The Bankruptcy Act of 1978 created the United States Trustee Program (USTP) as a component of the Department of Justice (DOJ) and charged the USTP with the responsibility for supervising the administration of bankruptcy cases and trustees, including Chapter 7 panel trustees. Chapter 7 panel trustees are usually attorneys or accountants who are appointed by the USTP to administer bankruptcy cases filed under Chapter 7 of the U.S. Bankruptcy Code.¹

As of June 2007, there were 1,140 Chapter 7 panel trustees operating nationwide, who processed a total of 484,162 Chapter 7 filings. Annually, Chapter 7 panel trustees are responsible for collecting over $2.7 billion in funds through the liquidation of debtors’ estates, and distributing those funds to creditors, in accordance with the Bankruptcy Code. Given the significant dollar amounts involved, the risks associated with the handling of cash and other liquid assets, and the inherently adversarial relationship between debtors and creditors, the integrity of the bankruptcy process relies on the effectiveness of panel trustees.

Passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) on April 20, 2005, brought significant changes to the bankruptcy industry and created additional responsibilities for the USTP especially with regard to debtor oversight. Among the more significant changes was the implementation and monitoring of a screening process for all debtors filing for protection under Chapter 7 and Chapter 13 of the Bankruptcy Code.

Chapter 7 bankruptcy filings peaked in 2005 when they reached 1.3 million. After the implementation of BAPCPA requirements, Chapter 7 filings dropped to 833,000, and in 2007, Chapter 7 filings dropped even lower to 484,000. The table below shows the total number of Chapter 7 and 13 filings since 2002.²

CHAPTER 7 AND 13 FILINGS FOR
FISCAL YEARS 2002 THROUGH 2007

Source: EOUST

The USTP consists of the Executive Office for United States Trustees (EOUST), which is led by a Director who oversees 21 United States Trustee Regions each headed by a United States Trustee (UST). Within the 21 regions are 95 field offices each headed by an Assistant United States Trustee (AUST). The Director acts under authority delegated by the Attorney General to provide day-to-day policy, legal direction, and coordination to the regional offices. USTs are DOJ employees appointed by the Attorney General and are responsible for supervising the administration of bankruptcy cases and panel trustees within their region.

OIG Audit Approach

The objectives of this Office of the Inspector General (OIG) audit were: (1) to determine if the USTP is providing adequate monitoring and oversight of Chapter 7 panel trustees, and (2) to assess the USTP’s compliance with requirements of the BAPCPA with regard to implementation of the means test and debtor audits.³ We did not review other requirements of the BAPCPA, including the USTP’s implementation of credit counseling and debtor education because the Government Accountability Office (GAO) has recently reviewed these issues.⁴

We conducted our audit work at EOUST headquarters in Washington, D.C., where we interviewed officials involved with panel trustee and debtor oversight; reviewed pertinent policies and procedures; and analyzed reports, memoranda, and other documents related to the oversight process. We also reviewed the process of awarding contracts to certified public accountants (CPA) for both panel trustee and debtor audits, and we examined the most recent contracts that were awarded, with a specific emphasis on the statements of work. Finally, we compared the recent CPA audit reports with previous Chapter 7 audits issued by the OIG.

In addition to our work at EOUST headquarters, we conducted site work at regional offices in Cleveland, Ohio; Los Angeles, California; San Francisco, California; and Seattle, Washington. At the regions, we interviewed the U.S. Trustees, Assistant U.S. Trustees, bankruptcy analysts and attorneys, and other field staff. We also examined audits and field examinations of panel trustee operations and reviewed files to determine whether adequate follow-up was performed to document corrective action taken on deficiencies identified in audits and field examinations. In addition, we examined files to determine whether the required panel trustee interim report reviews were performed. With regard to debtor oversight, we examined debtor audits that included material misstatements in order to determine whether appropriate follow-up procedures were followed. We also assessed the means testing process for debtor bankruptcy filings to determine whether means testing was being performed in accordance with the BAPCPA.⁵

Results in Brief

We found that the USTP’s system of audits and reviews was adequate to monitor Chapter 7 panel trustees. However, from FYs 2004 through 2007 we noted that many field examinations were not conducted in a timely manner. USTP policy requires that a panel trustee receive a field examination or CPA audit every 4 years.⁶ We found that several panel trustees did not receive any on-site review of their work for up to 8 years. This lack of timely oversight increases the risk that poor performance or misconduct may be left unchecked and jeopardize the integrity of the bankruptcy system.

To assess the USTP’s compliance with certain provisions of the BAPCPA, we also reviewed the USTP’s implementation of means testing and debtor audits. We conducted a sample review of completed means tests and also observed and documented means tests being performed at UST field offices. Based on our review, we concluded that the USTP had adequate controls in place for Chapters 7 and 13 bankruptcy filings. Similarly, we found that debtor audits by contract CPA firms were being conducted in accordance with the BAPCPA. However, we noted that the USTP’s efforts to achieve compliance with the BAPCPA’s means testing requirement is resource intensive. Should bankruptcy filings increase significantly and approach their pre-BAPCPA levels, the amount of resources required to maintain means testing compliance may significantly affect the USTP’s ability to provide timely and comprehensive oversight of other panel trustee operations.

In our report, we make four recommendations to assist the EOUST in implementing USTP policy and complying with BAPCPA requirements. Our recommendations include ensuring that panel trustees undergo CPA audits or UST field examination every 4 years, as required by EOUST policy, and that the EOUST continue to work with the Administrative Office of the United States Courts (AOUSC) to implement automated bankruptcy forms. The remaining sections of this Executive Summary describe in more detail our audit findings.

Oversight Regimen and Reforms

In conducting our audit, we focused on the oversight regimen established by the USTP, including:

• CPA Audits and Field Examinations. Although similar in scope and methodology, field examinations are focused more on the trustee’s case administration, whereas CPA audits provide a greater emphasis on the trustee’s internal controls. In CPA audits, an independent CPA conducts an on-site review of a panel trustee’s operations. Field examinations are performed by UST field staff. Both CPA audits and field examinations result in an opinion regarding the panel trustee’s ability to safeguard bankruptcy case assets. The opinion rates the trustee’s practices and procedures in one of three categories: adequate; adequate, except for certain listed deficiencies; or inadequate because of certain listed deficiencies (see Appendix VII for a list of possible deficiencies). CPA audits and UST field examinations are to be conducted on a rotating basis every 4 years.

• Annual Trustee Interim Report Reviews. A trustee interim report review assesses the trustee’s activities and accomplishments during the reporting period. Conducted annually at the regional UST office, the trustee interim report review evaluates the panel trustee’s completeness in reporting financial information on all asset cases, summarizes reported cases, provides case administration analysis, and evaluates the accuracy of case and asset information reports. The trustee interim report review is not performed in years in which an audit or a field examination is conducted.

• Biennial Trustee Performance Reviews. Trustee performance reviews do not involve on-site work, but are performed by UST field staff who document the panel trustee’s performance during the review period. The review includes an evaluation in each of the trustee’s areas of responsibility, such as trustee reporting, performance at the meeting of creditors, and securing estate property. The final results are communicated to the panel trustee.

Three major reforms came out of the 2005 BAPCPA that create other responsibilities for the USTP:

• Means Testing. Means testing prevents debtors who can repay their creditors from being discharged from their debts under protection of the Bankruptcy Code. Means testing is the process through which the USTP reviews and if necessary verifies the information provided on the debtor’s Statement of Current Monthly Income and Means-Test Calculation (SCMI), debtor’s bankruptcy petition, and supporting schedules to make a determination as to whether the debtor qualifies for relief under Chapters 7 or 13 of the bankruptcy code.⁷ If filing under Chapter 7 and repayment is deemed possible, the debtor’s case may be dismissed or the debtor may voluntarily convert to Chapter 13 of the Bankruptcy Code, which requires individuals to repay a portion of their debt under a payment plan – usually 3 to 5 years – or face dismissal of their case altogether.

• Debtor Audits. The BAPCPA mandated that a system of audits be established to determine the accuracy of information provided by individuals filing for bankruptcy under Chapters 7 or 13. The BAPCPA further states that the audits will be performed by independent CPAs or independent licensed public accountants. Cases are selected on a random or non-random basis with non-random selections based on income or expenses that deviate significantly from the norm.

• Credit Counseling.⁸ Individuals must receive credit counseling before filing for bankruptcy and also take a debtor education course before having debts discharged. The BAPCPA assigned responsibility to the USTP for implementing these requirements, including the development of rules and guidance and the certification of approved credit counseling and debtor education programs.

Monitoring Panel Trustees

To assess the oversight of panel trustees, we selected a judgmental sample of 54 panel trustees in 4 UST regions that we visited. We reviewed the CPA audits, field examinations, trustee interim report reviews, and biennial trustee performance reviews that were maintained in the files for the 54 panel trustees.

In addition, we obtained data from the EOUST on all CPA audits and field examinations conducted between FYs 2004 and 2007. As of June 2007, there were 1,140 panel trustees. Of this number, 34 panel trustees were appointed within the last 4 years and therefore were not required to have an audit or field examination. Therefore, we reviewed the information provided by the EOUST on the remaining 1,106 panel trustees to determine if the reviews were being performed as required.

Overall, we determined that the USTP’s system of audits and reviews to monitor Chapter 7 panel trustees was adequate. However, we found that field examinations were sometimes delayed or not completed at all. Of the 1,106 panel trustees, 421 required an on-site field examination between FYs 2004 and 2007. Of the 421, we found that 111 (26 percent) of the panel trustees did not have a field examination conducted within the required 4 years. In 6 instances, the field examinations were not conducted at all, which means that the panel trustees were allowed to administer cases for 8 years without any on-site review. We also noted that annual trustee interim report reviews were not performed or consistently documented in the 4 regions that we visited. Of the total 156 trustee interim reports selected, we found that 28 reports (18 percent) were either not reviewed or there was no evidence to document the review. To the extent that the USTP fails to provide timely and effective oversight through its system of reviews, it increases the risk that a panel trustee’s poor performance or misconduct may go undetected.

Debtor Oversight

The BAPCPA requires that the USTP perform means testing on all bankruptcies filed under Chapters 7 and 13. We selected a judgmental sample of 40 means test reviews in progress at the time of our field visits and followed up with the regional USTs to determine the outcome of the reviews.

Based on this sample review, we concluded that the USTP had adequate controls in place to ensure that means testing was conducted on Chapter 7 and Chapter 13 bankruptcy filings as required by the BAPCPA. However, both EOUST officials and UST field staff raised concerns regarding the level of resources that would be required to remain in compliance with the means testing requirements of the BAPCPA should bankruptcy filings return to their pre-BAPCPA levels.

However, if bankruptcy filings return to pre-BAPCPA levels, a significant reallocation of resources may be required. We believe that if the USTP does not plan for such an eventuality, it could compromise the agency’s ability to provide effective oversight in other key areas, such as panel trustee operations.

During the course of this audit, we found that bankruptcy filings in 2007 were roughly half the number of filings recorded in the 3 years leading to passage of the BAPCPA in October 2005. Even at 2007’s historically low level of filings, however, efforts to achieve compliance with means testing requirements appear to have had an impact on the USTP’s panel trustee oversight responsibilities. This was evident in the 26 percent failure rate we observed in the regional UST’s ability to complete field examinations of panel trustee operations in a timely manner. One of the main reasons cited by both EOUST and regional UST officials for the decline in panel trustee oversight was the diversion of regional UST resources to means testing.

We could not confirm EOUST and UST officials’ assertions. However, we believe that a correlation could exist because: (1) USTP staff are required to conduct panel trustee oversight as well as means testing, and (2) the decline in panel trustee oversight has coincided with the increase in debtor oversight mandated by the BAPCPA.⁹ The return of bankruptcy filings to their pre-BAPCPA levels, therefore, could have a significant impact on the USTP’s ability to provide effective oversight in other key areas, in particular oversight of panel trustee operations.

To minimize the impact of the BAPCPA’s means testing requirements, the EOUST has been working with the AOUSC to implement the use of standardized automated bankruptcy forms. EOUST officials stated that automated bankruptcy forms would significantly streamline the means testing process. However, the EOUST cannot unilaterally make such a change because the AOUSC is responsible for implementing automated bankruptcy forms. We agree with EOUST officials that the use of automated bankruptcy forms would streamline the means testing process, and believe that the EOUST should continue to work with the AOUSC to implement the use of automated forms.

We also reviewed the USTP’s implementation of debtor audits based on the BAPCPA requirements. Independent auditors conduct debtor audits and issue either a report of audit or a report of no audit to the regional UST. Each report of audit is also filed with the court. The report of audit can include no findings or may include material misstatements.¹⁰ A report of no audit identifies when the audit firm receives no response from the debtor, an insufficient response from the debtor, or the case is dismissed before a sufficient response is received.

According to EOUST records, 4,095 debtor audits were selected for audit in FY 2007. This included 3,161 random audits and 934 non-random audits. The random audits represented 1 of every 250 of the roughly 795,000 filings recorded in FY 2007. Non-random audits are selected for cases when the debtor’s income or expenses deviate significantly from the statistical norm of the district in which the schedules were filed. We verified the audit selection process and concluded that the BAPCPA criteria were followed. Additionally, we reviewed 12 debtor audits at the 4 regions that we visited that had resulted in audit reports with material misstatements. We verified that the regional UST was performing follow-up procedures on these audits in accordance with the BAPCPA. Based on the work performed by the independent auditors, we concluded that the debtor oversight provided by the USTP in the cases we reviewed was in accordance with the BAPCPA’s requirements.

Conclusion and Recommendations

We concluded that the USTP’s system of audits and reviews was adequate to monitor the effectiveness of panel trustee operations. However, while the oversight system was adequate, we noted some problems in its execution. Specifically, we found that many field examinations were not conducted within the required 4 year interval. We also noted that annual trustee interim report reviews were not always performed or consistently documented. Failure to complete these oversight activities in a timely manner could result in poor performance or misconduct by panel trustees going undetected.

With regard to debtor oversight, our review of the USTP’s activities in the areas of means testing and debtor audits found that the USTP had met its obligations under the requirements of the BAPCPA. We noted, however, that means testing is a labor-intensive process, and that if bankruptcy filings return to their pre-BAPCPA levels, the diversion of resources required to remain in compliance with the BAPCPA may significantly affect the USTP’s ability to accomplish its overall mission, particularly in the oversight of panel trustee operations.

Our audit made four recommendations to assist the EOUST in implementing USTP policy and complying with BAPCPA requirements. First, EOUST should ensure that CPA audits or UST field examinations are conducted every 4 years. Second, regional USTs should complete annual trustee interim report reviews for all panel trustees unless a CPA audit or UST field examination has been conducted within the same year. Third, the EOUST should continue to work with the AOUSC to require mandatory use of automated bankruptcy forms. Fourth, the EOUST should formulate a strategic plan to meet means testing requirements in the event that filings increase and available resources remain static.

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1. Bankruptcy under Chapter 7, also referred to as the “liquidation” Chapter, results in a debtor’s non-exempt assets being reduced to cash by the panel trustee and distributed to creditors of the estate after administration expenses are paid. In most cases, the debtor then obtains a discharge of virtually all pre-bankruptcy debts.

2. Under Chapter 13, debtors file a repayment plan with the court under which they agree to pay their debts over a period of usually 3 to 5 years. In these cases debtors obtain discharges from their debt upon completion of the repayment plan.

3. Means testing refers to the process through which the USTP reviews and, if necessary, verifies the information provided by the debtor in order to make a determination whether the debtor qualifies for relief under Chapters 7 or 13 of the bankruptcy code. Debtor audits are performed by certified public accountants (CPA) to determine the accuracy, veracity, and completeness of debtors’ petitions, schedules, and other information that the debtor is required to provide in cases filed under Chapters 7 or 13.

4. U.S. Government Accountability Office, Bankruptcy Reform, Value of Credit Counseling Requirement is Not Clear, GAO-07-778T, May 1, 2007, found that the BAPCPA had been implemented as required. However, the GAO also found that it is not possible to determine if debtors benefited from credit counseling and debtor education because there is no mechanism in place to track outcomes.

5. Appendix I contains further description of our audit objectives, scope and methodology.

6. CPA audits are required to be conducted every 8 years, while field examinations are required to be conducted 4 years after every CPA audit.

7. According to the BAPCPA, all individuals filing for bankruptcy relief under Chapters 7 or 13 are required to complete a SCMI and submit it to the court along with the bankruptcy petition. The SCMI requires the debtor to provide the following information: (1) current monthly income, (2) allowable deductions such as living expenses and future payments on secured claims, and (3) the median family income for the state in which the debtor resides. Based on the information provided, a debtor makes a self-assessment of eligibility for relief using a basic mathematical formula that is built into the SCMI. The SCMI is required to be submitted along with the debtor’s bankruptcy application.

8. See GAO, Bankruptcy Reform. We did not test credit counseling because of the GAO’s report.

9. UST field offices have developed a two-tiered system of means testing based on the complexity of the case. The tier-one review is designed to quickly assess and eliminate those means tests results that demonstrate the debtor is eligible for protection under the bankruptcy code. The tier-two review includes all cases where additional analysis is required to determine whether a presumption of abuse exists on the part of the debtor. USTP policy requires that UST field staff performing tier-one reviews should confer with paralegals, bankruptcy analysts, or trial attorneys if any questions arise as to whether a case should be closed or referred for a tier-two review.

10. Material misstatements are generally defined as the underreporting or omission of a debtor's assets. This may include, but is not limited to monthly income, bank accounts, personal property, and real property.