operating exclusively for exempt purposes, and therefore, may
be in violation of tax regulations because they are providing
excess benefits.\65\ If the revenues received by DebtWorks from
their affiliated CCAs were the result of excess benefit
transactions, then intermediate sanctions may be warranted.\66\
---------------------------------------------------------------------------
\64\ DebtWorks 1999-2002 Form 1120S, Bates DWS 005411-5510.
DebtWorks was allegedly unable to provide the Subcommittee with
executed tax returns. This data was therefore taken from its draft
returns.
\65\ Treas. Reg. Sec. 1.501(c)(3)-1(a), see also, Private Benefit
Under IRC 501(c)(3), p. 135.
\66\ 26 U.S.C. Sec. 4958.
---------------------------------------------------------------------------
Servicing the DebtWorks portfolio has continued to be
lucrative for Ballenger since its transaction with DebtWorks.
In 2003, Ballenger realized gross receipts of $37,390,906.\67\
Ballenger is owed an additional $10.7 million from affiliated
CCAs, most of which are in arrears. Like DebtWorks' revenue,
all of the revenue received by Ballenger comes from consumers
who enroll in DMPs through the ``non-profit'' CCAs.
---------------------------------------------------------------------------
\67\ Ballenger Accounts Receivable, Bates 01241.
---------------------------------------------------------------------------
Mr. Pukke also continues to profit from Ballenger's CCAs by
offering consumers debt consolidation loans through his company
Infinity Resources. Several of the current Ballenger CCAs
operate a program where they refer consumers to Infinity
Resources, which charges a fee to process a consumer's loan
application and then profits from the interest earned on the
loan itself. For example, Eriks Pukke's CCA--Debticated--
promotes the Infinity Resources debt consolidation loan as a
key component of Debticated's program:
Debticated, Inc. is the ONLY company in the country that
offers such a unique and beneficial debt consolidation program.
Our ``six month'' program has revolutionized the debt
consolidation industry by providing clients with the benefits
associated with working with a non-profit credit counseling
company, combined with the opportunity for a complete debt
consolidation loan.
If you successfully complete the [six month] program we
will attempt to secure a debt consolidation loan for you. . . .
This is the ultimate goal of the program.\68\
---------------------------------------------------------------------------
\68\ Debticated promotional materials faxed to a consumer (name
withheld) on February 28, 2001 (emphasis in original).
This advertisement indicates that the stated goal of Debticated
is not to provide credit counseling, education, or debt
management, but rather to refer consumers to a for-profit
entity for a loan consolidation. Additionally, Debticated is
hardly the ``only'' CCA that offers debt consolidation loans
with Infinity Resources: A Better Way, The Credit Network, and
AmeriDebt all offer the same service.\69\ Mr. Pukke and
Infinity Resources have become the subject of a number of legal
actions for their treatment of consumers referred to Infinity
Resources by AmeriDebt. In addition to several civil lawsuits
brought against Infinity Resources, Mr. Pukke pleaded guilty in
1996 to a Federal charge of defrauding consumers by falsely
promising to broker debt-consolidation loans while pocketing
excessive application fees.\70\ Nevertheless, between 1999 and
2002, Infinity Resources reported gross revenues in excess of
$8.3 million.\71\
---------------------------------------------------------------------------
\69\ A Better Way Form 1023, Tab D, dated January 20, 2000; The
Credit Network Form 1023, Tab D, dated September 23 1999; Caroline E.
Mayer, ``Easing the Credit Crunch?,'' The Washington Post, November 4,
2001.
\70\ Caroline E. Mayer, ``Easing the Credit Crunch?,'' The
Washington Post, November 4, 2001.
\71\ Infinity Resources 1999-2002 Form 1120S, Bates DWS 005289-
5410. Infinity Resources was allegedly unable to provide the
Subcommittee with executed tax returns. This data was therefore taken
from its draft returns.
---------------------------------------------------------------------------
A referral by a non-profit CCA to a for-profit entity for
debt consolidation loans does not serve any educational or
charitable purpose. Such referral activities, if more than
insubstantial, may constitute a private benefit to Infinity
Resources that is prohibited under the tax code and could
support revocation of the Section 501(c)(3) status of any
Ballenger CCA that makes such referrals. If the revenues
received by Infinity Resources between 1999 and 2002 were the
result of excess benefit transactions, then intermediate
sanctions may be warranted.\72\
---------------------------------------------------------------------------
\72\ 26 U.S.C. Sec. 4958.
---------------------------------------------------------------------------
(4) Harm to Consumers
Consumer Jolanta Troy, who was harmed by AmeriDebt,
testified about her experiences at the hearing on March 24,
2004. Ms. Troy was a 46-year-old mother of two children, ages
11 and 16, when she heard an AmeriDebt radio commercial. Ms.
Troy had recently been divorced and began accumulating debt
soon thereafter. Her job as a behavior specialist consultant
working with mentally ill and behaviorally challenged children
did not provide her with enough income to repay $30,000 in
credit card debt and support her children. Ms. Troy contacted
AmeriDebt in 2001, and was informed by Vicky, an AmeriDebt
``counselor,'' about the benefits of enrolling in a DMP. Ms.
Troy told Vicky that she wanted to think about whether to sign
up for a DMP, but soon thereafter received 3 to 4 additional
calls from AmeriDebt, pressuring her to enroll.
Ms. Troy agreed to enroll and was told that her first
payment would be $783. She was told to rush the payment by
Western Union ``so that her bills would be paid on time.''
Vicky told her that she could make a voluntary contribution at
a later date when she was more financially stable. Ms. Troy
mailed in her $783 payment, but continued to receive calls from
creditors. She then called AmeriDebt to inquire about her
account and was informed that AmeriDebt had kept her first
payment and had sent nothing to her creditors. Ms. Troy
requested a refund and was denied, even after complaining to
the Better Business Bureau. Ms. Troy then believed her only
option was to declare bankruptcy, which she did later that
year. Needless to say, she received no counseling or education
from AmeriDebt during any of their telephone conversations.\73\
---------------------------------------------------------------------------
\73\ Subcommittee interview with Jolanta Troy (3/15/04).
---------------------------------------------------------------------------
Ms. Troy's experience with AmeriDebt appears to be all too
common. Like most consumers with severe financial problems, Ms.
Troy was vulnerable to the sales pitch of a company claiming to
be a ``non-profit'' that would solve all her debt problems. She
testified, ``The counselor said that AmeriDebt was a non-
profit--like a charity--and I needed their help. Because
AmeriDebt said it was a non-profit, I thought I could trust
them.'' AmeriDebt counselors preyed on her fears and
vulnerabilities with high-pressure sales tactics that were
intrusive and often belittling.
At the Subcommittee's hearing, Senator Carl Levin
questioned Matthew Case, the President of AmeriDebt, about such
tactics. Senator Levin asked Mr. Case about an AmeriDebt script
that tells employees how to respond to a consumer that says,
``I can't afford a contribution right now but maybe I can
afford to contribute later.'' The AmeriDebt script instructs
the counselor to respond with:
If you can afford to make a monthly payment, you can
afford to make a contribution. That contribution is not going
into our pocket. It is going to cover the costs of setting you
up on the program. Would you rather have that payment go to us
to help people like you get out of debt or would you like it to
go into the creditor's pocket as extra interest? Would you
rather support a non-profit company or help a bank get richer?
\74\
---------------------------------------------------------------------------
\74\ Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, March 24, 2004, Official Hearing Record, Exhibit No.
14, p. 260.
Senator Levin asked Mr. Case ``If you don't call that
pressure on somebody to make a contribution how would you label
that?'' ``I would call it pressure,'' Mr. Case said.
Other examples of instructing AmeriDebt counselors how to
quickly make a ``sale'' are found in the AmeriDebt employee
training manual:
If you can assume a position of authority, you
will find that people give it over to you without resistance.
\75\
---------------------------------------------------------------------------
\75\ Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, March 24, 2004, Official Hearing Record, Exhibit No.
12, p. 258.
Create a sense of urgency, ``Your creditors want
you to get started as soon as possible. The quicker you get
started, the faster you will be out of debt.'' \76\
---------------------------------------------------------------------------
\76\ Id.
Be prepared! If you can't answer questions or
make the right point, it could be the difference in a sale or
no sale. \77\
---------------------------------------------------------------------------
\77\ Id.
By focusing on the sale of DMPs, the consumer misses
valuable counseling and education addressing the source of the
consumer's financial problems. Senator Mark Dayton asked Mr.
Case at the hearing, ``Where is the counseling? What is the
content of the counseling?'' Mr. Case replied, ``Right up
front, there is a budget analysis done right away because
different people are in different situations.'' The
Subcommittee finds that a simple budget analysis solely to
determine if a consumer is a candidate for a DMP fails to meet
the charitable purpose required of tax-exempt organizations. In
addition, the consumer's desperate state generally makes it
easier for AmeriDebt, and other companies like it, to persuade
consumers to ``buy'' a DMP at inflated prices with few
services. As in Ms. Troy's case, the non-profit status often
provides a sense of trustworthiness that lowers the consumer's
scrutiny of both the DMP and AmeriDebt.
The Subcommittee's investigation also determined that the
fee Ms. Troy was charged bore no relation to the cost of the
services that would have been provided to her by AmeriDebt. The
initial DMP start-up fee charged by AmeriDebt and the other 10
CCAs serviced by DebtWorks and Ballenger is based upon the
consumer's aggregate debt, rather than the actual expense of
initiating a DMP. Specifically, the consumer is generally asked
to make a contribution equaling 3% of their aggregate debt. For
example, if a consumer owes a total of $25,000 the initial
``contribution'' would be $750 (3% of $25,000). In contrast,
the start-up fee at the average NFCC member agency for a
consumer who owes $25,000 would be $23.09.\78\
---------------------------------------------------------------------------
\78\ NFCC 2002 Member Activity Report, p. 30.
---------------------------------------------------------------------------
Furthermore, as in the case of Ms. Troy, consumers are
often left with the impression that this initial fee amount
will be sent to their creditors, when in fact it is retained by
the CCA. Ms. Troy testified at the Subcommittee's hearing, ``I
could not afford to give AmeriDebt almost $800. I thought the
money would go to my credit cards to pay down the balances.''
Aside from the initial start-up ``contribution,'' Ballenger
also charged consumers a monthly DMP maintenance
``contribution.'' Again, the contribution amount was not based
upon actual costs or the value of the service to the consumer,
but upon the number of credit cards included in the DMP--
generally $7 per credit card with a minimum of $20 per month
and a maximum of $70 per month. Average monthly fees at NFCC
members, in contrast, are $10 per month.
The profit motive of AmeriDebt is also illustrated through
its employee management practices. John Paul Allen, a former
AmeriDebt ``counselor,'' testified at the hearing, ``I should
have seen a red flag during my interview with AmeriDebt when I
was asked by my interviewers to sell them a stapler. That is
really what AmeriDebt is about--sales.'' AmeriDebt's objectives
are evident through management incentives such as bonuses for
DMPs both in quantity and quality--the more DMPs signed up and
the larger the first up-front payment, the larger the bonus for
the counselor.\79\ NFCC and AICCCA member CCAs do not allow
incentives tied to DMPs, because it gives counselors a motive
to place consumers on DMPs instead of just providing counseling
or financial education. In fact, Mr. Allen was reprimanded
repeatedly for informing his customers that they did not have
to pay the ``voluntary contribution.'' Allen testified, ``My
managers would say `Think of all the money you could make if
you would collect those voluntary contributions.' '' When
consumers were hesitant to give a contribution, Allen
testified, ``We were instructed to say things like `Don't you
want us to be around for the next person?' or we would tell
them that we were a non-profit and thus subject to audit by the
IRS.'' \80\
---------------------------------------------------------------------------
\79\ Subcommittee interview with John Paul Allen (2/21/04).
\80\ Id.
---------------------------------------------------------------------------
Customer service was another AmeriDebt issue Allen had
concerns with.\81\ He testified, ``I would get calls from
people two and three months after I set them up on a plan,
complaining that their creditors still had not received a
payment.'' These situations, like Ms. Troy's, are examples of
consumers who were unaware AmeriDebt would keep the first
payment. Since their creditors did not receive payment, the
consumers accrued monthly late fees, and could end up in a
worse financial predicament than when they started with
AmeriDebt.
---------------------------------------------------------------------------
\81\ Id.
---------------------------------------------------------------------------
B. The Ascend One-Amerix Conglomerate
The second case study examines the Ascend One-Amerix
conglomerate. Amerix Corporation (``Amerix'') provides DMP
processing services for five non-profit CCAs: (1) American
Financial Solutions (``AFS''); (2) Genesis Financial
Management, Inc. (``Genesis''); (3) Consumer Education
Services, Inc. (``CESI''); (4) Clarion Credit Management
(``Clarion''); and (5) Debt Management Group. The combined
consumer debt under the management of these five CCAs exceed
$4.1 billion.\82\
---------------------------------------------------------------------------
\82\ Amerix Active Clients and Total Debt as of October 2003, Bates
AMX 000001.
---------------------------------------------------------------------------
(1) Formation of the Ascend One-Amerix Conglomerate
Amerix is one of four for-profit companies wholly owned by
a holding company called Ascend One Corporation (``Ascend
One''), 87% of which is owned by Bernaldo Dancel, the President
and CEO of Ascend One.\83\ An organizational chart of Ascend
One and its affiliates is shown below:
---------------------------------------------------------------------------
\83\ Stockholders of Ascend One Corporation, Bates AMX 000008.
In November 1992, Mr. Dancel founded a non-profit CCA
called Genus Credit Management (``Genus''). In October 1996,
Mr. Dancel split Genus into two parts, dividing the counseling
function and DMP portfolio from the processing function. On
October 3, 1996, Mr. Dancel incorporated Amerix as a for-profit
business to provide DMP processing services for the Genus DMP
portfolio. Mr. Dancel severed his management ties to Genus
around that same time in order to run Amerix.
Over the next several years, Amerix facilitated the
establishment of several CCAs to serve as sources of revenue
for Amerix. Amerix approached community colleges and
universities with the express purpose of proposing a ``start-
up'' CCA.\84\ In all, between 1998 and 2003, Amerix made
presentations to almost 30 colleges and universities.\85\ Under
normal circumstances, a new CCA is required to apply to the IRS
for Section 501(c)(3) status. The IRS then has the opportunity
to review the application of each new CCA and determine whether
the applicant qualifies for non-profit status. However, by
finding existing Section 501(c)(3) organizations (such as
community colleges and universities) that could be used to
establish CCAs, Amerix facilitated the establishment of new
CCAs while bypassing the scrutiny of the IRS associated with
applying for new Section 501(c)(3) status. In this manner, AFS
was organized under the Section 501(c)(3) status of the North
Seattle Community College Foundation.\86\ Other Amerix CCAs
such as Clarion and Debt Management Group were similarly
organized through pre-existing Section 501(c)(3) entities that
did not perform credit counseling services prior to their
relationship with Amerix.\87\ This practice effectively side-
stepped IRS review of these new entrants into the credit
counseling industry.
---------------------------------------------------------------------------
\84\ Subcommittee interview of Amerix representative (1/30/04).
\85\ See list of colleges, universities, and non-profits presented
with start-up opportunity, Bates AMX 001732.
\86\ Letter from AFS to Subcommittee, dated 11/19/03.
\87\ Telephone interview of Clarion representative (3/9/04).
---------------------------------------------------------------------------
In addition to Amerix (which provided DMP processing
services), Ascend One created additional for-profit
corporations to serve its CCAs, including FreedomPoint, 3C
Inc., and FreedomPoint Financial. FreedomPoint marketed various
specialized products such as ``prepaid'' credit cards and tax
settlement products to consumers carrying significant debt.\88\
3C Inc. owned the ``CareOne'' service mark under which Amerix's
CCAs are marketed to the public. FreedomPoint Financial served
as a mortgage broker and marketed mortgage-related products to
highly indebted consumers. Ascend One also operated a website
called ``CareOne,'' which functioned as a referral service,
matching inquiring consumers with the closest CCA in the Ascend
One conglomerate.
---------------------------------------------------------------------------
\88\ Subcommittee interview of Amerix representative (1/30/04).
---------------------------------------------------------------------------
Some of the five CCAs in the Ascend One conglomerate
referred consumers to FreedomPoint and FreedomPoint Financial.
As noted above, a CCA will not be regarded as tax-exempt ``if
more than an insubstantial part of its activities is not in
furtherance of an exempt purpose.'' \89\ Referrals by a non-
profit CCA to for-profit entities selling credit cards,
mortgage brokerage services, and other products are
questionable because a non-profit must serve an educational or
charitable purpose. Such referral activities, if more than
insubstantial, may constitute a private benefit to Ascend One
that is prohibited under the tax code and could lead to
revocation of the Section 501(c)(3) status of each CCA that
makes such referrals.
---------------------------------------------------------------------------
\89\ Treas. Reg. Sec. 1.501(c)(3)-1(c), see also, Private Benefit
Under IRC 501(c)(3), pp. 135-39.
---------------------------------------------------------------------------
(2) Control of the Affiliated Credit Counseling Agencies
Although Amerix did not own any of the five CCAs it helped
to establish, Amerix exerted control over them through its
Service Agreements. The Service Agreements were generally
entered into by Amerix and a new CCA as part of the CCA's
``start-up'' arrangement. A key term in Amerix's Service
Agreement required CCAs to enroll 30% of their callers onto a
DMP: ``During the Term, [the CCA] agrees to maintain an Assist
Rate of not less than 30%'' where ``Assist Rate'' is defined as
``the ratio of Client Commitments to First Time Calls per
Counselor per month.'' \90\ That meant for every 10 calls
received by a CCA, at least three must be placed into a DMP or
the CCA was considered in breach of contract. Indeed, Amerix
has taken legal action against one of its CCAs--Genesis--for
its failure to maintain a 30% ``assist rate.'' \91\ Such
contractual requirements essentially remove the discretion and
judgment of a credit counselor as to which consumers they
should enroll in DMPs.
---------------------------------------------------------------------------
\90\ Service Agreement between Amerix and Genesis Financial
Management, Inc., dated 9/9/02, para. 14. Amerix's other CCAs are also
required to carry an Assist Rate of 30%.
\91\ Amerix Corporation v. Genesis Financial Management, Inc., No.
16 Y 181 00463 03, Before the American Arbitration Association, filed
on 9/2/03.
---------------------------------------------------------------------------
In addition to the ``assist rate'' requirement, additional
provisions in the Service Agreements required each DMP to
generate a minimum of $30 each month per DMP, termed the
``revenue standard.'' \92\ This requirement meant that each CCA
was contractually required to find money from some source for
each DMP to meet the ``revenue standard'' in their Service
Agreement. Each CCA was therefore required to generate income
from its consumers or be considered in breach, regardless of
the fact that all income generated from consumers was
supposedly ``voluntary.''
---------------------------------------------------------------------------
\92\ See, e.g., Service Agreement between Amerix and AFS, dated 10/
18/02, para. 15.
---------------------------------------------------------------------------
The control granted to Amerix through the ``assist rate''
and ``revenue standard'' provisions indicates that Amerix's
CCAs may be operating for a private, rather than public,
purpose. Control of a non-profit by a for-profit is not
permitted under the Internal Revenue Code due to the potential
for abuse of the non-profit agency by the for-profit
corporation. If a CCA ``is closely controlled . . . by . . . a
for-profit management company that operates with a great amount
of autonomy'' then the CCA must establish that the CCA is not
organized or operated for the benefit of private interests,
according to the IRS.\93\ This analysis is called the
``operational test'' and is usually conducted during the
Section 501(c)(3) application process. Amerix's practice of
organizing CCAs through existing Section 501(c)(3) entities,
however, deprived the IRS of the opportunity to determine the
extent of control that Amerix would possess over associated
CCAs when first established.
---------------------------------------------------------------------------
\93\ Private Benefit Under IRC 501(c)(3), p. 136.
---------------------------------------------------------------------------
(3) Private Benefits to the For-Profit Corporations
On November 1, 2001, Mr. Dancel sold Genus' DMP portfolio
to AFS for $17 million. AFS told the Subcommittee that the sale
price of the Genus portfolio was based upon the future revenues
that would be generated by the portfolio from fees and fair
share payments over a period of several years.\94\ AFS,
however, was already under contract to pay Amerix for
processing services on all of AFS's DMP accounts. Therefore,
AFS paid $17 million to Amerix for the DMP portfolio itself,
and since that time has paid Amerix out of the revenues
generated by the same portfolio. For example, in fiscal year
2001, AFS paid Amerix more than $70 million in processing fees
for servicing their DMP portfolio and paid back over $7.4
million of the outstanding loan.\95\ Such ``double payment'' by
AFS to Amerix for the same goods and services may constitute an
excess benefit transaction under the Internal Revenue Code, and
could subject Amerix to excise taxes on any excess benefit.\96\
---------------------------------------------------------------------------
\94\ Subcommittee interview of AFS representative (1/22/04).
\95\ AFS 2001 Form 990.
\96\ 26 U.S.C. Sec. 4958.
---------------------------------------------------------------------------
Amerix and Ascend One have enjoyed great financial benefits
from their contracts with the CCAs. Under the terms of Amerix's
``Fee Schedule,'' Amerix was to receive between 50-85% of every
dollar received by the CCA. If a consumer contacted an Amerix
CCA directly and enrolled in a DMP, then Amerix was to receive
50% of all the non-profit's revenue--enrollment fees, monthly
fees, voluntary contributions, and creditor fair share
payments--generated by that DMP in exchange for Amerix's
processing services.\97\ If the consumer contacted and enrolled
with the CCA as a result of a referral from Amerix, Amerix was
then entitled to 68% of all revenue generated by the DMP.\98\
Finally, if a consumer enrolled in a DMP entirely through the
``CareOne'' website, then Amerix was entitled to 85% of all
revenue generated by the DMP.\99\ Such pricing levels were
based not upon the cost of the processing services provided by
Amerix, but rather upon the results of lead generation and
marketing activities.
---------------------------------------------------------------------------
\97\ See, e.g., Service Agreement between Amerix and AFS, dated 10/
18/02, Schedule B, p. 20.
\98\ Id.
\99\ Subcommittee interview of Genesis representative (2/24/04).
The questionable practice of enrolling on a DMP entirely through the
Internet is discussed below.
---------------------------------------------------------------------------
The Service Agreements have, in fact, been lucrative for
Amerix. Amerix reported gross revenues of $43,292,677 in 1998,
$79,805,084 in 1999, $91,686,853 in 2000, $76,382,167 in 2001,
and $95,286,442 in 2002.\100\ These figures represent an
increase of 120% in gross revenues during this time period. In
all, between 1998 and 2002, Amerix received $386 million in
gross revenues--all of which was generated by the ``non-
profit'' credit counseling industry. Even if the amounts above
had been realized by Amerix through arms-length transactions at
fair market value, the absence of any charitable or educational
purpose suggests that the Amerix CCAs were not operating
exclusively for exempt purposes and therefore may be in
violation of tax regulations.\101\ If the revenues received by
Amerix between 1998 and 2002 were the result of excess benefit
transactions, then intermediate sanctions may be warranted
against Amerix.\102\
---------------------------------------------------------------------------
\100\ Amerix/Ascend One 1998-2002 Form 1120S, Bates AMX 001452-
1730.
\101\ Treas. Reg. Sec. 1.501(c)(3)-1(a); see also, Private Benefit
Under IRC 501(c)(3), p. 135.
\102\ 26 U.S.C. Sec. 4958.
---------------------------------------------------------------------------
(4) Harm to Consumers
Like DebtWorks CCAs, some Amerix CCAs charged excessive DMP
fees. On the other hand, at least two Amerix CCAs--AFS and Debt
Management Group--had capped their fees as a result of their
membership in the Association of Independent Consumer Credit
Counseling Agencies. As such, the harm caused to consumers from
unreasonable DMP fees was greatly mitigated at these two CCAs.
Even these Amerix CCAs, however, failed consumers by neglecting
to provide adequate counseling and education.
Amerix CCAs provided few services to their clients. Through
Ascend One's ``CareOne'' website and links at each of the
Amerix CCA websites, a consumer was permitted to enroll in a
DMP without a single contact with a credit counselor at any of
the five CCAs in the Amerix conglomerate. Since a CCA's
charitable status is largely dependent upon its providing
educational services, there is no reasonable reading of IRS
regulations or case law that permits a CCA to enroll a consumer
into a DMP without the consumers interacting with a credit
counselor.\103\
---------------------------------------------------------------------------
\103\ See, e.g., Consumer Credit Counseling Service of Alabama v.
United States, No. 78-0081, 1978 U.S. Dist. LEXIS 15942 (D.D.C. Aug.
18, 1978).
---------------------------------------------------------------------------
Until March 24, 2004, Amerix employed between 30 and 40
``credit counselors'' at its location in Columbia, Maryland.
These ``counselors'' provided DMP enrollment services for
Amerix's affiliated CCAs when a particular CCA could not at
that moment provide services to a consumer. For instance, if a
consumer on the East Coast telephoned AFS (located in Seattle)
during the morning hours (before AFS was open for business) the
caller was routed to Amerix in Maryland. From there, an Amerix
``credit counselor'' enrolled the consumer in a DMP. Any CCA
that knowingly allowed its services to be transferred to a for-
profit company, however, may be placing itself in jeopardy of
losing its license in states that allow only non-profit
agencies to provide credit counseling services.
Amerix stated that the reason why it approached colleges
and universities to pitch CCA ``start-up'' opportunities was
because those organizations could educate consumers about their
finances.\104\ It does not appear, however, that any Amerix
CCAs provide classes to consumers on credit practices or
budgeting. Genesis told the Subcommittee that it would like to
provide counseling and education, but it was unable to do so
due to a lack of funds after making the payments required under
its Service Agreement with Amerix.\105\
---------------------------------------------------------------------------
\104\ Subcommittee interview of Amerix representative (1/30/04).
\105\ Subcommittee interview of Genesis representative (2/24/04).
---------------------------------------------------------------------------
Consumers who actually enrolled in a DMP with AFS were
allowed access to a website that had some form of interactive
program regarding spending and budgeting.\106\ However, AFS did
not permit consumers who did not enroll in a DMP to have access
to that website even though AFS's non-profit mission is to
provide counseling and education to all consumers in need of
such help.
---------------------------------------------------------------------------
\106\ Subcommittee interview of AFS representative (1/22/04).
---------------------------------------------------------------------------
AFS told the Subcommittee that, originally, it had high
hopes of raising funds for grants and scholarships for students
enrolled at North Seattle Community College. On March 18, 2002,
shortly after AFS acquired the DMP portfolio of Genus, the CEO
of AFS stated that ``we're generating more revenue than the
foundation ever did. We anticipate giving (North Seattle
Community College) in the multimillions of dollars over the
next few years'' and expected that their next donation would
perhaps be in the million-dollar range.\107\ Although AFS
obtained gross revenues of $75,165,312 during the following
fiscal year, it managed to donate only 0.8% of that amount
($581,766) for the college's grants and scholarships.\108\
Ironically, 2 years prior to the AFS-Genus transaction, when
AFS had total revenues of just $4,180,059, it donated 16% of
that amount ($673,306) in grants and scholarships.\109\
---------------------------------------------------------------------------
\107\ Jeanne Lang Jones, ``A Strong Foundation: $17M Purchase Makes
College's Nonprofit Arm the Largest U.S. Credit Counseling Firm,''
Puget Sound Business Journal, March 18, 2002.
\108\ AFS 2002 Form 990, pp. 1-2, Bates AFS 01849-01882.
\109\ AFS 2000 Form 990, pp. 1-2.
---------------------------------------------------------------------------
C. The Cambridge-Brighton Conglomerate
The third case study examines the Cambridge-Brighton
conglomerate, a complex web of interrelated non-profit and for-
profit entities with overlapping directorates and ownership.
The Subcommittee's investigation has determined that the
operations of the Cambridge-Brighton conglomerate were
completely integrated and controlled by brothers John and
Richard Puccio. Brighton Debt Management Services, Ltd.
(``Brighton DMS'') provided DMP processing services to three
CCAs: (1) Cambridge Credit Counseling Corp., a non-profit CCA
based in Massachusetts; (2) Brighton Credit Management Corp., a
for-profit CCA based in Florida; and (3) Cambridge/Brighton
Budget Planning Corp., a CCA based in New York with a pending
application for Section 501(c)(3) status. Debt Relief
Clearinghouse Ltd. was the for-profit marketing arm for the
conglomerate, and Cypress Advertising & Promotions, Inc.
(``Cypress'') provided advertising services.\110\ Brighton DMS
processed DMP accounts amounting to approximately $900 million
of consumer debt.
---------------------------------------------------------------------------
\110\ Subcommittee interview of Cambridge and Brighton DMS
representatives (1/20/04).
(1) Formation of the Cambridge-Brighton Conglomerate
The Cambridge-Brighton conglomerate was originally
organized by John and Richard Puccio as a for-profit
enterprise. Two entities--Cambridge Credit Corporation
(``Cambridge Credit'') and Brighton Credit Corporation
(``Brighton Credit'')--were incorporated on April 20, 1993 and
October 28, 1993, respectively, as for-profit corporations in
New York.\111\ The two entities operated out of the same
location.\112\ Cambridge Credit performed the DMP enrollment
function while Brighton Credit performed the DMP processing
services.\113\ In 1996, after operating for approximately 3
years, the New York Banking Department served a cease and
desist order prohibiting the two entities from performing
credit counseling services in New York because they were for-
profit organizations.\114\
---------------------------------------------------------------------------
\111\ Cambridge Credit Corporation 1998 Form 1120S, Bates 00297-
312; Brighton Credit Corporation 1998 Form 1120S, Bates 00230-243.
\112\ Id.
\113\ Subcommittee interview of Cambridge and Brighton DMS
representatives (1/20/04).
\114\ Id.
---------------------------------------------------------------------------
The Puccio brothers moved their principal operations to
Massachusetts where they formed several new corporations,
including Cambridge Credit Counseling Corp. (``Cambridge'') and
Brighton Credit Corporation of Massachusetts (``Brighton
Mass.''), later known as Brighton Debt Management Services
(``Brighton DMS).\115\ As was the case in New York, one
entity--Cambridge--was organized to perform the DMP enrollment
function while a for-profit entity--Brighton Mass.--was
organized to perform the DMP processing and to lease equipment,
personnel, software, and provide ``other services'' to
Cambridge.\116\ Cambridge applied for Section 501(c)(3) status,
which was granted by the IRS on February 12, 1998.\117\ In
terms of aggregate debt, Cambridge is currently the largest CCA
in the Cambridge-Brighton conglomerate.
---------------------------------------------------------------------------
\115\ Brighton Mass. 1998 Form 1120S, Bates 00423-435 (Brighton
DMS, incorporated on March 21, 2003, was originally incorporated and
did business as ``Brighton Credit Corporation of Massachusetts'').
\116\ Cambridge 1997 Form 990, p. 16, Bates 00175; Subcommittee
interview of Cambridge and Brighton DMS representatives (1/20/04).
Brighton DMS was incorporated on March 21, 2003 to perform DMP
processing for all Cambridge-Brighton CCAs.
\117\ Letter from IRS to Cambridge, dated 2/12/98, Bates 00002-4.
---------------------------------------------------------------------------
Despite the cease and desist order from the New York
Banking Department, John and Richard Puccio incorporated
another New York entity--the non-profit Cambridge/Brighton
Budget Planning Corporation (``Cambridge/Brighton'')--on
December 6, 1996.\118\ Cambridge/Brighton operated in the same
space previously occupied by Cambridge Credit and Brighton
Credit.\119\ Like Cambridge, Cambridge/Brighton was under
contract with Brighton DMS for all processing services
associated with its DMP portfolio. A third CCA was organized as
a for-profit corporation in Florida--Brighton Credit Management
Corp. (``Brighton Credit Management''). Like Cambridge and
Cambridge/Brighton, Brighton Credit Management outsourced all
of its DMP processing services to Brighton DMS.
---------------------------------------------------------------------------
\118\ Cambridge/Brighton Attachment to Form 1023, Bates 20698.
\119\ Cambridge/Brighton 2002 Form 990, Bates 20643-65.
---------------------------------------------------------------------------
In addition, the Puccio brothers created two other wholly-
owned and controlled, for-profit entities that conducted
business with the three Cambridge-Brighton CCAs. On July 17,
1996, Cypress Advertising & Promotions, Inc. was created by the
Puccios to ``procure advertising space/time'' for the
Cambridge-Brighton CCAs. On January 27, 2000, another for-
profit company named Debt Relief Clearinghouse, Ltd. (``Debt
Relief'') was created by the Puccios to ``produce television
infomercials'' and operate a call center to screen calls for
the Cambridge-Brighton CCAs.\120\ Both Cypress and Debt Relief
operated from the same location as Cambridge/Brighton in New
York. Each of the Cambridge-Brighton CCAs paid Debt Relief and
Cypress for their services. In sum, although credit counseling
is supposedly a ``non-profit'' industry, only two entities
within the Cambridge-Brighton conglomerate were organized as
non-profits. All of the revenue realized by the conglomerate
was generated by consumers who enrolled in DMPs.
---------------------------------------------------------------------------
\120\ Debt Relief 2000 Form 1120S, Bates 00333-340; Cambridge/
Brighton Attachment to Form 1023, Bates 20701.
---------------------------------------------------------------------------
(2) Control of the Affiliated Credit Counseling Agencies
Unlike the Amerix and Ballenger conglomerates that
exercised control over their CCAs through the terms of complex
service contracts, the principals of Brighton DMS actually
owned or controlled each of their three CCAs, Cambridge,
Cambridge/Brighton, and Brighton Credit Management, as well as
all of the affiliated for-profit entities, Brighton DMS, Debt
Relief, Cypress, Cambridge Credit, and Brighton Credit. The
Cambridge-Brighton non-profit CCAs (Cambridge and Cambridge/
Brighton) were controlled by John and Richard Puccio through
their positions as directors, officers, and ``key employees.''
John and Richard Puccio have served as directors of Cambridge
since its inception.\121\ John Puccio served as president and
director of Cambridge/Brighton, and Richard Puccio served as
``strategic planner.'' \122\ Additionally, the for-profit
entities in the Cambridge-Brighton conglomerate were wholly or
collectively owned by John and Richard Puccio:
---------------------------------------------------------------------------
\121\ Cambridge Schedule of Officers and Directors, Bates 01120-
01125.
\122\ Cambridge/Brighton 2002 Form 990, p. 4, Bates 20646.
\123\ Brighton Credit Management 2002 Form 1120S, Schedule K-1.
\124\ Subcommittee interview of Cambridge and Brighton DMS
representatives (1/20/04); Brighton Mass. 1998 Form 1120S, Bates 00432.
\125\ Debt Relief 2000 Form 1120S, Bates 00339.
\126\ Cypress 2000 Form 1120S, Bates 00364.
\127\ Cambridge Credit 1998 Form 1120S, Bates 00309.
\128\ Brighton Credit 1998 Form 1120S, Bates 00240.
------------------------------------------------------------------------
CAMBRIDGE-BRIGHTON FOR-PROFIT JOHN PUCCIO (% RICHARD PUCCIO
ENTITIES Ownership) (% Ownership)
------------------------------------------------------------------------
Brighton Credit Management \123\ 100% 0%
------------------------------------------------------------------------
Brighton Mass.\124\ 50% 50%
------------------------------------------------------------------------
Brighton DMS 50% 50%
------------------------------------------------------------------------
Debt Relief \125\ 100% 0%
------------------------------------------------------------------------
Cypress \126\ 100% 0%
------------------------------------------------------------------------
Cambridge Credit \127\ 50% 50%
------------------------------------------------------------------------
Brighton Credit \128\ 50% 50%
------------------------------------------------------------------------
Through their joint ownership and control of each entity in
the Cambridge-Brighton conglomerate, John and Richard Puccio
directed all operations and executed all contracts. Almost
every possible operation of Cambridge, for example, was
contracted out to a related for-profit entity. Cambridge paid
Brighton DMS to provide processing for Cambridge's DMP
portfolio.\129\ Cambridge paid Brighton Mass. to lease its
equipment, personnel, and software.\130\ Cambridge paid Debt
Relief for referrals of consumers \131\ and paid Cypress to
place advertising.\132\ The level of control over the
Cambridge-Brighton entities by John and Richard Puccio is
illustrated by the fact that some of the entities within the
conglomerate conducted millions of dollars of business with one
another without any written contract. For example, Brighton
Credit Management (the CCA based in Florida) had no contract
with Brighton DMS or Debt Relief, but they have conducted
business with one another for almost 3 years. Such control of
CCAs by for-profit organizations, whether under contract or
not, may violate the ``private benefit'' prohibitions of the
tax code.\133\ To illustrate this point, Senator Levin asked
Chris Viale, the general manager of Cambridge, at the
Subcommittee's hearing, ``And the people who control the non-
profit also control the for-profit, is that fair to say?'' Mr.
Viale replied, ``Yes, that is fair to say.'' \134\
---------------------------------------------------------------------------
\129\ Administrative Services Agreement between Cambridge and
Brighton DMS, dated 6/1/03.
\130\ Cambridge 2001 Form 990, p. 19, Bates 00085.
\131\ Client Subscription Services Agreement between Cambridge and
Debt Relief, dated 1/1/03.
\132\ Advertising Services Agreement between Cambridge and Cypress,
dated 4/1/99.
\133\ Private Benefit Under IRC 501(c)(3), pp. 135-39.
\134\ John Puccio was invited to testify at the Subcommittee's
hearing, however the night before the hearing, Mr. Puccio informed the
Subcommittee of health problems that would prevent him from appearing.
Mr. Viale, general manager for Cambridge, testified in his place.
---------------------------------------------------------------------------
(3) Private Benefits to the For-Profit Corporations
The for-profit entities in the Cambridge-Brighton
conglomerate have realized great private benefits from the
Cambridge-Brighton CCAs they control. These benefits have been
realized in two principal ways: (1) the two original New York
for-profit entities (Cambridge Credit and Brighton Credit)
created and executed a windfall transaction by selling their
``intangible assets'' to the non-profit Cambridge, and (2) the
for-profit entities in the current structure (Brighton DMS,
Brighton Mass., Debt Relief, Cambridge Credit, Brighton Credit,
and Cypress) have obtained large amounts of money from the non-
profits, Cambridge and Cambridge/Brighton, through various
service contracts.
When Cambridge was organized in Massachusetts, John and
Richard Puccio executed a transaction between Cambridge and
their two original New York corporations (Cambridge Credit and
Brighton Credit) in which the New York corporations ``sold''
their ``intangible assets'' to Cambridge for $14.1 million.
These ``intangible assets'' included ``trademarks and goodwill
in the marks utilizing `Cambridge' and `Brighton' . . .
copyrights, general business goodwill, business plans, creditor
contacts and relationships, referral source contacts and
relationships, business `know-how,' trade secrets and
proprietary information.'' \135\ Since Cambridge had no money
(being a newly-formed, non-profit organization), the two New
York entities ``loaned'' Cambridge the necessary $14.1 million.
John and Richard Puccio therefore created an artificial,
``paper'' debt that Cambridge would be obligated to pay back to
them for purchasing the ``intangible assets'' of Cambridge
Credit and Brighton Credit. In effect, John and Richard Puccio
sold their ``business goodwill'' and ``know-how'' to John and
Richard Puccio.
---------------------------------------------------------------------------
\135\ Intangible Assets Sale Agreement between Cambridge, Cambridge
Credit, and Brighton Credit, dated 11/27/96, Bates 00038-46.
---------------------------------------------------------------------------
As a result of this artificial sale, the Puccios required a
non-profit agency (Cambridge) to pay two for-profit
corporations (Cambridge Credit and Brighton Credit) $14.1
million plus interest instead of spending that money on
improving education, expanding community outreach programs, or
any other activity for which Cambridge had been granted tax-
exempt status. Cambridge Credit and Brighton Credit have
received repayments on the $14.1 million ``loan'' over the past
several years from revenue realized by Cambridge from DMP fees
paid by consumers. Although Cambridge has 50 years under the
terms of the ``loan'' to repay the two New York entities, over
$11.5 million has been paid back over the past 5 years alone.
This $14.1 million transfer may constitute an ``excess benefit
transaction'' prohibited by the tax code.\136\ Indeed, the IRS
may determine that Cambridge was arguably created in part for
the purpose of generating $14.1 million for two related for-
profit corporations, and may not have been organized
exclusively for non-profit purposes.\137\
---------------------------------------------------------------------------
\136\ 26 U.S.C. Sec. 4958(c)(1)(A), (f)(1)(A).
\137\ Treas. Reg. Sec. 1.501(c)(3)-1(a).
---------------------------------------------------------------------------
Beyond the revenue generated by the 1996 ``intangible
assets'' sale, the Subcommittee's investigation determined that
Cambridge has generated substantial additional revenues for the
other for-profit entities in the Cambridge-Brighton
conglomerate. In the Ascend One-Amerix and DebtWorks and
Ballenger conglomerates discussed previously, all revenues
generated by the CCAs streamed to a single entity.
Specifically, in the Ascend One-Amerix conglomerate, all of the
revenue from the CCAs streamed to for-profit Amerix, while in
DebtWorks and Ballenger conglomerate all revenues streamed to
for-profit DebtWorks or Ballenger. In contrast, the revenue
streams were more diversified in the Cambridge-Brighton model.
The three CCAs (Cambridge, Cambridge/Brighton, and Brighton
Credit Management) have distributed their revenues to three or
four for-profit entities, all owned and controlled by the
Puccio brothers. The bulk of the funds generated by the three
CCAs were allocated to Brighton DMS (formerly Brighton Mass.),
Debt Relief, and Cypress.
The primary function of for-profit Brighton DMS/Brighton
Mass. was to provide DMP processing services, as well as to
lease equipment, personnel, software and other goods and
services to the Cambridge-Brighton CCAs. While it is not
unusual in the credit counseling industry for a CCA to lease
equipment, pay for potential leads, or pay for advertising,
such payments are usually made as a result of arms-length
transactions between unrelated parties at market rates. In the
Cambridge-Brighton model, however, the revenues were
transferred among related entities.
Since 1998, Brighton DMS/Brighton Mass. has realized gross
receipts in excess of $40.5 million.\138\ Since 2000, for-
profit Debt Relief has produced television ``infomercials'' and
operated a call center to screen calls for the Cambridge-
Brighton CCAs. Debt Relief was paid $750 for each consumer it
transferred to a CCA and who enrolled in a DMP.\139\ Through
2002, Debt Relief referrals have resulted in gross receipts of
over $25 million.\140\ Cypress has served as an advertising
agency for the Cambridge-Brighton conglomerate since 1999, and
has realized gross receipts in excess of $6.5 million.\141\
---------------------------------------------------------------------------
\138\ Brighton Mass. 1998-2002 Form 1120S, Bates 00423, 00412,
00400, 00388, and 00375.
\139\ See, e.g., Client Subscription Services Agreement between
Cambridge and Debt Relief, dated 1/1/02, at para. 4(b).
\140\ Debt Relief 2000-2002 Form 1120S, Bates 00333, 00324, and
00313.
\141\ Cypress 1999-2002 Form 1120S, Bates 00369, 00359, 00350, and
00341.
---------------------------------------------------------------------------
While purportedly operating non-profit, educational
entities, the individuals that own and operate the Cambridge-
Brighton conglomerate have grown extremely wealthy from their
activities. The IRS Form 990s submitted by Cambridge state that
Richard and John Puccio each received a salary in 2001 of
$624,000 for managing its operations. In addition they received
compensation from related organizations of more than $600,000
in that same year. The Subcommittee elicited some of this
information related to Puccio's salary through testimony at the
March hearing from Chris Viale, the general manager. By way of
contrast, Senator Mark Pryor asked the representative of a NFCC
agency, ``What is your salary at your non-profit?'' The witness
replied, ``My annual salary is sixty thousand dollars.'' As
noted above, organizations do not qualify for non-profit status
under Federal regulations if they are organized or operated for
the benefit of individuals associated with the corporation.
The Subcommittee has been told that the IRS has initiated
an audit of Cambridge.\142\ As part of that audit, the IRS
should determine whether the revenues received by Cambridge
Credit and Brighton Credit from the sale of their ``intangible
assets'' amounted to an excess benefit transaction and to what
extent, if any, excise taxes should be assessed.\143\
Additionally, the IRS should determine whether Cambridge was
organized or now operates for private benefit and, if so,
whether its Section 501(c)(3) status should be revoked.\144\
Finally, the IRS should examine the organization and operation
of Cambridge/Brighton, whose Section 501(c)(3) application is
currently pending. Since Cambridge/Brighton was designed to
operate in a similar manner to Cambridge, the IRS should fully
scrutinize its application in order to determine whether it is
organized and operated for the public benefit and to ensure
that its assets do not inure to the benefit of any private
individual.\145\
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\142\ Subcommittee interview of Cambridge and Brighton DMS
representatives (1/20/04).
\143\ 26 U.S.C. Sec. 4958.
\144\ Treas. Reg. Sec. 1.501(c)(3)-1(a) (``[A]n organization must
be both organized and operated exclusively for [tax exempt] purposes''
or ``it is not exempt.''
\145\ Treas. Reg. Sec. 1.501(c)(3)-1(c)(2).
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(4) Harm to Consumers
The Subcommittee interviewed a former client of Cambridge,
Raymond Schuck, to evaluate the CCA's services. Mr. Schuck told
the Subcommittee that, in the summer of 2001, he had $90,000 in
debt distributed among nine credit cards.\146\ After hearing
about Cambridge on the radio, he called them and spoke with a
counselor. Mr. Schuck said that the counselor suggested a debt
management plan, and promised him a reduction in interest
rates. After answering a list of questions about his various
credit cards. Mr. Schuck said that the counselor told him that
his monthly payment would be $1,946 and that Cambridge would
charge him 10% of his monthly payment for their services, or
$194 a month. Mr. Schuck testified at the hearing, ``I thought
that $194 was high, but I knew very little about the industry
and what were appropriate fees. I made the apparently naive
assumption that because it was a non-profit agency, I could
trust them.''
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\146\ Subcommittee interview with Raymond Schuck (2/24/04).
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Mr. Schuck said the counselor told him to hurry and send
the first monthly payment to Cambridge to get the program
started. He immediately sent in a cashier's check. Although he
had already sent in the check to Cambridge, Mr. Schuck said
that he started getting calls from some of his creditors asking
why he had not made any payments. As in Ms. Troy's situation
with AmeriDebt, the creditors told him that they were unaware
that he was on a DMP with Cambridge and told him that no
payments had been received.
Mr. Schuck said that he called Cambridge to find out what
was going on. He said he found it very difficult to contact
someone in customer service who could tell him about his
account. Mr. Schuck said at the hearing, ``Getting in touch
with someone who knew about my debt management plan and the
status of my payments was an exercise in frustration.'' When
Mr. Schuck did speak with Cambridge, he was informed that the
first payment he had sent was a fee for initiating his DMP. He
testified, ``I was absolutely shocked by this information. Had
I known this policy in advance, I would have searched for a
different credit counseling agency.'' Mr. Schuck continued, ``I
would not have agreed to give Cambridge $2,000 when that money
could have gone to my creditors.''
Ultimately, Mr. Schuck declared bankruptcy. Mr. Schuck said
that he felt that if Cambridge had done a reasonable analysis
of his financial circumstances, the proper recommendation would
have been to seek legal assistance and declare bankruptcy. In
addition, because Cambridge kept his first payment without his
knowledge, Mr. Schuck missed payments to nine creditors. As a
result, Mr. Schuck's credit rating now bears the consequences
of missed and late payments as well as the bankruptcy.
Unfortunately, Mr. Schuck's experience was very consistent with
current and former clients interviewed by the Subcommittee.
The fee structure of the Cambridge-Brighton CCAs was the
highest of any CCA that the Subcommittee investigated.\147\ The
fees were clearly excessive and bore no relation to the actual
expense of initiating and maintaining a DMP. At the hearing,
Senator Levin questioned Chris Viale, the general manager of
Cambridge, ``Shouldn't it [the fee] relate to the services
rendered?'' Mr. Viale, said ``No.'' Senator Levin went on to
ask, ``But you keep that first monthly fee regardless of what
subsequently comes in terms of benefits to that consumer, is
that correct?'' Mr. Viale said, ``That is correct.''
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\147\ Unfortunately, Cambridge's fee schedule is not unique in the
industry. The Subcommittee's investigation identified several other
CCAs who charged an initial fee equal to one month's payment, including
Express Consolidation, Inc. of Delray Beach, Florida, and CreditCare
Credit Counseling, Inc. of Boca Raton, Florida.
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The Subcommittee determined that the initial start-up fee
charged to a consumer by the Cambridge-Brighton conglomerate--
the ``Payment Design Fee''--was typically an amount equal to
the consumer's monthly payment. The vast majority of these
monthly payments were several hundred dollars, and many were in
excess of $1000 or even close to $2000. The result was that the
Cambridge-Brighton CCAs routinely charged a consumer $500 or
$1000 for merely setting up a DMP. Like AmeriDebt and Ballenger
CCAs, the Cambridge-Brighton CCAs retained this fee instead of
sending it to creditors. Also like AmeriDebt, the Cambridge-
Brighton CCAs too often failed to adequately disclose that fact
to clients. Like many other consumers who dealt with Cambridge,
Mr. Schuck was not informed that his ``Payment Design Fee'' of
$1,946 would not go to his creditors, but would in fact be kept
by Cambridge. The monthly DMP ``Program Service Fee'' charged
by Cambridge-Brighton CCAs was also high. The amount had no
relation to Cambridge's actual expenses but was instead set at
10% of the monthly DMP payment. Therefore, a consumer who was
already paying an $800 monthly payment would also be required
to pay an $80 maintenance fee each and every month. By
contrast, the average NFCC agency's monthly DMP maintenance fee
in 2002 was $14.\148\
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\148\ NFCC 2002 Member Activity Report, p. 30.
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A related problem uncovered by the Subcommittee is that the
initial 10% fee does not reflect payment for actual services
rendered. Cambridge gets the ``Payment Design Fee'' (10% of
total debt) up-front (as well as their monthly service fee).
However, Chris Viale testified at the Subcommittee's hearing
that, although its plans are designed to last 60 months, ``The
average length of time for a consumer on the plan is 23 months.
We have a little over a thirty percent completion rate [for
their program].'' This data is clear evidence of Cambridge's
understanding that although they were charging a financially-
strapped consumer in advance for 60 months of service, the
likelihood that the consumer would actually require Cambridge's
services for the full term of their plan was less than one-
third. The fact that two-thirds of their client base failed to
finish the plan, cutting short any services obligated by
Cambridge, was not evident in their fee structure.
Still another problem identified by the Subcommittee
involves the bonuses paid to CCA employees. The ``credit
counselors'' in the Cambridge-Brighton CCAs were given bonuses
for enrolling consumers on DMPs and could accumulate bonus
money equal to as much as 25% of their clients' aggregate
start-up fees for the month.\149\ Additionally, counselors
could earn 2-week trips to Florida and other prizes by placing
consumers on DMPs.\150\ At the same time, like the counselors
at other new CCAs, Cambridge-Brighton ``credit counselors''
appeared to provide minimal credit counseling. Mr. Schuck told
the Subcommittee that he was on the phone with his
``counselor'' for a mere 20 minutes before he was convinced to
mail a cashier's check for $1,946 to set up his DMP. When asked
by Chairman Coleman at the Subcommittee's hearing about how
many people received face-to-face counseling, Mr. Viale
responded, ``Approximately 10 to 20 a day.'' Unfortunately,
most Cambridge clients do not receive face-to-face counseling.
They receive, as Mr. Schuck did, a sales pitch over the
telephone.
---------------------------------------------------------------------------
\149\ Subcommittee interview of former Cambridge employee (2/2/04).
\150\ Id.
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John Pohlman, a former Cambridge credit counselor,
testified at the Subcommittee's hearing about his experiences
at Cambridge. Mr. Pohlman offered a unique perspective having
worked for a NFCC agency for 11 years before going to work for
Cambridge.\151\ Mr. Pohlman described a ``boiler-room''
mentality at Cambridge. He testified that on his first day he
was forced to pick a fake name to use when dealing with
consumers. He also testified, ``There was an electronic board
at the front of the room that reminded me of the leader's board
in a golf tournament. It had the names of the counselors who
had the top sales for the month flashing in red and yellow
lights.'' Incentives like this, the bonuses, and the free trips
and other gifts exhibit an obvious emphasis on the DMP.
Consumers unfit for a DMP could fall prey to counselors with
self-serving motives who fail the consumer in need of education
or counseling, or perhaps, as in Mr. Schuck's case, an attorney
to file bankruptcy.
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\151\ Id. John Pohlman worked at the Consumer Credit Counseling
Services of Southern New England prior to working at Cambridge.
---------------------------------------------------------------------------
Mr. Pohlman also testified about his dissatisfaction with
the level of scrutiny Cambridge gave consumers' financial
circumstances. Through his experience working at NFCC agencies,
Mr. Pohlman believed a worthwhile counseling session should
last an hour to an hour and a half in order to get all
necessary information. Mr. Pohlman said that at Cambridge, this
process was expected to last 10 to 15 minutes. He testified,
``This was all the time we needed, however, because the only
information we got from the consumer was account information.
There was no true budget analysis done for the consumer, just
an analysis to determine whether their creditors would allow
the consumer to enroll in a debt management plan.'' He went on
to say, ``I was uneasy with the fact that I did not know
anything about a person's mortgage payment, health care costs,
car insurance, etc. . . . I knew nothing about them except they
were in debt.''
Mr. Pohlman admitted that with the limited amount of time
he spent with the consumer, he had little confidence that they
understood that the first payment went to Cambridge and not to
their creditors. Mr. Pohlman testified, ``The goal was to
authoritatively take them (the consumer) through the process of
getting signed up on a plan as quickly as possible so they did
not have time to consult a spouse or family member.'' Mr.
Pohlman said, ``I was even instructed by one member of
management to quote `Treat them like alcoholics.' In other
words, they know they need help--make them get it. I truly
believe that Cambridge preyed on consumers' desperation.''
Mr. Schuck's and Mr. Pohlman's testimony offers a great
deal of insight into Cambridge's profit-driven approach to
credit counseling. Their experiences suggest that when profit
motives are injected into a traditionally non-profit industry,
harm to consumers may follow. When Senator Pryor asked Mr.
Viale, ``Why did you choose to operate under a non-profit
label?'' Mr. Viale responded, ``Well, I don't have a specific
answer for that, but I know the industry forces us to be a non-
profit.''
V. REGULATION AND ENFORCEMENT
The credit counseling industry is currently governed by a
patchwork of professional, state and Federal standards, some of
which are mandatory and others of which are voluntary. They
include standards issued by credit counseling professional
associations, guidelines issued by creditors, state statutes,
and Federal tax and fair trade laws.
A. Industry Self-Regulation
The credit counseling industry has two major membership
associations, the NFCC and the Association of Independent
Consumer Credit Counseling Agencies (``AICCCA''), each of which
has issued mandatory membership standards for their
members.\152\ The NFCC standards, adopted through the Council
on Accreditation for Children and Family Services (``COA''),
are the more restrictive of the two. COA is an independent
third-party not-for-profit accrediting body that has reviewed
or accredited more than 1,400 international social service
programs.\153\
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\152\ Another organization, the American Association of Debt
Management Organizations (``AADMO''), is a trade association that does
not maintain membership standards.
\153\ NFCC information production to the Subcommittee, 9/10/04.
---------------------------------------------------------------------------
If applied throughout the industry, these professional
standards could significantly address the abusive practices
identified in this Report. For example, agencies seeking COA
accreditation are reviewed in eight specific areas:
Mission and Purpose--determines whether consumer
needs and preferences guide the organization in its design and
delivery of services.
Quality Assurance--evaluates the effectiveness
and efficiency of services provided and corrects any observed
deficiencies.
Governance and Administration--determines whether
the organization is governed and administered according to
legal requirements and sound principles of effective management
and ethical practice, evaluated by neutral oversight through a
diversified board.
Human Resources--evaluates the organization's
ability to deploy personnel and foster efficient, effective
service delivery for clients.
Service Environment--ensures safe, accessible,
and appropriate delivery for the needs of clients, employers,
and other stakeholders.
Financial Management--ensures that an
organization manages its fiscal affairs according to sound
financial practices and applicable statutory and professional
requirements.
Professional Practices--determines whether
services are conducted with due regard to ethical and
professional requirements and protects confidential information
regarding clients.
Service Delivery--ensures that an organization
focuses its services on identifying the needs and problems of
clients.\154\
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\154\ Id.
In addition, to obtain and maintain accreditation, all NFCC
member agencies must adhere to a rigid set of COA standards
specific to the credit counseling industry. The standards
---------------------------------------------------------------------------
include the following:
Agencies must have annual audits of operating and
trust accounts.
Agencies must be licensed, bonded, and insured.
Agencies must support and provide a variety of
consumer education programs.
Agencies must comply with consumer disclosure
requirements.
DMPs must include a detailed review of current
and prospective income, as well as present and anticipated
financial obligations.
Funds are disbursed to creditors on behalf of the
clients at least twice per month.
Clients have a variety of deposit options
including electronic methods, and are offered immediate
correction of improper postings.
Each client receives counseling, including an
assessment of how he/she got into trouble, and a written
comprehensive financial action plan.
Clients receive a statement, at a minimum, every
quarter.\155\
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\155\ Id.
All agencies must be re-accredited by COA every 4 years.
Additionally, all NFCC agencies are required to abide by strict
Member Quality Standards.\156\
---------------------------------------------------------------------------
\156\ Id.
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On August 18, 2004, the NFCC announced that it had
tightened its member standards to prohibit questionable
practices.\157\ The NFCC enhanced seven existing member quality
standards and added four new member quality standards.\158\
With the additions and modifications, the NFCC specifically
prohibited the payment of bonuses to credit counselors,
announced that public relations and marketing activities do not
qualify as educational activities, and prohibited charging fees
in advance of services.\159\ Additionally, the NFCC required
all members to complete their submission for COA certification
within 9 months of their application to COA (which is half the
time previously required) and to establish a formal system of
addressing consumer complaints. It also specifically prohibited
the practice of ``pre-screening'' consumers for DMPs.\160\
---------------------------------------------------------------------------
\157\ NFCC information production to the Subcommittee.
\158\ NFCC 2004 Member Quality Standards.
\159\ Id.
\160\ Id.
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AICCCA maintains similar standards as part of the code of
practice to which its members must adhere. For instance, AICCCA
sets a maximum initial fee of $75 for setting up a DMP and a
maximum $50 fee for monthly maintenance.
Several CCAs have pointed to their compliance with an
industry standard named ISO 9000 as ensuring that they adhere
to high standards. ISO 9000 is a generic set of quality
assurance standards that are followed by many large businesses,
but it is not specific to the credit counseling industry.\161\
Pursuit of ISO 9000 standards may be helpful as a first step
toward improving performance, because it requires careful
documentation of business procedures. But ISO 9000 does not
address business products or services. For instance, nothing in
the ISO 9000 standard provides guidance to an entity on how
much it can charge, what services it should offer, or what
should be done with excess funds.
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\161\ The ISO 9000 Quality Systems Handbook, Fourth Edition, David
Hoyle, Butter-Heinemann, 2001.
---------------------------------------------------------------------------
Self-regulation also has limitations. First, although NFCC
and AICCCA standards are mandatory for members, joining the
association itself is voluntary. CCAs that wish to operate
pursuant to lower business standards or no standards can simply
refuse to join. Unrestrained by strict standards of practice,
these CCAs may even obtain a competitive advantage over those
who adhere to more ethical conduct. Second, it is unclear
whether the associations have the resources and mechanisms
needed to monitor and consistently enforce compliance with
their standards. Weak enforcement reduces the efficacy of even
strong standards.
B. Creditor Standards
A second source of credit counseling standards lies not
with the CCAs themselves, but with the large creditors, such as
banks and credit card operating companies, which interact with
CCAs on a regular basis. Large creditors often support CCAs by
providing them with a percentage of the payments made by the
debtors that the CCAs counsel. Often referred to as ``fair
share,'' these payments are intended to reimburse some
operating costs in exchange for the CCAs' positive work in
helping debtors repay their debts. Many of the largest
creditors have developed standards to determine which CCAs are
eligible to receive fair share payments. If well developed and
carefully enforced, the Subcommittee believes these standards
could play a major role in reducing abuses and encouraging best
practices within the credit counseling industry.
(1) History of the Creditor-Credit Counseling Agency Relationship
In the late 1950s, credit card issuers played a key role in
developing what we refer to today as the credit counseling
industry. Originally, they helped establish local offices,
known as Consumer Credit Counseling Services (``CCCSs''), which
offered face-to-face counseling related to an individual's
finances. These counseling sessions were viewed as comparable
to other social services available at the time such as
substance abuse or family counseling. These CCCSs took a
comprehensive approach to treating a consumer's financial
instability. Through tools such as debt management plans,
referrals to other social agencies (to address other problems
associated with the symptoms of the financial stress), and
adequate financial education and counseling, these CCCSs nursed
debt-ridden consumers back to financial health.
The NFCC is the parent organization of the CCCSs and
historically has worked with creditors to operate and fund
these non-profit credit counseling agencies through fair share
payments.\162\ The purpose of these fair share payments was to
provide funding for the non-profit agencies to establish
educational programs, implement debt management programs, and
assist with operating expenses.\163\ This funding afforded CCAs
the financial freedom to offer their services to customers
without charge or to make payment of a modest fee voluntary.
The consumers' voluntary contributions were relatively small
amounts and were waived when necessary for hardship cases.
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\162\ The creditors interviewed by the Subcommittee typically
viewed fair share payments as a form of voluntary contribution to a
non-profit agency, rather than as payment for a contracted service.
However, many creditors apparently treat these payments as ordinary
business expenses rather than take charitable deductions for them on
their tax returns.
\163\ Historically, 60% of NFCC funding came from creditors and 40%
came from charities. Subcommittee interview of NFCC representatives (1/
12/04).
---------------------------------------------------------------------------
Fair share payments are typically paid by creditors on a
monthly basis on the aggregate debtor payments managed by a
CCA. Until the mid-to-late 1990s, this payment was typically
12-15% of the aggregated debtor payments. In recent years, the
expense associated with fair share payments has increased, at
times taking up 25-30% of the budgets of the collections
departments at major creditors.\164\ This increase has caused
some creditors to reduce their fair share payments to a lower
percentage. In addition, to improve the debt management plans
they receive, some creditors have moved to performance-based
fair share models. These models link the percentage of fair
share payments each credit counseling agency receives to the
success rates of the DMPs that the creditor receives from each
CCA. \165\
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\164\ Subcommittee interview with Citigroup representatives (3/9/
04); Bank One operating expenses spreadsheet, Bates BO 253-254.
\165\ Common ways to measure success rates are: (1) retention rate
(the length of time a consumer stays on the DMP), (2) declination rate
(the number of proposed DMPs declined by the creditor), and (3) a
combination of those two measures as well as other factors.
---------------------------------------------------------------------------
In addition to their historic funding relationship with
non-profit CCAs, major creditors have traditionally acted in an
advisory role for the NFCC through membership on the NFCC's
board of directors. The close ties between creditors and NFCC
members, however, led to the filing of two legal actions. In
1994, a number of independent CCAs filed an antitrust suit
against the NFCC, its member agencies, and the Discover Card.
The plaintiffs alleged that the NFCC members and the creditors
were operating to prevent new agencies from offering certain
credit counseling services. The parties eventually entered into
a settlement agreement which, in part, removed the creditors
from the NFCC's national board of directors.\166\ In 1996, the
NFCC entered into an agreement with the FTC to require its
members to disclose the fact that they receive fair share
payments from creditors. It is noteworthy that non-NFCC members
are not required to disclose this information, even though they
receive the same payments.
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\166\ Individual NFCC members may still have representatives from
the local banking community on their board of trustees.
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In the mid-1990s, the rapid increase in consumer debt
dramatically increased the number of potential clients. Some
new CCAs began using more technologically advanced practices to
implement their DMPs through innovative software. Some also
launched heavily funded advertising and marketing campaigns
using late night television infomercials and the Internet.
Through these practices, these new entrants to the credit
counseling market were able to reach hundreds of thousands of
potential clients. The ability to reach and serve a national
market has gradually shifted the industry from a local,
community-based, client-specific operation to include
nationwide, mass-marketed sales operations.
As consumer debt reached new heights during the late 1990s
and early 2000s, the DMP became the method of choice
recommended to consumers by many of the new CCAs to resolve
unsecured debt problems. These CCAs used DMPs to generate two
streams of revenue, one from creditors providing them with fair
share payments, and the second from consumers charged DMP
start-up and monthly maintenance fees.
Even without some CCAs' aggressive advocacy of DMPs, the
rapid increase in consumer debt over the last decade would
likely have produced a sharp increase in the use of DMPs.\167\
At the same time, as fair share payments also increased, it
should not surprise anyone that creditors began to examine the
nature of this growing expense. Some creditors apparently
concluded that the wrong consumers were being placed on DMPs.
For example, consumers who could afford to pay their debts but
were looking for a break in interest rates were unnecessarily
and incorrectly placed on DMPs. As a result, the creditors
heightened the level of scrutiny of proposed DMPs. Some
creditors also began issuing more detailed CCA and DMP
standards, in effect becoming a regulator of credit counseling
practices.
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\167\ The Subcommittee's concern is not with DMPs per se, but
whether distressed consumers are inappropriately placed onto DMPs
instead of receiving counseling or education to address the financial
problem.
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(2) Three Creditor Models
The Subcommittee interviewed three major creditors to gain
an understanding of the industry as well as of actions taken by
the creditors towards CCAs. These creditors were Bank One
Delaware, N.A. (``Bank One''), MBNA America, N.A. (``MBNA''),
and Citigroup, Inc. (``Citigroup''). The Subcommittee found
that all three have promulgated standards for CCAs seeking fair
share payments, and that all three have recently revised and
tightened their standards to eliminate abusive practices.
(a) Bank One
Bank One utilizes a combination of a minimum standards
model \168\ and a performance-based model when deciding whether
to make fair share payments to a particular CCA. Bank One told
the Subcommittee that before it will even consider making fair
share payments, a CCA must be equipped to make debtor payments
and submit debtor proposals electronically, and it must not be
involved in any pending litigation. The agency's business
eligibility is then assessed, and Bank One said the CCA must
meet the following minimum standards:
---------------------------------------------------------------------------
\168\ A minimum standards model requires that certain minimum
criteria be met before any fair share payments will be made to a credit
counseling agency.
The CCA must be accredited; \169\
---------------------------------------------------------------------------
\169\ Industry-accepted accreditation organizations include COA,
BSI, BVQI, and ISO 9000 with an accepted ``Code of Practice.'' NFCC and
AICCCA have each developed a code of best practices for their members
that set accreditation standards.
The counselors employed by the CCA must be
---------------------------------------------------------------------------
certified;
Any fees charged to consumers must meet Bank One
guidelines; and
The CCA's marketing budget and content must be
approved by the CCA's board.
Once these criteria were met, Bank One told the
Subcommittee that it would make a maximum of 9% fair share
payments to the CCA. It said that a CCA which meets the
business eligibility requirements received a minimum of 2%, and
the CCA may receive up to an additional 7% depending upon the
performance of its portfolio of DMPs.\170\ Bank One explained
that its performance criteria measure the average fixed payment
and the default rate of the agency, both equally weighted to
provide a maximum of 3.5% in additional fair share payments for
each criteria. In addition, Bank One said that it measures a
CCA's performance in meeting a ``New Inventory Criteria'' which
measures whether the agency is continuing to sign up new Bank
One card members or just administering existing Bank One
accounts.
---------------------------------------------------------------------------
\170\ Subcommittee interview of Bank One representatives (2/10/04).
The new model was implemented in July 2003.
---------------------------------------------------------------------------
(b) MBNA
MBNA told the Subcommittee it also utilizes a minimum
standards model coupled with a performance-based model.\171\
MBNA said that it had set minimum requirements that must be met
before a CCA qualifies for any fair share payments:
---------------------------------------------------------------------------
\171\ Subcommittee interview of MBNA representatives (2/17/04).
MBNA's new model was implemented in February 2004.
---------------------------------------------------------------------------
The CCA must be accredited;
The CCA must have non-profit status under Section
501(c)(3);
The CCA may not be affiliated with any entity
that is not a Section 501(c)(3) agency; \172\
---------------------------------------------------------------------------
\172\ MBNA allows outsourcing only for payment processing.
All DMP proposals and debtor payments must be
---------------------------------------------------------------------------
transmitted electronically;
A complete budget disclosure must be attached to
all DMP proposals;
No DMP start-up fee may exceed $75, no monthly
fee may exceed $50, and there can be no fee assessed for early
termination of the DMP;
At least 90% of the CCA's consumers must have
completed a full budget disclosure; and
At least 85% of the DMP proposals submitted by
the CCA must meet MBNA's criteria for establishing a DMP.
Upon meeting these criteria, MBNA said that it assesses a
CCAs' DMP portfolio to measure its payment volume and portfolio
vintage. MBNA explained that the older the DMP account, the
larger the percentage of fair share available, starting with 2%
for brand new accounts and rising to a maximum of 15% for
accounts that last 36 months or more.
(c) Citigroup
Citigroup told the Subcommittee that it had recently
introduced a fair share model new to the credit counseling
industry.\173\ In fact, Citigroup indicated that it had
abandoned the fair share model altogether in favor of a new
``Grant Program.'' Under this program, Citigroup said that it
will pay CCAs according to Citigroup's ``perception of the
agency's needs and the benefits they provide to the customer
and the community.'' \174\ Citigroup explained that these
payments will be made in quarterly advances of a lump sum
contribution, \175\ and the amount of payment will reflect
Citigroup's judgment of the value that the CCA is delivering to
consumers, based on a 29 question ``application.'' The
questions in the Citigroup application address many of the same
issues utilized by other industry leaders to assess CCAs,
including whether the CCA has non-profit status, appropriate
business practices and structure, and low start-up and monthly
fees. CCAs must also submit to and pass an audit by Citigroup.
---------------------------------------------------------------------------
\173\ Subcommittee interview with representatives of Citigroup (2/
20/04). Citigroup's new model was implemented on January 1, 2004.
\174\ Citigroup model letter to CCA, dated November 4, 2003, Bates
CC 00073-74.
\175\ Id.
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Citigroup said that its new grant program took effect in
2004. Citigroup said that, since it began, approximately one-
third of the agencies who previously received fair share from
Citigroup did not qualify for grant funding under the
eligibility criteria.\176\ However, those agencies that did
qualify for grant funding received a higher payment than they
historically received under the former fair share model,
according to Citigroup.\177\
---------------------------------------------------------------------------
\176\ Information provided by Citigroup 8/24/04.
\177\ Id.
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(3) Using Fair Share Payment Standards to End Abuses
The collective impact on the credit counseling industry of
the minimum and performance-based standards issued by major
creditors such as Bank One, MBNA, and Citigroup could be
substantial. Since many CCAs depend upon fair share revenue as
a major source of income, they are obligated to comply with
creditor standards. Creditors may therefore play a major role
in eliminating some of the abusive practices examined in this
Report. Standards setting limits on fees, for example, directly
attack the problem of CCAs' charging excessive fees unrelated
to costs. Standards restricting or prohibiting CCAs from
affiliating themselves with for-profit entities addresses the
core of the profiteering problem. Some of the performance-based
requirements also encourage CCAs to initiate only DMPs that set
realistic goals for consumers.
As with the professional standards set by credit counseling
associations, the effectiveness of the creditor standards will
depend in large part upon the extent to which the creditors
monitor compliance and discontinue fair share payments to CCAs
that do not comply with their standards. Creditors informed the
Subcommittee that they felt limited in their ability to police
the industry, and some expressed reluctance to condition the
concessions they provide to a debtor upon the debtor's choice
of a particular CCA. Some creditors also worry about appearing
to favor some agencies over others, although choosing to do
business with some entities and not others is a routine
business decision encountered every day in the marketplace.
CCAs are less sanguine about the creditor standards. A
common CCA complaint is the absence of uniformity among
creditor standards that can translate into higher costs and
administrative burdens for agencies.\178\ Creditors respond
that, while uniformity in criteria for fair share payments may
be desirable, current antitrust laws prohibit creditors from
collectively agreeing on common standards. Another common CCA
complaint is that creditors retain the right to change their
criteria without notice and may apply changes retroactively.
CCAs also contend that sudden changes to creditor criteria
leave them with little time to respond. This complaint applies
not only to the amount of fair share payments the creditor will
pay, but also to the terms a creditor will offer debtors under
a DMP.
---------------------------------------------------------------------------
\178\ Subcommittee interviews with NFCC and AICCCA representatives
(10/16/03, 10/9/03).
---------------------------------------------------------------------------
CCAs also assert that the ambiguous tone of some fair share
policies and an inability to obtain creditor clarification
complicates the job of administering DMPs. For example,
Citigroup announced its new ``grant'' program on November 4,
2003.\179\ Some CCAs complained that the criteria for
determining fair share payments under this program are
subjective, leaving agencies unsure of how to operate in order
to maximize their Citigroup fair share payments. Citigroup also
required CCAs to respond by November 24, 2003, only 20 days
after receiving notice of the change in policy, \180\ which
some CCAs complained left them with little understanding of
what to expect from Citigroup and an inability to plan their
operating budgets.\181\
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\179\ Citigroup model letter to CCA, dated 11/4/03, Bates CC 00073-
74.
\180\ Id.
\181\ A CCA may request a quarterly payment in advance; however,
the weight Citigroup affords any such request is unknown, since
Citigroup pays CCAs according to a perception of their needs and the
benefits provided to customers and the community. Subcommittee
interview of Citigroup representatives (2/20/04).
---------------------------------------------------------------------------
These developments suggest that bad actors have had a
disproportionate impact on the credit counseling industry. As
the Report has detailed, some new entrants have heavily
marketed DMPs and failed to properly scrutinize the consumers
placed on DMPs. In turn, creditors were forced to react to the
increased volume of DMPs for which they were paying fair share.
After finding inappropriate consumers placed on DMPs, many
creditors reduced their fair share. Although an appropriate
reaction to the activities of some new entrants, it is an
unfortunate result for the CCAs that have traditionally
provided quality services with careful selection of candidates
for DMPs. Subcommittee Chairman Coleman questioned James
Kroening, the director of an NFCC agency, Family Means, about
this phenomenon at the Subcommittee's hearing. Mr. Kroening
testified, ``It is my belief that we have seen a major decrease
in creditor support for our type of counseling and debt
management work that we do related specifically to the number
of new entrants and the number of folks that they are putting
on plans. Specifically, I believe it is related to the fact
that many people are being put into debt management plans that
simply do not need it and creditors have seen their line item
expense go [through] the roof.'' This is another negative side
effect of the new entrants profit-driven practices.
Ultimately, CCAs concede that creditors have no obligation
to make any fair share payments to them. Many smaller
creditors, in fact, do not typically provide fair share
payments to CCAs. Thus, they recognize that creditors have the
right to condition these payments as they see fit. Since having
debtors pay their debts is in the best interests of the
creditors, and many CCAs provide worthwhile counseling and debt
management services that assist debtors in meeting their
financial responsibilities, major creditors indicate they are
likely to continue making fair share payments. Thus, creditor
standards related to fair share payments continue to provide a
valuable mechanism for curbing abusive practices in the credit
counseling industry.
C. State Regulation and Enforcement
Although many states have statutes concerning the credit
counseling industry, effective regulation at the state level is
hampered due to the wide variety of differing state
requirements and inadequate resources for monitoring
compliance. In addition, many states still lack legislation
directly applicable to the credit counseling industry. In these
states, general laws against false advertising and fraud
provide the only protection for consumers. In other states with
laws that at least partially relate to credit counseling, the
statutes were written when the industry generated few
complaints, and therefore, either limit credit counseling to
non-profit agencies or provide non-profits with an exemption
from mandatory requirements. This type of exemption is the
primary reason why many of the CCAs discussed in this Report
applied for Section 501(c)(3) status. In recent years, a few
states, such as Maryland, have passed more comprehensive laws
dealing specifically with the debt management industry.
The widespread use of the telephone and Internet by CCAs to
contact and service consumers also inhibits effective state
enforcement. Many CCAs assert that they do not need to be
licensed in a state unless they maintain a physical presence in
that state. Under this interpretation, a company located in
Maryland could contact and serve consumers in every other state
without obtaining separate state licenses or being bound by
laws of the states in which its consumers reside. Those CCAs
that attempt to comply with the laws of each state in which
they serve consumers are burdened by a mix of different
regulations and bonding requirements.
Currently two alternatives offering model legislation for
states to adopt are available. In February 2004, the National
Consumer Law Center and the Consumer Federation of America
jointly issued a Model Consumer Debt Management Services
Act.\182\ In March 2004, the National Conference of
Commissioners on Uniform State Laws discussed a draft of the
Consumer Debt Counseling Act.\183\ Both laws would impose much
tighter licensing and business practices on all credit
counseling agencies.
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\182\ Available at www.law.upenn.edu/bll/ulc/UCDC/
Feb2004modelbill.pdf.
\183\ Available at www.law.upenn.edu/bll/ulc/UCDC/
Mar2004mtgdraft.htm.
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In many states, the most significant regulatory action has
come from suits filed by state attorneys general. In addition
to an earlier action brought by the District of Columbia, \184\
the attorneys general in Illinois, \185\ Minnesota, \186\
Missouri, \187\ and Texas \188\ have each filed lawsuits
against AmeriDebt over the past few years. These suits have
typically charged AmeriDebt with consumer fraud and deceptive
business practices such as false advertising,
misrepresentation, non-disclosure of fees, and failure to
obtain the proper licenses. The Subcommittee believes that
these suits have convinced AmeriDebt to stop enrolling new
consumers into DMPs. Nevertheless, they do not necessarily
prevent the same business model from being used by other CCAs
or conglomerates.
---------------------------------------------------------------------------
\184\ District of Columbia v. AmeriDebt, Inc. and Andris Pukke,
Superior Court of the District of Columbia.
\185\ State of Illinois v. AmeriDebt, Inc., Circuit Court of the
Seventh Judicial Circuit, Sangamon County.
\186\ State of Minnesota v. AmeriDebt, Inc., District Court, Fourth
Judicial District.
\187\ State of Missouri v. AmeriDebt, Inc., Circuit Court of St.
Louis City.
\188\ State of Texas v. AmeriDebt, Inc., et al., District Court of
Travis County, Texas.
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D. Federal Regulation and Enforcement
On the Federal level, two key agencies, the U.S. Internal
Revenue Service and the Federal Trade Commission, are aware of
the major problems in the credit counseling industry, and have
taken steps to enforce the tax code and the Federal Trade
Commission Act, respectively.
(1) The Internal Revenue Service
As the Report notes, CCAs typically apply for non-profit
status under Section 501(c)(3) of the Internal Revenue Code.
The IRS has recognized more than 850 credit counseling
organizations as tax exempt under Section 501(c)(3).\189\ The
non-profit status of CCAs arose mainly by historical pattern,
rather than pursuant to any specific decision by Congress. When
creditors established the first CCAs, they set them up as non-
profits, presumably because of the tax savings and because this
status harmonized with their original purpose of providing
debtors with general financial education in exchange for little
or no fee. State laws often made non-profit status a legal
requirement to conduct debt proration activities within their
borders.
---------------------------------------------------------------------------
\189\ Testimony of Commissioner Mark Everson before the House Ways
and Means Committee, Subcommittee on Oversight (11/20/03).
---------------------------------------------------------------------------
As the recent problems in the credit counseling industry
began to surface, the IRS has taken several steps to address
the problems both retroactively and prospectively.
Retroactively, the IRS has initiated audits of 50 CCAs,
including nine of the fifteen largest CCAs in terms of gross
receipts.\190\ The IRS Commissioner informed the Subcommittee
that the Service will not hesitate to revoke the Section
501(c)(3) designation of any CCA that has abused its non-profit
status.\191\ The process for revoking non-profit status is
fairly lengthy. The IRS must conduct a full audit of the
agency's finances and make a formal finding that it does not
qualify as a Section 501(c)(3) organization under the statute.
The non-profit can appeal this decision both within the IRS and
in the courts. In addition, the IRS is considering giving more
explicit guidance on what the law requires of non-profits,
which would put CCAs on formal notice of the standards they
should follow.
---------------------------------------------------------------------------
\190\ Everson letter, p. 1. Section 6103 of the Internal Revenue
Code prevents the IRS from publicly revealing the identities of the
CCAs currently under audit.
\191\ Id. at p. 7.
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Prospectively, the IRS has taken measures to subject new
CCA applications for Section 501(c)(3) status to greater
scrutiny. It has formed a specialized group within the IRS
called the Consumer Credit Service Compliance Team to develop
and pursue strategies to address: (1) inurement and private
benefit issues, and (2) issues related to CCAs that operate as
commercial businesses.\192\ The Compliance Team currently has
12 staff members, including technical specialists, examination
agents, and attorneys from the Office of Chief Counsel.\193\
These individuals review the applications, including budgets
and outsourcing contracts, of new CCAs to ensure that they plan
to operate as bona fide non-profits.
---------------------------------------------------------------------------
\192\ Id. at p. 4.
\193\ Id.
---------------------------------------------------------------------------
Since the Subcommittee's hearing on March 24, 2004, the IRS
has identified 59 CCAs for examination.\194\ It has contacted
39 of the selected CCAs and has begun examinations.\195\ It has
already proposed revoking the tax-exempt status of one Section
501(c)(3) credit counseling agency.\196\ In June 2004, it filed
a $15 million suit against AmeriDebt in anticipation of
revoking its Section 501(c)(3) status.\197\ The IRS has also
sent denial letters to four applicants for exempt status
because the organizations were operating for the substantially
non-exempt purpose of marketing and selling debt management
plans for the private benefit of insiders and related
commercial entities.\198\
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\194\ Internal Revenue Service information production to the
Subcommittee 9/1/04.
\195\ Id.
\196\ Everson letter to the Honorable Amo Houghton, dated 7/15/04,
p. 1.
\197\ Proof of Claim for Internal Revenue Taxes, In the Matter of
AmeriDebt, Case No. 04-23649, filed 6/5/04.
\198\ Everson letter to the Honorable Amo Houghton, dated 7/15/04,
p. 1.
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As a result of these efforts, the IRS will have about 50%
of the total revenues of the credit counseling industry under
examination.\199\ For those CCAs under examination, the IRS has
identified individuals and businesses that are involved in a
scheme to create CCAs as a front for related for-profit
businesses.\200\ Referrals have been made to investigate these
abusive tax shelter promotions. The referrals include the
promoter, all related entities and individuals, as well as the
attorney and the CPA.\201\
---------------------------------------------------------------------------
\199\ Id.at p. 3.
\200\ Internal Revenue Service information production to the
Subcommittee 9/1/04.
\201\ Everson letter to the Honorable Amo Houghton, dated 7/15/04,
p. 3.
---------------------------------------------------------------------------
To combat such violations, the IRS has announced revisions
of its Form 990, Return of Organization Exempt from Income Tax,
and the Form 1023, Application for Tax Exempt Status Under
Section 501(c)(3).\202\
---------------------------------------------------------------------------
\202\ Id.
---------------------------------------------------------------------------
On July 30, 2004, the IRS also released a memorandum of
legal analysis related to the revocation of Section 501(c)(3)
status for credit counseling organizations.\203\ This can be
viewed as a sign of the IRS bracing for litigation ahead as it
implements its more stringent practices, most likely leading to
the revocation and denial of exempt status for existing
organizations.
---------------------------------------------------------------------------
\203\ Office of the Chief Counsel, Memorandum No. 200431023.
---------------------------------------------------------------------------
(2) The Federal Trade Commission
The FTC is charged with enforcing Section 5(a) of the FTC
Act, which prohibits unfair and deceptive acts or practices
affecting interstate commerce.\204\ The FTC lacks jurisdiction,
however, to enforce consumer protection laws against bona fide
non-profits. Nevertheless, the FTC may assert jurisdiction over
a CCA if it demonstrates that the CCA is ``organized to carry
on business for its own profit or that of its members.'' \205\
Alternatively, the FTC may assert jurisdiction over a non-
profit CCA if it is a ``mere instrumentality'' of a for-profit
entity, or if it operates through a ``common enterprise'' with
one or more for-profit entities.\206\ Even with these
jurisdictional issues to contend with, the FTC has made inroads
in enforcing the FTC Act against CCAs who may be abusing their
non-profit status and engaging in unfair or deceptive
practices.
---------------------------------------------------------------------------
\204\ 15 U.S.C. Sec. 45(a).
\205\ 15 U.S.C. Sec. 44.
\206\ See Sunshine Art Studios, Inc. v. FTC, 481 F.2d 1171 (1st
Cir. 1973); Delaware Watch Co. v. FTC, 332 F.2d 745 (2d Cir. 1964).
---------------------------------------------------------------------------
At the Subcommittee's hearing, FTC Commissioner Thomas
Leary testified to a number of practices that have come to the
agency's attention that may violate the FTC Act. For example,
Commissioner Leary listed the following as concerns with some
existing CCAs:
Misrepresentations about fees or ``voluntary
contributions.''
Promising great savings they often cannot
deliver.
Abuse of non-profit status.
Failure to pay creditors in a timely manner or at
all.
Failure to abide by telemarketing laws.
Noncompliance with the privacy and security
requirements of the Gramm-Leach-Bliley Act, which restrains
unauthorized use of personal financial information.\207\
---------------------------------------------------------------------------
\207\ Testimony of Commissioner Thomas Leary at Subcommittee
hearing, Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, March 24, 2004.
On November 19, 2003, the FTC filed a complaint in Federal
court against AmeriDebt, DebtWorks, Andris Pukke, and Pamela
Pukke, and a second complaint against The Ballenger Group
alleging these types of unfair and deceptive practices.\208\
The first complaint seeks to enjoin AmeriDebt, DebtWorks, and
Mr. Pukke from making false and deceptive claims about the
nature and costs of the services provided by AmeriDebt. That
suit is ongoing. The FTC has settled the second case against
Ballenger, which agreed to pay a $750,000 fine and change its
practices, as described later in this Report.
---------------------------------------------------------------------------
\208\ FTC v. AmeriDebt, Inc., et al., Case No. PJM 03cv3317, United
States District Court for the District of Maryland; FTC v. The
Ballenger Group, LLC, et al., United States District Court for the
District of Maryland.
---------------------------------------------------------------------------
In addition to its joint efforts with the IRS to inform
consumers of the deceptive practices of some CCAs, at the
hearing, the Honorable Commissioner Thomas Leary told the
Subcommittee: ``the Commission is also currently conducting
several non-public investigations of additional CCAs, debt
negotiators, and related entities.'' Most likely, such
investigations will result in the FTC taking additional action
against existing CCAs and their for-profit affiliates.
(3) Pending Bankruptcy Legislation
Another factor affecting Federal oversight of the credit
counseling industry is the possibility that Congress may enact
bankruptcy reform legislation requiring greater use of credit
counseling. In the 108th Congress, for example, Section 106 of
H.R. 975 would have amended Federal bankruptcy law to require
that all consumers receive ``an individual or group briefing .
. . that outlined the opportunities for available credit
counseling and assisted that individual in performing a related
budget analysis.'' The briefing would have to come from an
approved non-profit budget and credit counseling agency within
180 days prior to filing a petition for bankruptcy. The bill
would have also required debtors to complete ``an instructional
course concerning personal financial management'' after filing
for bankruptcy under either Chapter 7 or Chapter 13.
Moreover, the bill would have required the clerk of each
bankruptcy district to maintain a public list of CCAs and
instructional courses approved by the United States Bankruptcy
Trustee or the bankruptcy administrator in the district. CCAs
and instructional courses would have had to meet the following
criteria:
Provide qualified counselors;
Maintain adequate provision for the safekeeping
and payment of client funds;
Provide adequate counseling with respect to
client credit problems; and
Deal responsibly and effectively with other
matters as they relate to the quality, effectiveness, and
financial security of counseling programs.
Although the bill leaves these requirements to the Bankruptcy
Trustee or the bankruptcy administrator for the individual
districts to define, it does spell out certain minimum
criteria. To be approved, a credit counseling agency must,
among other requirements:
Be a non-profit agency;
Have a board of directors, the majority of which
are not employed by the agency, and will not directly or
indirectly benefit financially from the outcome of a credit
counseling session;
Charge a ``reasonable'' fee and provide services
without regard to the debtor's ability to pay the fee;
Provide full disclosure to clients regarding
funding sources, counselor qualifications, possible impact on
credit reports, any costs that will be paid for by the debtor,
and how such costs will be paid;
Provide adequate counseling that includes an
analysis of the debtor's current situation, what brought them
to that financial status, and how they can develop a plan to
handle the problem without incurring negative amortization of
their debts; and
Provide trained counselors who receive no
commissions or bonuses based on the counseling session outcome
and who have adequate experience and training.
The bill also spelled out minimum requirements for
instructional courses on personal financial management. These
courses, among other requirements, would have had to:
Provide experienced and trained personnel;
Provide relevant learning materials and teaching
methodologies;
Provide adequate facilities: instruction may
occur over the telephone or the Internet if it is effective;
and
Demonstrate after the probationary period that it
has been or is likely to be effective in assisting ``a
substantial number of debtors'' to understand personal
financial management.
The bill would have allowed CCAs and courses to be approved for
a 6-month probationary period and for 1-year terms thereafter.
The bill also would have allowed ``interested parties'' to seek
judicial review of these approvals. The bill also would have
allowed a district court to investigate any credit counseling
agency and remove it from the list.
VI. POST HEARING CHANGES IN THE INDUSTRY
Since the Subcommittee's hearing in March of 2004, a number
of reforms have taken place throughout the credit counseling
industry that may benefit consumers. Most notably, the three
credit counseling agencies chronicled in this Report have
undergone drastic changes ranging from bankruptcy to complete
reorganization. The Internal Revenue Service has tightened its
application process for Section 501(c)(3) status and heightened
their scrutiny of current CCAs with tax-exempt status. Trade
associations have tightened their member standards and educated
their members on the current scrutiny and the need to comply
with the requirements of Section 501(c)(3). Creditors have
similarly tightened their standards for making fair share
payments. The industry has a long way to go; however, with each
improvement, consumers are one step closer to a service they
can rely on.
A. DebtWorks and The Ballenger Group
Ballenger performed DMP processing for 11 non-profit CCAs,
including AmeriDebt. Representatives of DebtWorks, Ballenger,
and AmeriDebt were invited to testify at the Subcommittee's
hearing. Matthew Case, chief operating officer of AmeriDebt,
testified on behalf of AmeriDebt. Andris Pukke who was
subpoenaed to appear on behalf of DebtWorks, invoked his Fifth
Amendment privilege to remain silent. Michael Malesardi, the
chief financial officer for Ballenger, testified in his place
on behalf of Ballenger.
At the time of the hearing, the FTC had filed complaints
against AmeriDebt, DebtWorks, Andris Pukke, Pamela Pukke, and
Ballenger.\209\ Currently, AmeriDebt's action is still pending,
while Ballenger settled with the FTC on November 19, 2003,
agreeing to pay a $750,000 fine and change its business
practices.
---------------------------------------------------------------------------
\209\ FTC v. AmeriDebt, Inc., et al., Case No. PJM 03cv3317, United
States District Court for the District of Maryland; FTC v. The
Ballenger Group, LLC, et al., United States District Court for the
District of Maryland.
---------------------------------------------------------------------------
(1) AmeriDebt Files for Chapter 11 Reorganization
On June 5, 2004, AmeriDebt filed a petition for relief
under the Chapter 11 reorganization provision of the Bankruptcy
Code.\210\ Eight months earlier, AmeriDebt had stopped
enrolling clients on DMPs.\211\ However, Federal and state
enforcement actions have not been stayed by AmeriDebt's
bankruptcy petition.\212\ On June 24, 2004, the U.S. Bankruptcy
Court in Maryland directed the United States Trustee to appoint
an Examiner for AmeriDebt in order to determine if a trustee
should be appointed to manage AmeriDebt operations.\213\ The
court ordered the Examiner to assess AmeriDebt's financial
status, assess AmeriDebt's connection or relationship with
Ballenger (including the officers, directors, and employees),
and perform a preliminary preferences analysis.\214\ On August
11, 2004 Raymond Peroutka, Jr. was appointed as the Bankruptcy
Examiner in the matter.
---------------------------------------------------------------------------
\210\ AmeriDebt letter to the Subcommittee, dated 8/23/04. In Re:
AmeriDebt Inc., Case No. 04-23649-PM, In the District Court of
Maryland, Greenbelt Division.
\211\ AmeriDebt letter to the Subcommittee, dated 8/23/04.
\212\ Id. at p. 2.
\213\ Report for Examination, Case No. 24-23649-PM, United States
Bankruptcy Court, District of Maryland, Greenbelt Division, p. 1.
\214\ Id.
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AmeriDebt currently manages 57,000 DMPs all serviced by
Ballenger.\215\ The remaining nine employees at AmeriDebt
provide ``credit counseling'' to AmeriDebt's existing clientele
via the telephone. The service processing provided by Ballenger
makes up AmeriDebt's largest monthly expense. In the first 7
months of 2004, AmeriDebt earned a net profit of approximately
$1.5 million.\216\ Despite earning a net profit each month
excluding May, the AmeriDebt management informed the Examiner's
staff they do not anticipate reorganizing and emerging from
Chapter 11.\217\
---------------------------------------------------------------------------
\215\ Id. at p. 3.
\216\ Id.
\217\ Id.
---------------------------------------------------------------------------
In assessing AmeriDebt's finances, the Examiner took issue
with the transfer of AmeriDebt's servicing rights to DebtWorks
in 1999. The Examiner pointed out that AmeriDebt transferred to
DebtWorks, for virtually no consideration, servicing rights
that would generate $107 million in fees over the next 4\1/2\
years.\218\ Using the January 2003 sale of 51% interest in the
company owning the servicing rights and the profitability of
the current owner of the servicing rights, Ballenger, the
Examiner deduced that had this transfer been properly priced,
AmeriDebt would have earned net profits for 2003 of $9.1
million.\219\ Even with such profitability, the Examiner noted
the pending state and Federal suits against AmeriDebt seeking
restitution as a concern. Most important of these suits is an
IRS claim for $15 million in anticipation of a finding that
AmeriDebt violated its Section 501(c)(3) status. Ultimately,
the Examiner recommended appointing a trustee and on September
20, 2004 the court approved Mark D. Taylor as trustee.\220\
---------------------------------------------------------------------------
\218\ Id. at p. 7.
\219\ Id.
\220\ Order Approving Appointment of Trustee, Case No. 24-23649 PM,
United States Bankruptcy Court, District of Maryland, Greenbelt
Division, 9/20/04.
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On January 23, 2005 the Federal bankruptcy judge approved
the sale of roughly 60,000 remaining accounts to Money
Management International, a large Houston CCA. This sale paves
the way for the eventual dissolution of AmeriDebt as a company.
The judge had earlier determined that, given the number of
suits pending against AmeriDebt, dissolution was the best
option.
(2) The Ballenger Group
Since the Subcommittee's hearing and the settlement of the
FTC lawsuit, Ballenger has made a number of reforms to conform
to the laws governing tax-exempt organizations and is also
working as an advocate of for-profit CCAs. Among its reforms,
Ballenger has modified its Fulfillment Agreement, changed its
fee structure, and renegotiated its debt to Andris Pukke.
Of the 11 CCAs that the Report described Ballenger as
previously serving, only five currently have agreements with
Ballenger for future DMP processing. Ballenger has executed
Fulfillment Agreements with Debtscape, Debtserve, Fairstream,
The Credit Network, and Visual Credit Counseling. According to
Ballenger, it has made the following modifications to its
Fulfillment Agreement with these CCAs: \221\
---------------------------------------------------------------------------
\221\ Subcommittee interview with Ballenger representatives (9/29/
04).
(1) The agreement between Ballenger and each CCA is now
an ``at will'' contract. Either party may terminate the
agreement at any time for any reason.\222\
---------------------------------------------------------------------------
\222\ The ``at will'' contract comes with two requirements: (1)
from date of notice, Ballenger will process the CCA's DMPs for 90 days
and (2) the CCA must have a zero balance for their receivables with
Ballenger or a ``mutually agreeable plan'' for resolving them.
(2) Ballenger has eliminated the right to transfer
consumers' DMPs from one CCA to another Ballenger CCA for any
---------------------------------------------------------------------------
reason.
(3) The rights to exclusive access to the CCAs' consumer
trust accounts (consumers' monies designated for payment to
creditors) have been eliminated. However, Ballenger maintains
the right to access CCA escrow accounts in the event of non-
payment.
(4) An automatic fee increase of 3% annually was
eliminated.
(5) Ballenger's right to market CCAs' consumers for
goods and services in exchange for a revenue sharing agreement
with the CCA has been eliminated.
(6) All non-competition and exclusivity clauses
requiring the CCA to do business only with Ballenger have been
removed.
(7) A clause requiring each agency to comply with all
rules and regulations issued by the IRS has been added. In
particular, Ballenger requires each CCA to certify that all
necessary steps have been taken to comply with section 4958
which guards against excess benefit to a third party.\223\
---------------------------------------------------------------------------
\223\ Ballenger Fulfillment Agreement with The Credit Network
executed September 1, 2004 para. 2.10.
Ballenger has also reduced its fees to each CCA from $25/
$30 per DMP per month (depending on electronic submission) to
$16/$19 per DMP. Ballenger has reduced the monthly fee by 10%
on pre-2003 DMPs. Such reductions make Ballenger's fees
competitive with the lowest in the industry.\224\
---------------------------------------------------------------------------
\224\ Fair Market Value Evaluation prepared for The Ballenger
Group, April-June 2004.
---------------------------------------------------------------------------
As the Report detailed, on October 2003 Andris Pukke sold
the rights to service various CCAs to Ballenger for $43 million
with an outstanding note to Pukke for $37 million. Ballenger
has renegotiated this debt, settling with Andris Pukke for
$500,000 plus another payment to Pukke of $250,000 for an
agreement not to compete with Ballenger.
At the same time it has reformed its practices, The
Ballenger Group has recently started and funded a new group
called the Coalition for Responsible Credit Solutions
(``CRCS''). CRCS aggressively advocates the for-profit CCA
model and has launched a well-funded campaign to influence the
pending language of a state model law regulating the credit
counseling industry to allow for-profit CCAs. The CRCS
criticizes the creditors and the NFCC and its CCAs, asserting
that a CCA that accepts money from a creditor is working only
for the creditor's interests.
The CRCS's website includes a checklist for consumers on
how to pick a CCA.\225\ This list suggests that face-to-face
counseling is unnecessary and that a consumer should be able to
get all needed education and counseling from the Internet.
Additionally, CRCS suggests the IRS may revoke CCAs' tax-exempt
status for accepting fair share payments from creditors,
leaving few financial options for debtors and causing ``a
bankruptcy explosion.'' \226\
---------------------------------------------------------------------------
\225\ Available at www.responsiblecredit.com/index.php. See also,
``New Debt Counseling Group Draws Fire; Doubts: A Consumer Advocacy
Group is Accused of Being a Creature of the Growing Debt Counseling
Industry,'' The Baltimore Sun, July 21, 2004.
\226\ ``Consumers for Responsible Credit Solutions Warns of a
Future Bankruptcy Explosion if Most States or Congress Don't Act to
Change Current Credit Counseling Laws,'' PR Newswire, August 26, 2004.
---------------------------------------------------------------------------
For-profit CCA advocates have apparently convinced the
National Conference of Commissioners on Uniform State Laws
(``NCCUSL'') to incorporate a place for for-profit CCAs in
their model law. As mentioned, the Consumer Federation of
America and the National Consumer Law Center have also prepared
a model law, which allows for-profit CCAs. However, in a letter
to NCCUSL, the groups expressed reservations about the for-
profit model's ability to survive with the imposed fee limits
they are suggesting.\227\ The CFA and NCLC maintain that they
are neutral on the issue and have neither ``endorsed'' nor
rejected the for-profit model.\228\ They also state: ``We note
with concern that some of the credit counseling entities that
have been most aggressive in insisting that creditors and
legislators endorse the for-profit model, like The Ballenger
Group, are the very same companies who have been investigated,
sued or sanctioned for deceptive acts by state and Federal
regulators or lawmakers.'' They go on to say, ``In our opinion,
this means that their claims that the for-profit model would be
the salvation of the credit counseling industry completely lack
credibility.'' \229\ The CFA and NCLC support a non-profit
presence as vital to the credit counseling industry and its
future.\230\
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\227\ NCLC/CFA letter to Commissioner William C. Hiloman, dated 8/
3/04.
\228\ Id. at p. 5.
\229\ Id.
\230\ Id.
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B. The Ascend One-Amerix Conglomerate
As the Subcommittee's investigation proceeded, both AFS and
Amerix notified the Subcommittee that each intended to modify
its business practices. At the hearing, Cuba Craig, president
and CEO of AFS, described the reforms that AFS had undertaken
to conform to the letter and spirit of the law. It should be
noted that AFS did not charge up front fees and had capped its
monthly fees at $50 per month even prior to the Subcommittee's
investigation. Criticisms of AFS operations were confined to
its outsourcing and service agreement with Amerix. Cuba Craig
testified, ``Since the Subcommittee began its investigation, we
have stepped up our efforts to ensure that AFS meets all
applicable requirements.''
To that end, AFS told the Subcommittee that it had
implemented the following changes to its operations:
(1) Origination, counseling, and all DMP enrollment are
now done in- house.\231\
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\231\ Second Addendum to Service Agreement between Amerix and
American Financial Solutions, dated 4/12/04.
(2) The service agreement requirements to enroll 30% of
all first time callers on DMPs (the ``assist rate'') and to
generate $30 revenue per month in consumer fees for each DMP
(the ``revenue standard'') were eliminated in April 2004. \232\
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\232\ Id.
(3) AFS terminated both the FreedomPoint Strategic
Marketing Agreement and the the FreedomPoint Mortgage Brokerage
Prospect Lead Agreement on May 1, 2004, which meant that AFS
was no longer required to make client referrals to these for-
profit companies.\233\
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\233\ AFS letter to the Subcommittee, dated 8/31/04.
(4) On May 5, 2004 AFS gave notice to Amerix that it
would not renew the Amerix Benefits Package Marketing Agreement
at the end of its initial term, and that AFS wished to cease
marketing the Member Benefits Package. AFS was released from
its marketing obligations in mid-August.\234\
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\234\ Letter from AFS to Amerix, dated 5/5/04.
(5) AFS solicited information about competitive bids for
marketing services and conducted an analysis of the back office
servicing in order to assess the fair market prices of such
services. AFS issued a request for proposal for back office
services in mid-September.\235\
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\235\ Id.
(6) AFS scripts regarding voluntary contributions have
been revised to ensure that consumers are clear that any
contribution is voluntary. \236\
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\236\ AFS letter to the Subcommittee, dated 8/31/04.
(7) The AFS website has been changed to provide
educational resources to all visitors, not just AFS clients.
\237\
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\237\ Id.
(8) In August 2004, AFS opened a community learning
center in the poorest neighborhood school in the Bremerton
School District, near an AFS call center in Washington state.
The Learning Center offers classes, tutoring, counseling and
other financial and credit education to anyone who wishes to
participate, free of charge.\238\ In addition, AFS has created
an internship where the students work with the AFS Education
Manager conducting surveys of the community to identify
financial education needs.\239\
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\238\ AFS received partial funding for the learning center from the
Association of Independent Consumer Credit Counseling Agencies. 2004
AICCCA Consumer Education Grant 7/13/04.
\239\ AFS letter to the Subcommittee, dated 8/31/04.
(9) In an effort to ensure that appropriate consumers
are on DMPs, AFS has assigned three counselors to follow up
with consumers who miss payments to determine whether the
consumers should remain on the DMP and provide additional
counseling if needed.\240\
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\240\ Id.
Amerix, which provides debt servicing to CCAs in the
conglomerate, has also made a number of significant changes in
its operations. Bernaldo Dancel, president and CEO of Ascend
One, the holding company of Amerix, said at the hearing, ``We
recognize that we can always do better, and this investigation
has played quite a constructive role for our company in helping
us.'' Mr. Dancel noted, ``I think, frankly, the area where I
believe there is particular room for improvement is in seeing
the CCAs we serve offer good education and counseling to all
consumers seeking assistance, whether they are suitable for a
DMP or not.'' Amerix told the Subcommittee that its reforms
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include the following:
(1) Amerix has enlisted ``Enhanced Standards'' that will
be required of every non-profit CCA wishing to do business with
Amerix. Amerix told the Subcommittee that these enhanced
standards include all of the requirements of AICCCA or NFCC
membership, and require CCAs to conduct community outreach of
1,000 hours per year, perform individual client assessments
regardless of whether clients choose to enroll in a DMP,
prepare budgeting worksheets with tips for the client, and
partner with an educational institution to increase educational
offerings and consumer financial awareness.\241\
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\241\ Ascend One letter to the Subcommittee, dated 8/23/04.
(2) Amerix ceased providing overflow origination
services to American Financial Solutions on March 15, 2004 and
determined not to provide such services to any other CCA.\242\
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\242\ Second Addendum to Service Agreement between Amerix and
American Financial Solutions, dated 4/12/04.
(3) Amerix eliminated any assist rate or revenue
standard from its service agreement with its CCAs so there are
no minimum DMP enrollment or monthly fee generation, as
explained earlier with respect to AFS.\243\
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\243\ Id.
(4) Amerix worked with its CCAs to review and modify all
scripts used by counselors when assisting clients with credit
counseling.\244\
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\244\ Ascend One letter to the Subcommittee, dated 8/23/04; CESI
Financial Counseling Session Guidelines and Disclosure Requirements;
AFS Scripts.
(5) Ascend One has provided funding of $500,000 and
pledged over $5 million over 10 years to the Ascend One fund
for financial literacy. In addition, on July 21, 2004, Ascend
One made a $24,000 grant to Junior Achievement to provide
financial literacy education in the Baltimore City Schools, and
another grant on July 28, 2004, of $50,000 over a 5-year period
to the Maryland Council on Economic Education.\245\
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\245\ Ascend One letter to the Subcommittee, dated 8/23/04; Ascend
One, Concentration Account, bank statement March, 2004.
(6) Amerix also agreed to negotiate in good faith the
fee structure for the services Amerix provides for AFS to
reflect actual costs and the value of services provided.\246\
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\246\ American Financial Solutions letter to the Subcommittee,
dated 8/31/04.
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C. The Cambridge-Brighton Conglomerate
Cambridge representatives were invited to testify at the
Subcommittee's hearing on March 24, 2004. Mr. Viale was invited
to represent Cambridge, the non-profit CCA. Mr. Puccio was
invited to represent the back office service provider for
Cambridge and Brighton Debt Management. On the eve of the
hearing Mr. Puccio informed the Subcommittee of health concerns
that would prevent him from testifying. Mr. Viale attended the
hearing and provided testimony on the CCA part of Cambridge's
operations. A deposition of Mr. Puccio took place on July 1,
2004 and is included in the hearing record.\247\
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\247\ Profiteering in a Non-Profit Industry: Abusive Practices in
the Credit Counseling Industry, March 24, 2004, Exhibit No. 18, p. 264.
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Since the Subcommittee hearing on March 24, 2004, Cambridge
has taken steps to overhaul its entire corporate structure.
Discussed below are changes that the Cambridge-Brighton
conglomerate told the Subcommittee it was making to transition
from a profit-driven group of companies to a system of
operations driven by non-profit motives.
Cambridge-Brighton told the Subcommittee that a new non-
profit holding company will be created called ``Cambridge
Credit Non-Profit Holding Company'' that will function as the
parent company.\248\ This company will be the sole owner of
each non-profit CCA and the sole shareholder of two of the for-
profit companies, Cambridge Index and Brighton Credit
Management Corp.\249\ In addition, the for-profit service
companies still wholly owned by John and Richard Puccio,
Brighton DMS, Debt Relief Clearing House Ltd., and Cypress
Advertising & Promotions, Inc. (``the servicing companies''),
will become wholly owned subsidiaries of a new for-profit
holding company called ``Cambridge Credit For-Profit Holding
Company,'' whose stock will be wholly owned by the non-profit
CCAs, Cambridge and Cambridge Budget Planning.\250\ As a
result, Cambridge-Brighton told the Subcommittee that any and
all profits of the servicing companies and the for-profit
Cambridge Index and Brighton Credit, the for-profit CCA, will
inure to the benefit of the non-profit CCAs and the non-profit
holding company.
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\248\ Cambridge letter to the Subcommittee, dated 8/31/04.
\249\ Id.
\250\ Id.
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The Subcommittee was also told that officers and employees
of Cambridge will transfer the capitol stock of Brighton DMS,
Debt Relief Clearing House, and Brighton Credit (the for-profit
CCA) to the non-profit holding company.\251\ Pursuant to these
changes, the non-profit CCAs will control through the non-
profit holding company, Cambridge Credit Non-Profit Holding
Company, 100% of the stock of each of the servicing companies.
The non-profit holding company will also own all of the stock
of the servicing companies and the for-profit CCA, Brighton
Credit. Consequently, all profit generated by the for-profit
companies will be in the control of and available for use by
the non-profit companies.
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\251\ Id.
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Cambridge-Brighton said that with the reorganization, the
board of directors of the non-profit CCAs and the non-profit
holding company will be expanded to include nine members, eight
of whom will be independent directors who may not be officers,
employees, or independent contractors of the non-profit CCAs or
the non-profit holding company.\252\ For the for-profit
companies, the governing board will consist of three directors,
two of whom will be independent.\253\
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\252\ Id.
\253\ Id.
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Cambridge-Brighton told the Subcommittee that as of June 1,
2004 all of its CCAs--Cambridge, Cambridge/Brighton Budget
Planning, and Brighton Credit--had modified the fees charged to
consumers for the construction and maintenance of the DMP.\254\
The maximum fee charged for initiating a DMP will be $75 and
the maximum monthly fee for maintenance is $50 per month.\255\
Additionally, Cambridge has instituted a new refund policy
allowing consumers to cancel the DMP at any time in the first
90 days of enrollment with a full refund available.\256\
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\254\ Id.
\255\ Id.
\256\ Id.
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Cambridge-Brighton told the Subcommittee that its CCAs have
introduced a system called ``post counseling'' in which their
counselors follow up with consumers placed on DMPs to ensure
that they are utilizing the budgeting tools provided to track
their finances. Three scheduled calls are supposed to be
completed within the first 90 days of entering the DMP and the
goal is to emphasize the need to develop savings. \257\
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\257\ Id.
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For the community, Cambridge told the Subcommittee that it
has committed $4 million over the next 3 years for the program
``Learn Now or Pay Later,'' \258\ working with high school
students across the nation to educate them on the
responsibilities that accompany credit. Students achieving
excellence in the program will be awarded scholarships.
Additionally, Cambridge works with a local Job Corp program to
educate at-risk youths about the importance of responsible
financial habits.\259\ Speaking engagements at local colleges
and information booths at local shopping malls are also part of
their community outreach.\260\
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\258\ Id.
\259\ Id.
\260\ Id.
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If implemented, these and other reforms should help resolve
the abusive practices documented in this report.
D. Recommendations
Based upon its investigation of the credit counseling
industry, the Subcommittee makes the following recommendations:
(1) Complete Industry Cleanup. The IRS and FTC should
complete their ongoing reviews of the credit counseling
industry to eliminate abusive conduct by credit counseling
agencies that have been operating in violation of restrictions
on non-profit charities or using unfair or deceptive trade
practices.
(2) Establish Five-Year Review. In light of past
industry abuses, the IRS should require each credit counseling
agency exempt from Federal taxation under Section 503(c)(3) to
submit every 5 years, for IRS review, return information
establishing its charitable activities and a certification that
the agency is not providing a private benefit to any individual
or entity. The IRS should review these materials to ensure each
credit counseling agency is operating as a charitable
organization and in compliance with the law for non-profit
entities. Congress should consider enacting legislation
conditioning a credit counseling agency's tax exemption on the
submission of this documentation and the IRS's renewal of its
tax-exempt status for 5-year periods.\261\
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\261\ The United States Senate Finance Committee has circulated a
Discussion Draft of proposals for reforms and best practices in the
area of tax-exempt organizations. The Committee suggests a five-year
review of tax exempt status by the IRS, including the filing of current
articles of incorporation and by-laws, conflict of interest policies,
evidence of accreditation, management policies regarding best
practices, a detailed narrative about the organization's practices, and
financial statements.
(3) Provide Consumer Education. To address rising
consumer debt and bankruptcy rates, each credit counseling
agency should provide affirmative financial counseling and
educational programs designed to reduce excessive indebtedness
within the populations they serve, and should evaluate,
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improve, and document the effectiveness of these programs.
(4) Continue Creditor Support and Standards. Major
creditors should continue to provide financial support to
appropriate, non-profit credit counseling agencies, conditioned
upon the agencies' achieving specified standards that
contribute to the public good, including standards requiring
agencies to maintain good standing and accreditation status
within the industry, assess reasonable fees based upon actual
costs, provide individualized debt counseling to clients, and
avoid conduct or transactions that generate or create the
appearance of generating a private benefit for any individual
or entity. Creditors should carefully screen credit counseling
agencies to ensure they provide funds only to reputable
agencies that comply with their standards.
(5) Clarify Federal Standards. The IRS and FTC should
work together to clarify the standards that credit counseling
agencies must meet to maintain tax exempt status under Section
501(c)(3) and avoid deceptive or unfair trade practices,
including by making it clear that a non-profit credit
counseling agency must:
(a) Accreditation--maintain good standing and
accreditation status within the credit counseling industry,
such as by meeting the accreditation standards of the Council
on Accreditation for Children and Family Services;
(b) Independent Board--maintain an independent Board
of Directors that includes representatives of the community
served by the agency and that includes no more than a minority
of directors who are employed by the agency, a related entity,
or any other person who stands to gain direct or indirect
financial benefit from the agency's activities;
(c) Public, Not Private Benefit--avoid conduct or
transactions that generate or create the appearance of
generating a private benefit for any individual or entity;
(d) Full Disclosure--disclose to each client the
existence and nature of any financial relationship that the
agency has with a creditor of the consumer or with a for-profit
entity that provides data processing, marketing, or financial
services to the agency or the client;
(e) Reasonable Fees--assess clients reasonable fees
that are based upon the agency's actual costs and charged as
services are provided, rather than substantially in advance of
such services; and
(f) No Improper Incentives--refrain from accepting
compensation for referring clients to any service or
organization, and refrain from paying compensation to any
employee based upon the number of clients enrolled in debt
management plans or the amount of client debt managed by the
agency.