|Return to the USDOJ/OIG Home Page|
The U.S. Trustee Program's Efforts to Prevent Bankruptcy Fraud and Abuse
Report No. 03-17
Office of the Inspector General
According to the United States Bankruptcy Court, bankruptcies are at an all-time high, with new filings reaching 1.5 million for the 12-month period ending June 2002. The Executive Office for U.S. Trustees (EOUST), through regional U.S. Trustees (UST), manages the bankruptcy system and is largely responsible for maintaining the integrity of the system. Collectively, the EOUST and the USTs constitute the U.S. Trustee Program. The UST Program is the "watchdog" over the entire bankruptcy process and is responsible for promoting the efficiency of the bankruptcy system and securing the just, speedy, and economical resolution of bankruptcy cases.
The Federal Bureau of Investigation (FBI) estimates that 10 percent of all bankruptcy filings involve fraud, especially evasion by debtors to fully disclose their assets. If so, there were about 100,000 cases of fraud in Calendar Year (CY) 2001. Because bankruptcy fraud and abuse by debtors, creditors, attorneys, and others threaten the integrity of the system, the UST Program's ability to deter and detect bankruptcy fraud and abuse and make criminal fraud referrals to law enforcement or to take civil action is critical to protecting the bankruptcy system.
The bankruptcy process is governed by Title 11, U.S. Code, known as the Bankruptcy Code. There are two basic types of bankruptcy filings: liquidation under Chapter 7 of the Code and rehabilitation of the debtor under Chapters 11, 12, and 13 of the Code. A brief description of bankruptcy under each Chapter follows.
The UST Program consists of three major organization units: the EOUST, 21 regional offices each headed by a UST, and 95 field offices headed by an Assistant United States Trustee (AUST). The EOUST (1) provides general policy and legal guidance to the regional and field offices in their implementation of federal bankruptcy laws, and (2) oversees the Program's operations. Each UST is responsible for managing the field offices located within his or her region. The USTs' responsibilities include:
Given the vulnerability of the bankruptcy system to fraud and abuse and the UST Program's stated key role to deter and detect such fraud and abuse - especially during the current period of escalating bankruptcies - the Office of the Inspector General (OIG) selected the UST Program for audit. The objectives of our audit were to assess: (1) the management controls implemented in UST offices to identify and eliminate fraud and misconduct by debtors, private trustees, and others, and (2) compliance with the Government Performance and Results Act, which requires federal agencies to measure and report on their program performance.
To perform our audit, we interviewed EOUST officials in the Director's Office, Office of Review and Oversight, Office of Research and Planning, and Office of Administration. Additionally, we conducted interviews, reviewed documents, and analyzed information at 5 of the 21 UST regional offices: Atlanta, Chicago, Los Angeles, New York, and Philadelphia. We selected these five offices because collectively they referred about 56 percent of the Program's criminal fraud cases to law enforcement and provided a cross section of the Program's bankruptcy fraud and abuse control procedures and practices. We reviewed documents relating to pending bankruptcy legislation, fraud referral case files, civil enforcement case files, trustee performance evaluations, semiannual report reviews, trustee final and distribution report reviews, monthly operating reports, audits, UST field examinations, and training.
We found that the USTs rely substantially on the initiative of private trustees and on tips to detect most fraud. The UST Program has begun initiatives to target certain types of fraud, specifically the use of false identities or false social security numbers and also unscrupulous bankruptcy petition preparers. However, the UST Program does not have an ongoing, systematic process to identify vulnerabilities in the bankruptcy system and it has not established uniform internal controls to detect common, higher-risk frauds such as a debtor's failure to disclose all assets. In fact, the management controls in place did not address most of the fraud indicators identified in the UST Manual and instead focused primarily on fraud that might be committed by trustees and their employees rather than by debtors.
While such controls over trustee operations are necessary and are likely to contribute to deterring fraud and abuse by trustees and their employees - which accounted for less than one percent of UST referrals to law enforcement over the last 15 years - they do not focus on debtor and debtor-related fraud. As a result, the FBI's estimated 10 percent of bankruptcy cases that involve fraud may not be discovered, and the UST Program's mission to preserve the integrity of the bankruptcy system may not be accomplished as effectively as it should.
The primary methods used by the UST Program to deter and detect fraud are (1) private trustees' review of case information and (2) tips from ex-spouses, ex-business partners, creditors, and others, who could have a grievance with the debtor or who might be offended by the debtor's behavior and misuse of the bankruptcy system. Some UST regions do not rely as extensively on trustees and tips to detect fraud. Instead, these regions have implemented their own fraud detection measures such as reviewing bankruptcy petitions and schedules of assets in an attempt to identify concealed property. In addition to criminal fraud referrals to law enforcement agencies, the UST Program has placed its highest priority on filing civil lawsuits against those who attempt to abuse the bankruptcy system, especially where criminal prosecution of a case is unlikely due to the lower dollar value of the case or where evidence may not be substantial. Although UST Program officials told us they never will be able to prevent or identify all instances of fraud and abuse, they stated that civil enforcement has been a successful initiative.
Although the USTs view private trustees - primarily Chapter 7 trustees - as the first line of defense in detecting bankruptcy fraud, the trustees do not always have the incentive, time, or initiative to review cases for potential fraud. Still, trustees are in a good position to help identify fraud and abuse in the bankruptcy system. For most debtors, the private trustee is the only bankruptcy official with whom the debtor will interact during the bankruptcy process. Also, trustees have access to debtors' petitions and schedules, and they can request additional information such as tax returns and bank statements. According to UST Program officials, trustees can discover fraud in several ways, such as:
The AUSTs at the five regional offices we audited stated that in addition to the private trustees as the first line of defense against fraud, the UST Program relies substantially on complaints or tips from the public to detect instances of bankruptcy fraud. Because the UST Program data did not indicate what percentage of the UST referrals to law enforcement authorities were based on tips, we reviewed the fraud referrals made in FYs 1999 to 2001. We reviewed all the referrals made during these three years, except in one large-volume2 regional office where we sampled the referrals. In total, our sample included 302 referrals for the five regional offices that we audited. We reviewed the case files for each fraud referral to determine the method of detection. We found that about 48 percent of fraud referrals to law enforcement resulted from tips from creditors, ex-spouses, ex-partners, and victims. Other cases were mostly detected by private trustees and sometimes by the UST reviews of debtors' records. The predominant source of fraud cases was in Chapter 7 filings, which accounted for over 70 percent of all bankruptcy filings in 2001, although other Chapters were found to be vulnerable to fraud.
In addition to relying on the initiative of trustees and the public to identify and report suspected fraud, the UST Program has begun to emphasize civil lawsuits in addition to referrals for criminal prosecution. The UST Program refers to these civil lawsuits as civil enforcement actions. Civil enforcement action may be taken by the UST against a debtor without referring the case to a law enforcement agency for investigation. The USTs or another interested party must first identify the benefit of the fraud and then select the appropriate civil enforcement action to deny that benefit. The most common benefits of bankruptcy fraud include: (1) an automatic stay, which prevents a creditor from pursuing any action against the debtor or the property of the estate to collect or enforce a pre-petition debt; (2) a discharge, which removes the debtor's obligation to pay a debt; and (3) creditor inertia where a creditor writes off a debt upon learning that a bankruptcy case has been filed and abandons collection efforts even if the case is subsequently dismissed. In a civil lawsuit, the UST or other interested party files a motion or complaint with the court. A bankruptcy court judge hears the case and issues a court order outlining the findings of the court.
Another part of the UST Program's oversight responsibilities include establishing controls to ensure that trustees and their employees do not embezzle funds or misappropriate property from the bankruptcy estates entrusted to them. The management controls directly implemented by the UST Program are primarily designed to detect fraud committed by trustees and their employees rather than by debtors or others. The controls established by the Program to detect trustee-related fraud include: (1) review of the trustee's semiannual report, which provides information on the Chapter 7 trustee's financial management, internal controls, organizational effort and legal administration of cases administered by the trustee; (2) review of cash receipts and disbursements reports; (3) review of the trustee final report, which certifies that all assets have been liquidated and are properly accounted for and that funds of the estate are available for distribution; (4) review of the trustee final account, which certifies that funds have been distributed to creditors; and (5) external audits3 and UST field examinations. Over the past 15 years (1986 through 2001), the Program made 71 referrals to the U.S. Attorneys for embezzlement by trustees or their employees, which accounts for less than one percent of total referrals during that period.
The UST Program established in 1988 a Criminal Referral Tracking System for performance measurement reporting and for monitoring fraud referrals to law enforcement authorities. However, we found that the tracking system, which depends on complete and accurate data submissions by UST regional offices, was materially inaccurate. The usefulness of the system for performance measurement and tracking of referrals was limited due to inaccurate, missing, or inconsistent data; lack of standard data protocols; and lack of review by UST and EOUST personnel to ensure the accuracy and completeness of the data. In addition, the system did not record data on the USTs' efforts to investigate bankruptcy fraud cases. Specifically, the system did not include cases that the USTs investigated but did not refer to law enforcement. As a result, the UST Program was not able to conduct complete and accurate trend analyses of fraudulent activity to help target program attention to the greatest risks. Also, the current data system and its data limitations may allow the UST Program, the Department, and Congress to rely on incomplete and inaccurate data in measuring the UST Program's performance and making funding and resource allocation decisions.
The 21 UST regional offices provide data on fraud referrals for input to the EOUST tracking system. The regional offices submit the data quarterly on spreadsheets designed by the EOUST. The EOUST performs a limited review of the 21 spreadsheets to ensure that the data fields are properly formatted so the spreadsheets can be downloaded into the EOUST's tracking system. However, the EOUST does not verify that the data is accurate, complete, or consistent. An EOUST staff member stated that the regions are responsible for ensuring the integrity of the data, because the regions maintain the supporting documentation. We found inconsistent and missing data in 19 of the 33 data elements in the tracking system. For example, regional offices used over 2,000 descriptions to identify the type of fraud. Also, in about 72 percent of cases the amount of loss due to fraud was not entered into the system, and in 46 percent of the cases there was no code to indicate the type of person (such as debtor or debtor's attorney) who was the subject of the referral. Further, the statute of limitations for the crime was almost never recorded to help ensure timely action.
To determine the accuracy of data submitted by individual UST regional offices, we analyzed the sample of 302 fraud referrals discussed previously. We reviewed the case file for each of the sampled referrals. The case files varied widely in size depending on the nature of the allegation and the complexity of the investigation. Our review of the supporting documentation for the regional offices' 302 fraud referrals determined that approximately 34 percent of the cases contained at least one error or omission and another 9 percent could not be verified due to missing files. Data for 102 referrals was incomplete or inaccurate because the regional offices either failed to enter the required data or entered erroneous data. Data errors included referral date, subject name, case disposition, status, referral source, amount of loss, bankruptcy case number, and the subject of the referral such as debtor or attorney. Data omitted included type of alleged fraud, referral source, amount of loss, name of subject, and bankruptcy case number.
Subsequent to the completion of our audit fieldwork, the UST Program began taking a number of actions to improve its data system, including issuing protocols to the field offices and placing the system under the supervision of a Chief Information Officer.
Limitations of the data system also affect the accuracy of the UST Program's performance measurement. The Program prepared a Performance Plan for FY 2002 and FY 2003, and incorporated the plan into its budget submission. The UST Program established a performance goal to ensure that parties adhere to the standards of the law and to police for embezzlement, fraud, and other abuses. To meet the performance goal, the Program developed several performance indicators. In accordance with Departmental policy,4 the Program did not establish targets for the number of criminal referrals and convictions but instead reported data on a prior-year basis. A recent performance plan stated that in FY 2001, the UST Program made 586 referrals to law enforcement and 45 referrals resulted in a conviction. However, the referral data is derived from the Criminal Referral Tracking System, which we have found materially unreliable due to errors, inconsistencies, and omissions.
Among the recommendations we make to the Director, Executive Office for U.S. Trustees, are: