Law Related to Fraud. Bankruptcy (Insolvency) Fraud Association of Certified Fraud Examiners, Inc.

Transcription

1 Law Related to Fraud Bankruptcy (Insolvency) Fraud

2 Bankruptcy Court 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

3 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

4 Office of Trustee Staff Staff attorneys review pleadings. Bankruptcy analysts analyze and review relevant financial information. Special investigative units investigate criminal referrals in bankruptcy cases. Panel trustees are independent professionals who serve in Chapter 7 and sometimes Chapter 11 cases.

5 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

6 Debtors and Creditors A debtor is defined as a person (individual, partnership, corporation) or municipality. A creditor is defined by the code as one who holds a claim. 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.

7 Adjusters Adjusters are the right hand to trustees and debtors. An adjuster is an individual who handles the peripheral duties of a trustee: 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

8 The 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 reorganizing the business. Chapter 13 allows a debtor to pay off his debts over time in accordance with a courtapproved plan.

9 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 shoes of the debtor, which allows him the opportunity to break 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.

10 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.

11 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. Assets might consist of cash, consumer property, houses, and interests in partnerships and corporations, as well as lawsuits in which the debtor is a plaintiff. Assets also include books and records of the debtor.

12 Fraudulent Transfer Bankruptcy Schemes 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 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 perpetrators then close shop, abscond with the proceeds, and leave the suppliers unpaid.

13 Sample Prep Question 1. A bustout is planned bankruptcy. To perpetrate this type of scheme, in which order must the following steps be taken? I. The business closes and files bankruptcy II. Purchases large quantities of inventory III. Obtains large credit from vendors IV. Sells 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

14 Correct Answer: C A bustout is a planned 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 perpetrators then close shop, abscond with the proceeds, and leave the suppliers unpaid.

15 Sample Prep Question 2. Which of the following statements regarding a 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.

16 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 shoes of the debtor, which allows him the opportunity to break the attorney-client privilege. Attorneys might attempt to raise the attorney-client privilege as a defense to providing information, 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.

17 Sample Prep Question 3. The most common type of bankruptcy scheme is the concealment of assets. A. True B. False

18 Correct Answer: A The most common bankruptcy-related crime is the concealment of assets rightfully belonging to the debtor estate. Concealments vary from little or no monetary value to tens of millions of dollars.

19 Law Related to Fraud Tax Fraud

20 Introduction The most important distinction in determining whether an individual or company has committed tax fraud is whether the tax-filing party intentionally provided false tax information to the government. The intent of the party to wrongly file a return or provide other false tax information will determine the difference between tax avoidance and tax evasion.

21 Objectively Reasonable Good Faith Misunderstanding of the Law 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 Destruction of books or records Concealment of assets Covering up sources of income Avoiding making records usually made in transactions of the same kind Conduct that misleads or conceals

22 Fraud Is More Than a Mistake in Judgment The failure to know and understand the rules of first in, first out (FIFO) is not sufficient to sustain a fraud charge, Smith v. Commissioner, 40 BTA 387, supplemental opinion 42 BTA 505. Corporate fraud depends on intent of the corporate officers, Auerbach Shoe, 21 TC 191.

23 Burden of Proof No presumption of correctness is afforded to the IRS when fraud is involved. The IRS has the burden of proof to prove fraud by the taxpayer.

24 Taxpayer Penalties Civil or criminal penalties IRS pursues civil violations Refers criminal prosecutions to the Dept. of Justice 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

25 Tax Preparer Penalties Aiding and abetting Civil penalty on any person who aids or assists in the preparation of any tax-related document if the person knows or has reason to believe that the document will be used in connection with a material tax matter and will result in the understatement of a taxpayer s liability

26 Defenses for Tax Fraud No deficiency Objectively reasonable position Claim of right doctrine Mental illness Reliance on attorney or accountant

27 Defenses for Tax Fraud Inappropriate defenses Amended or delinquent return Statute of limitations Death of taxpayer Bankruptcy

28 Other Legal Elements Embezzled money is immediately income to the embezzler even though he is under a duty to repay it, but upon repayment, the embezzler gets a deduction for the repayment.

29 Sample Prep Question 1. Tax avoidance is lawful, but tax evasion is not. A. True B. False

30 Correct Answer: A The U.S. courts have determined evasion to be unlawful, while avoidance has been deemed lawful.

31 Sample Prep Question 2. According to cases interpreting the U.S. Tax Code, a taxpayer cannot be guilty of a taxrelated crime if he or she had a good faith or legitimate misunderstanding of the requirements. A. True B. False

32 Correct Answer: A Good faith or a legitimate misunderstanding of the requirements of the law negates willfulness [U.S. v. Cheek, 911 USTC 50,012 (7th Cir 1991), aff d. 111 U.S. 604 (1991)]. The case held, however, that the belief that taxes are in violation of the Constitution was not objectively reasonable so as to negate willfulness.

33 Sample Prep Question 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

34 Correct Answer: C Taxes owed as a result of filing fraudulent federal income tax returns are not dischargeable in bankruptcy. [11, U.S.C., Sec. 523(a)(1)(c). In Re: Harris, 59 BR 545 (BC-DC Va. 1986); Rev. Rule 87-99, C.B. 291.] Therefore, bankruptcy is not an acceptable defense to criminal tax fraud.