As with any growing industry the complaints increased. Consumers said some firms charged thousands of dollars in upfront fees and never delivered any debt relief. The Better Business Bureau has received more than 2,500 complaints about debt relief firms this year. The bureau started tracking the debt relief services industry as a separate category in 2010 in response to a “significant increase” in the number of complaints it received about the companies, she says.

Hoping to stop rip-offs, the Federal Trade Commission last year barred debt settlement companies that use telemarketing from accepting upfront fees. (The FTC regulates firms that sell over the phone.) Some companies soon found a loophole, though. It remains unclear whether the rule applies to legal fees, so debt settlement firms are affiliating with lawyers to charge initial fees as high as $7,000 or more.

J. Reilly Dolan, acting director of the division of financial practices at the FTC, says that the telemarketing rule includes no specific exemption for lawyers and that the FTC would need to evaluate firms that affiliate with attorneys on a case-by-case basis to see whether they are in compliance. “We are concerned about companies that are associating themselves with attorneys but are not complying with the telemarketing sales rule,” he says. Trying to rein in dodgy debt settlement practices is “like playing Whack-A-Mole,” says Suzanne Martindale, an attorney for the Consumers Union in San Francisco. “We do expect we’ll continue to see more businesses cropping up trying to exploit loopholes” in the new regulations.

The premise behind debt settlement firms has always been questionable. When customers enroll in a debt settlement program, they’re usually told to stop making minimum payments to creditors and instead to pay into a trust or escrow account. Once that account has accumulated enough money, the firm negotiates with creditors to try to settle in cash for an amount less than the consumer’s outstanding debt.

The problem with charging upfront fees is that all of a consumer’s monthly payments may go toward the settlement firm’s charges first, meaning customers may not accumulate a positive balance in their accounts for months after starting a program, according to critics such as Martindale. Customers may continue to accrue late fees or interest and possible negative marks on their credit reports, and they may still be sued by creditors after enrolling in a program. Says William Binzel, corporate secretary for the National Foundation for Credit Counseling, a Washington-based network of nonprofit credit-counseling agencies: “I think a consumer goes into a debt settlement thinking, ‘At last, I’ll solve the problem,’ only to find out nine or 10 months down the road that while they’ve been paying into this account, they’re actually deeper in debt and may be subject to being sued by creditors.”

Some firms began shifting to an attorney model—partnering with a law firm—before the FTC rule took effect because of loopholes for lawyers in state laws, says Scott Johnson, chief executive officer of U.S. Debt Resolve, a settlement firm that does not charge upfront fees. In the past two years attorney-model firms have become a majority of the debt settlement industry, says Amy Clark Kleinpeter, an Austin (Tex.) attorney who represents consumers against debt settlement firms. “Most seem to have converted relatively easily,” she says. Some also have started meeting with clients face to face when signing documents because the FTC rule was directed at telemarketers and may not cover agreements made in person, says Housser of the American Fair Credit Council.

Membership in the U.S. Organizations for Bankruptcy Alternatives, a trade association for debt settlement firms, has declined to about 30 from more than 200, according to Executive Director Jenna Keehnen. The American Fair Credit Council is down to about 35 firms from about 220, Housser says. Both groups require that members comply with the FTC rule and only charge “performance-based” fees, meaning fees are assessed only after a debt is settled. “They haven’t left the industry,” says USDR’s Johnson. “They’ve left the trade associations, because they don’t want to abide by a performance-based service fee.”

Morgan Drexen’s consumers are charged with upfront fees which goes against the FTC ruling. Companies within the debt settlement industry have to abide by the rule that fees cannot be charged until a settlement is reached an executed.

Jenny Sykes enrolled with Morgan Drexen and she initially owed $7,844 on three credit cards and was current on her payments. Sykes paid Morgan Drexen $7,014.10 over more than three years, Ms. Sykes found herself more deeply in debt because of her creditors assessed late fees and penalty interest when her monthly payments started going to Morgan Drexen rather than to them. Ultimately three of her creditors obtained judgments against her.

The position of the suit is that Morgan Drexen provided unlicensed debt services in the State of Virginia.

The suit revealed that Sykes was suppose to pay $145 for 49 months to be debt free, after paying $140 to $235 per month for 41 months, her payments equaled $7,014.10. After reviewing these totals and reviewing the worksheet that Morgan Drexen provided, she was 65 months and $13k away from becoming debt free.

By November 2010, Morgan Drexen had collected $3,936.86 of statutorily prohibited fees from Ms. Sykes, yet Ms. Sykes was even deeper in debt than when she began the program.

At the end of three years Morgan Drexen claimed they had negotiated settlements that saved the consumer $3,919 while at the same time had charged $3,936 in fees.

After Ms. Sykes was sued in 2008 by one of her creditors she was instructed to sign a “Limited Scope Representation Agreement” with Mr. Jim Bowman, an attorney licensed in Virginia. Bowman provided her with a consultation that cost Ms. Sykes $45 and she was instructed to represent herself.

The suit claims Morgan Drexen’s Business Model is a Facade.