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© 2016 Association of Certified Fraud Examiners, Inc.

Law

Bankruptcy (Insolvency) Fraud

© 2016 Association of Certified Fraud Examiners, Inc. 2 of 27

Debtors and Creditors

A debtor is defined as an individual,

partnership, corporation, or municipality.

A creditor is a person to whom money is owed

by a debtor. Creditors can be either secured or

unsecured.

A secured creditor holds a claim for which

there is a properly perfected security interest.

Such claims have priority over unsecured

claims.


Bankruptcy Court

Cases are filed in a local district of the U.S.

Bankruptcy Court

Bankruptcy judges hear all cases involving:

• Debtors’ and creditors’ rights

• Approval of plans of reorganization

• Awarding of fees to professionals

• Hearings and trials necessary to resolve

disputes


Office of the U.S. Trustee

A Department of Justice agency responsible for: • Administering bankruptcy cases

• Appointing trustees, examiners, and Chapter 11 committees

• Overseeing and monitoring trustees

• Reviewing employment and fee applications

• Appearing in court on matters of interest to the estate and creditors


Office of the U.S. Trustee Staff

Panel trustees are independent

professionals who serve in Chapter 7 and

sometimes Chapter 11 cases. Duties

include:

Administer assets of the estate

Liquidate assets

Pay creditors

Litigate matters (sue and be sued)

Conduct hearings

Conduct investigations of financial affairs

File reports and criminal referrals


Adjusters

Adjusters are the “right hand” to trustees and

debtors.

An adjuster is an individual who handles a

trustee’s peripheral duties:

• Securing business location or changing locks

• Locating, storing, or selling assets of the estate

• Locating business records

• Opening new bank accounts

• Investigating theft of assets in conjunction with the

trustee


Examiners

Normally appointed in a bankruptcy proceeding

to investigate certain allegations of fraud and

misconduct on the part of the debtor

Sole responsibility is to “investigate and report”

results to the court

• Power to subpoena records and depose witnesses

• DO NOT have power to run business or make

business decisions


The U.S. Bankruptcy Code

Chapter 7 is the most common type of

bankruptcy; it involves liquidation of the

debtor’s assets by a trustee to pay the

creditor’s claims.

Chapter 11 is designed to help the debtor by

allowing the debtor to reorganize its financial

affairs and continue in business.

Chapter 13 allows a debtor to pay off his

debts over time in accordance with a court-

approved plan.


Investigation by the Trustee

The trustee’s powers enable him to gather financial

information from various sources, including the debtor’s

attorneys and accountants.

A trustee steps into the debtor’s shoes, which allows him

to bypass information restrictions, such as those afforded

by the attorney-client privilege.

The trustee also should have access to the accountant’s

work papers, tax returns, and client documents.

The trustee also has power to access the debtor’s

records that are in the possession of the criminal

authorities.


Investigation by Creditors

Individual creditors may conduct their own

investigations and assist Chapter 7 and

Chapter 11 trustees in performing their

investigations.

Creditors also can attend the 341(a)

examination of the debtor and ask pertinent

questions.


Bankruptcy Schemes

Bankruptcy crimes are investigated by the FBI,

and the U.S. Attorney’s Office prosecutes them.

Concealed Assets

• This scheme involves the concealment of assets

rightfully belonging to the debtor’s estate.

• It is the most common scheme.

• Concealed assets might include cash, consumer

property, houses, and interests in partnerships and

corporations, as well as lawsuits in which the debtor is

a plaintiff. Assets might also include the debtor’s

books and records.


Bankruptcy Schemes

Fraudulent Transfer

• In this scheme, property is “knowingly or

fraudulently” transferred to prevent it from rightfully

being part of the bankruptcy estate.

The Planned Bustout

• A bustout is a planned and fraudulent bankruptcy.

• The basic approach is for an apparently legitimate

business to order large quantities of goods on credit,

and then dispose of those goods through legitimate

or illegitimate channels. The perpetrator then closes

shop, absconding with the proceeds and leaving the

suppliers unpaid.


Sample Prep Question

1. A bustout is planned bankruptcy. To perpetrate this type of scheme, in which order must the following steps be taken by the underlying business?

I. Close and file bankruptcy.

II. Purchase large quantities of goods on credit.

III. Obtain credit from vendors.

IV. Sell the inventory at deep discounts.

A. I, then IV, then III, then II

B. III, then II, then I, then IV

C. III, then II, then IV, then I

D. II, then, III, then IV, then I


Correct Answer: C

A bustout is a planned and fraudulent

bankruptcy. It can take many different forms,

but the basic approach is for an apparently

legitimate business to order large quantities of

goods on credit, and then dispose of those

goods through legitimate or illegitimate

channels. The perpetrator then closes shop,

absconding with the proceeds and leaving the

suppliers unpaid.



2. Which of the following statements regarding a U.S.

bankruptcy trustee’s rights and powers is ACCURATE?

A. The trustee is typically unable to obtain information

that is under the scope of the accountant-client

privilege.

B. The trustee steps into the debtor’s shoes in regard to

accessing the debtor’s books and records.

C. The trustee is typically unable to obtain information

that is under the scope of the attorney-client privilege.

D. The trustee is not allowed to access the debtor’s

records that are in possession of law enforcement

authorities.


Correct Answer: B

The trustee’s powers enable him to gather financial

information from various sources, including the debtor’s

attorneys and accountants. A trustee steps into the

debtor’s shoes and has all of the debtor’s ownership

rights; this gives the trustee the ability to bypass

restrictions on information, such as those afforded by

the attorney-client privilege. Attorneys might attempt to

raise the attorney-client privilege as a defense to

providing information to the trustee, but they are usually

unsuccessful in this regard. The trustee also should

have access to the accountant’s work papers, tax

returns, and client documents, as well as access to the

debtor’s records that are in the possession of law

enforcement authorities.



3. The most common type of bankruptcy fraud

scheme is the concealment of assets.

A. True

B. False


Correct Answer: A

The most common type of bankruptcy fraud

scheme involves the concealment of assets

rightfully belonging to the debtor’s estate to

avoid forfeiting the assets in bankruptcy. In

these schemes, concealed assets might

include cash, consumer property, houses, and

interests in partnerships and corporations, as

well as lawsuits in which the debtor is a

plaintiff. Concealed assets might also include

the debtor's books and records.

© 2016 Association of Certified Fraud Examiners, Inc.

Law

Tax Fraud


Introduction

Tax evasion -- fraudulent actions to avoid

reporting or paying taxes.

• Requires a willful attempt to evade or defeat the tax

in an unlawful manner.

Tax avoidance -- legal means of lowering

one’s tax bill through legitimate deductions,

credits, and shelters.

Intent of the taxpayer to wrongly file a tax

return or provide other false tax information will

determine the difference between tax evasion

and tax avoidance.


Intent

Good faith or a legitimate misunderstanding of the requirements of the law negates willfulness.

Willfulness can be inferred from conduct, such as: • Keeping a double set of books

• Making false entries or alterations or creating false invoices or

documents

• Destroying books or records

• Concealing assets

• Covering up sources of income

• Avoiding making records that are typical in transactions of the

kind

• Engaging in conduct designed to mislead or conceal


Burden of Proof

Internal Revenue Service (IRS) pursues civil

violations. Refers criminal tax cases to the

Department of Justice (DOJ) for prosecution.

No presumption of correctness is afforded to

the government when fraud is involved.

The government has the burden of proof to

prove fraud by the taxpayer.


Tax Offenses

Civil or criminal penalties

Frivolous returns

• Incorrect on its face or does not contain enough

information to determine tax liability

Making a false return

• Uses false or misleading information on tax return

Tax preparer penalty for understatement

• Not realistically possible

• Not disclosed

• A frivolous position


Common Defenses to Allegations of

Tax Fraud

No deficiency

Objectively reasonable position

Mental illness

Reliance on attorney or accountant

Ineffective defenses:

• Death of taxpayer

• Bankruptcy

• Amending return


Taxation of Illegal Income

Individuals are taxed on their taxable

income, and income from illegal activities,

such as money from illegal kickbacks, must

be reported and taxed just like legitimate

income.



1. Tax avoidance is legal, but tax evasion is not.

A. True

B. False


Correct Answer: A

The primary distinguishing characteristic of tax

evasion as compared to tax avoidance is that

tax evasion is illegal, but tax avoidance is legal.



2. In most jurisdictions, a taxpayer cannot be guilty

of a tax-related crime if he had a good faith or

legitimate misunderstanding of the law’s

requirements.

A. True

B. False


Correct Answer: A

To establish criminal liability for tax evasion,

most jurisdictions require a willful attempt to

evade or defeat taxes in an unlawful manner.

For the purpose of tax law, a good faith or

legitimate misunderstanding of the law based

on the law’s complexity typically negates

willfulness (the voluntary, intentional violation of

a known legal duty). That is, honest mistakes, in

contrast to willful evasion, do not constitute tax

evasion.



3. All of the following are acceptable legal defenses to

criminal tax fraud EXCEPT:

A. No tax deficiency

B. Good faith reliance on an attorney or accountant

C. Bankruptcy

D. Mental illness


Correct Answer: C

Generally, some defenses will be ineffective against charges for tax crimes. For example, liabilities owed as a result of tax evasion may not be discharged in bankruptcy proceedings.

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