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4 Massive Fraud Scandals You Might Not Know About

December 6, 2013

Enron and WorldComm scandals are just the latest of massive fraud cases. The scandals occurring years ago are still bear to mention, some even leading to significant changes within the accounting professions and introductions to new government laws.

Equity Funding Corporation of AmericaEquity Funding Corporation of America 
Equity Funding Corporation of America (EFCA) began selling life insurance in the early 1960s, with an innovative twist that combined the safety of traditional life insurance with the growth potential of stock mutual funds. The company would sell a mutual fund to a customer, who would then borrow against the fund to purchase life insurance. This strategy was predicated on the assumption that the return on the mutual fund would be sufficient to pay the premiums on the insurance policy.

The fraud began in 1964, when EFCA was bumping up against a deadline to complete and issue its annual report. The company’s new mainframe computer couldn’t produce the needed numbers in time and Stanley Goldblum, the CEO of the company, ordered fictitious accounting entries made to the company’s financial statements to meet the deadline.

Goldblum and other employees of EFCA continued this fraud by creating phony life insurance policies to produce revenue to back up these earlier false entries. The company then reinsured these fake policies with a number of other insurers, and even faked the deaths of some of these nonexistent individuals.

The fraud eventually reached mammoth-sized proportions, with tens of thousands of phony insurance policies and nearly $2 billion in nonexistent revenues over a multi-year period. One shocking component of the fraud was the number of employees that participated. Prosecutors successfully charged 22 individuals and estimated that 50 others at the company had knowledge of the fraud.

In 1973, a disgruntled employee, who had been fired by Equity Funding Corporation of America, reported the fraud to Ray Dirks, a Wall Street analyst who covered the insurance industry. Dirks did his own research and then discussed the company with his clients, many of whom sold the stock prior to the fraud becoming public knowledge.

Another noteworthy part of the case is that it led to the establishment of a new legal precedent regarding insider trading by the courts. After the fraud became public, the Securities and Exchange Commission (SEC) censured Dirks for aiding and abetting violations of the Securities Exchange Act of 1934 and Rule 10b-5, which prohibits insider trading.

Dirks fought the censure through several appeals until he found himself before the Supreme Court in 1983. The court ruled in his favor, and said that no violation occurred because Dirks had no fiduciary duty to the shareholders of EFCA and did not misappropriate or illegally obtain the information.

The fraud at EFCA is considered by some to be the first computer-based fraud, as the creation of phony documents needed to back up the phony policies became so cumbersome that the company started using computers to automate the deception.

Crazy Eddie
Crazy Eddie was a retail store chain run by the Antar family, which began operations as a private company in the 1960s. The fraud at Crazy Eddie was one of the longest running in modern times, lasting from 1969 to 1987.

The fraud began almost immediately, with the management of Crazy Eddie underreporting taxable income through skimming cash sales, paying employees in cash to avoid payroll taxes and reporting fake insurance claims to the company’s carriers.

As the chain grew in size, the Antar family started planning for an initial public offering (IPO) of Crazy Eddie and scaled back the fraud so that the company would be more profitable and get a higher valuation from the public market. This strategy was a success and Crazy Eddie went public in 1984 at $8 per share.

The final phase of the Crazy Eddie fraud began after the IPO and was motivated by a desire to increase profits so the stock price could move higher and the Antar family could sell its holdings over time. Management now reversed the flow of skimmed cash and moved funds from secret bank accounts and safety deposit boxes into company coffers, booking the cash as revenue. The scheme also involved inflating and creating phony inventory on the books and reducing accounts payable to boost profits at the company.

The fraud was uncovered in 1987 after the Antar family was ousted from Crazy Eddie after a successful hostile takeover by an investment group. Crazy Eddie limped along for another year before being liquidated to pay creditors.

Eddie Antar, the CEO of Crazy Eddie, was charged with securities fraud and other crimes, but fled before his trial. He spent three years in hiding before he was caught and extradited back to the U.S. Antar and two other family members were also convicted for their role in the fraud.


McKesson & Robbins

McKesson & Robbins was a drug and chemical company in the mid-1920s that attracted the attention of Philip Musica, an individual with an unsavory past that included criminal acts and multiple fake names.

Under the name Frank D. Costa, Musica greeted the advent of U.S. Prohibition in 1919 with the creation of a company that manufactured hair tonic and other products that had high alcohol content. These products were sold to bootleggers, which used the alcohol to produce liquor to sell to customers.

Musica purchased McKesson & Robbins in 1924 using the name F. Donald Coster, and seeded the company with family members to help loot the company. The fraud involved fake purchase orders, inflated inventory and skimming cash from company sales, and occurred despite the presence of Price Waterhouse as the company’s auditors. When the scam was finally detected in 1937, the SEC determined that $19 million in fictitious inventory was on the balance sheet of the company. This is equal to approximately $285 million in current dollars.

McKesson & Robbins had a profound impact on the accounting industry and led to the adoption of Generally Accepted Auditing Standards (GAAS), including the concept of an independent audit committee. Another change included having auditors personally inspect inventory to verify its existence.

Republic of Poyais

The Poyais fraud was a major scandal in the 1800s. This fraud was certainly the most audacious and imaginative of all, as the perpetrator, Gregor MacGregor, created a fictional country in Central America.

MacGregor served in the British army and was involved in various operations in the Americas. During his travels, he visited the coastal areas of present-day Honduras and Belize. MacGregor claimed to have received a land grant from a local native leader, and upon his return to London, announced the new nation of the Republic of Poyais.

MacGregor created a flag, a coat of arms, currency and other trappings of a sovereign nation and then proceeded to sell off land to investors and settlers in the London markets. He also issued sovereign debt backed by the promise of this new nation, and induced settlers with glowing accounts of the capital city and the fertility of the soil.

The first group of settlers arrived in Poyais in 1823, and found nothing except dense jungle and abandoned wood shacks. Three other shiploads of settlers arrived over the next few years and found a similar situation. Disease and hunger soon worked through the settlers, and almost 200 colonists died.

The news eventually reached London and the authorities arrested MacGregor. While awaiting trial, he fled to France and attempted the same Poyais scam on French investors. MacGregor ended up in Venezuela, where he helped the nation in its fight for independence and for his efforts was awarded a pension and the title of general by the newly established government.

Corporate fraud has had a long history in the making, despite the best regulatory efforts of various federal governments, these large-scale swindles only seem to be increasing and escalating.

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