April 13, 2005

Bankruptcy “Reform”: The “Fraud” Canard, Today’s Word Games, and Tomorrow’s Word Games

Filed under: Bankruptcy & Reform — Tom @ 11:52 pm

The hysterical claims of widespread bankruptcy “fraud” and “abuse” are being bandied about again:

    - Todd Zywicki at Volokh cites the tired IRS and FBI 10% claims.
    - Hey, why not 15%? A Credit Union National Association rep claims that “ about 15% of people who file bankruptcy abuse the system.”

Puh-leeze. Spare me.

Since this unsupported claim won’t go away, and because it raises some bigger points, I’m going to have to hit this hard.

Please understand:

    - Zywicki fails to answer the core question of my previous post that addressed alleged fraud (go to topic 4 near the end of the post): How can FBI and IRS efforts that include task forces devoted exclusively to this supposedly widespread problem only get about 100 prosecutions a year out of 150,000 or so assumed cases, when even to get that many, they have to go after filings involving as little as $10,000? Again (zheesh), there is no good answer; either the fraud isn’t there or the cops are completely incompetent; I believe the former.
    - Zywicki also cites a sensationalistic “research report” being peddled to creditors that purportedly looked at specific cases and found high rates of “fraud,” but doesn’t bother to buy the report to bolster his claim, and overlooks its clear lack of objectivity in appearance given the market it serves. To use legal language, it shouldn’t be admitted as evidence.
    - Moderate Mainstream (MM) provides plenty of real-world experience to anecdotally refute the “widespread fraud” claim, notes that creditors are involved in some fraud of their own in the bankruptcy system (I am SOOOO shocked), and digs up the goods about the “research report” provider’s motivations.
    - Somebody is forgetting that attorneys, even bankruptcy attorneys, are officers of the court. As MM informed me previously (some items removed or modified to protect confidentiality), “…. Clients pay between $_____ and $_____ to file a case with us….. NO client pays enough for (my boss) to risk his/her license. Fraud means a complete loss of income. An attorney that suggests fraud to a client is deserving of anything they get, up to and including jail. The US Trustee can select at random any debtor’s file for audit. They can do an unlimited number of them. Those audits require the attorney to justify any and all entries in the petition. We have hundreds and hundreds of files and we would not have a problem with any one of them being selected for audit. I suspect this is the norm, not the exception.

So the heavy burden of proof is on those who casually kick around the 10% real “fraud and abuse” claim, and they can’t meet it.

But what really irks me about the fraud claim involves the definitions of the key words, how the bill’s supporters have been deceptively playing with those definitions, and how the bill if enacted will enshrine their deception.

So let’s start with official definitions.

First, the two common definitions of “fraud”:

    (per investorwords.com):
    Intentional misrepresentation or concealment of information in order to deceive or mislead. It is illegal.
    (FIRST definition at dictionary.com):
    A deception deliberately practiced in order to secure unfair or unlawful gain.

And here’s “abuse”:

(go to number 4 as a noun at dictionary.com)

    An unjust or wrongful practice.
    (note that there is no business or legal definition of “abuse” at two popular legal/business web dictionary sites).

Now, if there is no financial consequence involved in the debtor’s errors or omissions in a bankruptcy filing, even if they are intentional, even technically illegal, was it “fraud”? The first definition might lead you to say “yes.” But, if so, who freaking cares? Nobody lost anything. I suspect this is the copping-out and more than a bit deceptive definition of “fraud” that both the law-enforcement types (who want investigation budgets) and the B-”R” cheerleaders (who want harsh legislation) are using to make their “10%” claim.

But in the real world, everyday people define “fraud” according to the second definition above: it has to have financial consequence, or it doesn’t count. Let’s say the filer in the current Chapter 7 regime whose reported liabilities exceed assets by 10 grand forgets to list a $2,000 couch. It’s still a Chapter 7. It may be “fraud” in the one sense, but, again WHO CARES? No harm, no foul. Let’s say the filer’s petition says that his last dollars were the ones used to pay the filing fees (which Zywicki comes perilously close to declaring prima facie proof of “fraud”). If there’s $10 in the kid’s piggybank at home, is this “fraud”? Heck, it’s more than a little likely that the filer is playing the float with his checking account and really has a negative balance.

And here’s one for the fraud brigade to ponder: How many filers have borrowed from relatives and family, haven’t paid them back, and fail to list those unsecured debts in their petition? I’m going to hazard a guess that the aggregate amount of unreported family debt in bankruptcy petitions is huge. Friends and family have equal standing with the other unsecured creditors (I think a good case could be made that they should get their money before the card sharks do, but since I would hate to see Todd Zywicki smash his computer, I’ll refrain).

Now, those who are so outraged about the alleged level of fraud and abuse could have drafted a bankruptcy reform bill that dealt solely with ferreting it out: closer scrutiny of each filing, a higher after-the-fact audit rate, maybe even more stringent definitions of actions taken in contemplation of bankruptcy that would disqualify more suspect pre-filing actions. But they haven’t, even though I suspect that such a bill would have had absolutely zero difficulty becoming law.

Why not? Simple–They really know that fraud as the real world defines it is not there to the extent they claim.

So what do you do when you know you can’t prove your point with the current system? You change the system: the “reform” braintrust knows that it needs to change the definition of “fraud” and “abuse” so that it WILL be found after a more complicated bill passes. Then they can say “see, we told you so.”

B-”R” accomplishes that goal by radically changing a key term:

    - The term “substantial abuse” is gone, replaced by mere “abuse.” Remember the definition above: An unjust or wrongful practice. Whereas in the current law a mistake or even an intentional deception has to have a consequence, in the new law a simple mistake or oversight signifying nothing could actually qualify as “abuse” simply because it isn’t correct.
    - Then the watered-down term “abuse” is used to describe ANY circumstance where a bankruptcy filing with above-median income attempts to file a Chapter 7 petition and, for whatever reason (error, mistake, oversight, whether or not intentionally deceptive or not), gets moved into 13.
    - Voila, the bill’s fans will have their “see we told you so” 10% abuse “proof,” with probably plenty of room to spare.
    - As a bonus, attorneys who are now subject to the lower-threshold “abuse” standard along with their clients will be forced to practice very defensively, scrutinize their clients intensely, get outside appraisals in many cases, and raise their fees substantially, discouraging many scaring many potential filers from going through the process.

Then you can look for the word “fraud” to quietly disappear from the 10%ers lexicon, replaced by “abuse.”

He who contols the terms of the discussion controls the discussion.

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