Mainframe: Madoff-size Money, Monstrous Misapplication – LOOP

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Equity Funding Corp Certificate

In the early 1960’s, Stanley Goldblum created Equity Funding Corporation of America, also known as EFCA. In 1964, EFCA, under the direction of Goldblum, began to create fictitious entries, to make the company look good to investors.

The Way

What happened next was a natural progression of Goldblum’s “always thinking ahead” philosophy. It had occurred to him that he needed to come up with “actual” sales to back-up the financial figures, in order to pass muster with the independent audit required by the Securities and Exchange Commission of public companies like EFCA. It was then that he got the idea of producing fake policies by a hand-picked team of trusted employees working overtime after hours. To help the hired hands handle the increased workload, a legendary in-house tradition was launched, a midnight fringe benefit party known as “file folder forgery”.

How Reinsurance Provided Revenue

In addition, the role of reinsurance played a big part in Goldblum’s plan. Reinsurance is the insurance industry’s internal business of spreading risk and profit between more than one insurer. The way it works is relatively simple; Company A re-sells a percentage or a portion of the policies on its books to Company B and/or Company C. Doing so has the immediate effect of generating cash flow on an annualized basis and further mitigating against what could be a catastrophic event, concurrent and/or consecutive claims adversely affect the company’s bottom line and effectively affording it assurance against bankruptcy.

Goldblum: Image courtesy of the Federal Bureau of Investigation

EFCA issued fictitious policies in order to put them on the books to back the actual accounting entries. The company then turned around and sold the fake policies as legitimate policies to reinsurance companies. EFCA then used the income money to pay a portion of the fake policies’ first year premiums, making the sales results appear all the more real to the auditors, who dutifully prepared financial report and statements. It wasn’t long before EFCA’s earnings per share increased, and its stock prices sky rocketed. Virtually overnight, Wall Street embraced Equity Funding as its wunderkind.

Mainframe Computing Automates Fraud

In 1968, Goldblum gathered his cohorts in the conference room on the 28th Floor of EFCA’s home office to announce two things, a problem and its solution. Making up new business manually by hand to put on the company’s books was too time consuming a task. He had come up with another way – their IBM manufactured mainframe. Goldblum had been fascinated by it from the beginning. It was intimidating even to him. Yet there was something about it that inspired trust. Who, he asked, was going to question a computer, with all its bells and whistles and blinking lights? Plus, he assured all, the accountants and auditors were afraid of its abilities.

In the late 1960s and early 1970’s, accountants didn’t have the know-how to audit computer systems. In addition, IBM had a 95% market share of computer hardware and software, and protected its proprietary intellectual property akin to King Midas hoarding his gold. The initial mainframe manufacturers were known collectively as “IBM and the Seven Dwarfs”: IBM, Burroughs, UNIVAC, NCR, Control Data, Honeywell, General Electric and RCA. After a while it was shortened to “IBM and the Bunch”. IBM’s 700/7000 of mainframes dominated the market. EFCA’s “money machine” was an IBM model 704 mainframe.

Stanley Goldblum and Equity Funding were able to get away with their shell game because nobody understood computers. Back then, personal computers were just a gleam in the eye of Don Estridge, the father of the IBM PC model 5150. Computers were great big whirring machines that took up an entire floor in an office building. Only a select few knew how to operate them, and everyone believed in what the computer came up with and printed out. Programming was the key, and whoever was in control of the programs was king. Goldblum paid a computer programmer to write a program that generated fake policies with access to the IBM mainframe restricted by a complex password known only to EFCA’s executives. Thus commenced the mass production of computerized records which calculated the financial health of EFCA under a confidential code called “Class 99”.

At the end of 1968, Equity Funding’s financial statements showed $425 million worth of life insurance policies and $100 million in mutual funds sold. From 1969 to 1973, EFCA created 64,000 bogus records which were used to create reported revenues of $1.8 billion dollars. Then, almost as to add insult to injury EFCA executives came up with what they called the “Cookie Jar Caper”, where deaths were reported on a few past fake policies in order to collect on the reinsurance firms’ death benefits. At the time the ruse was revealed, it was rumored EFCA had developing a new program which would “kill off” phantom policy- holders on a regular basis without arousing the suspicions of the reinsurers.

Sources:

• Clarke, Tom. The Billion Dollar Bubble. (1978). © British Broadcasting Corporation

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• 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.

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• Soble, Ronald L. & Dallos, Robert E. The Impossible Dream: The Equity Funding Story; The Fraud of the Century. (1975). © G. P. Putnam’s Sons.

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• 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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