The Internal Revenue Service and the Federal Trade Commission are cracking down on debt counseling and debt consolidation companies that use nonprofits as a front for their for-profit activities.

The IRS says it is currently auditing 30 of the nation's 850 non-profit debt counseling services. It won't release the names of those companies or those it has already penalized. The FTC, meanwhile, has acted on other cases.

The crackdowns are aimed at companies that charge exorbitant fees or funnel their income to a for-profit affiliate that acts as a debt collector.

The actions are causing considerable upheaval in the industry, and could force some nonprofits to reorganize as for-profit firms, thereby reducing the options for people ordered by bankruptcy courts to seek debt counseling.

"You would think this industry would be counter-cyclical," says Brad Stroh, founder and CEO of Freedom Financial Network LLC, a for-profit company that provides debt-resolution services at offices in San Mateo and Sacramento. "But the fact of the matter (is that) this is a growing business in any business cycle because of growing consumer debt."

In fact, American consumer credit card debt grew 4 percent last year to a total of more than $2
trillion, according to the U.S. Federal Reserve. Bankruptcies in Santa Clara County had been rising
through the first years of the decade, but dropped 5.3 percent over the last 12 months, according
to the U.S. Bankruptcy Court. A total of 7,837 people filed for bankruptcy in the court's San Jose
District over the last 12 months.

"We're very pleased that the IRS is looking into the credit industry," says Ann Ray, senior vice president of the National Foundation for Credit Counseling, a trade association for debt counseling firms. "Our members have always been held to high standards."

Drawn by new marketing tools like call centers and e-mail, companies have entered the business over the last decade. Debt counseling began in the 1950s as community-based organizations funded by local stores.

"It has evolved into national operations that enroll consumers in debt management plans, take money to pay off the debt and leave out the counseling element," says Jen Schwarzman, FTC spokeswoman.

This summer, the FTC was tipped off to a problem when it began to get calls and e-mails from people who had registered for the Do Not Call Registry but had been receiving telephone solicitations for debt counseling and consolidation. The callers said they worked for nonprofit companies. Nonprofits are exempt from the Do Not Call restrictions.

When it investigated, the FTC found that that Debt Management Foundation Services Inc. was making calls across the country, falsely claiming to be a nonprofit agency and telling people that they had been approved for debt consolidation loans. Later those people would find that there was an upfront fee of as high as $1,000 in addition to monthly fees.

In addition, according to the FTC, the company did not provide debt management services, but
merely sent its customers' paperwork to apply for services from another company that did not
necessarily offer the promised interest rates and low monthly fees.

A U.S. District Judge in Tampa, Fla., has issued an injunction prohibiting Debt Management Foundation Services and its affiliates from engaging in the suspect activities.

The Internet is now one of the biggest marketing venues for debt consolidation. For example, Azoogle Advertising Network Inc. in Toronto, which has not been accused of improper activities by either the IRS or the FTC, maintains a Web site that draws consumers who want to consolidate their debt. At the site, consumers provide information that Azoogle then makes available to third-party firms that will offer the loan money.

"It's a marketing site," says Jeff Botnick, vice president of business development. "People give their information to get called back later by a debt-settlement company."

What many of the national debt consolidators leave out is the counseling about how to stay out of debt, says Joy Thormodsgard, CEO of the Consumer Credit Counseling Service, which serves Santa Clara County and five other counties.

"They don't review the complete financial situation," she says. "They will put anyone who wants it on a debt management plan. Their interest is not in providing in-depth money management or credit education."

Click here to go to Freedom Debt Relief's website