Fraud: Jon Corzine, George W. Bush and the 2005 Bankruptcy Reform

New York -- Yesterday the House Financial Services Committee confirmed what we already know, namely that former Goldman Sachs CEO Jon Corzine deliberately stole customer funds when he was CEO of MF Global.  See Blomberg News story below:…

But what the Republican Committee report does not say is that the mechanism that allows Corzine and many others to walk away from such disasters without any civil liability for fraud is the 2005 Bankruptcy Reform Act, which the Republicans sponsored almost unanimously.  And we wonder why nobody is pursuing MF Global for the theft that it clearly involved?

By the bankruptcy code Congress adopted and which congress alone can change: (i) Bankruptcy Judges are PRECLUDED from appointing "receivers" (Sec. 105(b)), (ii) the stay precludes creditors who were robbed from pursuing a receiver at the District Court, (iii) state receiverships are collapsed into the bankruptcy when it is filed and (iv), at least in the 2nd Cir., only a receiver can pursue claims based on theft.

Ergo:  There is almost no way to go after people to collect stolen money in corporations that are subject to the Bankruptcy Code (particularly in NYC).  As one veteran litigator told me yesterday: “AND WE CONSIDER OURSELVES AS A NATION GOVERNED BY "THE RULE OF LAW”?

The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” was styled as a way to prevent abuse of bankruptcy by creditors, but really it was a way for the banking industry to protect itself from claims due to predatory lending.  Maryscott OConnor noted in an excellent 2005 analysis in the Daily Kos:

“The details of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 reveal it to be a bill crafted as a Republican paean to MBNA, the largest single contributor to the Republican party.  Far from being either an effort to stem "Bankruptcy Abuse" or an effort at "Consumer Protection", the bill is in fact an attempt to rewrite bankruptcy laws to reduce the ability of those laws to protect consumers from predatory lending practices on the part of MBNA members, and to stiffen the capabilities of those corporations to collect from consumers already suffering from extreme financial hardships.”

She notes that the legislation received unanimous support in the Senate from Republicans and that several Democrats also supported this legislation, including:

Sen. Nelson (D - Nebraska)

Sen. Johnson (D - South Dakota)

Sen. Carper (D - Delaware)

Also frequently voting with the Republicans was then Sen. Joe Biden (D - Delaware).

But what even the critics did not understand at the time was that the 2005 Bankruptcy legislation also effective prevents investors from bringing civil fraud claims against the likes of Jon Corzine or Madoff in the case of a bankruptcy.  Once a firm files bankruptcy, the officers and directors effectively get a “get out of jail free” card because the trustee cannot pursue fraud claims.  Unlike the case of  a failed bank where the FDIC is automatically appointed receiver, in bankruptcy a trustee’s powers are limited to the claims by the estate of the dead corporation. 

As I have written previously in ZH, only a receiver can go after fraud by third parties in a bankruptcy.  But since the 2005 Bankruptcy law effectively prohibits the appointment of a receiver in bankruptcy, the bad guys get away.  This is one of the proud legacies of President George W. Bush and the Republican Congress, BTW.

So when you hear Republican politicians pointing figures at Jon Corzine for his “alleged” acts of fraud in the MF Global collapse, ask them why they changed the bankruptcy code to allow such acts of fraud to go unpunished.  The answer is that MBNA and other large banks pushed the changes, but only now do we understand that the targets were not merely hapless consumers but all investors.  

The fact is that the Republicans sponsored the legislation to help banks continue to prey upon consumers is bad enough, but the real impact of the 2005 legislation was to give the officers and directors of failed broker-dealers effective immunity from civil fraud claims in the case of bankruptcy.  Until Congress repeals the 2005 Bankruptcy legislation, no investors’ funds are safe inside a broker-dealer – period.