Posted by Todd Zywicki:
How Much Bankruptcy Fraud is There?
Although most of the debate over the bankruptcy reform legislation has
focused on the means-test and the problem of bankruptcy abuse, the
bulk of the consumer provisions are dedicated to the much more
mundane, uncontroversial, and damaging problem of bankruptcy fraud.
The biggest problem, as one might expect, is simply hiding assets from
creditors and the court. [1]Tom Blumer at Bizzyblog has nonetheless
suggested that perhaps the bankruptcy fraud problem is minor. Here's a
quick roundup on the estimates of bankruptcy fraud I have been able to
find with a moderate degree of searching:
The [2]FBI estimated a decade ago that about 10% of consumer
bankruptcy cases have some sort of fraud:
Bankruptcy laws were put in place to protect businesses and
individuals from losing everything they owned in the event of
financial failure. But who protects us from those who use this
system to defraud their creditors and actually get rich through
bankruptcy? Some people duped the bankruptcy courts with fabricated
petitions and testimony resulting in unpaid debts and money in
their pockets. Bankruptcy fraud costs businesses and taxpayers
billions every year.
A wider acceptance of bankruptcy in this country, as well as a
changing economic climate, has led to a 500 percent rise in
bankruptcy filings since 1973. About 10 percent of all bankruptcies
involve fraud. So in 1995 alone, almost 250 fraudulent bankruptcies
were filed every day. Bankruptcy fraud schemes include the hiding
of assets, false statements, multiple filings, forged petitions and
petition mills that crank out phony information. Two-thirds of all
bankruptcy fraud involves hidden assets.
A few years ago [3]the IRS endorsed the 10% figure:
The Bankruptcy Reform Act of 1978 restructured the bankruptcy court
system and overhauled the nation�s bankruptcy laws to more closely
conform to modern commercial transactions. Since these changes
liberalized debtor access to bankruptcy relief, annual bankruptcy
filings have increased from approximately 300,000 in 1980 to
approximately 1.4 million in FY2001. The increasing number of
bankruptcy petitions filed has been accompanied by a correlative
increase in bankruptcy fraud.
Industry experts estimate that 10% of all bankruptcy petitions
contain some elements of fraud. This results in serious
consequences which undermine public confidence in the system, taint
the reputation of honest citizens seeking protection under the
bankruptcy statutes, and have a negative impact on voluntary
compliance in our income tax system. With so much at stake, the
detection and prosecution of bankruptcy fraud continues to be a
priority for the IRS, as well as the Department of Justice.
A recent analysis by [4]SMR Research states that this probably
underestimates the extent of fraud in the system. (Note: This is a
summary of a bankruptcy fraud study which is for sale, and which I
haven't purchased, so this is from the summar on the SMR Research
website):
We gathered a random sample of Chapter 7 petitions in 24 states,
all filed the same day: June 5, 2002. It was the day in the middle
of the worst year for filings. Our sample size was about 7.9% of
all the Chapter 7 filings of that day.
All the cases we studied were successfully discharged.
We created a database of asset, debt, income, and living expense
numbers and looked at the statistical results. We also did
something judges don�t always do: We read some of the petitions
carefully.
The FBI estimates that 10% of bankruptcy filings involve fraud of
some kind. But fewer than 0.1% of filers are convicted. And our
statistical analysis suggests that even the 10% fraud estimate is
probably low.
For people who are in bankruptcy because of poor financial planning
skills, apparently some bankruptcy filers can make some pretty
accurate calculations:
9.5% of filers claim that, in a wild coincidence, their bankruptcy
fees of about $1,000 were their last cash, down to the penny.
Nearly one-third of filers claimed they were nearly penniless after
paying these fees.
And SMR notes some interesting case studies:
Among individual petitions, one after another stretched credibility
to its limits. We illustrate with 30 case studies, all pretty clear
stuff. Check James, who had $800,000 of unsecured debt but claimed
the assets he acquired were gone after being struck by lightning.
Russ in California had no job, no income, and no cash but somehow
maintained his monthly gym membership. Brian owed money on a hot
tub he claimed was stolen (by a gang of patient thieves,
apparently; it takes hours to drain one and at least six large men
to lift the shell.)
Bob and Susan had $120,000 of annual income but couldn�t pay their
debts for one big reason: $826 per month they spent on a SeaRay
boat. Still, they reaffirmed the boat loan. Alexis filed, owing
only $2,088 in total debt, even though she had a good job and could
have paid half the debt with what she spent on lawyer and filing
fees.
Note again that every debtor in the study received a discharge, even
Brian, the unfortunate victim of hot tub theft.
In a positive note, the DOJ appears to be ramping up its efforts to
rein in bankruptcy fraud. (See, for instance, [5]Operation Silver
Screen.")
References
1. http://www.bizzyblog.com/?p=56
2. http://www.fbi.gov/hq/cid/fc/video_text/bf_txt.htm
3. http://www.irs.gov/compliance/enforcement/article/0,,id=107634,00.html
4. http://www.smrresearch.com/bankruptcyfraud03.html
5. http://www.usdoj.gov/ust/press/silver_screen_final_10-28-04.htm
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