CFE Exam Quiz 06

There are a number of international instruments related to money laundering. These include:
 Financial Action Task Force’s (FATF) Forty Recommendations on Money Laundering
 FATF’s Nine Special Recommendations on Combating Terrorist Financing
 UN Convention Against Transnational Organized Crime
 Instruments developed by the Egmont Group of Financial Intelligence Units
 Instruments developed by the International Monetary Fund/World Bank For more information on the various international instruments related to money laundering.

There are international instruments in the area of banking and financial system regulation and supervision, including:
• International Organization of Securities Commissions’ (IOSCO) Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the
Exchange of Information
• Basel Committee on Banking Supervision Core Principles for Effective Banking Supervision
• Basel Committee on Banking Supervision Core Principles Methodology

If a party, such as a person or business, cannot repay the debts it owes to creditors, it may file for bankruptcy to initiate a process whereby it can resolve its debts. While the types of parties that may file for bankruptcy vary by jurisdictions, it is common for individuals, corporations, limited liability companies, partnerships, and other entities to be able to file for bankruptcy. For debtors, the biggest benefit of filing for bankruptcy is the discharge of debts. When a debt is discharged, the debtor is no longer required to pay it, and creditors cannot collect on it. Bankruptcy fraud occurs when an individual or organization makes false or misleading representations in the course of petitioning for debt relief. Bankruptcies are governed by legislation, and illegal conduct related to bankruptcies is almost always a criminal offense. Bankruptcy proceedings often play a substantial role in fraud examinations for two reasons. First, there are many fraud schemes that are perpetrated using the bankruptcy system. Additionally, for any investigation into financial crimes, fraud examiners need to be able to consider the role that bankruptcy might play if attempting to recover the victim’s assets.

A secured creditor is one who has a secured interest in some of the debtor’s property, meaning that if the debtor defaults on payments to the creditor, the creditor may possess or liquidate the secured property to satisfy the debt. Creditors typically prefer to have secured interests because such claims have priority over unsecured claims, meaning they normally get paid before unsecured claims in the distributions to creditors made by the trustee or debtor-in-possession. The most common example of a secured interest occurs when a lender finances a debtor’s purchase of a particular property (e.g., a home or vehicle) and, as part of the debt agreement, takes a collateral interest in the financed property. The method of establishing oneself as a secured creditor varies from jurisdiction to jurisdiction. There might be a filing requirement to register a financing statement with a public registry or a government agency. A secured creditor’s claim is secured to the extent of the property’s value on the petition date. When the debt is unsecured (the debt is secured by property that is worth less than the amount of the debt), the debt will be considered both unsecured and secured. For example, if a note for $500 is secured by property having a value of $400 on the petition date, there will be a secured claim for $400 and an unsecured claim for $100.

Bankruptcy is a federal court process in the United States. All bankruptcy cases are filed in federal court, and many are filed in the local district of the U.S. bankruptcy court. The U.S. district courts have jurisdiction over bankruptcy proceedings, but in practice, virtually all cases are referred to the U.S. bankruptcy courts. Although bankruptcy courts are federal courts, they do not derive their power from Article III of the Constitution. Article III courts include the U.S. district courts, the U.S. Circuit Courts of Appeal, and the U.S. Supreme Court. Instead, bankruptcy courts derive their power from Article I (congressional powers). Article III states that the judicial power of the United States rests with the Supreme Court and in inferior courts established by Congress. Bankruptcy courts are not contemplated within this scheme as “inferior” courts, but they are considered as an adjunct to “inferior” U.S. district courts. Bankruptcy judges hear all cases involving debtors’ and creditors’ rights, approve plans of reorganization, award fees to professionals, and conduct hearings and trials when necessary to resolve disputes.

The Office of the United States Trustee (UST) is a Department of Justice (DOJ) agency that is responsible for administering bankruptcy cases; appointing Chapter 11 committees; overseeing and monitoring trustees; reviewing employment and fee applications, and appearing in court on matters of interest to the estate and creditors. The Office of the UST is subdivided into 21 regions, each made up of one or more federal districts. Each region has a U.S. Trustee (or an Assistant Trustee in several regions). The Office of the UST in each region principally is comprised of staff attorneys, bankruptcy
analysts (including accountants), and, in some instances, special investigative units. Staff attorneys review pleadings (e.g., fee applications and motions to appoint trustees and examiners) and represent the UST on these matters. Bankruptcy analysts analyze and review operating reports and other relevant financial information and, in general, oversee the debtor’s case to ensure compliance with the Bankruptcy Code and to protect the assets of the estate. Special investigative units investigate criminal referrals (complaints) in bankruptcy cases. In some cases, they work with criminal investigative agencies, such as the Federal Bureau of Investigation and the Internal Revenue Service Criminal Investigative Division.

The Office of the Superintendent of Bankruptcy (OSB) is a federal agency that seeks to protect the integrity of Canada’s bankruptcy and insolvency system. It engages in the following activities:
 Supervises the administration of estates in bankruptcy, commercial reorganizations, and receiverships under bankruptcy and insolvency legislation
 Maintains public records of bankruptcy and insolvency proceedings
 Licenses private-sector trustees to administer estates in bankruptcy
 Records and investigates complaints regarding possible wrongdoing by someone involved in the bankruptcy or insolvency processes
 Sets and enforces professional standards for the administration of estates in bankruptcy
 Promotes awareness of the rights and responsibilities of those involved in the bankruptcy and insolvency system

In Canada, bankruptcy trustees are licensed and regulated by the Office of the Superintendent of Bankruptcy. Some of the duties of trustees in bankruptcy include:
 Arranging mandatory counseling for the debtor
 Presiding over meetings of creditors
 Selling nonexempt assets
 Objecting to the debtor’s discharge
 Distributing the debtor’s property among the creditors

In the United Kingdom, Official Receivers are trustees appointed by the courts in bankruptcy proceedings who are charged with overseeing liquidation and using any proceeds to pay outstanding debts on the bankrupt party’s behalf. An Official Receiver is also typically responsible for:
 Investigating the bankrupt party’s financial affairs and conduct and reporting findings from such investigatory efforts to the court
 Protecting the bankrupt party’s estate
 Obtaining custody of the bankrupt party’s property and assets of worth

Liquidation is the most basic type of bankruptcy proceeding and involves accounting for all dischargeable debts the subject owes, identifying all of the subject’s assets, and liquidating nonexempt assets to pay off creditors. This process allows the debtor to get a court or administrative order under which some or all of his debts may be eliminated. Each jurisdiction determines what exceptions there are in terms of debts that may not be discharged and assets that may not be liquidated. Some debts, like taxes owed or child support payments, might be non-dischargeable, meaning the bankruptcy will not wipe these debts away. Typical items that may not be liquidated include the debtor’s primary residence, items of nominal value, or assets deemed necessary for the debtor to maintain employment. However, there might be exceptions to protected assets that allow creditors to reach them. Frequently, bankruptcy laws will not protect assets that were obtained through fraudulent means, even if they are normally subject to protection. The laws might also only protect assets up to a certain amount (e.g., a debtor’s luxury home is liquidated in bankruptcy and he is only entitled to 20 percent of the sale price).

Bustout schemes are planned and perpetrated by individuals both before and after the
formation of the new business entity. Other characteristics of bustout schemes include:
 They are planned from the beginning.
 Sometimes organized crime is involved.
 Credit is established with numerous vendors; prompt payments are made to all vendors and vendors feel comfortable in dealings, thereby extending existing credit lines.
 Perpetrators build inventory by ordering everything they can from vendors; they promise to pay soon and order more merchandise.
 Perpetrators sell out inventory at a deep discount or move it before vendors can take possession of it.
 The business fails or closes up, files bankruptcy, or creditors beat them to it with involuntary bankruptcy.

Some red flags that signal that a bustout scheme might be in the process include:
 A business relationship exists that is based principally on trust. Creditors are willing to offer extended terms for payment, hold checks, or take post-dated checks, all of which make them vulnerable.
 The buyers have a history of purchasing goods for an unreasonable discount.
 Many bank accounts exist, which indicates a possible kiting scheme. The perpetrator occasionally pays some of his creditors with funds generated by floating checks between bank accounts.
 Inexplicably large purchases of inventory or goods (e.g., perishable goods that could not likely be sold to customers before going bad) are made.

Many of the world’s major economies are subject to some form of a cross-border insolvency regime for handling cross-border insolvencies. Cross-Border insolvency is insolvency in which the insolvent debtor has assets in more than one country or where some of the insolvent debtor’s creditors are from different countries. Cross-border insolvency regimes are legal frameworks designed to address cross-border insolvency proceedings, and the lack of such regimes often results in cross-border insolvencies being dealt with through inadequate and unorganized approaches that are unpredictable and time-consuming. The United Nations Commission on International Trade Law (UNCITRAL) Model Law on Cross-Border Insolvency is a model law that established the international standard for crossborder insolvency frameworks. Twenty-three jurisdictions have adopted legislation based on the Model Law, including the United States, Japan, the United Kingdom, Australia, Canada, and South Korea. The Model Law was designed to assist countries in equipping their insolvency laws with a legal framework that can effectively address cross-border insolvency proceedings. In addition, all member states of the European Union are bound by the EU Insolvency Regulation, which establishes a regional cross-border insolvency regime for insolvency cases arising within the EU. There is, however, an absence of cross-border insolvency regimes in major emerging economies. In particular, none of the BRIC countries (Brazil, Russia, India, and China) have adopted any regimes for handling cross-border insolvencies.

A modern, credit-based economy requires predictable, transparent, and affordable enforcement of both unsecured and secured credit claims by efficient mechanisms outside of insolvency, as well as a sound insolvency system. These systems must work in harmony. Commerce is a system of commercial relationships predicated on express or implied contractual agreements between an enterprise and a wide range of creditors and constituencies. Although commercial transactions have become increasingly complex as more sophisticated techniques are developed for pricing and managing risks, the basic rights
governing these relationships and the procedures for enforcing these rights have not changed much. These rights enable parties to rely on contractual agreements, fostering confidence that fuels investment, lending, and commerce. Conversely, uncertainty about the enforceability of contractual rights increases the cost of credit to compensate for the increased risk of non-performance or, in severe cases, leads to credit tightening.

Though approaches vary, effective insolvency systems have a number of aims and objectives. Systems should aspire to the following:
 Integrate with a country’s broader legal and commercial systems
 Maximize the value of a firm’s assets and recoveries by creditors
 Provide for both efficient liquidation of nonviable businesses and those where liquidation is likely to produce a greater return to creditors and reorganization of viable businesses
 Strike a careful balance between liquidation and reorganization, allowing for easy conversion of proceedings from one proceeding to another
 Provide for equitable treatment of similarly situated creditors, including similarly situated foreign and domestic creditors
 Provide for timely, efficient, and impartial resolution of insolvencies
 Prevent the improper use of the insolvency system
 Prevent the premature dismemberment of a debtor’s assets by individual creditors seeking quick judgments
 Provide a transparent procedure that contains, and consistently applies, clear risk allocation rules and incentives for gathering and dispensing information
 Recognize existing creditor rights and respect the priority of claims with a predictable and established process
 Establish a framework for cross-border insolvencies, with recognition of foreign proceedings

Though approaches vary, effective insolvency systems have a number of aims and objectives. Systems should aspire to the following:
• Integrate with a country’s broader legal and commercial systems
• Maximize the value of a firm’s assets and recoveries by creditors
• Provide for both efficient liquidation of nonviable businesses and those where liquidation is likely to produce a greater return to creditors and reorganization of viable businesses
• Strike a careful balance between liquidation and reorganization, allowing for easy conversion of proceedings from one proceeding to another
• Provide for equitable treatment of similarly situated creditors, including similarly situated foreign and domestic creditors
• Provide for timely, efficient, and impartial resolution of insolvencies
• Prevent the improper use of the insolvency system
• Prevent the premature dismemberment of a debtor’s assets by individual creditors seeking quick judgments
• Provide a transparent procedure that contains, and consistently applies, clear risk allocation rules and incentives for gathering and dispensing information
• Recognize existing creditor rights and respect the priority of claims with a predictable and established process
• Establish a framework for cross-border insolvencies, with recognition of foreign proceedings

Though approaches vary, effective insolvency systems have a number of aims and objectives. Systems should aspire to the following:
• Integrate with a country’s broader legal and commercial systems
• Maximize the value of a firm’s assets and recoveries by creditors
• Provide for both efficient liquidation of nonviable businesses and those where liquidation is likely to produce a greater return to creditors and reorganization of viable businesses
• Strike a careful balance between liquidation and reorganization, allowing for easy conversion of proceedings from one proceeding to another
• Provide for equitable treatment of similarly situated creditors, including similarly situated foreign and domestic creditors
• Provide for timely, efficient, and impartial resolution of insolvencies
• Prevent the improper use of the insolvency system
• Prevent the premature dismemberment of a debtor’s assets by individual creditors seeking quick judgments
• Provide a transparent procedure that contains, and consistently applies, clear risk allocation rules and incentives for gathering and dispensing information
• Recognize existing creditor rights and respect the priority of claims with a predictable and established process
• Establish a framework for cross-border insolvencies, with recognition of foreign proceedings

A debtor is an individual, partnership, corporation, or municipality who is the subject of a bankruptcy filing. Municipality refers to a political subdivision, public agency, or instrumentality of a state. Debtors might have different goals in seeking bankruptcy. For example, a debtor seeks a liquidation bankruptcy (e.g., Chapter 7 bankruptcy in the United States) to be relieved of all dischargeable debts and allowed to start over with a clean slate. But a debtor files for a reorganization bankruptcy (e.g., Chapter 11 bankruptcy in the United States) if, despite its financial problems, it wants to reorganize and continue operating as a business. (Liquidation and reorganization bankruptcies are discussed in more detail below.)

A secured creditor is one who has a secured interest in some of the debtor’s property, meaning that if the debtor defaults on payments to the creditor, the creditor may possess or liquidate the secured property to satisfy the debt. Creditors typically prefer to have secured interests because such claims have priority over unsecured claims, meaning they normally get paid before unsecured claims in the distributions to creditors made by the trustee or debtor-in-possession. The most common example of a secured interest occurs when a lender finances a debtor’s purchase of a particular property (e.g., a home or vehicle) and, as part of the debt agreement, takes a collateral interest in the financed property. The method of establishing oneself as a secured creditor varies from jurisdiction to jurisdiction. There might be a filing requirement to register a financing statement with a public registry or a government agency. A secured creditor’s claim is secured to the extent of the property’s value on the petition date. When the debt is unsecured (the debt is secured by property that is worth less than the amount of the debt), the debt will be considered both unsecured and secured. For example, if a note for $500 is secured by property having a value of $400 on the petition date, there will be a secured claim for $400 and an unsecured claim for $100.

Bankruptcy is a federal court process in the United States. All bankruptcy cases are filed in federal court, and many are filed in the local district of the U.S. bankruptcy court. The U.S. district courts have jurisdiction over bankruptcy proceedings, but in practice, virtually all cases are deferred to the U.S. bankruptcy courts. Although bankruptcy courts are federal courts, they do not derive their power from Article III of the Constitution. Article III courts include the U.S. district courts, the U.S. Circuit Courts of Appeal, and the U.S. Supreme Court. Instead, bankruptcy courts derive their power from Article I (congressional powers). Article III states that the judicial power of the United States rests with the Supreme Court and in inferior courts established by Congress. Bankruptcy courts are not contemplated within this scheme as “inferior” courts, but they are considered as an adjunct to “inferior” U.S. district courts. Bankruptcy judges hear all cases involving debtors’ and creditors’ rights, approve plans of reorganization, award fees to professionals, and conduct hearings and trials when necessary to resolve disputes.

The Office of the United States Trustee (UST) is a Department of Justice (DOJ) agency that is responsible for administering bankruptcy cases; appointing Chapter 11 committees; overseeing and monitoring trustees; reviewing employment and fee applications, and appearing in court on matters of interest to the estate and creditors. The Office of the UST is subdivided into 21 regions, each made up of one or more federal districts. Each region has a U.S. Trustee (or an Assistant Trustee in several regions). The Office of the UST in each region principally is comprised of staff attorneys, bankruptcy
analysts (including accountants), and, in some instances, special investigative units. Staff attorneys review pleadings (e.g., fee applications and motions to appoint trustees and examiners) and represent the UST on these matters. Bankruptcy analysts analyze and review operating reports and other relevant financial information and, in general, oversee the debtor’s case to ensure compliance with the Bankruptcy Code and to protect the assets of the estate. Special investigative units investigate criminal referrals (complaints) in bankruptcy cases. In some cases, they work with criminal investigative agencies, such as the Federal Bureau of Investigation and the Internal Revenue Service Criminal Investigative Division.

The Office of the Superintendent of Bankruptcy (OSB) is a federal agency that seeks to protect the integrity of Canada’s bankruptcy and insolvency system. It engages in the following activities:
 Supervises the administration of estates in bankruptcy, commercial reorganizations, and receiverships under bankruptcy and insolvency legislation
 Maintains public records of bankruptcy and insolvency proceedings
 Licenses private-sector trustees to administer estates in bankruptcy
 Records and investigates complaints regarding possible wrongdoing by someone involved in the bankruptcy or insolvency processes
 Sets and enforces professional standards for the administration of estates in bankruptcy
 Promotes awareness of the rights and responsibilities of those involved in the bankruptcy and insolvency system.

In Canada, bankruptcy trustees are licensed and regulated by the Office of the Superintendent of Bankruptcy. Some of the duties of trustees in bankruptcy include:
• Arranging mandatory counseling for the debtor
• Presiding over meetings of creditors
• Selling nonexempt assets
• Objecting to the debtor’s discharge
• Distributing the debtor’s property among the creditors

In the United Kingdom, Official Receivers are trustees appointed by the courts in bankruptcy proceedings who are charged with overseeing liquidation and using any proceeds to pay outstanding debts on the bankrupt party’s behalf. An Official Receiver is also typically responsible for:
 Investigating the bankrupt party’s financial affairs and conduct and reporting findings from such investigatory efforts to the court
 Protecting the bankrupt party’s estate
 Obtaining custody of the bankrupt party’s property and assets of worth

Liquidation is the most basic type of bankruptcy proceeding and involves accounting for all dischargeable debts the subject owes, identifying all of the subject’s assets, and liquidating nonexempt assets to pay off creditors. This process allows the debtor to get a court or administrative order under which some or all of his debts may be eliminated. Each jurisdiction determines what exceptions there are in terms of debts that may not be discharged and assets that may not be liquidated. Some debts, like taxes owed or child support payments, might be non-dischargeable, meaning the bankruptcy will not wipe these debts away. Typical items that may not be liquidated include the debtor’s primary residence, items of nominal value, or assets deemed necessary for the debtor to maintain employment. However, there might be exceptions to protected assets that allow creditors to reach them. Frequently, bankruptcy laws will not protect assets that were obtained through fraudulent means, even if they are normally subject to protection. The laws might also only protect assets up to a certain amount (e.g., a debtor’s luxury home is liquidated in bankruptcy and he is only entitled to 20 percent of the sale price).

Unlike liquidation, which seeks to give the debtor a fresh start, the purpose of reorganization bankruptcies is to allow the debtor breathing room from creditors so that the debtor can reorganize its financial affairs and continue as a going concern. The hope is that the debtor will be able to pay the creditors back more of the debt in the long run by staying in business than if the entire business was ended and liquidated. However, debt is often restructured and reduced to some extent. Some reorganization proceedings involve putting the debtor’s business under receivership for a certain period to ensure as much debt is paid back as possible. Reorganization bankruptcies are growing more popular, with many countries allowing business entities to declare bankruptcy using this method. Some countries also allow individuals to use reorganization.

Bustout schemes are planned and perpetrated by individuals both before and after the formation of the new business entity. Other characteristics of bust-out schemes include:
 They are planned from the beginning.
 Sometimes organized crime is involved.
 Credit is established with numerous vendors; prompt payments are made to all vendors and vendors feel comfortable in dealings, thereby extending existing credit lines.
 Perpetrators build inventory by ordering everything they can from vendors; they promise to pay soon and order more merchandise.
 Perpetrators sell out inventory at a deep discount or move it before vendors can take possession of it.
 The business fails or closes up, files bankruptcy or creditors beat them to it with an involuntary bankruptcy

Some red flags that signal that a bust-out scheme might be in the process include:
1. A business relationship exists that is based principally on trust. Creditors are willing to offer extended terms for payment, hold checks, or take post-dated checks, all of which make them vulnerable.
2. The buyers have a history of purchasing goods for an unreasonable discount.
3. Many bank accounts exist, which indicates a possible kiting scheme. The perpetrator occasionally pays some of his creditors with funds generated by floating checks between bank accounts.
4. Inexplicably large purchases of inventory or goods (e.g., perishable goods that could not likely be sold to customers before going bad) are made.

Most bankruptcy processes, whether through a court or otherwise, involve granting a person or group administrative powers to oversee the processes. The name of this appointee varies among jurisdictions but often is called the administrator, trustee, receiver, examiner, or supervisor. The World Bank Principles recommend that the administrator have broad powers, including:
 Right to cancel fraudulent contracts or transactions entered into by the debtor
 Powers to collect, preserve, and dispose of the debtor’s property
 Ability to interfere with contracts to meet the objectives of the insolvency process
 Powers to examine the debtor, the debtor’s agents, or other people with knowledge of the debtor’s affairs and compel them to provide relevant information

In liquidation proceedings, management should be replaced by an independent insolvency representative with the authority to administer the estate in the interest of creditors. Control of the estate should be surrendered immediately to the insolvency representative. In creditor initiated filings, where circumstances warrant, an interim administrator with limited functions should be appointed to monitor the business to ensure that creditor interests are protected. There are typically three preferred approaches in reorganization proceedings:
 Exclusive control of the proceeding is entrusted to an independent insolvency representative.
 Governance responsibilities remain invested in management.
 Supervision of management is undertaken by an impartial and independent insolvency representative or supervisor.