Crime does pay, sometimes

By Peter Farkas
Illustration: Steve Adams

When it comes to fraud, some crimes go unpunished because there’s not enough integration among the good guys

There is an untold story in Canadian insolvency circles that is leaking out: you can take advantage of your creditors for millions of dollars and get away with it. And the reason for that is there are practically no police resources to enforce the law.

The Bankruptcy and Insolvency Act (BIA) is studded with investigative powers provided to trustees to uncover financial wrongdoing. For example, Section 163 allows trustees to examine any person reasonably thought to have knowledge of the financial affairs of a bankrupt. It gives trustees access to books, records and documents of a bankrupt wherever they are. Section 164 compels third parties to produce documents and records relating to the bankrupt. Trustees can ex-amine bank accounts, working papers and correspondence.

If wrongdoing is discovered, Section 206(1) states: “Where the official receiver or trustee believes on reasonable grounds that an offence under this Act or the Criminal Code relating to the property of the bankrupt was committed either before or after the date of the initial bankruptcy event by the bankrupt or any other person, the official receiver or trustee shall make a report thereon to the Deputy Attorney General or other appropriate legal officer of the province concerned or to such person as is duly designated by that legal officer for that purpose.”

Yet, based on experience and discussions with bankers, it seems fraud is increasing.

Take as an example one case from our practice. In July 2000, a bank lent a company $5 million and two months later the company closed its doors. The loan was to be secured by accounts receivable, inventory and fixed assets. When our practice inspected the premises there were no tangible assets. A review of the accounts receivable indicated they were negligible notwithstanding the vast amount reported to the bank as part of the regular margin calculation.

The bank, needless to say, was furious and wanted to get to the bottom of the situation. It turned out the financial statements presented to the bank to obtain the loan were made up by the owner, who copied letterhead from an accounting firm and forged a CA’s signature. Because the statements had been faxed to the bank, the cut and paste job went undetected. After further review, including an examination of the owner under oath, the truth came out.

The business had been losing money for years. The owner had begun doctoring the records while he was doing business with another bank. That bank eventually suspected it had a problem (although it had no idea there was an overt fraud being committed) and pushed the company out. As losses mounted, the owner continued to increase his profits and marginable assets until the business collapsed. Eventually, presented with a preponderance of evidence, the owner confessed to all.

We invoked Section 206 of the BIA and had a meeting with the official receiver (a representative of the Superintendent of Bankruptcy) who in turn called in the RCMP. The analysis (totaling five volumes of analysis, copies of all source documents, transcripts, bank records, etc.) was presented to the RCMP commercial fraud squad. The RCMP was initially quite receptive, happy to receive a pre-packaged case where all the work had been done for it. However, that enthusiasm quickly faded. After not hearing from the RCMP for several months, when the force was called to ask what was happening, we were told the constable was gone and another had replaced him. Four years later, the bank, having invested upward of $200,000 in the investigation, lost interest as did everybody involved in the process. The owner was charged five years later, but prosecuting him will be difficult as the bank manager is gone, and witness testimony and evidence are stale.

We are of the view that if a similar situation arose again, it would be difficult to encourage creditors to make an investigation investment knowing the likelihood of enforceable charges being laid is low.

Such a case is hardly unique. The profession has seen all types of fraud, from inventory manipulation to the “midnight express.” All too often, we receive a call from a financial stakeholder with a troubled situation and, upon performing due diligence, we learn that the stakeholder has been subject to a fraud of some sort.

In advising the stakeholder of available options, we are challenged to provide what would otherwise be the appropriate advice: go after the alleged criminal. On the one hand, we would like to advise the stakeholder that there is a high probability the stakeholder will recover its advances or that the criminal will pay for the crimes, but the reality is uncovering wrongdoings is an expensive and time-consuming exercise. Halfway through the exercise, there will be next to nothing to show for the effort because in a process such as this, you either go all the way or don’t start. At some point, everyone will be fatigued. The stakeholder will be faced with a dilemma: keep going or quit? If the choice is to abandon the project, all efforts will have been for nothing. If the choice is to continue, there is no guarantee of success. Further, many of these criminals have managed to creditor-proof themselves, but just before doing so, many siphon off enough money to engage the most confrontational legal counsel they can find. Upon realizing that the criminal has creditor-proofed himself, the stakeholder may ask if there are laws against this. The answer is yes, the BIA. However, again the quasi-criminal sections of the BIA are not effectively enforced and we are back where we started.

So what’s the solution? There has to be better integration amongst trustees, the official receiver, RCMP and Crown prosecutors. There has to be dedicated resources to bankruptcy fraud. For example, the RCMP commercial fraud squad for Toronto is located in Milton, Ont. To have a meeting in Toronto, police waste two hours’ driv-ing time. One solution would be to have representatives of the commercial fraud squad located in the official receiver’s office so there is immediate interaction amongst officials.

Secondly, RCMP officers have to be better trained to investigate commercial fraud. It seems training in financial statements, banking and basic accounting should be provided. Police need better training to work in this area or have the ability to retain forensic accountants to assist in complex projects.

Thirdly, once an officer transfers into the commercial fraud unit, there should be a minimum time commitment. This will allow for continuity and prosecution of cases from start to finish. In our situation, there appeared to be a revolving door of officers or they were regularly pulled off our case for other assignments.

Industry Canada (the department responsible for bankruptcy legislation) has recognized this issue. In its September 2002 report to Parliament, it commented: “Insufficient allocation of resources to investigations can cause many people to believe that offenses can be committed with impunity and perpetuates the idea that a person can plan a fraudulent bankruptcy without incurring meaningful risks.”

The report goes on to request additional police resources to conduct bankruptcy investigations.

Prevention of fraud is important for the smooth functioning of our economy. If creditors and lenders feel they can be defrauded with impunity, credit policies will tighten and legitimate businesses will not be able to access capital. The BIA has sections that deal with bankruptcy fraud but these are limited resources for prosecutions. The word should be that Canada is tough on this type of crime.