Credit Repair Firms Look for Loophole : Regulation: Some Southland companies are seeking not-for-profit status to get around tough new regulations implemented by the state on the scandal-ridden industry.

Trying to slide through a legal loophole, some credit repair companies in Southern California are seeking not-for-profit status to get around tough new regulations on the scandal-ridden industry.

The firms are trying to skirt a 5-month-old state law that requires credit repair companies to register with the state Department of Justice and to post a $100,000 bond to protect consumers against losses. The law also forbids credit repair firms from collecting fees from consumers before service is performed.

The law was enacted to protect debt-ridden Californians from paying fees that run into the thousands of dollars to credit repair firms that promise to fix negative items on credit reports issued by TRW, Equifax, Trans Union and others. These negative items--such as bankruptcies, tax liens and delinquent payments--could result in consumers being denied credit. Though some credit repair firms perform a legitimate--if costly--service, many do not. If accurate, negative items usually cannot be deleted from credit reports.

The law exempts not-for-profit corporations from its requirements, providing relief for such long-established organizations as Consumer Credit Counseling Service, which operates a nationwide network of low-cost counseling centers.

But credit repair companies are applying to the Internal Revenue Service for tax-exempt status to avoid the financial restrictions imposed by the new law.

One company with tax-exempt status from the IRS has been linked to the former owner of Anaheim-based United Credit Repair, which collapsed last year amid fraud allegations. The company took in $7 million from 9,000 people, leaving a mess that helped inspire the law.

When told about the corporate maneuvering by credit repair firms, a spokeswoman for state Assemblyman Steve Peace (D-Chula Vista), the law’s sponsor, commented: “When there is a scam artist out there, they find a way to get around the law.”

The spokeswoman, Robin Larson, said new legislation may be needed “to close the loophole--if that’s what it is.”

To date, only one credit repair firm--Ontario-based Coast Credit--has registered with the Department of Justice and put up the hefty six-figure bond, said state Deputy Atty. Gen. Susan Henrichsen. She said an application from a second company is pending.

Random calls to credit repair companies turned up some that are ignoring the law entirely. In other cases, firms have folded but employees have gone to work for lawyers. Under certain circumstances, lawyers are exempt from the new law.

The most surprising development is the proliferation of not-for-profit credit repair companies.

One company that has received tax-exempt status from the IRS is Consumer Debt Management Corp. of Anaheim. Its president is Ray Reynolds, a former principle of United Credit Repair. He is paying $20,000 to settle state charges that United Credit Repair falsely promised to fix bad credit.

In an interview, Reynolds said that Consumer Debt Management is not a credit repair company but a counseling service that puts people on budgets and helps to consolidate their debts. Reynolds said the company performs certain credit repair functions, however.

“If people come in, and there is something not accurate on their credit report, or something they tell us is wrong and shouldn’t be there, we can work to correct that,” Reynolds said.

Other companies say they are seeking tax-exempt status because they cannot obtain a bond. Among them is Orange-based Credit Counseling Assn. of America and New Century Credit Restoration & Services of Studio City.

New Century owner Marjorie McCoy said she plans to offer senior citizen discounts and consumer education to qualify as a tax-exempt organization. As an example, she cited an article she wrote about her business in Mortgage Originator, an obscure industry magazine.

Credit Counseling Assn. of America plans to hold free debt-counseling seminars, a spokesman said. Credit repair companies have been known to conduct free seminars to recruit new clients.

Whether these firms will receive IRS approval is not known. The IRS would not confirm whether the firms have applied. It did confirm that Consumer Debt Management is tax-exempt.

Ironically, the maneuvering on the part of some credit repair companies comes as some of them are challenging the new law in the courts.

Four credit repair companies--including New Century--have sued the state in federal court in San Diego, seeking to have the law set aside as unconstitutional. The companies argue that the bonding requirement will force them out of business.

“You can transport dynamite in this state with a smaller bond,” said Tim McDermott, attorney for San Diego-based Giving You Credit Inc., the largest company involved in the suit.

According to state official Henrichsen, a federal judge has denied the credit repair companies’ request to suspend enforcement of the law until the case is settled later this year. “The judge essentially said the state has the right to ban the industry if it wants to,” Henrichsen said. “I’m pretty confident about this one.”