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Ten Things About Bankruptcy and Fraud

A review of bankruptcy filings


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With economic conditions likely to drive more companies to consider filing for bankruptcy protection, one potential concern is whether the greater scrutiny that generally results, could lead to claims of fraud against the company and its executives.

The correlation between bankruptcy and fraud is highlighted in a study performed by the Deloitte Forensic Center and the Corporate Restructuring Group of Deloitte. The study analyzed SEC Accounting and Auditing Enforcement Releases (“SEC Enforcement Releases”) from 2000 to 2007 and bankruptcy filings from 2000 to 2005.

The study’s findings included:

  • Companies filing for bankruptcy protection are three times more likely than non-bankrupt companies to face enforcement action by the SEC relating to alleged financial statement fraud.
  • Companies that were issued financial statement fraud-related SEC Enforcement Releases were more than twice as likely to file bankruptcy protection as those not issued one.
  • Approximately one in seven financial statement fraud SEC Enforcement Releases issued to companies that filed for bankruptcy protection were issued prior to their bankruptcy filings. These situations may provide a warning signal of potential bankruptcy filing.
  • Bankrupt companies receiving SEC Enforcement Releases were twice as likely as non-bankrupt companies to have more than 10 alleged financial statement fraud schemes – and at least 1.5 times more likely to have six to 10 alleged fraud schemes than non-bankrupt companies.

“With economic conditions likely to increase corporate bankruptcy filings, companies should be aware of their potential exposure to allegations of fraud that may be sustained by the SEC,” said Toby Bishop, director of the Deloitte Forensic Center. “Consideration of potential fraud issues may be a wise part of bankruptcy preparations.”

Changes in corporate financial structures may impact fraud exposures going forward. “In the past few years, many companies have created highly-leveraged balance sheets with many layers of debt. When such a highly-leveraged company files for bankruptcy protection, its creditors may have little other recourse than to seek recovery from non-traditional sources such as challenging potentially fraudulent conveyances, seeking recovery under D&O (Director and Officer) policies, and filing other (non-bankruptcy) litigation,” said Sheila Smith, principal and national service line co-leader, Corporate Restructuring Group, Deloitte Financial Advisory Services LLP. “This strategic shift has raised risks for directors, officers, and senior management and increased the importance of fraud detection.”

As used in this document, ‘Deloitte’ means Deloitte Financial Advisory Services LLP, a subsidiary of Deloitte LLP. Please see  www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.

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