Bankruptcy Fraud Resource Center

Deloitte report studying link between bankruptcy and fraud available

The Deloitte Forensic Center and its Reorganization Services Group has produced the findings of a report that studied the correlation between bankruptcy and fraud.  The primary question examined was whether the increased scrutiny that follows a company's bankruptcy filing leads to more incidents of fraud claims as compared to companies that have not filed bankruptcy.    The report is available here.

Among its findings:

·         Companies filing for bankruptcy protection are three times more likely than non-bankrupt companies to face enforcement action by the SEC relating to alleged financial statement fraud.

·         Companies that were issued financial statement fraud-related SEC Enforcement Releases were more than twice as likely to file bankruptcy protection as those not issued one.

·         Approximately one in seven financial statement fraud SEC Enforcement Releases issued to companies that filed for bankruptcy protection were issued prior to their bankruptcy filings. These situations may provide a warning signal of potential bankruptcy filing.

·         Bankrupt companies receiving SEC Enforcement Releases were twice as likely as non-bankrupt companies to have more than 10 alleged financial statement fraud schemes – and at least 1.5 times more likely to have six to 10 alleged fraud schemes than non-bankrupt companies.

Cross examination into possible bankruptcy fraud did not constitute improper "other crimes" evidence in bank fraud trial

Earlier this week in this post, we reported on Brenda Hartman' s loss of her Oregon state insurance producer's license as a collateral conseqence of her conviction for committing bankruptcy fraud.  Today, we again are reporting on collateral consequences - only this time there was no bankruptcy criminal conviction - only evidence of possible bankruptcy fraud.

In United States v. Ross, No. 05-4469 (6th Cir., Sept. 21, 2007), Ross appealed his conviction on two counts of bank fraud for depositing multiple counterfeit checks as part of a so-called Nigerian counterfeit check scam.  During the course of trial, Ross testified on direct examination that he had filed a personal bankruptcy petition under chapter 7 of the bankruptcy code and "all the loans and people that [he] owed were put into the bankruptcy...."  Over a timely defense objection, the government was permitted to cross-examine Ross by attempting to elicit that Ross had improperly failed to schedule some of his personal creditors.  Ross was convicted of the bank fruad and on appeal argued that the government's cross-examination was improper Rule 404(b) evidence of other crimes, wrongs or acts - namely bankruptcy fraud. 

The Sixth Circuit flatly rejected the argument holding that Ross' direct testimony that he scheduled all of his creditors "open[ed] the door for exploration of that statement on cross-examination."  Because the government is permitted to impeach any statement made by Ross on direct examination, the cross-examination - though it may have related to a possible bankruptcy fraud - was entirely permissible.

No privilege or immunity for draft bankruptcy schedules in bankruptcy criminal investigation

Two of the most valuable sources of information in the investigation of a debtor's alleged bankruptcy fraud are the debtor's bankruptcy attorney and drafts of the debtor's schedules (including the completed intake questionnaire).  With limited exceptions, a debtor's bankruptcy counsel may properly be interviewed by investigating authorities, and both he and his files may be subpoenaed for use before a grand jury or during trial.  The contours of this rule, and its exceptions, I analyze in Chapters 5 and 6 of my treatise on bankruptcy fraud, Bankruptcy Crimes Law and Procedure (LRP 2006).

Most recently, the U.S. District Court for the District of Columbia enforced the general rule in United States v. Naegele, No. 05-0151 (PLF) (D. D.C. Jan. 4, 2007), denying the attorney client privilege and work product immunity for a debtor's draft bankruptcy schedules that the government had subpoenaed during the investigation of several alleged bankruptcy crimes.  Upon receiving a subpoena, for his files and trial testimony, the debtor's bankruptcy attorney moved for a protective order, which the government opposed. 

While several categories of documents were at issue, the district court held that the attorney client privilege did not attach to draft bankruptcy schedules because the information they contained was intended to be disclosed publicly to the bankruptcy court and therefore was not confidential.  Naegele, slip op. at 9.  The court also denied the draft schedules any work product immunity holding: "the bankruptcy filing was not itself 'litigation' in anticipation of which protected attorney work product can be created."  Naegele, slip op. at 13.

While neither of these rulings beaks new ground the opinion is important reading for bankruptcy practitioners.  The full text of the opinion is available here.

Does amending schedules preclude a bankruptcy fraud conviction?

One of the most common misconceptions concerning bankruptcy fraud is that a amending a petition or schedule to supply missing (or to correct inaccurate) information in an original filing protects the debtor from a bankruptcy fraud charge.  In the classic context, suppose a debtor omits an asset from the schedules.  A trustee's examination during a meeting of creditors uncovers the asset and the debtor is instructed to amend the appropriate schedule.  The schedule is in fact then duly amended, filed and noticed.  Does the amendment - and hence the disclosure - mean the debtor could not properly be charged with a concealment or false statement?  The answer is no.  While amendments are liberally allowed (see Fed.R.Bank.P. 1009(a)), subsequent remedial measures do not shield a debtor from criminal prosecution (or conviction), although the corrective action may be admissible in a criminal case to show a lack of fraudulent intent. 

Applying this well established rule, the Tenth Circuit recently rejected a debtor's argument that amending his schedules to correct a false social security number (SSN) operated as a defense to a false declaration charge (18 U.S.C. 152(3)).  In United States v. Beach, Nos. 05-3362 - 063053 (10th Cir. Apr. 9, 2007) (unpublished) (available here), a debtor filed a pro se chapter 7 bankruptcy petition in which his SSN was reversed, except for one number.  The clerk eventually noticed the inaccuracy and alerted the debtor to the deficiency.  Within a week of the original filing the debtor filed an amended petition with his correct SSN.  Before discovering the deficiency, however, the clerk published a Notice of Commencement of Case containing the incorrect SSN.  Following his conviction for making a false declaration, the debtor appealed, raising the amendment, among other issues, as a challenge to his conviction.  The circuit court properly rejected the argument finding significant that the "damage" was already done by the time of the amendment because the clerk had issued the Notice with the incorrect SSN (slip op. at 10 n.4). 

While the result is correct, the rationale is not.  The crime was complete the moment the debtor filed the original schedule containing the false declaration with fraudulent intent.  The "harm" caused to creditors or the public in receiving an incorrect Notice is irrelevant to the issue of liability.  In other words, the debtor would properly have been convicted even had he amended the petition in time for the original Notice to be published and had no creditor ever been deceived. 

A final note.  Interestingly in this case, the clerk noticed the error and called it to the debtor's attention before the amendment, making the case even weaker for an "amendment defense."  As a  practical and legal matter, a debtor must have corrected the original inaccuracy before it was discovered to have any realistic chance of demonstrating that the corrective measure shows a lack of fraudulent intent.      

The collateral consequences of a client's bankruptcy fraud

One of the perils of bankruptcy work, particularly in representing debtors, is the risk that a client accused (or convicted) of bankruptcy fraud will claim "my lawyer told me to do it."  Of course, the allegation is nearly never true, and is no defense besides.  But the allegation once made can be a nightmare for the bankruptcy practitioner.  The Seventh Circuit's recent decision in United States v. Roti, No. 06-3192 (7th Cir. May 3, 2007), illustrating this point, should be mandatory reading for the bankruptcy bar - or at least that segment of it that does debtor work. 

Judge Easterbrook's opening paragraph sets the tone:

EASTERBROOK, Chief Judge.  Saddled with a judgment for more than $400,000 on account of a guarantee of his small corporation's debts, James Roti decided to hide his assets from creditors.  He has been convicted of bankruptcy fraud, see 18 U.S.C. § 157, and concealing assets from the bankruptcy trustee, see 18 U.S.C. § 152.  His sentence is 21 months' imprisonment.  Roti concedes that he parked some assets with family members and moved others to accounts unknown to his creditors, and that he lied to his principal creditor, to the federal bankruptcy court, and to the trustee.  Roti says that his lawyer Andrew Werth put him up to it, and at trial he contended that he should be acquitted because Werth managed the scheme's details. . . .

The full text of the opinion is available here.

Hale indictment highlights criminal implications of 341(a) meeting

Nathan Hale's indictment (now available here) for making a false oath (falsely confirming the accuracy of his schedules at the first meeting of creditors) and concealing an asset in bankruptcy (previously discussed here, here and here) highlights an important point I've made previously about the investigatory nature - and criminal implications - of the 341(a) meeting in a bankruptcy case.  When a debtor confirms at the meeting that he has read and signed the schedules, confirms their accuracy, and states that there are no changes to be made, these responses can form the basis of a false oath charge, if the schedules are fraudulently inaccurate (in addition to the false declaration charge for signing the schedules).  Affirmatively answering the "confirming" questions also tends to establish the "knowingly" element of the false oath offense in part by precluding the debtor later from arguing that he did not read the schedules or that he intended to make changes.

Suspicious Activity Reports (SARs) in bankruptcy fraud investigations

The Financial Crimes Enforcement Network (FinCEN) of the Treasury Department recently announced here revisions to the Suspicious Activity Report (SAR) Forms for various industries, including financial institutions.  So it seems like an appropriate time to mention that SARs are an often overlooked tool available to investigators in bankruptcy criminal cases.  For the uninitiated, SARs are forms required by financial institutions (and other industries) that detect known or suspected violations of federal law.  The newly revised SAR Form for depository institutions is available here.

As detailed in this excerpt of an issue of The SAR Activity Review, FinCEN has identified several instances in which information reported in a SAR has lead to or assisted a bankruptcy criminal prosecution.  In the examples cited, one case involved numerous concealed assets while another case involved a large credit card bankruptcy bustout scheme.  To the extent SAR information may be made available to trustees (or U.S. trustees) in bankruptcy cases, SARs could be an important additional tool available to detect and combat the commission of bankruptcy crimes.      

Ambiguity in Statement of Financial Affairs creates criminal defense for lawyer charged with bankruptcy fraud

A fundamental ambiguity in Question 1 of the Official Form Statement of Financial Affairs created a defense to several bankruptcy fraud charges in United States v. Neagele, 05-0151 (D. D.C.) (available here).  Neagele, a lawyer, was charged with (among other offenses) three counts of making a false declaration in a bankruptcy case (18 U.S.C. 152(3) for stating his sole proprietorship's "net income" (revenue less expenses) rather than "gross income" in response to Question 1.  That question, of course, requires debtors to "state the gross amount of income the debtor has received from employment, trade, or profession, or from operation of the debtor's business . . . .  In a pre-trial motion to dismiss the false declaration counts, Neagele successfully argued that the language of the Official Form is fundamentally ambiguous - thus precluding a conviction - because the question readily lends itself to the interpretation that it means income the debtor actually received from operation of his law practice (i.e., revenue minus expenses), and that is what he did disclose.  The United States District Court for the District of Columbia agreed and dismissed the false declaration charges.