Bankruptcy court overwhelmed.

Officials suspect widespread fraud, but say they lack means

With an estimated 10 percent of all bankruptcy filings nationwide, the six-county region anchored by L.A. County long ago gained a reputation as the nation's bankruptcy capital.

But despite a sharp rise in filings - up 16 percent between 1996 and 1997, and up 100 percent from 1990 to 1997 - little or no new resources have been deployed to investigate bankruptcy fraud, records and interviews show.

Federal officials estimate that of the nearly 100,000 Chapter 7 personal bankruptcy filings last year, anywhere from 10,000 to 15,000 may have been fraudulent. Yet only 24 indictments were handed down for bankruptcy fraud - the cost of which is passed on to consumers and businesses through higher credit card and loan rates.

Moreover, the system set up to review and approve bankruptcy applications is composed largely of private trustees, typically attorneys or accountants, who get paid by the case and have scant financial incentive to root out fraud, federal officials and the trustees themselves concede.

"All the time you ask yourself if these cases deserve more scrutiny in order to satisfy the creditors, but you just can't do it," said Robert Pryce, a private trustee with the downtown law firm of McKenzie, McGhee & Pryce.

Pryce and others say the trustees, who get a flat $60 fee for each bankruptcy they approve, don't have time to investigate fraud unless it is so large that it "undermines the credibility of the system," or could yield millions of dollars of assets (of which trustees receive a small percentage).

The more than 95,000 Chapter 7 bankruptcy petitions filed last year were screened by just 42 private trustees. For many of them, it's effectively a full-time job - with most trustees handling more than 2,200 cases per year, or better than one case per hour based on a 260 working-day year.

Despite a doubling in their workload, the number of trustees has increased just 5 percent (from 40) since 1990.

"The system is overwhelmed," said Sam Gerdana, executive director of the Bankruptcy Research Institute in Washington, D.C. "It is a fact thai each (trustee in the Central District) has several thousand cases to deal with, so the level of inquiry and scrutiny in any one case is not going to be intense. The low-grade fraud may well go undetected. Criminal elements perhaps know that."

Indeed, the Justice Department estimates 10 percent of the bankruptcy cases are fraudulent; the FBI puts the figure even higher, at 15 percent. Yet last year, the 24 indictments for bankruptcy fraud handed down by the U.S. Attorney's Office for the Los Angeles area accounted for just 0.00025 percent of the cases filed.

Of the 1997 indictments, eight have resulted in convictions; the rest are fugitives or are awaiting trial.

The record-keeping system at the Office of the U.S. Trustees cannot track how much debt is written off through bankruptcy each year in the Central District or how much is lost to fraud.

But according to a nationwide study by Georgetown University completed late last year, the average Chapter 7 debtor took $93,000 worth of debt into bankruptcy, of which $43,000 was unsecured. based on that average, perhaps $8.8 billion in personal debt was written off in the L.A. area in 1997.

And if 10 percent to 15 percent of those bankruptcy filings were fraudulent, then $800 million to $1.2 billion was lost to fraud in the L.A. area last year.

Typically, the victims of bankruptcy fraud are banks, credit card agencies and mortgage lenders that must wipe the slate clean when the debts are forgiven. But almost everyone pays the price: According to a report by research firm WEFA Group, bankruptcy in 1997 resulted in U.S. households paying an additional 3 percent in interest on unsecured debts, such as credit cards.

With more property-related bankruptcy fraud showing up, the mortgage-lending industry is starting to feel the effects. For the first time, the number of bankruptcies that Calabasas-based Countrywide Credit Industries has on its books exceeds the number of loans it has in foreclosure, according to its chairman, Angelo Mozilo.

Out of the 15,000 loans Countrywide has in bankruptcy, 1,500 are multiple filings, up from zero just a few years ago, he said.

One example of a multiple filing is when a family divvies up ownership of its home, with each member taking turns filing for bankruptcy to prolong eviction proceedings.

"First the husband files. Then the wife files. Then the daughter files. It can go on forever until we are able to prove abuse," Mozilo said. During that period the "homeowner" does not pay any mortgage.

In some cases, individuals filing for bankruptcy aren't really bankrupt at all - they have simply concealed their assets.

How do they get away with it? Filing for bankruptcy, in most cases, does not involve going before a judge or even appearing in federal bankruptcy court.

The most common type of bankruptcy filing is a Chapter 7, to erase personal debt. There were 95,572 Chapter 7 cases in 1997 in the Central District of California, which encompasses Los Angeles, Ventura, Orange, Riverside, San Bernardino and Santa Barbara counties. L.A. County accounts for about 70 percent of filings in the district.

When debtors file a petition for Chapter 7 liquidation, they are referred to one of the private panel trustees hired by the Justice Department to screen petitions and find any assets that could be liquidated in order to pay back creditors.

Panel trustees say they almost always decide that the debtor does not have any assets worth liquidating and recommend that the debts be discharged.

If he or she can find assets, the panel trustee will receive a percentage of the proceeds; usually, well under 10 percent. The rest is divided among the creditors.

In a few cases, the trustee may find evidence that the debtor is deliberately hiding assets, in which case he or she can refer it to the Office of the U.S. Trustee, a civil division of the Justice Department.

The Office of the U.S. Trustee hires, and sometimes fires, panel trustees. It also reviews the suspected fraud cases referred by the panel trustees, as welt as complaints from creditors, and decides whether to send them to the Office of the U.S Attorney for criminal investigation.

But it is the panel trustees who must identify fraud at its root. And due to their workload and lack of financial incentives, the odds of uncovering misdeeds are slim, officials acknowledge.

"It would require overt fraud (to uncover wrongdoing)," said David Ray, a panel trustee at Saltzburg, Ray & Bergman in West Los Angeles. "If the fraud is not overt, you are not going to go after it."

The panel trustee must determine whether the debtor is telling the truth based on a handwritten questionnaire the debtor submits and a brief "under oath" question-and-answer session.

Because of time constraints, trustees estimate that they spend less than 10 minutes reading through each written petition, while the question-and-answer sessions typically last less than five minutes.

"If the debtor lies, there is no way you can know if they are lying unless you get a tip," said Gilbert Vasquez of Vasquez, Farukhi & Co., a trustee for five years.

Under Chapter 7 bankruptcy rules, debtors are not required to submit tax statements, credit checks or any other evidence to prove that they are telling the truth. They are also not required to submit fingerprints or photographs in order to prove their identity.

"In most cases there are no assets, so there is nothing to go after. By requiring tax returns, we would just be collecting paper," said Charmayne Mills, assistant U.S. trustee.

Mills said trustees have the right to demand documentation if they suspect concealed assets, but trustees say they rarely do so.

"It is easier to file for bankruptcy than it is to get a drivers license," said Assistant U.S. Attorney Angela Davis, who leads the bankruptcy fraud squad in the Central District. She said that in one case, a suspect was caught only after the FBI managed to lift his fingerprints off a bankruptcy petition.

If fraud is suspected, it is up to the trustee to decide whether to investigate further. But financially, it is usually in the trustee's interest to do as little digging as possible.

Trustees receive a $60 fee for each "no-asset" case, whether they spend 10 minutes or 10 days investigating it.

To block a discharge, the trustee must prove that the debtor intended to defraud creditors. The trustee could spend days, if not weeks, mounting an investigation and may need to hire experts to review the books.

And if the debtor does not have very large assets that can be liquidated, the trustee will end up bearing most, if not all, of the cost of the court case.

"Because it is a detailed procedure it is always expensive," said David Gill, at Danning, Gill, Diamond & Kollitz in Century City. "It is not a matter of making money, it is an issue of how much you are going to lose."

As a result, trustees say that in almost all cases they will only investigate cases on which they receive tips about hidden assets from lenders, disgruntled ex-spouses or others.

"I think the trustees would like to research every case but they just don't have the resources," said Assistant U.S. Attorney Maureen Tighe, who has been prosecuting bankruptcy fraud since 1988. "If they do not have help from the creditors, their hands are tied."

Even when tips are received, the chances are slim that they will lead to an investigation, according to Joe Brown, special assistant to the U.S. Trustee's Office.

"I call it the herd mentality. You can't shoot the whole herd, so you just shoot a couple and that keeps them stirred up," Brown said.

If a private trustee suspects fraud, he or she refers the case to the U.S. Trustee's Office. The Trustee's Office then must decide whether to forward the complaint on to the U.S. Attorney's Office for prosecution.

Between 1995 and 1997, the number of fraud complaints leveled by panel trustees and creditors with the U.S. Trustee's Office rose by more than 100 percent, to 542.

But the Trustee's Office continues to send the U.S. Attorney only about 200 cases per year, Tigre said. With two investigators assigned to bankruptcy fraud full time, she said, there is a limit to what her office can do.

"They know how many cases we can handle and select cases accordingly," said Tighe, who added there is enough fraud in the district to "keep seven prosecutors busy full time."

"Every year we request more funding for white-collar crime, and every year we are turned down. There are just too many other chines," she said.