Bankruptcy Fraud Resource Center | Wayne D. Holly, P.C.

Debtor audits: are they an effective means of detecting bankruptcy fraud? Rand report on fraud and abuse available.

Did you know that the United States Trustee Program initiated an independent study on the nature and prevalence of fraud, abuse and error in the bankruptcy system?  The final report, by the RAND Corp. entitled, Identifying Fraud, Abuse, and Error in Personal Bankruptcy Filings (authored by Noreen Clancy and Stephen J. Carroll) was completed in June 2007 and is now available here and here.

Among the procedures used to identify fraud, abuse and error in bankruptcy cases, the report identifies: (1) private trustees' case reviews, (2) field office case reviews, (3) tips, and (4) debtor audits as significant.  While case reviews and tips historically have been the only (significant) means of discovering bankruptcy frauds and abuse (civil and criminal), the BAPCPA's debtor audit requirements may have added an additional method.  I say may because experience under BAPCPA is still in its infancy and because the number of debtor audits being conducted is substantially less than originally conceived. 

Beginning October 20, 2006, 1 out of every 250 randomly selected chapter 7 and chapter 13 cases were selected for audit, together with certain other cases targeted for their deviation from a statistical norm.  In January, 2008, however, the United States Trustee Program suspended its designation of cases subject to audit for budgetary reasons.  While the Program's designation of cases for audit resumed in May, "random" audits (as opposed to "targeted" audits) now are conducted in only 1 out of 1,000 cases filed in a judicial district, causing me to wonder whether debtor audits really are a significant means of discovering bankruptcy fraud and abuse and further to wonder (as I did here and here) whether they will increase the number and quality of bankruptcy fraud criminal referrals.  Time will tell - and reader comments welcomed.

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.

Bankruptcy Fraud Task Forces aid successful prosecution of bankruptcy crimes

DID YOU KNOW that in response to then Attorney General Janet Reno's 1995 memorandum (available here) announcing a "renewed emphasis" on the "aggressive prosecution of bankruptcy fraud," the U.S. Trustee Program began establishing local district Bankruptcy Fraud Task Forces and "Working Groups?"  As of March, 2003 (when the OIG audited the U.S. Trustee Program) there were established Task Forces or Working Groups in 66 of the 95 U.S. Trustee field offices.  According to the Office of Inspector General, the Task Forces and Groups "were formed to aid in the successful prosecution of bankruptcy fraud cases by meeting periodically to discuss potential and actual bankruptcy fraud referrals, allow unproductive cases to be set aside and productive referrals brought to resolution quickly, and allow all parties to keep up to date of the status of the cases."  They include members from U.S. Trustee's offices, U.S. Attorney's Offices, the FBI, and other federal agencies such as the Internal Revenue Service and the Social Security Administration.   

Today there is also a National Bankruptcy Fraud Working Group comprising members from the U.S. Attorneys' Offices, DOJ Criminal Division, FBI, IRS Criminal Investigation Division, Postal Inspection Service, U.S. Trustees' Offices and the Executive Office for U.S. Attorneys. The National Group coordinates a national response to bankruptcy fraud issues, facilitates pro-active national investigations, assists districts in establishing local bankruptcy fraud task forces, tracks all bankruptcy fraud referrals and convictions, and develops training programs on bankruptcy fraud.

OIG Audit reveals few (but costly) embezzlements by bankruptcy trustees

According to the Office of Inspector General's (OIG) 2003 audit of the U.S. Trustee Program's efforts to combat fraud in bankruptcy cases (Report No. 03-17), over the fifteen year period, 1986 through 2001, the U.S. Trustee Program made 71 out of 7,564 total criminal referrals to U.S. attorneys for embezzlement by bankruptcy trustees or their employees.  The estimated loss associated with the conduct criminally referred totaled $18.8 million.  The 71 individuals were convicted, sentenced and ordered to pay $6.9 million to the victmized estates.

The methods of detection for the 71 referrals were:  25 - discovered by the U.S. trustee; 16 - based on tips; 9 discovered by trustees; 5 discovered through audits; and 16 unknown.

Bankruptcy trustees evaluated on compliance with fraud detection procedures

DID YOU KNOW that according to an OIG Audit of the U.S. Trustee Program's efforts to combat bankruptcy fraud (OIG Report No. 03-17), to evaluate panel trustees' performances in activities that could help identify fraud, the U.S. trustee reviews or attends at least one of the trustee's section 341 meetings of creditors?  The result of that evaluation is documented in the U.S. trustee's annual performance evaluations of Chapters 7 and 13 trustees.

OIG findings on bankruptcy fraud detection methods

Several years ago the The Office of Inspector General audited the UST Program's efforts to combat bankruptcy fraud and reported findings in March, 2003.  The audit is replete with interesting information and I plan to make it available here very soon and discuss some of the highlights. 

While examining the UST Program's methods of combatting fraud, the OIG examined existing sources of bankruptcy criminal referrals through a sampling of five regional UST offices (New York, Philadelphia, Chicago, Los Angeles and Atlanta).  According the sampling, most bankruptcy fraud reports originated from public tips - usually an ex-spouse or ex-business partner - and the fewest reports were developed from judicial proceedings (adversary proceedings and Rule 2004 examinations).  A summary of the OIG's findings is below.  Interestingly, the sampling results reflect nearly identically what has been my experience from practice.

Method	NY	PHL	CHG	LA	ATL	Total
Tips	23	24	18	44	36	145
Review of debtor's financial records (69 by trustees; 6 by USTs; 8 by hired professionals)	7	3	21	32	20	83
Unable to determine	8	9	1	3	11	32
Section 341 meeting of creditors	7	3	4	4	11	29
Reverse referrals (USAs or FBI to UST Program)	0	0	5	3	0	8
Judicial proceeding	3	2	0	0	0	5
Total	48	41	49	86	78	302

   

Administrative expense claim for assistance in criminal prosecution

DID YOU KNOW that the Bankruptcy Code allows compensation to creditors from estate assets for their expenses incurred while assisting the prosecution of a bankruptcy crime?  Section 503(b)(3)(C) provides an administrative expense claim for the actual necessary expenses incurred by a creditor in connection with the prosecution of a criminal offense relating to the case or to the business or property of the debtor.  Reasonable professional fees and actual expenses incurred by a creditor's attorney may also be allowed under 11 U.S.C. 503(b)(4).  Together, these sections promote the sort of voluntary assistance in bankruptcy fraud matters that 18 U.S.C. 3057 requires of trustees and judges.