Equity Funding Corporation of America

Equity Funding Corporation of America

UCLA Extension

INTRODUCTION..........................................................................................................................3

1. Equity Funding Corporation of America fraud……………………………...…...…………...…..3
2. How to prevent and detect corporate fraud applied to Equity Funding…….…………………….5
3. Importance of Communication skills...…..................................................................................….7
4. Electronic environment…………………………………………………………………………...9

CONCLUSION.............................................................................................................................10

References……….........................................................................................................................12

INTRODUCTION

I decided to pick up a company who I can apply all these questions to.

In 1960, Equity Funding Corporation of America (EFCA), a Los Angeles-based holding company, was founded by four people who considered equal partnership interests in the company. Two of the partners soon resigned, leaving the small company to Stanley Goldblum, who held the title of president, and Michael Riordan, who worked as chairman of the board. Equity Funding’s main business purpose was selling life insurance policies and “funding programs” that joined life insurance with mutual funds into one financial burden for investors. The trademark of Equity Funding during its existence was a development of creative financial investments.  Equity Funding went public in 1964 and quickly earned a nationwide reputation as one of the most innovative firms in the ultraconservative life insurance business.

  1. At the beginning of the history of the company, almost all of its income was received from commissions earned. EFCA's expenses were commissions paid to agents, the cost of managing a marketing organization, the cost of administering funded plans and interest on borrowed money. In the next years, the most significant part of the EFCA's operation was the sale of funded programs.

 The fraud story began in 1964 after Equity Funding hit against a deadline to complete and issue its annual report. The company's new mainframe computer couldn't provide the required numbers in time and Stanley Goldblum, who was the CEO of the company, asked to make fictitious accounting entries to the company's financial statements to meet the deadline.

Before 1971 employees began misrepresenting records to improve reported income and raise assets-presumably to maintain and encouraging the market for EFCA's securities. The falsification consisted of numerous factors; the two most important involved the recording of fictitious funded loans receivable, which seems to have occurred as early as 1964, and the recording of fictitious insurance policies, which started in 1969. After 1969, was used a different way of forging funded loans and commission income. This affected the record of false receivables meaning to reflect loans made to pay policy premiums and record a similar amount of fictitious commission income.

As stated above, the fraud at Equity Funding Corporation began as early as 1964, just a few years after the company was developed.

The falsification of funded loans receivable accounts and similar commission accounts was achieved simply. The general ledger accounts were falsified by making fictitious journal entries, and there was practically no effort to create any backup documentation. For instance, the subsidiary loan records were not misrepresented to agree with the general ledger control account; neither were memoranda collateral records provided to support the necessary rate of collateral to funded loans receivable.

In 1969, EFCA borrowed nearly $9.1 million through an international brokerage firm. The loan was not entered as a liability but was reported instead as a decrease of funded loans receivable. The committee was notified that the liability was not shown until the lender finally asked why the obligation did not appear on the borrowers' financial statements. In 1970 this liability was finally entered with an offsetting charge to a new asset account indicating to represent a loan receivable from Grandson. The net outcome of these records was to decrease funded loans receivable and create a new fictitious asset of a similar amount.

But I believe that the key element of this aspect of the fraud was Fictitious Insurance Policies. Goldblum and other workers of EFCA continued this fraud by creating false life insurance policies to generate revenue to back up these earlier false entries. The company later reinsured these fake policies with several other insurers and even falsified the deaths of some of these fictitious people.

The fraud ultimately reached enormous-sized balances, with tens of thousands of false insurance policies and almost $2 billion in fictitious revenues over a multi-year term. The huge number of employees were participating in this fraud or at least had an awareness of it.

In 1973, a disappointed ex-employee, who had been fired, reported the scheme to Ray Dirks, a Wall Street critic who covered the insurance business. Dirks did his own investigation and then reviewed the company with his clients, many of whom sold the stock before the fraud becoming public.

Another outstanding part of this case is that it led to the establishment of a new legal model concerning insider trading. After the fraud became public, the Securities and Exchange Commission (SEC) condemned Dirks for helping and participating in violations of the SEC of 1934 and Rule 10b-5, which forbid insider trading. Dirks fought out the blame through many appeals, all the way up to the Supreme Court in 1983. The court approved his clime saying that no violation happened because Dirks had no fiduciary duty to the shareholders of EFCA and did not abuse or illegally get the information.

The fraud at Equity Funding Corporation is viewed as the first computer-based fraud, as the production of false documents needed to back up the false policies became so "heavy" that the company began using computers to automate the fraud. During the later years accounting records, including general ledgers, of EFCA and its subsidiaries were prepared almost fully by using a computer. Nevertheless, the fraud was not based on a sophisticated form of data processing technology. The main falsifications were performed by manually making fictitious journal entries and posting them on the books of some Equity Funding companies. A large amount of administrative work would have been needed to create the supporting detail manually. Public described it as a "computer fraud." But it would be more proper to call it a "computer-assisted fraud." Mostly, the computer was used to manipulate data and generate detail designed to cover the fraud. Much of this work was conducted by employees from outside the Electronic data processing department who has access to computer hardware, software, and other data.