Lessons After MF Global: Tracing Assets After Bankruptcy

November 2011

IN THIS ISSUE

— After the Fall: Finding Assets After Bankruptcy
— Turning Over Every Rock: Finding Hidden Assets

GREETINGS!

AFTER THE FALL: FINDING ASSETS AFTER BANKRUPTCY

The recent bankruptcy of investment firm MF Global — reportedly on pace to be the eighth largest bankruptcy on record, with as much as $1.2 billion of client funds unaccounted for — has cast a renewed spotlight on both the financial system and the corporate bankruptcy process. Having long been the arena of last resort for fraud victims to make their claims in hopes of recovering lost assets, bankruptcy courts are becoming unwilling watchdogs as we enter a new era of financial regulation.

In many instances, the damage to a company’s assets has been done long before bankruptcy is a consideration, although we have seen cases where the looting of a corporation occurs until days before a petition is filed. These are typically involuntary, brought by deceived or angered creditors to force a change in management and to create a focus on asset recovery. Given the wave of bankruptcies and bailouts that have occurred in the last three years, and those yet to come, the stakes in bankruptcy-related asset searches could not be higher.

TURNING OVER EVERY ROCK: FINDING HIDDEN ASSETS

While discovery during a bankruptcy proceeding is the surest way to obtain information, it can be costly, lengthy, and sometimes unreliable. As a complement to that process, it’s often wise to hire an outside examiner to scour public records for assets held by the principals of the now-bankrupt entity, their spouses and other confidants. While some of these efforts can be brazen — such as setting up a “management company” that can be used to siphon revenue from a company’s operations via related-party contract — others would appear to be more benign, such as the purchase of a lavish vacation property; in other instances, we have encountered principals of companies who bought more unconventional assets, such as professional sports franchises, in the months leading up to a firm’s bankruptcy — often after the principals have sold their interest for a lavish sum, before frauds are discovered that significantly diminish the new owner’s investment. Thorough analysis of the public record, especially after developing a matrix of a subject’s known associates and company interests, can help determine where the funds may have gone.

After determining who benefited from a fraud that precipitated a bankruptcy, and what they did with those proceeds, the next step is to determine the value of those assets, and see what has been left that creditors could claim in an effort to recoup funds. While this step also benefits from discovery, and the use of forensic accountants to ascertain value, measures can be taken via the public record. For instance, in the past we have examined public sources to determine the ongoing viability of several companies offered top creditors as a partial settlement in a bankruptcy-related adversary proceeding; we were able to determine, by examining public company documents, news articles and other sources, which companies were mostly likely to fail within a year (such as one operated by the subject’s son-in-law that had announced a series of layoffs) versus ones that seemed likely to earn proceeds for creditors if they kept them after seizure.

Bankruptcy is always a difficult process, and bankruptcies promulgated by a betrayal of trust between parties can create even more doubt, uncertainty and anger. Yet by dispassionately analyzing both public records and discovery-obtained information, a fraud examiner can help bring the process to a more satisfactory end, making creditors more whole than they may have previously anticipated.