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Bankruptcy and Fraud: The Ties That Bind?

By Toby J.F. Bishop and Sheila Smith

As economic turmoil continues, many companies face erosion of revenues, pressure for cost containment, and diminished liquidity. Filing for bankruptcy protection is sometimes part of the solution. In-house counsel should, among other things, consider the potential impact of current economic pressures on financial controls and the risk of fraud during a restructuring, when headcount is reduced, morale is eroded, and risk mitigation can inadvertently take a back seat to the day-to-day focus of management.

A 2008 study by the Deloitte Forensic Center and Deloitte's Reorganization Services group found that companies filing for bankruptcy protection (“Bankrupt Companies”) are three times as likely as non-Bankrupt Companies to face enforcement action by the SEC for financial-statement fraud allegedly committed pre-petition. Conversely, companies that were the subject of SEC enforcement releases related to financial-statement fraud were more than twice as likely to file for bankruptcy protection than companies that were not.

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