U.S. Targets Bankruptcy Fraud

The Justice Department is expected to announce today a surge in prosecutions for alleged bankruptcy fraud, including 31 cases involving 35 defendants in the Los Angeles area, a leading trouble spot in the country.

The Los Angeles area accounts for nearly a third of the more than 100 cases brought under a a stepped up prosecution effort, dubbed Operation Total Disclosure, that Atty. Gen. Janet Reno ordered earlier this year, according to Justice Department officials.

Reno took the action after U.S. trustees said they were concerned that increased fraud could undermine faith in the system, an official said. The fraud included illegally hiding assets, filing falsified petitions and otherwise abusing the system.

In an Orange County case, a man was indicted Tuesday on charges that he manipulated bankruptcy protections to halt foreclosures on real estate. He allegedly transferred phony partnership stakes in troubled properties to a bankrupt person, thus stalling foreclosures.

That case will be the first in the nation to be prosecuted under a 1994 law that was drafted specifically to deal with bankruptcy fraud, according to federal authorities. The law arose from difficulties in dealing with such sham property transfers, authorities said.

In a Palmdale case, a sporting goods merchant claimed to have no remaining inventory when filing for bankruptcy but was found to have $70,000 of inventory in his garage, car trunk and a storage locker, a department official said.

In a Los Angeles case, defendants allegedly secretly transferred more than $1 million from a troubled gas station into other accounts they controlled but did not disclose to the bankruptcy court, according to a report prepared for Reno.

Elsewhere in the country, a Pennsylvania man filed to clear his debts five times in five years, each time allegedly concealing his previous difficulty.

A Chicago attorney declared personal bankruptcy, allegedly concealing at least two bank accounts, several real estate parcels and two automobiles.

A Seattle case involved a woman who solicited $1.5 million from 15 elderly investors, some of whom gave her their life savings. She allegedly diverted the money to buy condominiums and luxury automobiles but concealed those assets from the court when she declared bankruptcy.

Maureen Tighe, head of the bankruptcy fraud task force in the U.S. attorney’s office in Los Angeles, noted that the area accounts for nearly 10% of the bankruptcies filed annually in the country.

“We have the largest number of prosecutions in part because we have led the nation in bankruptcy filings,” she said.

Tighe said that Los Angeles served as the model for the stepped-up prosecution effort and acknowledged that the region does have a serious bankruptcy fraud problem, partly reflecting a major downturn in the real estate market.

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The Orange County case represents the first concerted attack on what the U.S. trustee’s office calls the use of “fractionalized interests” to delay foreclosures and frustrate creditors.

In that case, Jimmie W. (Pat) Patterson of Victorville is accused of giving a bankrupt Orange County resident 1% stakes in three real estate partnerships.

The bankrupt person, James S. Davis of Laguna Beach, filed amended documents to show his new ownership stakes, thus invoking the Bankruptcy Code’s automatic stay against foreclosures.

He later admitted in court that he had no interest in those properties and that he simply acquiesced to Patterson’s request for the amended filing.

The indictment alleges that Patterson collected $1,000 for every month he was able to keep properties out of foreclosure.

“These guys have been getting away with this for years,” said Arthur N. Marquis, assistant U.S. trustee in Santa Ana. “I have another case now where they’re using other people’s properties to take advantage of the automatic stay.”

Authorities said the idea behind the scheme is to make repeated filings with various debtors so that as soon as a creditor gets the stay removed, the same property is back in bankruptcy in another case.

“These people live in the house rent-free and mortgage-free for months,” said Richard H. Golubow, a Newport Beach lawyer who is on a committee that tries to stem fraud by bankruptcy preparers. “I’ve seen them keep it going for up to a year and a half.”

A Justice official said that, in starting the Total Disclosure program, Reno sought to make it clear that federal authorities will prosecute those who misuse a system intended to give debtors a fresh start.

The operation, which the official said is continuing, involves the FBI, the tax and criminal divisions of the Justice Department, the Internal Revenue Service and Postal Inspection Service, in addition to U.S. attorneys and the U.S. Trustee Program.

Ostrow reported from Washington, Granelli from Orange County.