Opening

When you think of high-growth companies, you probably don’t think of life insurance. But Equity Funding Corporation of America was the exception. The company reported strong growth for nearly a decade, culminating in a record profit in 1973.

But just a few weeks later the firm imploded. It seems the company wrote insurance policies for people who didn’t exist, and it wrote so many fake policies that the fraud wouldn’t have been possible but for a relatively new invention: the computer.

I’m Michael McLaughlin, and this is Scheme.

The founding of Equity Funding

Equity Funding was founded in 1960 in Los Angeles, and it went public in 1964. But before we discuss the company, we need to talk about its eventual president: Stanley Goldblum. Goldblum was born in Pittsburgh in 1927, but his family later moved to L.A. He attended several colleges, but not long enough to get a 4-year degree. Goldblum’s real passion was weightlifting, and he got a job doing physical labor at his father-in-law’s meatpacking plant to pay the bills. But Goldblum had higher ambitions, and he took a job selling life insurance for Gordon McCormick in 1958.

Innovative life insurance

Very few people get excited about buying life insurance, but McCormick had come up with an innovative idea: he convinced people to buy a mutual fund, and then borrow against the mutual fund to pay the premiums on a life insurance policy. As long as the mutual fund earned a higher rate of return than the interest rate on the debt, the customer wouldn’t have to pay a single dollar for the life insurance policy. But if the mutual fund performed poorly, the customer wouldn’t have the money to pay the interest on the loan. Either way McCormick and his sales team made money; they received commissions for both selling the mutual fund and selling the insurance policy.

This was the idea that Equity Funding Corporation of America was based on. But before Equity Funding got started, McCormick was ousted by four members of his team. Two of these partners left the firm within a few years, and the third died in a mudslide. The fourth and last partner was Goldblum, who was now in control of the company.

The fraud unravels

In the beginning, Equity Funding was just a sales company. Goldblum’s staff pitched other company’s products and received a commission. But when the company went public in 1964, Goldblum tried hard to meet earnings targets so he could grow the firm and keep the stock price high.

He tried to transform Equity Funding into more than just a sales company by purchasing life insurance companies and creating mutual fund products. Equity Funding then encouraged customers to buy 10-year bundles of its life insurance and mutual funds, telling them they would not only get life insurance but make a profit. But this sales pitch wasn’t enough to hit the profit targets

Goldblum wasn’t about to dial back investors’ expectations, as he’d made millions of dollars and bought himself $100,000 of weightlifting equipment. Instead, Goldblum decided it was time to get creative.

Details of the fraud

Goldblum realized that Equity Funding could never reach the sales targets; it simply couldn’t sell enough policies. So Goldblum directed his staff to create fictitious policies. For example, they might say that Lucy Smith bought a mutual fund and a life insurance policy, when there was no Lucy Smith…they just made the name up.

This required a massive amount of paperwork; they needed to create fake bank statements, fake purchase confirmations for the mutual funds, and fake insurance policies. These fake documents fooled the auditors and created the illusion of profitability. They also allowed the company to tap bond markets for funding and acquire other firms.

The fraud accelerates

But Equity Funding needed cash, not just fake profits; the fraud had to go deeper. Goldblum had employees sell the fake policies to reinsurance companies. Reinsurance companies buy policies from insurance companies, so that the original insurer can reduce their risk; the reinsurer receives the premiums and bears the risk of a payout. Of course Equity Funding wasn’t interested in reducing risk as these weren’t even real policies. It just wanted to get cash, and it sold $2 billion worth of policies.

While this provided Equity Funding with cash, there’s a huge catch. Those reinsurance companies expect to receive premiums from the customers…and the customers don’t exist! Equity Funding thus needed cash to pay the premiums, so it sold even more fake policies.

Dozens of employees were now involved with creating the fake policies, but it became too time-consuming for them to handle. So they turned to computers…mainframe computers made it a lot easier to create the 60,000 fake policies.

But this was still not sustainable; all those premiums add up, and Equity Funding couldn’t continue the payments forever. Thus, it started killing off its customers

It didn’t kill real customers, just the fake customers. It told the reinsurance companies the fake customers had died. This meant Equity Funding no longer had to pay the premiums, and it provided an added bonus; it received the life insurance proceeds from the fake person’s death.

The fraud is discovered

This fraud went on for years. But in 1973, a former employee named Ronald Secrist told Ray Dirks about the fraud. Dirks was a financial analyst for the insurance industry, and he told some institutional investors the bad news. They dumped their stock, and Dirks was charged with insider trading. The case went to the Supreme Court, and Dirks was found not guilty.

But back to Equity Funding: the Illinois Insurance Department did a surprise audit, and found $20 million of bonds didn’t exist. This tipped off other states’ insurance regulators and before long the government was all over the company.

You might think the executives at Equity Funding would realize the gig is up at this point. But they decided to double-down on their bad behavior. They installed electronic listening devices in their offices so they could eavesdrop on the conversations of the state insurance regulators. They wanted to know what the regulators were saying, so they could adopt countermeasures.

But it didn’t matter; there was just no way to hide all those fictitious policies. Pretty soon the SEC, the FBI, and even the Postal Inspection Service all were involved. And you know how it is: once the postal inspectors get on your case, you’re done.

 Aftermath

Equity Funding eventually settled with the SEC. It didn’t admit to doing anything wrong, but agreed to stop its behavior in the future.

It seems the company got off pretty light, but not really. First, the company went bankrupt; it’s whole business model was predicated on lies, so this shouldn’t come as a surprise. Second, the government indicted 20 people who worked at Equity Funding, including Stanley Goldblum. The government even indicted two of the external auditors.

Most of these people pled guilty, but Goldblum decided to fight the charges. Goldblum was worth $25 to $30 million, so he could afford to put on a high-powered legal defense. But in the middle of his trial, Goldblum surprised everyone by taking a plea deal. He pled guilty to conspiracy and fraud, and was sentenced to 8 years in prison.

Goldblum probably thought he had no chance to win; after all, he tried to sell $900,000 of shares just one day before the New York Stock Exchange stopped the company’s trading

Wait, there’s more…

But this isn’t the end of the story. Goldblum got out of jail 4 years later… and you would hope he learned his lesson. But no.

Goldblum ended up in court again after serving as a consultant to Primedex, a group of workers’ compensation clinics that was accused of faking injury claims, money laundering, and tax fraud. And while that case was in progress, Goldblum was arrested for lying about his assets to get a $150,000 loan. He told the lender he had $900,000 in securities, but they were really worth $300.

Goldblum died in 2011, so we’ll never know whether he was a very unlucky person who constantly got caught up in frauds or whether he really was a con artist…

Okay, I’m pretty sure we know the answer to that.

Takeaways

So how did this happen? And how did they get away with it for so long? After all, the majority of this company’s business was a scam.

In my opinion, several factors allowed this fraud to take place. First, there was an audit failure. The fact that two auditors were criminally charged means they didn’t bring a whole lot of objectivity to the audit. Second, the reinsurers clearly didn’t know what they were buying. I know this was the pre-internet days, but there must have been some way to verify that the policies they were buying belonged to actual people.  For example, when the fake policy holders died, they could have checked the newspaper to see if there was an obituary. Third, Equity Funding did business in multiple states, each of which had a regulatory agency for insurance companies. If the auditors were corrupt and the reinsurers were naïve, we should have still been able to count on the regulators to notice that there was something funny about all these policies.

How did so many people fail to catch this fraud?

I’ve thought a lot about why so many groups failed to catch the fraud, and I think it comes down to this:

To create 60,000 fake insurance policies, with all the supporting documentation, is a MASSIVE undertaking. And then to pay out all the premiums, start faking people’s deaths… this type of fraud would require 50 or 100 employees. And most frauds don’t involve such large numbers of people; you often have a small group of executives, or sometimes a rogue employee. To coordinate dozens of people on a fraud over a period of years is difficult; all it took was one person to snitch out the group, and it was all over. And this is ultimately what happened.

I think no one suspected an entire company could be corrupt, from the president on down.

It was so corrupt that when Stanley Goldblum caught three of his employees embezzling money in a separate fraud, he responded by INCREASING their salaries, because he knew they were critical to the main fraud and didn’t want to upset them.

So maybe the lesson here is that people, even large groups of people, can do surprisingly bad things when there’s a culture of dishonesty at an organization. If regulators, auditors, and customers don’t exercise an appropriate level of skepticism, a lot of people could end up getting burned.

Because there are people like Stanley Goldblum who are willing to do just about anything to make money…Hey, weightlifting equipment is expensive.

References

SEC documents:
https://www.sec.gov/news/digest/1973/dig110273.pdf
SEC charges firm with fraud (April 4, 1973)
https://www.nytimes.com/1973/04/04/archives/insurance-fraud-charged-by-sec-to-equity-funding-difficulties-were.html
Executives indicted (November 2, 1973)
https://www.nytimes.com/1973/11/02/archives/22-indicted-by-us-inequity-scandal-goldblum-former-chairman-heads.html
President and Chairman pleads guilty (October 9, 1974)
https://www.nytimes.com/1974/10/09/archives/goldblum-enters-equity-guilt-plea-move-by-former-chief-on-5-counts.html?_r=0
Background on Stanley Goldblum:
https://www.nytimes.com/1973/04/21/archives/associates-find-goldblum-is-not-too-easy-to-know-100000-salary-an.html
https://www.latimes.com/archives/la-xpm-1995-11-02-fi-64042-story.html
https://www.latimes.com/archives/la-xpm-1999-feb-17-fi-8769-story.html
Crazy story about an additional fraud going on at Equity Funding:
https://www.nytimes.com/1974/10/03/archives/gold-blum-accused-of-classic-fraud-at-equity-fudding.html
Contemporary Auditing Issues and Cases, by Michael C. Knapp. Case 5.6 Equity Funding Corporation of America:
https://web.archive.org/web/20161221161835/http://sjjx.znufe.edu.cn/jxzy/aljx/200704/P020070429018677265387.pdf
Called to Account: Fourteen Financial Frauds that Shaped the American Accounting Profession, by Paul Clikeman (2008).
https://books.google.com/books?id=vZ-RAgAAQBAJ&pg=PT92&lpg=PT92&dq=stanley+goldblum+%2B+meat+packing+plant&source=bl&ots=ilyU0IV8OW&sig=ACfU3U18F_FUZV8ts-9_K5LMAjeU2CiVxA&hl=en&sa=X&ved=2ahUKEwj336Ov8pjqAhVKLKwKHYjqAR8Q6AEwAHoECAoQAQ#v=onepage&q=stanley%20goldblum%20%2B%20meat%20packing%20plant&f=false