BULL STREET – The art of the Con

Equity Funding And Counterfeiting

Moreover, how many of us remember the folks at Equity Funding, a West Coast Insurer that was perceived by Wall Street analysts as one of the foremost growth companies in the United States.  Its management style was cited countless times as being tops in their field and its seven-day a week work ethic was hailed by many as the reason for their success.  Ultimately it was discovered that the round the clock work day put in by the executives was required to keep the company growing primarily because it was on nights and on the weekends when the company’s officers would fuel their growth by creating brand new, totally bogus insurance policies. 

Regulators within the states that Equity Funding operated never caught on to the racket and it was only by the efforts of a securities analyst by the name of Ray Dirks that the plot was uncovered.  Dirks reported his findings to his clients, the press, the SEC and State of California Regulators and was suspended from the securities industry for his efforts.  It would have seemed that cash receipts when weighed against insurance written would have quickly put an end to this sham, but a major accounting firm did not see fit to analyze the company from that point of view and regulators say they relied on the outside accountants.

But we are getting far ahead of our story. Equity Funding had so little about it that was real that we hardly know how to begin, but I think that anyone would go along with our choice of awarding it the Babe Ruth Award for financial scandals and the Gold Medal Award for accounting hoaxes to the Company and their prestigious accountants.  Equity Funding in this regard become our first time double winner and the folks that brought us all the enjoyable reading material about how they did it will be able to retire the trophies if they ever get out of jail.  I guess you get the point, there is fraud and then there is Equity Funding, forever to remain a cut above the McKesson’s, The Billy Sol Estes’ and the Tino DiAngelis.

As a matter of fact we are so sure that you would agree that we have now taken the liberty of placing Equity Funding ahead of both Samuel Insull and Ponzi.  For separating people from their money, we are convinced that Equity Funding has never had an equal. And yet, its fearless leader, Stanley Goldblum chaired the prestigious ethics committee of the Los Angeles branch of the National Association of Securities Dealers. In a book co-authored by Ray Dirks, The Great Wall Street Scandal, he pointed out that Goldblum was quick to weed out those how he didn’t believe we toeing the ethics mark closely enough. “He was harsh on transgressors…and gave substantially stiffer penalties than had been anticipated.” Something like the pot calling the kettle black I guess.

The company was founded in 1960 by four equal shareholders. Two of the shareholders pulled out soon after the company was formed and the remaining executives were Michale Riordan, the Chairman and Stanley Goldblum, a college dropout suddenly became its president. The company became public in 1964 and a quickly gained a solid reputation as an innovator with a host of unique products. Riordan was killed in early 1969 by mudslide that encompassed his Brentwood, California home. Goldblum took on Riordan’s role as Board Chairman and simultaneously appointed Fred Levin as an executive vice-president and gave him the job of running the company’s insurance operations.

Levin, before he had joined Equity Funding had received a law degree and had gone to work for Illinois State Department of Insurance, the state insurance regulator. Levin was much in demand on the Wall Street speaking circuit and always had a fast answer for the toughest of questions. In one such session Levin wowed his audience when asked what the company’s management philosophy was; “We’re conservative in our financial management…We are innovative in product development…and we are very traditional in our conviction that be serving the public’s real needs, we will continue to grow in accordance to the objectives we set for ourselves.”[66] The two proved to be a powerful team and soon they were able to substantially increase the company’s sales and earnings.  By 1972, Equity Funding had achieved the stratospheric status of being named one of the 10 largest life insurance carries in the country. ([67])

Not long afterward, the West Coast based seller of insurance and mutual funds was ranked by Fortune as the fastest-growing financial conglomerate in America. A year later the company was literally no more. Not that Equity Funding blew out after its rookie year, no way, this Company had been around for a lot of years and their fraud continued to scam the public for almost 10 years. We are talking about longevity unknown in the history of financial scandals. And the people, when you are committing a major crime, your best bet is to share your little secret with as few people as possible just in case someone gets a guilty conscience or wants to make a deal. A virtual army of people were aware of what was going on both within and without of company, many regulators have put the number around the century mark.  A number that is literally mind boggling when you consider that this scam operated seven-days a week, on holidays and Sundays and even on Christmas. These folks were among the most dedicated criminals that have ever appeared on the face of the earth. 

A New York Stock Exchange listed company, this company’s regulators had regulators and yet between all of the people looking over their shoulder, they fouled everyone. Maybe what they were doing was so outrageous that the auditors could not even dream that anyone would attempt to get away with such a gross theft. The fraud started slowly. First the customer would buy a mutual fund and then at the end of the year, the fund owner would borrow on some of the fund’s equity and purchase insurance. Theoretically, if the market performed well, the increase in value of the fund’s shares would cover the interest payments on the borrowed money to purchase more insurance.  Nothing really wrong so far but Equity Funding wasn’t bringing enough to the bank with this project so the planning group at the company held a special meeting to try to figure out what they could do to improve their bottom line.

Their first move into penitentiary-ville was to plainly and blatantly overstate the commissions that they were earning on the business that they were writing.  All of the major executives in the company were involved in that decision including the CEO and the CFO. The looked and when they saw that this was good, they made immediate plans to go public on the basis of such solid financial growth.  But these were not sanguine folks and things were not moving fast enough so another special meeting was held and it was determined that the more money that Equity Funding had available, the more it could make. The insiders determined to just plain borrow on non-existent assets. The more the assets the more insurance Equity Funding could write so it was entirely logical to this little band of criminals that they could easily pay back the banks that were funding them from the increased cash flow that the policies would generate.  Conceptually brilliant but this bunch had not counted on either of two things, human nature (the more you want the more you want) and plain old greed. (Why pay back anything when the company could continue parlaying the proceeds?) 

The cohorts then indicated that they were being very foolish, if they didn’t show the money that they borrowed, they could go to other institutions and get money from them as well, yes, what about the stock market.  There is preferred financing and bond financing and equity financing, let’s make plans to do them all and do everyone else while we are doing it.

Why not set the company up to do a mammoth funding and then go straight.  The accountants would have gotten suspicious if the company carried little or no debt so the financial people started disguising the nature of their indebtedness through the use of highly sophisticated transactions activated within the subsidiaries or within the subsidiaries of subsidiaries. Everything that are merry midnight workers had accomplished to this point was really the minor leagues, what sets this company apart is what they did next.  They determined to manufacture insurance polices. If they just issued policies and showed them to the banks and accountants, they could probably borrow a couple of additional bucks but that would take far to much work. What they thought up was literally amazing. They reinsured the imaginary policies and got the insurance company that they had laid them off with to pay them substantial money in front.  Soon everyone was clamoring for Equity Funding’s reinsurance and it was then that the management started putting in 365-day years to keep up with demand.  They had arrived.

Someone came up with a problem. “What if the re-insurers ask to see the application forms or the medical reports on the policies, what are we going to do then? We as I always say, for every problem, there is a solution. The folks at Equity Funding were not only hard workers but they were also quick on their feet. They created a division known within the office as the Maple Hill Gang. The Gang, which was primarily made up of middle-aged women, was made a deal that they couldn’t turn down. As long as no one asks for the backup records for the policies we are inventing, you can party here at the office all day long. We will supply the champagne but remember that you guys are on call for serious counterfeiting should we call on you.  The regulators, accountants and re-insurers were not particularly interested in looking at the backup material for the policies so that for the part, the Maple Hill Gang, drank their champagne, downed their Quaaludes, did their knitting and all in all had a great time. However, on the few instances where they were needed they performed flawlessly.

As technology advanced and as the fraud became more sophisticated, programmers were not only able to randomly create authoritative new policies by computer, but their software guy was also able to have imaginary policy holders die at regular intervals in keeping with historic census statistics. It is interesting to note that the computer seemed to go haywire for a spell, too many people were dying.  The techies traced the problem to four guys that were in business for themselves while working for the company. They would create phony death claims and then try to collect on them. Senior management thought that there stunt was so good that instead of throwing them out the door, they were given a raise and ordered to create a much needed death claim unit for the parent company itself.  These people never got rid of a body that had life in it and were always able to turn a good fraud innovation into a usable corporate product.. 

Toward the end of Equity Funding’s existence, fully 50% of the policies outstanding, 64,000 with a $2 billion face value, were phony, and 70% of those written in the last year were about as good as a three dollar bill ([68]).  Stanley Goldblum, the company’s president when asked how Equity Funding could turn in this sort of performance on a regular basis he stated that, “Quite obviously, this kind of production can only be generated by a professional, thoroughly dedicated group of people.” What a guy. Later, Goldblum, along with twenty of his confederates, either pled guilty of engaging in a crime or were convicted of it.  Goldblum spent some period of time as a ward of the state and soon after he got out he became the chief executive officer of a small chain of medical care clinics. Interestingly enough, literally the day that Goldblum took over the top spot in that company, Seidman & Seidman, Equity Funding’s auditors at the end, submitted their resignation and walked a way from a handsome fee that they had already earned. Goldblum next became the comptroller of Primedex and was once again indicted for fraud relative to that company. Among other things that he was charged with was bilking the State of California out of millions of dollars in what was described as the largest workers’ compensation fraud in state history.

                “Prosecutors charged that the defendants defrauded insurance companies and employers by, among other things, charging for medical services that were never provided, providing illegal kickbacks to doctors and chiropractors, and submitting ghostwritten medical reports.” ([69])  While in court attempting to beat his ongoing State of California rap, policeman nabbed Goldblum, handcuffed him and took him off to jail. It turns out that this arrest had absolutely nothing to do with his workers’ comp fraud. It turned out that he was then arrested for submitting false information and phony collateral in obtaining a $150,000 bank loan. Poor Goldblum; life just isn’t any fun when you are seventy-two years old and keep getting arrested.

Prosecutors were expecting that evidence would prove that the boys had carefully planned every move they had made for years, and that some mad genius had literally structured this colossal rip-off.  However, no such grandiose scheme existed. This was a case of reaction rather that action. When they needed to make more profit, they sat down and thought up magical ways to mystically create revenue. When they needed medical reports and backup material, they formed an entire group that they could call on at a moment’s notice. Everyone kind of pitched in to create phony policies.  Until the end, a good time was had by all.

Moreover, everyone helped to create an environment that could devise foolproof schemes.  Once in a while they kind of got off track. One of the detours makes a rather interesting story and indicates how hit or miss the operation really was. The boys were allocating reinsurance based on the size of the company that was purchasing it, how thorough they would be in doing a background check, and the money that they would receive in exchange for the phony policy. Thus, every re-insurer took its piece of the action, and the computer abused all of the re-insurers based on the predefined formula. One of the senior executives at a re-insurer made an anti-Semitic remark as to which the mostly Jewish staff of Equity Funding took umbrage. They had the  computer reallocate a substantially higher percentage of phony policies to that re-insurer from that moment on.  As the guys used to say at Equity Funding, bigotry can be very expensive. 

The outside auditor compounded the problem early on by bringing in a senior auditor who came with immense baggage. That he was not necessarily all that bright was only the beginning of the story.  His son was on Equity Funding’s payroll; thus, he had an immense conflict. But considering his other problems, this wasn’t the most serious.  He was a big bettor and lost habitually.  When he was broke, he would go to one of the Equity Funding executives for money. His conflicts, his need for money and his lack of understanding of insurance created a perfect scenario of the boys at Equity Funding.  This guy was in their pocket and the outside auditor would not present a problem.

The people from the State were a different matter. Once again, “the boys” got together and came up with a simple and straightforward strategy to cover potential problems. They “wired” the room that the state people were using to go through Equity Funding’s records.  Then, whenever they came across a problem that needed immediate attention, if was not to serious, it would be turned over to the Maple Hill Gang for resurrection. If the problem was more complex and needed the attention of top management, the midnight oil would burn. Thus, Equity Funding, in spite of red flags flying all over the place, was consistently getting great marks from the auditors and the regulators. As we have always said, hard work is the key to success. One of the regulators had indicated that he had felt that Equity Funding possessed the most pre-emptive management relative to problem solving that he had ever seen in the insurance industry. 

There were endless clues about what was going on.  As Lee Seidler of Bear Stearns indicated, the most telling of all was the fact that while sales were growing at a torrid pace, the expenses to produce those sales hardly budged. Seidler made one other statement that is beyond comprehension. Seidler said, “No major fraud has ever been discovered by auditors.”  He says he has repeated this assertion for years and has never been challenged on it.

Well, we can’t end the story without telling how the thieves got caught. There was a guy who had worked been fired from Equity Funding (it took a lot to get fired) named Ron Secrist.  After trying to tell everyone one he knew about what was going on, he found Ray Dirks, an insurance analyst.

Dirks knew insurance cold and flew out to take a look at Equity Funding under the guise of his day job as a security analyst. Dirks was convinced that Secrist was right, and just as Secrist had done before him, reported the matter to literally all of the regulatory people that would listen. In the meantime, Dirk’s called his top clients and started dumping the stock.

As the stock started to collapse, the SEC stepped in and confirmed for themselves what they had been told by both Dirks and Secrist. That was the beginning of the end of the story as far as Equity Funding was concerned, but as far as Dirks was concerned, it was only the beginning. The SEC didn’t listen to Dirks at the beginning, but decided that he had committed various securities crimes by calling his people and having them sell. They mumbled something about inside trading, but by this time, Dirks had published just about everything there was regarding Equity Funding and was certainly not dealing in a vacuum. Eventually, the case went all the way to the Supreme Court, which found for Dirks and suggested that the SEC did not really understand their own regulations.

Shareholders lost hundreds of millions of dollars when Equity Funding collapsed; as a matter of fact the market value of its stock diminished by $15 billion just in the week that the scandal became public. Goldblum served only a tad more than four years in jail and his compatriot, Levin only got 30 months. Levine may have been helped by his impassioned plea to the court on the eve of his sentencing, “Someday when this nightmare is over, I will conduct myself in a highly ethical manner which hopefully will repay for some of the crimes and fraud I committed.” ([70]). As we discussed earlier, Goldblum when released from prison didn’t take long to once again turn back to his criminal ways. After the speech that Levin gave you would not of though him capable of that kind of action. You’d have been wrong if you agreed. Believe it or not, soon after Levin’s release from jail, he was back in business running a small plastics company. It wasn’t too long after he had started to live the puritanical life that he told the court about when Levin was once again arrested, this time for stealing $250,000 from his own company’s pension fund. His indictment charged Levin with literally dozens of counts including forgery.     

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