Bankruptcy Fraud in the Spotlight?

USTP, DOJ and the FBI

The U.S. Trustee Program (USTP), an unheralded DOJ component, was created under the Bankruptcy Reform Act of 1978. It is funded primarily by fees paid by parties and businesses invoking federal bankruptcy protection. It views itself as a “high-performance, litigating component of the [DOJ] with growing capacities to fulfill its mission, including combatting fraud and abuse in the bankruptcy system.” USTP Strategic Plan FY 2005-2010. The USTP has developed a 112-page manual outlining its bankruptcy fraud and abuse enforcement program. http://www.usdoj.gov/ust/ ustp_manual/manual.htm.

The Attorney General appoints U.S. Trustees and Assistant U.S. Trustees. An Executive Office for U.S. Trustees in Washington provides policy, legal, and administrative guidance, but the USTP operates through 21 regional offices and 95 field offices. U.S. Trustees have a statutory mandate to notify the appropriate U.S. Attorney of matters that “may constitute a crime” and, on request, to assist in prosecution. 28 U.S.C. ' 586(a)(3)(F). Bankruptcy judges, receivers and trustees, “having reasonable grounds for believing that any violation…of laws of the United States relating to insolvent debtors, receiverships or reorganization plans has been committed, or that an investigation should be had in connection therewith,” have a similar statutory duty to refer to the U.S. Attorney. 18 U.S.C. ' 3057(a); see U.S. Attorneys' Manual at ' 9-41.010.

The U.S. Trustee may develop or assimilate evidence of fraud uncovered by creditors or other parties. The U.S. Trustee's Office also presides at the “Section 341″ meetings of creditors. 11 U.S.C. ' 341. There, the debtor must appear and answer, under oath, questions posed by creditors, the case trustee or the U.S. Trustee's office. The U.S. Trustee may also seek to compel testimony of the debtor or others at “Rule 2004″ examinations. Fed.R.Bankrptcy.Proc. 2004.

Importantly, in July, 2003, the USTP created a Criminal Enforcement Unit (CREU) specifically to identify potential bankruptcy crimes. The CREU employs lawyers with white-collar experience, conducts in-house training of Trustee employees to help identify cases for potential referral, liaises with various U.S. Attorney's Offices to help package and “sell” particular cases for prosecution, and, on occasion, assists in further investigation and prosecution. See www.usdoj.gov/ust/mission.htm.

Investigation and enforcement of bankruptcy fraud laws fall within the exclusive jurisdiction of the FBI. However, as a practical matter in white-collar investigations, agents from other agencies (IRS, Postal Inspection Service, etc.) often participate in such investigations. The FBI reports that its investigations primarily originate from USTP referrals. See http://www.fbi.gov/hq/cid/fc/ec/about/about_bf.htm. .

SOX and Bankruptcy Fraud

The news media has focused on the good-governance and financial-transparency aspects of SOX, but the Act also gave the government a slightly enhanced weapon for bankruptcy fraud and obstruction prosecutions. SOX's “Arthur Andersen” provision, 18 U.S.C. ' 1519, provides in relevant part: “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case [commits a federal offense].” 18 U.S.C. ' 1519 (emphasis added). Thus this “anti-shredding” provision is expressly made applicable to bankruptcy matters. The maximum penalty is 20 years in jail, in sharp contrast with the 5-year maximum under an earlier statute prohibiting fraudulent concealment or alteration of the records of a debtor. 18 U.S.C. ' 152(8).

This 15-year spread might make a big difference in light of the recent demotion of the Sentencing Guidelines to advisory status. A sentencing judge in theory now has more play on the upside in imposing sentence. As others have noted, the SOX obstruction statute, ' 1519, also has slightly broader coverage and an arguably lower intent standard, because it: 1) requires only an “intent to influence” rather than ' 152(8)'s “knowing and fraudulent” state of mind; 2) covers tangible objects, which are unmentioned in ' 152(8); and 3) does not require that the altered materials relate strictly to the debtor's financial affairs or property. See M. Tighe and R. Calo, “Bankruptcy Crime Does Not Pay,” Annual Survey of Bankruptcy Law (2004).

Whether these differences in coverage and required intent will have a practical impact in more than the occasional case remains to be played out. However, the inclusion of a bankruptcy-related provision in SOX, with a higher maximum penalty, and the retraining within DOJ and USTP which follows statutory changes, may provide further impetus for bankruptcy fraud prosecutions.

Bankruptcy Fraud Sentencing After Booker

While the Sentencing Guidelines are no longer mandatory per Booker, the government takes the position that the Guidelines calculations provide the “reasonable” range of sentences from which judges may depart only at their peril. Obviously, no defendant or defense counsel can afford to ignore Guidelines calculations. For bankruptcy fraud, the Guidelines can be severe.

Starting from a base offense level of 6 or 7, depending on the maximum penalty provided for by the charging statute, U.S.S.G. ' 2B1.1(a), the fraud Guideline provides for a two-level upward adjustment for misrepresentations “or other fraudulent actions” in a bankruptcy proceeding. U.S.S.G. ' 2B1.1(b)(7). In addition, post-SOX Guideline amendments include upward adjustments to the base offense level for the number of victims and the amount of intended loss. See U.S.S.G. ' 2B1.1(b)(1)-(2). Either of these factors can have a dramatic impact.

Take, for example, the concealment of estate assets. The FBI reports this to be the most common type of bankruptcy fraud which it investigates. See http://www.fbi.gov/hq /cid/fc/ec/about/about_bf.htm. For the purpose of setting loss under the Guidelines, a concealment-of-assets fraud likely will be considered a continuing offense. See United States v. Brennan, 326 F.3d 176, 194-195 (3d Cir. 2003); 18 U.S.C. ' 3284 (concealment of assets a continuing offenses for statutes of limitations purposes). That is, the crime will be deemed to continue from the date of concealment at least until it is “detected or its consequences are purged.” United States v. Stein, 233 F.3d 6, 18-19 (1st Cir. 2000). Thus, where the concealed assets increase in value during the period of concealment, that higher value may be used to calculate – either directly or under a relevant-conduct analysis — the “Guidelines loss” intended to be inflicted on the victims (the estate and its creditors). In Brennan, bonds valued at about $4 million and concealed from the estate appreciated in value to $22 million during that period. The court counted this appreciation of the value of the bankrupt's estate in its calculation of loss for purposes of bankruptcy fraud. This $18-million boost in fraud loss resulted in a 110-month sentence.

Finally, note that a post-SOX amendment bumped the base offense level for obstruction of justice under statutes like ' 1519 from 12 to 14 with an additional two-level upward adjustment if the crime involved “(A) … the destruction, alteration, or fabrication of a substantial number of records, documents or tangible objects … (B) … the selection of any essential or especially probative record, document, or tangible object, to destroy or alter; or (C) … otherwise [was] extensive in scope, planning, or preparation… U.S.S.G. ' 2J1.2(a), (b)(3). Thus even absent a criminal history, a defendant convicted under ' 1519 for destroying a key document would be at an offense level of 16 for which the Guidelines “advise” a 21-to-27 month range of incarceration.

Conclusion

According to the U.S. Attorneys' Annual Statistical Report for Fiscal Year 2003, some 116 bankruptcy-related criminal cases involving 133 defendants were filed in fiscal year 2003, and 118 convictions were obtained. http://www. usdoj.gov/ usao/reading_room/foiamanuals.html. The USTP, DOJ, FBI and other agencies periodically combine on national “projects” to spotlight their enforcement efforts. In 1996, “Operation Total Disclosure” resulted in charges being filed against 123 defendants in 36 federal districts. In 2004, “Operation Silver Screen” resulted in criminal charges against 21 individuals in 11 districts.

The investigation and prosecution of bankruptcy fraud and related obstruction is likely to increase. Due diligence in the preparation and filing of bankruptcy-related documents is necessary.

As we all know, the feds continue to investigate and prosecute fraud in the financing, accounting and operation of businesses. The Second Year Report of the President's Corporate Fraud Task Force declares that over 500 corporate fraud convictions have been obtained to date and that charges have been brought against over 60 corporate CEOs or presidents. See www.usdoj.gov/ dag/cftf. However, executives and their counselors would do well to note that the government's will and ability to prosecute high-level management may not lessen just because a business is in extremis.

About 35,000 business bankruptcy petitions are filed each year, a little over 2% of the total filings in the nation. See www.abi world.org. Bankruptcy fraud has been a white-collar priority of the Department of Justice (DOJ) at least since a 1992 declaration of then Attorney General Reno. The DOJ and the FBI are now armed with an additional obstruction statute under the Sarbanes-Oxley Act (SOX), a revitalized U.S. Trustee Criminal Enforcement Unit designed to detect and refer bankruptcy fraud, Bankruptcy Fraud Task Forces within some U.S. Attorney's Offices, and the “built-in” referral sources of creditors and the Bankruptcy Court itself.

Thus as much diligence must be put into bankruptcy planning and court filings as is applied in issuing financial statements or prospectuses.

USTP, DOJ and the FBI

The U.S. Trustee Program (USTP), an unheralded DOJ component, was created under the Bankruptcy Reform Act of 1978. It is funded primarily by fees paid by parties and businesses invoking federal bankruptcy protection. It views itself as a “high-performance, litigating component of the [DOJ] with growing capacities to fulfill its mission, including combatting fraud and abuse in the bankruptcy system.” USTP Strategic Plan FY 2005-2010. The USTP has developed a 112-page manual outlining its bankruptcy fraud and abuse enforcement program. http://www.usdoj.gov/ust/ ustp_manual/manual.htm.

The Attorney General appoints U.S. Trustees and Assistant U.S. Trustees. An Executive Office for U.S. Trustees in Washington provides policy, legal, and administrative guidance, but the USTP operates through 21 regional offices and 95 field offices. U.S. Trustees have a statutory mandate to notify the appropriate U.S. Attorney of matters that “may constitute a crime” and, on request, to assist in prosecution. 28 U.S.C. ' 586(a)(3)(F). Bankruptcy judges, receivers and trustees, “having reasonable grounds for believing that any violation…of laws of the United States relating to insolvent debtors, receiverships or reorganization plans has been committed, or that an investigation should be had in connection therewith,” have a similar statutory duty to refer to the U.S. Attorney. 18 U.S.C. ' 3057(a); see U.S. Attorneys' Manual at ' 9-41.010.

The U.S. Trustee may develop or assimilate evidence of fraud uncovered by creditors or other parties. The U.S. Trustee's Office also presides at the “Section 341″ meetings of creditors. 11 U.S.C. ' 341. There, the debtor must appear and answer, under oath, questions posed by creditors, the case trustee or the U.S. Trustee's office. The U.S. Trustee may also seek to compel testimony of the debtor or others at “Rule 2004″ examinations. Fed.R.Bankrptcy.Proc. 2004.

Importantly, in July, 2003, the USTP created a Criminal Enforcement Unit (CREU) specifically to identify potential bankruptcy crimes. The CREU employs lawyers with white-collar experience, conducts in-house training of Trustee employees to help identify cases for potential referral, liaises with various U.S. Attorney's Offices to help package and “sell” particular cases for prosecution, and, on occasion, assists in further investigation and prosecution. See www.usdoj.gov/ust/mission.htm.

Investigation and enforcement of bankruptcy fraud laws fall within the exclusive jurisdiction of the FBI. However, as a practical matter in white-collar investigations, agents from other agencies (IRS, Postal Inspection Service, etc.) often participate in such investigations. The FBI reports that its investigations primarily originate from USTP referrals. See http://www.fbi.gov/hq/cid/fc/ec/about/about_bf.htm. .

SOX and Bankruptcy Fraud

The news media has focused on the good-governance and financial-transparency aspects of SOX, but the Act also gave the government a slightly enhanced weapon for bankruptcy fraud and obstruction prosecutions. SOX's “Arthur Andersen” provision, 18 U.S.C. ' 1519, provides in relevant part: “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case [commits a federal offense].” 18 U.S.C. ' 1519 (emphasis added). Thus this “anti-shredding” provision is expressly made applicable to bankruptcy matters. The maximum penalty is 20 years in jail, in sharp contrast with the 5-year maximum under an earlier statute prohibiting fraudulent concealment or alteration of the records of a debtor. 18 U.S.C. ' 152(8).

This 15-year spread might make a big difference in light of the recent demotion of the Sentencing Guidelines to advisory status. A sentencing judge in theory now has more play on the upside in imposing sentence. As others have noted, the SOX obstruction statute, ' 1519, also has slightly broader coverage and an arguably lower intent standard, because it: 1) requires only an “intent to influence” rather than ' 152(8)'s “knowing and fraudulent” state of mind; 2) covers tangible objects, which are unmentioned in ' 152(8); and 3) does not require that the altered materials relate strictly to the debtor's financial affairs or property. See M. Tighe and R. Calo, “Bankruptcy Crime Does Not Pay,” Annual Survey of Bankruptcy Law (2004).

Whether these differences in coverage and required intent will have a practical impact in more than the occasional case remains to be played out. However, the inclusion of a bankruptcy-related provision in SOX, with a higher maximum penalty, and the retraining within DOJ and USTP which follows statutory changes, may provide further impetus for bankruptcy fraud prosecutions.

Bankruptcy Fraud Sentencing After Booker

While the Sentencing Guidelines are no longer mandatory per Booker, the government takes the position that the Guidelines calculations provide the “reasonable” range of sentences from which judges may depart only at their peril. Obviously, no defendant or defense counsel can afford to ignore Guidelines calculations. For bankruptcy fraud, the Guidelines can be severe.

Starting from a base offense level of 6 or 7, depending on the maximum penalty provided for by the charging statute, U.S.S.G. ' 2B1.1(a), the fraud Guideline provides for a two-level upward adjustment for misrepresentations “or other fraudulent actions” in a bankruptcy proceeding. U.S.S.G. ' 2B1.1(b)(7). In addition, post-SOX Guideline amendments include upward adjustments to the base offense level for the number of victims and the amount of intended loss. See U.S.S.G. ' 2B1.1(b)(1)-(2). Either of these factors can have a dramatic impact.

Take, for example, the concealment of estate assets. The FBI reports this to be the most common type of bankruptcy fraud which it investigates. See http://www.fbi.gov/hq /cid/fc/ec/about/about_bf.htm. For the purpose of setting loss under the Guidelines, a concealment-of-assets fraud likely will be considered a continuing offense. See United States v. Brennan , 326 F.3d 176, 194-195 (3d Cir. 2003); 18 U.S.C. ' 3284 (concealment of assets a continuing offenses for statutes of limitations purposes). That is, the crime will be deemed to continue from the date of concealment at least until it is “detected or its consequences are purged.” United States v. Stein , 233 F.3d 6, 18-19 (1st Cir. 2000). Thus, where the concealed assets increase in value during the period of concealment, that higher value may be used to calculate – either directly or under a relevant-conduct analysis — the “Guidelines loss” intended to be inflicted on the victims (the estate and its creditors). In Brennan, bonds valued at about $4 million and concealed from the estate appreciated in value to $22 million during that period. The court counted this appreciation of the value of the bankrupt's estate in its calculation of loss for purposes of bankruptcy fraud. This $18-million boost in fraud loss resulted in a 110-month sentence.

Finally, note that a post-SOX amendment bumped the base offense level for obstruction of justice under statutes like ' 1519 from 12 to 14 with an additional two-level upward adjustment if the crime involved “(A) … the destruction, alteration, or fabrication of a substantial number of records, documents or tangible objects … (B) … the selection of any essential or especially probative record, document, or tangible object, to destroy or alter; or (C) … otherwise [was] extensive in scope, planning, or preparation… U.S.S.G. ' 2J1.2(a), (b)(3). Thus even absent a criminal history, a defendant convicted under ' 1519 for destroying a key document would be at an offense level of 16 for which the Guidelines “advise” a 21-to-27 month range of incarceration.

Conclusion

According to the U.S. Attorneys' Annual Statistical Report for Fiscal Year 2003, some 116 bankruptcy-related criminal cases involving 133 defendants were filed in fiscal year 2003, and 118 convictions were obtained. http://www. usdoj.gov/ usao/reading_room/foiamanuals.html. The USTP, DOJ, FBI and other agencies periodically combine on national “projects” to spotlight their enforcement efforts. In 1996, “Operation Total Disclosure” resulted in charges being filed against 123 defendants in 36 federal districts. In 2004, “Operation Silver Screen” resulted in criminal charges against 21 individuals in 11 districts.

The investigation and prosecution of bankruptcy fraud and related obstruction is likely to increase. Due diligence in the preparation and filing of bankruptcy-related documents is necessary.