Bankruptcy Fraud By Robyn Carter

Forensic Accounting Data Analysis Bill Makkkawi October 13, 2009
Bankruptcy Fraud
What is Bankruptcy? Bankruptcy is a way for individuals or businesses to satisfy debts. There are four types of bankruptcy. There is Chapter 7 which is a complete liquidation for individuals. Chapter 7 bankruptcy liquidates assets that are not exempt and uses the proceeds to pay creditors. In this bankruptcy creditors may be paid in full or a percentage based on the assets that were available. There is Chapter 11 which is for a business. Chapter 11 allows a business to reorganize its operation and finances so that it can pay its creditors. Sometimes in Chapter 11 another entity may take over the original entity in the reorganization. Creditors are told to give the entity time to reorganize and pay the debts. Then, there is Chapter 13 which is reorganization for individuals. Chapter 13 gives individuals a chance to pay creditors over 3 to 5 years through a Bankruptcy Trustee. Most assets can be kept depending on what percentage of the debts will be paid. If the debtor is paying the creditors in full then they would be able to keep all of their assets. This is only available for debtors with verifiable disposable income. The last type is Chapter 12 which is for farmers and fishermen (LII / Legal Information Institute). After completion of whichever chapter used, the creditor gets a “fresh start”.
White Collar Crime Why is this considered white collar crime? Although there are people in blue collar positions that file bankruptcy, they usually don’t have many assets to hide. People in white collar positions, when they get in to a bind and have to file bankruptcy, they tend to do what they need to do so that they don’t lose all of their assets. “The bankruptcy system is designed to give individuals and companies a chance to reorganize their affairs or to equitably distribute the non-exempt assets of the debtor among the creditors if reorganization is not possible” (FBI). Because of the thought of the distribution of their non-exempt assets, those with a lot of assets that are not exempt may tend to commit some type of fraud to keep them. And those debtors are usually in the middle or upper class, white collar workers. The blue collar workers that get caught up in bankruptcy fraud are usually caught up in petition mills, to be discussed later.
Types of Bankruptcy Fraud There are three types of bankruptcy fraud: Concealment of assets, petition mills and multiple filings. Concealment of assets accounts for a large majority of bankruptcy frauds, 70 percent, filed by individuals. This type of bankruptcy fraud is committed by not listing all of the assets on the petition. It can also be committed by transferring assets to relatives. Creditors cannot liquidate assets that they don’t know about. Petition mills are schemes where someone takes advantage of a debtor that is about to be evicted or their house is going to be foreclosed on. Petition mills prey on low income people facing eviction or foreclosure with help for them to keep their homes. When a debtor gets caught up in a petition mill, they are not the ones actually committing the fraud, it is the representatives of the petition mill. Multiple filings happen when a debtor files multiple bankruptcy petitions in different states listing the same assets, although still not listing all of them. They may use fake names or fake social security numbers in different states. This is similar to concealment of assets, because they are still concealing assets from the creditors.
How Does The Fraud Triangle Fit? The fraud triangle is perceived pressure, opportunity and rationalization. Following the fraud triangle, we look at perceived pressures. One of the biggest perceived pressures in bankruptcy fraud is the thought of losing everything. When someone is used to having a lot of assets but find themselves in a situation that they are unable to pay their creditors and must file bankruptcy, they look for ways that they won’t lose everything they worked so hard for. If something is hidden from the bankruptcy petition it can’t be taken. For a business it is the thought that they may be bought out by another company during reorganization. That is what happened to a company that I worked for. I was a remote coder for Onsite Sourcing which was a company that prepared litigation for court. I did indexing of scanned documents for many different cases. All of a sudden I received information of a filing for Bankruptcy by Onsite. Soon after, I received a document from Bankruptcy Court with information on filing for compensation if I had not been paid for some of my work. Then I got a notice from the HR person that Onsite had been purchased by another litigation company. The opportunity is that the debtor is filing the bankruptcy petition either on his own or through an attorney and they are able to just leave some of the assets off. There is usually quite a bit of time between when a debtor realizes they are going to have to file bankruptcy and when they actually do the filing. When bankruptcy is anticipated, many of the assets are transferred to family members or friends so that they won’t lose them. If it is an involuntary bankruptcy, the debtor still has to file the assets and still has a chance to leave some off. In some cases though, the creditors may know about some of the assets that the debtor may try to hide. At times the creditors may force an involuntary bankruptcy because they fell if they wait too long the debtor will have time to hide assets. The sooner the petition is filed the better chance the creditors will have of getting some if not all of the debts paid. They fraudster rationalizes their actions by the fact that nobody actually gets hurt. Bankruptcy Fraud is considered a victimless fraud because it only involves material things. Many times the debtor doesn’t realize that the bankruptcy fraud they committed with affect many other people with higher prices to cover the loss they creditor had. Also they think that they need the money, or they shouldn’t have to lose everything that they worked so hard for.
Changes in the Bankruptcy Code in 2005 The bankruptcy code changed to help eliminate fraudulent filing in 2005. The changes included income limits for filing Chapter 7 liquidation. There is a means test to determine if the debtor has enough disposable income after allowed expenses and required debt payments to make Chapter 13 payments. There is required counseling prior to filing Chapter 7 or 13 and also just before completion or discharge. Attorneys are now required to personally vouch for the accuracy of what they put in the petition, which may make it difficult to find an attorney to handle bankruptcy. There are also some regulations on refilling which may appear to be abuse of the system. The changes help to prevent that. There are some other changes, but these are the big changes that are trying to stop the fraud.
Changes in Bankruptcy Fraud Bankruptcy fraud was increasing substantially until the changes in the code in 2005. With the increase in bankruptcy filing there was also an increase in bankruptcy fraud. It is estimated that 10% of all filings have some element of fraud (IRS). The table below shows the statistics from the IRS website on bankruptcy fraud cases.
| |FY 2009 |FY 2008 |FY 2007 |
|Investigations Initiated |18 |25 |30 |
|Prosecution Recommendations |18 |10 |20 |
|Indictments/Informations |20 |15 |18 |
| Sentenced |13 |16 |16 |
|Incarceration Rate* |92.3% |93.8% |87.5% |
| Avg. Months to Serve |36 |43 |23 |

*Incarceration includes confinement to federal prison, halfway house, home detention, or some combination thereof.
Data Source: Criminal Investigation Management Information System.
The IRS is involved in the investigations because a great majority of the bankruptcy filings include money owed to the IRS. I know that taxes owed to the IRS and the State is considered unsecured priority debts so they are paid right after any secured priority debts. But I don’t know if they are discharged if there aren’t enough assets to pay all of the taxes.
How has the economy changed the face of bankruptcy? It doesn’t look like the changes are actually preventing fraud bankruptcy fraud. Maybe it has cut down on some of the individual frauds but as I see it, there still continues to be bankruptcy fraud. With the economy the way it is and all the foreclosures many people are looking for ways to save their home. When get to their last straw they may turn to something that appears like a lifesaver but it really isn’t. This case may have appeared to be a lifesaver to some people. In August 2009 a couple in Mississippi pled guilty to mail fraud, bankruptcy fraud and falsifying documents in a bankruptcy case. This case stemmed from the couple having a petition mill. The couple went after people that were in foreclosure and told them they could stop the foreclosure and help them save their home. It would be necessary for them to transfer their home to them and pay them rental payments. Without the debtor’s permission or knowledge the couple then filed bankruptcy. This filing did help save the debtor’s home, temporarily. Because the debtor’s didn’t know anything about it, they didn’t go to the required court hearings so the case was dismissed and the house was foreclosed on. I have started hearing warnings about this type of thing on the radio. The Lt. Governor of Indiana has a radio commercial advising people to be careful and the Lt Governor reminded people if it sounds too good to be true, it probably is. This couple will be sentenced in November with the maximum sentence for the man is 10 years in prison and $250.l00 and the wife is looking at a maximum of 3 years in prison and a $250,000 fine.
Punishment For Bankruptcy Fraud in the Past. This couple is lucky they were not in England in the 1700’s because they used capital punishment for bankruptcy fraud. France also had capital punishment for bankruptcy fraud iin 1560. In England bankruptcy fraud was a “person who neglects or omits to discover and deliver his, her or their estates and effects, and in everything act and do as in this act directed.” (Credit Slips). The punishment for fraudulent bankruptcy was to ‘suffer as a felon without benefit of clergy”. The punishment for felons was hanging so that meant a person filing a fraudulent bankruptcy was also hung. There was Perrott that was hung in 1761 for concealing his effects. James Bullock was sentenced to death for failure to discover his assets in 1807 although it was appealed and his sentence was changed. So we are not as harsh with the punishment for bankruptcy fraud now as they were then, but in some cases I wonder if they English and French had a better idea to help deter the bankruptcy fraud.
Bankruptcy Fraud Involving a Business This case took place in Alexandria Louisiana and the perpetrator plead guilty in January of 2009. In this case Bobby Curtis concealed $1,000,000 in contracted business and assets of his company. He was sentenced to 37 months in federal prison and $355,119 in restitution. In this case Curtis filed Chapter 13 for his company Gen-I-Tech and it was converted to a Chapter 11 and was subsequently converted to a Chapter 7 in February 2003. Curtis had received $200,000 in payments prior to his bankruptcy discharge and also won a $1.1 million contract in February 2003. When filing bankruptcy you agree to disclose any income, for I believe it is 6 months, after discharge. In this case the debtor did not disclose these additional funds that could have been used to pay something to the creditors.
How the IRS Has Helped Find and Prosecute Perpetrator’s of Bankruptcy Fraud and What Else They Have Found. In many cases of bankruptcy fraud investigated and convicted by the IRS other crimes have been found. Quite often the one of the additional crimes is tax evasion or some other tax fraud. People don’t remember that income tax evasion is what brought Al Capone down. That alone should tell people that the IRS is not something to mess with. The cases that I found on the IRS website are from 2008. There was Lou Pearlman that was sentenced to 25 years in prison along with other monetary punishments. He pled guilty to “conspiracy to commit an offense against the United States, money laundering, and presenting or using a false claim in a bankruptcy proceeding.” Bankruptcy was low on the charges presented here. Charles Etwell was sentenced to 51 months in prison and a $500,000 fine. He will also have to work with the IRS in the filing of back tax returns. Etwell was convicted of “four counts of tax evasion and one count of make false statements in a bankruptcy petition.” Again bankruptcy was low on this case. Charles Lancaster was sentenced to 46 months in prison and ordered to pay $444, 435 in restitution. Lancaster pleaded guilty to bankruptcy fraud and tax evasion. Karl James was sentenced to 36 months in prison and ordered to pay $1.12 million in restitution to the victims of his bankruptcy fraud and $1.17 million in restitution to the IRS for unpaid taxes. James pleaded guilty to bankruptcy fraud and tax evasion. All of this information came from the IRS website “Examples of Bankruptcy Fraud Investigations FY2008.
Conclusion
There were many more cases investigated, charged and convicted by the IRS. Although bankruptcy fraud may have been the cause for the investigation by the IRS, I don’t think they would have stuck to the investigations like bloodhounds had the fraudsters paid income tax on their ill gotten gains. Bankruptcy fraud seems to be a continuing problem and I really don’t know how it can be eliminated, but, I think, the changes made to the Bankruptcy Code has helped to eliminate some of the fraud. Maybe there needs to be more changes and deeper investigations by the Bankruptcy court, but the expense of that may out weight the results. Someday maybe there will be a reduction in bankruptcy fraud, but in the mean time I guess more people need to be vigilant in helping with tips on fraudulent behavior.

References

Albrecht, Albrecht, Albrecht and Zimbelman (2009). Fraud Examination 3rd Ed. Chapter 16, South-Western, Mason OH.
LII / Legal Information Institute, Bankruptcy: an Overview, retrieved October 13, 2009 from the Worldwide Web: http://topics.law.cornell.edu/wex/bankruptcy.
The Lawyershop, Bankruptcy Fraud, retrieved from the Worldwide Web: http://www.lawyershop.com/practice-areas/criminal-law/white-color-crimes/bankruptcy-fraud/.
U.S. Department of Justice (2009), United States Attorney Southern District of Mississippi, Couple Pleads Guilty to Mail Fraud, Bankruptcy Fraud and Falsifying Documents in Bankruptcy Cases, retrieved October 13, 2009 from the Worldwide Web: http://www.usdoj.gov/ust/r05/pdfs/pr20090821.pdf.
FBI, White-collar Crime, Bankruptcy Fraud: Overview, retrieved October 14, 2009 from the Worldwide Web: http://www.fbi.gov/whitecollarcrime/bankruptcy_fraud/about.htm.
Find Law, The New Bankruptcy Law: Changes to Chapters 7 and 13, retrieved October 14, 2009 from the Worldwide Web: http://bankruptcy.findlaw.com/new-bankruptcy-law/new-bankruptcy-law-basics/big-changes.html.
IRS.gov, Bankruptcy Fraud - Criminal Investigation (CI), retrieved October 14, 2009 from the Worldwide Web: http://www.irs.gov/compliance/enforcement/article/0,,id=117520,00.html.
IRS.gov, Examples of Bankruptcy Fraud Investigations FY2008, retrieved October 14, 2009 from the Worldwide Web: http://www.irs.gov/compliance/enforcement/article/0,,id=174629,00.html.