Fraud and deceit in debt settlement

You’d have to be living on Mars not to have seen or heard the ads: Settle your debt for pennies on the dollar. Get out from under credit card bills you can’t pay.

It sounds too good to be true.

It is, the U.S. Government Accountability Office reported last week, saying an investigation found rampant fraud, abuse and misrepresentation in debt settlement. In a report to a Senate committee, the GAO wrote:

While we determined that some companies gave consumers sound advice, most of those we contacted provided information that was deceptive, abusive, or, in some cases, fraudulent. Representatives of several companies claimed that their programs had unusually high success rates, made guarantees about the extent to which they could reduce our debts, or offered other information that we found to be fraudulent, deceptive, or otherwise questionable.

For its report (.pdf file), GAO investigators, posing as consumers with credit card debt, called 20 debt-settlement companies. The GAO monitored those calls for quality-control purposes, and you can hear some of the misrepresentations its agents found, such as companies claiming to be government-approved or part of the economic stimulus program.

Complaints about debt-settlement companies have risen during the recession as the number of companies offering to negotiate settlements with credit card companies for consumers has skyrocketed.

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But few of the companies, which charge hefty fees up front before they begin the negotiation, get results. While there are no definitive statistics, the GAO said state and Federal Trade Commission investigations have found that fewer than 10% of the people who work with such agencies actually settle their debt for pennies on the dollar. The industry claims a higher success rate, but even the most optimistic industry claim is that only about 34% of customers complete the programs.

Sen. John D. Rockefeller, D-W.Va., chairman of the Senate

Commerce Committee, summed up the issue in a news release: “… these companies keep the fees, but don’t keep their promises. In reality, signing up to work with these companies usually makes struggling consumers’ financial situation much worse. They fall farther behind on their debts, they see their credit scores plunge, and they get sued by their creditors.”

Rockefeller told the story of Mark Spaulding of West Virginia, who owed $23,000 in credit card and hospital bills. The Spauldings paid a California company more than $2,400 in fees and followed the company’s advice for 14 months.

The result, according to Rockefeller: Spaulding owes 40% more than he did when he started, his credit is ruined, he has two court judgments against him, and he has been advised to think about bankruptcy.

"It is appalling beyond words," Rockefeller said. "These debt-settlement companies are kicking people when they are down."

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John Ansbach, legislative director for the U.S. Organizations for Bankruptcy Alternatives, an industry group, said there are problems in the industry, The Washington Post reported. His organization and another industry group, the Association of Settlement Companies, support proposed FTC regulations that would require more disclosure and ban some types of advertising.

"This is not a rosy picture," Ansbach said at the hearing. "There are absolutely issues in this industry that must be addressed."

The FTC has no timetable for imposing new rules. In the meantime, some states have banned advance fees, including Arkansas, Hawaii, Kentucky, New Mexico and Wyoming, the Post reported.

Sen. Charles E. Schumer, D-N.Y., is planning to introduce a bill that would ban advance fees and cap total fees.

Steve Rhode at Get Out of Debt reported that the legislation would limit upfront fees to $50, ban monthly fees, cap fees at 5% of the debt actually settled and allow customers to get full refunds. Oh, and it also would prohibit claims of settlement success unless they were verified by an independent audit.

Rhode has an interesting post about his efforts to determine the success rates of debt-settlement programs.

Debt settlement might work for a small number of people in specific circumstances, while others would be better off declaring bankruptcy.

When considering debt settlement, it’s important to be extremely careful, cautions MSN Money columnist Liz Pulliam Weston. She writes:

Some companies offering debt settlement are fly-by-night scams, eager to take big upfront fees and then disappear. Others are too inept or inexperienced to negotiate effective deals. Either way, the result is the same: money down the drain at a time when you can ill afford the loss.

Related reading:

• Solutions to debt dilemmas: Debt settlement
• Consumer Affairs’ top 10 scams of 2009
• Insider's guide to debt consolidation
• Credit card debt: How to cut a deal