Scheme Scheme is a podcast about accounting fraud. Not run-of-the-mill fraud like passing $200 of bad checks, but large-scale frauds involving millions of dollars that ruined people’s lives. Each episode discusses how a fraud was carried out, and what we can learn from it. Scheme is created and produced by Michael McLaughlin, an accounting professor and creator of Edspira. Thu, 10 Nov 2022 15:38:36 +0000 en-US hourly 1 Blubrry PowerPress/9.7.3 Scheme is a podcast about accounting fraud. Not run-of-the-mill fraud like passing $200 of bad checks, but large-scale frauds involving millions of dollars that ruined people's lives. Each episode discusses how a fraud was carried out, and what we can learn from it. Scheme is created and produced by Michael McLaughlin, an accounting professor and creator of Edspira. Michael McLaughlin clean episodic Michael McLaughlin (Michael McLaughlin) © Michael McLaughlin & Edspira Scheme is a podcast about accounting fraud. Not run-of-the-mill fraud like passing $200 of bad checks, but large-scale frauds involving millions of dollars that ruined people's lives. Each episode discusses how a fraud was carried out, and what we can l Scheme TV-G Monthly Episode 10: Take-Two Interactive Software Mon, 29 Mar 2021 18:15:43 +0000 Take-Two Interactive was forced to restate its financials 3 times in a span of just 5 years. Each time you thought it was over, Take-Two ended up in the news again. And the company’s founder was right in the middle of it.


Grand Theft Auto is one of the best-selling video games of all time.  If you’ve never played it, it’s a unique experience.  You can do almost anything – change the radio station while you’re driving, go scuba diving, or enjoy a night at the movies.  But you can also kill prostitutes and police officers.  This has made Grand Theft Auto the poster child for violence in video games.  The company that makes the game, Take-Two Interactive, has been criticized for inspiring school shooters and mass killings.

But this episode isn’t about violence in video games.  It’s about the violence that Take-Two did to its financial statements.

Take-Two was forced to restate its financials 3 times in a span of just 5 years.  Each time you thought it was over, Take-Two ended up in the news again.  And the company’s founder was right in the middle of it.  Would the guy behind Grand Theft Auto get sent to prison?

I’m Michael McLaughlin, and this is Scheme.


Ryan Brant founded Take-Two Interactive Software in 1993 when he was just 21.

Take-Two later acquired Grand Theft Auto from another company, and it created a subsidiary called Rockstar Games to produce a whole series of Grand Theft Auto games.  Those games have been very successful.  Grand Theft Auto III was the best-selling video game of 2001.  I still remember playing it on my PlayStation 2… speeding down the streets of Liberty City with the radio blaring while the cops chased me.

I wasn’t in college at the time, so I didn’t know anything about accounting.  I had no idea the company’s accounting was more lawless than the game itself.

Now Ryan Brant wasn’t just the company’s founder; he was also the CEO, and he got paid a lot more money if the company met its earnings targets.  Giving a CEO bonuses for hitting profit targets is a good idea in theory, as it gives the CEO an incentive to improve the company’s performance.  But it also gives them an incentive to lie, cheat, and do whatever it takes to hit the target.

And that’s exactly what happened here.

Grab some popcorn and put your feet up, here comes the unethical behavior.

The first restatement

To boost sales, Take-Two engaged in hundreds of so-called “parking transactions.”

Here’s how this works:

Take-Two shipped product to distributors and asked them to hold it for a while.  Then after the quarter was over and Take-Two had hit its sales target, the distributors would return the product.  That’s why it’s called a “parking transaction.” Take-Two parked its inventory with the distributor for a little while – but it didn’t actually sell the inventory, since the distributor was just going to return the games the next quarter.

Clearly these were bogus sales.

Now you might be wondering, “Why would Take-Two pay to ship the games out and then pay to have them shipped right back?” Why not just write up a fake invoice?  It’s because Take-Two needed to create the illusion that these were real sales.  If the auditors asked for proof that these were actual sales, Take-Two could show them evidence that the games had been shipped out.

But what happens when the distributor returns the games the very next quarter?  If the auditors see a massive amount of returns, they’re going to get suspicious.  This is where Take-Two got really creative.  When the distributors returned the product, Take-Two didn’t record a return.  Instead, they treated it as a purchase of inventory.  All these games that arrived in the mail today aren’t returns, they’re the new shipment of inventory we’ve been expecting.  Pretty clever, right?

But Take-Two didn’t want to limit itself to just one type of fraud.  It improperly accounted for two acquisitions to boost profit by $20 million.  And in some cases, it recorded sales when production hadn’t even been completed.

Because of all this fraud, Take-Two met its earnings targets for every quarter in 2000.  Brant and the other executives got their bonuses.

So how did they caught?

Well, someone pointed out that Take-Two was reporting a lot higher figures for game sales than the figures being reported by retailers.

The SEC launched an investigation, and Take-Two had to restate its earnings in 2002.  Ryan Brant had resigned from being CEO a year before, so he couldn’t be fired.  But he remained chairman of the board.  Thus, I don’t think the company didn’t take the fraud that seriously.  But it definitely should have… because it was about to happen again.

The second restatement

In 2004, the SEC forced Take-Two to restate its financials again.  The company was forced to remove 88 sales that had inflated revenue.  It had also failed to set aside enough reserves for price concessions it granted to customers.  The bottom line is that the company overstated profits for 9 out of 15 quarters between 2000 and the third quarter of 2003.

Brant and Take-Two settled with the SEC, paying $11 million in fines.  Brant resigned as chairman, so you’d think we’re all done with this… but no.

The third restatement

In 2006, the Wall Street Journal blew the lid on a huge scandal.  Executives at hundreds of firms had been backdating their stock options.

Here’s how backdating works:

A stock option gives you the right to buy a stock at a certain price.  Companies typically set that price, which is called the strike price, to be the same as the stock price on the day the option was granted.  If a company gives its CEO an option on December 31 and the stock price on December 31 is $50, then the company would set the strike price to be $50.  This makes the intrinsic value of the option zero.  If the CEO exercised the option immediately, they wouldn’t make any money.

But what if the CEO looked back over the past year and saw that the stock price reached a low of just $32 on June 15?  A dishonest CEO could change the grant date of the option to make it look like the option was really granted back on June 15 when the price was just $32.  The strike price would then be set at $32, instead of the current price of $50.  The CEO is now getting an “in-the-money” option; they have the option to immediately buy a $50 stock for just $32.

The SEC investigated more than 140 companies for options backdating, and of course Take-Two and Ryan Brant were right in the middle of it.  Brant had been backdating options for years, making millions in the process.  But that’s not the only adverse effect of backdating options.  Because you’re giving out in-the-money options but pretending like they’re not in-the-money, you’re understating stock compensation expense.  And this overstates the company’s profit.  Thus, Take-Two had to restate its financials a third time, having inflated profit by $42 million from 1997 to 2005.

But this time things went different for Brant… This time he got charged with a crime

Criminal Conviction

Now you might be surprised to hear this, but backdating options is perfectly legal.  It’s failing to disclose that you backdated options which is illegal.  Take-Two is a publicly-traded company, and Brant had lied to its investors… that’s why he got charged with a crime.

Brant didn’t want to take his chances with a jury, so in 2007 he pled guilty to “falsifying business records.”  So do you think he’ll get sentenced to prison?  Nope.  Despite all the accounting tricks, Brant was sentenced to just 5 years of probation.  He did have to pay a $1 million fine, and another $6.3 million to settle a civil case.  And the SEC banned him from serving as an executive at a publicly-traded company.  So Brant did get punished.  But all things considered, I think he got off pretty easy.


Brant’s days of accounting fraud were over, but he did make the news again.  In 2017 he stiffed a nonprofit on a $70,000 painting that he’d won at an auction.  The nonprofit, which was run by a member of the Kennedy family, Anthony Shriver, kept asking Brant for the money.  Brant wrote several checks, but they kept bouncing.

When The Miami Herald ran a story about it, Brant said, “I did buy a painting in an auction that year, but I don’t remember if I paid. I think I did.  And I don’t know no Anthony Shriver.”  That sounds like the something a character in Grand Theft Auto would say.


I’ve thought about Brant and the fraud at Take-Two for weeks, because I still don’t understand why it happened.  The company wasn’t struggling, and it sold lots of video games.

But that wasn’t enough for Brant, and he kept cutting corners to make more money.

I don’t get this, because Brant came from a very wealthy family.  He clearly didn’t need the extra cash.  His dad, Peter Brant, was a billionaire at one point.  Peter Brant published magazines, produced films, and married a famous supermodel Stephanie Seymour.  Maybe Ryan wanted to have the same lifestyle as his dad?

Brant died in May of 2019 at the age of just 47 due to cardiac arrest.  Grand Theft Auto lives on, however, and it’s as popular a game as ever.

Maybe the next Grand Theft Auto will be about a guy who commits accounting fraud again and again but never has to go to jail.


SEC press release / settlement
SEC complaint (covers the first 2 restatements)
2009 SEC press release – backdating options
2009 SEC complaint – backdating options
Most recent 10-Q filing (quarter ended 9/30/20)
Most recent 10-K (year ended 3/31/20):
How ex-auditor missed the fraud (2008 article)
Former CEO sentenced for options backdating
Other executives settle backdating:
Summary of options backdating scandal
Take-two adjusts non-GAAP earnings for deferred revenue (2019)
Strauss Zelnick and his management company took over after the 2007 accounting scandal:
Electronic Arts offers $2 billion to buy Take-Two (Take-Two didn’t accept b/c it wasn’t enough)
2002 – Take-two restates its financials for 2000 and 2001
Great history of the various Take-Two frauds (as of 2005):
Founder Ryan Brant dies from cardiac arrest at age 47:
Grand Theft Auto V
Grand Theft Auto and school shootings
How Grand Theft Auto changed gaming
Brant pleads guilty for backdating options
Options backdating scandal
Take-Two Interactive was forced to restate its financials 3 times in a span of just 5 years. Each time you thought it was over, Take-Two ended up in the news again. And the company’s founder was right in the middle of it. Take-Two Interactive was forced to restate its financials 3 times in a span of just 5 years. Each time you thought it was over, Take-Two ended up in the news again. And the company’s founder was right in the middle of it. Michael McLaughlin clean 9:59
Episode 9: Cobalt Family Investors Tue, 12 Jan 2021 16:35:50 +0000 The story of Cobalt involves a former associate of the Wolf of Wall Street, and a Ponzi scheme run by a convicted fraudster. Then, Donald Trump got involved.


It’s 2006, and you just received a phone call about an exciting opportunity in real estate development.  A company called Cobalt has been acquiring, developing, and marketing residential properties for decades, and it’s looking for new investors.  Under the leadership of CEO William Foster, the company has acquired several well-known hotels in Miami.  Some of the properties have earned returns as high as 204%!

It’s a great story…too bad none of it is true.

William Foster isn’t running the firm, and the company doesn’t own those hotels.  In fact, the company hasn’t made a single dime.

The real story of Cobalt is much darker…

It involves a boiler room run by a former associate of the Wolf of Wall Street, and a Ponzi scheme run by a convicted fraudster.  It’s a crazy story, I know.  But then Donald Trump got involved.

Hang tight, this episode is going to get ugly.

Background – Mark Shapiro

Its brochures said the company had been in business for decades, but Cobalt Multifamily Investors was in business for just two years.  Headquartered in Massachusetts, Cobalt was started in 2004 by 45-year old Mark Shapiro.  Cobalt said he was just a consultant, but Shapiro actually ran the company.

So why didn’t Shapiro just acknowledge that Cobalt was his company?  Well, he had a bit of a shady past…here’s the backstory.

In 1998, Shapiro pled guilty to bank fraud and conspiracy to commit tax fraud.  He’d defrauded a bank out of millions in loans, kept a phony set of books, and failed to report income to the IRS.

Now Shapiro later tried to back out of his guilty plea, claiming he was innocent, and that he’d only pled guilty to stop the feds from indicting his wife.  But Shapiro’s request was denied.  As it turns out, it’s not illegal for the government to pressure you to plead guilty by threatening to prosecute a family member.  It’s only illegal if the government has no legit reason to prosecute that person.  Shapiro’s own lawyer told him that his wife was implicated in the scheme.

In any case, Shapiro was sentenced to 2.5 years in prison and ordered to pay $350,000.  He tried to get his sentence reduced by snitching out an employee of the bank he’d defrauded.  Shapiro was supposed to call the employee and get him to admit that he participated in the scheme while the feds listened in on the call.  But the FBI insisted that Shapiro make the call from their offices in Connecticut.  This made the bank employee suspicious, as he didn’t recognize the number on the caller ID when Shapiro called him. So the FBI dropped the ball on that one.

Background – William Foster

So Shapiro couldn’t get out of going to prison.  And when he got out and started Cobalt, he needed to keep his dark past a secret.  But this meant he needed someone to be the front man, to pretend to be the CEO. That man would be 64-year old William Foster.

Foster didn’t know how to run a real estate firm, but he was a loyal friend. Foster had visited Shapiro back when he was in prison. Shapiro now rewarded that kindness by making Foster “CEO in name only.” What a great job.

So we’ve got a fake company with a fake track record and a fake CEO…

But we’re still missing a key component: fake or not, the company needed money!

Shapiro decided Cobalt would get that money by offering people an opportunity to invest. Shapiro placed ads in newspapers and magazines, and handed out glossy brochures at business networking events. But it wasn’t enough; Shapiro needed to kick things up a notch…

So he hired the sleaziest person he could find to start a boiler room.

Background – Irving Stitsky

49-year old Irving Stitsky was the perfect candidate.  He had worked for the notorious boiler room Stratton Oakmont in the 1990’s.  If that name doesn’t ring a bell, it’s the brokerage firm that was co-founded by Jordan Belfort, the so-called “Wolf of Wall Street.”  Stratton Oakmont had manipulated the price of penny stocks in pump-and-dump schemes, with the Wolf of Wall Street eventually going to prison.  They would tell clients things such as, “who wears the pants in your family?” or “Bill Gates and Warren Buffet are going to invest, you’ve got to get in.”

Stitsky thus learned high-pressure sales from the best in the business. But these tactics got him banned from associating with securities dealers & investment firms.  But that didn’t stop Stitsky.  After leaving Stratton Oakmont, he got involved in another scheme.  But this time he got in even more trouble.  He pled guilty to conspiracy to commit securities fraud & got 21 months in jail.

The SEC again banned him from being involved with broker dealers.  But then Shapiro found Stitsky.  Shapiro put him in charge of fundraising, and told him to find investors for Cobalt.  Stitsky set up the boiler room in New York and got to work, making tens of thousands of phone calls across the country.  He promised the sales staff 9% of whatever money they brought in, and he gave them strict instructions not to reveal Shapiro’s involvement.  They didn’t want investors to know the guys running the company had recently been convicted of fraud.  After all, Cobalt was committed to “high ethics in all its business dealings.” I’m not kidding, their brochures actually said that. 

The Fraud Develops

So the boiler room was successful; the sales staff raked in millions from investors.  And they did this with lies.  They said Cobalt was run by people who had managed $2 billion in real estate.  They said Cobalt bought Miami’s Simone Hotel, and that its value had since doubled.  And they told investors they’d receive an 8% annual return.  Every one of these statements was a lie.

Cobalt showed investors a portfolio of more than 50 properties it had supposedly acquired and sold, with returns ranging from 9 to 204%.  But in reality, Cobalt owned just a handful of properties, and it had defaulted on its mortgage payments.  So this raises the million-dollar question: what happened to investors’ money?

What Cobalt Really Did with the Money

Well, most of the money was siphoned away through excessive fees.  Cobalt said it took a 9% “acquisition fee” from each investment.  In reality, it took up to 20%.  It did the same thing with its 9% “sales compensation” fee.

Some of the money went to boiler room and its leader, Stitsky.  But the one who profited the most was Shapiro.  He received at least $2.6 million of investors’ money.  Shapiro used it to pay his credit card bills, buy jewelry, and make the payments for his Porsche and Land Rover.

Now you’re probably wondering, “How did this last for two years? Wouldn’t the initial investors be demanding some return on their investment?”  Well, some of the investors did receive money – about $400,000.  But remember: Cobalt owned very few properties and didn’t make any money.  Thus, the $400,000 return paid to the old investors came from new investors.

That’s right, it was a Ponzi scheme.  Cobalt’s only cash flow came from the investors themselves. 

Cobalt Gets Shut Down

The feds must have been tipped off because they executed a search warrant at Cobalt’s offices in December of 2005.  But this didn’t even phase Shapiro or Stitsky, as they continued to seek new investors! This is insane…

But remember, we’re dealing with professionals here. This wasn’t their first fraud.  In fact, Stitsky was involved in two other SEC enforcement actions and criminal cases during this exact same time period.  He may have been dishonest, but he knew how to multi-task.

Cobalt finally shut down when the SEC filed a complaint on March 27, 2006.  In turned out Cobalt had swindled 250 investors out of $23 million.  Shapiro and Stitsky were arrested by the FBI.  They rejected a plea deal, and were convicted of fraud after a 3-week trial.


The judge threw the book at Shapiro and Stitsky at the sentencing.  They both got 85 years in prison.  That’s a long sentence for white-collar crime, but I see why the judge did it.  Both of these guys were career con men, and the fraud had wiped out the life savings of several investors.

Foster (the fake CEO) got off the easiest with a sentence of just 3 years.  Foster later died while appealing his case, so his conviction was wiped out.

And that was the end of the matter…Or was it?

President Trump

In 2020, Stitsky asked the court to be released early.  He said he had a medical condition and was worried about COVID-19, but his request was denied.

Then in December of 2020 came a bombshell.

President Trump commuted the sentences of both Stitsky and Shapiro.  Both of them would be getting an early release.  In a press release mentioning the commutations, the president’s press secretary said Cobalt had failed due to the 2008 financial crisis.  That’s very misleading; the SEC filed its complaint against Cobalt a full two years before the financial crisis.  It seemed like the White House was trying to downplay the severity of Shapiro and Stitsky’s actions.


In any event, I found this entire case to be really sad.  All people make mistakes, and I don’t think that committing fraud necessarily makes someone a bad human being.  But Shapiro and Stitsky didn’t just commit fraud once; they did it again and again, and they never seemed to accept responsibility for what they did.

Shapiro tried to withdraw his first guilty plea by saying he was coerced.  Then, Stitsky tried to get out of jail early by complaining about his health.

Hopefully they changed during their time in prison, and have remorse for their actions.  They just got out of an 85-year sentence and have a new lease on life!  They can start an organic garden, adopt a gluten-free lifestyle, and collect stamps.  I mean, they’re both in their sixties now, so they’re not going to get involved with another fraud…Right?

I’m Michael McLaughlin, and you’ve been listening to Scheme.


SEC complaint
SEC litigation release
2006 – arrested by federal agents
2009 – FBI press release / convicted after a 3-week jury trial
2009 – Stratton Oakmont boiler room
Convicted after a 13-day trial
More details about the trial; also, tried to get compassionate release
2010 – FBI press release for sentencing
2010 – sentenced to 85 years
2010 – details about the case & sentencing from the U.S. Attorney’s Office
2014 – investors court case against Shapiro (great background info)
Trump commutations
The 1998 case against Shapiro
Stratton Oakmont
The Wolf of Wall Street
The story of Cobalt involves a former associate of the Wolf of Wall Street, and a Ponzi scheme run by a convicted fraudster. Then, Donald Trump got involved. The story of Cobalt involves a former associate of the Wolf of Wall Street, and a Ponzi scheme run by a convicted fraudster. Then, Donald Trump got involved. Michael McLaughlin Episode 9: Cobalt Multifamily Investors clean 10:24
Episode 8: Interpublic Group Mon, 14 Dec 2020 15:33:10 +0000 Interpublic was forced to restate its financials back to 1997. Had the company committed ANOTHER fraud, right after the first one?


In the early 2000’s, Interpublic Group was a successful advertising firm with over $6 billion in annual revenue. Interpublic had dominated the ad industry for decades and had a stellar reputation. But the company’s public image was about to change.

In 2002, Interpublic was forced to restate its financials going all the way back to 1997. In 2002 alone, the company had overstated its profit by 496%.

Executives blamed the problem on poor internal controls, & said it was an honest mistake. But the SEC began an investigation, and the results were shocking. Had the company committed ANOTHER fraud, right after the first one?

I’m Michael McLaughlin, and this is Scheme.


In 1930, two companies merged to form the largest advertising agency in the world: McCann-Erickson. In 1961, this company would carry out an innovative restructuring plan. It divided itself into several business units, which operated as part of a holding company called, “The Interpublic Group of Companies.” Today, most large advertising agencies follow this model.

Interpublic continued to grow over the years, mainly by acquiring other ad agencies. By 2008, Interpublic owned over 600 agencies in 130 countries. McCann-Erickson was its largest subsidiary, accounting for as much as 50% of Interpublic’s revenue.


Both Interpublic and McCann had a dark culture. They focused on hitting profit targets, by whatever means necessary.

Here’s how it worked. Each fall, McCann asked its agencies to submit profit targets. McCann would either accept or reject those profit targets. If McCann rejected an agency’s profit target, the agency had to come back with a more ambitious, higher profit target. But that’s not all. McCann would revise its budgets in the spring and summer, raising the profit targets even higher and calling them “stretch targets.”

But remember, McCann is part of Interpublic, so it had to submit its own profit targets. Interpublic would either accept them, or reject them and request a higher target. If you didn’t meet the targets, you could lose your bonus or be fired.

This constant pressure to meet targets created the perfect environment for fraud.

Intercompany transactions

To explain the fraud, we need to discuss something called intercompany transactions.

McCann owned hundreds of ad agencies, and these agencies often entered into transactions with each other. For example, one agency might provide services to another agency. This would result in revenue for one agency but an expense for the other agency. Since the agencies are all owned by the same company, a $100 increase in revenue and a $100 increase in expenses would cancel out, and have no effect on the company’s overall profit on a consolidated basis.

But here’s the catch: sometimes there were imbalances. One agency would record $100 of revenue, but the other agency would delay recognizing the $100 expense. This could occur for innocent reasons; there could be a delay in processing the invoice, or the agency might dispute the amount of money. For example, an agency might say the expense shouldn’t be $100 but rather $80. In such a case, the agency would only record an $80 expense; the other $20 would be categorized as accounts receivable because it hopes to have the $20 returned.

Once the dispute is resolved and it’s found that you really do owe $100 (not $80), McCann would write off the accounts receivable to acknowledge the full $100 expense. At least, that’s what was supposed to happen…

The fraud

In reality, McCann never wrote off the accounts receivable. The disputes weren’t being resolved and intercompany accounts weren’t being reconcile. They didn’t even have a system in place for doing a reconciliation. They literally just kept putting it off.

In 1998, a member of the finance team said in an email that disputed amounts had reached “an unacceptable level.” But then he said, “Hey, what’s a $28 million discrepancy between friends.” I’m not kidding. He literally wrote that in an email while committing a large-scale fraud.

Writing off the accounts would have prevented McCann from reaching its profit target. Executives knew about this for years, but most of them did nothing. The finance director for McCann’s Europe-Middle-East-Africa region resigned, so he must have had some type of conscience. In his resignation letter, he said that he had brought up the write offs to his boss, only to be told “not to discuss these matters further.”

With no finance director, the Europe-Middle-East-Africa region had its COO handle the finance duties. The COO had no training in accounting, but that was totally okay because he had a willingness to commit fraud. He then told the finance team: “the stretch goal is not a ‘goal’, it is a mandate and we are the people who make it by whatever means we can dream up!”

The fraud is discovered

So you’re probably wondering how the fraud was discovered.

Well, Interpublic had a rough year in 2001. The advertising market was in a downturn, and Interpublic was having problems related to one of its acquisitions. Thus, Interpublic decided to take a large restructuring charge, which included the cost of layoffs and lease termination fees.

McCann’s Europe-Middle-East-Africa region spotted an opportunity. They could finally take the write offs that they’d been putting off for years by just lumping them in with the restructuring charge. The company was having a bad quarter, so executives weren’t going to hit their profit targets anyways; it was the perfect time to recognize the write offs. Interpublic’s CFO said it was like having “Christmas in July.”

But there was a problem. The company’s auditor, PWC, said it would be a violation of GAAP for the write offs to be included with the restructuring charge. PWC also said there had been a “fundamental breakdown of internal controls” at McCann. This came to the attention of Interpublic’s Audit Committee, which demanded that McCann’s CFO reconcile the accounts by September 30, 2002.

Then came the surprise; few people had realized how big the write offs really were. Interpublic would have to restate its financials going all the way back to 1997. The company issued a $181 million restatement, with $101 million relating to the intercompany transactions.

Another fraud

After all this, you’d think Interpublic would be eager to get a fresh start. They could put all the fraud behind them and focus on growing the company.

But no…Interpublic immediately became involved in another fraud

The SEC launched an investigation, the CEO resigned, and the company went through four CFOs over the next few years. It was a mess. PWC and teams of forensic accountants tried to piece together what happened. It turns out Interpublic had overstated its profits again, but this time the fraud was more complicated.

First, Interpublic recorded revenue for AVBs that should have been returned to clients. AVB stands for “Agency Volume Bonification.” AVBs are rebates that companies like Interpublic receive when they buy a large volume of advertising from a media company. Interpublic was supposed to pass these rebates on to their clients, but they failed to do so.

Second, Interpublic improperly recognized the profits of companies it acquired. If your fiscal year-end is December and you acquire a company in August, you can include the profits earned by the company from August to December in your consolidated income statement. But you can’t book profits that occurred prior to August, since you didn’t own the company then. That’s what Interpublic did; they booked the full year, recognizing profits that occurred before they even acquired the company.

Third, Interpublic had reduced expenses by capitalizing some of its earnouts as goodwill. Earnouts are a type of contingent consideration that are a part of acquisitions. The acquirer, in this case Interpublic, will agree to make an additional payment if the target company achieves certain financial goals after the acquisition. The SEC said that some of the earnouts were really a form of compensation and should have been expensed.

Interpublic’s response

Interpublic initially said these were all honest mistakes that occurred because of the company’s “extensive global presence.” But the firm later admitted it was fraud and fired several employees.

The firm found itself in the embarrassing position of having to restate its financials yet again. The restatement forced Interpublic to recognize an additional $420 million of expenses between 2000 and 2004. In 2002, for example, Interpublic had reported a profit of nearly $100 million when its true Net Income was just $16 million.

The constant scandals were taking a toll. Interpublic lost some of its biggest customers, including Bank of America and Lowe’s, and some of Interpublic’s senior managers decided to leave. They were tired of all the fraud and deception, and they wanted to work for an honest, values-based company like Enron. I’m just kidding; Enron had already imploded and gone bankrupt by then.

The outcome

After concluding its investigation, the SEC accused Interpublic, McCann, and two executives of fraud. They each settled with the SEC, neither admitting nor denying the fraud. McCann agreed to pay a $12 million fine, while the executives were fined a grand total of $75,000. Given that the company had to restate nearly a decade of financials, I’d say the company and its executives got off pretty easy.


So, how did all this happen? One reason is the lack of internal controls.

It’s absolutely inexcusable that a large, publicly-traded company like Interpublic didn’t have a formal policy for reconciling the intercompany transactions. They clearly knew they should do it, as they emailed each other about it each year. But it wasn’t explicitly stated who was responsible for carrying out the reconciliation, and clearly no one did. They just kept kicking the can down the road, and as the write offs grew larger, the incentive to ignore them grew stronger. No one wanted to do the right thing and take the write offs, because it would cause them to miss their profit targets… which leads to the second issue.

There was a serious problem with Interpublic’s culture. Giving someone an unrealistic target and telling them they’ll be fired if they don’t achieve it is a recipe for unethical behavior. As the COO said, their job was to make the numbers “by whatever means we can dream up!” This was a culture of fraud.

But I think Interpublic’s auditor, PWC, also deserves some of the blame. They made statements about Interpublic’s weak internal controls for years, but continued to sign off on the audits.


If you’re wondering what happened to Interpublic, it’s still around. It’s one of the Big Five advertising firms and had 54,300 employees at the end of 2019, when it reported a $674 million profit on $8.6 billion of net revenue. The company has had to change with the times; digital advertising is now a major focus.

To help its clients show more relevant ads, Interpublic has invested in consumer data. In 2018, it acquired Acxiom’s consumer data division for $2.3 billion. There are serious privacy concerns for firms when it comes to consumer data, particularly after Facebook’s data scandal with Cambridge Analytica. Hopefully Interpublic will show more integrity with people’s data than it did with its own financial statements. If not, you might see the company in the news again.


Interpublic’s 10-K for FY 2019
Interpublic’s 10-K for FY 2009
10/21/20 Morningstar
7/2/18:  Wall Street Journal
6/28/18:  Wall Street Journal
5/2/08:  New York Times
5/1/08:  SEC litigation release
5/1/08:  SEC press release
5/1/08:  SEC complaint:  LaGreca
5/1/08:  SEC complaint:  Interpublic
9/16/05:  New York Times
Interpublic was forced to restate its financials back to 1997. Had the company committed ANOTHER fraud, right after the first one? Interpublic was forced to restate its financials back to 1997. Had the company committed ANOTHER fraud, right after the first one? Michael McLaughlin Episode 8: Interpublic clean 11:41
Episode 7: Capitol Investments Thu, 05 Nov 2020 11:00:29 +0000 Nevin Shapiro was living the high life, and people assumed his high-roller lifestyle was funded by his business, Capitol Investments. But Shapiro’s business hadn’t conducted operations in years...


Nevin Shapiro had what many would consider a great life. He drove nice cars, had a beautiful home in Miami Beach, and spent his nights partying with famous athletes like Shaquille O’Neal. Shapiro was living the high life, and people assumed his high-roller lifestyle was funded by his business, Capitol Investments.

But, Shapiro’s business hadn’t conducted operations in years. The money was actually coming from investors who didn’t realize that their money was being used to pay old investors. That’s right, it was a Ponzi scheme… a $900 million dollar Ponzi scheme.

I’m Michael McLaughlin, and this is Scheme.

The beginnings Capitol Investments

Nevin Shapiro was born in Brooklyn, but when he was a kid his family moved to Miami Beach. It was there that Shapiro incorporated Capitol Investments USA in 1998. Capitol Investments was a grocery diverter, aka food broker. Thus, Capitol Investments was part of the billion dollar industry for product diversion.

The product diversion industry

Product diversion is when goods are shifted away from their authorized distribution channel without the consent of the manufacturer. Product diversion can happen in several ways.

  1. Let’s say that you create a hair care product that you only want sold in certain salons, to maintain its image as a prestige brand. But then you find out that your salons bought too much product and re-sold it to a pharmacy in another part of the country. You might be upset that your prestige brand now appears on the shelves of a drugstore.
  2. Product diversion is also used to take advantage of price differences across regions. Let’s say a manufacturer sells its product to distributors in the U.S. for $60 and to distributors outside the U.S. for $35. The international distributors might divert the product by selling it to retailers in the U.S. for $50. The U.S. retailers are happy to buy the product at a cheaper price, but this cuts into the U.S. distributor’s sales. And it might create an excess of product in the U.S.

Product diversion is kind of a sketchy business, and it sometimes results in lawsuits from angry manufacturers. But this is what Capitol Investments did; it bought diverted groceries and re-sold them at a higher price in different geographic regions.

Capitol Investments

Now Shapiro told people that Capitol Investments was highly successful, and they believed him. After all, he owned a $5 million home, a $1 million boat, and donated lots of money to the University of Miami. Besides, he showed sales invoices and customer orders to prove the business was legit.

So when Shapiro began raising money from investors in 2003, no one questioned him. Shapiro told investors he was selling so many groceries that he needed short-term bridge loans. He said the loans were risk-free because he had already made the sale, he just needed to fill the purchase order. Investors would be paid back in 30 days, and get a 10 to 26% return.

Investors were so happy with this deal that many chose to reinvest their principal. Some even took money out of their retirement account to invest more.

Shapiro ultimately raised about $900 million from 60+ investors. And he continued to talk about how great Capitol Investments was doing, saying it sold $64 million of groceries in 2008 and was on pace for $70 million in 2009.

Trouble brewing…

But in 2009 things went bad; Shapiro began having difficulty repaying investors. In July he convinced one investor to loan the company $170,000, saying he’d pay it all back in 5 days…but didn’t pay him a single dollar.

So investors started asking questions. They wanted to know where their money was; this was supposed to be risk-free! Shapiro came up with a variety of excuses: grocery stores were behind on their payments, his accountant was on vacation, etc.

But when Shapiro still didn’t pay, the investors had had enough. They forced Capitol Investments into bankruptcy. This is when things got really interesting.

The fraud is discovered

It turns out that Capitol Investments hadn’t done business in years. Remember how Shapiro said the firm did $64 million in sales in 2008? Well the company was insolvent by then.

The last time Capitol Investments had sales was in 2005 and 2006, when it did just $300,000 in sales. This wasn’t a multimillion-dollar successful business. Capitol Investments was a house of cards, and it couldn’t survive without constant injections of capital from new investors. That’s why Shapiro paid out $13 million in sales commissions to get people to bring him new investors. He constantly needed people to give him money, or else the whole thing would collapse.

It was a classic Ponzi scheme: convince people to give you money by telling them they can get rich quick, and if they ask for their money back convince new investors to give you more money so you can repay the first group of investors.


While Shapiro repaid $769 million over the years to keep the scheme going, he took at least $38 million for himself. This paid for his extravagant lifestyle and $5 million of gambling debts.

Shapiro was indicted, and he pled guilty to securities fraud and money laundering. He was sentenced to 20 years in prison and ordered to pay $82 million in restitution.

But while Shapiro was in prison, he tried to remain productive. He decided to attack the school where he had been an athletic booster, the University of Miami. Shapiro accused more than 70 of Miami’s athletes of breaking NCAA rules by accepting money, cars, and jewelry from him. There was an investigation, and it resulted in minor sanctions. After serving half his sentence Shapiro was released in 2020, just in time for a pandemic.


So what can we learn from this?

Shapiro worked hard to create the illusion of success. He made sure everyone saw he was a big-spender, and surrounded himself with wealth. And it worked; people saw Shapiro as a success. This led to the halo effect. Investors had a positive image of Shapiro personally, so they had a positive image of their investment in his company. Shapiro was good at gaining people’s confidence, which is why we call someone like him a “confidence man” or a “con artist.”


Shapiro was just 51 years old when he was released from prison, so I wonder if we’ll see another scam from him. He’s been in or around trouble his whole life. In his twenties he picked up a felony assault charge for sucker punching someone at a nightclub, nearly blinding him. And Shapiro’s stepdad did time for a fraud of his own, as did Shapiro’s girlfriend/ business partner.

But people can change, and I really hope Shapiro’s done with fraud. Maybe he’ll try selling mattresses, or create a YouTube channel about people who fall in love with their cats. There are lots of legal ways to make money; I just hope he picks one. Only time will tell.

Nevin Shapiro was living the high life, and people assumed his high-roller lifestyle was funded by his business, Capitol Investments. But Shapiro’s business hadn’t conducted operations in years... Nevin Shapiro was living the high life, and people assumed his high-roller lifestyle was funded by his business, Capitol Investments. But Shapiro’s business hadn’t conducted operations in years... Michael McLaughlin Episode 7: Capitol Investments clean 6:47
Episode 6: Harvey, Illinois Mon, 05 Oct 2020 11:00:01 +0000 Satish Gabhawala convinced the city of Harvey to raise $14 million from bond issuances to construct a hotel and 24-hour diner. However, 5 years later the buildings were never finished. Where had the 14 million gone?


In 2008, Satish Gabhawala ran a motel off the interstate in Harvey, Illinois. The motel had a 24-hour diner and was used primarily by truckers. But Gabhawala had a vision: he was going to transform the motel into a Holiday Inn and conference center.

There was just one problem: Gabhawala didn’t have the money. So he contacted an advisor, who convinced the city of Harvey to raise $14 million from bond issuances to back the project. Harvey had been in decline for years, so this was an opportunity to turn things around and generate some tax revenue.

But 5 years later, the hotel still wasn’t finished. All the city had to show for its money was a gutted building, full of exposed wires. People began asking questions. Where had the $14 million gone?

The SEC then launched a bombshell, charging the city of Harvey with fraud. They found out what happened to that money, and it wasn’t good. Millions of dollars had been misappropriated, and the city’s comptroller got rich in the process. It was a complete mess. And before it was all over, someone would end up dead.

I’m Michael McLaughlin, and this is Scheme


Harvey is about 20 miles south of Chicago and has a population of about 25,000 people. It once was a thriving blue-collar town. But several large businesses shut down in the 1970’s and 1980’s. Crime and poverty increased, and the city became littered with vacant homes.

Harvey’s mayor, Eric Kellogg, tried to entice businesses to come back. He offered developers incentives to rehab the Dixie Square Mall. This mall was the scene of the car chase in the Blues Brothers movie. The mall had closed in the late 1970’s after a series of murders, and it would sit vacant for decades. No one ever renovated the mall, and it was demolished in 2012

But one developer did step forward with an idea to attract more people to Harvey.

Chicago Park Hotel

Satish Gabhawala owned the Chicago Park Hotel at 17040 Halsted in Harvey. It was a 4-story, 75,000 square foot motel with a good location near I-80/I-294. But this wasn’t the type of place you’d go on vacation with your family. It was a little bit sketchy. There was a strip club right next to the motel, and at one point, there was a strip club located inside the motel. Yes, you heard me correctly; there was a strip club literally inside the motel.

That sounds crazy, but when I hiked the Appalachian Trail I walked past a strip club in Pennsylvania that used to be on a bus. So apparently strip clubs are pretty flexible when it comes to location.

Gabhawala said the motel was initially profitable. However, in 2007 he lost a contract in which trucking companies prebooked rooms. The motel fell behind on its bills, and it got hit with some lawsuits. Gabhawala didn’t want to give up, so he reached out to an accountant who was a frequent customer of the motel’s diner: Joseph Letke.

The advisor

Letke was a CPA and he ran an accounting firm called Letke & Associates. He and his firm handled the bookkeeping for a number of south suburbs: Robbins, Riverdale, Dolton, & Markham. In 2008, Letke also happened to be the comptroller for Harvey.

Letke listened to Gabhawala’s plan for turning the rundown motel into a Holiday Inn with 239 rooms, a conference center, a restaurant, and an indoor pool. Apparently Letke liked what he heard, because he advised the city of Harvey to lend Gabhawala the money.

The bond issuances

To fund the project, the city raised $6 million in 2008 by selling limited obligation bonds. The fact that these were limited obligation bonds is really important. It means Harvey can’t do whatever it wants with the money; it should strictly be used to fund the redevelopment project. Investors would be paid back through the hotel tax and sales tax revenues that the project would generate.

But $6 million wasn’t enough, and Harvey ended up raising another $3 million in 2009 and $5 million in 2010. These were again limited obligation bonds. But this time Harvey promised to repay the money through something called Tax Increment Financing, or TIF. In short, Harvey expected the redevelopment to increase property tax values in that district. The investors who bought Harvey’s bonds would then be paid by the increased property tax revenues.

Harvey ended up raising a total of $14 million from issuing bonds between 2008 and 2010.

Lack of oversight

But you know what’s really interesting? Harvey didn’t need voter approval to issue the bonds per Illinois law. This is because Illinois provided very little oversight of municipal governments. It simply required cities to submit annual audits and self-reported data. After 2008, Harvey would go 5 years without issuing audited financial statements.

If you’re wondering, “Why didn’t the state of Illinois keep a closer eye on Harvey?” it’s because the state of Illinois has its own problems. The SEC accused Illinois of securities fraud for misleading investors about its unfunded pension obligations when it sold bonds to investors. And Illinois is famous for having governors and other political officials sent to prison for corruption on a regular basis.

The key takeaway for Harvey’s taxpayers was this: if the hotel redevelopment project didn’t work out, taxpayers would be on the hook for the $14 million, plus interest.

The fraud

Now the $14 million was supposed to be used to build the new hotel. But in reality, the money was spread all over the place.

Millions of dollars went to the developer, Gabhawala. He was supposed to receive money so he could build the hotel. Makes sense, right? But here’s the catch. Gabhawala owed money to a lot of people, and instead of using the bond money to build the hotel, he spent more than $5 million paying off his old debts.

But the bond proceeds didn’t just go to the developer. Letke, Harvey’s comptroller, got a big piece of the action. Letke received $547,000 for serving as an “advisor” on the development project. Letke also received $269,000 of payments on the side, which had not been communicated to investors when the bonds were issued. Also, Letke’s firm was doing Harvey’s bookkeeping, and his firm received over $1 million for this.

In total, Letke and his businesses received $1.9 million from Harvey between 2008 and 2010. Oh, and Letke also had the developer pay $100,000 to a woman who had “no apparent connection to the Hotel Redevelopment Project.” But I’m sure there’s nothing sketchy about that.

More fraud

Now, Gabhawala and Letke weren’t the only ones to misuse the bond money. In February of 2009, Harvey was in dire straits financially. It couldn’t afford to pay its employees or even its water bill. Harvey was out of option, but then one of Letke’s employees had an idea. He suggested that Harvey use the bond money. That money was supposed to be used for the redevelopment project; using it for Harvey’s general expenses would be securities fraud. But that’s exactly what Harvey did, using $290,000 of the bond money to make payroll. This soon became a pattern, and Harvey ending up diverting $1.7 million of the bond money for everyday expenses

The project fails

It should come as no surprise that the hotel project failed. Gabhawala ran out of money, and contractors began filing liens against the hotel. Gabhawala then took out a $2.3 million mortgage at 22% interest to try and save the project.

It didn’t work, but Gabhawala still didn’t give up. He talked about reviving the project by selling 100-year old Chinese gold bonds. These are bonds that China had issued in the early twentieth century. China defaulted on these bonds when it turned communist in 1949, but some investors have held onto the bonds as a collector’s item.

The fact that he even brought this up shows how desperate the situation was. If a child had come to him with an idea about a lemonade stand I think he would have said yes.

Lenders foreclosed on the property in August 2011, and Gabhawala went to India.

The fraud is discovered

But if Letke and Harvey city’s officials thought the story was over, they were wrong. In 2013, the Chicago Tribune published an exposé. It said the hotel was an empty shell and asked what happened to the $14 million.

So people were getting the idea that something had gone very wrong here. But Harvey was still in financial trouble, so despite the negative publicity it planned to push ahead with yet another bond offering in 2014. This time it would issue limited obligation bonds to finance a grocery store.

But the SEC stepped in to stop the madness. In June 2014 the SEC asked a federal judge to issue a restraining order prohibiting Harvey from issuing more bonds. The judge agreed, saying that Harvey couldn’t be trusted with the money.

Also, The SEC filed a complaint against Harvey and its comptroller, Letke. The main two issues were (1) Harvey’s use of the bond money for unauthorized purposes, and (2) the undisclosed side payments to Letke. These acts constituted securities fraud. 


Six months later, Harvey reached a settlement with the SEC. Harvey agreed not to issue bonds for three years.

Letke was out as Harvey’s advisor and comptroller, so you’d hope the city would get a fresh start. But that same year it hired a disgraced former mayor as its new advisor. Donald Luster had been mayor of the nearby town of Dixmoor until he was ousted in 2004 after being convicted of tax violations and other crimes. Harvey’s problems continued. In 2018 the state of Illinois had to garnish $1.5 million of Harvey’s revenues to fund Harvey’s pension liabilities.

The mayor of Harvey, Eric Kellogg, also settled with the SEC. He was fined $10,000 and banned from ever participating in a bond offering. It wasn’t his first brush with the law, though, as he’d also used federal grant money to buy himself a Chevy Tahoe.

As for the hotel, the Cook County Land Bank Authority seized the property in late 2017, as the property taxes hadn’t been paid in five years. The gutted building was demolished a year later.

But I was most interested to know what happened to Letke. After all, he was Harvey’s comptroller and advisor, and it was his job to look out for Harvey’s finances.

In 2015 a federal court banned Letke from serving as an advisor for any bond offerings. It also ordered him to pay $217,000, but Letke was never arrested or charged with a crime. So I’d say Letke got off pretty easy, but this is where the story takes a dark turn.

Letke’s suicide

In 2016, Letke’s CPA license was suspended for failing to pay his state income taxes. That same year, he lost his home to foreclosure. He filed bankruptcy, and said the feds told him they’d make it so he couldn’t get a job working at McDonald’s. Letke was 57 years old, and his life had fallen apart.

So in August 2017, he took a road trip. Letke went to southern Indiana to visit his ex-wife and two children. He wanted to see his kids one last time, and then he shot himself. 


This is a tragic story on so many different levels, and it left me with a lot of unanswered questions.

Was Letke a good guy, who made mistakes that financially ruined not just himself but an entire city? Or was he a crook who took advantage of a town that was down on its luck?

And what about the developer, Gabhawala? He really wanted to make the hotel deal work.  Was the project just too ambitious for him?  He seemed like the type of guy who always owes people money.

Probably the only innocent victims here are the people of Harvey. They’ll get hit with higher taxes to pay for a project they didn’t even approve. Their schools will miss out on millions of dollars in tax revenues, and Harvey will continue to lose residents and businesses as people move away.

Corruption, financial mismanagement, and a lack of oversight are the core problems here. I don’t pretend to have the answers for the city of Harvey, or the state of Illinois, but I do know this: You shouldn’t bet the future of your city on a rundown truckers’ motel with a strip club inside it. And if you do, taxpayers should at least get to vote on it, since they might end up paying the bill.

Satish Gabhawala convinced the city of Harvey to raise $14 million from bond issuances to construct a hotel and 24-hour diner. However, 5 years later the buildings were never finished. Where had the 14 million gone? Satish Gabhawala convinced the city of Harvey to raise $14 million from bond issuances to construct a hotel and 24-hour diner. However, 5 years later the buildings were never finished. Where had the 14 million gone? Michael McLaughlin Episode 6: Harvey, Illinois clean 12:08
Episode 5: Equity Funding Corporation Sat, 05 Sep 2020 11:00:07 +0000 Equity Funding Corporation of America 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 even exist.


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.


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.


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.


SEC documents:
SEC charges firm with fraud (April 4, 1973)
Executives indicted (November 2, 1973)
President and Chairman pleads guilty (October 9, 1974)
Background on Stanley Goldblum:
Crazy story about an additional fraud going on at Equity Funding:
Contemporary Auditing Issues and Cases, by Michael C. Knapp. Case 5.6 Equity Funding Corporation of America:
Called to Account: Fourteen Financial Frauds that Shaped the American Accounting Profession, by Paul Clikeman (2008).
Equity Funding Corporation of America 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 even exist. Equity Funding Corporation of America 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 even exist. Michael McLaughlin Episode 5: Equity Funding Corporation clean 10:26
Episode 4: American Bank Note Holographics Thu, 06 Aug 2020 01:51:29 +0000 Just 6 months after American Bank Note Holographics' IPO, the company said it needed to restate its financials…A company that had been created to prevent fraud had lied about its revenue.


In 1998, American Bank Note spun off part of its business in an IPO.  Investors were excited. American Bank Note had been making products to prevent counterfeiting since the 18th century. This was a chance to invest in a company with a long tradition, and that made products which prevented fraud. But just 6 months after the IPO, the company said it needed to restate its financials. A company that had been created to prevent fraud had lied about its revenue. The stock price dropped 80% in just two days, and investors lost millions.

The company’s executives were put on trial and convicted, but then nothing happened for an entire decade. Would these con artists ever face justice?

I’m Michael McLaughlin, and this is Scheme.


American Bank Note was founded in 1795 to print money for the U.S. government. But by the 1990’s it had expanded into a variety of products. It made counterfeit-resistant checks, money orders, credit cards, passports, and stock and bond certificates.

This expansion led to a lot of debt, and the company needed to pay off some of its loans. So in 1998, it spun off part of the company as American Bank Note Holographics. This company specialized in making holograms, which are very helpful in determining whether something is counterfeit. Holograms are useful because they’re made with lasers, not ink, and they feature depth and movement when viewed from different angles. This isn’t possible with a two-dimensional image. American Bank Note was the leader in holographic technology, and it raised over $100 million from the IPO in July of 1998.

The fraud begins

Now a lot of work goes into preparing for an IPO; the company needs to make extensive disclosures, such as filing prior periods’ financial statements with the SEC. Investors want to see that the company’s profits are rising. Would you want to invest in a company with flat or declining profits? Investors want to see growth, so American Bank Note Holographics was under pressure to show increasing profits in the years leading up to the IPO. This is where things got ugly.

Two years before the IPO, the company’s president Joshua Cantor received the financials for the 1996 fiscal year-end and they didn’t look good. The company had missed both its revenue and earnings targets. But rather than accept the bad news, Cantor decided to get creative.

He had the company book revenue for two “bill and hold” sales and pretend they had taken place in 1996. Bill and hold sales are sketchy to begin with. You’re essentially saying that you made a sale even though you’re still holding the inventory. But under strict circumstances, companies can recognize bill and hold sales.  You’re supposed to separate the inventory and make it clear that title for that inventory has passed to the customer.  American Bank Note Holographics didn’t do this, and one of the sales kicked out and had to be reversed.  But it’s a moot point; the 1996 fiscal year was already over, so there was no way the company should have been recognizing revenue for 1996.  This was clearly fraud.

But this wasn’t Cantor’s only trick.

Cantor had the company book $800,000 of revenue for a customer in Japan. Now the customer had asked the company to develop holograms for a game called Pachinko. While American Bank Note Holographics did do some work on this, the customer had said it would only pay contingent on approval from the Japanese government…which it never received. But Cantor was desperate, so he booked the revenue anyway.

Thanks to the fraud, the company met its profit targets for 1996.

Things were looking good, until the end of 1997. The company once again failed to meet its profit target. Cantor had to be furious with the company’s sales team. ‘You mean I need to commit fraud again? Come on!’ Or, maybe Cantor enjoyed the fraud…because he got really creative.

In December, Cantor set up a legitimate bill and hold order with MasterCard, one of the company’s largest customers. To book the revenue for 1997, he needed to produce the holograms by the end of the year. Problem was, the company didn’t have the production capacity to make all the holograms. So Cantor hired another firm, Crown Roll Leaf, to help make the holograms. But that firm couldn’t finish the holograms in time either.

Cantor didn’t care, and he booked the revenue for 1997 anyway. Then the auditor, Deloitte, started asking questions. To cover his tracks, Cantor had employees backdate and change the receiving documents to make it look like Crown Roll Leaf had delivered the holograms in time. Cantor even convinced Crown Roll Leaf’s security firm to say that their employees had personally witnessed the holograms being picked up on time.

Going to the cookie jar too much?

Cantor got away with this, but he knew he couldn’t overuse the bill-and-hold strategy. The auditors were clearly on to him. He had to physically ship some product so he could show the shipping confirmations to the auditors. But how do you ship product when customers don’t want any?

There are lots of ways…

In some cases, Cantor sent customers more product than they needed and told them just to return it.  Then he booked revenue for the entire shipment. He also started shipping out products to customers who hadn’t even submitted an order. On New Year’s Eve, Cantor showed he would truly do anything to make the numbers. He had employees box up unfinished products and ship them to a customer. Then he booked $1.3 million of revenue and celebrated the New Year.

If you’re wondering, “Won’t customers return unfinished products, or products they didn’t order?” The answer is yes, absolutely! But Cantor didn’t care, he just wanted to make the numbers for 1997.  He’d figure out 1998 when he got there. And that’s the trouble with stealing from next year’s sales. You constantly have to keep the fraud going. 

The fraud continues after the IPO

Thus, after American Bank Note Holographics went public, Cantor continued the fraud. He booked $4 million of revenue after shipping one customer pieces of scrap material and empty boxes. Yes, I’m serious; he literally shipped empty boxes to a customer. Cantor shipped test materials to another customer who hadn’t ordered anything at all.

Customers were no doubt getting upset about receiving all this garbage.  Thus, Cantor rented a warehouse and began shipping the products there instead. Customers didn’t know about the warehouse or order the products shipped there, so these were completely bogus sales. But Cantor booked another $5.8 million of revenue this way.

How did Cantor get away with all this?

This is a lot of fraud, and the company went several years without being caught. One way Cantor avoided detection was by keeping two sets of books. The accounting records were stored in a computer, which the auditors checked. The actual records were written out by hand in a ledger; like the old days. Thus, auditors never saw the real accounting numbers.

Now if you know about auditing, you might be thinking, “The auditors should have sent confirmations to customers, to see if the amounts owed matched the company’s records.” Well, the auditors did send those confirmations…but Cantor convinced the customers to lie and confirm the false account balances. Thus, this fraud involved a lot of people. But a fraud that is dependent on so many people telling lies is bound to break down eventually.

How the fraud was discovered

When the auditors were doing the audit for the 1998 fiscal year, they didn’t just ask customers to confirm their balances. Instead, they asked customers to forward the invoices they’d received from the company. The customers’ invoices were identical in every way to the invoices that the auditors received from American Bank Note Holographics; except for one thing: The sales totals were different.

The auditors reported this to the audit committee, and it triggered an investigation and a phone call to the SEC. Everyone in the C-suite resigned or was fired.


On January 19, 1999, American Bank Note Holographics announced it would be restating its financials. The stock price plummeted, going from $16/share to $1.80/share. Investors lost $190 million.

When the restated financials came out, they showed that revenue had been overstated by 34% in 1997. But profit had been overstated by 167%. Cantor was arrested and charged with securities fraud. He was also charged with violating the Foreign Corrupt Practices Act by bribing a Saudi Arabian official. Apparently he had transferred a $239,000 “consultancy fee” to a Swiss bank account to try and win a contract.

But the government wasn’t satisfied with only convicting Cantor; it wanted to take down the company’s CEO, 59-year old Morris Weissman. So on July 18, 2001 Weissman was indicted. Cantor testified against his former boss, saying Weissman had approved the fraud. The trial lasted 5 weeks, and the jury had no verdict after the first day of deliberations.

But halfway through day 2 the jury returned a verdict: guilty of securities fraud, conspiracy, and lying to auditors. Weissman was going to prison for a long, long time…or was he?

Why did it take a decade to sentence them?

Weissman was supposed to be sentenced in 2003…but it didn’t happen. It wasn’t until a decade later that Weissman was finally sentenced. In 2013, he was sentenced to time served. Since he had been free on bond that whole time, this means Weissman spent a grand total of one day in jail.

He was ordered to pay $64 million of restitution, but I think he got off easy. I tried really hard to find out why it had taken so long to sentence him, and all I could find was some articles about Weissman doing classified work for U.S. intelligence. That reminded me of the movie “Catch me if you can” about Frank Abagnale, who got a reduced sentence for teaching the government how to catch other fraudsters.

But you know what’s really weird? Cantor wasn’t sentenced for more than a decade either.

In May 2014, the court sentenced him to time served. This made slightly more sense though. The government said Cantor had cooperated with them for 15 years and met with them 40 times. His testimony was critical in convicting Weissman because some of the case documents had been lost in the 9/11 attacks. Thus, the government couldn’t have convicted Weissman without Cantor.

What happened to the company?

Now you might be wondering what happened to the company, American Bank Note Holographics? It got off pretty easy. The firm settled with the SEC and didn’t admit guilt, paying just a $75,000 fine. But the parent corporation declared bankruptcy in December of 1999. American Bank Note Holographics hung around though, and in 2007 it was acquired by JDS Uniphase for $138 million.


So what can we learn from all this? One lesson is that it’s absolutely critical to question transactions occurring at the fiscal year-end. In 1996 and 1997, the company didn’t commit fraud throughout the entire year; it was just a few weeks at the very end when Cantor saw they weren’t going to meet the earnings targets. It’s easy to blame the auditors for not catching this, but it’s hard to detect fraud when there’s collusion of so many people.

Cantor convinced customers and even a third-party security agency to lie to the auditors. My first thought was that the guy must have been exceptionally charming. Then I remembered that he was convicted of bribing a foreign official, so he probably just paid everyone kickbacks to go along with the fraud. In any event, it’s not possible for a single person to do what Cantor did. It truly takes a village to commit this kind of fraud.

But I found it shocking that Weissman and Cantor didn’t receive long prison sentences. Fortunately Sarbanes-Oxley was passed in 2002, and it ensured that executives like Jeff Skilling of Enron received long prison sentences.

By the way, did you know Skilling is out of prison now? He’s trying to start an energy company, and he’s looking for investors. And no, I’m not kidding. Those former McKinsey consultants, they’re the best…

Just 6 months after American Bank Note Holographics' IPO, the company said it needed to restate its financials…A company that had been created to prevent fraud had lied about its revenue. Just 6 months after American Bank Note Holographics' IPO, the company said it needed to restate its financials…A company that had been created to prevent fraud had lied about its revenue. Michael McLaughlin Episode 4: American Bank Note Holographics clean 12:17
Episode 3: Electronic Game Card Mon, 06 Jul 2020 23:11:29 +0000 Electronic Game Card had created an innovative new product. Sales were growing and the company was profitable. But there was something not quite right about the company…


Electronic Game Card had created an innovative new product. After spending hundreds of thousands of dollars on R&D, it had patented a small digital device, about the size of a credit card. The CEO said this device was in high demand; particularly from the lottery industry, where companies saw it as an alternative to the scratch card. Sales were growing and the company was profitable; the future looked bright.

But there was something not quite right about the company…Its customers had no online presence, and the company’s bank account and accounts receivable were linked to offshore P.O. boxes. The audit partner said everything was fine, and signed off on the audits. But when a new CFO flew to London to track down a bookkeeper, he uncovered the company’s dark secret.

I’m Michael McLaughlin, and this is Scheme.

The invention

Electronic Game Card, which I’m going to refer to as “EGC,” was incorporated in Nevada, with offices in New York and London. EGC wasn’t a large company; at the end of 2008, it had just 10 employees. But it claimed to have designed a revolutionary product for the lottery industry.

There are many different types of lottery games, but one of the more popular ones is called instant win. You buy a paper card, scratch off the front of the card, and instantly find out if you won. Lotteries had been making paper scratch cards larger so that customers could play multiple times and have multiple chances to win on the same card. But you can only make the card so large.

And that’s where EGC comes in. It designed a microchipped digital card that was operated by touch. The card had an LCD screen (so the player could see numbers or images) and a random number generator. The device was very small: about the size of a credit card, just 3 millimeters thick and weighing half an ounce. EGC called it the, “digital evolution of the scratch card, offering multiple plays and multiple chances to win.” The device was clearly a substitute for the paper scratch card, but there were applications in the promotional and education industries as well. EGC said it was developing games for children, so they could improve their matching and math skills.

Electronic Game Card history

Now from 2003 through 2008 EGC was led by Lee Cole, a British citizen who lived in England and Spain, and the CFO was also a British citizen, Linden Boyne. Business seemed to be going well. EGC reported $6 million of revenue in 2007, and more than $10 million in 2008. While those aren’t gargantuan revenue figures, the company had very high margins, earning an operating profit of $6 million in 2008. And the firm was poised for growth: EGC said it had distributors in Native American casinos, plus state and national lotteries in the U.S., Mexico, and Italy.

But at the start of 2009 the company’s executive chairperson, Lord Leonard Steinberg, decided it was time for a change in management. Lord Steinberg had made a name for himself in the British gaming industry as the founder of Stanley Leisure, a company that owned casinos and betting shops. Lord Steinberg owned 14% of EGC’s stock, so he had significant influence over the company. He brought in a new CEO, Kevin Donovan, in February of 2009. Donovan was a marketing guy, with 25 years of experience in brand building. Even though Donovan was technically the CEO, he continued to report financial disclosures given to him by the previous CEO, Cole, and the CFO Boyne. But then Lord Steinberg brought in a new CFO to replace Boyne 7 months later

And this is where things get ugly.

Electronic Game Card fraud is discovered

The new CFO was Thomas Schiff, an American who worked out of the new headquarters in Irvine, California. Schiff was a former KPMG auditor & had been the CFO of a digital security firm, and apparently, Schiff was not easily conned.

He demanded access to EGC’s general ledger, checkbook, bank statements, and sales contracts. But EGC’s former CEO, Cole, was still on the board and stonewalled him.

This should have been an immediate red flag, for several reasons. First, you’ve got 2 former officers in Cole and Boyne effectively running the firm. Second, you’re not giving the new CFO access to bank statements? What?!?

Cole and Boyne eventually said they would mail the documents to Schiff, but they never arrived. So what did Schiff do? He flew to London. I love this guy.

Cole and Boyne then tried to prevent Schiff from meeting with the bookkeeper in London, but Schiff tracked him down. And once Schiff saw the financial documents, he knew the company was a fraud. Schiff told Lord Steinberg what was going on…and Lord Steinberg died. I’m not kidding. On November 2, 2009 Lord Steinberg died suddenly at the age of 73.

Anatomy of a fraud

So what exactly did Schiff find out? A heck of a lot, it turns out.

First, EGC hadn’t filed tax returns over a 5-year period. That doesn’t guarantee the company’s committing fraud, but it’s not a good start.

Second, EGC’s revenue was bogus. Most of its sales contracts were fake, and the manufacturer of its game cards said it’d been more than 2 years since it made any cards.  Most of EGC’s phantom “sales” were made to shell companies in the British overseas territory of Gibraltar; and these offshore entities were affiliated with Cole and Boyne.

Third, EGC overstated its assets. The company said it had $10 million cash in its bank account, but the bank account didn’t even exist.  The company said it had millions of dollars in investments, but most of the investments were held by Cole and Boyne’s entities in Gibraltar.

Fourth, EGC understated the amount of common stock outstanding by at least 10%. This made shareholders think they owned a higher percentage of the company and inflated the stock price.

Fifth, Cole and Boyne fraudulently issued and sold $12 million of EGC stock without investors’ knowledge. Here’s how they did it:

  • First, they forged documents, such as the minutes of board meetings, to show that EGC’s board had approved a stock issuance when it really hadn’t.
  • Next, they transferred the EGC stock to their entities in Gibraltar, had the Gibraltar entities sell the stock, and directed the proceeds to family members.
  • In one transaction a Gibraltar entity sold $35,000 of EGC stock and wired the proceeds to Cole’s sister.
  • For another Gibraltar entity, Cole’s brother-in-law had check-writing privileges.
  • Cole and Boyne sold 20 million shares this way, generating $12 million.

Why didn’t the auditor catch this?

If you’re wondering “Why didn’t the auditors catch this?” the answer is, they kind of did. The California-based Mendoza Berger & Co. was the company’s auditor, and the partner assigned to lead the audit was Timothy Quintanilla. Quintanilla’s team expressed skepticism about EGC’s financial reporting. They were concerned about sending the bank account and accounts receivable confirmations to offshore P.O. boxes, and they couldn’t find information to verify that EGC’s customers existed. A Google search turned up nothing, and several customers had the same address.

One auditor told Quintanilla in an email, “I significantly doubt the Company has any operations at all.” They thought EGC was either a means of defrauding investors, or a money laundering operation. But Quintanilla did nothing, and EGC received clean audit opinions year after year…

So the question is: was Quintanilla just incompetent, or was he in on the fraud?  It’s difficult to say; but when the PCAOB came to inspect his firm, Quintanilla had employees create & backdate documents to fill gaps in the EGC audit. Thus, Quintanilla must have known he didn’t do a proper audit.


After Schiff blew the whistle on the fraud, it was clear EGC had no future. The company filed bankruptcy on September 28, 2010.

The SEC conducted an investigation, and handed out punishments. It fined Cole & Boyne $29.6 million and banned them from serving as officers or directors of a public company. Neither of them were criminally prosecuted, and I’m assuming this is because they were British citizens and lived outside the U.S.

The CEO who took over from Cole, Kevin Donovan, was banned from serving as an officer or director of certain companies for 5 years. While Donovan didn’t start the fraud, the SEC said he saw lots of red flags. People warned him repeatedly that the financials were sketchy, but he did nothing.

And speaking of doing nothing, the SEC also punished EGC’s auditor, Quintanilla. He got hit with a $100,000 fine, and was banned from appearing or practicing before the SEC as an accountant. This means he can’t be involved with the preparation of financial statements for a publicly-traded company. Quintanilla’s audit firm, Mendoza Berger & Co., filed bankruptcy on June 8, 2012.

Takeaways from the Electronic Game Card scandal

So what can we learn from all this? At one point EGC was valued at $150 million…but it was all a sham.

One could say that the lesson is to be wary of so-called penny stocks. EGC had a small market cap and traded for less than a dollar per share. Such companies are often targets of market manipulation and fraud. But I don’t think that’s the real lesson here.

This story is about the importance of a proper audit. We take auditors for granted, or see them as a nuisance, but they play an important role when they do their job right. In EGC’s case, there really wasn’t an audit.

Quintanilla failed to exercise an essential trait of an auditor: professional skepticism. Before EGC released its 10-Q in November of 2009, the company emailed Quintanilla a bank statement that Boyne had created in Microsoft Word. Like most documents, it was fake. And yet Quintanilla took it at face value.

This was wrong. You don’t just take the client’s word for it; you independently verify. Quintanilla and his team should have contacted the bank directly; they shouldn’t have relied on Word docs or confirmations sent to a P.O. box in Gibraltar. The auditor is supposed to be the watchdog, and this time the watchdog failed.

Class action lawsuit
SEC’s punishment of the external auditor (outcome)
10-K for 2008 fiscal year:
Disclosure that shows “Executive A” was Thomas Schiff:
Thomas Schiff’s background:
Electronic Game Card had created an innovative new product. Sales were growing and the company was profitable. But there was something not quite right about the company… Electronic Game Card had created an innovative new product. Sales were growing and the company was profitable. But there was something not quite right about the company… Michael McLaughlin Episode 3: Electronic Game Card clean 9:59
Episode 2: Adelphia Communications Mon, 06 Jul 2020 21:59:14 +0000 In March of 2002, Adelphia was the 6th largest cable TV provider in the U.S.  But then the company made one tiny financial disclosure…and within 3 months it was bankrupt. 


In March of 2002, Adelphia was the 6th largest cable TV provider in the U.S. But then the company made one tiny financial disclosure…AND WITHIN 3 MONTHS IT WAS BANKRUPT.  Shareholders filed lawsuits, the SEC alleged there was fraud, and executives went on trial.  What the heck happened?

I’m Michael McLaughlin, and this is Scheme.

The founding of Adelphia

Adelphia’s founder, John Rigas, came from humble beginnings.  He was born in 1924 to Greek immigrants in Wellsville, New York, and his dad ran a hot-dog stand.  After serving in World War II, Rigas got into business by purchasing a movie theater.  But then a friend gave him a hot tip: cable TV, not movie theaters, was the future.  Rigas listened, and in 1952 he paid $300 for a license to become a cable TV provider. He started out with just 2 channels.  Rigas called the company “Adelphia” which means “brothers” in Greek.

Adelphia grows larger as the family joins the business

Adelphia became successful; so successful that Rigas was able to send his kids to the finest schools in the country: Harvard, Wharton, Stanford.  And when they finished school, Rigas’s sons came back to work for the company.  One son would become CFO, and another Chief Accounting Officer.

Rigas’s sons wanted to expand, and Adelphia went public in 1986.  But even with the inflow of capital from outside investors, Adelphia remained a family-dominated business: 5 of the 9 people on the company’s board were part of the Rigas family.  And the company remained headquartered in the small town of Coudersport, Pennsylvania.

But there were many changes on the horizon.

The rise of the internet and digital cable in the 1990’s led to consolidation in the cable TV industry, with lots of acquisitions.  Adelphia expanded, acquiring 3 companies in a single month in 1999.  The company doubled in size over just a few years.  By 2002, Adelphia was doing business in 32 states with more than 5 million subscribers.

So what seems to be the problem? 

Everything seems great so far; we’ve got the son of immigrants building a business from scratch and turning it into a thriving family business.  But there were several issues.

First, the Rigas family operated a number of cable entities outside of Adelphia, which had 300,000 subscribers of their own. No one thought much of this complex series of partnerships at the time, but their interactions with Adelphia would lead to serious problems.

Second, Adelphia’s growth was funded by debt. Adelphia first borrowed to create the infrastructure to provide cable TV, and then it borrowed again to acquire other cable TV providers.  As a result of these acquisitions, Adelphia’s debt ballooned from $3 billion to nearly $13 billion.

The fraud develops…

And this growing debt put the company at risk of violating its debt covenants.

You see when banks lend money, they make borrowers agree to certain stipulations—for example, that their debt load won’t exceed a certain threshold—and they do this to make sure companies can continue making their interest payments. But Adelphia’s strategy required more and more debt; so to get around the debt covenants Rigas began hiding some of the debt.

This is called off-balance sheet financing, and Rigas did it in several ways.

First, he transferred debt from Adelphia to his own partnerships. Adelphia would remove a liability and then add that liability to one of Rigas’s entities. They called this a quarterly “re-classification.”  Basically, the debt of one company was transferred to another company.

Second, the Rigas family started buying massive amounts of Adelphia stock. Rigas said was putting more money into the firm to “de-leverage” the company. Investors see this as a great sign; management has faith in the company’s stock, because the executives are putting their own money at risk. Except they weren’t…

Rigas wasn’t actually paying for the stock; he has borrowing the money. Worse yet, Adelphia guaranteed the borrowings.  Rigas was effectively borrowing money from Adelphia to buy stock in Adelphia. The Rigas family didn’t disclose these co-borrowings, and some people wondered how the family kept coming up with money to put into Adelphia. The secret was, they weren’t putting money into the company. These were not trivial amounts. They bought 29 million shares for $1.8 billion between 1998 and 2002, and Rigas had employees forge receipts to make it look like the family actually paid for the stock.  In reality, they were just overstating the company’s equity.

But the hidden debt was just one part of the fraud…

Overstating profits

Adelphia was also overstating its profits with fictitious transactions. It did this in several ways. First, it booked phony management fees from Rigas’s partnerships for services it never provided to those entities. Second, it pretended to pay an extra $26 per cable box to its suppliers. On the side, the suppliers agreed to return the money as “marketing support payments.” Adelphia amortized the extra $26 in costs, effectively spreading it over a period of years. But the $26 of marketing support payments was fully booked as revenue in the current period. Third, Adelphia shifted expenses to the Rigas partnerships. So they took expenses of Adelphia and booked them to unconsolidated entities.

But Adelphia didn’t just overstate profits; it also overstated number of basic cable subscribers by including subscribers of unconsolidated affiliates. So this is a pretty complicated fraud; Adelphia didn’t do just one thing wrong. Adelphia concealed all of this fraud by creating a second set of books; it had a special accounting system that pooled cash from Adelphia and Rigas’s separate entities.

Was this all just a misunderstanding?

John Rigas was in his seventies when all this happened, so some people in the town of Coudersport thought this might just be a misunderstanding. After all, Rigas had a reputation for being a really nice guy, and he was very kind and giving toward the Coudersport community where Adelphia was headquartered.

However, the story gets darker when you consider that the Rigas family profited significantly from this fraud. They didn’t actually sell any stock, which makes this different from Global Crossing, Enron, and other accounting scandals. However…Rigas lent $150 million of company money to a hockey team he owned, the Buffalo Sabres. The Rigas family also:

  • Spent $3 million of company money on a movie produced by Rigas’s daughter.
  • Spent $12.8 million of company money on a golf course.
  • Rigas let his kids enjoy rent-free apartments on the company’s dime.
  • And they used Adelphia’s 3 corporate jets quite liberally, at one point flying one of Rigas’s sons and his friends to Africa for a safari.

Now Rigas was deep in personal debt, and he was withdrawing so much money from Adelphia that his son had to ask him to withdraw no more than $1 million/month. All of this without investors’ knowledge.

Discovering the fraud

Now the fraud was eventually discovered when a bond analyst and a new outside director on Adelphia’s board began asking questions. After significant pressure, Adelphia disclosed the hidden liabilities on March 27, 2002. In a small footnote, it acknowledged that it had $2.3 billion in off-balance sheet debt.

This disclosure caused a firestorm. Investors panicked, the stock price plummeted, the SEC launched an investigation. Shockingly, the Rigas family continued to commit fraud even after this happened. They had bought some of the Adelphia stock on margin so the large decline in the stock price led to a lot of margin calls. Rigas responded by transferring $252 million from the company to pay the margin calls.


But the Rigas family and several other executives soon stepped down. The company disclosed the details of the fraud, and Adelphia filed for bankruptcy on June 25, 2002. In 2006, its assets were sold to Comcast and TimeWarner, and Adelphia was no more. The government indicted the 77-year old Rigas, two of his sons, and two other executives. They were charged with securities fraud, wire fraud, and bank fraud. In 2004, Rigas and one of his sons were found guilty – Rigas was sentenced to 15 years, while his son was sentenced to 20.


So how did something like this happen? What went wrong here?

In my opinion, this fraud was able to take place for two reasons:

  1. The combination of a public company and all these private family entities made it easy for the Rigas family to shift debt and expenses around, and to create bogus revenue.
  2. There was no outside oversight. The top executives were members of the Rigas family. A majority of the board was part of the Rigas family. Thus, no one was looking out for the interests of shareholders. Had it not been for all of Rigas’s private entities, and had there been more oversight from the board, maybe this never would have happened.

In March of 2002, Adelphia was the 6th largest cable TV provider in the U.S.  But then the company made one tiny financial disclosure…and within 3 months it was bankrupt.  In March of 2002, Adelphia was the 6th largest cable TV provider in the U.S.  But then the company made one tiny financial disclosure…and within 3 months it was bankrupt.  Michael McLaughlin Episode 2: Adelphia clean 9:25
Episode 1: Homex Sun, 05 Jul 2020 22:08:11 +0000 In 2013, Homex was the largest real estate development company in Mexico. But just one year later Homex was bankrupt, and under investigation by the SEC.


In 2013, Homex was the largest real estate development company in Mexico.  The Mexican government had pushed to increase the amount of affordable housing, and Homex had responded.  It rapidly built homes in cities across Mexico, while investors made millions.  But just one year later Homex was bankrupt, and under investigation by the SEC.  It turns out that much of the company’s revenue was completely bogus.  And the SEC had satellite images to prove it…

I’m Michael McLaughlin, and this is Scheme.

The founding of Homex

Homex was founded in 1989 in Culiacan, Mexico.  It was just a small construction company back then, founded by 4 brothers from the de Nicolás family.  One of those brothers, Gerardo, would serve as the CEO for 20 years.  Gerardo led Homex through its period of explosive growth in the early 2000’s.

Homex’s growth phase

There are two main reasons that Homex was transformed from a small, family-owned construction company into a publicly-traded housing developer.  First, Vicente Fox was elected president of Mexico in 2000.  This was historic, because the presidency had been held by the members of the same political party for more than 70 years, ever since the Mexican Revolution.

Fox was elected by promising reforms; and after he took office, he took action.  Fox declared that all Mexicans should have access to affordable housing.  Rather than building your own house room-by-room over a period of years, Mexicans should be able to purchase a house on credit.  And this credit would come from a federal agency, Infonavit.  The Mexican government started providing thousands of loans through Infonavit, which led to increased demand for housing. Homex, along with several other companies, stepped in to meet the demand.

But Homex needed capital to build homes, and this leads to the second reason for Homex’s growth.  In 2002, the U.S. investor Sam Zell invested $32 million in Homex in exchange for 26.5% of the company.  Zell was a billionaire, and he had a private equity firm that invested in real estate in emerging markets.  Zell saw the Mexican government’s commitment to housing development as an opportunity to make lots of money.  Zell would later sell his shares and make a tidy profit, but not before he had taken the company public.  On June 29, 2004 Homex did an IPO and raised well over a hundred million dollars.

So what seems to be the problem? 

At this point, Homex had everything going for it: plenty of capital to build homes, and a government that loaned people money to buy those homes.  Homex spread to more cities across Mexico and dramatically increased the number of homes it was building.  It was held up as a great example of a public-private partnership.  Investors make money, and the affordable housing crisis gets solved.  Except it didn’t…

Many of the homes built by Homex had serious problems.  In some cases the land wasn’t properly graded, resulting in cracked sidewalks, walls, and floors.  Storms washed away some of the streets, and caused homes to collapse; some of the homes had been built on flood plains. There were rolling blackouts and sewage wasn’t being processed.  In some cases residents didn’t even have water, and Homex failed to provide schools it had promised.

These issues arose within just a couple years of Homex going public, but Homex blamed homeowners for failing to maintain their homes.  But the real problem was that Homex had a strong incentive to build houses, but no incentive to ensure that those homes were structurally sound or that the neighborhoods would have basic utilities.  Residents complained, and many of them simply abandoned their homes.  A report by the OECD in 2015 said that nearly half a million Homex homes were vacant.

But it gets worse for Homex…

The Mexican government changed its policy.  The president who succeeded Vicente Fox, Felipe Calderon, began steering government loans to urban housing instead of the suburbs.  Mexico’s next president, Enrique Peña Nieto, took office in 2012 and went a step further, declaring that almost all governmental loans would be directed to vertical housing in Mexico’s cities.

Homex said it could meet the demand for vertical housing, but its revenue fell precipitously in 2013.  The company was in shambles; the stock price had fallen from $69/share to $1/share in six years’ time.  Homex owed $2.5 billion in debt and had just $8 million of cash by 2014, so it declared bankruptcy.  The company’s fall from grace was sudden, with Homex having raised $400 million with a bond issuance just two years prior.

Homex blamed the change in government policy for its problems, and surely this played a significant role. But then just as Homex was emerging from bankruptcy in 2015, the SEC brought charges of fraud and things got really interesting…

Fake sales

According to the SEC, Homex had been lying to investors for years.  You might be thinking this is going to have something to do with the poor quality homes they had built, but people had been complaining about that as far back as 2004.  What came to light from the SEC’s investigation was something more sinister.

Homex had been recognizing revenue for homes it hadn’t even built.  That’s right; this is a case of bogus revenue.  Homex’s accounting policies stated that it didn’t recognize revenue until a home had been built and title had transferred to the buyer.  But the SEC said that Homex had recorded revenue for homes when it hadn’t even broken ground, or sold the homes.  And the SEC proved this using satellite images from Google Earth.

Photos of Homex’s best-selling housing developments showed empty patches of dirt.  For example, Homex reported that it had built and sold all of the planned homes for its Benevento development. But hundreds of these homes hadn’t been built, and Homex still recorded revenue anyway.  The SEC said Homex had overstated revenue by $3.3 billion from 2010 to 2012 alone and had faked the sale of more than 100,000 homes. 

The cover-up

You might be wondering how Homex got away with this for so long.  The executives completely made up sales over a period of several years.  Wouldn’t Homex’s receivables explode due to the fake sales?  Why didn’t Homex run out of cash, since its “sales” weren’t even real?  The Homex executives were aware of these issues, and they adopted countermeasures to avoid being caught.

First, they kept 2 sets of books. They literally had a spreadsheet with one part called “real sales” and another part called “accounting sales”.  No, I’m not making this up.  This allowed executives to track the company’s actual progress while reporting fake numbers.

Second, they recorded fake data for Cost of Goods Sold and inventory.  It might seem weird that they recorded fake expenses, but think about it: the auditor is going to get suspicious if you report sales revenue without reporting Cost of Goods Sold.  They had to pretend like it was an actual sale; they couldn’t just fake the revenue, they had to fake the corresponding expense.

Third, they had to do something about the growing receivables. They knew even an entry-level auditor would start asking questions if receivables grew a lot faster than sales.  Thus, they sold the fake receivables to banks.  This actually solved two problems: it prevented the receivables account from skyrocketing, and it generated cash.  This last part was critical, as you don’t get cash from fake home sales.  You can get cash from selling phony receivables, however, and that’s what Homex did.

How did the banks get fooled?

If you’re thinking, “Hey, won’t the banks realize what’s happening when they aren’t able to collect any of the receivables?”  Yes they absolutely would—except that Homex generated cash for them, by selling more fake homes and thus more fake receivables.  Thus, the “receivables” were more like short-term loans, which Homex paid by getting more short-term loans.  Homex did this with $7.7 billion in receivables using 13 Mexican banks, and the SEC called it a giant check-kiting scheme.

Thus, by faking the Cost of Goods Sold and selling phony receivables, Homex was able to stay afloat for a while. But it couldn’t keep the fraud going forever, and began defaulting on its debt payments.  This is what led to Homex filing for bankruptcy in April of 2014.

So why did this all happen?

You might be wondering, “why did this all happen?” and I’m wondering the same thing.  Here’s my theory.

Once Homex took money from outside investors and went public, there was tremendous pressure for the company to grow.  The company did grow, but at the expense of quality, which explains why the homes had so many defects.  Then when the Mexican government began steering loans toward a different type of housing, Homex wasn’t able to adjust, and its executives resorted to fraud.

They faked the sales so Homex could continue to raise money in bond issuances and sell fake receivables, which kept the company afloat (at least for a while) and delayed the firing of the executives.  In short, the company used the fraud to buy more time.  And the executives surely knew the walls were closing in on them toward the end, as the CEO Gerardo de Nicolás sold a lot of his Homex stock the year before Homex went bankrupt. 


Homex settled with the SEC in March of 2017.  It didn’t admit to doing anything wrong, but was banned from U.S. markets for 5 years.  Homex also had to pay a $1.2 million fine to the National Banking and Securities Commission in Mexico, which seems trivial given the losses of its investors.  Later that same year (October, 2017), the SEC charged Gerardo and 3 executives with fraud. Surprisingly, Homex managed to raise an additional $48 million from investors that same month.

It’s unlikely the executives will face any serious punishment. Gerardo is a Mexican citizen and isn’t likely to return to the United States.  Gerardo was fired, and his brother Eustaquio briefly become CEO.  A former executive at Banco Santander, José Alberto Baños López, took over Homex in 2017, but Eustaquio was still on the board as of 2019.

Homex reported that it was profitable in fiscal year 2019, and that its revenue had increased each of the past two years.  But I’m not sure I’d trust their financial statements. 


So how this happen?  What went wrong here?  In my opinion, 2 critical things allowed this fraud to take place.

First, there was an audit failure.  To be clear: the purpose of the external auditor is not to detect fraud.  However, the auditor is supposed to conduct tests to provide reasonable assurance that the financial statements are free from material misstatement.  For example, the auditor is supposed to test for the existence of inventory; in this case, the existence of the homes.  The auditor can’t verify that every single home was actually built and must rely on a sample, so there’s always a chance the auditor will be fooled by management.  But in this case there were so many fake homes, it’s shocking that the auditor didn’t discover this.

Second, people badly wanted to believe this would work; it was a great cause.  Who wouldn’t want to ensure that everyone in Mexico had access to affordable housing? Even the World Bank invested in Homex.  And the de Nicolás brothers were held up as successful entrepreneurs.  Everyone wanted to believe this was a success story, not a combination of dilapidated housing and fake sales

I hope that this fraud doesn’t make investors less likely to invest in Mexican firms.  I used to work in Mexico, and it’s a great place.  But the fact that Homex’s executives didn’t go to jail or face serious punishment sends a message that CEOs can get away with this type of behavior.

And that used to be the case in the U.S., prior to the Sarbanes-Oxley Act.  Several executives have since been sentenced to long prison terms in the U.S., and I’d like to think that’s had a deterrent effect with respect to accounting fraud.  But executives still play accounting games, in both the U.S. and in Mexico.  I guess death, taxes, and accounting scandals are inevitable.


Gorman, T. (2017, October 11). SEC files financial fraud action “caught on camera.” SEC Actions.
Guthrie, A. (2014, May 4). Mexican home builder Homex files for bankruptcy protection: Homex hopes to restructure, remain viable. The Wall Street Journal.
Guthrie, A., & Glazer, E. Mexican builder Homex reaches deal with creditors: bankruptcy filing in Mexico is imminent, creditors say. The Wall Street Journal.
Homex. (2019). Annual Report
Homex. (2020). Website
Marosi, R. (2017, November 26). The Homex story: A boom and a bust. Los Angeles Times.
Marosi, R. (2018, March 2). Mexico’s Homex faces accusations of a massive fraud from the SEC, but the case has stalled. Los Angeles Times.
U.S. Securities and Exchange Commission. (2016, May). Form 6-K
U.S. Securities and Exchange Commission. (2016, October). Form 6-K
U.S. Securities and Exchange Commission (2017). SEC charges Mexico-based homebuilder in $3.3 Billion accounting fraud.
U.S. Securities and Exchange Commission (2017). Securities and Exchange Commission vs. Desarrolladora Homex S.A.B. DE C.V.
U.S. Securities and Exchange Commission (2017). Litigation Release No. 23964
U.S. Securities and Exchange Commission (2017). Securities and Exchange Commission vs. Gerardo de Nicolás Gutiérrez, Carlos Javier Moctezuma Velasco, Ramón Lafarga Bátiz and Noe Corrales Reyes.
Whelan, R. (2017, March 3). Mexican home builder Homex settles SEC fraud charges: Homex overstated its revenue by roughly $3.3 billion, SEC says. The Wall Street Journal.

General info about Homex

“Homex’s equity securities were dually listed on the New York Stock Exchange (“NYSE”) and the Mexican Stock Exchange (“BMV”).”
“Homex exited from bankruptcy through a Court Judgment issued on July 3, 2015”
In 2013, Homex was the largest real estate development company in Mexico. But just one year later Homex was bankrupt, and under investigation by the SEC. In 2013, Homex was the largest real estate development company in Mexico. But just one year later Homex was bankrupt, and under investigation by the SEC. Michael McLaughlin Episode 1: Homex clean 12:14