I  Executive summary

Fraud, asset tracing and recovery always present challenges.  Fortunately, in the U.S., the process is less problematic because we have the benefit of:

  • established common law and statutory law designed to protect against fraud;
  • well-developed case law interpreting the law;
  • a well-trained and educated judiciary;
  • adherence to the Rule of Law;
  • effective criminal law enforcement authorities that assist with the pursuit of criminal wrongdoing; and
  • a legal system that protects the parties' rights while providing effective relief to victims of fraud and other illegalities.

The system is not perfect, and there are often limitations or restrictions that make the pursuit of fraud difficult, time-consuming and expensive.  Nevertheless, the U.S. legal system is admired as one of the most effective for combatting fraud.  The intent of this chapter is to give the reader a better understanding of the U.S. legal framework relating to fraud, asset tracing and recovery.

II  Important legal framework and statutory underpinnings to fraud, asset tracing and recovery schemes

The U.S. has federal jurisdictions and 50 states, plus the District of Columbia, Puerto Rico, and other districts and territories.  In addition to consulting federal law, one must analyse the laws of the various other jurisdictions that could apply.  The state and local systems are beyond the scope of this chapter, but one should review applicable state laws for any helpful claims or remedies.

A) Fraud causes of action

1 Common law fraud

The most basic fraud claim is common law fraud.  Common law, or judge-made law, is the body of law in the U.S. derived from judicial precedent, as opposed to legal codes and statutes.  The U.S. traces its common law history to England.  In general, common law fraud occurs when a party makes a false representation of fact to another party who relies on the representation and is injured as a result.  (See, e.g., Vicki v. Koninklijke Philips Elecs., N.V., 85 A.3d 725, 773 (Del. Ch. 2014) (citing Delaware law); Cromer Fin. v. Berger, 137 F. Supp. 2d 452, 494 (S.D.N.Y. 2001) (citing New York law).)  The representation must be material and the injured party must be unaware of its falsity.  (See, e.g., Strategic Diversity, Inc. v. Alchemix Corp., 666 F.3d 1197, 1210 n.3 (9th Cir. 2012) (citing Arizona law).)

Less commonly, a claim may exist based on fraud by non-disclosure, which occurs when a party fails to disclose material facts that the non-disclosing party has a legal duty to disclose.  The injured party must rely on the non-disclosure and be injured as a result.  (See, e.g., Bombardier Aero. Corp. v. SPEP Aircraft Holdings, LLC, 572 S.W.3d 213, 219-20 (Tex. 2019) (citing Texas law); Wallingford Shopping, L.L.C. v. Lowe's Home Ctrs., Inc., No. 98 Civ. 8462 (AGS), 2001 U.S. Dist. LEXIS 896, *43-44, 2001 WL 96373 (S.D.N.Y. Feb. 5, 2001) (citing Connecticut law).)

2 Statutory fraud

U.S. federal and state laws contain various types of statutory fraud.  These statutes were enacted to address fraud committed in the course of a particular type of transaction (e.g., securities fraud or real estate fraud).

a) Securities fraud

The most significant securities fraud statutes are found in the Securities Act of 1933 (the "Securities Act") (15 U.S.C. §§ 77a et seq.) and the Securities Exchange Act of 1934 (the "Exchange Act") (15 U.S.C. §§ 78a et seq.).  The U.S. Securities and Exchange Commission ("SEC") has supplemented the anti-fraud provisions of the Securities Act and the Exchange Act with its own rules, which also provide causes of action.  For example, SEC Rule 10b-5, codified at 17 C.F.R. § 240.10b-5, supplements Section 10(b) of the Exchange Act by making it unlawful to make an untrue statement of material fact in connection with the purchase or sale of a security (17 C.F.R. § 240.10b-5).

Some causes of action in securities laws provide a private right of action, meaning that a private party may bring suit based on the statute; SEC Rule 10b-5 is one example.  Other causes of action are available only to the government; e.g., claims under Section 17 of the Securities Act.  (See SEC v. Pocklington, No. EDCV 18-701 JGB, 2018 U.S. Dist. LEXIS 227362, *42, 2018 WL 6843663 (C.D. Cal. Sept. 10, 2018) (stating that no implied private right of action exists for Section 17(a) claims).)

In addition to the federal securities laws, states have adopted their own securities regulations known as "blue sky laws", many of which allow private rights of action for injured parties.  (See, e.g., Tex. Civ. Stat., Title 19, Art. 581-1 et seq.)

b) Other types of statutory fraud

States have enacted numerous statutes addressing fraud in various contexts.  For example, Section 27.01 of the Texas Business & Commerce Code provides a cause of action and exemplary damages for a person injured by fraud in a real estate or stock transaction.  All states have laws prohibiting the use of deceptive trade practices, including fraud.  (See, e.g., Cal. Bus. and Prof. Code §§ 17500 et seq.; 2019 Minn. Stat., Chapter 352D, § 325D.44 et seq.)  Also, Title 18 of the U.S. Code, as well as the statutes of each state, make the commission of fraud a criminal offence in many contexts.  (For example, using the mail to commit fraud is prohibited by 18 U.S.C. § 1341.)

c) Fraudulent transfer law

The U.S. has a well-developed body of law permitting creditors to recover fraudulent transfers of money and other property.  Most states have adopted the Uniform Fraudulent Transfer Act ("UFTA") or the more recent Uniform Voidable Transactions Act ("UVTA"), with minor differences existing between the statutes enacted by the states.  (See, e.g., Tex. Bus. & Com. Code §§ 24.001 et seq. (setting forth Texas's version of the UFTA).)  The U.S. Bankruptcy Code also contains provisions allowing for recovery of fraudulently transferred property, which are generally similar to the UFTA and UVTA (11 U.S.C. § 548).

The UFTA and UVTA allow for recovery of two types of fraudulent transfers.  The first type – transfers made with actual intent to hinder, delay, or defraud a creditor – are commonly referred to as actual fraudulent transfers.  (See, e.g., Tex. Bus. & Com. Code § 24.005(a)(1).)  Despite the name, fraudulent intent is not required so long as the transfer was at least intended to hinder or delay a creditor's collection efforts.  Fraud is, by definition, secretive.  The UFTA and UVTA provide a non-exclusive list of factors (so-called "badges of fraud") a court may consider in determining whether a transfer was made with fraudulent intent (e.g., that the transfer was concealed) (Tex. Bus. & Com. Code § 24.005(b)).

The second type of recoverable transfer is commonly referred to as a constructively fraudulent transfer.  Constructively fraudulent transfers need not involve actual fraud, but merely require that the transferor received less than reasonably equivalent value for the property transferred.  In addition, constructive fraudulent transfer law has a solvency element: the transfer must have been made while the transferor was insolvent, undercapitalised, or unable to pay its debts as they became due.  (See, e.g., Tex. Bus. & Com. Code §§ 24.005(a)(2), 24.006(a).)  Constructive fraudulent transfer law protects creditors by discouraging a party with limited assets from transferring those assets away for less than reasonably equivalent value.

A creditor with a fraudulent transfer claim may sue both the initial transferee of the transferred property and any subsequent transferee.  But a subsequent transferee who took the property in good faith and in exchange for value is immune from a fraudulent transfer suit.  (Tex. Bus. & Com. Code § 24.009(b).)  In this way, U.S. fraudulent transfer law balances protecting a creditor's right to recover property while protecting innocent third parties who took property without knowledge of the fraudulent transfer.

B) Tools for practitioners

1 Discovery

Practitioners seeking to trace and recover assets can use the extensive discovery process allowed in American litigation.  Litigants may serve requests for production of documents, demand that adversaries answer sworn interrogatories, and depose witnesses.  (See, e.g., Fed. R. Civ. P. 30-34.)  Third parties may be compelled by subpoena to provide testimony or produce documents.  (See, e.g., Fed. R. Civ. P. 45.)  Some U.S. jurisdictions permit pre-suit discovery from third parties.  However, the U.S. lacks a uniform streamlined process such as the Norwich Pharmacal orders allowed in the U.K., which permit the requesting party to obtain a court order requiring a third party to disclose information or preserve assets or documents.

The permissible scope of discovery is broad.  Once a lawsuit has been filed and the defendant has appeared, the plaintiff can generally obtain discovery regarding any non-privileged matter that is relevant to a party's claims or defences and proportional to the needs of the case.  Information need not be admissible in evidence to be discoverable.  (See, e.g., Fed. R. Civ. P. 26(b)(1).)  Courts in the U.S. also generally prefer disputes to be resolved after discovery has been conducted, meaning that a plaintiff need not obtain and plead most of its evidence when it files its initial complaint.  Some U.S. jurisdictions do require that certain claims be pled with particularity, including fraud claims.  (See, e.g., Fed. R. Civ. P. 9(b).)

For these reasons, the discovery process may be the most potent tool for practitioners to uncover concealed assets.  In limited circumstances, a party may conduct discovery prior to filing a lawsuit, though the extent to which pre-suit discovery is allowed varies significantly between U.S. jurisdictions.  For example, Texas Rule of Civil Procedure 202 permits pre-suit discovery to investigate a potential claim, while Illinois Supreme Court Rule 224 generally allows pre-suit discovery only to identify potential defendants.

2 Injunctive relief

A party concerned that someone may take steps to shelter or conceal assets should consider requesting injunctive relief.  An injunction is an equitable remedy under which a court orders the enjoined party to refrain from certain acts.  Temporary injunctions (also called preliminary injunctions) operate to preserve the status quo until a case can proceed to trial.  Temporary restraining orders remain in place for only a brief period (e.g., 14 days) until a request for a temporary injunction can be heard.  Permanent injunctions permanently require the enjoined party to refrain from engaging in certain conduct.

A temporary injunction can serve as an important remedy for a party who suspects that another party is fraudulently transferring assets.  The party should apply to the court for a temporary injunction preventing the other party from disposing of property without court permission.

Although temporary restraining orders can often be obtained on an ex parte basis, temporary injunctions typically require an extended hearing on the following elements: (1) proof of an underlying cause of action (e.g., actual fraudulent transfer); (2) a probable right to recover on the underlying claim; (3) probable, imminent, and irreparable harm to the applicant if the injunction is not granted; (4) the injury that will occur if the injunction is not granted outweighs any harm that will result from granting the injunction; and (5) a showing that the injunction serves the public interest.  (Paulsson Geophysical Servs. v. Sigmar, 529 F.3d 303, 309 (5th Cir. 2008); Butnaru v. Ford Motor Co., 84 S.W.3d 198, 204 (Tex. 2002).)

An injury is irreparable if the applicant cannot be made whole with an award of damages against the enjoined party (Butnaru, 84 S.W.3d at 204).  If the enjoined party violates the injunction, it may be held in contempt of court and be subject to criminal and/or civil liability.

3 Receiverships

A more drastic equitable remedy is a court-appointed receiver.  Under U.S. law, a receiver is a custodian who takes control of a business or enterprise, generally to preserve its value.  Both federal and state courts may appoint receivers and litigants may file applications seeking their appointment.  (See, e.g., Fed. R. Civ. P. 66 (providing that an action in federal court in which the appointment of a receiver is sought is governed by the Federal Rules of Civil Procedure); Brill & Harrington Invs. v. Vernon Savs. & Loan Ass'n, 787 F. Supp. 250, 253 (D.D.C. 1992) (considering several factors in appointing a receiver, such as fraudulent conduct on the defendant's part and imminent danger of property being lost, concealed, or diminished in value); Tex. Civ. Prac. & Rem. Code § 64.001(a) (permitting a Texas court to appoint a receiver in several situations, including for an insolvent corporation or a corporation in imminent danger of insolvency, and further permitting a receiver to be appointed under the rules of equity).)

The scope of a receiver's powers is established by court order, meaning that most courts have broad discretion to tailor a receiver's powers to a particular situation.  (See, e.g., Fed. R. Civ. P. 66 (providing that an action in federal court in which the appointment of a receiver is sought is governed by the Federal Rules of Civil Procedure); Brill & Harrington Invs. v. Vernon Savs. & Loan Ass'n, 787 F. Supp. 250, 253 (D.D.C. 1992) (considering several factors in appointing a receiver, such as fraudulent conduct on the defendant's part and imminent danger of property being lost, concealed, or diminished in value); Tex. Civ. Prac. & Rem. Code § 64.001(a) (permitting a Texas court to appoint a receiver in several situations, including for an insolvent corporation or a corporation in imminent danger of insolvency, and further permitting a receiver to be appointed under the rules of equity).)  Typically, courts are inclined to appoint receivers only when the person running a business has engaged in fraud or the value of the business is in serious jeopardy.

Receiverships are potent mechanisms to unwind complex fraud schemes affecting numerous individuals.  For an example, see the SEC's receivership set up to unwind the Stanford International Bank, Ltd. multi-billion-dollar Ponzi scheme.  See Securities and Exchange Commission v. Stanford Int'l Bank, Ltd. et al., Case No. 3:09-cv-0298-N (N.D. Tex.).  A detailed description of this receivership is beyond the scope of this chapter, but the receivership litigation has resulted in multiple opinions from the U.S. Court of Appeals for the Fifth Circuit and the Texas Supreme Court on the subject of the Texas Uniform Fraudulent Transfer Act ("TUFTA").  As of April 30, 2021, the receiver had recovered approximately $937.2 million in funds before deducting fees and expenses.  See Docket No. 3086.  Additional information is available on the case docket, the dockets of related lawsuits, and at Hyperlink.

4 Involuntary bankruptcy

Involuntary bankruptcy may be an intriguing possibility for a party seeking to recover assets.  Most bankruptcies in the U.S. are voluntarily filed by the debtor.  Section 303 of the U.S. Bankruptcy Code, however, permits a bankruptcy to be filed by one or more creditors holding claims that are not contingent as to liability or subject to bona fide dispute.  (See 11 U.S.C. 303(b).  A single creditor may file an involuntary bankruptcy proceeding if the creditor's claim exceeds $16,750; otherwise, three creditors with combined claims in the amount of $16,750 or more must sign the bankruptcy petition.  Id.  The minimum claim amount is periodically adjusted upward by the U.S. Congress when the Bankruptcy Code is amended.)  If the bankruptcy is contested by the debtor, the court will hold a trial to determine whether an order for relief should be entered (meaning that the case will proceed) or the case should be dismissed (11 U.S.C. § 303(h)).

Filing an involuntary bankruptcy is a serious act and a petitioning creditor may be subject to damages and sanctions (including exemplary damages) if the petition is dismissed or filed in bad faith (11 U.S.C. § 303(i)).  For a good faith creditor concerned about preserving or recovering assets, however, an involuntary bankruptcy has significant advantages.  The debtor must prepare schedules of assets and liabilities and disclose pre-bankruptcy transfers of property, with all of these disclosures being signed under penalty of perjury (11 U.S.C. § 521(a)).  If the court approves, the creditor may examine the debtor or third parties under oath and obtain production of documents to determine what happened to the debtor's assets.  These examinations are referred to as Rule 2004 examinations, so named because they are authorised under Rule 2004 of the Federal Rules of Bankruptcy Procedure.  These examinations are commonly granted and have been approvingly referred to as "fishing expeditions".

Bankruptcy courts take fraudulent representations and omissions made in the course of a bankruptcy seriously and Title 18 of the U.S. Code makes bankruptcy fraud a federal crime.  (See, e.g., 18 U.S.C. § 157.)  A bankruptcy trustee may file suit to recover fraudulently transferred property under Section 548 of the Bankruptcy Code (11 U.S.C. § 548; see also 11 U.S.C. § 544(b), which authorises the trustee to file suit based on state fraudulent transfer law to the extent a creditor could otherwise bring such a suit outside of the bankruptcy).  Accordingly, under appropriate circumstances, involuntary bankruptcies can provide significant advantages to parties seeking to recover fraudulently transferred assets.  For an example of a creditor successfully using an involuntary bankruptcy proceeding to enforce a judgment in light of alleged fraudulent transfers, see In re Acis Capital Mgmt., L.P., 2019 Bankr. LEXIS 292 (Bankr. N.D. Tex. Jan. 31, 2019) (confirming involuntary Chapter 11 plan) (full docket available at Case No. 18-30264).  In October 2019, Highland Capital Management, L.P., an entity affiliated with, but adverse to, the Acis Capital Management debtors, filed its own Chapter 11 bankruptcy proceeding.  See Case No. 19-34054-sgj11 (Bankr. N.D. Tex.).

5 Assistance to foreign tribunals (28 U.S.C. § 1782)

Section 1782 of Title 28 of the U.S. Code permits a U.S. district court to order a person to provide testimony or produce documents to assist a foreign tribunal.  The order may be issued upon request by the foreign tribunal or upon application of an interested party.  Section 1782 is an important tool for litigants in non-U.S. proceedings to obtain testimony and information from persons located within the U.S.

III  Case triage: main stages of fraud, asset tracing and recovery cases

The following is a general guide to typical stages of a U.S. proceeding based on a defendant's fraudulent conduct:

A) Pre-suit investigation

One should conduct as much pre-suit investigation as possible before filing suit.  Frequently, only limited information can be obtained before filing.  But at a minimum, a party should search public records (e.g., prior court filings, lien searches), which are accessible online.  Internet searches and review of public social media accounts frequently turn up significant information that can later be used during lawsuit discovery to uncover fraudulent conduct or hidden assets.  Parties may also consider hiring a private investigator or paying an internet asset search provider if the fees are reasonable.  If the applicable jurisdiction allows for pre-suit discovery, those tools should also be considered.  However, because many jurisdictions limit pre-suit discovery, the party should balance whether tipping off the suspected fraudster by requesting pre-suit discovery can be justified by the anticipated benefit from such discovery.

When considering what steps to take before filing suit, timing is critical.  A party who suspects that its adversary is fraudulently transferring assets generally cannot afford to take a leisurely approach to litigation, particularly when assets can easily be moved.  In such circumstances, a party should consider moving immediately for a temporary restraining order and temporary injunction to preserve the status quo.

B) The lawsuit

A "traditional" lawsuit is the most commonly commenced proceeding, but receivership and involuntary bankruptcy proceedings can also be considered.  If the defendant fails to appear in the lawsuit, the plaintiff should move for default judgment.  (See, e.g., Fed. R. Civ. P. 55.)  If the defendant does file an answer, the parties then generally proceed to serve discovery.  The broad scope of discovery, and the various discovery tools available in the U.S., are an excellent means to uncover fraud.  If the plaintiff believes that money has gone missing and can obtain financial records, the plaintiff should consider retaining a forensic accountant to determine whether funds were fraudulently transferred.

C) Judgment enforcement

U.S. courts almost never permit a party to recover assets prior to a judgment being obtained.  A party may obtain a temporary injunction preventing a defendant from transferring or disposing of assets.  However, a temporary injunction order is intended only to preserve the status quo prior to trial, not to permit a plaintiff to seize assets.  Once a judgment has been obtained, however, the plaintiff is generally free to enforce it against whatever property it can locate belonging to the defendant.  A defendant who wishes to appeal the judgment may be able to forestall enforcement while the appeal is pending.  (See, e.g., Fed. R. App. P. 8.)

If the defendant does not appeal, if the judgment is not stayed pending appeal, or if an appeal is ultimately resolved in the plaintiff's favour, the plaintiff faces a daunting task: identifying assets sufficient to satisfy its claims.  The plaintiff will usually serve post-judgment discovery requests to identify assets.  Or, in some jurisdictions, the plaintiff may request an examination of the defendant, in which the defendant is required to submit to examination regarding the availability of assets to satisfy the judgment.

Once the plaintiff has located assets, it can proceed to enforce its judgment against them, depending on the type of assets identified.  Frequently, discovery will uncover fraudulent transfers by the defendant.  In such case, the plaintiff can sue to recover the transfers.

IV  Parallel proceedings: a combined civil and criminal approach

Parallel civil and criminal proceedings have proliferated in recent decades in the U.S.  The U.S. Supreme Court acknowledged 50 years ago that parallel civil and criminal proceedings are proper and constitutional (United States v. Kordel, 397 U.S. 1, 11 (1970)).  Such proceedings routinely arise where one federal agency has civil regulatory authority over a particular category of fraud (e.g., the SEC (securities fraud), Commodity Futures Trading Commission ("CFTC") (commodities fraud), Federal Trade Commission (consumer fraud)), while the Department of Justice ("DOJ") has concurrent criminal jurisdiction over the same subject.

These complex situations raise a host of issues under the U.S. Constitution and other federal law.  For example, invocation of the Fifth Amendment's privilege against self-incrimination has vastly different repercussions in the criminal context – where no adverse inference may be drawn from the invocation – versus the civil context – where an adverse inference can be drawn.  (See, e.g., Baxter v. Palmigiano, 425 U.S. 308 (1976).)

A) What are the benefits/difficulties of a combined approach?

Parallel proceedings in which a private litigant seeks asset recovery while a government agency simultaneously pursues the fraudsters are also relatively common.  These situations raise similar challenges and opportunities as in the parallel regulatory civil and criminal prosecutions.

One issue that may arise in such situations is where a stay of the civil proceeding is sought pending the criminal prosecution.  If a plaintiff sues for fraud, and the government contemporaneously prosecutes the defendant for a crime arising from overlapping conduct, either the defendant or the government may move for a stay.  Issuance of a stay will obviously delay any efforts to recover assets through the civil action.

If the defendant seeks a stay, he will argue that the civil action should be stayed until the criminal proceeding is concluded so that he does not have to choose between testifying (and thereby potentially waiving his Fifth Amendment privilege in the criminal case) and invoking the Fifth Amendment (thereby giving rise to an adverse inference in the civil action).  If the government seeks a stay of the civil case, it will argue that the criminal defendant should not be permitted to avail himself of the more liberal civil discovery procedures for use in the criminal case.

These questions are highly fact-specific and courts do not automatically grant a stay on the request of either party.  Generally speaking, the more the conduct at issue in the civil and criminal proceedings overlaps, the likelier it is that a stay will be granted.  Courts also consider prejudice to the parties, delay, the public interest, and other relevant factors.

B) Civil and criminal asset recovery

There are a number of potential remedies in the civil context.  The primary remedies in the criminal context (apart from incarceration) are asset forfeiture and restitution orders.  The following is a brief overview of various civil and criminal remedies.

Federal Rule of Civil Procedure 64 authorises remedies relating to the seizure of persons or property – including arrest, attachment, garnishment, replevin, sequestration, and other similar remedies – to secure satisfaction of a potential judgment to be entered in the civil action (Fed. R. Civ. P. 64; HMG Prop. Investors, Inc. v. Parque Indus. Rio Canas, Inc., 847 F.2d 908, 913 (1st Cir. 1988)).  Obtaining these prejudgment remedies creates considerable leverage.

Other aggressive prejudgment relief includes temporary restraining orders and preliminary injunctions against further activity, freezing assets to prevent dissipation of investor proceeds, and receiverships.  (See Fed. R. Civ. P. 64-66; 28 U.S.C. § 3103 ("Receivership").)  A receiver is a person or entity appointed by a court to hold property that is subject to a dispute, whether the dispute concerns ownership or rights in the property or claims against the property's owner that might be satisfied from the property.  A receiver is obligated to manage the property, to conserve it, and to prevent its waste.  The receiver is authorised to receive rents and other income from the property, to collect debts, to bring or defend actions related to it, and to receive a fee for doing so.  A receiver is subject to court supervision and responsible to the court for carrying out all orders regarding the property.

Asset freezes, orders appointing receivers, and related court orders may be enforced through civil or criminal contempt.  Criminal contempt must be prosecuted by the government or the court, not the private plaintiff.  Therefore, it is less useful as a method of recovery than civil contempt.  Criminal contempt, unlike civil contempt, involves punishment such as incarceration or fines for doing something prohibited by a court order.  In civil contempt, the remedy is designed to be compensatory, not punitive.  So, if a defendant dissipates assets or refuses to tender property to the receiver, the plaintiff or receiver can compel compliance by showing – generally by clear and convincing evidence – that the defendant violated an order and is therefore in contempt.  If the contemnor does not purge the contempt, he may be incarcerated pending compliance with the court order.

In criminal cases, the primary means of asset recovery are forfeiture and restitution.  Criminal forfeiture is the taking of real or personal property by the government due to its relationship to criminal activity, such as when the property is used in the commission of a crime or was obtained through criminal activity.  Civil forfeiture is similar to criminal forfeiture except it is brought against the property itself as an in rem action.

Restitution means payment by an offender to the victim for the harm caused by the defendant's misconduct.  Courts are empowered (and often required) to order convicted criminals to pay restitution.

There are considerable disadvantages to relying on criminal remedies in asset recovery.  First, the criminal authorities may not prosecute the offence.  Of course, the victim may assist the government and encourage prosecution, but there are no guarantees.  If the government does prosecute, it bears the burden of proving guilt beyond a reasonable doubt, a much higher burden than the preponderance-of-the-evidence standard in civil cases.  Finally, the government will have to distribute the assets seized or restitution paid.  In practice, this may take many years.  Because of these disadvantages, judgment creditors and other victims of fraud should almost always pursue their own asset recovery in the U.S. through civil proceedings.

C) How does the U.S. view private prosecutions?

Private prosecutions, meaning criminal prosecutions conducted by private attorneys or laymen, have long been disfavoured in the U.S., to the point of extinction.  This stands in contrast to the U.K., where private prosecutions have flourished in recent years.  Indeed, the U.S. has not permitted private prosecutions in over 150 years except in exceedingly rare and unusual circumstances.  For instance, a federal district court may appoint a private attorney to prosecute a criminal contempt of court if the executive branch refuses to prosecute.  (Young v. United States ex Rel. Vuitton Et Fils, S.A., 481 U.S. 787 (1987).)

In practice, this situation is extremely uncommon and not susceptible to prediction or planning.  Federal statutes confer the exclusive power to prosecute crimes in the name of the U.S. on the Attorney General and his delegates.  (See 28 U.S.C. §§ 516, 519; United States v. Nixon, 418 U.S. 683, 693 (1974) ("the Executive Branch has exclusive authority and absolute discretion to decide whether to prosecute a case").)  Thus, private prosecutions are not a realistic option for asset recovery.

V  Key challenges

Among the key challenges is the cost to pursue and recover assets from fraudsters.  Cost can be an impediment to deserving victims and must be managed whenever fraud and asset recovery are being pursued.  In addition, there are challenges in exporting recovery efforts outside the U.S.  In many "less established" jurisdictions, there is an ad hoc and lengthy process for judgment enforcement, discovery is limited or unavailable and the recovery of assets is chaotic and unpredictable.  Some jurisdictions do not have the necessary legal framework, experienced and trained judiciary or respect for the Rule of Law to facilitate the recovery of assets for fraud victims.  While the concept of a Model Law for cross-border insolvencies undertaken by UNCITRAL has been successful, recent UNCITRAL meetings have focused on the need for a Model Law for asset recovery.  Although this is commendable, it may take many years to implement.

Other challenges unique to the U.S. are outlined below.

A) Attorneys' fees

Unlike many jurisdictions, the default rule in the U.S. is that each party bears its own attorneys' fees.  This is not to say that attorneys' fees are never recoverable in U.S. litigation if a statute so provides.  (See, e.g., Tex. Civ. Prac. & Rem. Code § 38.001 (providing for recovery of attorneys' fees in certain types of cases, such as breach of contract cases).)  Parties to a contract are also free to specify how attorneys' fees should be allocated in light of a dispute.  Without a contractual or statutory basis for fees, however, each party must pay its own fees.  Mounting attorneys' fees can prove to be a significant hurdle for a plaintiff pursuing a lawsuit and attempting to enforce a judgment.

B) Tracing commingled proceeds

One of the difficulties frequently faced by a party attempting to recover fraudulently transferred funds is how to identify those funds when they are commingled with other money in a bank account.  U.S. courts have applied several tests to address this issue, with the most widely applied test being the lowest intermediate balance rule.  This test assumes that the owner of a bank account preserves fraudulently obtained money for the benefit of defrauded victims.  Funds from other sources are presumed to be withdrawn first.  Only if the balance of the account drops below the amount of fraudulently obtained funds are the victims' funds presumed to be gone.  (See Blackhawk Network, Inc. v. Alco Stores, Inc. (In re Alco Stores, Inc.), 536 B.R. 383, 414 (Bankr. N.D. Tex. 2015) (explaining application of lowest intermediate balance rule).)  An additional problem arises if funds are spent and new funds are subsequently deposited.  Courts are split on whether victims' funds can be replenished.

C) Exemptions

A common obstacle to judgment recovery in the U.S. against an individual person (as opposed to an entity) is state property exemption laws.  The U.S. Bankruptcy Code also contains federal exemptions for debtors filing for bankruptcy that differ from state exemptions, which debtors filing bankruptcy in some (but not all) states can choose to use (11 U.S.C. § 522(d)).  The goal of exempt property laws is to ensure that creditors do not leave individual debtors destitute.  The breadth of exemptions varies significantly by state, with states such as Texas providing robust protection with respect to real property used as a domicile and other states providing only a limited homestead exemption.  (Compare Tex. Prop. Code § 41.001 with Ark. Code, Chapter §§, § 16-66-210.)

In addition, some states wholly exempt retirement accounts, certain life insurance policies, annuities, and other financial instruments, meaning that a plaintiff facing a debtor that has properly structured his or her limited assets may be out of luck.  In most states, a transfer of an exempt asset cannot constitute a fraudulent transfer because the UFTA (in effect in most U.S. jurisdictions) excludes exempt assets from its scope.  (See, e.g., Tex. Bus. & Com. Code § 24.002(2).)

VI  Coping with COVID-19

So far, the economic uncertainty resulting from the COVID-19 pandemic has not exposed fraudulent schemes on the level of the 2008 economic crisis (e.g., Bernie Madoff and Stanford Financial).  Perhaps the most notable (though unsurprising) development is that government relief programmes intended to mitigate the economic effects of COVID-19 shutdowns, such as the U.S. Paycheck Protection Program ("PPP"), have proven tempting to fraudsters.

On May 17, 2021, the U.S. Attorney General established the COVID-19 Fraud Enforcement Task Force to marshal the resources of the DOJ and other government agencies to enhance efforts to combat fraud.  DOJ Fraud Section attorneys have prosecuted over 100 defendants in more than 70 criminal cases.  As of October 13, 2021, the Fraud Section had seized more than $65 million in cash proceeds derived from fraudulently obtained PPP funds.  See Hyperlink (Oct. 13, 2021).

VII  Cross-jurisdictional mechanisms: issues and solutions in recent times

Obtaining assistance in the U.S. on cross-jurisdictional matters involving fraud and asset recovery can be challenging even for the experienced practitioner.  This is not because of the lack of available tools or an unwillingness to assist, but rather determining what mechanisms are available and best suited for your situation.  The online resources of the DOJ and Department of State are an excellent starting point.  (See, e.g., U.S. Asset Recovery Tools & Procedures: A Practical Guide for International Cooperation (2017).)

The insolvency process can be one of the most effective tools to combat fraud (Jean-Pierre Brun and Molly Silver,  2020.  Going for Broke: Insolvency Tools to Support Cross-Border Asset Recovery in Corruption Cases.  Stolen Assets Recovery series.  Washington, D.C.: World Bank doc: 10.1596/978-1-4648-1439-9).  As such, it is appropriate to discuss Chapter 15 of the U.S. Bankruptcy Code, which addresses cross-border insolvencies.  Chapter 15 is designed to promote cooperation between the U.S. courts and parties of interest and the courts and other competent authorities of foreign countries involved in cross-border insolvency cases while providing for the fair and efficient administration of cross-border bankruptcies (11 U.S.C. § 1501.  See Chapter 15 – Bankruptcy Basics: Ancillary and Other Cross-Border Cases (Hyperlink)).

A Chapter 15 case is commenced by a "foreign representative" filing a petition for recognition of a "foreign proceeding" (11 U.S.C. § 1504).  The U.S. court is authorised to grant preliminary relief upon the filing of the petition for recognition (11 U.S.C. § 1519).  Upon the recognition of a foreign main proceeding, the automatic stay and other important provisions of the Bankruptcy Code take effect within the U.S.  The foreign representative is also authorised to operate the debtor's business in the ordinary course (11 U.S.C. § 1520). 

Chapter 15 is the principal means for a foreign representative to access U.S. federal and state courts (11 U.S.C. § 1509).  Upon recognition, a foreign representative may seek additional relief from the bankruptcy court or from other state and federal courts and is authorised to initiate a full (as opposed to ancillary) bankruptcy case (11 U.S.C. §§ 1509, 1511).  In addition, the representative is authorised to participate as a party in interest in a pending U.S. bankruptcy and to intervene in any other U.S. case where the debtor is a party (11 U.S.C. §§ 1512, 1524).

Chapter 15's use has increased since its adoption and there is now an established body of case law.  Moreover, more countries have adopted some corollary of the Model Law on which Chapter 15 is based.  Importantly, Chapter 15 is being used more frequently in cross-border fraud and corruption cases.  See, e.g., In re Comair Ltd. (In Bus. Rescue), Case No. 21-10298-jlg, 2021 Bankr. LEXIS 3137, *25-30, 2021 WL 5312988 (Bankr. S.D.N.Y. Nov. 14, 2021) (holding that Section 1521 of the Bankruptcy Code may provide grounds to conduct discovery to investigate potential causes of action against a third party to the extent discovery would effectuate the purpose of Chapter 15).  Accordingly, Chapter 15 must be considered a formidable weapon in appropriate fraud, asset tracing and recovery efforts.

VIII  Using technology to aid asset recovery

While there is no substitute for hard work, technology can be vitally important in pursuing claims for fraud.  A party may obtain up-to-date information regarding assets and individuals from public and non-public databases.  Comprehensive online resources include BlackBookOnline.info, Accurint.com and TLO.com.  Social media has become a useful tool for investigators to find out what might otherwise be considered private information from numerous sites like Facebook, LinkedIn, Twitter and Instagram.

Various products and providers offer assistance in managing data and discovery, which can often involve millions of documents.  Technologies like GreyList Trace (Hyperlink), while new, appear promising and can provide information on banking relationships that help to focus investigative resources.  Technology will continue to play an important, and indeed critical, role in fraud, asset tracing and recovery in the future.

Conversely, technology is being used more and more by fraudsters, often making recovery more difficult and challenging.  The best examples are the fast-paced developments regarding cyber-crimes and fraud involving cryptocurrencies.  On the other hand, proponents of blockchain technology tout its development – and its inherent transparency and immutability – as a game changer in combatting fraud through improved identity verification, increased traceability of products or financial transaction, and similar potential benefits.  See, e.g., Ross Mauri, Blockchain for fraud protection: Industry use cases (July 12, 2017), available at Hyperlink.

IX  Highlighting the influence of digital currencies: is this a game changer?

Digital currencies have exploded in popularity since the advent of Bitcoin in 2008, particularly in the last few years.  While speculative investment in Bitcoin and other cryptocurrencies initially received the bulk of media coverage, investors are increasingly focused on making use of the inherent transparency of blockchain transactions.  For example, the decentralised nature of digital currencies means that cross-jurisdictional financial transactions can, in theory, be conducted without the use of a financial intermediary (i.e., a bank or other third-party payment facilitator).

Complex cross-jurisdictional financial transactions often carry the risk that a third-party payment facilitator will siphon off or divert funds, leaving the payor and payee to determine in multiple jurisdictions what happened to the money.  The risk of this happening is low with an established financial institution, but even banks risk being hacked – and these types of transactions often involve multiple intermediaries.  The transparent nature of the blockchain ledger allows digital currencies and smart contracts to minimise this risk.  On the other hand, the anonymous nature of digital currencies is appealing to entities involved in illicit transactions, such as drug smuggling, illegal arms transactions, and transfers of stolen funds.

The SEC, CFTC, Federal Trade Commission, Internal Revenue, Office of the Comptroller of the Currency, and the Financial Crimes Enforcement Network ("FinCEN") (along with various state regulators) have all focused significant attention on regulating digital currencies.  One major issue they have confronted is which agency(ies) have jurisdiction to regulate digital currencies.

The CFTC has generally taken the position that digital currencies are commodities subject to the CFTC's jurisdiction.  See, e.g., Daniel Roberts, CFTC says cryptocurrency ether is a commodity, and ether futures are next (Oct. 10, 2019), available at Hyperlink.

The SEC has taken the position that digital tokens and other digital assets are investment contracts, and, therefore, securities subject to the SEC's jurisdiction.  This position has been litigated favourably in federal court.  See SEC Obtains Financial Judgment Against Kik Interactive For Unregistered Offering (Oct. 21, 2020), available at Hyperlink.

One area of regulation that may be of particular interest to fraud and asset recovery practitioners is FinCEN guidance on virtual currencies.  FinCEN's primary mission is to safeguard the financial system from illicit use and combat money laundering.  As early as 2013, FinCEN issued guidance that virtual currency exchanges and certain administrators of virtual currency repository would be considered money services businesses ("MSBs") subject to FinCEN's regulation under the Bank Secrecy Act.  An MSB that is a money transmitter must, among other things, implement an anti-money laundering programme based on a comprehensive risk assessment.

While the extent of FinCEN's jurisdiction is still being fleshed out, the extent to which a digital currency seller must comply with FinCEN's regulations is an area of concern.  FinCEN's increased focus on digital currencies was underscored by the appointment of its first ever Chief Digital Currency Advisor in July 2021.  See FinCEN Welcomes First-Ever Chief Digital Currency Advisor and First Director of Strategic Communications (July 6, 2021), available at Hyperlink.

To the extent digital currencies are used as speculative investments, they are likely not game changers.  Investors have always speculated and will continue to do so regardless of the class of asset.  The decentralised aspects of digital currencies (and of blockchain technology in general), however, and the susceptibility of these currencies to misuse by bad actors wishing to remain anonymous, present challenges to regulators, not least of which is determining which regulatory body has jurisdiction over digital currencies.

The potential benefits of blockchain technology for participants in the global financial system means that exponential growth in this area is likely over the next few years.  Perhaps the most significant challenge faced by proponents of digital currencies is preserving the efficiency of blockchain transactions while enacting additional safeguards designed to allow regulators to identify bad actors and ensure continued transparency.  Whether this challenge can be met remains to be seen.

X  Recent developments and other impacting factors

One development that continues to receive attention is the extra-territorial application of U.S. law, especially as it relates to avoidance actions.  The Second Circuit Court of Appeals addressed this issue in the context of the Madoff Ponzi scheme (In re Picard, 917 F.3d 85 (2d Cir. 2019)).  In declining to rule that the presumption against extra-territoriality was applicable, the Court determined that the trustee could recover a domestic transfer to foreign transferees (so-called "feeder funds") under the avoidance powers of the Bankruptcy Code (RJR Nabisco, Inc. v. European Cmty., 136 S.Ct. 2090, 2100, 579 U.S. 325 (2016) ("absent clearly expressed congressional intent to the contrary, federal laws will be construed to have only domestic application")).  As the Court noted, under a contrary ruling, fraudsters would enjoy an easy way to protect their ill-gotten gains (Picard, 917 F.3d at 102-03).

When this ruling is combined with a prior decision in Madoff on the extra-territorial application of the automatic stay (Van der Hahn, D. and Wielebinski, J., Extraterritoriality Arguments Ruled Extraneous: Second Circuit Permits Trustee to Recover Fraudulent Transfers from Foreign Recipients, International Bar Association.  Insolvency and Restructuring International, Vol. 13 No. 2, Sept. 2019), it may be a harbinger of future expansion of the reach of the Bankruptcy Code in international fraud cases (Picard v. Maxam Absolute Return Fund, L.P., 474 B.R. 76, 84-85 (2012)).

The Stanford International Bank, Ltd. receivership (see Section II.B.3 above) has resulted in multiple opinions from the U.S. Court of Appeals for the Fifth Circuit and the Texas Supreme Court on the scope of the TUFTA.  In 2020, the Fifth Circuit held, after certifying the question to the Texas Supreme Court, that a defendant in a fraudulent transfer suit must have conducted a diligent investigation designed to uncover potentially fraudulent conduct to be able to rely on the TUFTA's good faith affirmative defence.  The court rejected the defendants' argument that they were excused from investigating fraudulent conduct if such an investigation would have been futile.  See Janvey v. GMAG, L.L.C., 977 F.3d 422 (5th Cir. 2020).  For a detailed analysis of the Fifth Circuit's opinion, see Joe Wielebinski and Matthias Kleinsasser, Ponzi Ruling Complicates Texas Fraudulent Transfer Litigation (Nov. 16, 2020), available at Hyperlink.

Finally, the commencement of the Biden/Harris administration has resulted in increased enforcement by the SEC and other regulators with respect to certain issues.  In general, the Trump/Pence administration oversaw a decrease in enforcement actions by federal regulators.  For example, a National Public Radio analysis determined that the SEC brought the fewest insider trading cases in 2019 since 1996.  See Hyperlink.

Under the Biden/Harris administration, the SEC and other regulators have focused heavily on regulating Special Purpose Acquisition Companies ("SPACs") and cryptocurrencies and addressing cybersecurity risks.  See Soyoung Ho, Swift Change in SEC Enforcement Under Biden Administration (Aug. 11, 2021), available at Hyperlink.  The SEC has also sought to return to an Obama-era policy that required settling defendants to admit wrongdoing, rather than entering into "no admit, no deny" settlements.  See, e.g., Dave Michaels, Wall Street, Companies May Have to Give Up More to Settle With SEC (Oct. 13, 2021), available at Hyperlink.

Originally published by ICLG

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.