FINDING 1: MANAGEMENT CONTROLS

The UST Program has begun some initiatives to target certain types of fraud and has made civil enforcement - in addition to criminal referrals to law enforcement - its number one priority. However, the UST Program relies substantially on the initiative of private trustees and on tips to detect most fraud. Moreover, the UST Program does not have an ongoing, systematic process to identify vulnerabilities in the bankruptcy system and establish uniform internal controls to detect common, high-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 focused primarily on fraud that might be committed by trustees and trustees' employees. While such controls over trustee operations are necessary and likely 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 - these controls do not focus on other, higher-risk sources of fraud. As a result, bankruptcy 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 possible.

Department's Emphasis on Fraud

Bankruptcy fraud threatens the integrity of the bankruptcy system because the system depends on full disclosure by debtors, creditors, and professionals in order to resolve disputes and to distribute money and property. The protection and integrity of the bankruptcy system is dependent upon the UST Program identifying bankruptcy fraud and abuse and taking appropriate actions.

In an October 1995 memorandum, the Attorney General emphasized the need for Departmental components to work together for the successful prosecution of bankruptcy fraud cases. The Attorney General stated in the memorandum:

[I]t is imperative that the integrity of the bankruptcy system, an integral component of our national economy, be preserved and enhanced. Debtors who conceal assets, trustees who administer estates to their own improper advantage and professionals who run bankruptcy mills and other schemes involving the bankruptcy laws all undermine our faith in the integrity of the system.

The Attorney General identified the basic components essential to a successful bankruptcy fraud effort: training, a team approach and coordination of all available resources, and prosecutorial discretion that focuses on the merits of a case rather than a blanket declination policy based solely on dollar amount.

Bankruptcy Fraud Task Groups

In response to the Attorney General's memorandum, the UST Program began establishing interagency Bankruptcy Fraud Task Groups (Task Groups)¹³ and at the time of our audit had established Task Groups in 66 of the 95 UST field offices. The Task Groups were formed to aid in the successful prosecution of bankruptcy fraud cases by meeting periodically to discuss potential and actual bankruptcy fraud referrals, allow unproductive cases to be set aside and productive referrals brought to resolution quickly, and allow all parties to keep up to date of the status of the cases. Task Groups include members from UST offices, U.S. Attorney's Offices, the FBI, and other federal agencies such as the Internal Revenue Service and the Social Security Administration.

We spoke with the UST, FBI, and U.S. Attorney's representatives of the Task Groups for the five regional offices we audited. Before the September 11, 2001, terrorist attacks, the Task Groups met quarterly or semiannually to discuss cases. Since then, the Task Groups have not met regularly. According to the representatives, resources within the law enforcement agencies have been shifted to other priorities. In addition, most representatives told us that the establishment of the Task Groups had not necessarily aided in the successful prosecution of bankruptcy fraud cases. The National Bankruptcy Fraud Tracking System (discussed in Finding 2 of this report) showed that since FY 1995, 482 convictions resulted from the 6,090 fraud referrals made by the UST Program, or 8 percent. Between FYs 1988 and 1995, 355 convictions resulted from 1,474 fraud referrals, or 24 percent. No data was available to show how many convictions resulted from Task Groups' involvement. However, some Task Group representatives said that the Task Groups remain beneficial because the groups allow sharing of information about bankruptcy fraud with other federal law enforcement agencies.

Fraud Indicators

The UST Program has identified in the UST Manual a detailed list of fraud indicators and the most common fraud schemes perpetrated by debtors, creditors, petition preparers, and others. Examples of the types of fraud indicators and schemes are shown in the following table. A complete listing of the fraud schemes and indicators appears in Appendix 6.

A fraud indicator could be present in situations where there is no fraud. The USTs, trustees, and law enforcement officials must conduct an investigation to determine if a prosecutable fraud exists.

The UST Program's Methods Of Combating Fraud

The UST Program relies substantially on trustees to monitor for fraud and also on tips from ex-spouses, ex-business partners, creditors, and others. Based on information developed by trustees or through tips, the UST can investigate the circumstances and refer fraud cases to law enforcement agencies or to U.S. Attorneys for potential criminal prosecution. The management controls implemented directly by the USTs do not address most of the fraud schemes and indicators identified in the UST Manual but instead emphasize deterring and detecting fraud by trustees against bankruptcy estates. However, some UST regions do not rely as extensively on trustees and tips - even though tips are a valuable tool - to detect fraud by debtors and others and have implemented their own fraud detection measures, such as reviewing bankruptcy petitions and schedules of assets to identify concealed property. Where no criminal violation occurs or where prosecution for fraud may be unlikely due to U.S. Attorneys' guidelines or the nature of the case, USTs can file civil lawsuits against debtors or others who attempt to defraud or abuse the bankruptcy system. The UST Program has begun to emphasize such civil enforcement actions and has established nationwide initiatives to address two specific types of bankruptcy fraud - use of false identities and false social security numbers, and unscrupulous bankruptcy petition preparers - for either criminal enforcement or civil enforcement. Lastly, to prevent or detect fraud and abuse by bankruptcy trustees themselves, UST offices review trustees' financial reports and also rely on on-site reviews and external audits.

Trustees

The USTs rely on private trustees as the first line of defense in detecting bankruptcy fraud, but trustees do not always have the incentive, time, or initiative to conduct the research necessary to detect fraud. Still, trustees are in a good position to help identify fraud and abuse in the bankruptcy system. For most debtors, the 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 can request additional information such as tax returns and bank statements. According to the UST Program, trustees can discover fraud in several ways:

• initial review of property schedules, statements of affairs, and statements of current income and expenses;
• review of records such as financial statements and records, Uniform Commercial Code filings and title searches, insurance records, divorce files, bank loan files, proofs of claim, and tax returns;
• interview of debtor at the Section 341 meeting of creditors; and
• complaints or tips from third parties.

To evaluate trustees' performance in activities that could help identify fraud, the UST reviews or attends at least one of the trustee's Section 341 meetings of creditors. The result of that evaluation is documented in the UST annual performance evaluations of Chapters 7 and 13 trustees.

We reviewed the latest UST performance evaluations of Chapters 7 and 13 trustees. In 102 of 118 performance evaluations we reviewed, the USTs determined that trustees implemented the procedures that might detect fraud and abuse. However, in 16 instances the USTs found that trustees did not implement the fraud-detection procedures. Specifically, these trustees failed to: adequately investigate the financial affairs of debtors, ask required questions (listed in Appendix 7) at the Section 341 meeting of creditors, or obtain proof of the debtor's social security number. In nearly all cases of substandard performance, the USTs reminded the trustees during the evaluation of the importance of asking the required questions and obtaining the proof of the debtor's social security number. However, a UST immediately suspended one trustee from receiving new cases for failing to adequately investigate the financial affairs of debtors; the trustee was later reinstated once the deficiencies were resolved.

According to one UST, several obstacles limit the role of trustees in preventing and detecting fraud in bankruptcy cases. The UST indicated that trustees do not have an economic incentive to pursue bankruptcy fraud in Chapter 7 cases where no money is returned to creditors. According to the UST Program, historically 95 percent of Chapter 7 cases are cases where no money is returned to creditors. These cases are commonly known as "no-asset" cases. As stated earlier in this report, Chapter 7 trustees receive $60 for administering a "no-asset" case. In cases where money is returned to creditors (asset cases), Chapter 7 trustees receive compensation based on a percentage of the funds disbursed to creditors; the percentage varies depending on the size of the estate. The trustees have little financial incentive to spend many hours reviewing "no-asset" cases to detect potential fraud. However, if the trustees elect to perform the review and uncover assets, they would receive additional compensation for administering the case.

The same UST stated that another obstacle is that trustees' calendars are crowded and a short period of time is allocated for the Section 341 meeting of creditors. Therefore, trustees may not have sufficient time to thoroughly examine the debtors for concealment of assets, false statements, and multiple filings.

Another UST stated that trustees do not always implement controls to detect bankruptcy fraud. The UST stated that the number of complaints, or tips, received from the public indicates a greater level of criminal activity than is being reported by the trustees. The following example illustrates how debtors' fraudulent behavior may go undetected by trustees administering the cases for many years.

A couple filed 16 bankruptcy petitions in 10 years, from 1990 to 2000, to hinder and delay foreclosure of real property. In addition, the couple used multiple social security numbers not assigned to them, and failed to disclose prior bankruptcy cases to the court. Six of the 16 petitions were filed in violation of a court order barring the couple from further filings for a period of 180 days. The husband filed four Chapter 13 petitions during the period 1990 to 1992 for the purpose of delaying foreclosure of their residence. When the court barred him from further filings for a period of 180 days, his wife filed a Chapter 13 petition, which included the same residential property, again to secure the automatic stay and delay foreclosure. When the case was dismissed with a bar to further filings, she filed two additional Chapter 13 petitions in violation of this order. When the two cases were dismissed with an order that any further filings by the wife would be null and void, the husband filed another Chapter 13 petition including the same residential property. The husband then filed a Chapter 7 petition in which he obtained a discharge of his debts in 1998. The most recent case was filed in January 2000, at which time the same Chapter 13 trustee was administering the case and the two previous cases filed by the couple.

Although there is no stipulation in the law as to how many times a debtor can file for bankruptcy without a discharge, filing for bankruptcy in an attempt to defraud creditors is a violation of the Code. Action was not taken against the couple until a secured creditor stated in a motion for relief from the automatic stay that the filing was the 13th filing and that creditors were forced to cancel and resume foreclosure proceedings 11 different times. After reviewing the motion for relief, the Chapter 13 trustee referred the case to the UST. The UST reviewed on-line public credit records and found that the couple used multiple social security numbers and various aliases to file for bankruptcy relief and obtain credit. The UST then referred the case for potential criminal prosecution. The UST Program contracts with a company to provide access to on-line public information. As of the third quarter of FY 2002, the UST Program spent about $122,000 for the on-line service contract. Every UST office has access to the database by a dial-up line. The UST offices use the on-line service to identify and locate concealed assets, verify social security numbers, and obtain litigation history information after receiving an allegation of fraud. In our judgment, the on-line service also would be effective in detecting debtor fraud if USTs routinely used it in the course of reviewing bankruptcy petitions.

Tips

The AUSTs at the five regional offices we audited stated that they rely substantially on complaints, or tips¹⁵ from the public - usually an ex-spouse or ex-business partner - to report instances of bankruptcy fraud. Because UST Program data did not indicate what percentage of UST referrals to law enforcement authorities were based on tips, we reviewed the fraud referrals made in FYs 1999 to 2001. We reviewed all of the referrals made during the three years, except in the Los Angeles Regional Office where we sampled because of the volume of referrals.¹⁶ In total, our sample included 302 referrals for the five regional offices.¹⁷ We reviewed the case files for each fraud referral to determine the method of detection. The table below shows that most of the criminal referrals (48 percent) resulted from tips by creditors, ex-spouses, ex-partners, and victims. The method of detection for the 302 referrals to law enforcement authorities is detailed in the following table.

• Referrals for 145 of 302 sampled cases were made based on tips received by either the UST or the trustee from individuals outside of the Department such as creditors and victims of the fraud. The subjects of the referrals were debtors, debtor's principals,¹⁸ and private attorneys. The types of frauds allegedly committed by these individuals included bribery, concealment of assets, consumer fraud, equity skimming, counterfeiting, false identity, false statements or documents, embezzlement, forgery, and multiple filings.
• Eighty-three referrals were based on reviews of debtors' financial records; 69 by trustees, 6 by USTs, and the remaining 8 by professionals hired by trustees and creditors. The subjects of the referrals were debtors and petition preparers. The type of alleged fraud committed by these individuals included concealment of assets, false identity, consumer fraud, false statements or documents, embezzlement, serial filers, and rigged auction.
• Thirty-two referrals either did not have a case file or the method of detection was not stated in the file. Case files were not available because either the referrals were made verbally or were destroyed after the U.S. Attorneys declined the cases. According to the UST Program's fraud referral database (discussed in Finding 2), the subjects of the referrals were debtors, private attorneys, and petition preparers. The types of suspected fraud included false identity, concealment of assets, embezzlement, arson, false statements or documents, and forgery.
• Twenty-nine referrals were based on the Section 341 meeting of creditors. The subjects of the criminal referrals were debtors and debtors' attorneys. The type of fraud allegedly committed by these individuals included concealment of assets, equity skimming, false identity, false statements or documents, forgery, and embezzlement.
• Eight referrals were from the U.S. Attorney or the FBI to the UST for initial investigation of suspected debtor fraud such as concealment of assets and false identity.
• Five referrals were based on judicial proceedings such as adversary proceedings, a rule 2004 examination,¹⁹ and a court hearing. The subjects of the referrals were debtors and debtor's principals who allegedly committed fraud through bid rigging, concealment, and false statements or documents.

Tips from outside sources are one useful tool in combating bankruptcy fraud; however, tips are a passive method and are not a substitute for effective management controls to prevent and detect the most significant bankruptcy problems and to target resources accordingly. Further, not all tips are legitimate, yet the information provided requires time and effort to investigate. The amount of resources the UST Program devotes to these cases is unknown since field offices do not track their investigations (see Finding 2).

Civil Enforcement

Civil enforcement action - as well as criminal prosecution - can be an effective tool to help combat bankruptcy fraud. Although criminal prosecution is a strong method for combating bankruptcy fraud, not all fraud referrals result in prosecutions. Therefore, the UST, or another interested party, may file a civil lawsuit against a debtor or a petition preparer. Unlike a criminal fraud prosecution, civil enforcement actions do not require a criminal investigation or involvement of a U.S. Attorney. Instead, the UST may file a complaint with the court to outline the alleged wrongdoing of the debtor or others after identifying the benefit of the fraud and then selecting the appropriate civil enforcement action to deny that benefit. The most common benefits of fraud include: (1) the automatic stay, which prevents the creditor from pursuing any action against the debtor or the property of the estate to collect or enforce a pre-petition debt; (2) the discharge, which removes the debtors obligation to pay a debt; and (3) creditor inertia, which causes many creditors to write off debt when a bankruptcy case is filed and abandon collection efforts even if the case is subsequently dismissed. A bankruptcy court judge hears the case and issues a court order outlining the findings of the court. The UST Program has made civil enforcement its number one priority.

Among the civil enforcement actions available to USTs are:

• a motion to dismiss a case,
• an objection to the dismissal of a case,
• a motion to deny or revoke a discharge,
• a motion to appoint a trustee or an examiner,
• a motion to convert a case to another chapter,
• a motion to compel a debtor to appear or provide documents,
• a motion for sanctions against a party for failure to adhere to the ruling of the court,
• a complaint for permanent injunction, and
• a recovery of unauthorized expenses or excessive compensation.

In addition the UST may take administrative action to:

• suspend a panel trustee from case assignments, and
• remove a trustee from the panel of trustees.

On October 30, 2001, the then Acting Director of the EOUST announced an initiative intended to more aggressively use existing civil enforcement methods to curb abuse of the bankruptcy system. The Acting Director stated:

[E]ffective case administration is vital to ensure the American public that the bankruptcy system provides relief for honest but unfortunate debtors overcome by serious financial difficulties. The Civil Enforcement Initiative emanates from the U.S. Trustee Program's long-standing commitment to enforce the Nation's bankruptcy laws and explore other meaningful strategies to bolster public confidence in the integrity and effectiveness of the bankruptcy system.

According to the Acting Director, the priorities of the Civil Enforcement Initiative require a concerted effort nationwide to use existing tools in a way that best accomplishes tangible results and improvements for case administration. The priorities of the Civil Enforcement Initiative are to:

• ensure that Chapter 7 is not abused and that Chapter 7 debtors are held accountable;
• protect consumer debtors, creditors, and others who are victimized by those who mislead or misinform debtors, make false representations in connection with a bankruptcy case, or otherwise abuse the bankruptcy process;
• ensure that Chapter 11 debtors proceed with their cases promptly and are informed of and held to account for their obligations under the bankruptcy code; and
• fight fraud and abuse by making criminal referrals and assisting United States Attorneys in criminal prosecutions.

To ensure the success of the initiative, each UST was asked to develop an action plan to identify the highest-priority civil enforcement problems in each office and assess the progress made in addressing the problems. The action plan was to:

• identify and describe each civil enforcement problem;
• describe previous actions taken to address each problem, analyze the effectiveness of such prior actions, and list any measures that quantify the scope of the problem; and
• recite the range of remedies available to address each problem and analyze which actions are most likely to be pursued.

At the time of our audit, all 95 offices had submitted civil enforcement action plans to the EOUST. The five UST regions we audited identified either credit card "bust-out" schemes²⁰ or serial filers as the most common problem in their region to be addressed through civil enforcement actions.

For credit card bust-outs, four of the five regional offices we audited reviewed petitions that had at least $100,000 in consumer debt and little to no assets. In these cases, the regional offices determined whether the debtors filed a bankruptcy petition in bad faith or concealed assets. Filing a petition in bad faith means the debtor made a significant amount of credit card purchases without the intent and means to repay creditors and then immediately filed bankruptcy. The regional offices or trustees requested those debtors who met the criteria for a credit card bust-out to provide additional financial information such as tax returns, bank statements, and credit card statements to assist with the review of the debtor's financial background. One of the five regional offices did not implement credit card bust-out procedures because it did not consider credit card bust-outs to be a significant problem in that region.

Serial filers are individuals who repeatedly file bankruptcy to gain the benefit of an automatic stay²¹ or a discharge of debts. Serial filers usually do not disclose that they have previously filed for bankruptcy. Some, but not all, UST regional offices use the UST Program's Automated Case Management System (ACMS) to determine if debtors have multiple filings. The ACMS generates a daily exception report that identifies social security numbers that have been used in more than one bankruptcy filing. In one region, for example, an attorney reviews the exception report to determine if a debtor has received a discharge within the past six years or has been barred from refiling a bankruptcy petition. The attorney notifies the case trustee to obtain additional information from the debtor at the Section 341 meeting of creditors.

The ACMS exception report compares the current filing with at least one previous filing within the same judicial district. This method of detecting serial filers is limited because a comparison is not made nationwide; if a debtor filed for bankruptcy in more than one judicial district, the debtor would not appear on the exception report. For example, a debtor filed two bankruptcy petitions in the Northern District of California and received discharges in April 1989 and June 1992. The debtor then moved to the Northern District of Georgia, filed an additional two bankruptcy petitions, and received discharges in April 1995 and May 1998. According to the Code (11 USC 727), a debtor is barred from receiving more than one discharge in a six-year period. If the ACMS system were enhanced to provide regional offices with the ability to compare bankruptcy filings nationwide, the exception report would be a more effective control for combating serial filers, as long as the regions were required to use the system to help identify serial filers. However, officials in some regional offices suggested that serial filers were not a significant problem in their region.

UST Program officials told us that although they never will be able to prevent or identify all instances of fraud and abuse, civil enforcement has been a successful initiative as evidenced by numerous examples among significant UST events reported weekly to the Attorney General. Subsequent to completion of our audit field work, UST Program officials provided us examples of the reports to the Attorney General. Among the many successful civil enforcement actions reported were:

• Voluntary dismissal of a case in September 2002 prevented discharge of $1.3 million in debts where debtor had transferred substantially all assets to his spouse or to himself and his spouse as tenants by entirety. The debtor and his non-filing spouse earned over $180,000 annually, and the spouse owned an estate paid for by the debtor three years before the debtor's bankruptcy filing.
• In August 2002 a debtor converted her Chapter 7 case to Chapter 13 at a hearing on the UST's motion to dismiss the case. The debtor was a single wage earner with no dependents, a $90,000 income, and a $215,000 home. Her monthly expenses included: $2,070 in payments for three notes secured by her house; $636 for a vehicle; $411 for telephone, cable, and internet services; and $340 for furniture. The UST argued that allowing the debtor to maintain her high lifestyle while discharging over $76,000 in debt would constitute a substantial abuse of the bankruptcy system.
• The Bankruptcy court in July 2002 entered a default judgment denying discharge to a debtor who listed $1,625 in personal property and $617,267 in credit card debt on his bankruptcy schedules. The debtor during the Section 341 meeting stated that a former roommate removed over $60,000 in appliances and furniture without authorization and that he (the debtor) lost over $100,000 through gambling, used his credit card to cover living expenses for his pregnant wife and four children whom he brought from overseas, for one month visited a discount store almost daily and spent $62,347, and flew to London and made duty free purchases. An investigator for the discount store disclosed the debtor's scam of purchasing cigarettes for resale through a wholesaler's license allowing tax-free purchases. The former roommate was a producer and wholesaler of food, tobacco, and alcoholic beverages. The UST filed a complaint based on the debtor's false oaths, inability to explain the location of estate property, and failure to keep records.

Debtor Identification Program

The UST Program established a Debtor Identification Pilot Program in 2001 to confirm debtors' identities and social security numbers, ensure a more accurate bankruptcy court record, and assess whether the problems of misidentified debtors and incorrect social security numbers on petitions were widespread. The initiative included efforts to help victims whose credit reports could be affected by the use of incorrect social security numbers on bankruptcy petitions.

The pilot program was based on an identification project begun in September 1999 in Chicago and on similar practices in several other offices nationwide. The Chicago project was expanded to 25 UST offices in 14 regions, covering 18 federal judicial districts, from January 1, 2001 through June 30, 2001.

During the pilot program, all individuals who filed a bankruptcy petition under Chapters 7 or 13 of the Code were required to produce photo identification and confirmation of social security number at the Section 341 meeting of creditors. Acceptable forms of photo identification included:

• driver's license,
• government identification,
• state picture identification,
• student identification,
• U.S. passport,
• military identification, or
• resident alien card.

Acceptable proofs of social security number included:

• social security card,
• medical insurance card,
• pay stub,
• IRS W-2 form,
• IRS Form 1099, or
• Social Security Administration report.

The pilot program included 127,590 Chapter 7 and Chapter 13 cases filed in the 18 federal judicial districts. Of these cases, about 1,225 (one percent) initially had problems with the debtors' identifications or social security numbers. While most of the problems proved to be typographical errors (1,006), some involved questionable names or identity documents (191), and possible misuse or falsification of social security numbers (32).

If the debtor failed to bring the proof of identification or social security number to the meeting or the name or social security number did not match the information on the petition, trustees proceeded with the standard questions at the Section 341 meeting but continued the meeting on another date for production of the required documentation. Trustees referred cases to the UST for appropriate action if debtors failed to provide the documentation or file amended petitions. The UST would then take civil action to dismiss the case, object to bankruptcy discharge, or object to confirmation of a Chapter 13 repayment plan. Instances of possible identity fraud were referred to the U.S. Attorney for criminal investigation and potential prosecution.

Based on the results of the pilot program, the then Acting Director of the EOUST issued a new rule that required every individual filing a personal bankruptcy case under Chapters 7 or 13 to show proof of identification at the Section 341 meeting. The new requirement began phasing in nationwide in January 2002.

Petition Preparer Program

Some non-attorneys charge debtors a fee for preparing bankruptcy petitions. The UST Program has found that some petition preparers have attempted to provide legal advice and services to debtors but lack the necessary training and experience to provide these services in an adequate and appropriate manner. Other petition preparers have defrauded or charged excessive fees to debtors who are unaware of their rights both inside and outside of the bankruptcy system. UST Program officials said that fees unlawfully taken by petition preparers are usually small, but the victims are destitute, distraught, and vulnerable to fraud schemes. Further, UST Program officials said they have seen a proliferation of bankruptcy petition preparers nationwide, although they have not specifically estimated the extent of the problem. Section 110 of the Code provides the UST Program with a new civil remedy for unscrupulous petition preparers. The Code establishes requirements for petition preparers and penalties for those who negligently or fraudulently prepare bankruptcy petitions. For example, petition preparers must:

• sign the bankruptcy petition and include the preparer's name, address, and social security number;
• furnish a copy of the bankruptcy petition to the debtor;
• not file any document (bankruptcy petition) on behalf of a debtor;
• not use the word ''legal'' or any similar term in any advertisements, or advertise under any category that includes the word ''legal'' or any similar term;
• not collect or receive any payment from the debtor or on behalf of the debtor for the court fees in connection with filing the petition; and
• within 10 days after the filing of a petition, file a declaration disclosing any fees charged to the debtor within 12 months prior to the filing of the case (the court will disallow and order the return to the bankruptcy trustee of any fees found to be in excess of the value of the services rendered by a petition preparer).

If a petition preparer violates the above requirements, the court can fine the preparer up to $500 per violation. For example, if a petition preparer fails to comply with all six requirements in one petition, the preparer can be fined as much as $3,000.

In FY 2000, the UST Program awarded a $60,000 contract to develop a database that would track petition preparers nationwide. The database was to perform several functions: (1) monitor petition preparers who are suspected of violating the Code; (2) improve timely and effective enforcement techniques; (3) provide sample pleadings and other court filings; and (4) provide the current status on pending actions. The database is available to the entire UST Program because it is accessible through the UST Program's intranet website. We did not audit the petition preparer tracking system because it was being implemented at the time of our audit. However, it appears that the tracking system should be helpful to the UST Program in monitoring petition preparers.

UST Program Monitoring of Trustees

Part of the UST Program's oversight responsibilities includes establishing controls to ensure that trustees and their employees do not embezzle funds or misappropriate property from the bankruptcy estates entrusted to them. In fact, most of the management controls implemented by the UST Program have been designed to detect fraud committed by trustees and trustees' employees rather than by debtors or others. The controls established by the UST Program to detect fraud committed by trustees and their employees include: (1) review of the 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 (TFR), 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 (TDR), which certifies that funds have been distributed to creditors; and (5) external audits and UST field examinations.

UST Program officials told us that due to their success in monitoring trustees, they have begun to reallocate resources to civil enforcement actions against debtor fraud and abuse. The UST's monitoring efforts have resulted in faster administration of Chapter 7 cases. For example, the number of Chapter 7 cases open longer than three years declined from 22,404 in April of 1992 to 5,430 at the end of FY 2001. As a result, the UST Program has streamlined its oversight procedures for Chapter 7 trustees by: (1) reviewing trustees' financial reports annually instead of a semiannually; (2) eliminating the review of the trustee's financial report if scheduled for an OIG audit or UST field examination; and (3) conducting a limited review of trustee final reports in cases where the gross receipts total $5,000 or less. The additional resources that resulted from the streamlining have been allocated to reviewing bankruptcy petitions for possible civil enforcement actions.

Over the past 15 years (1986 through 2001), the UST Program has made 71 out of 7,564 total referrals to the U.S. Attorneys for embezzlement by trustees or their employees with estimated loss totaling $18.8 million. These 71 individuals were sentenced and ordered to repay $6.9 million (37 percent) to the estates. The methods of detection for the 71 referrals were:

• 25 discovered by the UST,
• 16 based on tips,
• 9 discovered by trustees,
• 5 discovered through audits, and
• 16 unknown.

Review of Semiannual Reports

Chapter 7 trustees are accountable for all property of an estate assigned to them, and the trustees are required to report on their administration of the estate. The UST Program established a uniform record-keeping and reporting system so that Chapter 7 trustees can properly perform their duties and effectively administer cases. The system consists of three reports: Individual Estate Property Record and Report (Form 1), Cash Receipts and Disbursements Record (Form 2), and Summary Interim Asset Report (Form 3). These reports were commonly known as the "semiannual report" or the "180 day report" because trustees were required to submit the report semiannually to the UST.²² Each UST office must review the semiannual reports within 60 days of receipt from a Chapter 7 trustee. The review concentrates on the trustee's: diligence in identifying, pursuing, and recovering assets for the benefit of creditors; timeliness in closing cases; compliance with reporting and other requirements of the UST; and performance of the trustee responsibilities. The UST office is required to document its findings in writing and provide the findings to the trustee for corrective action. Any major problems identified during the review process are to be discussed with the trustee. Trustees who are deficient in their administration of cases can be subject to a wide range of compliance measures by the UST Program or the court.

From the five offices we audited, we judgmentally selected the two most recent semiannual reports for a total of 52 Chapter 7 trustees covering the period January 2001 through December 2001. We found that of the 104 semiannual reports, 94 were reviewed by the UST offices. Five reports were not submitted because the trustees filed a TFR for the only remaining case they administered. According to one UST field office representative, if a TFR is filed for the only remaining case administered, then the semiannual report is not required because the UST will review the TFR. Another five reports were not reviewed because there had been an on-site review or an external audit.²³

USTs reviewed the 94 semiannual reports and reported findings to the trustees for each report. The findings dealt primarily with administrative matters such as incorrect dates, bonding amounts, and reference numbers.²⁴ For 44 of the 94 reports, the regions noted fraud indicators such as failure to secure sale of proceeds from an auctioneer; unauthorized use of a professional; and failure to disclose a petition asset. The regional offices followed up on each of the findings until corrective action was completed; however, the regional offices had not discovered fraud through the semiannual reports we sampled.

We noted during our review that UST regional offices did not always review the semiannual reports timely. USTs are required to review semiannual reports within 60 days of receipt from the trustee. Timely review can minimize the amount of loss if a trustee or a trustee's employee is engaging in embezzlement or other fraud. Twelve of the 94 reports were reviewed from 1 to 45 days late or an average of 15 days late.

Review of Final Reports and Final Accounts

Chapter 7 trustees are required to prepare and file a TFR with the UST for review before filing it with the court. The TFR certifies that all assets have been liquidated and properly accounted for and that funds of the estate are available for distribution. The TFR must be prepared when all monies have been collected, all claims have been reviewed or determined by the court, and the date has expired for creditors to file claims. Also, the TFR summarizes all actions taken by the trustee to administer the case. The TFR must:

• describe the disposition of each estate asset,
• report all financial transactions by the trustee,
• request payment of the trustee's compensation and expenses and any unpaid professional fees and expenses,
• report the trustee actions on claims or their disposition,
• propose the distribution to creditors bankruptcy code, and
• include the original bank statements and original canceled checks received by the trustee during the case.

USTs are required to conduct a thorough review of each TFR within 60 days of receipt from the trustee to assess whether the trustee has properly and completely administered estate property. The UST is to examine exemptions, abandonments, sales or other liquidations; ensure inclusion of all necessary court orders; and verify the accuracy of calculations. The UST also determines whether the trustee reviewed and properly dealt with all claims. Deficiencies in the trustee's administration or other problems or mistakes are to be brought to the trustee's attention for corrective action. Upon completion of the review, the UST forwards the TFR to the court.

The UST Manual provides a checklist for USTs to use in reviewing TFRs. Each regional office develops its own review procedures to comply with the UST Manual. We compared the review procedures for the five regional offices we audited to the checklist and found that each of the five regional offices did not implement at least one of the required TFR review procedures. The following table shows the procedures that were not implemented by the regional offices.

UST regional office officials stated that although the procedures listed above are not included on the TFR review checklists, the analysts are implementing the procedures. We were not able to verify whether or not analysts carried out all the procedures due to the lack of documentation. These procedures are crucial in identifying fraud indicators within a bankruptcy case. For example, verifying any transfers of estate funds between checking and savings accounts ensures that the funds were transferred to the account stated in the report and not possibly to the trustee's private account. The USTs in the regional offices should include the missing procedures in their review checklists to ensure that all bankruptcy analysts and paralegals are implementing all required procedures. In addition, regional offices implement the review procedures during field examinations and semiannual reviews. However, the procedures are carried out on a sample basis. The review of the final report provides the regional offices with the opportunity to review a case in its entirety and discover any errors or potential fraud that might have been missed during the semiannual report reviews.

USTs are required to review TDRs within 125 days after the entry of an order allowing final compensation and expenses. The trustee must submit to the UST the TDR certifying that the estate has been fully administered. Along with the TDR, the trustee must submit the original bank statement(s) showing a zero balance and all original canceled checks except those already submitted with the TFR. The TDR is to be submitted to the UST, who must review and file the TDR with the court within 30 days of receipt. The UST review is to verify that all disbursements were made in accordance with the trustee's approved TDR. The USTs are to ensure that funds were issued to appropriate parties and for the correct amount.

To assess whether the review of TFRs and TDRs would detect fraud, we judgmentally sampled 150 TFRs and TDRs filed for the period July 2000 to March 2002 within the five regional offices.²⁵ Eighty-four trustees filed the 150 TFRs and TDRs. In the Atlanta and Los Angeles regional offices, the reviewers did not always formally document the review of the TFRs and TDRs. Our review found that only 5 of the 150 reviews identified potential fraud such as unexplained reimbursements, unapproved payment for professional fees, and proposed distributions for unallowed claims. The Philadelphia Regional Office discovered fraud indicators in four of the five TFRs and did not file the TFRs with the court until the trustees took corrective action. However, after investigation, the regional offices did not verify fraud in any of these cases.

Review of Cash Receipts and Disbursements Reports

The UST Program requires debtors-in-possession²⁶ and trustees for Chapter 11 cases to submit monthly financial reports. According to the UST Manual, these reports are intended to provide the USTs, court, creditors, and other interested parties with reliable information on the current status of a case. The financial reports are filed with both the UST and the clerk of the court. The debtor is also required to provide the financial reports to the chair of any creditor's committee appointed to serve in the case.

The Cash Receipts and Disbursements Statement is one of the financial reports. The statement shows the receipts and disbursements of the debtor, as well as a separate cash account reconciliation statement for each of its bank accounts such as the general account, tax escrow account, and payroll account. The information included in the statement is to be analyzed by the USTs to discover whether:

• the debtor is making unauthorized payments to professionals,
• the debtor is improperly paying pre-petition debtors,
• the debtor has sufficient cash flow to effectively reorganize,
• inordinate payments are being made for travel, entertainment, other employee benefits, and
• improper payments are being made by the debtor that will hamper the ability to reorganize.

To assess the effectiveness of this management control in detecting potential bankruptcy fraud among Chapter 11 trustees and debtors-in-possession, we reviewed 40 cash receipts and disbursements statements submitted to four of the five field offices²⁷ between February 2001 and March 2002. In each field office audited, analysts did not formally document their review of cash receipts and disbursements statements. Also, no documented findings resulted from the reviews in any of the four field offices. According to UST Program representatives from each office, cash receipts and disbursements statements are primarily used to calculate monthly fees owed to the UST Program by the bankrupt entity. UST Program personnel also indicated that a more extensive review occurs; however, we were unable to verify the extent of the review. As a result, we were unable to assess the effectiveness of this management control for detecting fraud among the Chapter 11 trustees and debtors-in-possession.

Field Examination and External Audits

Chapter 7 and Chapter 13 trustees are required to receive an audit or a field examination over specified time frames. During an eight-year cycle Chapter 7 trustees must receive at least one audit conducted by the OIG and a field examination by the UST. The scope of the audits and field examinations generally encompasses a review of the trustee's: (1) case reporting; (2) banking and bonding practices; (3) internal controls, including segregation of duties; (4) automated data processing and file maintenance; and (5) accounting for, securing, and administration of assets. Field examinations and audit reports render one of three opinions: (1) adequate; (2) adequate, except for certain deficiencies; or (3) inadequate. If a trustee receives an inadequate opinion from a field examination or an OIG audit, the UST Program will suspend the trustee from active rotation. Suspension from active rotation means that the trustee no longer receives new cases. Reinstatement of the trustee requires the approval of the EOUST Deputy Director. Prior to reinstatement, the trustee must provide evidence that the necessary corrective actions were implemented. The UST reviews the trustee's response and makes an on-site visit to the trustee's office to verify compliance, if necessary.

Each Chapter 13 trustee is required to be audited by an independent accounting firm annually. The audit may be supplemented by a management review performed by the UST at the trustee's office. The objective of the management review is to assess the trustee's performance in specific areas such as case administration, case closing, claims review, and personnel management. Whenever an audit report contains a consequential finding or a series of less consequential findings, the trustee must submit a written statement confirming that the deficiencies have been corrected. Within three months, the UST is to visit the trustee's office to verify compliance.

To assess the effectiveness of this management control, we reviewed the case files for 210 Chapter 7 trustees within the five regional offices and all 186 Chapter 13 trustees within the UST Program. Our review showed that each of the 210 Chapter 7 trustees received a field examination and an OIG audit from 1994 to 2002. We also found that all 186 Chapter 13 trustees received an independent audit in annually. Therefore, the UST Program has ensured that trustees are audited or reviewed.

In the past 15 years, the USTs made five referrals to the FBI or U.S. Attorneys as a result of external audits. Although the audits focus on trustees' administrative procedures, in a few instances the audits have identified potential fraud.

Conclusions

The USTs rely predominantly on trustees and tips from the public to detect fraud by debtors, creditors, and others. While the UST Program has some basis for viewing trustees as its first line of defense against fraud, trustees may not have the time or inclination to rigorously investigate debtors or others for potential fraud and may only detect the more obvious and flagrant cases. In fact, we found numerous examples of fraud being detected as a result of tips from persons other than the trustees. Although tips are a valuable tool for detecting fraud, if the UST intends for trustees to bear the main responsibility for fraud prevention and detection, the trustees require more definitive guidance and training on the specific steps they are required to take, and time and resources must be made available for that purpose.

Aside from relying on trustees and tips, the UST Program has begun to address directly two nationwide problems - identity theft and unscrupulous bankruptcy petition preparers. However, the extent of controls over other types of fraud varies by region. In general, the UST Program concentrates its efforts on controls over trustees and their employees rather than over some of the higher risks for fraud. Through the deterrence of UST Program monitoring and the integrity of the trustees themselves, only 71 (less than one percent) of the 7,564 referrals made to law enforcement over the past 15 years related to trustees and their employees. Without ignoring the possibility of trustee fraud, the UST Program needs to improve its own efforts to control fraud by debtors, creditors, and others. For example, in August 2001, the FBI stated that serial filings, and concealment of assets were among the serious problems that deserve national investigation. UST Program officials have not established management controls on a national level to address these types of fraud. Also, we noted that local UST Program efforts to control various types of fraud lack uniformity; some regions take more vigorous action on certain types of potential fraud than do others. The UST Program has begun to emphasize civil enforcement actions as well as referrals to law enforcement agencies where it has identified fraud or abuse. This emphasis, along with the refocusing of resources from less-likely trustee fraud, should contribute to meeting the goal of protecting the integrity of the bankruptcy system.

Recommendations

We recommend the Director, Executive Office for U.S. Trustees:

1. Establish uniform management control procedures within the UST offices to prevent and detect the more common and higher-risk types of fraud affecting the bankruptcy system, such as concealment of assets and serial filers, and ensure that resources are targeted accordingly.
2. Expand the existing data system to allow for detection of multiple bankruptcy filings nationwide.
3. Ensure uniform and complete reviews of Final Reports and Final Accounts.
4. Ensure that review procedures for cash receipts and disbursements reports are fully implemented.

13. The USTs could not provide us the dates for the establishment of the Task Groups.
14. The Bankruptcy Code Section 341 meeting of creditors allows creditors, trustees, and other parties of interest to question debtors about the debts and assets of the estate.
15. The Program does not provide rewards or other financial incentives for tips that lead to prosecution or civil enforcement.
16. The Los Angeles Regional Office made 865 referrals during the three years; we judgmentally selected 10 percent (86) of the 865 cases.
17. According to the EOUST, USTs are not always made aware of the outcome of fraud referrals. Therefore, complete data on prosecutions is not available for the 302 referrals.
18. Debtor's principals are officers of entities that filed for bankruptcy protection.
19. A rule 2004 examination allows trustees or creditors to conduct a more extensive examination of debtors' petitions, schedules and financial documents.
20. Credit card bust-outs occur when individuals declare bankruptcy after obtaining goods on credit without the intent to pay and then dispose of the goods for cash.
21. Debtors receive an automatic stay when they file for bankruptcy protection. Creditors must cease all collection efforts under the stay unless the bankruptcy court orders a relief from the automatic stay or the case is dismissed.
22. Effective July 1, 2002, Chapter 7 trustees are required to submit these reports annually unless the trustee is newly appointed, suspended from rotation, or the UST has a concern or perceives a problem with the trustee's administration of cases.
23. According to the UST Manual, USTs are not required to conduct a separate review of the semiannual report for any period that is also the subject of a UST field examination or an OIG audit.
24. Trustees use reference numbers to track assets listed on debtors' schedules.
25. We selected 25 or 10 percent of the TFRs and TDRs filed, whichever was less, during the period from the five regional offices.
26. Debtors-in-possession are debtors who are in custody of the estate because the court has not appointed a trustee in the case.
27. The control was not tested at the first location audited, but we added a testing procedure at the subsequent four locations.