Mainframe: Madoff-size Money, Monstrous Misapplication – LOGOFF

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Wall Street Scam by EFCA: Image courtesy of NASDAQ

Stanley Goldblum created Equity Funding Corporation of America in the 1960’s. The company combined an IBM mainframe to falsify accounts in bulk, and increased funding through a reinsurance scheme,  to perpetrate fraud on a vast scale.

The End of the Swindle

Equity Funding Corporation of America was the talk of the town in Los Angeles and the toast of the town in New York City. Stanley Goldblum was touted as both the brains behind a business that was the best of the best, and the brawn. He was, in fact, a six-foot-three-inch body building fanatic, and applied the same drive to the expansion of his business.

According to an article in Forbes magazine, EFCA hired 150 new employees each and every month. Fortune magazine called EFCA the fastest growing financial company in the country.

After all, the Equity Funding story was the stuff dreams were made of. Record breaking results were regularly reported to the private and public sectors, repeatedly startling EFCA’s rivals in the insurance and investment industries. By 1972, EFAC stock was being traded at $28 per share with $500 million in assets and pre-tax earnings of $26 million. Goldblum couldn’t resist rubbing it in, when he remarked to the reeling competition with a well-circulated comment about Equity Funding’s sales success; “Quite obviously, this kind of production can only be generated by a professional, thoroughly dedicated group of people”. One year later in January of 1973, EFCA executives claimed to manage assets of one billion dollars, an unbelievable achievement.

Equity Funding Scam Crumbles

Of course, unbeknownst to the competition at the time, Goldblum was covering up a colossal computer-generated con. Three months later, in the spring of 1973, the pyramid crumbled. If it weren’t for a whistle blower, Ronald Secrist, an ex-EFCA employee and Ray Dirks, a security-selling analyst with registered broker-dealer and research firm Delafield, Childs, Inc. the deception might have continued for years. After it was discovered, it took Touche Ross two years to confirm that EFCA’s business was one big confidence game. It was the first case where accountants had to audit a computer. As the result of an investigation by state and federal authorities, EFCA became known as the “Wall Street Watergate”.

EFCA Stock and Bond Certificate: Image courtesy of Scripophily

The flimflam was so fantastic, that everyone wondered who was at fault and how it had happened. Eye-opening was the finding that when the conglomerate collapsed, more than half of the business on its books was bogus. Further, it was missing assets valued at $100 million and had a negative worth of $50 million. About 10,000 individual and institutional investors lost in excess of $300 million, and a dozen reinsurers were left holding the bag with $1.8 billion dollars in losses. Mindboggling was the calculation that if the criminal enterprise had been allowed to continue unabated to the end of the 1970s at the same rate of fraud, its purported assets would have surpassed the gross national product of the planet and it could have claimed the citizens of every civilized country as its clients.

The failure of EFCA cost the accounting, auditing, insurance and investment business and industry credibility with their clients, and caused class action suits by shareholders and stockholders to occur. Robert Loeffler was the court-appointed attorney picked by U.S. District Court Judge Harry Pregerson on April 10, 1973 to “reorganize and rehabilitate” EFCA. He stated, about midway through the job: “I don’t know how many lawyers there are in the U.S., but I’m sure half of them are involved in this case”. Accounting and audit companies would end up paying out $44 million dollars to settle claims against them after EFCA’s crash.

Equity Funding’s burst bubble changed the way the CPA firms audited clients, and the case is taught in every auditing class as what constitutes crime. CPAs consider the EFCA house of cards the event that prompted creation of “standards” in accounting, so as to avoid the cooking of books by a company. One of the most common forms of computer crime, since the start of electronic data processing, is “data diddling” – unauthorized data alteration. Reporter Robert Cole wrote in The New York Times on April 15, 1973; “Those closest to (the scam) were believed to have cleverly concealed their tracks through the use of doctored computer tapes”.

Even the computer, almost considered an alien life form back then, became a suspect. EFCA’s mainframe had automated the fakery, which many felt was an inhuman intrusion upon industry. It was the first case of fraud where fault came to center on the conjecture that “the computer did it”. The finger-pointing caused an early expert to explain to The New York Times, that accusing a computer system was “like blaming pencils for all the swindles that happened before”.  Another egghead acknowledged “it’s easy to think of dollars and cents in terms of bits and bytes” and “a computer crunches numbers, that’s its job
description”.

Central Processing Units have had bugs, bullies and bums since then, but it’s tough to think  about the bugaboos EFCA and Goldblum and his bandits would have brought to bear with today’s technologies. To say that Goldblum and EFCA were ahead of their time is unthinkable in the high-tech times of today.

Sources:

Clarke, Tom. The Billion Dollar Bubble. (1978). © British Broadcasting Corporation
Gross, Leonard & Dirks, Raymond L. The Great Wall Street Scandal. (1974) © McGraw Hill.
Hancox, David R. Could the Equity Funding scandal happen again? Auditors need to guard against the scenario that led to one of auditing’s darkest hours. (1997). © Internal Auditor.
Kabay, M.E. The Equity Funding Fraud. (2002). © Network World Security Newsletter.
Kabay, M.E. Use of Computers in Crime. (2003). Bidgoli, H., editor. Encyclopedia of Information Systems, Volume 1. © Academic Press.
Keough, Howard R. An Inside Job. (1989). © American Society for Industrial Security.
Seidler, Lee J. & Epstein, Marc J. & Andrews, Frederick The Equity Funding Papers: The Anatomy of a Fraud (1977). © Wiley.
Senft, Sandra & Manson, Daniel P. & Gonzales, Carol & Gallegos, Frederick. Information Technology Control and Audit. (2004). © Auerbach Publications.
Soble, Ronald L. & Dallos, Robert E. The Impossible Dream: The Equity Funding Story; The Fraud of the Century. (1975). © G. P. Putnam’s Sons.
Trumbore, Brian. Ray Dirks and the Equity Funding Scandal. (2004). © Stocks and News.
Wells, Joseph T. Frankensteins of Fraud. (2004). © Obsidian Publishing Company.
Zigler, Brad. The Felon Index: Valhalla of the Vile. (2002). © Registered Rep.

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